December 30, 2014 Sallie Mae (SLM-NASDAQ) Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Outperform Date of Last Change 01/08/2013 Current Price (12/29/14) $10.32 Target Price $11.00 52-Week High $27.24 52-Week Low $8.23 One-Year Return (%) -60.43 Beta 1.27 Average Daily Volume (sh) 3,803,308 Shares Outstanding (mil) 423 Market Capitalization ($mil) $4,365 Short Interest Ratio (days) 2.97 Institutional Ownership (%) 95 Insider Ownership (%) 1 SUMMARY Sallie Mae s third-quarter 2014 earnings came in line with the Zacks Consensus Estimate. Results reflected increased net interest income, a strong capital position and improved balance in the private education loan portfolio. However, higher expenses were on the downside. The company started operating independently, focused on consumer-banking following the split of SLM Corporation into two distinct publicly-traded entities in Apr 2014. We believe that Sallie Mae s leading position in the student lending market and increasing private student loan originations will help it navigate well in the upcoming quarters. Nevertheless, we remain cautious owing to the tough competition and stringent regulations in the consumer banking space. Risk Level * Low, Type of Stock Large-Blend Industry Fin-Cons Loans Zacks Industry Rank * 171 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) Annual Cash Dividend $0.00 Dividend Yield (%) 0.00 5-Yr. Historical Growth Rates Sales (%) -3.6 Earnings Per Share (%) 12.3 Dividend (%) 17.1 using TTM EPS N/A using 2014 Estimate 24.0 using 2015 Estimate 16.9 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page 2012 1,367 A 1,602 A 1,457 A 1,680 A 6,106 A 2013 1,643 A 1,827 A 1,409 A 1,409 A 6,288 A 2014 936 A 152 A 144 A 148 E 570 E 2015 636 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2012 $0.54 A $0.49 A $0.58 A $0.55 A $2.16 A 2013 $0.61 A $1.01 A $0.60 A $0.61 A $2.83 A 2014 $0.51 A $0.10 A $0.17 A $0.06 E $0.43 E 2015 $0.61 E Projected EPS Growth - Next 5 Years % Note: Revenue and EPS figures till first-quarter 2014 are not adjusted for the split. So full-year 2014 estimates do not add to the quarterly data. 2014 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606 N/A
OVERVIEW Following the separation of SLM Corporation into two distinct publicly-traded entities on Apr 30, 2014, Sallie Mae (SLM) started operating independently as a consumer-banking focused company. The loan management, servicing and asset recovery businesses of SLM Corporation remained with the other public company Navient Corporation (NAVI). Sallie Mae is now part of the S&P MidCap 400 index owing to its decreased size. Based in Newark, DE, Sallie Mae is a bellwether in education finance in the U.S. Prior to the split the company provided funding, delivery and servicing support for education loans in the U.S. through its nonfederally guaranteed Private Education Loan (PEL) programs and as a servicer and collector of loans for the U.S. Department of Education (DOE). In addition, the company was the largest holder, servicer and collector of loans made under the Federal Family Education Loan Program (FFELP). However, the program was discontinued following a legislation by the Congress in 2010, pursuant to the Health Care and Education Reconciliation Act of 2010 (HCERA). Precisely, this legislation effectively removed federal subsidy to the company. Further, defaulting student loans in the face of persistent unemployment and a sluggish economy, fueled the disappointing scenario. This has led Sallie Mae s board of directors to take the decision to split it into 2 distinct publicly traded companies. Consumer Banking Business The new entity Sallie Mae continues to operate the consumer banking business of the former company, focused on catering to private education loans, and providing saving and insurance products for higher education to students and families. The company will also operate Upromise, Inc. a leading saving-forcollege company that the former company acquired in 2006. Sallie Mae Bank a subsidiary of Sallie Mae will continue to originate private education loan. Chartered in 2005, Sallie Mae Bank is a Utah industrial bank. It is regulated by the Utah Department of Financial Institutions (UDFI) and the Federal Deposit Insurance Corporation (FDIC). Currently, the company s private education loan portfolio is worth around $6.5 billion. Sallie Mae s private student loans are offered to graduate students, under graduate students and families with K-12 school children. Apart from this, the company is engaged in servicing private student loans. Its portfolio of banking products includes money market, high-yield savings account and certificate of deposits. The Insurance products include tuition refund, auto, term life and health insurance. Credit cards, Upromise rewards and scholarships plan for college are among other products and services. The company s source of funding for its Private Education Loan originations are term and liquid brokered and retail deposits raised by the bank. Going forward, the company expects additional funding, liquidity and revenue through sale or securitization of loan assets, which it originates as well as the servicing of the loan assets that are sold to third parties. As of Sep 30, 2014, Sallie Mae had total assets of $11.7 billion, $7.8 billion in Private Education Loans, $1.3 billion of FFELP loans and total deposits of $9.2 billion. Equity Research SLM Page 2
REASONS TO BUY REASONS TO SELL Following the strategic separation, Sallie Mae is now being able to primarily focus on the growing consumer banking business. The economic recovery and declining unemployment rate should further enhance the prospects of consumer banking. So the specialized focus in that space will be advantageous to Sallie Mae. Sallie Mae is the dominant player in every phase of the student loan life cycle, providing the continuing competitive advantage of scale. The company is a leader in education finance, with a significant market share. Its operations are more dependent on students demand for educational loans, which is expected to be fairly strong in the foreseeable future. According to the data from the National Center for Education Statistics U.S. Department of Education, college enrollment is projected to increase 12% from 2012 to 2021. Therefore, the demand for education credit is also expected to rise. This expectation, combined with increasing tuition costs, should drive solid growth for Sallie Mae in the upcoming years. Following the spin off, Sallie Mae is relieved from much of the legacy legal overhangs of the former company. Except from the fines and penalties directly imposed on Sallie Mae Bank, Navient Corporation stands liable for the fulfillment of all the obligations arising out of the Federal Deposit Insurance Corporation (FDIC) and the Department of Justice (DOJ) issues. Sallie Mae is currently making progress in the five important objectives set this year. The company aims to enhance Private Education Loan assets and revenues, maintain a strong capital position and complete the process to independently originate and service Private Education Loans. Further, it is focused on expansion of the bank's scope in improving risk management and internal controls along with expense management to enhance efficiency. In this context, during third-quarter 2014, the company originated $1.6 billion of new loans, an increase of 8% year over year. Also it remains focused to achieve the 2014 target of $4 billion in originations. In October, Sallie Mae completed the operational separation of its servicing platforms and personnel from Navient and introduced new customer service operation. Further, it expects to establish the Sallie Mae Bank s independent loan originations platform in the first half of 2015. We believe the gradual achievement of these goals will increase growth prospects of the company. The new entity will face huge competition in the saturated banking space as it does not have significant experience in the consumer banking arena. Also, due to the split, the size of the balance sheet has reduced significantly, so the large scale benefits will not be there. We remain cautious owing to the current stringent regulatory landscape. In pursuant to the U.S. Basel III final rule issued in Jul 2013 by the federal banking regulators, Sallie Mae Bank will have to meet higher risk-based capital requirements and higher leverage requirements starting Jan 1, 2015. Further, a capital conservation buffer will be phased in over four years commencing on Jan 1, 2016. Such requirements may limit the company s allocation of capital in other strategic ventures. Currently, the company s source of funding for its Private Education Loan originations are term and liquid brokered along with retail deposits raised by the bank. However, such funding poses refinancing risk as the average term of the deposits is shorter than the expected term of the education loans originated by the company. Further, concentration risk arises from the company s over dependence on brokered deposits as a major source of funding. To ease the matter, the Equity Research SLM Page 3
RECENT NEWS company needs to generate deposit from non-brokered channels, which will require significant time. Sallie Mae Meets Q3 Earnings Estimates Oct 22, 2014 Sallie Mae s core earnings of $0.17 per share for third-quarter 2014 came in line with the Zacks Consensus Estimate. However, results compared favorably with $0.11 per share earned in the year-ago quarter. Results reflect increased net interest income, partially offset by higher expenses. A decent capital position, rise in loan originations and increased balance in the private education loan portfolio were the positives. Core earnings (primarily adjusts for derivatives) for the quarter were $79 million, up from $49 million in the year-ago quarter. Sallie Mae reported GAAP net income of $83 million or $0.18 per share compared with $49 million or $0.11 per share in the prior-year quarter. Quarter in Detail Net interest income (NII) came in at $144 million, up 23% year over year. The increase was primarily due to higher average private education loans outstanding. Net interest margin ('NIM') increased to 5.25% from 5.14% in the prior-year period. The company s operating expenses rose 24.4% year over year to $87 million. The increase primarily reflects reorganization expenses of $14 million. Private Education Loan Portfolio As of Sep 30, 2014, the private education loan portfolio stood at $7.8 billion, up 26% year over year. Loan origination increased 8% year over year to $1.6 billion. Average yield on the loan portfolio was 8.20%, down from 8.22% in the year-ago period. Provision for loan losses stood at $15 million, down from $19 million. Deposits As of Sep 30, 2014, deposits of Sallie Mae Bank stood at $9.7 billion, up from $9.3 billion as of Dec 31, 2013. Increase in money market accounts contributed to the rise in deposits. Capital Position Sallie Mae Bank reported a strong capital position. As of Sep 30, 2014, Tier 1 leverage ratio and Tier 1 risk-based capital stood at 12.3% and 15.7%, respectively. Capital ratios exceeded the well capitalized regulatory requirements. Outlook for 2014 Sallie Mae provided an updated guidance for 2014. Equity Research SLM Page 4
For full-year 2014, the company expects core earnings per share in the range of $0.42 0.43, while operating expenses to be $312 million, including restructuring expenses of $32 million. Private education loan originations are projected to be $4 billion for the year. For fourth-quarter 2014, the company expects provision for private education loan losses to be around $35 million. Sallie Mae Closes Asset-Backed Securitization Aug 8, 2014 Sallie Mae announced that it has completed its first asset-backed securitization as a standalone consumer banking business and entered into a deal for its first loan sale. Sallie Mae s off-balance sheet securitization included around $380 million of Smart Option Student Loans that were privately placed with a single, third-party investment manager. In line with its new business model, Sallie Mae inked an agreement to sell around $820 million of Smart Option Student Loans to Navient. Equity Research SLM Page 5
VALUATION On a price-to-earnings () basis, Sallie Mae s shares trade at 24.0x the Zacks Consensus Estimate for 2014, which is at a 98.3% premium to the industry average of 12.1x. On a price-to-book (P/B) basis, the shares currently trade at 3.3x, which is at a 65.0% premium to the industry average of 2.0x. Our 6-month target price of $11.00 equates to 25.6x the Zacks Consensus Estimate for 2014 and implies an expected return of about 6.6% over that period. This is consistent with our long-term Neutral recommendation on the shares. Currently, Sallie Mae carries a Zacks Rank #3 (Hold). Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Sallie Mae (SLM) 24.0 16.9 N/A 3.4 N/A 12.0 3.1 Industry Average 12.1 13.1 9.7 17.0 12.9 37.0 8.4 S&P 500 17.8 16.6 10.7 16.1 19.2 19.6 12.0 Santander Consumer USA Holdings Inc. (SC) 8.9 8.5 10.7 NA NA NA NA Navient Corporation (NAVI) 10.7 10.0-5.0 NA NA NA NA Springleaf Holdings, LLC (LEAF) 18.0 15.9 10.7 29.4 18.8 20.4 10.7 Cash America International, Inc. (CSH) 5.7 18.9 5.0 3.1 4.8 14.0 5.2 TTM is trailing 12 months; F1 is 2014 and F2 is 2015, CF is operating cash flow P/B Last Qtr. P/B P/B ROE D/E Div Yield 5-Yr High 5-Yr Low Last Qtr. Last Qtr. Sallie Mae (SLM) 3.3 3.3 0.7 20.1 0.0 0.0 1.3 EV/EBITDA Industry Average 2.0 2.0 2.0 15.2 3.6 0.4 41.7 S&P 500 7.2 9.8 3.2 23.3 NA 1.9 NA Equity Research SLM Page 6
Earnings Surprise and Estimate Revision History Equity Research SLM Page 7
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of SLM. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1141 companies covered: Outperform - 15.8%, Neutral - 78.2%, Underperform 5.7%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Coverage Team QCA Lead Analyst Analyst Copy Editor Content Ed. 11B Kalyan Nandy Priti Dhanuka Anindita Chaudhury Ishani Mukherjee Priti Dhanuka Equity Research SLM Page 8