Sallie Mae (SLM) Beats Q2 Earnings Estimates on Higher NII

Clearing all skepticism, the new Sallie Mae (SLM) delivered a positive earnings surprise in its standalone financials for second-quarter 2014. Core earnings of 10 cents per share outpaced the Zacks Consensus Estimate by a penny. However, results compared unfavorably with 17 cents earned in the year-ago quarter.

Sallie Mae started operating independently as a consumer-banking company focused on offering private education loans, saving and insurance products for higher education to students and families following the separation of SLM Corporation into two distinct publicly-traded entities on Apr 30, 2014. The loan management, servicing and asset recovery businesses of SLM Corp. remained with the other public company – Navient Corp. (NAVI).

Sallie Mae’s second-quarter 2014 results included the impact of the split. The company stated that the transaction was treated as a reverse-spin for accounting purposes. Consequently, Sallie Mae’s historical financial statements and details of the education loan portfolio prior to Apr 30, 2014 include only those operations, assets, liabilities and equity of the consumer banking business.

Better-than-expected results were aided by increased net interest income, partially offset by higher expenses. A decent capital position and increased balance in private education loan portfolio were the positives.

Sallie Mae reported GAAP net income of $44 million or 9 cents per share compared with $76 million or 17 cents per share in the prior-year quarter. Notably, the company’s GAAP results for the year-ago period include gains on sales of loans. Excluding such gains, GAAP net income stood at $32 million in second-quarter 2013. GAAP results for second-quarter 2014 included $7 million of pre-tax losses from derivative accounting treatment, compared with pre-tax losses of $0.4 million in second-quarter 2013.

Core earnings (primarily adjusts for derivatives) for the quarter were $48 million compared with $77 million in the year-ago quarter.

Quarter in Detail

Net interest income ('NII') came in at $144 million, up 35% year over year. The increase was primarily due to higher average private education loans outstanding. Net interest margin ('NIM') increased to 5.08 % from 4.64 % in the prior-year period.

The company’s operating expenses rose 11.9% year over year to $75 million. The increase primarily reflects reorganization expenses of $14 million.

Private Education Loan Portfolio

As of Jun 30, 2014, the private education loan portfolio stood at $7.4 billion, up 40% year over year. Loan origination increased 3% year over year to $373 million. Average yield on the loan portfolio was 8.23%, up from 8.20% in the year-ago period. Provision for loan losses stood at $1 million, mainly due to a benefit of $14 million from a change to the loss confirmation period charge-off policy of the company owing to the spin off.

Deposits

As of Jun 30, 2014, deposits of Sallie Mae Bank stood at $9.5 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 Jun 30, 2014, Tier 1 leverage ratio and Tier 1 risk-based capital stood at 11.6% and 15.2%, respectively.

Outlook for 2014

For full-year 2014, Sallie Mae expects core earnings per share in the range of 41–43 cents, 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 the later part of 2014, the company expects private education loan sales of $1.2 billion and provision for private education loan losses of around $60 million.

Our Viewpoint

Despite the challenges, we believe that Sallie Mae’s leading position in the student lending market, efforts to diversify and increasing private student loan originations would help it to navigate well in the upcoming quarters. Also, specialized focus on solidifying its presence in the consumer banking business space will be advantageous to the company.

The economic recovery and declining unemployment rate should further enhance the prospects of consumer banking. We believe the new company should capitalize on these grounds.

Nevertheless, we remain cautious owing to several issues that the new entity is encountering. These include a competitive environment in the saturated banking space, absence of large scale benefits and the prevailing stringent regulatory landscape.

Sallie Mae currently carries a Zacks Rank #4 (Sell).

Performance of Other Companies in Finance – Consumer Loans Sector

Lower credit cost and growth in fee income drove Capital One Financial Corp.’s (COF) second-quarter 2014 earnings of $2.04 per share, which surpassed the Zacks Consensus Estimate by 14%. Further, the figure was up 10% from $1.85 earned in the prior-year quarter.

Discover Financial Services (DFS) managed to keep its surprise streak alive with the second quarter earnings, marking three straight quarters of earnings beat averaging 4.6%. Second-quarter 2014 earnings per share of $1.35 exceeded the Zacks Consensus Estimate of $1.30 per share and improved 13% from the year-ago quarter.

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