Private Credit Partnership And Capital Return Strategy Will Increase Long Term Earnings And Risk

Catalysts

About SLM

SLM operates as a leading U.S. private education lender focused on originating, servicing, and selling student loans and related products.

What are the underlying business or industry changes driving this perspective?

• The planned multiyear private credit partnership, which shifts a larger share of production to held for sale status, could erode stable, spread based net interest income if loan sale volumes grow faster than retained balances. This may constrain long term earnings visibility.
• Heavy reliance on federal PLUS reforms to expand originations in the $4 billion to $5 billion range may encourage management to prioritize volume over risk discipline. This could lift delinquency and net charge-offs over time and pressure net margins.
• Ongoing use of loan modification programs and tighter forbearance policies, while stabilizing late stage metrics today, risks masking emerging stress in early cohorts. This could result in a step up in future credit losses and weaker bottom line performance.
• Increasing exposure to graduate lending as Grad PLUS is scaled back may concentrate risk in a segment that is sensitive to labor market softness for recent graduates. This may raise the probability of higher loss content and compress return on equity.
• The strategy of aggressive capital return via buybacks combined with modest balance sheet growth, in the face of potentially volatile gain on sale economics and ABS spread cycles, could leave limited capital flexibility to absorb adverse credit or funding shocks. This may amplify downside risk to earnings.

Assumptions

This narrative explores a more pessimistic perspective on SLM compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming SLM's revenue will grow by 4.3% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 41.6% today to 33.4% in 3 years time.
• The bearish analysts expect earnings to reach $554.0 million (and earnings per share of $2.98) by about December 2028, down from $606.9 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $815.1 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 10.8x on those 2028 earnings, up from 9.0x today. This future PE is greater than the current PE for the US Consumer Finance industry at 9.5x.
• The bearish analysts expect the number of shares outstanding to decline by 3.51% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.85%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Private student lending demand may structurally increase as federal PLUS reforms phase in, with management estimating a potential four billion to five billion uplift in annual originations. This could support higher long run revenue and earnings than currently assumed.
• The company continues to demonstrate disciplined underwriting, with rising average FICO scores, a higher cosigner rate and improving credit performance over several years. This could sustain strong net interest margins and protect net income from severe credit deterioration.
• Stability in late stage delinquencies, roll rates and net charge offs in the high one percent to low two percent range, supported by effective loan modification and loss mitigation programs, suggests credit losses may remain manageable and preserve earnings power over the cycle.
• The planned multiyear private credit partnership and ongoing loan sales, which have historically generated mid to high single digit gain on sale margins, could build a recurring, capital light fee based revenue stream that supports valuation multiples and long term earnings growth.
• Management’s consistent execution of sizable share repurchases, reducing the share count by fifty five percent since 2020, combined with solid capital ratios and liquidity, may amplify earnings per share growth and shareholder returns even if headline earnings grow modestly.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for SLM is $24.17, which represents up to two standard deviations below the consensus price target of $31.91. This valuation is based on what can be assumed as the expectations of SLM's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $37.0, and the most bearish reporting a price target of just $23.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $1.7 billion, earnings will come to $554.0 million, and it would be trading on a PE ratio of 10.8x, assuming you use a discount rate of 10.8%.
  
• Given the current share price of $26.89, the analyst price target of $24.17 is 11.3% lower.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.