Boost In Credit Quality And Tactical Capital Returns Clashing With Revenue Declines And Analyst Concerns

Key Takeaways

• Enhanced credit and loan performance metrics hint at potential for higher net margins and stronger net income through improved credit quality and loss mitigation programs.
  
• Capital return strategies, including share repurchases fueled by loan sale gains, aim to boost earnings per share and optimize capital for further investments or shareholder returns.
  
• SLM's financial performance could be adversely affected by regulatory changes, market volatility, and shifts in loan origination trends.

Catalysts

Through its subsidiaries, originates and services private education loans to students and their families to finance the cost of their education in the United States.

• Continued improvements in credit quality with increased cosigner rates and higher average FICO scores may lead to reduced losses and higher credit performance, potentially boosting net margins through reduced provisions for credit losses.
  
• Enhanced credit performance, evidenced by lower net private education loan charge-offs and improved delinquency rates, suggests potential for reduced credit losses and stronger net income.
  
• A successful capital return strategy through share repurchases, driven by gains from loan sales, could enhance earnings per share by reducing shares outstanding.
  
• Loan sale activities generating significant gains indicate strong demand for the company’s loan portfolios, possibly leading to improved liquidity and further capital optimization for reinvestment or shareholder returns.
  
• Introduction and optimization of loss mitigation programs are expected to support borrowers and sustain healthy repayment behaviors, potentially leading to lower credit losses and improved profitability through better loan performance.

Assumptions

• Analysts are assuming SLM's revenue will decrease by -1.9% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 42.8% today to 36.3% in 3 years time.
• Analysts expect earnings to reach $576.9 million (and earnings per share of $3.32) by about October 2027, down from $721.1 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 10.0x on those 2027 earnings, up from 7.0x today. This future PE is about the same as the current PE for the US Consumer Finance industry at 10.0x.
• Analysts expect the number of shares outstanding to decline by 7.21% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.94%, as per the Simply Wall St company report.

Risks

• The delay in the FAFSA reforms rollout and its implications might lead to lower loan originations and associated revenue if the issues are not remedied in time, potentially impacting SLM's revenue growth.
  
• SLM's reliance on market conditions for loan sales might pose risks to their capital return strategy through share repurchases if market volatility affects the ability to execute sales at favorable prices, impacting shareholder returns.
  
• The change to a new loan level future default rate model for reserve calculations could result in unforeseen adjustments to credit loss provisions, potentially impacting net income if the model does not accurately predict future defaults.
  
• The tightening of eligibility for loss mitigation programs might lead to higher delinquencies or defaults if borrowers who marginally qualify for assistance do not receive the support they need, potentially increasing net charge-offs.
  
• If the trend toward more fixed-rate loan originations continues, and interest rates fall, SLM could face a mismatch in interest income, affecting net interest margins as the yield on the portfolio may not adjust as quickly as funding costs.

Valuation

• The analysts have a consensus price target of $26.5 for SLM based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $29.0, and the most bearish reporting a price target of just $23.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $1.6 billion, earnings will come to $576.9 million, and it would be trading on a PE ratio of 10.0x, assuming you use a discount rate of 7.9%.
• Given the current share price of $23.18, the analyst's price target of $26.5 is 12.5% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• 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.