Private Credit Partnership And Grad PLUS Reforms Will Reshape Long Term Earnings Power

Catalysts

About SLM

SLM focuses on private education lending and related fee-based services for students and families.

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

• The company is positioning itself as a key private lender as recent federal reforms change how students and families use government loan programs, which can support private loan demand and future revenue.
• Management expects a multiyear partnership in private credit that uses SLM's customer base and is intended to grow capital light fee-based revenues, which directly supports earnings with less balance sheet usage.
• The planned first of its kind funding partnership, including reclassifying a portion of existing loans as held for sale, is set up to create more consistent gain on sale economics and CECL reserve releases, which can support EPS.
• The company reports loan originations of US$2.9b in the quarter and focuses on maintaining a net interest margin in the low to mid 5% range, which can help sustain net interest income and overall revenue.
• Credit underwriting metrics such as a 756 average FICO score at approval, a 95% cosigner rate and private education loan net charge offs of 1.95% of loans in repayment support portfolio quality, which can benefit net margins and earnings stability.
• Management sees a future opportunity from Grad PLUS reforms that could add US$4b to US$5b of annual originations when fully phased in, which can have a direct impact on revenue growth and scale driven earnings.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more optimistic perspective on SLM compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts.
• The bullish analysts are assuming SLM's revenue will decrease by 1.9% annually over the next 3 years.
• The bullish analysts assume that profit margins will shrink from 44.0% today to 40.4% in 3 years time.
• The bullish analysts expect earnings to reach $636.1 million (and earnings per share of $4.14) by about July 2029, down from $732.9 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 11.3x on those 2029 earnings, up from 6.4x today. This future PE is greater than the current PE for the US Consumer Finance industry at 8.9x.
• The bullish analysts expect the number of shares outstanding to decline by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.48%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Private education lending is closely tied to the health of the job market for recent graduates and broader consumer credit conditions, so if early career unemployment for 20 to 24 year olds rises more meaningfully than it has so far, Sallie Mae could see higher early stage distress, more delinquencies transitioning into charge offs, and pressure on earnings and net margins.
• The current 4% delinquency rate on private education loans in repayment already sits above the 3.6% level a year ago, and management attributes roughly 25 basis points of that to changes in modification practices. If roll rates or late stage delinquencies start to worsen rather than remain flat, the through the cycle net charge off range of roughly high 1% to low 2% could prove optimistic and reduce future earnings and revenue from interest.
• The partnership driven, capital light model that relies on recurring loan sales and gain on sale economics introduces exposure to securitization and private credit market conditions. If spreads widen or demand for student loan assets weakens for a sustained period, gain on sale margins and associated CECL reserve releases may be less attractive, which would weigh on EPS and make revenue more volatile.
• The planned multiyear private credit partnership and the shift to designating more loans as held for sale depend on being able to consistently sell meaningful volumes at acceptable premiums. If the partner’s appetite or funding structure changes, Sallie Mae may have to retain more loans on balance sheet, which can raise capital needs and risk weighted assets and in turn constrain capital returns and pressure net interest income growth.
• Management is building its business plan around federal Grad PLUS reforms and has cited a possible US$4b to US$5b uplift in annual originations when fully phased in. If the regulatory rollout is delayed or altered, or if schools and borrowers adopt private loans more slowly than expected, the long term growth opportunity in originations and fee based revenue could be smaller, limiting potential upside to revenue and earnings.

Valuation

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

• The assumed bullish price target for SLM is $35.0, which represents up to two standard deviations above the consensus price target of $28.45. 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 bullish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $35.0, and the most bearish reporting a price target of just $23.0.
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2029, revenues will be $1.6 billion, earnings will come to $636.1 million, and it would be trading on a PE ratio of 11.3x, assuming you use a discount rate of 10.5%.
• Given the current share price of $24.73, the analyst price target of $35.0 is 29.3% higher. Despite analysts expecting the underlying business 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.