SLM Corporation

Moat: 1/5

Understandability: 3/5

Balance Sheet Health: 3/5

SLM Corporation is a consumer banking company that primarily provides loans to students and is focused on financing higher education.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Moat Analysis: 1/5 SLM Corporation, commonly known as Sallie Mae, lacks a significant economic moat. Its business is highly susceptible to competition and shifts in the regulatory and economic landscape. Here’s a detailed breakdown:

Lack of Intangible Assets: While Sallie Mae is a well-known brand in student loans, this alone doesn’t confer a pricing power advantage. The product they offer is essentially a commodity loan with limited brand differentiation.
Minimal Switching Costs: Student loan borrowers may switch lenders if they find more favorable rates or terms elsewhere, despite the effort involved, because the nature of student loans is to be repaid over a long period which amplifies small differences. There are no significant switching costs.
No Network Effect: Student lending isn’t a network business. The value of a loan doesn’t increase with the number of borrowers, as is the case in tech companies.
No Cost Advantage: While the firm has some scale in the education loan market, low-cost funding is also readily available to competitors, so they don’t have a special ability to be the lowest cost lender. Additionally, if they do enjoy some sort of cost advantages, this is offset by the relatively low quality of credit, meaning higher costs for loans in the long run and higher risk.

Risks to the Moat & Business Resilience

Regulatory Risk: The student loan industry is highly regulated, and changes in regulations could significantly affect Sallie Mae’s business. The company has faced scrutiny and legal pressure related to its lending practices and servicing models. In their 10-K, many regulations are mentioned and how they are affecting the business.
Credit Risk: Sallie Mae’s loans are exposed to credit risk because borrowers may default on their loans, especially if they are unable to get a job after graduation.

In the most recent report, management noted that “Our credit risk is primarily attributable to loans which are no longer eligible for federal government support as well as an unsecured debt. The performance and repayment of these loans is particularly sensitive to economic downturns, student employment rates, and changes in borrower behavior.”
Competition: The student loan market is highly competitive with numerous players and many alternative financing options. It may become very difficult to sustain any profit margins.
Economic Slowdowns: Slowing economic activity may increase job losses, and in turn, make it more difficult for borrowers to pay their student loans, increasing defaults on the loan book.
Changes in educational costs: If there is decline in education costs, it may also mean lesser demand for student loans and hence, lower revenues for SLM.
Technological Disruptions: New technologies could make certain aspects of the business model obsolete or less relevant (such as call centers).
Limited Pricing Power: The company has limited ability to increase its revenue through prices, because of regulatory oversight, and because of the low switching costs from the borrower side.

Business Overview

Revenue Distribution: SLM Corporation generates revenue primarily through student loans, but it also offers other financial products and services. Net interest income remains the main source of revenue at about 78% of total. The remaining revenues come from services (at about 18%) and other sources. As it can be seen, Sallie Mae is primarily a student loan business.

Management has said in their reports, that they are focused on “innovative solutions for students to achieve their academic goals. The first component of that is the private student loans that enable students to bridge the funding gap that federal loans don’t cover.”
Industry Trends: The higher education sector is undergoing changes such as increasing costs and a greater reliance on private financing, and student loan regulations are constantly changing and evolving.
Margins: Sallie Mae operates with quite attractive margins, with net operating margin of 38.5% on net interest income and 10.6% on non-interest income. However, the company struggles to make any significant profits.

Management mentions “The increase in our credit loss provision was driven by credit deterioration for loans in our private education portfolio, especially loans not eligible for federal backing. These loans are very sensitive to economic downturns and student employment rates.” in the risk section of their filings.
Competitive Landscape: Sallie Mae’s competitors in the private student loan market include banks, credit unions, and other financial institutions. As such, there is a wide array of alternatives for students to take student loans from.

Management has also pointed out that the “demand for private student loans is sensitive to shifts in college tuition rates, as well as availability and pricing of alternative sources of financial assistance for students.”

What Makes it Different?: The company is a large and well-known player in the student loan market, and provides for a whole suite of loans, from education loans to graduate loans.

Financials

Profitability: The company is barely profitable, given how much revenue they generate. They are spending large amounts of their resources and money to write off bad loans which are hampering profits. Also, their operating expenses are a bit high, considering the nature of their business.
Income Statement Analysis: Interest income is the main driver of revenues. However, expenses for provision for losses on credit lines remain quite high, negatively impacting operating profit. As such, even though the interest margin seems good, there is a significant loss once all other expenses are taken into account. Management has specifically mentioned that they are struggling with the higher loss rates for private education loans which are not government subsidized. They are trying to diversify their source of income as there is increased competition in their core business segment.

The management has noted, “While we have a relatively stable net interest income, we need to continue to improve non-interest income in order to drive higher net revenues.”
Balance Sheet: The company’s balance sheet is okay but not great. Debt of about $30 billion, as well as negative equity makes them sensitive to interest rate increases. Intangible assets are also a big portion of their asset book, leading to writeoffs which also may further decrease their assets.

Management notes in one of their financial reports, “Given the volatile operating environment and the significant financial transformation of the industry we were in, we’ve built capital to provide a margin of safety and increased the overall risk profile of our balance sheet by creating capital cushion.”

Cash Flows: The cash flows from operations are good, however, capex expenditures for a financial company like them is low, meaning they do not have much to spend cash on, and this could further impact profitability.

Understandability: 3/5 While the basic concept of SLM’s business is easy to understand—lending money to students—the complexities of the student loan market, including regulatory framework, risk assessment, and government loan involvement make the company’s financial model and operations fairly intricate.

Balance Sheet Health: 3/5 Sallie Mae has substantial debt, along with non-performing loans, and large loan provisions which lower their book value substantially. As such, their balance sheet is not terrible, but it is not great either, indicating moderate financial health and resilience.