Notable Calls

JP Morgan is upgrading SLM Corp (NYSE:SLM) on a long-term view that its transition to primarily a loan servicer, as opposed to a lender, will lower interest rate and funding risks, thus improving earnings visibility. Firm emphasizes they are taking a longer view on this call, but with the successful inception of Straight-A funding greatly improving the liquidity profile and the recent award of the ED servicing contract, they think SLM is currently trading at about 50% of their conservative DCF estimate of $15. As such, they are upgrading the stock to OW (a 6 to 12-month rating), and setting a YE09 price target of $12, a 20% discount to our estimated DCF value.

FFEL portfolio run-off alone worth $7.60/share. SLM's $140B+ FFEL book is already in run-off, as SLM is expected to sell its ECASLA loans to ED this year and next, and FDLP should become the sole provider of federal student loans beginning in the '10/'11 academic year. Discounting cash flows at 6% with est. 100bps net margin, JP Morgan values this portfolio to be worth $7.60 per share.

Estimate servicing business worth at least another $7.50/share. Firm assumes SLM will capture 30% of total loan volume, which they believe is conservative given the company is the largest of the four servicers selected. Based on their estimate of 25bps of servicing fee with 12bps of servicing expense, they model this business will produce a 50% gross margin.

Expect CP/Libor spread, private loan losses to drag on earnings near term. Firm models CP/Libor tightens to -15bps in 3Q09 from -23bps today, but still wider than the -10bps that was standard historically. In addition, although traditional private loan losses have held up well so far in this credit cycle, they believe fewer employment opportunities for recent grads will lead to credit pressure. JP Morgan has thus lowered their FY09 EPS est. to $0.68 and FY10 to $1.00.

With many key questions answered, stock looks cheap. JP Morgan notes their initial concern with SLM was liquidity and normalized interest expense; the commencement of Straight- A funding and renewal of the ABCP facility has improved visibility on that topic. Firm had also expected the recent ED servicing contract to encompass just ECASLA's two years of loans, but were positively surprised to see it also applies to FDLP loans going forward. With the future of SLM’s business model now more certain, they find shares are cheap, trading at 55% of sum-of-the-parts valuation.

Notablecalls: I´m sure Reverend Jim Bob Cramer will use this upgrade as an opportunity to pump SLM on TV.

Seriously speaking, I think the call will create some buying interest in the name. The stock is likely to trade in the $8.50-$9.00 range today or in the coming days.