Will Moody’s Downgrade Sallie Mae?

Moody’s Investors Service said on Thursday that is thinking about downgrading the long-term ratings of the nation’s biggest student lender, SLM Corp. or Sallie Mae (SLM).

Previously, on May 13, Moody’s cut Sallie Mae’s ratings to junk, prompting the student loan provider to call the action “premature”. The expected action by the rating agency would affect Sallie Mae’s long-term Ba1 (non-investment grade) rating.

The agency is considering a possible downgrade as Sallie Mae faces significant uncertainties related to the political and consumer lending environment for student lenders. According to Moody’s, these issues could challenge the company’s liquidity and funding position as it nears large unsecured debt maturities in 2010 and particularly in 2011.

The agency also cited that cash flow generation is taking on greater importance in the lender’s credit profile because the firm’s unsecured debt balance exceeds its unencumbered earning assets.

Higher funding costs have added to the negative results for Sallie Mae for the last several quarters. However, we expect funding costs to come down slightly once the federally sponsored programs gather momentum.

However, one of the items in President Obama’s budget proposals for fiscal 2010 - the elimination of private lenders from the student-loan market and the shift of the entire system to direct governmental loans in order to eliminate uncertainty for students and save approximately more than $4 billion a year - is a major concern for Sallie Mae at this point as it will lose the bulk of its business, if the proposal is enacted. The expected action by Moody’s will further add to the negatives.

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