The corporate ratings of student lender SLM Corp. or Sallie Mae (SLM) was downgraded by Fitch Ratings yesterday. The outlook assigned was negative. The ratings downgrade reflects the agency’s concern about the company’s business model. Fitch expects the company to continue to shift to a fee-for-service business model with its subsidiary Sallie Mae Bank originating higher-risk private education loans.

Fitch downgraded the long-term issuer default and senior debt ratings to “BBB-” from “BBB”, while preferred stock was downgraded to “BB” from “BB+”. The short-term issuer default rating and short-term debt ratings were affirmed at “F3″. About $34.4 billion of debt and preferred stock is affected by these actions.

To restore the $92 billion student loan market, the House Education committee approved a legislation, which closes the Federal Family Education Loan Program and shifts most of the student lending into the Education Department’s Direct Loan program.

The bill is expected to go the House for a vote this week. If enacted, Sallie Mae is expected to be a major participant in the Department of Education’s servicing contract under which it will service and collect government guaranteed loans. Though the bill would allow some of the private firms to remain in the market as loan servicers, this business line would however be much smaller compared to that of loan originations.

The servicing contracts are also subject to renewal in five years and the federal government has the discretion regarding the distribution of the contracts and the servicing volume. Hence, any improper distributions of the servicing contracts will weaken the company’s profitability.

Sallie Mae’s management expects credit losses to pile up in the third quarter as non-traditional loans and loans without a co-borrower account for a lower percentage of loans entering repayment. Also, near-term asset quality trends remain a matter of concern.

Besides Sallie Mae, the other companies whose businesses could be at risk under the new legislation are Student Loan Corp. (STU), Nelnet Inc. (NNI), ITT Educational Services (ESI), SunTrust Banks (STI) and Corinthian Colleges Inc. (COCO).

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