Financial stocks shot higher than the rest of the market Thursday on the power of positive analyst research as well as a red-hot recovery at

Sallie Mae

(SLM) - Get Report

.

As relayed shortly before Wednesday's close in a Sallie press release, the J.C. Flowers-led investor group that agreed to

buy the education lender in April said it didn't expect to close the $25 billion deal in light of a congressional bill -- signed into law this morning by George Bush -- that will cut education-lending subsidies. Sallie estimated that "core earnings" will recede by 1.8% to 2.1% annually over the next five years as a result of the legislation.

Sallie vowed to "pursue all remedies available to it to the fullest extent permitted by law," saying that the group -- which also includes

Bank of America

(BAC) - Get Report

and

JPMorgan Chase

(JPM) - Get Report

-- "has no contractual basis to repudiate its obligations under the merger agreement." But the group said in a statement that they informed Sallie they're "open to discussing a revision of the transaction that reflects this new

legislative and economic environment."

Sallie shares vaulted 8.3% to $48.76 in heavier-than-usual action, more than recovering from yesterday's

furiously traded drop. That helped lift the

NYSE

Financial Sector Index, which gained 0.8% at 9,277.81 to sharply outperform the broad indices. Fellow members BofA and J.P. Morgan were both off marginally in recent trading.

In garden-variety M&A news, meanwhile,

Washington Banking

(WBCO)

soared 32.4% after

Frontier Financial

( FTBK) agreed to buy it out for around $21.40 a share, or $191.1 million, in cash and stock. The transaction should close in the first quarter. Shares of Washington, the parent of Whidbey Island Bank, were up $4.95 to $20.25. Frontier slipped 0.6% to $23.76.

Investment Technology Group

(ITG)

traded higher on word investment firm D.E. Shaw had snapped up about another 966,000 shares of the online broker for a 9.9% stake as of Sept. 21, vs. the prior 7.7% interest. Shares of the New York company gained 98 cents, or 2.4%, to $41.91.

In brokerage calls,

KKR Financial

(KFN)

climbed 3.1% to $16.95 after Bear Stearns upped the specialty-finance firm to outperform, partially citing the nearly $1 billion cash pile it has raised this summer.

And Bernstein began coverage of

Capital One

(COF) - Get Report

with an outperform rating, saying that the credit-card issuer trades cheaply compared to other banks even though it has expanded significantly into the banking sector. Shares tacked on 1.6% to $67.16 in support of the KBW Bank Index, which recently gained 0.3% at 106.61 to hold in line with the major indices.

On the flip side, New York's

Signature Bank

(SBNY) - Get Report

fell 2.5% on a Sterne Agee downgrade to hold from buy. Shares were off 91 cents to $35.39.

Among the other scarce financial losers today, student lender

First Marblehead

(FMD)

lost 4% to $37.93; mortgage lender

Thornburg Mortgage

( TMA) sank 2.3% to $12.25; and insurer

Conseco

(CNO) - Get Report

gave up 1% at $15.56.