SLM Corp (SLM) 2014 Q4 法說會逐字稿

Good morning. My name is Angel and I will be your conference operator today. At this time I would like to welcome everyone to the 2014 Q4 Sallie Mae earnings call.

(Operator Instructions)

Thank you. I would now like to turn the call over to our host, Mr. Brian Cronin, Senior Director of Investor Relations. Sir, you may begin your conference.

Thank you, Angel. Good morning and welcome to Sallie Mae's 2014 forth-quarter earnings call. With me today is Ray Quinlan, our CEO, and Steve McGarry, our CFO. After the prepared remarks we will open up the call for questions.

Before we begin, keep in mind our discussions will contain predictions, expectations, and forward-looking statements. Actual results in the future may be materially different from those discussed here. This could be due to a variety of factors. Listeners should refer to the discussion of these factors on the Company's Form 10-Q and other filings with the SEC.

During this call we will refer to non-GAAP measures we call core earnings. A description of core earnings, a full reconciliation to GAAP measures and our GAAP results can be found in the fourth-quarter 2014 supplemental earnings disclosure. This is posted along with the earnings press release on the investors' page at salliemae.com.

Thank you. And I'll now turn the call over to Ray.

Thanks, Brian. And good morning and thank you all for calling and attending our session. As I start the meeting, I'd like to discuss some of the results in 2014 first, and then as we pivot into 2015, we'll talk about the outlook there, and then of course we can engage in a discussion of Q&A.

2014 was a very good year for our Company. We concentrated on six items in particular. And they were -- the spin from the prior company; building the team; putting in place the financials and the good results for our shareholders; the regulatory environment as the Bank entered 2014 with a cease-and-assist order on it, and there was a consent order right before the spin, and of course those things had to be addressed; the future; and then any other opportunities.

In regard to the spin, we have been fabulously successful. We had legal day one successfully executed on May 1 of 2014. As you know, we then entertained -- obtained an independent company, we've had our first quarter of earnings in the second quarter, and the third quarter went well, and we are now in the forth quarter.

The team which was an almost entirely new team, certainly a new org structure, at the Bank has been put in place. We established the position of CRO. We've recruited high-quality talent throughout. And we are now completed on that path.

In our financials, we, of course, were concerned that while we were doing the spin and we were distracted to some extent with all of the corporate activity, that we might suffer in regard to our position in the marketplace. We are happy to report that after giving $4 billion of origination guidance throughout the year we ended the year at $4.1 billion.

We naturally wanted to ensure that the quality of our new customers was equal to or better than the quality of the pre-existing customers. In fact that happened.

We naturally wanted to ensure that we maintained credible and healthy spreads. We'll talk a little bit later that is certainly the case.

Very concerned about the credit performance. We will talk about that at length in this call but we are exactly where we want to be on that. And of course we wanted to manage our operating expenses which we will also expand on.

In regard to the regulatory environment, we've had a very good year. The cease-and-desist order that was on the Bank for six years was lifted in June of this year. We are in compliance with all of the mandates associated with the consent order.

We have shared our three year plan with our regulator, our primary regulator, the FDIC, along with the UDFI folks in Utah. And we are in very good working partnership with all of our regulators.

In regard to the future, the future is bright for us. We can now turn from a year of distraction and we can focus entirely on building our consumer franchise. And that will be something you will hear about from us on a consistent basis as we go forward.

In regard to those results. We did hit $4.1 billion of origination. That carried with it the consequence that we were able to, despite all of our distractions, increase our market share by an estimated 1 to 2 percentage points, which was a terrific performance on the part of our sales and marketing organization.

As you know, we have provided guidance that $4.1 billion of originations this year will increase to $4.3 billion next year. And, so, we are right on the trend that we had always discussed with all regulators as well as investors, reflecting approximately a 5% growth in that particular variable.

We're gratified that the quality of our new customers is, in fact, as measured by independent indicators such as the FICO score, higher quality than what we had experienced heretofore, with an average FICO of 748, and we maintain a consistent 90% co-sign.

Our yield in the quarter and the year of 8.07% and our NIM of 5.01% bodes steady. And as we think about those going into the future we do believe that they will continue to be steady at those levels.

Our credit losses were right on track to where we wanted to be in 2014 as the portfolio grows rapidly. And we will talk about the dynamics associated with that. That number, the loan loss reserves will increase proportionately in 2015 but this is a consequence of the rapid growth and maturation of the portfolio, along with the attendant dynamics that in all consumer portfolios, credit losses associated with a particular vintage are concentrated in the early years, specifically years one and two.

Our operating expenses, as we look forward, it is the case that if we take the fourth quarter operating expenses, which reflects our true operating base, and we were to use that as a run rate, and to glance into 2015 based upon what we are thinking about so far as revenues, that our marginal efficiency ratio is 22%, an astounding number and reflecting the leverage that we had discussed with many audiences and which we fully expect to realize.

Our taxes are aberrantly high in the fourth quarter. Steve will explain that in detail. We believe that to be a one-time event and we believe that we will return to approximately the 40% range, as is normal for American companies.

Guidance for EPS in 2014 was $0.42 to $0.43. We hit $0.42 so we are right on the button in regards to that. We are giving guidance of $0.48 to $0.50 for 2015 and that's based on the $0.42, moving to $0.48 to $0.50. It is, of course, 14% to 19% range. We can say casually 15% to 20% range, consistent with discussions that we have had with many audiences.

Let me talk about the portfolio. The private student lending portfolio that we manage and/or own was, in the third quarter of 2013, approximately $5 billion. And as we know, it ended this year, 2014 that is, at about $8.2 billion.

At that run rate, by the second quarter of 2015, the portfolio of $5 billion in the third quarter of 2013, by the second quarter of 2015 will be $10 billion. So, we will have a doubling of the portfolio that we're servicing and which is the driver for our revenue as well as our costs and losses doubling in less than two years.

On the trend rate that we have talked about, if that were to continue, and we expect it might, by the third quarter of 2016 that portfolio will be approximately $15 billion. So, from 3Q 2013 to 3Q 2015, a doubling; from 3Q 2013 to 3Q 2016 a tripling. So, we have a portfolio that's up 3X.

Over that period of time, what happens is students, as you know, have a choice with us to either make the minimum payment of $25 a month whilst in school, to pay the interest, or to defer payments until full P&I manages to come about, about six months after graduation. 57% of our new customers choose some payment option in school.

As people come into full P&I, it is the case that the loan, as everyone knows, is a seven-year term. And during those first two years, based upon our models, we experience 55% of the losses attendant to a vintage.

So in the first two years, two of seven years goes by, 28%. In the first two years we experience 55% of the losses to the vintage's entire life. And so the ratio of time or of losses to time is 2X during that period.

As we layer on new vintages from that 3Q of 2013, through 2014, through 2015 and into 2016, we will have no change in our credit modeling, no change in our expectation that we will experience an actuarial 1% loss rate per year for the seven years and accum rate of 7%. And it will be the case that the experience that we have so far as the accelerated weighted average associated with the maturation of the portfolio will be 100% consistent with our prior model.

So, what we have here is a rapidly growing portfolio, a disproportionate amount of it in the less than two years full P& I period, and acceleration or escalation in losses attendant to that, so 100% consistent with our modeling. It's also the case, as I said, that our NIM should be steady as we go through the year, and that efficiency ratio at 22% is prima facie evidence of the fact that we now have reached a particular level of efficiency. As has been communicated in many arenas, we believe that when the portfolio gets to about that $15 billion that we in fact will have a plateau of economies of scale.

In conclusion, 2014 was a great year. We have a strong market position. We have great opportunity and have realized great actuals in regard to growth in our top line. We have high credit quality and we have a 5% NIM.

We have good leverage, as I said. We are on target in regard to growth, in regard to credit losses and in regard to EPS.

As we enter 2015 it will be our first year of just about 100% pre-spin. We have, as everyone knows, a little bit of work to do in the first half of the year in order to finish up completely but it's minimal. Second is we continue to grow our EPS in that 15% to 20% range. The third is the portfolio will continue to mature through 2015 and 2016.

Once we hit that $15 billion, however, we believe that we will be much closer to steady state in all variables. The leverage will be seen in the results. We will be concentrating on our customer franchise. And of course we will maintain our strong capital position and our strong funding position.

One item that stands out as a standalone is our gain on sale. We're happy in 2014 to be able to complete an independent sale of over $1 billion at 7.5%. We have in our thinking that we would sell $1.5 billion in 2015. We are forecasting that to be at 7.5%.

Many observers have thought that we could do better than that. We are trying to be conservative, both on the amount as well as on the proportion of premium. And Steve can talk about that in greater detail.

So with that, I will turn over the table to Steve.

Thank you very much, Ray. And good morning, everybody. I'll be referencing the earnings call presentation available on our website during my prepared remarks as we drill down a little bit deeper into the details of our key financial results, which you can find on slide 4.

Outstanding private education loans at December 31 were $8.2 billion, up 27% from the prior year, 6% from the prior quarter. Over the course of the year, our Bank balance sheet grew 19%.

Net interest income for the fourth quarter was $151 million, which was $7 million or 5% higher than Q3, and $29 million or 23% higher than the prior-year quarter. For 2014, net interest income was $578 million versus $462 million, a 25% increase over 2013.

Growth in net interest income is being driven by the relative increase in our private education loan portfolio. The Bank's net interest margin on interest-earning assets was 5.01% in the fourth quarter, which compares to 5.25% in the prior quarter and 4.95% in the year-ago quarter. For the full year, the net interest margin was 5.26% compared to 5.06% in the prior year.

The average yield on our private education loan portfolio in the fourth quarter was 8.07% compared to 8.20% in the prior quarter and 8.17% in the year-ago quarter. For the full year, the average yield was 8.16%, unchanged from the prior year. Our cost of funds was 1.11% compared to 1.07% in the prior quarter and 1.13% in the year-ago quarter.

For the full year, our cost of funds dropped to 1.04% from 1.14% in 2013. The two main drivers for the Bank's lower net interest margin in the quarter were lower yield on our private education loan portfolio and a higher cash balance, earning negative carry. The decline in the portfolio yield was driven by lower yields on recently originated loans and a higher accrued interest reserve build as the portfolio seasons.

We don't believe that the quarterly decline represents a trend. We expect private education loan yield to remain above 8% over the course of 2015.

In the quarter, our cash balances were high as we built liquidity for Q1 disbursements. As our portfolio grows, our cash position will have a declining impact on the overall NIM which we expect as Ray mentioned, to remain above 5% over the course of 2015.

Non-interest income totaled $12 million in the quarter compared to $96 million in the prior quarter and $79 million in the year-ago quarter. In Q4 we did not sell any loans which was cause for a big decline versus the prior quarter. And in the prior year's quarter we sold a portfolio of asset-backed securities in preparation for the spin, which had a relatively large gain, which also obviously wasn't repeated in the current year.

Fourth-quarter operating expenses were $77.8 million compared with $75 million in the year-ago quarter. In addition, there were $11 million in restructuring costs.

For the year, operating expenses totaled $278 million plus an additional $38 million in one-time restructuring and reorganization expenses. In the fourth quarter these restructuring expenses were significantly higher than our recent guidance.

The separation was a very complex undertaking from an IT perspective. To give you a sense of the size of this project, we invested over 350,000 hours of programming into the effort and completed nearly 100 different projects, moving nearly 50 bank systems into our new data center. We accomplished all of this without impacting our origination goals and maintaining a focus on our customers. Final project costs came in higher than expected.

The majority of the restructuring has now been completed, now that we've established our independent servicing and collection platforms. There will be an additional expense in 2015 of $5 million that Ray mentioned. A majority of this spend will be to complete the buildout of our originations platform and the migration of the remainder of our systems, principally financial systems for the new data center.

In the quarter, you may have noticed we experienced a significant increase in the effective tax rate. This was primarily the result of a one-time build up of reserves for uncertain tax positions. The tax rate for the quarter was 55% compared to 38% a year ago.

The full year-ended at 42% compared to 38% in 2014. Needless to say, this had a significant impact on quarterly earnings and had a dampening effect on the full year, as well. We don't expect these adjustments to continue to affect future quarters, and our tax rate for the full year is likely to be around 40% in 2015.

The Bank remains well capitalized. The risk-based capital ratio is 15.9% at the end of the quarter, significantly exceeding the 10% risk-based capital ratio required by the regulators to be considered well capitalized. In addition, the Parent Company has excess capital available to the Bank as an additional source of strength.

We will continue to maintain high levels of capital to support the projected growth of the Company. We don't anticipate returning capital to shareholders as we reinvest in our business.

On slide 5 you'll see a summary of our origination volume. Ray already talked about this. We originated $557 million of Smart Option private loans in the quarter, up 7% from the prior year.

In 2014, we originated $4.1 billion, a 7% gain again. Loans in the quarter had an average FICO score of 748, 88% of which were co-signed. Full-year average FICO score of 749 and co-sign rate of 90% compares favorably to an average FICO score of 745 in 2013 and those loans were 90% co-signed, as well.

Getting into credit performance on page 6, these are our performance stats. As expected our delinquencies and charge-offs are increasing as the portfolio seasons and loans move into full principal and interest repayment.

Loans delinquent 30 days were 1.2% compared to 0.7% in the year-ago quarter. Loans in forbearance have increased to 2.6% from 0.4% in the year-ago quarter. This is typical in the fourth quarter as there is a temporary jump in forbearance due to the increase in loans entering full P&I.

The volume of loans entering forbearance in the fourth quarter was in line with Q4 2013. And we've reported our Smart Option portfolio stats at the end of 2013 and all of these stats are well in line with what we experienced historically in the Smart Option student loan portfolio.

In the fourth quarter -- and we talked a little bit about this on the third-quarter conference call -- $900 million of loans entered full principal and interest repayment. This brings the percentage of loans in full P& I to 28% for the full portfolio and 40% of our loans that are in repayment.

Charge-offs on in-school loans -- those are the loans that are making interest-only or a $25 flat fee payment -- charge-offs on those loans are very low. Losses typically emerge once the loan enters full principal and interest repayment. There's a slide on the investor deck which is posted on our website, slide 7, that has some relevant statistics to this discussion.

Charge-offs on private education loans are front loaded, as you can see from the loss emergence curve. 50% of charge-offs occur in the first two years after entering repayment.

Looking at our portfolio and repayment, it's very young. 28% of our portfolio is in repayment for less than one year. Another 9% has been a repayment between one to two years, and just 3% of our portfolio in repayment has been in full principal repayment for more than two years.

Based on our expected loss emergence curve, charge-offs on our current portfolio should peak in 2016. The allowance for these expected charge-offs will we built over the course of 2015 as we build an allowance that covers one year of expected charge-offs.

Our approach to provisioning for loans will continue to be conservative as our portfolio seasons and we accumulate additional performance history under our 120-day collection policy. Statistics under our new collection policy have been volatile, particularly during October and November as we transition to our new servicing collection platform. In addition, we have very few stats on loans in full principal and interest repayment under this 120-day policy.

So, the allowance for loan losses was $79 million or 1.5% of loans in repayment at year end. Provision in the quarter was $30 million versus guidance at the end of Q3 of $35 million. But the better provisioning was simply due to the fact that losses came in better than we thought over the course of the quarter.

I want to repeat what Ray said. I want it to be totally clear that the portfolio is performing exactly as we expect it to and consistent with our expected cumulative charge off rate over the life of the loan in the neighborhood of 7% for any cohort of loans.

Moving on, we'll talk about our earnings metrics. SLM Corp has metrics that we call core earnings. The only difference between core earnings and GAAP net income is that core earnings excludes the mark-to-market on unrealized gains and losses on effective derivatives, excludes that from earnings. We use derivatives, predominantly interest rate swaps, managed interest rate risk in our portfolio.

We believe all of these hedges are sound, economic hedgings. The core adjustments are very small in the current period, so they're larger back in quarter two, but we gain hedge effectiveness on most of our hedged portfolios so this is not a major impact to our earnings in recent quarters. Core earnings for the quarter were $20 million, $0.03 diluted earnings per share, compared with $64 million or $0.14 diluted earnings per share for the year-ago quarter which had an outsized securities gain.

Our core ROA for the quarter was .06% compared to 2.7% at Q3 and 2.3% in the year-ago quarter. Our return on common equity was 4.7% compared to 24.2% in Q3 and 18% in the year-ago quarter. Obviously these stats are going to be very volatile and be impacted by gains on our loan sales as we go forward. ROA and ROE were at 1.7% and 15.1% effectively for the full year.

Again, going back to Ray's comments, the Bank's performance is solid in 2014 and is extremely challenging transition year with significant complexity. We executed our business strategy, gained market share, exceeded our originations goal, completed significant capital markets transactions, and produced very strong earnings per share.

Now what we will get into, I'll repeat the guidance and I'll make a few additional comments. We expect to originate $4.3 billion in high-quality private student loans in 2015. This is a 5% growth rate.

Our operating expenses for the full year will be $325 million plus one-time restructuring and reorganize expenses of $5 million to complete the spin. We view a good run rate of operating expenses, as we discussed in Q3, as the fourth-quarter run rate annualized to $77.8 million. That's a good number as it now reflects our servicing and collection platform. We use that, as we discussed, at higher operating expenses in 2015, driven by the growing portfolio of loans, as well as certain investments that we're going to be making to improve our customers' experience.

For example, we will have an additional expense of nearly $10 million over our Q4 run rate and our servicing and collection operations. And this is principally driven by increased volume. As we'll be servicing an additional $4 billion of loans on our platform by year end, this demonstrates a substantial operating leverage that our platform is capable of.

On the investment side, we'll spend just under $5 million to onshore our sales call center and improve our mobile capabilities. We expect that these investments will pay dividends in the form of higher originations and more efficient operations. But these benefits are difficult to quantify prior to implementing the change.

Loan sales, again that will be a big part of our 2015 business plan as we manage the balance sheet growth. As Ray mentioned, we plan on selling $1.5 billion of loans in 2015. For guidance purposes we are assuming that we will execute these transactions at a 7.5% premium.

While it is true that if we were in the market today, we think that we would probably receive a better premium for these loans. But, again, we want to be conservative as we won't be doing our first transaction until the beginning of the second quarter, and, as we all know, markets can be particularly volatile. So we'll do a transaction early in the second quarter and then we'll look to do another transaction in the late third quarter. We have these transactions penciled in at $750 million worth of loan sales.

It's important to remember that these loan sales are principally to manage our balance sheet in the early days of our operation as an independent bank. It's in Sallie Mae's P&A to hold these loans on our balance sheet. With that being said, we will take advantage and toggle our sales up and down if it looks like we could receive a larger premium in the market for these sales in 2015.

We expect the provision, as already discussed, to be between $116 million and $130 million for the year as we reserve for a growing portfolio of loans, that's entering full repayment. And just to repeat, as Ray mentioned, we expect our EPS to be between $0.48 and $0.50.

That concludes my prepared remarks. And, operator, we will now be happy to take any questions that are in the queue.

(Operator Instructions)

Your first question comes from the line of Brad Ball with Evercore ISI.

Thanks. Yes, I have a couple of questions. Just starting with the expected gain on sale premium, the 7.5%, Steve, I wonder if you could talk about what gives you confidence that you'll be able to do that 7.5% in two transactions in the second quarter and the third quarter, and whether there's any change in the pricing you would expect now that you're retaining servicing as opposed to selling with servicing transferred.

Sure, Brad. It's always difficult to get a deferred transaction off, and that was the $1.2 billion that we sold in August, a good $400 million with a third party and sold another $800 million to Navient. Private student loan portfolio sales so far have not been done in the marketplace, so, as you know, the first transaction is very much a price exploration process. We were very pleased with the 7.5% premium that we received.

We spend a lot of time with our ABS bankers, as you might imagine. And as we look at transactions with other asset classes and how the pricing for typical ABS loans has evolved since we did that transaction, there's definitely evidence that the premium should be somewhat stronger the next time around.

An example of that would be the Navient transaction that was recently executed. That deal had a mix of Smart options and older collateral in it, so our collateral would be somewhat more high quality than what they securitized. But the key point was they were able to get a full 100% release of cash flow on their deals. That is new. It's an evolution of how student loans have been securitized.

Over the last three or four years there's typically been turbo charges, turbo deals with cash going to pay down the bonds. Freeing up more cash makes the transaction more appealing and more valuable to ultimate residual holders, which is what drives the price on these premiums.

There's a lot of supporting evidence in the market that suggests that the pricing should be somewhat better the next time around. But, again, we not coming until late March, early April so who knows what can transpire between now and then.

And I forget what's your second question, Brad? Oh, servicing retained. I would view that as basically a sweetner, the buyer pays the servicing fee regardless of who's servicing. So, we will receive the premium and the servicing stream as we go forward in the future.

The servicing dynamic that you mentioned is similar, is identical from a buyers point of view so (inaudible).

Great, thank you. And then, Ray, in your comments, a couple things. You mentioned a gain in market share. I just wonder if you could talk about what you think is driving that 1% to 2% pick up in market share.

And you also noted that you thought that private education loans would reach $15 billion by the third quarter of 2016. Does that imply no additional sales beyond the $1.5 billion in 2015? As we look at our model it looks like you'd have to retain pretty much all of your originations to get to that $15 billion by Q3 of 2016.

Two things. One is the market share. And one of the items that occurred in 2014, of which we were most proud, is that, while we were doing quite a bit of work that was driven by corporate decisions; the launching of the new companies, the spin, the change in the operating platforms, all of that -- that we were able to, successfully apparently, isolate that series of activities from our customer efforts. And, so, our efforts with customers in both sales and marketing continued unabated.

And, as you know, we are the premier company focusing almost entirely on the student lending market in the private space. So, I think that it's a benefit of that continued focus.

The effort on the part of the entire management team, but especially those in sales and marketing, could not be distracted by what has been happening back at home. And I think that this is a trend that we've actually seen in previous years, as well. And so while we think our strong market position, our care for our customer bases, of which there are several, including the financial aid offices, the parents, the students, we believe that that constant effort, not interrupting, not being flavor of the month, that sort of thing, has paid off quite handsomely.

In regard to your second question, and this is a projection based upon current trends, we will hit $15 billion. The amount that would be sold in regard to that $15 billion, you might think in terms of, oh I don't know, 10% to 15% of it. So, that would be the noise around that number. It's not a very large order of magnitude.

If it's not $15 billion in the one quarter it would be in the next quarter so far as helds. But this is an important point here so far as servicing because if we continue with our plans to sell asset servicing retained, we will continue to get the operating leverage associated with the larger receivables. And, so, we have an interest in both of those items.

And just with respect to the market share gain, are you seeing any changes in the competitive landscape? Are you seeing new entrants or are your big two competitors getting any more aggressive? I note that the $4.3 billion origination target is up 5%. You grew originations last year 7%, 14% the year before that, so it looks like a deceleration in origination growth. Is that just the markets growing somewhat slower or is there competition as a factor there?

The market growth, as we've said, is, in aggregate, relatively low, so 1% to 2% in new entrants. And it's a question of what the schools charge and then there's always the dynamic of the federal program, the discounting on the part of the schools. We don't see any particular change in what we think of as the top of the funnel dynamic of what's going on at the schools. We have seen that there has been some shift in our originations, more concentrated in higher-quality traditional four-year not-for-profit schools, a little bit less in the for-profit schools which have lost out given all of the noise that has been around certain franchises there.

In regard to the competitors, we watch them very carefully. We have seen no major shifts in the behavior of either one of our primary competitors. But they remain organizations of great reputation, extreme capability, lots of muscle power. We are the smallest among them but we are the most focused on this particular market.

But in both of those dynamics, in answer to your question, we don't see too much of a change in the momentum associated with the basic portfolio of schools and the need for families to finance the gap that is left after grants and federal programs have been exhausted. And we have not, as far as we can tell, seen any major shifts in the competitive frame.

Great. And then my last question, I want to clarify the message here on credit. Are you saying that there's really no fundamental deterioration in credit in the book but that the higher provision guidance for 2015 just reflects a higher proportion of loans that are entering repayment? And can you talk about how we should expect $900 billion just entered repayments, how much more over 2015 and into 2016 will be entering that first phase of repayment that might over the near term, next couple of years, keep provisioning levels at elevated levels?

Sure. Let me go back to your first point which is, as I recall your comment, no fundamental shift. Let me be more stringent than that. There's no shift, period. It's not fundamental or otherwise.

We're exactly on the models that we have always talked about. The seven years for the term of the loan with an actuarial loss rate of 1% per annum is still what we are working on. We haven't shifted that one point at all.

It is the case, as I said, that during the first two years of full P& I payment, it's two years of seven that are on the calendar, and so that's 28% of the time elapsed. During that same 28% of the time, we experience 55% of our losses. So 55% divided by 28% is a nice clean 2X.

During the first 24 months of portfolio entering full P&I, we expect to experience double the rate of losses, and we expect that to mitigate after or during the second year. And, so, as we grow the portfolio from $5 billion to $10 billion to $15 billion, we will have a series of those elevated loss curves that will disappear in the same two years that I've just mentioned.

And then, Steve, if you can talk a little bit about the number and volumes entering P& I during the next year or two that would be helpful.

Sure. Brad, our portfolio is going to be very seasonal and the pattern is going to repeat itself. We had $300 million of loans going to P&I in June and another $1 billion go in in December. This follows basically the spring/winter graduation pattern.

We would expect to have growing cohorts of loans enter principal and interest repayments in basically June and December of every year. So, the $300 million becomes $350 million to $400 million, and the $900 million becomes $1 billion to $1.1 billion at the end of 2015. And then the pattern will repeat itself in 2016 and 2017. And the key part to note, it's an obvious one, that as the portfolio grows and seasons, the provision will be a diminishing percentage of overall net income.

Net portfolio.

Yes, net income of the portfolio.

Very helpful. I appreciate it guys, thanks.

Your next question comes from the line of Michael Tarkan with Compass Point.

Thank you. First on the provision for 2015, just a point of clarification. Does that reflect the $1.5 billion of expected loan sales for the year? In other words, if you sell the $1.5 billion, I would assume there would be provisions associated with that that would go away. Are you factoring that in with the $116 million to $130 million of guidance?

Yes, Michael, that's factored into that guidance. We've accounted for that.

Okay. As we think about the provision, a long-term reserve that you guys want to hold against this portfolio, I know you mentioned an annual loss rate of around 1%. Can we think about that in terms of reserves? Are you going to manage longer term to a reserve around 2% or 1%? How do we think about reserves long term once the portfolio has matured?

The allowance for the total portfolio at the end of Q4 was 1%. We are reserving for expected losses over the next year. The reserve as a percent of loans in repayment, both will grow over the next year or so. We would expect the reserve to end 2015 at roughly 1.25% of the total portfolio and that translates to 1.75% of loans in repayment. So, the reserve will reflect the front-loaded nature of our expected charge offs.

And once the portfolio has matured, how should we think about where that 1.75% would go?

Using 2017 as a maturity point, when we get out to that $15 billion that we've been talking about, the 1.75%, it probably plateaus out around that level, possibly a little bit higher.

Okay. Shifting on to expenses, did I hear you correctly in terms of the incremental revenue that you brought on this year came in at a 22% efficiency ratio? And then are you still targeting a mid 30%s efficiency ratio by 2017?

First the 22%, in order to get to that number you take the fourth-quarter expenses that we had, multiply that by 4, and then take a look at the projected expenses for 2015, which are $325 million. So, as we look at that versus the incremental revenue associated, the marginal efficiency ratio associated with the fourth-quarter run rate versus the 2015 projection is 22%.

Yes. And, look, there's no doubt that there's a lot of operating leverage in this platform. And we continue to expect the efficiency ratio overall to migrate down from the 43% into the 30%s in three years' time.

Okay, thank you.

Your next question comes from the line of Sanjay Sakhrani with KBW.

Thank you, good morning. First question just on reserve methodology. I know you guys have been -- that methodology has been evolving because you've changed, you've converted from a 212- to 120-day policy. Could you just talk about how that evolves over the course of this year and what's contemplated within your guidance? That's probably my first question.

Just to refresh everybody's memory, the migration model that we use uses an average of 16 months of roll rates through the delinquency buffers. And we have been using, pre-split the roll rates from the 210-day collection policy.

And I know this is arcane stuff but the important fact here is we have been using roll rates in the first four buckets under the 210-day policy where there is very little activity. There's very little effort to collect loans under the 210-day policy. Most of the activity took place in the last three buckets because delinquencies had a tendency to self-cure. So when we've had more time, we spend less money in the earlier buckets.

We only have 120 days so we focus more intently, obviously, on the first four buckets. The point is, we're using is we're using very high roll rates, pre-split, and we expect those high roll rates to migrate down over time, which would result over time in a lower provisioning.

We have, as I mentioned earlier, even less stats under the full principal and interest repayment model because obviously they just went into repayment. So, what we are using is a blend of old and new rates.

As things usually happen, complicating factors took place during the transition where roll rates were slightly elevated in October and November, so our overall roll rates didn't come down significantly. They dropped quite a bit in December but we erred on the conservative side wanting to see more evidence with how we collect loans that are in full principal and interest repayment before we take that into a long-term guidance for provision and allowance. I know that's a lot of --.

Maybe just to sum that up, that means if credit continues to perform as it has been for you guys, that should theoretically take down your provision rate as some of the points of volatility come off your calculation.

Yes, that's correct. And (prepared remarks), both myself and Ray, we did say that this provision is conservative. We don't want to second guess it at this point in time. We will continue to report information periodically as the process evolves.

We'll be in front of investors in February at an industry conference where we can share more detail with how the model is evolving. And, again, we will be communicating again in first-quarter conference call. But it is an evolving process. We do think the provision and loan loss allowance is conservative. And we do think that the portfolio is performing exactly as we expected it to when it was underwritten.

Okay. And then just when I look at that loss emergence curve on slide 7, are you guys using a historical pattern? Is there any evidence that some of the newer loans that you're originating, which are clearly better, have better attributes, would have maybe a lower level of peak losses?

The currents are informed by both old signature performance adjusted to reflect what a Smart Option student loan would look like, as well as the available Smart Option data that we have since we started to originate these things in 2009. But as a point of reference, in our investor presentations to date we've shown how Smart Option outperforms the legacy signature data.

So, layering that into the analysis might have a tendency to overstate the charge-offs. We do think we're adjusting appropriately for that. But you can see where cumulative defaults are trending towards in our investor presentations. And we believe that we are on track to match that type of a performance.

All right. One final question on credit. Just that 1.75% that you mentioned towards the end of 2015, did that migrate? And I understand some of the other dynamics that we talked about might bring that down in theory but does that migrate even higher in 2016 and 2017, all else equal?

The allowance migrates higher into 2016 to reflect the new repay wave that's coming in, and then into 2017, and then we think it will plateau.

But that ratio, does that change, the 1.75%?

The reserve of loans in repayment?

Repayment, yes.

Yes it ticks up from 2015 and we would expect it to tick up from 2015 into 2016.

And that 1.75% in 2015, that's assuming 100% coverage to losses, in theory?

Yes.

Okay, great. And then just last question, sorry -- to the extent that the gain on sale margin is higher when you're ready to sell, would that perhaps lead you in a direction where you might sell even more than what you're contemplating within your guidance?

Yes, I think that's correct. Look, if premiums are north of 1.08% I think our tendency would be to sell a little bit more; if they are 1.08% or lower we will stick with about $1.5 billion of loan sales. I don't see us, really, in any pricing environment selling more than $2 billion or so of these loans.

We love these Smart Option loans. We're in the student loan business and we want to build a balance sheet that's going to generate future earnings for the Company and shareholders.

And that hypothetical 1.08%, that's ex servicing, right?

That's correct.

All right, thank you very much.

Your next question comes from the line of Sameer Gokhale with Janney Capital Markets.

Thanks. Just, again, if you can just remind me the other income, $4.3 million, I think it's related to Upromise, some of the seasonal bump up in that. But can you just dive into some specifics about exactly, again, what that is related to Upromise that's driving that increase?

Actually, Sameer, the increase in other operating expenses from Q3 to Q4, the Q4 number of --.

I'm sorry, I meant other income.

Yes, that's what I'm talking about. The other income number was $12 million, I think, in the quarter. But the Q3 comparative number, I think it was $5.6 million, was actually, it had an impact on it that lowered it in Q3 due to a trueup on a tax indemnification line that we booked in Q3. So, the jump from Q3 to Q4 exaggerates the increase in that line. The Q4 number is a very good run rate.

Our Upromise business, the income that it generates is essentially from credit card, the Upromise credit card, and there is a Upromise online mall that generates revenue basically from advertising and fees from merchandise that sold from our partners.

Okay. And then sorry if I missed this earlier in your comments but the $1.5 billion target that you've given for loan sales, is that predicated on any assumption of securitization of loans, which would reduce the need to sell those loans? And have you spelled out a dollar amount that you intend to securitize? Again, apologies if you talked about that earlier in the call.

No, we didn't talk about that. It's a good question. We will be securitizing to fund our private student loans. Our strategy has always been to term out our funding, so we will be doing securitizations that are funding-driven that remain on the balance sheet. And the volume there, I think about $1.5 billion to $2 billion.

As it happened, to execute our loan sales I think the most efficient method is going to be to securitize the loans and sell the residual. So, you will see us doing that to the tune of $1.5 billion. If it happens that whole loan buyers step in and win at auction, we will be happy to sell the loans in the form of whole loans. But I think the best bid will probably come from the structured finance crowd where we sell whole bond, like we did last time, all of the AAA, A, and residuals to one buyer, or we distribute those bonds to different buyers and sell the residual to one investor, which would then deconsolidate the loans from our balance sheet.

So, just to clarify, Steve, the $1.5 billion, that consists of just whole loan sales, loans out of your portfolio. It doesn't include any off balance sheet securitizations that you will do, correct?

No. It will be done, it's highly likely that we will sell loans in the form of a securitization. So we will securitize them, and then once you sell the residuals you can deconsolidate that entire portfolio from your balance sheet.

Okay. But I was just trying to clarify, that is part of your $1.5 billion that's included in that?

That could be the entire $1.5 billion.

Okay. So, then, that gets me to my next question which is -- and again I don't know if you addressed this -- but your loan sales for this year I think were $1.8 billion, $1.9 billion and the guidance is for $1.5 billion. If one were to look at that decline, I'm not sure exactly what that's attributable to. Is there some conservatism built in there? And apologies if you talked about this earlier.

What happened in 2014 was we sold, post spin, $1.6 billion of loans. It's confusing because prior to the spin the old process would be the bank would sell loans to SLM Corp and SLM Corp would securitize them into the market. So, our $1.5 billion of loan sales, I would say, is comparable to the $1.6 billion we did in 2014 to third parties.

Okay. So, then, as I look at your guidance, you talked about the seasoning of the portfolio and how that's going to put some upward pressure on provisioning, you talked about the OpEx. Where do you think, if you were to say the guidance -- should we assume this guidance is conservative? Or should we assume that there is any give here or is this just your realistic scenario of where the numbers should shake out? I'm just trying to get a sense of where there could be some give.

You talked about the loan sales and maybe the premium coming in a bit higher, if that happens that's a possibility. But elsewhere, in your provisions, OpEx, where do you think there could be any give there, is what I'm trying to figure out -- or maybe your net interest margin.

Okay. It is our guidance, but that being said, to your question, the $4.3 billion in loan originations, I think that's pretty rock solid without a whole lot of variability. I think our $325 million operating expenses is pretty rock solid.

Loan sales are certainly a candidate for some variability. We could sell more and we could receive a higher price on the loan loss allowance. Look, it's conservative but I don't want to sit here today and encourage people to think that that is going to come down without further evidence of that actually happening over the next couple of months.

Okay, fair enough. And then just my last question was, again on slide 7, with just showing that curve with the loss emergence. I was curious, if that curve looks very meaningfully different, whether the loans are interest only in school, versus the $25 fixed, versus paying the full principal, when you think of the mix and when you think of loans as you originate them, are those curves any different meaningfully when you look at them?

If we were to plot out the interest-only and the fixed pay, what you would see is you would see a small amount of charge-offs prior to them going into full principal and interest repayment. But then if you average the fixed pay and the interest-only curve once they go into principal and interest repayment, they would be very much nearly identical to what we have laid out here for the deferred-only curve.

Okay, great. Thank you.

And your next question comes from the line of Eric Beardsley with Goldman Sachs.

Hi, thank you. I just wanted to follow-up on your EPS growth target. I think during the spinoff road show you talked about 20% plus EPS growth as a longer-term target. And I think, Ray, you'd mentioned earlier on this call you're looking at 15% to 20%. Just wondering what you are actually targeting and what your targets and incentives are based on.

Sure. The guidance that we've given for 2015 is clearly 15% to 20%. And it is the case that when you look at the dynamic of the originations and spreads and just run through the P&L that in the medium term of what's called, I think, three to five years, certainly 20% or 20%-plus is possible.

And so we, as I've said a couple times in this call, we haven't changed any of our modeling. We still are at that yield of 8%. We are still at the growth in portfolio we talked about. We're still at the NIM of 5%. We're still at the returns we talked about, which I believe are 16% ROE or so.

And, so, I think the message for 2015 is that we have this maturation of the portfolio. It will cause us to incur higher losses during those first two-year period, while large amounts of dollars go into full P&I. So, the 2015 will be a year that's experience a higher relative credit loss amount and proportion versus the out years once we're past those two years and we are experiencing the remaining five years of the loans for those vintages, which will have losses significantly under 1% after the first two years.

And, so, we have a weighted average heavier credit cost in 2015. But that hasn't changed any of our medium-term or longer-term objectives or trend line that we've discussed with you.

Okay. Your provision guidance, $116 million to $130 million, relative to the dollar amount of loans that are in full P&I repayment of $1.3 billion, that's a 10% provision to loans entering repayment. And then as you migrate up to 2% reserves to loans in repayment relative to 1% losses, how does that sync up with your reserving methodology for 12-month forward losses?

Keep in mind we're not just reserving for the loans that are in principal and interest repayment. There's also a factor in there for loans that enter TDR where we have a pretty high consumption of loss rates. And we are also reserving for loans that are in fixed and interest-only pay.

Is that really 2X, if we're thinking about this on a 12-month forward basis?

The portion of the portfolio that has just entered P&I, and is in the period from just entering to up to two years, is 2X. And, so, it's these things that the whole loan loss reserve is a weighted average of items that have been in the -- we ended 12/14 with $8.2 billion in private student lending. There's a reserve up against that. Those are long past their peak curve and that's part of the reserves.

Steve mentioned TDR. TDR requires that you reserve 100% of items in TDR, so that's a factor here. Then we have a high proportion of accounts entering at the full P&I as we escalate from that 28% that Steve mentioned to a more normal portfolio. That has the one-year loss projection associated with those loans, and that will be over the 1%. So, when we look at the entire loan loss reserve, it's a one-year outlook but it's for all of those slices.

Got it. And then just on the loan balance guidance, I just wanted to just get a clarification. When you're talking about having $15 billion at the third quarter of 2016, is that your private student loans on balance sheet or is that the service portfolio?

When we think about the private student loans, just remember this question came up a little bit earlier in the call about how much is that, let's remember that the starting point for any projection is the 12/31 number, which is $8.3 billion of private student loans owned and serviced by us, zero service for someone else.

So, when we talk about $1.5 billion going into the servicing for someone else but sold by us, by the time we're at that point of ending, let's say, the 12/15 numbers, we're going to add the $1.5 billion that we put into place, which is the gain on sale number, but the $8.3 million will, over that period of time -- just think about it, we started $8.3 billion, we originate $4 billion towards the loans, we sell $1.5 billion, the $8.3 billion turns into $8.3 billion plus roughly $2.5 billion. And, so, at the end of the year, we're at $12 billion or so in owned and serviced, and $1.5 billion in regard to service for others.

The proportion of service for others will be low. And even if we were to look in the out years, it's a number that doesn't really get above 15% in relationship to the private student loans held on balance sheet serviced by us.

Got it. So it's $15 billion all-in including service for others. That's a service portfolio, not what's on balance sheet? Okay. I just wanted to clarify that.

And then just on the loss curves, I'm looking back at the cohort default triangles for the signature loans with co-signers. And the most I'm ever seeing here with co-signers is a 2% loss rate, periodic default, loan repayment in year one. And that's across the whole credit spectrum. If I were just to look at higher FICO scores that are more representative of your loans, and again also factoring in the Smart Option, the most I'm seeing is 1.5% so 1.7% max. So, the 2.5% to 2% expectation that you have, it's almost 50% higher than the actual cohort default triangles I'm looking at for 2008 and even earlier vintages and I'm having a hard time reconciling that.

You have to factor in a lot of things when you're looking at those old cohort default triangles. And the first thing that comes to mind is that there is a much greater issuance of forbearance in the past so that tends to extend out and lower the default rates. And it's also the 210-day charge-off period pushed out, as well. So, there's a number of things that you have to factor in when you're looking at those older signature cohort default rates.

Okay, that's all I had. Thank you.

Your next question comes from the line of David Hochstim with Buckingham Research.

Hi, thanks. Sorry to revisit the credit issue again, but can you just give us some sense of what you're expecting in terms of charge-offs at this point using your more conservative assumptions for 2015, and how much better that could be if you use the Smart Option?

What are you looking for -- charge off rate or a dollar?

Dollar charge-offs. So you had a little over $10 million in Q4.

We would expect over the course of 2015 to see charge-offs in the vicinity of $80 million, gross actually. And that doesn't take into account a recovery rate.

And that's using your more conservative assumptions?

That's at a conservative curve assumption, that's right. Okay. And can you give us some sense of how loans might perform just as we see--

We should talk about net. Excuse me one second. So, it's $80 million gross and going to (inaudible), 20% recovery. So, it's $80 million gross, 20% recovery -- a number like $65 million.

Yes. You got that, David?

Yes, okay, thank you. And then I just wanted to know, layering on top of that, if we're seeing a better economic environment, lower unemployment, lower gas prices, rising incomes, and then as Eric and others have asked you about, the improving quality of the portfolio, it just seems like those forecasts are conservative. And then that gets back to the same issue we've been repeatedly talking about which is just the reserve build near term as opposed to spreading it out.

There's no doubt that this provision in loan loss allowance estimate is conservative. We've discussed the reasons. We are beholden to a model. The model is, I think, going to develop and probably point to lower provision requirements in the future.

But we do need to base our financial statements and our projections on something here and we are erring on the side of conservatism as we sit here today. To your point, we think that there are a lot of supportive factors in the economy, and we do think that the Smart Option student loans are going to perform very well over the life of the loans that we're originating.

You'd indicated you might give updates. Does that include revised guidance as we go through the year, including the February data?

Yes, we always freshen up our guidance quarterly and we will continue to do that. As I pointed out earlier, we were $5 million high on the guidance for Q4. We guided $35 million, we came in at $30 million so it's roughly a 20% miss.

Right. Now we're going to annualize it the other way.

Then could you just explain also your ability to retain loans and constraints that the regulators have on portfolio growth? I think before the spin you talked about needing to sell some loans to limit portfolio growth. What are the limits at this point? You talked about only selling $1.5 million.

As with many other pieces of the model that we've communicated over these last two months, I want to stress that this hasn't changed either. So, we end the year and it's a $12 billion balance sheet, roughly speaking. The FDIC has an upper bound on the growth they will allow for banks at 20%.

So, we might think $12 billion, 20%, $2.4 billion in growth. We originate $4.3 billion. We have to do something with the excess because we're not going to surrender any of our position in the market, and because we think we can sell these assets at attractive rates.

$4.3 billion minus $2.4 billion, you wind up with $1.9 billion, and stuff has to go somewhere. We decided we want to sell about $1.5 billion of it. We make the balance sheet a little bit thinner on some of the cash balances that Steve was talking about as having a negative carry in the fourth quarter. And we end up at the 20% at the $1.5 billion and a more efficient balance sheet.

So, if you could shrink other assets you could grow your private student loan book a lot faster?

That is correct.

So, it's not a constraint on private loans.

It's not a constraint on private loans. Yes, that's correct.

And we could sell less in 2015 and still meet our balance sheet objectives. We have flexibility.

And we will remember, we discussed this quite a bit early on after LD1, that we're still carrying over $1 billion of FELP loans which, in the event we need to do something or we don't like the pricing, that still gives us some optionality.

Right. There are few assets that have higher returns than your private education loans.

That's right. Our great preference and in our DNA, as Steve said earlier, is to hold those. So, when prices get over 8% you really have to stop and think about it.

Okay. All right, thanks.

Your final question comes from the line of Moshe Orenbuch with Credit Suisse.

Great, thanks. Taking a slightly different tack on the credit and sales question, first of all, if you were to originate more than $4.3 billion, is it reasonable that much if not all of that would actually get sold?

If we raise significantly more than $4.3 billion we would then probably increase our gain on sales, yes, and our sold assets.

Okay. Given the fact that you know what the market is today, and you don't know what the market will be in the back half of 2015 or at some other time, and you pretty much can -- essentially, can't you just pre-fund some of those sales and do them earlier, quicker in 2015 as opposed to spreading them over as much as out in the future? Wouldn't that lock in more of that gain at those levels?

There is a process, Moshe, particularly if we go the securitization route, you need to get these things rated, and it takes quite a while to get them through rating agencies. So, we have already kicked off the process for our first sale.

And then there's tradeoffs. If we front load the whole $1.5 billion, it hurts our net interest income over the course of the year. We do take all of those factors into consideration.

I think the best bet is what we're planning on doing and selling $750 million Q2, $750 million Q3. There's also demand to manage when we are selling asset-backed funds to do straight funding deals. We're also tapping, to a certain extent, some of the same buyers. And there's a limit to how much ABS you can put into the market at any given time.

We could easily do $1.25 billion in one fell swoop and start pushing the limit to $1.5 billion to $2 billion. The market can get saturated. So, there are a couple of different factors that we take into consideration on the pacing of these sales.

And remembering, as we said, that 85% of these portfolios are floating rates.

I get that. And I understand that obviously you don't want to oversaturate the market at any point in time. But it seems that there should be just some acceleration just given the pricing dynamics that you've got, which would solve some other problems, the give up of net interest income. The gain on sale that you're expecting is 5 times a quarter's net interest income.

So, if you're going to originate the loans at a later date anyway it wouldn't really have a negative impact on your current year's earnings. It would have a positive impact on your current year's earnings and it wouldn't in any way change your long-term positioning because you'd have the same amount of assets. Anyway that's just a thought. Thanks.

We will take that under advisement. I mean, look, we will watch the market. We haven't gone to price. Hopefully none of the buyers are listening to this conversation. So if it turns out the premium is higher than what we're suspecting, that there are ways that we could increase the size of the sale.

Great, thank you.

At this time I would like to turn the call back over to Mr. Brian Cronin for any closing remarks.

Thank you. Thank you all for your time and your questions today. A replay of this call and the presentation will be available through February 4 on our Investor Relations website, salliemae.com/investors. If you have any other further questions, feel free to contact me directly. This concludes today's call.

Ladies and gentlemen, thank you for your participation. This does conclude today's conference call. You may now disconnect.