SLM Corp (SLM) 2015 Q1 法說會逐字稿

Good morning. My name is Valerie, and I will be your conference operator today. At this time, I would like to welcome everyone to the 2015 Q1 Sallie Mae earnings conference call.

(Operator Instructions)

I would now like to turn the call over to Brian Cronin, Senior Director of Investor Relations. Sir, you may begin.

Thank you, Valerie. Good morning, and welcome to Sallie Mae's 2015 first-quarter earnings call. With me today is Ray Quinlan, our CEO, and Steve McGarry, our CFO. After the prepared remarks, we will open the call up 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 than those discussed here. This could be due to a variety of factors. Listeners should refer to the discussion of those factors on the Company's Form 10-Q and other filings with the SEC.

During this conference 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 Form 10-Q for the quarter ended March 31, 2015. This is posted along with our earnings press release on the Investors page at salliemae.com.

Thank you, and I will now turn the call over to Ray.

Thanks, Brian, and good morning, and thank everyone who has dialed in. As we have this meeting on April 23, I would be remiss if I didn't note that we are just about a year from the original launch of the spin, which happened April 30, May 1, depending on how you count that. And what a difference a year makes.

We have had a very successful 12 months, lots of gratifying points. And as we discuss this quarter, I think you will see that we have a continuation of the improvement of some of the items that we talked about, but along keeping with the original business model.

And the audiences to thank are numerous, but especially our employees. Our Board has been terrific through the first year. Our customers have been faithful to us. And, as everyone knows, we increased our market share during this volatile time. I want to thank some shareholders -- and you know who you are -- who have been with us from the very beginning. Our regulators have proven to be very good partners in launching our growth, especially for a new company. And I also want to thank Jack Remondi and his team at Navient. As we've separated, they have been very good partners in many areas of activity.

As you go back over 2014 and we think about the span: on operating day one, operating day two, we had a cease-and-desist order in the bank at this time a year ago; we did issue 425 million shares; we had our first quarterly report in July, our first asset sale at 7.5% in August; and we did manage to deliver earnings as well as very good ROE -- and a very good ROE on 15% last year.

As we enter the quarter here, as we discuss this quarter, we continue. And so we continue to do the separation from Navient; we're probably 90% done. As has been reported previously, the major outstanding system to be converted is Atlas. We are scheduled to continue to ramp up the use of Atlas. And we should be originating all of our applications on that system by about June 30 of this year. And so that will complete all the major steps as far as separation and [independent] operating for the bank.

Our team has been rounded out, and the senior managers are all in place, which was not exactly the case a year ago. In regard to our customer franchise, we continue to enhance our delivery systems. So, as I mentioned, Atlas will be on place before the end of the second quarter. We are upgrading our mobile interface with customers. We completed the onshoring of all servicing for the private student loans over the course of the first quarter, on March 31. We discontinued operations outside of the United States in regard to servicing those private student loans, and so we are all in the lower 48, as they say.

We've expanded the sales force, and, as I said, we gained market share. The business model is very much intact. And while we changed some small parameters -- the underwriting, the NIM, credit, ROE, leverage, servicing -- and I should say that our servicing, which we were not capable of executing a year ago, in regard to the asset sale, which we'll talk about here, we did sell servicing retained and our servicing was rated very highly by all the relevant agencies. And our market position remains very strong.

It's also the case that we talked about through 2014 and into 2015 the leveraging of infrastructure. And so the fourth-quarter run rate for our efficiency ratio -- that is into the fourth quarter of the Company when we were finally more or less on our own platforms and looked at the efficiency ratio in the fourth quarter of 2014 -- the number would be 48%. And with the guidance that we will talk about in a little bit, 2015, the efficiency ratio will be -- for all the expenses and revenues incurred in 2015 -- 20%, which is, obviously, an outstanding number.

Back to the first quarter, so we originated $1.7 billion -- or disbursed $1.7 billion for the new loans during the period -- which is an increase of 9% over the same period a year ago. And so, as people know who follow these things, the market is not growing 9%, and so that reflects a position that is still, A, very strong and, B, improving, which is consistent with our performance for the first four quarters. That is from 2014.

Credit quality remains very high and very stable: 90% cosigned; FICO average through the door, 748. Our credit losses, which as everyone knows have greatly improved during the quarter and represent one of the major deviations in guidance from 90 days ago, are, gratifyingly, one, very good; two, on our model; and, three, much better than they were 90 days ago.

It's right to say, as we discussed in January, that our portfolio is still relatively young. And so, if we look at the nature of the student loan portfolio maturation curve, it is the case that the portfolios last -- a typical loan lasts about seven years. In the first two years, you've used up about 28% of the loan time. However, because credit losses are front loaded, you wind up with exactly 2x, 28% of the time, 56% of the cume losses for the cohort. And so the losses are higher in the beginning -- that was the discussion we had very much in January -- but it's also the case that the volatility is very high during that period of time.

Some of us were discussing this a little bit earlier. And one of the analogies would be if you looked at a good life insurance underwriting firm, they would be able to predict with a reasonable degree of accuracy the loss rates for a cohort over 30 years. But if they were asked to do it over 30 days or in 90 days, that's not what the model is really set up to do.

So, when we look at that, and the fact that the P&I portion of our portfolio for ongoing loans to be held at the bank was roughly about $1 billion in outstandings a year ago, and as we sit here today is roughly $2.6 billion. So we've had a 160% increase in the P&I portfolio that we are forecasting. And, as we sat in January and looked at the forecast, we were experiencing some volatility. We took a conservative tactic on that, volatility has gone our way. We think it's much better now. That is, volatility is lower, and the performance is good. And we'll talk some more about that later.

Our NIM in the quarter, 5.6%, continues to be very good as an absolute number, up from 5.01% in the fourth quarter. The earnings, you know about -- [consensus] was pretty much [7]. We're at [10]. The ROAs look very good; the return on equities look good. Steve will talk about many of these items, and, of course, the new sale has been outstanding for us.

And so, as we continue to move into the second quarter, we will have more of the same. We will finish off the spin items. We will have all the servicing. We'll, of course, be on in the United States. We expect to maintain our position in the market.

We have been able to add two new Board members during the quarter -- Jim Matheson and Vivian Schneck-Last. Jim Matheson is a 14-year, seven-term congressman previously serving for Utah. And he has joined our Board as a member who can help us out quite a bit in the political arena, we hope, so far as his understanding of the dynamics there. Look forward to Jim's participation. Vivian has been spent over 20 years with Goldman Sachs and is a stellar IT and general manager expert. So we are very gratified that both of those people have accepted, and that the Board is nicely rounded out.

With those comments, I'm going to turn over the next few minutes to Steve to go through the financials. And then we will open for Q&A.

Thank you very much, Ray. Good morning, everybody. Thank you for joining our call. I'll be referencing the earnings call presentation available on our website during my prepared remarks. We will begin with our key financial results on slide 4.

Outstanding private education loans at March 31 were $9.7 billion, up 34% from the prior year and 18% from the prior quarter. Net interest income for the first quarter was $171 million, which was $20 million, or 13%, higher than Q4 and $32 million, or 23%, higher than the prior-year quarter. Gross and net interest income is being driven by the increase in our private education loan portfolio.

The bank's net interest margin on interest earning assets was 5.6% in the first quarter, compared to 5.01% in the prior quarter and 5.5% in the year-ago quarter. The change from the prior quarter was driven primarily from lower cash levels in Q1, which reduced the drag on NIM from negative carry. We typically ramp up cash levels in Q4 to prepare for our large origination season, and then draw them down as we disburse loans in January for the spring semester. Cash balances will increase in Q2 from proceeds of our loan sale.

The average yield on our private education loan portfolio was unchanged in the first quarter from the fourth quarter at 8.07%, and it compares to 8.14% in the year-ago quarter. Our cost of funds was 1.17%, compared to 1.11% in the prior quarter and 1.04% in the year-ago quarter. The higher cost of funds in Q1 compared to Q4 was the result of fees associated with our new secured-funding facility, which we haven't yet drawn on.

Non-interest income totaled $11 million in the quarter, compared to $12 million in the prior quarter and $41 million in the year-ago quarter. Our non-interest income is primarily fees from our Upromise business and late fees associated with the loan portfolio. There were no third-party loan sales in the first quarter, which accounts for the decrease from the year-ago quarter. In Q1 2014, we had gains on sales of loans that totaled $34 million.

First-quarter operating expenses were $81 million, compared to $66 million in the year-ago quarter. In addition, there were $5 million in restructuring costs. Over the course of the first quarter, we found that operating expenses were running a little bit higher than anticipated. This is the result of a number of different expense lines coming in higher by just a few million dollars for the full year. A few examples of this are our higher employee benefit costs and higher data center costs.

In addition, we're going to invest $3 million in the Sallie Mae brand over the remaining course of 2015. As a result, we're going to increase our operating expense guidance as reported in our press release. But we remain committed to managing our expense base carefully to optimize the efficiency of the organization. And, as Ray mentioned, when we look ahead, we continue to expect improvement in our efficiency ratio, and we expect to continue to benefit from scalable servicing platform in future years.

In the quarter, the tax rate was 40%, compared to 38% a year-ago quarter. We expect the tax rate for the full year is likely to remain around the 40% level. The bank remains well capitalized with a risk-based capital ratio -- a total risk-based capital ratio of 14.4% at the end of the quarter, well above the 10% risk-based capital ratio required to be considered well capitalized.

And, I'll point out, our capital levels will decrease significantly in the second quarter once we close out recent loans (technical difficulty). In addition, the parent company has excess capital that's 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 our Company. And we do not anticipate returning capital to shareholders as we reinvest this capital in our business.

Flipping to slide 5, you'll find the summary of our originations volume. As you can see, we originated $1.7 billion of smart option loans in the quarter, up 9% from the prior quarter. The loans we originated in the quarter had an average FICO score of 748, and 86% of the loans had a cosigner. These stats, particularly the cosigner rate, are very consistent with what we have seen in the first quarter, and we continue to expect the cosigner rate to trend back towards 90%.

Keep in mind that the growth rate in the first quarter is closely tied to the growth that we experienced in the peak season of 2014, as these are second disbursements. The guidance for originations growth of 5% from the prior year remains intact. And the marketing for the next academic year will begin shortly, and we will begin to learn how we're going to fare in that in the upcoming season.

On page 6, we report our performance statistics on the portfolio. As mentioned on our last earnings call, delinquency and charge-offs were elevated in the fourth quarter due to operational changes we experienced on the transition to our new servicing and collections platform back in October and November.

The impact of this is clearly evident in the graphs that we provide on slide 7. The good news is our collections team got back on track in December. And roll to default rates, the basis of our loan loss allowance model spiked in October and November, and then declined sharply in December and remained low through March. Specifically, the roll to default rates in the last bucket averaged in the low 50% in October and November, and then dropped to under 30% for the last four months -- very significant improvement. And this strong and consistent performance that we have seen over the last four months is largely responsible for what led to a change in our provision guidance.

Looking at the numbers, loans delinquent 30 plus days were 1.6%, compared to 2% in Q4. Loans in forbearance have increased to 2.8% from 2.6% in Q4. This increase in forbearance is very much expected due to the large wave of loans and during full P&I in the fourth quarter. And if you look in our 10-Q on page 46, we published some forbearance statistics that show $171 million of total loans in forbearance, but $102 million of that number had less than 12 scheduled payments. And this is very consistent with what we see when we look at individual cohorts of loans as they enter full P&I. Forbearance usage is heavily weighted to the early stages of repayment.

Charge-offs in the quarter were just 0.5%. And, as you can see, delinquencies and charge-offs decreased from Q4 to Q1 despite the seasonal pressure for them to increase. This demonstrates our ability to execute our default diversion strategies under the 120-day charge-off policy. We continue to be very confident in the quality of our portfolio and the life of loan-loss expectations that we frequently talk about for these smart option loans. We ended the quarter with 26% of our loans in full P&I.

So, as a result of this strong credit performance, our provision for private education loan losses was $16 million in the quarter. And we expect to book an additional $79 million of loan-loss provision in the remaining three quarters of the year, for a total of $95 million in 2015.

On page 8, we report our earnings metrics. SLM Corp reports a metric we call core earnings. The only difference between core and GAAP net income is core earnings excludes the mark-to-market on unrealized gains and losses on ineffective derivatives from earnings. We use derivatives, predominantly interest-rate swaps, to manage interest rate risk on our portfolio. And all of these hedges are sound economic hedges. Core earnings for the quarter were $46 million, $0.10 diluted earnings per share, compared to $48 million for the year-ago quarter.

As Ray mentioned, core ROA for the quarter was 1.5%, compared to 0.6% in Q4 and 1.8% in the year-ago quarter. And our return on common equity was 13.1%, compared to 4% (sic -- see slide 8, "4.7%") in Q4 and 16.6% in the year-ago quarter. Considering we had no loan sales in the quarter, these are good solid numbers, and we expect them -- both ROA and ROE -- to rise over the course of the year as we execute on our business plan.

Last Friday, we announced the pricing of our first loan sale of the year. This transaction was done as a securitization with the sales of residual interest in the trust. Important to note that the loans included in this sale was a representative sample of our portfolio. What we sold was very much like what remains on the balance sheet. This transaction was met with very solid demand for both the notes involved in the sale and the residual. We had over 30 investors buy notes and more than a half a dozen participated in the residual. Also, we saw a number of new investors in our asset-backed issuance, which was very positive.

We received a premium of 10.5% for the approximately $740 million in loans that will be in the trust when it closes. This will result in an estimated gain on sale of $78 million in the second quarter. And, additionally, we will receive a servicing revenue stream of 80 basis points over the life of this trust. So, this transaction is a major milestone for Sallie Mae. We will look to do a similar transaction late in the third quarter of another $750 million. So, as you notice, we also are increasing our guidance for the premium to be 10.5% on our remaining transaction for the year, bringing our total loan sales to approximately $1.5 billion of loans.

Recap our guidance for 2015, we still expect to originate $4.3 billion of high-quality smart option loans. We expect our provision for the private portfolio to be approximately $95 million for the full year. Our gain on sales is now expected to total approximately $155 million and total OpEx will be $347 million for the year. As a result, we are increasing our EPS range to -- expected range to between $0.57 and $0.59.

That concludes my prepared remarks. And we'll now open the call for Q&A.

(Operator instructions)

Michael Tarkan, Compass Point.

First, on credit, I know we saw the improvement this quarter, which drives the optimism. But how confident are you that that trend is sustainable? And I guess more specifically, is there any amount of conservatism built in the current provision guidance in the event that credit gets a little bit worse from here? Thanks.

Yes, thanks, Mike. Basically, the provision that we provided back in Q4 was based on a lot of uncertainty that we were seeing in the low rates. Our collection performance began prior to the separation as we expected it to, but there was a considerable amount of disruption in October and November.

And subsequent to that, the performance has been extremely steady. And what is important now is that we are dealing with delinquencies that are from our first [phase] principal and interest repay wave that went into repayments in November and December. And it's performing very well and very close to as we would expect it to, so we feel pretty confident in this $95 million loan-loss provision that we've guided to.

Is there conservatism in it? As a general rule we try to, we strive to provide guidance that we can meet. And we're pretty confident that we're going to meet the $95 million. If the portfolio performs better than that, then it's all to the good.

Okay. On the loan sales, I guess I'm a little surprised that you're still guiding to $1.5 billion if pricing is still around 10.5%. I think last quarter you mentioned that if pricing came in over 8% or so, that you would potentially look to sell more. Is that still in the cards? If that 10.5% is still there, would you consider selling more than [750] in late in the third quarter? Thanks.

There's actually a couple of factors there. We're very content with the $1.5 billion for 2015. The [one 10.5%] was a very good result. If we were concerned that that would not be achievable in late 2015 or early into 2016, we might consider to sell more loans sooner. But we are reasonably confident that these high-quality loans will garner the kind of premium that we just realized in the marketplace.

And I don't want to get out over my skis, but I think as we develop this market and people see the performance that we're talking about now to continued to persist, I think it will be easier to execute additional transactions in the future. And the other thing is, it's kind of operational, so we got a late start here.

The gestation period for these kinds of transactions is several months, and we would like to also execute at least one funding transaction. So I don't know that there would be enough room in the calendar to do additional sales in 2015. But I think the important thing is, we like these assets as much as the people that value them at [ one 10.5%], and we're confident that we will be able to realize value from these loans in the future, whether we hold them or sell them now.

Okay, and then last one real quick. Given that the secondary market for the private assets seems to be developing pretty well, any impetus to sell the rest of that [Pell] portfolio at this point? Thank you.

You know, look, the [Pell] portfolio provides fairly nice margin for the Company and a very strong return on equity. So we don't feel compelled to sell that portfolio in the near future and again we view it as a component of our liquidity portfolio. So I think we're going to hold onto it.

Thank you.

Moshe Orenbuch, Credit Suisse.

I was particularly impressed with the 9% growth in volume. We saw some of the other large players kind of stable growth, and one or two even slowing down. Talk a little bit about how your achieving that and what that might mean for your origination growth target as you go forward?

Sure, this is Ray. One is, we also are gratified by the 9% growth. As Steve says, the rhythm of this particular market is that you sign up customers. Over the summer they have first disbursements in September. There is a secondary disbursement over the January time period.

As you know, we had a very good year last year. We did gain market share, which is what you're alluding to. This, in some sense, first-quarter result reflects many of the activities that occurred last year. We'll have a new, what we refer to as, busy season occur over the summer.

We do think the market is growing slightly. Hopefully we will continue to both hold our current market share, as well as improve it. And so we're very comfortable with the [4.3] that we have.

But it's right to think of the first-quarter results as more closely tied to activity in 2014 than in the last nine months of 2015. So I think there is still quite a bit in front of us, but results thus far are quite gratifying.

Just to follow-up on that Ray. Have you seen anything from your competitors that would lead you to believe they're doing anything differently? You talked about investing $3 million in branding and, I'm sure, other sorts of things that you're moving forward on. Anything else in the competitive environment you could highlight?

No, we watch this very carefully. As you know, we have a nationwide sales force, and we're in constant contact with our customers, who, of course, have three embodiments. One is the school themselves; the second is the cosigner; and the third is the student.

And we're always alert for anyone's initiatives, but we haven't seen anything from the major players. And while there are, at the margin, people come in and go out of the market, we don't think there's any change in the structure, the pricing, and, indeed, even the product itself.

Okay, thanks. And just to follow-up on the loan sale. I think what was probably most interesting about it was how attractively people priced the equity tranche. Steve, anything you can talk about in terms of that? And maybe just why this is so much more efficient for you than the whole-loan sales?

The reason why this is more efficient for us than the whole-loan sales is principally because we take all of the pain out of it for the people that want the residual. So they don't have to then go refinance this transaction. And it opens it up to a much wider audience of investors.

So while we had more than a half a dozen people actually end up buying the residual, there was a field that exceeded 20 at the start of the process. And you know whole-loan sale was -- I view that as a first type of a transaction.

But this, in a lot of ways, was the first also. We were dealing with new investors that were looking at new information and taking a look at Sallie Mae Bank for the first time.

So I think the process should become better and more efficient from this standpoint going forward. They yield on the residual, I think, was attractive, but it depends upon what set of assumptions the buyers value in it.

So we look at once set of default, accumulative default rates and pre-payment rates, which are probably the two most important assumptions that go into pricing this thing. And I would hazard to guess that the people that actually bought the residual would look at those assumptions in a different light than we do. But hopefully down the road those two outlooks will converge.

And presumably, printing the better credit for the last few months will help that on the next sale.

Yes, I think that's absolutely correct.

Thanks so much.

Sanjay Sakhrani, KBW.

Obviously, you raised the target a little bit there, and I want to make sure I understood. The $3 million in branding, excluding that it's about a $12 million increase, so that is kind of the new normal increase going forward? And you guys are pretty comfortable with that level going forward as being pretty firm?

So for 2015 the [340] run-rate operating expenses, we feel very confident about. We've learned a number of things over the course of the first quarter. The control, if you will, is comparing the forecast to the actual.

And we learned quite a bit about the full cost of operating the company as a standalone over the course of the quarter. And we feel very good about the [340] number. And I would be remiss if I didn't point that the we also increased the restructuring costs by $2 million as well.

But we have a very high level of confidence that we will meet this guidance, and that we will continue to also improve the efficiency of the operation going forward. And we think our unit costs servicing are going to continue to decline over the course of 2015 and 2016 and beyond.

Okay, great. And then a question for Ray, you mentioned we're kind of a year in to this whole thing from the spin. Could you just talk about what kind of diversification efforts you might be considering in the future? And what kind of conversations you might be having with regulators in terms of your capital levels and what you could do going forward? Thanks.

Sure, and as we've discussed on prior occasions, it's the case that 2014 is the year of transformation and launch. 2015 is the year of getting our model down to where we want it to be. We have some cleanup to do, as I said, from the original spin, and so far we're doing very well on our results in 2015.

Over a period of time, diversification is something we will consider, but, certainly, nothing proximate. It is the case that our [relays] are very happy with our capital ratios. But we have to remember that in regard to the regulatory framework, we are one of the fastest-growing banks that is larger than $10 billion in the country, if not the fastest.

So we want to have the right balance there. So I think diversification is something that we'll talk about in periods to come. Certainly nothing in the close-in quarters. And the capital ratios, as Steve had said a couple of times here, both on the maturation of the portfolio, as well as watching the performance of the Company in general and its ability to display for the regulators how attractive our assets are, will put us in very good position in all those discussions.

I would also add to that, Sanjay, that we have one very important event coming up in the middle of 2016, which is our first stress test. That will give us an opportunity in the future to have a further discussion with regulators about the appropriate levels of capital for our asset.

And Steve did not misspeak. It is 2016 that that comes up.

Okay, thank you very much.

Mike Taiano, Burke & Quick Partners.

Good morning. Just a question on the loan sale. Looked like, if I did the math right, that the all-in cost of funds on the notes was a little over 2%. Is that the range we should expect when you guys eventually do your own securitization later this year?

So I would say two things. I think your number is way high. I think the number is probably under 1.5%. I'm not sure how you're calculating that, but we can talk about that offline later on this afternoon, or after the call.

But one other point that I would make, if we were securitizing loans to fund them as opposed to sell the residual, the structure of the stack of bonds would probably be significantly different. And so, in other words, it probably wouldn't have the B and the C bonds, so we wouldn't go that deep into the structure. So we tend to have probably more AAA and shorter floating-rate costs.

So that would suggest even potentially lower than 1.5% level?

Yes, I think that's what we would target.

Got it. And then in terms of the loss reserve, you had, I think, given guidance in January that you expected to be kind of reserve ratio around 1.75%? Is that -- you expect that to be somewhat less than that at this point given your provision expectation?

Yes, I think that's right, Mike. I think you might have been focusing on -- oh, no. That's right. So you're looking at the reserve as a percent of loans in repayment. We tend to look at reserve as a total portfolio balance, so [1.82%] -- I'm sorry, the 1.75% would come down a little closer to -- yes, closer to, call it, 1.5%.

Okay. And then, just quickly last question. Obviously a lot of talk in the market the last few months about marketplace lenders, and a few of them sort of targeted the student loan space. And I'm just curious, it doesn't seem like you guys have seen much of a pickup in pre-payments or consolidation out of your portfolio.

But I guess one of the concerns out there is that as a student is sent to repayment, the risk of those loans goes down. And so there is potential for some of these guys to pick off some your better loans. How do you protect against that from happening as students enter repayment?

Sure, it is the case that when people talk about that, one, is there are broad generalities that are typically used in those discussions. And two is they are typically talking about exactly what you said, which is a student borrower. In fact, our profile is, as you know, a cosigner borrower along with the student.

So with 90% of our portfolio being originated with an average FICO score of 748, we don't quite fit the profile that people think of when they're thinking about consolidation loans. And consolidation loans are, as you know, dependant upon two factors. One is that individual who is looking for consolidation has improved his or her credit profile in such a way that they can negotiate a better rate.

And secondarily, if that rate probably is best suited, if you're thinking about consolidations as a fixed rate, as opposed to variable. And because we have either one of those characteristics, with our average FICO being at 748, most people are not going up from that. So the improvement in the credit profile because of our cosigner profile does not really occur.

And secondarily 85% of our loans are already variable rate, and so as rates are either go down or they go up mildly, the change in the extent interest rate curve is already built into the product. So we think both on credit quality, as well as on product parameters, we are in very good shape in regard to giving our customers the benefit of consolidation before they actually have to do the consolidation. And to date, we have not seen any change in our pre-payments versus our model.

Great, that's helpful thank you.

(Operator instructions)

David Hochstim, Buckingham Research.

Could you just talk a little bit more about the move to onshore, your customer service, and servicing? What is that adding to expense? And what benefits do you get? And are you using outside providers of call centers exclusively or your own employees?

Sure, I'm sorry what was that last remark?

I wondered if you're using your own employees are you're using outside firms only.

Okay, and the answer is yes. We use both our own employees, as well as outside firms. But let me go back to the beginning of your question which is off-shoring versus onshoring. As we've done additional market research in regard to how our customers make decisions, in regard to the financing of college education, it is the case that it is a very important decision for American households. And that they take it quite seriously.

And as with most financial decisions, many families are concerned that they're going to make either the wrong decision, or that there is a bunch of things going on out there, as it were about which they are uninformed. And so as we seek to be good partners for planning, saving, and paying for college with the families with whom we do business, it's obvious to us that the conversations in regard to the loans, especially the setup of those and evaluation of alternatives, are indeed that. They are conversations.

It is not just order taking. It's a question of what is best for the family and how should we accommodate that. In keeping with the fact that American colleges are an American cultural foundation point, as we review the performance of various service providers in regard to the families' concerns, we thought that we are much better off from a, both control, as well as a cultural standpoint by having our agents resident in the same market in which our customers are and in which most of the colleges are.

And so we think it's good practice. We think it's improvement in our service profile to bring all the agents onshore. We do use an outside vendor. We do also use our own agents, and so it's a highly seasonal business. And so, especially when we have the seasonal peaks, we think it's prudent to use some providers of services with whom we work all year, but who can get agents more easily at the margin during peak.

And we work with tele-performance. We have two sites that we've added to our service footprint in the United States over these last 40 days. One in Abilene, Texas, and the other in Indiana. And we're working through the partnership with tele-performers as we speak.

Okay, and in terms of cost is there much of an incremental cost to bring it back?

When we looked at it for 2014, our original estimate was in relationship to the overall cost -- it's a number between [$3 million and $5 million]. And so that was algebra of A to B, and operating cost. What that did not capture was what we believe to be the better service that we will experience over a period of time by having service units all onshore.

Okay thanks. And then I had a question just about what Steve said about funding costs. Was the increase in the cost of funds from Q4 to Q1 entirely related to one-time charges associated with the new buying? Or that's a step up and that's the run rate?

Well, it depends, David. We have not used that facility, so we pay an unused fee. If we replaced deposit funding, for example, with that fee, it won't be incremental. There is a one-time fee that you pay, and that is, one-time.

But now that I say that, we will be renewing this facility for the foreseeable future. So what it really comes down to is, are we going to use the facility, which would tend to decrease the number of basis points incrementally by a handful. And in the future, we will use this facility, but we will not have an opportunity to do so until the second half of the year.

So the 117 basis points is a run rate for Q2 then; we should think about?

Yes, I think that's probably a pretty good number.

Okay, thank you.

Sameer Gokhale, Janney Montgomery Scott.

Thank you. I just have a question about your gain-on-sale margins and what level of confidence you have in that level of gain-on-sale margin persisting, and as we look into 2016 or in the higher rate environment? And I also wanted to get a sense for what types of investors invested in that residual piece?

With they retention funds? Hedge funds? I just wondered if you can give us some perspective there, that would be helpful as well.

Sure. So confidence in the pricing, look, I mean, when you look at the interest-rate environment, if you look at the LIBOR curve or something along those lines, there does not seem to be anybody that's anticipating a significant increase in the interest-rate environment over the next, call it, year or two. And what I think we're seeing happening here with the residual market is that it used to be a lot more esoteric than it is today.

So as a function of the search for yield, investors have become more used to investing in residuals. So it has become a more routine transaction. There are regularly residuals sold in the auto-finance industry for example.

And residuals for student loans have become more commonplace. So as people become accustomed to doing the analysis and investing in residuals, I think it broadens the investor base, and it has a tendency to bring yields down over time.

And also this is, again, sort of a first mover transaction, and I think people become, as the investors look at this transaction, who were looking at student loans for the first time, become more up to speed on how the asset performs, I think that will help broaden the market and hopefully help pricing improve in the future. I think you also asked who participated in this transaction.

It was actually a very diverse group of investors. There was what I would call real buy-and-hold money managers that are, by nature of their business, investing money for pension plans for example. So I would say that that type of money was involved. And there was also, obviously, hedge-fund/alternative-investment type of investors participating in the residual as well. So it was a pretty diverse group of investors across the board.

Okay, and then I heard you correctly, Steve, earlier when you were talking about the residual, I though you said that, something to the effect of investor expectations or estimates of pre-payments, or their assumptions and other assumptions they have may have embedded into the value of the residual, may have been different than what you were expecting. If you could just clarify what you meant by that, that would be helpful.

Sure. So what I meant to say is, the two major, two of the key assumptions that go into valuing residuals are the pre-payments fee and the cumulative default rate. If the assets pay off faster there's less value in the residual, and, obviously, if more loans default, there is less value in the residual.

What we would call the Sallie Mae case, for example, would be a 3% pre-payment speed and then a 7% cumulative default rate. Someone that's investing in the residual might have an assumption that calls for a 4% pre-payment speed and a 9% default rate.

If they ran the numbers based on their assumptions, they would think that they're going to get an IRR in the, call it, 9% vicinity. If you value it at our assumptions, we would think that they would be receiving an IRR of, call it, 12%. The beauty of these things is in the eye of the beholder.

Okay that's helpful. Your guidance was great. Credit quality clearly trending better than you had expected. And it sounds like from what you're saying that given the newer investors that are now being introduced to these types of assets, of the residual. And some of the assumptions they are using relative to yours, you feel, it sounds like, that gain-on-sale margin given all that it's equal, would actually improve from here rather than the [tail] rate off of these efforts.

But if I were to just point out one element of this that I think you have to replace out a little bit which is that if you're in an environment where gain-on-sale markets come down and credit normalizes -- because those two things seem to be some factors that are somewhat outside your control. The one thing that could be central is operating expense growth.

And that seems to be higher and you pointed out some of the reasons for why that is higher maybe than you initially had anticipated. How much flexibility have you built into your operating expense space in the event that gain-on-sale margins, for whatever reason, comes down and/or credit provisions normalize because of seeing the macro economy? Can you give us a sense of the flexibility baked into your OpEx space?

You're asking an interesting question, Sameer. I think you're asking, we're not looking at the business like that. So we're pretty confident in the gain-on-sale. And I think you're asking if the gain-on-sale declined by 0.5% are we then going to toggle the switch and have reductions in cost at Sallie Mae.

If something extreme was to happen, we might take that tack. But at this point in time, we're very comfortable with our 2015 guidance. And we don't think we're going to need to toggle back and forth between the three or four variables that are core to our EPS guidance here.

I think another point that should get made here is when we talk about credit quote, normalizing, the models that we have were developed over the course of five or six years. And the projections for the portfolio is a seven-year projection into the future. And so when we're looking at credit losses, we're looking at them over the medium to long term.

It's not the case as we might think of in some other arenas where the current benign credit profile and performance that people have experienced in their current portfolios have caused them to loosen credit standards in order to take advantage of the benign credit environment. We have not done that.

We're not a coincident credit opportunist. And so we think that the credit that's in our model, which is multi-year, is already normalized. And so this is not a betting on a best case scenario for credit.

So then just as my last question, which ties into your last commentary. If you were to look at EPS growth for 2016 then, should we assume you can generate a 15% EPS growth rate off of your guidance? Because it sounds like, again, gain-on-sale margins would be flat to up.

Provisioning, probably, is not more of a headwind. It just probably stays relatively stable. And you get operating expense leverage. So if all those three things are going in those directions, then sounds like you should be at the 15% EPS growth off of our updated guidance levels, unless we're missing something else, right?

Yes, and so we have a strong market position. We have a terrific business model. We're very optimistic about our multi-year future. 2016 will be amongst those items on which we are optimistic, but we're not in a position to give guidance in 2016 in this session.

Okay. Fair enough. Thank you.

(Operator instructions)

Eric Beardsley, Goldman Sachs.

Hi, thank you. Just back to the charge-off expectation. I presume your longer-term expectations of charge-offs did not change even when you had that hiccup in October, November.

So just curious given that you were just talking about how you have a long-term model that you don't look at things coincidentally. Can you just give us a little more context of what you were seeing, and based upon that October, November data might be hypothetical, but what would cume charge-offs have implied if performance went down that fast?

Sure, Eric; this is Ray. One is, let me not mis-communicate. While the model is multi-year, the idea that we would not pay attention to what's happening each day would be an erroneous conclusion. We're very much on top of these numbers every single day.

It is the case, though, that the model is a long-term relatively smooth curve, and that if we have a month or two may affect guidance for the next quarter or two, but it's not affecting the model. And so it's the case, as I said a little bit earlier, that when you're growing a portfolio -- and our full P&I portfolio has grossed over 100% from a year ago to the year now.

Two things are true. One is there is a higher concentration of losses in the relatively early parts of the life of those portfolios. And two is as people come into full P&I, the volatility in the early months is very high. And so I think forecasting off any one of those for a medium-term or long-term model would be an error in quantitative methods. But it's right to say that we expected a reasonable amount of noise.

We think it's incumbent upon us to guide our investors to what, as Steve said earlier, is a deliverable set of quantitative goals. We did that in January. We're doing it again now, but neither one of those points are significant enough to effect any model conclusions that are relevant in a period that is seven years long.

Got it. Well, I guess within those seven years, you do have the two years up front. So the provision came out. I was just curious, what was that provision implying for charge-offs, as you guys were running that?

Well, I think we could look at that, but there are two different questions. One is what is the calculation of that. And then second is whether or not there is any impact on the model. The answer to the second is no.

I don't know, Steve, if you have that handy so far as the provision guidance from January and what the implication on that would've been. But remember that the provision has a one-year outlook horizon of 12 months.

So the difference in charge-offs was 15 or 20 basis points.

Okay, if you heard that, it's 15 to 20 basis points is what Steve said.

Got it. That is on loans and repayment? Or the total book?

That would have been on total book.

Total book. All right, great. And then just, lastly, in terms of managing the cash balances, I understand you guys are going to have the $750 million increase with the sale in Q2. But what's the right level to think about of your cash and securities to total assets going forward?

So it's probably tied more to loan originations. And that should be coming down now that we have this additional $750 million in secured funding available to us. So you will be our cash coming down relative to the total balance sheet side and relative to originations as well in future years. Right now our hands are somewhat tied because we don't have major maturities of liabilities until the second half of the year.

Got it. So from a liquidity perspective, I don't know, say 15% the right level going forward? Is that something that the regulators would be comfortable with?

I think they would certainly be comfortable with that level, but there is a number of factors that are going to be involved here.

Okay, great. Now, on the tier 1 common ratio, you're able to bring that down now below 15%. Is there a level -- I guess you mentioned the stress test in 2016 -- is there a certain level that you're not comfortable going below in the near term?

So we continue to target total risk-based capital due to the nature of our asset base here, and our target there is 14%. We're, obviously, we're going to be well above that as of the end of the second quarter once we adjust our portfolio for the capital we generate through the sale and the release we get from the loans coming of the balance sheet.

And we will probably end the year closer to 15% than 14%. So we have a lot of run rate given our capital levels to support the growth in the portfolio over the next several quarters and years.

Okay, great. Thank you.

There are no further questions at this time. I would now like to turn the call over to Brian Cronin.

Okay. Thank you for your time and your questions today. A replay of this call and the presentation will be available through May 6 on our investor relations website salliemae.com/investors. If you have any further questions, feel free to contact me directly. This concludes today's call.

Thank you for participating in today's conference call. You may now disconnect.