SLM Corporation (SLM) Q3 2008 Earnings Report, Transcript and Summary

At this time, I would like to welcome everyone to the SLM Corporation's Third Quarter 2008 Earnings Conference Call. (Operator Instructions). Thank you. I would now like to turn the call over to Mr. Steve McGarry, Senior Vice President of Investor Relations. Sir, you may begin.

Thank you, Jessica. Good morning, everybody. Welcome to Sallie Mae's 2008 third quarter earnings conference call. With me on the call today are Al Lord, our CEO; and Jack Remondi, our Chief Financial Officer. After they finish their remarks, we will open up the call for questions. Please note that during the conference call, we may discuss predictions and expectations and may make other forward-looking statements. Actual results in the future may differ from those discussed here, perhaps materially based on a variety of factors. Listeners should refer to the discussion of those factors on the company's Form 10-K and other filings with the SEC. During the course of this conference call, we will refer to non-GAAP measures that we call our core earnings presentation. The description of core earnings, a full reconciliation of the core earnings presentation to GAAP and our GAAP results can be found in the third quarter 2008 supplemental earnings disclosure accompanying the earnings press release, which was posted under the investor page at our website, salliemae.com. Thank you. And now, I'll turn the call over to Al.

Thanks, Steve. Let me say good morning and welcome all of you to our third quarter earnings call. We will be talking about our third quarter operating results and of course the financing environment we are operating in, which is obviously responsible for much of the earnings results that we're going to talk to you about today. Obviously, our earnings are the product of much higher cost of funds this year than in previous periods. For us and I suppose other wholesale financials, it's been a challenging period. And I would guess at this point, you have read our press release on earnings and press reports that describe our GAAP earnings and our core earnings and the confusion that always results as a consequence of those two measures. Jack Remondi, our CFO, will cover that information in far more detail and sort a lot of that out for you. My comments will be brief, and I will cover the following subjects; the quarter's results, the large picture items, asset quality, and funding challenges. For the quarter, we reported $0.19 a share. That's measured against what we would refer to as recurring earnings per share of $0.36. They're both based on our core earnings. The major charges in the quarter were $242 million cost of restructuring and impairment at our asset purchase companies. The names of those companies are Arrow and GRP. We have talked about these companies with you before, I believe in the second quarter, and we talked about what we were going to do with the companies. We took a look at selling them, and in fact will sell some of those assets. For the most part, we're restructuring and re-managing those companies. And those changes were implemented in the third quarter. The assets that we don't sell, we will manage ourselves. There are other smaller non-recurring items in the second quarter that Jack will cover with you shortly. I want to also mention asset quality. This company made a presentation as recently as September 2nd. I believe it was in New York at a Lehman Brothers conference where we talked about asset quality. And frankly, it was really the first we had begun to see our delinquency buckets begin to back up a little bit. That backing up, if you will, has continued, and to a fairly sizable uptick in the September month, September delinquency buckets. I guess that's another way of saying that it's caused us, particularly in light of more macroeconomic developments, to reassess our third quarter loan loss provisioning and our fourth quarter and probably our 2009 bad debt provisioning, but we are here to talk about the third quarter at the moment. Accordingly, we increased our private provision to something slightly over $200 million, I believe $202 million. It's roughly a 25% increase from our previous quarters of 2008, and on a per share basis, cost us about $0.05. As you might guess, we continue to watch asset quality very closely as this economy evolves. Move to funding challenges. We have just left a quarter which for Sallie Mae began quite strongly. We completed three FFELP ABS transactions in the third quarter. Those transactions totaled $6.7 billion. I won't to tell you that they were done totally inexpensively, but frankly the cost of those deals was moving in the right direction as compared to where they were earlier in the year. They enabled us to reduce our asset-backed commercial paper facility by $6 billion from $34 billion to $28 billion. And so by mid-August, we were quite optimistic that we were going to reduce that ABCP facility even more significantly by the end of the year. The fact is since the second week of August, the ABS market and frankly other credit markets have shut tight, which I probably would suggest is an understatement. As you're well aware, Sallie Mae is a wholesale user of capital funds, and so we are very anxious to see the markets reopen. The federal government, as we are all well aware, has aggressively moved to fill an active role and has primed the pump and put a lot of money into circulation. We will be happy to see some of it. We also understand that the federal government is working in a variety of areas and departments to create additional means to provide further liquidity for FFELP loans in a fashion as contemplated in the Kennedy/Miller legislation. Just a brief primer on the way we're looking at our liquidity position and our capital position at the moment. For the most part, our FFELP loans are being funded through the means that were implemented by the Department of Education and Treasury back in the spring and summer, again, as a result of the Kennedy/Miller legislation and that allows us to fund all of our new loans. This company also funds loans that it acquires from others, some of which were made prior to 5/1/2008 and requires liquidity from other sources. But for the most part our new FFELP loans are being financed through the facility that I mentioned. Our private credit is originated at our bank, and we are financing that volume through our banking subsidiary. I think it would be remiss of me not to mention that we've tightened our credit standards in light of the economy, and frankly, because it's just impossible for us, at the moment, to meet all of the demand that we're seeing. The third use of cash that this company has in a major way is the repayment of debt maturities on its unsecured debt and we've managed to finance that out of cash flow. This means of financing ourselves works. I'd have to label it, as a 40-year veteran of the corporate wars and as a long time CFO, it is a situation that is not exactly ideal. We would certainly prefer to finance our FFELP loans and our private loans to term, as we have made a practice of doing for 40 years, 35 years at least. We prefer to repay our unsecured debt maturities with new unsecured debt. These are goals that we will work to meet and to continue to meet tomorrow. That market is not here today. One last issue I want to cover, and that is that we're continuously asked about rolling our one-year asset-backed commercial paper facility. It is a one-year facility. We had it in place about one month, before we began to be asked about when we were going to renew it. I just want to mention that it is due in four months, it is not due tomorrow. We are, as we speak, talking with the principle players in that facility. Again, we reduced that facility from $34 billion to 28 billion. Certainly our goal is to reduce it even more than that. It is not inexpensive. As I have said, we've begun conversations with several of the major banks, each of whom have expressed a willingness to work closely and to get this done. They recognize the significance of it. It is because of those conversations that I can tell you that we are confident that we will get that facility renewed. I am sure we won't renew it as fast as those of you who want to know when it's going to be renewed, but we are on the case and it is a very high priority for us. I think with that I am going to stop talking and let Jack cover the details and the big picture of our third quarter earnings. Jack?

Great. Thank, Al. Good morning everyone. I'll now take the next few moments to review our operating results for the quarter about the GAAP and a core earnings basis. In addition we'll look at funding activity and liquidity. I'll provide an update on our lending business and review the performance of our private credit portfolio. And finally, I'll provide an update on our outlook for the remainder of the year and the prospects for 2009. For the quarter, core earnings including non-recurring items were $117 million, or $0.19 per share compared to $259 million, or $0.59 per share in the year ago quarter; the non-recurring items include a charge of $7 million, or $0.02 for restructuring expense; and net loss of $147 million, or $0.31 per share, primarily from the impairments and our purchase paper businesses; and net income of $74 million, or $0.16 a share as a result of a significant reduction in prepayment speeds, which impacts premium amortization. Excluding these items, earnings were $0.36 a share. In addition, our third quarter results were lower due to higher funding costs including our asset-backed CP program, where the fees totaled 77 – the amortization of fees totaled $77 million in the third quarter, or $0.17 a share. Net interest income for the quarter was $712 million versus $664 million in the prior year period and our net interest margin increased to 1.52% from 1.50% in the year ago quarter. Our loan loss provision in the quarter was $263 million versus $102 million in the prior quarter. $50million of this provision was for federal loans, an increase of $25 million from the prior quarter. This is due to a $20 million cumulative adjustment to reflect higher loss assumption. At September 30th, our allowance for federal loans covered approximately eight-quarters of expected losses. We also increased our private loan provision by $39 million to $202 million, as a result of higher delinquencies and the continued weakening of the U.S. economy. Current economic conditions require us to remain cautious, and our provision this quarter reflects this caution. Fee income in the quarter was $64 million including $242 million in impairments and our purchase paper businesses compared to $283 million a year ago. And operating expenses excluding restructuring items were $316 million in the quarter compared to $333 million one year earlier. Total equity at September 30th was $5.3 billion, resulting in a tangible capital ratio at quarter end of 2% of managed assets, up from 1.9% a year ago. With 82% of our managed loans carrying an explicit government guarantee and with 70% of the managed loans funded for the life of the loan, we believe our capital levels are appropriate given our asset and funding mix. The credit markets are clearly presenting unprecedented challenges. And one of the largest funding challenges we have, and certainly one we are focused on, is our $28 billion in structured short-term facilities. During the quarter, we reduced these facilities by $6.2 billion and we are working with the lead banks to extend this facility well ahead of the February maturity date. Through the first nine months of 2008, we issued $21 billion in term funding, including $6.7 billion in term FFELP ABS in the third quarter. The all-in costs of our new FFELP issuance for the quarter averaged 144 basis points over LIBOR. We've not issued FFELP ABS since the end of August. And today, investors remain on the sidelines making access even to AAA rated FFELP ABS uneconomic at best. This for a structure where the AAA investors get paid in full even if one assumes a 100% default rate. As a result of the recently implemented Department of Education facilities, we now have unlimited funding for FFELP loans originated this academic year. With this facility in place, we've committed to make federal loans to every student at every school despite the current credit environment. This has allowed us to fully meet the needs of our most important customers: students, parents, and schools. Congress has already given the Departments of Education and Treasury the authority to extend this program through the next academic year. Secretaries Spellings and Paulson recently reaffirmed their commitment to do so. In addition, we expect the administration to take action soon to include all loans covered by the act that is Stafford or PLUS are first disbursed after September 30th, 2003. This would provide us funding for approximately $16 billion worth of loans. We continue to work closely with Education and Treasury to implement a workable long-term solution and we are thankful for their efforts and continued support of the Federal Student Loan Program. The current credit environment has prevented us from meeting the full demand for new private credit loans. Our lending is limited by what we can fund with term debt. Today, all new loans are funded with deposits through our bank's subsidiary. We continue, however, to work to develop term sources of funding for this important asset class. Our conservative approach to funding has served us well in this environment. At the end of the quarter, 70% of our managed student loans were funded for the life of the loan. Another 15% is funded with fixed-spread liabilities with an average life of 4.6 years. Our position is to remain consistent throughout 2008. We will only make new-term loans to the extent that we have secured access to term financing first. In this environment, maintaining significant liquidity is our most important task. At quarter end, we had just over $12 billion in primary liquidity consisting of cash, investments, and committed lines. In addition, we have $9 billion in what we call stand-by liquidity in the form of unencumbered FFELP loans. We project our free cash flow to exceed our debt service requirements through 2009. In August, we began using the Department of Education funding facility to originate FFELP loans. This facility enables us to originate and fund an unlimited amount of these assets. As a result of this and other recent significant changes in the industry, we have refocused our originations on our internal brands. As a result, our FFELP volume from this source is up 51% academic year-to-date. In addition, we originated over a $1 billion worth of loans this quarter for our service-only business. We continue to expect new FFELP application volume to exceed $20 billion in the '08-'09 academic year and our service volume to exceed $4 billion. Our forecast is consistent with what we originated this quarter and what we see our in our pipeline. In private education loans, our originations declined 24% to $2.1 billion in the quarter. In addition to reducing the amount of loans we have originated, we significantly increased the quality of the loans we are underwriting. In the most recent quarter for example, the average FICO score was 733, and over 70% of the loans we made had a co-borrower. For the quarter, our core student loan spread was 190 basis points, an increase of 21 basis points from a year ago. The increase was due to the reversal of premium amortization expense to the slower prepayment speed, partially offset by higher funding costs. In terms of credit in our traditional portfolio, the 90-day delinquencies as a percentage of loans and repayment increased by 0.7% to 2.3%, while forbearance usage at quarter end declined to 11% from 12%. Net charge-offs remain flat during the quarter and our reserves at September 30 were two times our annualized net charge offs. In our non-traditional portfolio, 90-day delinquencies during the quarter increased 2.1% to 11.9%. Exiting this business has put this portfolio into a run-off status, yet forbearance usage has declined significantly here to 14.4% from 18.5% with charge-offs also falling to 12.9% from 15%. Reserves at September 30 for this segment of the portfolio were 2.4 times annualized net charge-offs. Charge-offs and forbearances declined sequentially this quarter, evidence that our portfolio continues to perform well despite the extreme economic conditions. Delinquencies increased this quarter and while some of this is seasonal, we also attribute this to the weakening economy and the increase risk analysis being applied to forbearance requests. This increase in delinquencies requires us to remain cautious and this caution is reflected in our increased loan loss provision. Operating expenses in our lending segment declined significantly to $142 million in the third quarter from $164 million a year ago. This represents 32 basis points as a percentage of the average managed student loan portfolio, down from 42 basis points in the year ago quarter. This decrease is the result of our efforts to improve on our industry-leading efficiency given the changing economics of our student lending business. We are by far the largest, lowest cost originator, servicer and collector of student loans. Our scale and efficiency are a significant competitive advantage, helping us to secure profitable market share. We plan to continue to improve on this advantage in 2009. During the quarter, we earned $44 million in floor income, up from $40 million a year ago and there was an additional $1 million in floor income that is not included in our core results. In our asset performance group segment, we had a net loss of $124 million versus income of $17 million a year ago. Within this segment our core student loan contingent collection business generated net income of $26 million, while our purchase paper business generated $150 million loss due primarily to the $147 million impairment charge in our purchase mortgage portfolio and $95 million impairment charge in our purchase paper business. We announced last quarter that despite being good businesses, the purchase paper businesses were no longer a good strategic fit for Sallie Mae. After exploring the options available to us, we concluded that in the current economic environment, the company would realize more value by winding down these operations than by selling them. However, in light of the downward trends in the economy as a whole, and in the mortgage sector in particular, we determined that further impairments were warranted. After writing down the value of our mortgage portfolio by 16%, we believe we are now carrying it at levels that reflect the current real estate declines that are expected by mortgage industry participants. Of the $95 million in impairments in our purchase paper business, 56 million is from a loss associated with the sale of our international segment of this area. The sale is expected to close by November. The remaining $39 million impairment was taken in expectation of a significant slowing economy and the impact on collection revenues. We believe our carrying value of both the purchase paper and purchase mortgage portfolios anticipate significant further decline in both home prices and economic conditions. Revenues in the guarantor service business totaled $37 million in the quarter versus $46 million a year ago. The decrease in revenue is due to the legislative changes that reduce the account maintenance fee paid to guarantors by 40%. Total other fee income, including new promise and loan servicing, declined $12 million to $51 million in the quarter, due primarily to a one-time gain recorded in the year-ago period. We recorded a third quarter 2008 GAAP net loss of $159 million or $0.40 per diluted share compared to a net loss of $344 million or $0.85 per share in the 2007 third quarter. The largest difference between GAAP and core earnings this period is the net impact of derivative accounting, which resulted in a $201 million unrealized mark-to-market pretax loss, recognizing GAAP, but not in core earnings results. The GAAP provision for loan losses was $187 million, up from a year ago at $143 million and our GAAP net interest income was $475 million for the third quarter compared to $441 million in the third quarter of 2007. Under GAAP accounting, the provision for loan losses and net interest income are based only on on-balance sheet loans, whereas the comparable core earnings figures are based on the total managed portfolio. As 2008 has unfolded, we've seen several positive developments like the Department of Education funding facility, broad bipartisan support for FFELP and better-than-expected performance in our private credit portfolio year-to-date. At the same time, the credit markets and more recently the spread between commercial paper and LIBOR have weighed on our results. At September 30th, $120 billion of our managed loans are tied to a commercial paper index, while funded with liabilities index to LIBOR. We believe that there is broad recognition that due to the unintended consequences of government action in other areas of the capital markets and virtually no issuance of qualifying commercial paper that the CP index and its relationship to LIBOR is broken. We are working closely with government officials to swiftly address the issues presented by these developments. For the remainder of 2008 and 2009, much depends on the funding environment for student loan assets in this CP-LIBOR spread. In an environment where funding assumptions in the CP-LIBOR spread are unchanged, our guidance would be unchanged as well. However, given the issues with the markets and this important index in recent weeks, it's difficult to provide precision on the earnings potential of Sallie Mae. We expect the visibility on this index in the terms of the Department of Education program for both new and old loans to come into better view over the next several weeks. Once this occurs, we will provide guidance for the remainder of the year and 2009. With that said, we are confident that the significance of these issues is understood. In closing, we are proud to have been able to meet the student loan needs of our student, parent and school customers and to fill the gap vacated by others. We are working with government officials to fully implement the ensuring access to Student Loans Act and to ensure students and parents will have continued access to student loans in future academic years. With that, I'd now like to open the call to your questions.

(Operator Instructions). Your first question comes from Sameer Gokhale with KBW. Your line is open.

Thank you. Good morning. I had a couple of questions. The first one was in terms of credit quality. I know Al and Jack, both of you provided some commentary there. And I know in your press results, you mentioned that credit quality was trending a little better than expected. But credit metrics seem somewhat puzzling given the macroeconomic backdrop. You saw an increase in delinquencies, but forbearance rate came down, maybe contributing to go the increase in delinquencies, but charge-offs were also only kind of flattish, maybe down slightly in this kind of an environment. So, I just was wondering if you have anymore additional perspective as to why credit hasn't deteriorated more in the current environment. I mean I think it's easier to say, well, you maybe intensified your collections efforts, but is it as simple as that? Or is there something else going on there that's resulting in charge-offs, maybe, not moving up as much as one might expect?

There's a lot going on in this area, and I think it is a combination of efforts. Clearly, we are enhancing our collection efforts with a number of significant changes in that area to be more proactive at addressing higher risk accounts. On the forbearances side, for example, we are applying far more analysis to requests that we receive to make sure that borrowers are both, one committed to serving their debt, and two, have the actual ability to benefit from a forbearances. And so, we are working in those areas. And this whole effort is really being led by a new team of individuals who are doing far more segmentation of the areas and analytical approach to that space. We also have some of the, I would say, some of the more higher risk loans that were made over the last couple of years moving their way through the system. And as those charge-off, they're not being replaced by other loans in the pipeline of similar credit quality. So the quality of the portfolio that remains is improving each day, as you know, in particular the nontraditional portfolio moves. And then the last thing I would state is and this is particularly true on our traditional segment, it's who we are lending to. When we do our job right in making private credit loans, we're lend to people who will become college graduates and college graduates experience significantly lower levels of unemployment than the population as a whole, about half the rate of the population as a whole, and have significantly higher income potential. And that is a, I think a big issue. It's also, you know, when you look at the portfolio statistics here, there's about 26% or 28% of the U.S. population has a college degree. So we're in a small segment of that area. And the last piece I would add that this is unique, really unique to the student loan space is the existence of co-borrowers. Many loans have co-borrowers but they're typically spouses and the economic situations are the same. Our co-borrowers are typically parents with very distinct economic households, and therefore, really we get a very, very significant lift in terms of credit performance by their being on the account. And as I mentioned in my comments, it's one of the reasons why we're then far more active at promoting co-borrowers on the loans to the point where 70% of our loans made this quarter had a co-borrower.

But would you say that maybe given the weaker economy that maybe more students have decided to stay in school rather than otherwise drop out? In the margin, maybe that's contributing to maybe perhaps better than expected credit quality in some sort of sense?

Well, there's no question that there's that that is a counter-cyclical issue with education, demand for education but our denominator here just excludes loans in school. So, when we look at delinquencies as a percent of loans and repayments, it's not taking people who move back to the school channel.

Okay. Then just another question was in your debt purchasing business. You talked about some of the impairment charges and the like, but at this point, do you think you are done with all of the impairment charges you are going to take and all of those assets have been marked down given the way the accounting works in that business or should we expect additional impairment charges in the future as well from those businesses? Also, if you can just remind us as to how much equity you have allocated to those, the debt purchasing business, that would be helpful.

On the earnings front of that, the charges that we took this period are intended to put us on a path, where these business lines will be net contributors to earnings in the fourth quarter into 2009. The portfolios do run off have fairly steep amortization curves and we think we've anticipated very, as I said very significant deterioration in terms of economic environment as well as home prices. On the mortgage side, for example, we're taking an additional 17% or we're applying a further reduction in home prices of 17% from where we are today, not from the beginning but today. So I think that is just an indication of conservative nature there. In terms of the equity allocated to these businesses, these have far higher equity allocations and market conditions require even more of that today, as part of the reason for the not quite fitting well with the business as well as other aspects of it. We haven't broken this number out in terms of what we want to do here, but these are in run off mode and the capital contribution going to this is in a decline mode, not a increasing mode at this stage.

Okay. Thank you, Jack.

Your next question comes from the line of Lee Cooperman with Omega Advisors. Your line is open.

Thank you. Just three questions. I realize the first question is a very academic one because their charge...

Hey, Lee, can you speak up a little?

Yes. Can you hear me now?

Yeah. Yeah, we can hear you.

Good. I am saying the first question, I have three questions. But the first question, I think is academic because you are basically fulfilling your charge of lending loans to qualified students, making loans to qualified students. But we calculate that the company elected not to make any additional loans and go into a run off mode, then the net asset value of the company approaches almost $20 a share. Again, I understand it's an academic question, but I'd be curious if you have a view on that. Number one. Number two, do we have the financial flexible to buyback some of that debt that matures in a shorter timeframe, which is also in a discount to face value given the environment we're in? And third, I think I understand the answer. On the September 2nd meeting that Al spoke at the Lehman conference, you had hoped to be at the upper end 2 to 2.25 in guidance. And I assume we are right now not in a position to give guidance. Is that the infringe from – was set before. So those are the three questions that you could help on.

Well, you are right in stating that if we were to stop all kind of lending activity that the value of this franchise is certainly well in excess of the stock price. When you looked at things, if you assume a normal CP LIBOR spread, you would be in a number that would be well into the mid-teens in this environment. That assumes conservative assumptions about credit quality. The CP issue really creates a wrinkle in that process. The index is clearly not functioning today. Several times this in the last couple of weeks have been no paper has traded or small single-digit millions of paper have traded. Yet it drives the yield on about $400 billion worth of student loans outstanding. So, that issue needs to be fixed to kind of know where that number would be I think over a long-term horizontally and we certainly expect that and as people are aware of the issue and are working to address it. On the buyback side of the equation, we are with you on this. We would like nothing more than to be far more aggressive at buying back our debt in the marketplace. The yields that are available there are just, do not reflect the fundamentals of this company from the asset quality side and the cash flow side of the equation. However, in a capital markets environment, where there is no net new money being lent in the last couple of weeks, we just unfortunately are in the position of being super-conservative and not being aggressive in that front. Now, year-to-date, we have bought back about $1.8 billion in unsecured debt. Most of this is all in short durations. If we saw our opportunities to do that for '08 maturities and early '09 maturities, we would continue to be there. And on the guidance side of the equation, just on your first question, the CP issue is causing us to, to hold back on that until that issue is resolved.

Thank you very much and good luck.

Thank you.

Thank you.

Your next question comes from the line of Matt Snowling with FBR Capital Markets. Your line is open.

Hi, good morning. Jack, you mentioned, trying to work with the Government to address the CP LIBOR issue, I am just wondering does the department of Ed actually have any authority to change that index?

I think there are a wide variety of parties involved in this issue. It is not just a Department of Ed issue. And I would say at this stage in the game there, if all the people who are working and I'm not aware of anyone who doesn't appreciate the significance of it and the fact that you can't have an index that doesn't trade or one that is influenced or impacted by Government support of commercial paper programs to not address this. But, it is something that has really just cropped up in the last couple of weeks and has become far more significant as the volatility in that spread between the index and LIBOR, has just been all over the map in the couple of days.

But would any relief require an enact of Congress?

Well I think there is short-term fixes and there is long-term fixes. If you are talking about changing the index on the loans themselves, that would require a legislative fix. It's in the statute that the loans are tied to this index.

Okay, I understand. One other question. I think in the release you reported having $3.1 billion of loans from partners that don't qualify for the Government purchase program. Are these all loans that are going to get funded in the next quarter or two?

No, that was over through 2009 and they are commitments, they are Federal student loans and there are commitments to buy loans through our forward purchase customers. But the same business we have been in for a number of years. We are not generating a whole lot of new assets in that area. We are generating more on the servicing side from those customers than we are on loan purchases and they are, as I said that was scheduled to take place in both Q4 and then through 2009.

Any new loans that come through that program, would they then qualify for the government facility?

Correct. Yes. These are all our legacy loans.

Understood.

And I think we said this, about 0.5 billion of that is eligible for the DOE funding facility.

And Matt, just to make further one point on that. The DOE funding facility that is in place today, if they go back and fully implement, Ensuring Continued Access to Student Loans Act, that would make loans first dispersed after 10/1/03 eligible and then all of these loans would become eligible for that program.

Right, these are all Stafford loans, not consolidation loans.

Correct. Yes, there are no consolidation loans in that number.

Okay. Thanks.

Your next question comes from the line of Jay Sheth with Columbus Hill. Your line is open.

Yeah. Hi. I had two questions. One, could you talk a little bit about your efforts with Sallie Mae Bank and how you are able to grow deposits there and then secondly, Jack, to the extent that you can provide anymore detail regarding Government facility, this new facility that you referenced in your comments in terms of structure and timing, that would be great.

Sure. On the bank side of the equation, our primary source of deposits is broker deposits and because we are dealing with long average life assets, we focus on long average life CDs. So our deposits, our main focus area is deposits with two to five year maturities. We have had very good success, attracting more than sufficient deposits to meet the funding obligations that we have on the private credit side of the equation or what we are originating on the private credit side of the equation. On the new Government program, the terms and conditions of this are not yet out. We got a press release from Secretary Spellings and Paulson a couple of weeks ago now reaffirming their commitment to the fully implementing this what's known as the Kennedy/Miller proposal, ensuring continued access to Student Loans Act. It does go back to loans made, Stafford and PLUS loans made on or after 10/1/03. I think they fully appreciate and understand the importance of getting that out soon. As to the timing of it, we are working closely with them, and I would prefer to just let them lead that process than me.

And could you just tell us what are deposits now versus at the end of the third quarter?

Today versus the end of the third quarter?

Yes.

We have raised probably something in the magnitude of maybe around $500 million of deposits in October.

Okay.

From $744 million. And we broke out for you in the supplemental this quarter under what'd previously be listed as short-term funding, both bank deposits as well as the Department of Education facility program, which obviously is considered short term for GAAP accounting purposes. But because of the put, there is no short-term repayment obligation.

Okay, understood. And if I can just squeeze in one more question, if you could just talk a little bit. We have not yet heard of students not being able to go to school because they can't get private loans and fund the gap. And I guess just given where you sit on campus, can you talk a little bit about what's happening in terms of student budgets?

Student, what was the last word?

Student budgets and how they're funding the education shortfall or the funding shortfall?

I think when you look at what's gone on in the last year-and-a-half or so between the Higher Education Act Amendment that were passed in '07 and then later in '08, we've seen a significant increase in loan limits. And that increase in loan limits has helped meet some of the gap of how students actually pay for college. I mean I don't know the specifics on this, but anecdotally, you have read about colleges increasing financial aid and stuff and things of that nature. Clearly, there is demand. We are seeing higher demand for private credit loans than we are able to meet. Some of the demand is for people who would never qualify for a loan. Some would in normal circumstances, but because of limited funding resources on the term side, we just can't make it at this stage in the game. But two things are happening on our private credit lending. Clearly, in '08, we have changed the underwriting standards of what we operate. I mean the biggest example of that is exiting the non-traditional segment. But the rest of the private credit demand is being impacted just by funding. I also think it's important to note here, as we have said, we are committed, willing and able to make every FFELP loan to every student at every school. We have not turned down a single borrower in that area and we are not aware of a single borrower across the country who has not been able to access those loans. And it's important to note that we have stood up to that. We are very proud of that. The Department of Education and Treasury and Congress have supported us and others in the industry to be able to do that this year. And unlike other areas of consumer credit, this area is functioning and credit is flowing.

Got it. Thank you very much.

Your next question comes from the line of Bruce Harting with Barclays. Your line is open.

Jack, the prepayment activity adjustment, deceleration in prepayments and the premium amortization change of 27 basis points, from the text, it looks like that was a one-quarter adjustment. But should we expect anymore extension in prepayments that could impact that again in the fourth quarter? And then when will the impact of the LIBOR change really impact your margin? Will we see the brunt of that in the fourth quarter?

On the prepayment side, the adjustment there was cumulative, which is why it is in the non-recurring items. Under accounting rules, if you pay premiums or cost that get amortized over the life of the loan, you have to amortize on an effective interest method. And when the life of the loan extends, you have to in effect pull back premium amortization that you previously expensed and re-amortized it over that longer period. That is taking into account the lengthening that we see not just this quarter, but prospectively over the remaining life of the loans. Prepayment fees are low right now. It's coming principally from the virtual elimination of loan consolidation as a product for consumers on the FFELP side. And frankly, that's not a product that was eliminated because of the credit markets. That was eliminated because of the legislative changes that took place in '07, making the product uneconomic even at LIBOR plus eight type funding costs. So that's the area there. Your second question?

Margin outlook for the fourth quarter?

Yes. The CP index, that would be something that you would see an immediate impact in. So, you would see the full brunt of that in the fourth quarter based on whatever the average spread is for the quarter. It is important to note that the CP index on the loans is actually the quarterly average of the rate, so we won't know what the actual impact is until December 31st.

Okay and just a technical question, on page 53 where you talk about the purchase paper mortgage properties and non-mortgage, what are the actual outstandings in these discontinued programs right now and how do I, what's the tie back on to the balance sheet on page two of your consolidated balance sheet disclosure?

They're in other assets and the current carrying value is listed on that page on bottom of page 53. But it splits between purchase paper and real estate owned, the mix is about $470 million of loans and $330 million of real estate owned.

Okay.

And they are carried at what we believe is cost of 69% of fair market value today.

Okay, so the page 53 number, 544 of non-mortgage and 798 of mortgage, it is sum of those two and then those are carried in other assets of $10 billion on the balance sheet?

That's correct.

And those are just in runoff and now you feel that after the charge is taken in this quarter, you have written them down to the appropriate value for continued deterioration in the housing economy?

That's right.

There in the economy? Okay and then final question on the private loans. That's great about the FFELP loan and that you are making loans to every comer in terms of new originations on private. You went through your FICO score number of 733 and 70% co-borrower. Are you getting much higher interest rates on those loans as well, to keep you generating at that pace?

Yes. Obviously the interest rates we charge are a function of expected credit losses as well as cost of funds. Cost of funds in our business have gone from historical averages of about 35 to 50 over LIBOR to maybe what, theoretically today they are. It is probably not clear, but to qualify [ph] 600 over LIBOR. Those costs have to move through. What we have done by adding co-borrowers in the account, you get a massive change in the credit performance of the loans, huge. And so that rather than raising prices by adding co-borrowers, we can afford to make the same loan at a lower cost. But we have raised costs across the board on private credit as you can see in almost any kind of consumer product that's out there. To price these according to what we think the capital market funding costs are?

What was the historical percentage of co-borrowers, much lower?

Well it was lower, it is about 50% in total, but part of that was due to a lot of graduate volume as well.

Okay.

You will see this number continue to rise, the 70% number continue to rise. It is one of the ways we can continue to make private credit loans affordable for our customers.

Okay and can you comment at all on market share and any anticipated change, there are comments out there that the Federal Direct Program has reached some kind of servicing capacity and any comments on market share vis-à-vis your other private competitors and FFELP or the Federal Direct? That's it, thanks.

In the FFELP side of the equation, our volume from our internal brands is up 50%. And so if you look at it from that perspective, we are taking we believe significant market share. We don't have Government statistics yet. They take about anywhere six to nine months to come out after the fact. So we haven't seen that, but anecdotally we know we are capturing a bigger percentage of share at schools where we are on campus and that the shift to direct lending, although large is not as large as I think some people might have expected to be at the beginning of the year.

Okay. Thank you.

Your next question comes from the line of Mike Taiano with Sandler O'Neill. Your line is open.

Thanks, I had a couple of questions. First check on the ABCP conduit. I know you guys are feeling confident that you can renew that, but in a worse case if you weren't able to and you had to put those loans to the banks, can you give us some sense of what the risk to capital is in that? I assume that you have to post additional collateral to that facility as the loans get mark-to-market. Is that right?

That is correct. The facility is mark-to-market. The vast majority of the assets here are federally guaranteed. And so the market issues are not credit driven or credit-expectation driven. I think, although that is the ultimate and I guess worse case scenario. No one, neither us, the bank, no one involved in the facility even remotely wants to consider that as a possibility. And they want to work with us. They have expressed that desire to roll this. They're not in the business. A vast majority of these institutions are not in the business of holding student loans. We are the better manager of that. This asset class is not having economic or credit problems. It's all about credit spreads. And to the extent that the federal action that's going on between Treasury and the Federal Reserve and other areas of the capital markets, if it can begin to prime the pump for credit flowing again, this will not be an issue. Our counterparties I think recognize that. They want to work with us, and it means extending the facility for another year, while we work this process through. I think their verbal commitment at this stage is they want to be partners in that process. One thing I would say is we are ahead of schedule as to where we thought this facility size would be at this stage in the game. So we are not making progress at reducing it. If we get this Department of Education facility that they're working on up and running and expanded as we expect, that will help further reduce this. And as we securitize FFELP loans, we will continue to reduce it further.

Okay, great. Thanks. You had, I guess, forecasted for the next 15 months that you would be able to generate $8.5 billion in free cash flow to use to pay down your unsecured debt. Now, does that also take into account the slower payment rates that you are seeing as well as the dislocation in the CP-LIBOR spread? And if not, would it have a significant impact on that?

In our numbers, we have one set of amortization or prepayments-based assumptions for the entire portfolio. So, those numbers are consistent across the board. And on the CP-LIBOR spread, we do have an assumption in there. That assumption is, the volatile in the spread this month in October has been everywhere from I think about 8 basis points to 200. So, it's not clear exactly where it would be. We have an assumption in there that is conservative against historicals, but we need this issue addressed and fixed.

All right. Okay. And then just on the credit side, is there any way to quantify the impact of having the tighter guidelines on forbearance? What impact that had maybe in terms of basis points on your delinquency rate this quarter?

There is no question that it increased delinquencies overall, and it contributed to the overall delinquencies across all delinquency buckets. But that's what's supposed to happen, right? There are two categories of borrowers who don't get the forbearance: borrowers who don't need it; so in effect, avoiding or eliminating forbearance user; and then borrowers who won't benefit from it. So, if we don't think they're going to benefit from it, they're going to become delinquent borrowers. And all that would happen if we left them in a forbearance status would be delaying a delinquent account. The goal here is to be far more analytical in understanding who can qualify or who benefits from forbearance and ultimately is committed to repaying their account, and by granting that will repay their loan. If we don't think they're going to benefit, they don't belong in that status.

Right. No, that makes sense. Just a final question. I think you guys during the quarter had appealed to the GAO in terms of the servicing issue on the loans that you do potentially would put to the government. What is the status of that and when do you expect to get an answer?

We did win the first rounds. It's in, I guess, round two of this approach, and we are working to come up with a constructive solution to that.

Okay. Thanks, guys.

Jessica, are there any more questions? Hello.

(Operator Instructions). Your next question comes from the line of Moshe Orenbuch with Credit Suisse. Your line is open.

Thanks. Just some follow-ups on questions that have been asked already. If the authority for the Treasury program is extended back to 2003, would you expect it be on similar terms as the current? And also, what size warehouse line do you think you would need if that kind of came into being? I have a second question also.

The terms and conditions are still being developed on that program. I mean clearly the program needs to be economically attractive to lenders to keep them in. I think you've seen as a result of the program that are in place today at CP plus 50 that there was a fair amount of concern within the FFELP community overall about the lack of attractiveness of those economics. They work for us. And my point in my comments about our scale and efficiency are directly related to that. Our lower cost structure gives us the advantage of being able to deal with that far more effectively than others can. But as to what the actual terms will be, unfortunately we don't know. And that's why we don't have an announcement yet. Remember as part of that Higher Education Act provision, the OMB needs to assure budge neutrality in this process and that's part of the equation as well. Your second question?

Assuming that all of those loans would qualify, how larger warehouse line would you actually need to?

We have $16 billion worth of loans that are eligible for that today. You obviously would bring down the facility by double-digit billions.

Just one other follow up. There was some mention in the private loan presentation that you did about being able to begin using the bank to generate new deposits in November because of the regulatory issues. I think you actually said that you started already. Could you kind of just give us an update on what's going on there from the regulatory standpoint and how large you think that bank could get kind of over the next 12 months or so?

Well right now, we believe that we have the capacity to fund our private credit originations over the fourth quarter and into 2009 using bank deposits as the funding source. Obviously our funding or the amounts of private credit loans will originate in 2009 or let me start with the first, so far the quarter we are in is at a seasonal low. We are not originating a whole heck of lot of loans right now simply because of where we are in the academic season. And in '09, we will continue to see volume be moderated by not just the liquidity environment, but also the cost of that liquidity and the outlook for what the consumer credit profile will look like. The point I would make here is that, we have the ability to fund our originations through the bank. So it is not creating additional liquidity or cash needs outside of bank deposits.

Your next question. I'm sorry.

Go ahead. I'm sorry.

Your next question comes from the line of Ryan O'Connor with Citigroup. Your line is open.

Thanks very much. I have two questions. First, just following up what Moshe was talking about. Have you all given any consideration to becoming a bankholding company and taking part in the FDIC's Debt Guarantee program? That's the first question.

It is certainly the, the fashion of the moment; right, to be in that space. When we look at the environment here, we certainly have to look not just over the next couple of months as to what liquidity issues will be available to us, but what the long term situation is. And there's a movement here that says financial institutions should be under one kind of regulatory oversight umbrella. And that is something we need to consider in that process. It is not an easy slam dunk issue. There are no real banks out there that have a credit profile like this company. Remember 82% of our loans carry an explicit Government guarantee. And the normal kind of one size fits all capital requirements that one gets there don't fit particularly well with an asset that is Government guaranteed. So we certainly are looking at things, we would certainly love to have the ability to participate in some of these programs that are being developed under TARP, but we don't have any definitive statements to make on at that yet.

Okay. Fair enough. And then just in terms of the cash flow projection over the next four or five quarters, will the company be cash flow positive, vis-à-vis debt maturities in each quarter?

Yes or at least certainly on a cumulative basis.

Okay because I think what you said before is that you have a nice cushion this quarter and so that will help you tide you through the rest?

Cumulative means that each, the cumulative free cash flow generated exceeds the cumulative debt through to the end of '09.

Okay, again in each quarter?

Month by month by month.

Great. Okay, thanks a lot Jack.

Your next question comes from the line of Matt Burnell with Wachovia. Your line is open.

Hello. Can you hear me.

Yes.

Sorry. Thanks very much. First of all, Jack, you mentioned I believe in the presentation that year-to-date debt repurchases have been about $1 billion. Can you update us as to what your debt repurchase activity was in the third quarter specifically?

It has been $1.8 billion year-to-date.

Okay.

Third quarter.

And in terms of the third quarter number?

So it is like $800 million I believe. $1.8 billion is the total for the full year. I think it was $800 million in the third quarter.

Right. Okay and maybe this is an overly simple question, but you have got bank deposits that as of the end of September were about a little less than $800 million. You said in your comments that you have got about another $500 million in the bank in October. And it sounds as if the funding of the private student loan originations has gone down pretty dramatically over the last couple of quarters. Is that your expectation going forward? I know we are in a seasonally slow period, but presuming the markets don't get a whole lot better by the time seasonally more active periods occur, how much more do you think you will have to cut back in terms of the private student loan business.

We made $2.1 billion worth of private credit loans in the third quarter, which was down 24%. The October, November, December timeframes are very slow periods. You don't have a whole lot of academic starts happening during that time frame. So you don't get another peak and it is a much smaller peak in the third quarter until January. As to where volume will go, I think you will see origination numbers that will be consistent with what we did in the third quarter in 2009 unless we get some, unless the funding in economic environment change such that we can expand our lending activities because term funding proceeds it.

Okay. And let me ask a follow up on the debt repurchase question. Any chance you would give us the discount to book that you purchase the debt at this quarter?

Is it in the supplemental to how much we reported as gains?

No.

Well I would just say we bought this debt at market prices. Short-term debt was trading in teens to 20s yields in the last quarter. And those reflect the prices we were paying. We did not conduct a tender. We were just doing open market, open market purchases.

And your intention going forward is to focus, any repurchases that you do in the future on pretty short maturity obligations.

Correct. Yes I mean. As I said, we would love to have access to the liquidity to buy longer term stuff.

Sure.

In this marketplace, we think that's not the best use of our liquidity.

Okay. Thanks very much.

Not much in it [ph]. We would like it to be the other way, but that's where we are.

Thank you.

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

Thanks. I wonder could you give us an update or a sense of what the prospects for continuing to service the loans that you are likely to put to the Department of Education?

We couldn't hear you. Can you speak up and repeat?

Yes, sorry. Wondering if you can tell us what the prospect for continuing to service the new FFELP loans you are originating that you are likely to put to the Department of Education is and then what's the prospect for becoming a servicer under the DOP [ph]?

Well, if loans are put to the Department of Education in September of '09, we are looking at having over $20 billion worth of loans. We would expect that the magnitude of transferring something like that would certainly make us a logical servicer. That was part of our bid protest that we submitted to the DOE and we certainly have the strongest of desires to compete in that space and we fully expect that our economic structure will allow us to be successful. On the DL side of the equation, I don't think that contract comes up for renewal until sometime into 2010. We bid on it last time around, clearly interested in bidding on it again in future. We think we are a logical player in that space given our scale and efficiency and look forward to competing on it.

There are no further questions at this time.

Thank you very much, Jessica. Thank you everybody for joining the call this morning.

This concludes today's conference call. You may now disconnect.