SLM Corporation (SLM) Q2 2014 Earnings Report, Transcript and Summary

Good morning. My name is Toni, and I will be your conference operator today. At this time, I would like to welcome everyone to the 2014 Q2 Sallie Mae Earnings Call. (Operator Instructions) Thank you. I would now like to turn the conference over to Mr. Brian Cronin, Senior Director of Investor Relations. Sir, please go ahead.

Thank you, Toni. Good morning and welcome to Sallie Mae’s 2014 second quarter earnings call. With me today is Ray Quinlan, our CEO and Steve McGarry, our CFO. After the prepared remarks, we will open up the call for questions. Before we begin, keep in mind that our discussions will contain predictions, expectations and forward-looking statements. Actual results in the future may be materially different from those discussed here. This could be due to a variety of factors. Listeners should refer to the discussion of those factors in the company’s Form 10-Q and other filings with the SEC. During this call, we will refer to non-GAAP measures we call core earnings. A description of core earnings, a full reconciliation of GAAP measures and our GAAP results can be found in the second quarter 2014 Form 10-Q. This is posted along with the earnings press release on the Investors page at salliemae.com. Thank you. And I will now turn the call over to Ray.

Thank you, Brian. And good morning and welcome to our first call as an independent company. As you all know, the Sallie Mae did the split with Navient on May 1 of this year and so that is a point of time at 85 days ago. On the one hand, seems like very short period of time and sometimes it seems as though it is forever ago. When we talked about – about 2014, we’ve set out five main goals, and let me just briefly review them and then discuss our progress against them which I have to say is quite gratifying. So one was prudently grow the private education loan assets and revenues. Second, to maintain our strong capital position. Third is to complete necessary steps to permit the bank to independently originate and service private education loans. Fourth, to continue to expand the bank’s capability and enhance risk oversight and internal controls. And fifth, to manage operating expenses while improving efficiency and our customer experience. During our first quarter, we’ve made very good progress against all of those and the parameters for our P&L, the major variables that go in to specified models have all worked out at our goal or better. So if we look at originations, we had anticipated when we – before the spin that we would approximate $4 billion of new originations for the year. We are right on target to realize that goal. Our NIM, for the third balance sheet, we wanted to have over 5%. The NIM for the balance sheet in total is 5.08 which is an excellent number all by itself. All losses [ph] which we in our model have is a 1% annualized loss rate per loan year are virtually nil and certainly less than 1% as we entered the third quarter. Our operating expenses with the goal to have it under 300 million are on our run rate on a weeknight [ph] basis of 280. In addition to that there is some bandbox expenses [ph] which is our internal code for the result -- for the operational spend which will occur through the rest of the year and importantly in the fourth quarter. The growth in our private-label business in particular has been stellar, and so as we look at the private-label portfolio by itself, it has grown from $5.3 billion to $7.4 billion over the last year which is an increase of 40%. The balance as total has grown 20% and so as in many of our discussions with the individual analyst, we had said that the private-label high earning asset would grow as a proportion of the balance sheet and approximately 100% of the growth on the balance sheet is made up of the growth in the private education loan portfolio. And that 40% growth was accomplished while the team was spending considerable amount of time on preparing for the spin and in fact the continuing process of moving services from Navient over to the bank’s independent platform. All of this of course is done within the framework of our mission in regard to helping American families, save plan and pay responsibly for college. We have continued growth both in our receivables in a numeric sense and dollar sense as well as in expanding customer base which continues to grow at the same pace as the receivable is growing. A fifth portion of our activities here includes the loan sales. Loan sales are anticipated for the third and fourth quarter. We as everyone knows are engaging in the loan sale activity in order to manage the growth of our overall balance sheet as agreed-upon with the FDIC who has a limit on the growth of banks in general. Loan sale prospects look very good and Steve will expand upon those. In regard to the regulatory oversight and continuing improvement, as has been in the press, during the spin 10 days or so around 5/1 consent orders were agreed to, with the FDIC and DOJ. It is gratifying though now that the cease-and-desist order that has been on the bank since August of 2008, a full six years, has been lifted and agreed to be lifted by the FDIC and the UDFI, the Utah Department of Financial Institutions. And so the cease-and-desist order there for six years in our first quarter has gone away and we’re very happy about that. In addition, we rounded out our senior management team with Jeff Dale joining us on July 10. Jeff is a lad of city and will be the chief risk officer for the bank and the holding company and he will be the first person to have ever held that position. So I think it's a step forward and in the right direction for the company as a whole. In summary, we’re well started, we’re on the right path, we have a terrific team, a great franchise. We have a bright future and I want to thank all of you for participating in our call. I will mention that there was a misstep as we were doing our filing on the 10-Q and as a result of course it didn’t get released till 6 AM this morning. So I am sorry about that but there is a 5.30 cutoff and we just missed that, and that added about 12 hours to the delay. And when you do things for the first time sometimes situations like that arise. But moving forward here, I will turn the call over to Steve and then after that we will go to Q&A. Thanks for your attention.

Thank you very much Ray. Good morning everyone. I will be referencing the earnings call presentation available on our website during my prepared remarks, beginning with slide 3. Before we discuss the quarterly results, I would like to frame the discussion by describing the composition of Sallie Mae bank subsequent to the spin-off. We have a portfolio of $7.4 billion of high quality private education loans. 90% of our portfolio is cosigned and we have an average originations IFCO of 745. Nearly 80% of this portfolio has a FICO score greater than 700. 20% of our loans are currently in full principal and interest payment, and 52% of our customers are elected to make payments while they are in school. In addition to our private education loans, we have $1.4 billion of FFELP loans on our balance sheet which we view as supplemental liquidity, that’s in addition to our $1.5 billion in cash. As you can see, we maintain ample liquidity on our balance sheet. Sallie Mae Bank going forward is going to have a diversified approach to funding, which includes $9.5 billion in deposits which are comprised of $3 billion of retail deposits, $5 billion of brokered deposits where we typically focus on issuing longer term CDs such as three and five year CDs and swapping them back to LIBOR. In addition to that, we have $1 billion of other deposits which include $600 million from Utah Education Savings Plan which is a 529 program. This is a business which we are very happy to have recently won. The average cost of our deposits is less than 1% after taking into account the interest rate swap activity. We are currently in the market issuing five year CDs at in the vicinity of LIBOR plus 70 basis points. Recently we received the $500 million commitment for the secured financing facility while we are setting up, we’re very gratified to our banks for working with us to get back up and running shortly. And once we get our servicing platform up and running in the fourth quarter we’re going to then begin to securitize our high quality private education loans will start to term fund the portfolio exactly as we have done in the past. Moving on to bank’s net interest margin was 5.08% as measured over total assets. Comparable number for interest earning assets was 5.33%. The average yield on our private education loan portfolio in the quarter was 8.23%. Now I would like to review some of the key financial results which you can find on slide 4. Net interest income for the quarter was 104.5 million which was $5.3 million higher than in Q1 and $37 million or $0.35 higher than the prior year due to the increase in our portfolio of loans. As Ray mentioned, our portfolio is up by 40% from the prior year. Fee income in the quarter totalled $15.2 million, an increase of $6.5 million from the prior year. The increase was driven by a one time gain associated with the divestiture of our investment in MGI which is the insurance business that we are involved in and accrual associated with the tax indemnification receivable. That’s all in this historically reported core earnings, we’re going to continue to provide core earnings with a revised definition. As just mentioned, we use derivatives predominantly interest rate swaps to manage the interest rate risk in our portfolio. When we issue term fundings such as five year CDs, we swap it back into one month LIBOR and we’ve also issued fixed rate swaps to fund our growing portfolio of fixed rate loans. We believe that all these hedges are sound economic hedges. However for various reasons we do not always receive effective hedge treatment for accounting purposes. So for core earnings, we’re going to exclude from GAAP earnings, the change in value of all expected future cash flows associated with these swaps but include the actual periodic accruals of current payments. In the current quarter, of the $9.5 million the gain and losses on derivatives and hedging activities line, core earnings excludes $7 million of that on a tax adjusted basis. In the year ago period, core earnings excluded pretax losses of $0.4 million. We do expect to receive hedge effectiveness in the third quarter on derivatives that caused the vast majority of volatility to Q2 earnings. However, we thought it would be prudent to introduce the core earnings concept now in our first public quarter because we may very well have hedges that do not qualify for hedge accounting treatment in the future. Core earnings for the quarter were $48 million, $0.10 diluted earnings share compared with $77 million or $0.17 diluted earnings-per-share in the prior year quarter. The principal reason for the decline was the fact that we do not sell any loans in this quarter and we sold a significant amount in the year ago quarter. We’ll talk about that more in a few seconds. Second quarter operating expenses totaled $75 million compared with $67 million in the year ago quarter. The increase in operating expenses is primarily the result of $14 million in restructuring costs but this is partially offset by an $8 million reduction in our litigation reserve. The run rate for operating expenses in the quarter was basically $69 million. The tax rate for the quarter was 42% which pulled up the tax rate for the first six months of the year to 40%. Taxes are calculated on a year-to-date basis. What’s driving Sallie – SLM’s tax rate higher than it was in the past was primarily a higher state rate. Post spin certain business functions that were performed by Navient entities were consolidated into the bank which has increased number of states that the bank has to file in. Additionally tax rate is impacted by adjustments related to pre-spin uncertain tax positions. Because we’re indemnified for the vast majority of these positions, the increase for tax provision is offset by an increase in our fee income. This actually has no impact on our per share earnings and our expectation is that our tax rate for the full-year will be 40%. So I will refer some of the stats on slide 5. Now we originated $373 million of smart option private education loans in the quarter, up 3% from the prior year. For the year, we still expect to originate $4 billion of new smart option loans representing a 5% growth rate. Loans we originated this quarter have a FICO score of 744 and the seasonally consistent 78% cosigned rate. This compares to an average FICO score of 73 and a cosigned rate of 78% in the prior year. Cosigned rates are typically lower in the second quarter which is a low production quarter as you all know. So we expect that originations for the full-year will be consistent with what we have been doing in the past, now the 90% cosigned and then around that 744, 745 FICO level. So we’re going to talk about some of the changes that’s taking place in the way we treat delinquencies and calculate our provisions and allowances. Prior to the spinoff transaction, the bank sold loans that were delinquent more than 90 days to an entity that was now a subsidiary of Navient. This process was followed because the bank’s charge-off policy required charge-off – charging off loans at 120 days delinquent while pre-spin off SLM Corp’s policy was to charge-off loans at 212 days. These sales continued right up until the spin-date and were primarily comprised of loans that were 60 days or more past due. The company has changed this policy and now charges off loans after 120 days of delinquency. Under the new policy, the company has a shorter timeframe to cure delinquent accounts. Collection activity that used to occur between 150 to 212 days of delinquency will now occur between days 60 and 120. Through June 30, our delinquency cure rates have exceeded our expectations but we have very limited experience under the new policies since it really has just begun. The company has also changed its loss conservation [ph] period from two years to one year to reflect both the shorter charge-off policy and its related servicing practices such as a more stringent policy for the granting of forbearance. So consequently many of the pre-spinoff’s historical credit indicators and period over period trends are not comparable and they are not the indicative of future performance. Because the bank’s portfolio was comprised of high quality loans as discussed earlier, that has demonstrated very strong performance in the past, and underwriting practice has not changed, we’re confident that this portfolio will continue to perform very well. Our expectation continues to be that our smart option loans while accumulatively cohort default rate in the 7% neighbourhood and annualized FICO loan loss rates under 1% adding on the mix as the portfolio is seasoned. And we expect that 50 plus day delinquency rates will [inaudible] approaching but under 1% by year-end. So all of this can be viewed on slide six where we show our delinquency tables. I just like to say as the policy changes mentioned above, naturally had an impact on our provision and allowance for loan losses. The allowance for private education loan losses declined from 71 million in the first quarter to 54 million at the end of the second quarter, which is 1.2% of loans in repayment at the end of the quarter. The FFELP loan allowance was unchanged. The $17 million decline in the private education loan allowance was principally driven by the change in our loss emergence period from one year to two years. We believe that our loan-loss allowance is conservative given the high quality of our portfolio and it also reflects the uncertainties associated with the policy changes we recently adopted. Our provision for private education loans in the quarter was $0.3 million. The drivers of changes in the provision from prior quarters are not very instructive due to all the policy change we have been discussing. In the year ago quarter we had a negative provision because of a large sale of performing loans. In the prior quarter, the provision was large because we’ve had a large sale of delinquent loans. So what is important is where provision for loan-loss allowances and the reserve we’re headed [ph] in future quarters. Our portfolio was relatively unseasoned. Our allowance to loan losses covers expected charge-offs over the next year and the life of loan-loss reserve on troubled debt restructurings or TDRs. As of June 30, our TDR portfolio was just $5 million but we do expect it grow over the coming periods. In our portfolio, the vast majority of TDRs will come from loans that have used in excess of 3 months of forbearance or one of our workout programs. The final two quarters of the year, we will continue to build our loan-loss allowance to reserve for our emerging TDR portfolio and the seasoning of our loans. The bank remains well capitalized with a risk-based capital ratio of 15.9% at the end of the quarter. This significantly exceeds the 10% risk-based capital ratio required to be well capitalized. In addition, the parent company has nearly $450 million of capital available to the bank as an additional source of strength. On a consolidated basis, our total risk based capital ratio is 20%. We plan to continue to maintain high levels of capital to support the projected growth of the company. And we do not anticipate returning capital to shareholders as we invest in our high growth high quality business. So second quarter 2014 GAAP net income was $44 million or $0.09 diluted earnings-per-share. Quarter’s free cash includes expenses $0.02 per share of the restructuring and reorganizational activities as a result of the spin. Loan sales will be a key component of our business strategy going forward. We are in the process of developing a solid investor base for our products. We’ve recently priced whole loan securitization with a third party investor. Closing is contingent on many things including standard and customary rating agency approvals and finalizing servicing agreements for these portfolio loans. We expect to resolve these issues in fairly short order and look forward to closing this first transaction. Now that the spin is behind us, we do have a few months of owning the company under our belt and we think we have enough visibility now to provide some useful guidance for the remainder of the year. As mentioned earlier, we remain confident in our ability to original $4 billion of smart option student loans. We expect the provision for the remainder of the year to be just over $60 million. Operating expenses for the full-year will be approximately $280 million, plus an additional $32 million in one-time restructuring and reorganization expenses. We’re confident that we will execute loan sales totaling $1.2 billion in the second half of the year. We expect the premium for these sales to be at the high-end of the 6% and 8% range that we discussed with you all over the last several months. Finally, our diluted earnings-per-share expectation for 2014, which includes all the above, including the one time restructuring charges, is expected to be in the range of $0.41 to $0.43. That concludes my prepared remarks and we now look forward to taking your questions.

(Operator Instructions) Your first question comes from the line of Mark DeVries with Barclays. Mark DeVries – Barclays: I just wanted to make sure I understand the policy on a go forward basis on provisioning. Steve, I think you mentioned that you’re now going to be provisioning for 12 month forward and then life of loan on your TDRs; is that correct?

That’s correct, Mark. We’re building a lot – it’s very similar to prior year’s except the loss emergency period and we’re building a loan-loss allowance cover the next 12 months of expected charge-offs and to include life of loan expected cover on our TDR portfolio. Mark DeVries – Barclays: Okay, the 50 million guidance in the back half of the year was a little higher than we were expecting, if you kind of annualize that at 120 seems higher than kind of 1% annualized life of loan-losses you expected. Can you help us – give us little more context on why 50 million?

I can’t, Mark, and we do write about this in the Q. So basically we’ve gone through a number of policy changes. And our charge-offs forecast is based on a role model how loans go through our delinquency buckets into charge-offs. So it’s a migration model. And we’re in a position here where as I mentioned earlier where we’ve changed from 210 day period to 120 day period. And if you can think about this, in the past, the heavy cures took place in the final two buckets. Now we need to all of our cures – and still in the final two buckets but they come much earlier in the process. As I mentioned, this is a model based approach. So what we do is we calculate average roll rates in each of the model to come to a charge-off forecast. Because we have a paucity of experience in the 60 to 120 day bucket as opposed to the 150 to 210 day bucket, we are in a position where we’re using the earlier bucket which had much higher – low rates for the prior 12 months and for the last four month we’re using our actual experience in those 60 to 120 day buckets. This is the process and a model where we came up with, I think what we expect to see is that over time as our recent experience becomes more dominant, you'll see charge-off forecast decline and potentially the need for provision decline, but look, we got to take this model based approach and this is where we are ending up in the current period on. Does that make sense? Mark DeVries – Barclays: Yes that does. So is it reasonable to think – I guess with this new approach you are having given you have less time to cure, that you may have a little bit more charge-offs frontloaded but you may also have better recoveries than you might have historically had?

I mean it’s certainly possible, as I mentioned our early experience has been pretty positive. But we’re actually beholding to the model and because we don't have a lot of experience with his new policy, management can’t really apply a lot of judgment to this process at this point in time. Mark DeVries – Barclays: And then just one other question, any change or updates for us on – with your conversations on your regulators on your ability perspective way [ph] to build, grow the balance sheet at this 20% annual pace?

This is Ray. We met recently with both Utah Department of Financial Institutions and the FDIC and as we go into the planning cycle, which they both have for a three year horizon in the last quarter of the year, we have of course been transparent in regard to our intentions to continue to grow the franchise at 4 billion or more in private student loans. And this question of well how much of that stage on the balance sheet, they have a general guideline that says 20% is a number they like to see US banks not exceed. And so I would expect that we would be going forward integrating with the FDIC on a number for total balance sheet growth of just under 20%.

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

Just on the provision again, how much history will you need prospectively before you’re able to reevaluate that policy in terms of the roll rates?

You know, Eric, it will be really on a quarter by quarter basis but as we explained this process back in the Q on page 57, you want to take a look at that a little bit later. So what we are using right now is a rolling 16 month average. So what’s going to happen is the older higher roll rates are going to drop off and the newer hopefully lower roll rates will begin to dominate that calculation. So it will be a process for the mergers over a period of time.

And then on the loan sales, moving forward how long I guess do you expect it to take to execute a given loan sale as we look at your quarter to quarter earnings trends and the potential volatility as you might have outsized gains in a given quarter, how should we think about that?

Sure, so I understand that you’d like to have some certainty for the model as to when the loan sales will take place. This first loan sale has taken way longer than I ever would have hoped, that it would take. But we are pretty confident – we’re very confident that we’re going to close it in reasonably short order. We would expect – we think that’s the balance of our loan sales are going to take place in the current quarter and I think we will be then out of the market until 2015 and we’re not going to be able to give you any indication as to when the next batch of loan sales will take place until certainly later in 2014. This is going to be -- obviously we want to sync up your models as well as we can and we will try and provide guidance as to when loan sales are going to take place on a go forward basis.

So for this year, you expect all of the gains to be in the third quarter and then moving forward, I guess it sounds like you’re still developing how you might pace those out. But if you were to originate a certain amount in a given quarter, would you be able to sell those loans in that quarter, do you have an expectation that it might take a quarter to lag or more?

I think yes, our goal is to complete our loan sales in the third quarter. I think what we did – these current loan sales, we sold essentially a cross section of our portfolio and I think that is what you're going to – that is what you should expect to see going forward. So it’s not really going to be origination contingent. It’s going to depend upon several other factors.

Your next question comes from the line of Mike Kayano [ph] with BQ Partners.

Hey just wanted to clarify on the loss provision, the 60 million in the back half, does that imply a reversal from whatever loans that you sell during the third quarter is already in that number?

So the way the accounting works on this Michael is it’s not an assumption of loan sales in that loan loss provision and that would be counter balancing source to the provision guidance that we have provided.

So it could come in lower than the 60 million depending on how many loans you sell in the third quarter?

Yes, that’s one possibility.

And then just in terms of the – thinking about the cadence of your back half guidance which I guess is about $0.20. Can you give us some color in terms of directionally, will the third quarter, do you expect that to be higher just because the gain is going to happen in the third quarter?

I mean yeah, that would certainly be an obvious impact. I don’t want to try and get too precise in projecting the third quarter and fourth quarter EPS rate. But for example, the point that you just made about loan sales is valid for the third quarter, I would expect all things being equal that the provision might tend to be somewhat higher on the fourth quarter than the third quarter. And operating expenses associated with the restructuring I think since we are looking to get set up in the fourth quarter those spending might occur in the third quarter. So there are number of moves here unfortunately, so precision is difficult.

And then just one last one on the expense side, just curious – it looks like your run rate ex the cost to get your servicing platform up and running is around 280 million for the year. Is that would you say a good sort of level to think about for 2015? I know you guys aren’t giving guidance for 2015, but just thinking about that or is there potential greater efficiencies that you are expecting next year?

Michael, in the spirit of not giving guidance, I will say that we’re also going to be seeing significant balance sheet growth in 2015, so I would certainly not want to promise that operating expenses are going to be flat and certainly not low. I think you can expect to see operating expense growth but certainly not nearly at the same pace as we would expect our revenue and income should be growing.

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

Thanks. Just to confirm the $32 million of expenses -- unusual expenses for the year, that's not -- that is included in your guidance of $0.41 to $0.43, so that’s about $0.04 to $0.05 of impact on your guidance?

That’s absolutely correct. Right, that is in the $0.41 to $0.43 range and 4.5 cents plus discounts in that [ph].

4.5 cents, got it. And so separately on the loan sales, Steve, you mentioned that it’s taken surprisingly longer to execute a sale. Could you talk about why that would be and could you elaborate on your comments that you expect to see premiums the high-end of the range you talked about 6% to 8%, what kind of appetite are you seeing in the market for private education loans?

Sure, look, this did longer than we had anticipated when we were out on the roadshow we were telling people that we would hope that it could close by the end of the second quarter, that turned out to obviously be not the case. This was our very first transaction and we did end up doing it as a securitization. So we are packaging – pre-packaging these loans into a trust and we are selling all the bonds and the residual to one end investor. So that required us to go through, for example, the rating agency process which is where we are right now. In addition to that, we are not servicing these loans because our servicing platform is not up and running. So we were required to negotiate a new servicing contract and look, these things unfortunately take more time than one might ordinarily think when they set out to accomplish the task. We do think on a go forward basis that we will be able to lap transactions quicker than certainly this one.

In terms of the appetite in the pricing?

So I am sorry – the demand for this product turned out to be very strong. Of course, we’re in a yield hungry environment and we’re very aware that that can change it any given moment. But since we priced this deal, I think the market for past due loan assets has tightened further. I think if we were to come to market today there would absolutely be strong demand for our portfolio of smart option students –

And just finally would you do the 1.2 billion you’ve talked about now likely in the third quarter, would that be a one transaction or is it multiple transactions we’re talking about?

Let me get this first transaction behind us and then we will move on to the second transaction, Brad.

And then just actually Ray mentioned that the servicing platform is expected to be up and running in the fourth quarter. Would that be at the beginning of the fourth quarter or year-end?

No, this is Ray and the way we timed this is we’d like it to occur after the peak season for loan origination which as you might expect occur in August and September. But before the peak season for Christmas, which has FBR as the platform servicer that – we have two big increases, we want to be in the middle of that, so we’re hoping for early in – where we’re scheduled for early in the fourth quarter, so that would be the timing.

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

Steve, could you talk a little bit about how many buyers you had interested and – I thought you had said that, that you were expecting 1.6 billion secure -- of sales this year, I mean what made you change your mind to a lower number and does that mean the balance sheet grows faster, you just sell them in ’15?

Let me answer the second question first. We will end up selling 1.6 billion, actually little bit more than that and I'm sorry, if we weren't clear about this but we are considering the sale that took place in the first quarter as part of our loan sales for the full year. So sorry for any confusion around that issue.

That was over 400.

But in terms of our thought process it’s a 1.2 billion since the spin.

That’s correct. So we conducted an optionable portfolio back in April, Moshe and I think that we probably showed the portfolio to dozen different investors and if my memory serves me well, we received 8 or 10 of them, and look, this is a very attractive asset given its yield and loss expectations. So it has pretty high positive total returns. So I think it’s a asset class that will continue to generate pretty good interest on a go forward basis.

And on the credit side, I mean it seems like there is a certain acceleration of that preserving process. I mean you’ve had a couple of questions about this already, I don’t want to beat it up too much but it does seem like that high level of reserve build is a function of both the maturing of TDRs and kind of just a little bit of catch-up. I mean so is there any way to kind of frame out like how long that would go on or how you think about that in the context of the loans that you will be choosing to sell?

Well, we believe that it’s definitely – it’s a conservative loan loss allowance projection, and again it is model based and we have limited -- very limited history on the model and the model is essentially going to play through. We don’t have enough experience to exercise in our management judgment on the provision, and what loan loss allowance at this point in time. So we’re going to a very close attention to how defaults and TDRs emerge from the portfolio and react accordingly in future periods.

Great, any – in terms of the idea that you guys include the restructuring costs in your core earnings and Navient excludes this [indiscernible] show you guys on talk, is that the idea?

We’ve been so busy publishing our 10-Q in 21 days, we didn’t have an opportunity to look at that –

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

Just in terms of the guidance, just to clarify, does the $0.41 to $0.43 include the preferred dividends?

Yes.

And then I am not looking for specifics here but if I take the $0.41 to $0.43 and back out the restructuring and assume a little balance sheet growth through the rest of the year, I am coming up with an ROA of like I don’t know 1.7% for the year. And I realize this is somewhat of a transition year and it may take some time for the portfolio to scale little bit but can you just help us think about timing of when you will be able to approach that 2% ROA that we’ve heard?

It’s going to take some time as we grow into our operating expense base, look, we’re a $10 billion bank, we’re originating over $11.4 million – we’re originating $4 billion worth of loans. So that’s kind of a platform that [indiscernible] outsized for the size of a bank that we are. So I think it’s going to take a little bit of time for our balance sheet to catch up to our cost structure.

I mean that’s something that by 2016 we could be getting there?

I mean that’s – don’t call it guidance, certainly that’s a fair assumption.

And one way to think that this is – as we said if we look at the balance sheet over the last year it grew about 20% net from about 10.7 to 12.8 billion this year thereabouts and so that will be up $2 billion, hundred percent of that grows in the private education lending business has stayed on the balance sheet. And so as we change the proportion of the balance sheet it'll be the same case that as balance sheet grows the vast majority, the dominant proportion of that will be associated with private education loans that are held on the balance sheet. So we thought about the growth rate, you thought about the changing weighted average, I think it approximated quite well.

And then – yeah I know it’s early into peak lending season but do you have any color around just overall student demand trend – student loan demand trends, any disruption maybe from the spin out or some of the recent regulatory headlines?

As we’ve looked at the year where we have these -- basically three components which is our customer franchise, our spin and then thirdly is our balance sheet and our attitude in regard to it. And we have taken steps to preserve our customer franchise, continue to have it grow while we're doing the spin and while we're launching this company. And the $4 billion we’ve updated this every single day we are on track for the 4 billion, demand is up year-to-year. The quality of the profile of a person applying as well as people we’re accepting is extremely high and as you heard consistent and so despite any storms that take place in certain locales, in spite any headlines we haven't seen a disruption in our customer momentum of the franchise.

And then just real quick, on that regulatory front, any more color on the CID from CFPB, I know Navient is going to cover any expenses maybe associated with that. But is this related to similar issues that you guys have just settled with the DOJ?

Yes.

In fact, they are the same. And so the consent orders are targeted to payment allocation changes and the SDR rate. And all of the information that was available before the spin on 51 including the Navient participation in that and in fact, that Navient was our servicer for all the activities that occurred before 51 of ’14, one captures the information associated with the orders and two, also captures the liability associated with those. The bank had a $3.3 million fine which was paid and the rest of the activities associated with complying with consent order either in regard to customers or in regard to audit support on the backend are covered by Navient.

Your next question comes from the line of Sanjay Sakhrani with KBW. Sanjay Sakhrani – KBW: I got one question, on the gain on sale margin, I guess Steve, you mentioned that it’d probably be at the high-end of the range. And I was wondering are you guys getting any credit within the margin for servicing – because I guess Navient is going to do it but – or should we think about it as potentially being higher in a scenario where you would sell it, with servicing going to the third-party, are you retaining the value of that servicing?

So certainly on this transaction we will not be earning any significant servicing revenue. We will do the math to servicer. So there is a sliver but nothing that can be considered putting into your model. In the future we intend to be the servicer on asset sold. So there will be a revenue stream associated with that.

Of course, this is parallel to the spin timing from the operational standpoint. So if over the fourth quarter we are on track to our operating spin activities we will have in place as we leave the year our servicing platform which would be capable of our doing gain on sale with servicing retained. So that will change quite a bit from 2014. Sanjay Sakhrani – KBW: So when we think about this specific sale, it’s safe to assume you guys aren’t really getting whole lot of economic value out of servicing aspect of it?

That's correct. Yes, that’s correct. Sanjay Sakhrani – KBW: And then when we think about how much -- the pool that you’re selling, is that going to be part of your existing portfolio or is that going to be kind of the flow that we will see in the third quarter?

No, so as I discussed earlier, what this portfolio was and what we think – and what we expect to do in the future is sell essentially a cross-section of existing portfolio. So the buyers are interested in purchasing a representative sample and we have reasons why we would also like to be current [ph] representative samples of our portfolio.

And of course, that’s a different model than the standard mortgage business of originate, warehouse and sell in 30 to 45 days. So it’s a different profile. Sanjay Sakhrani – KBW: And final question just on the provision, I understand that there is all the different model changes that you’re making and that’s going to flow through. But when we think about the adequacy of reserves for our modeling purposes, is there any rule of thumb that we should apply to loans and repayment or ending loans, is it 12 month of losses based on your assumption of 1%, or maybe just any color around that. I understand for TDRs it’s different, you have to hold, life of loan kind of amounts but just on the remaining portfolio?

I mean the shorthand would be – so we expect based on a cohort default rates, expected life of loan default rates to see roughly 1%,defaulting annually in our portfolio and certainly the guidance on this would tell you that you cannot take a single metric such as the 1% of your loan and repayment and target that as a allowance for loan loss, but when you go through the math that does tend to be where it ends up arriving. That said, we’re clearly at 1.2% now, so there is some conservatism –

And that conservatism is consistent with the rest of our conservatism around the financing of the balance sheet and reflected in that total risk-based capital of 15.9 versus well capitalized guidance from the regulators of 10. And so we have a consistent conservative approach to the balance sheet as Steve says, early days on the credit was forecasting and as we get a year of actuals under our belt we will be much more precise on that.

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

Just a couple of ones, firstly to start off with the gain on divestiture and then the tax indemnity receivable, the increase from that -- this quarter, what was the actual breakout between the two and the total amount was about $6 million, that that was the benefit – I may have missed that in your comments, Steve?

So Sameer, the divestiture of the NGI was, I want to say $3.2 million and the accrual associated with the tax indemnification was $2.7 billion. Sanjay Sakhrani – KBW: And then the other question I had is – I mean you talked about provisioning, you talked about your life of loan expectation, your annualized charge off expectation 1% and I was wondering how we should think about the ramp up in your actual credit losses relative to what you have now? I mean do we expect this one percent kind of number in 2016 and you kind of gradually ramp up towards that level, like how do you think about?

That’s a very good question. If you look at -- and look at our roadshow, we did show some smart options only credit performance numbers and charge offs in 2013 were at six tenths of a percent. So I think it will actually take us a considerable period of time to get to the point where we are charging off 1% in a given year. But look, it's difficult to give you a precise forecast given all the [inaudible] parts that are going through the book. And for instance, since we’re going to see a big portfolio of loans and to repayments in the fourth quarter I think roughly $500 million of loans will get into repayments. So –

The loss rate is driven several factors, and the maturation of the portfolio, right? So one is the percentage of the loans that happen to be in full repayment of principal and interest which says 20% up from [ph] teams last year. The second of course is the curve that Steve mentioned in regards to the road show deck that everyone has received which looks like many credit loss curves in regard to portfolio. And the third is the dilution associated with the overall portfolio risk profile because of the $4 billion that’s originated – of course they are in the losses in regard to that. So it’s a fairly straightforward weighted average depending upon what curve numbers you put in but because we will be adding new loans that are not NP&I [ph] and don't have losses we will be on an actuarial basis below that 1% for a certain amount of time. Sanjay Sakhrani – KBW: And then in terms of the sale of loans which is being structured as the securitization, can you remind me why you are selling and structuring it as a securitization, are you crunching it out in selling the various tranches or are all the tranches going to one buyer who tends wants to the optionality of selling the tranches because – it sounds like it will be easier to just do a whole loan sale without securitizing. So just curious if you can remind me why you decided to go that down that route versus just whole loan sale without the securitization structure?

Sure. So let me give you a little bit of context there. We’ve discussed loan sales with a number of different types of institutions. We talked to banks which naturally might be a whole loan sale buyer. We talked to hedge funds which typically want to take the loan and then securitize themselves and we talked to buy an old fixed income type of institutions that are required to own actual securities. So this portfolio is going to an investor that needs to own securities in certain parts of their portfolios but – and actually hold the residual in another part of their portfolio. So it’s one of the many ways that we can conduct these asset sales and I think that in the future you will see us doing a number of different things, we will be doing whole loan sales, we will be doing exactly this and then in some circumstances you might see us securitize the loans on our own portfolio and then on certain [ph] in the future sell a residual which will also deconsolidate the loans in the portfolio. So there is a number of ways to go at this path and this particular structure worked for the buyer that will work [indiscernible]. Sanjay Sakhrani – KBW: And just my last question was around the regulatory issues, so it seems like the cease and desist in fact sounds like it was replaced by the consent order, and it sounds like you have to make some changes maybe to your internal processes and like, but aside from that they don’t seem to be any other restrictions associated with the consent order, is that right?

The consent order is very specific about its target activities which as I said relate to payment allocation and the service [relief pack]. And so that is a targeted order. I wouldn’t say that there is now a mathematical equivalency between a cease and desist and a consent order. They are somewhat related but if you were to line up two of them you would not find that they are identify. And looking at the cease and desist which was back to 2008 obviously had a genesis in a series of activity at that time. And lifting that is I think a terrific step for us especially in our first quarter as an company. A consent order there is there, it’s related to servicing before 51 and we will work out the compliance with that.

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

I wonder could you just tell us when you bring the servicing in-house is that likely to yield you some savings over time ,or you're getting a great deal from Navient on – what you really get is operational control.

Never let we say we are getting a great deal from Navient, on arms length everything is find there. And so over a period of time we will be doing two things. One of which will increase the cost base, second of which will lower the cost base. And so as Steve said earlier as the portfolio grows from 5.3 last year to 7.4 this year to over 10 next year, we certainly will have economies of scale and expect the unit cost to be dropping commensurate with that. On the other hand, to be distinguished from Navient we're in the customer franchise business and so as we experience for our customers interfacing with the servicing platform as well as with the questions platform, we would expect have a more robust servicing platform which will add some cost versus a very strong production mind of peace. So we will have lower unit costs, Steve said higher absolute cost and that we will blend within that increase in efficiency, enhancements of the customer as well as picking [ph] the economies of scale. So a couple of moving parts there.

Well your servicing costs go up a lot you’re now accelerating the timing of charge-offs, which means you got to do more outreach, and communication earlier it said –

That's true on a model basis but when you look at our actual delinquencies and our actual write offs for the current period of 2014 they are so tiny as to render the operating costs associated with them relatively insignificant in regard to the current P&L.

Could you remind us what is in the other noninterest income line, you told us about the variance but what’s kind of the base 8, 9 million that’s there?

Hand on a second, David, so where we’re looking now – $15.2 million, that is to promise and the other items that we mentioned –

But the base level is really promising.

Base what was – as you promised in the past quarter.

And then just sorry to go back to reserving at yet again but in thinking about – you have I guess about 73 basis points of reserves to ending loans at the end of June and you’re talking about another 60 million of provision adjusting maybe for the securitization but, that just seems like – when you’ve acknowledged it's conservative but it seems like a big number, if you’re talking about not getting to 1% charge-offs on the core business for quite a while and even if you think about – I was going to ask you – the way to expect the recovery rate is on the TDRs but even if it's only the 20% Navient talks about, it just seems how you – I guess I am just bundling over how in the model requires you that 60 million in the second half other than to be –

The four horse is nearly that David, but look, we are following a model, we have very limited history with our new operating policy. And I think hopefully over time that this reserve will prove to be conservative but look, as I mentioned several times we need to follow a model in this instance and we don’t have whole lot of leeway with management -- judgmental will arise, because again we don’t have the experience to demonstrate to for example internal – I am sorry our accounting firm that it’s an acceptable approach.

And in terms of the expected recoveries on TDRs, are you – I think came about 20% --

So under our new model – just this is not TDR related but we’re going to be selling defaulted loans and we expect a 17% recovery rate on defaulted loans. I think after recoveries the expected charge-offs – the life of loan charge off on TDRs is in the 20% area. So that’s correct.

Your next question is a follow up from Mark DeVries with Barclays. Mark DeVries – Barclays: Just two more quick questions. Is the gain on sale income included in the EPS guidance for the year?

Absolutely. Mark DeVries – Barclays: And then on your comments that the gain on sales margins were looking closer to high-end of the 6 to 8% range, is that due to the fact that the sale was done servicing release or is it more of an indication that the market is just a little bit more robust than years ago?

No, it doesn’t really have anything to do with the servicing release aspect – but what really drove that range Mark is when we started the road show pre-split, around about the time of split, we had not had a lot of experience with dealing with external investors. So we kind of – based on where we closed the fair market value of these assets was came up with a 6 to 8 bracket and we are very pleased to have found that the markets value them more towards the higher end than the low end of that range.

There are no further questions at this time. I would now like to turn the call back over to Mr. Quinlan.

All right. Thank you your time and questions today. That will end the call.

Thank you for your participation. This does conclude today’s conference call. You may not disconnect.