SLM Corporation (SLM) Q4 2014 Earnings Report, Transcript and Summary

Good morning. My name is Angel, and I will be your conference operator today. At this time, I would like to welcome everyone to the 2014 Q4 Sallie Mae Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-session. (Operator Instructions) Thank you. I would now like to turn the call over to our host, Mr. Brian Cronin, Senior Director, Investor Relations. Sir, you may begin your conference.

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

Thanks Brian. Good morning and thank all for calling and attending our session. And ao as I start the meeting I’d to discuss some of the results in 2014 first, and then as we pivot into 2015 we’ll talk about the outlook there. And then of course we can engage in the discussion over Q&A. So 2014 is a very good year for our Company, we concentrated on six items in particular and they were the spin from the private company, building the team, putting them in place, the financials and the good results for our shareholders, the regulatory environment as the bank entered 2014 with the cease-and-desist order on it and there was a consent order right before the spin, first those things had to be addressed, the future and then finding other opportunities. In regard to the spin, we have been fabulously successful. We have legal day 1 successfully executed on May 1, 2014. As you know we then entertained -- we obtained a independent company. We had our first quarter of earnings in the third quarter -- in the second quarter my mistake and the third went well and we are now in the fourth quarter. The team which was an almost entirely new team starting a new audit structure, the bank has been put in place. We established the position of the CRO. We’ve recruited high quality talent throughout and we are now completed on that task. In our financial, we of course were concerned that while we were doing the spin and we were distracted to some extent with all the cooperate activity that we might suffer in regard to our position in the marketplace. We’re happy to report that after giving you $4 billion of origination guidance throughout the year, we ended the year at 4.1. We naturally wanted to ensure that the quality of our new customers was equal to or better than the quality the preexisting customers in fact that happened. We naturally wanted to ensure that we maintained credible and healthy spreads, we’ll talk a little bit later, that is certainly the case, very concerned about the credit performance we would talk about that at length in this call. But we are exactly where we want to be on that and of course we might have to manage our operating expenses which we will expand on. In regard to the regulatory environment, we had a very good year, the cease-and-desist order that was on the bank for six years was lifted in June of this year. We are in compliance with all of the mandates associated with the consent order. We have shared our three year plan with our regulator, our primary regulator the FDIC along with the UDFI folks in Utah and we are in very good working partnerships with all of our regulators. In regard to the future, the future is bright for us. We can now turn from a year of distraction and we have been focused entirely on building our consumer franchise and that will be something you will hear about from us on a consistent basis as we go forward. In regard to those results, we did hit $4.1 billion of originations that carried with it the consequence that we were able to -- despite all of our distractions able to increase our market share by an estimated one-to-two percentage points which was a perfect performance on the part of our sales and marketing orientation. As you know we have provided guidance that $4.1 billion of originations this year will increase to 4.3 next year and so we are right on the trend that we had always discussed with all regulators, as well as investors reflecting approximately a 5% growth in that particular variable. We are gratified that the quality of our new customers is impacted measured by independent indicators such as the FICO score, higher quality than what we had experienced here before with an average FICO of 748 and we maintain a consistent 90% cosign. Our yield in the quarter and the year of 8.07 and our NIM of 5.01% both steady and as we think about those going into future, we do believe that they will continue to be steady at those levels. Our credit losses were right on-track to where we were in -- want to be in 2014 as the portfolio grows rapidly and we will talk about the dynamic associated with that, that number will be loan loss reserves will increase proportionately in 2015, but this is a consequence of the rapid growth in maturation of the portfolio along with the attendant dynamics that in all consumer portfolios credit loss is associated with a particular vintage are concentrated in the early years specifically years one and two. Our operating expenses, as we look forward it is the case that if we take the fourth quarter operating expenses which reflects our true operating base and we were to use that as a run rate and to glance into 2015 based upon what we are thinking about the product revenues that our marginal efficiency ratio is 22% an astounding number and reflecting the leverage that we had discussed with many audiences and which we fully expect to realize. Our taxes are apparently high in the fourth quarter, Steve will explain that in detail, and we believe that to be a one-time event and we believe that we will return to approximately the 40% range as is normal for American companies. Guidance for EPS in 2014 was $0.42 to $0.43, we hit $0.42 so we’re right on the button in regard to that, we’re giving guidance of $0.48 to $0.50 for 2015 and that’s based on the $0.42 moving to $0.48 to $0.50 is of course 14% to 19% range, we can take it casually 15% to 20% range consistent with discussions that we have had with many audiences. Let me talk about the portfolio. The private student lending portfolio that we manage and manage and/or own was in the third quarter of 2013 approximately $5 billion. And as we know it ended this year 2014 that is, at about $8.2 billion. At that run rate by the second quarter of '15 the portfolio of 5 billion and the third quarter of '13 by the second quarter of '15 will be $10 billion. So we will have a doubling of the portfolio that we’re servicing and which is the driver for our revenue as well as our cost and losses doubling in less than two years. On the trend grades that we have talked about if that were to continue, we do expect it might by the third quarter of '16 that portfolio will be approximately $15 billion, so in 3Q '13, 3Q '15 a doubling from 3Q '13 to 3Q '16 a tripling. So we have a portfolio that is up 3x. Over that period of time happens is, students as you know have a choice with us to either make the minimum payment of $25 a month while still in school to pay the interest or to defer payment until full P&I manages, comes out six months they are into graduation, 57% of our new customers choose some payment option in school. As people come into the full P&I it is the case that the loan as everyone knows is the seven-year term and during those first two years based upon our models, we experience 55% of the loss is attended to a vintage. So in the first two years, two of seven years goes by, 28% in the first two years we experienced a 55% of the loss is to the vintage’s entire life and so the ratio of time of losses to time is 2x during that period. As we layer on new vintages from that 3Q of '13, through '14, through '15 and into '16 we’ll have no change in our credit modeling, no change in our expectation that we will experience a actuarial 1% loss rate per year for the seven years and attune rate of 7% and it will be the case that the experience that we have as far as the accelerated weighted average associated with the maturation of the portfolio will be 100% consistent with our prior models. So what we have here is a rapidly growing portfolio, a disproportionate analysis ending less than two years full P&I period and acceleration or an escalation into what is attendant to that about 100% consistent with our modeling. It’s also the case as I said that our NIM should be steady as we go through the year and that efficiency ratio at 22% is prima facie evidence of the fact that we now have reached a particular level of efficiency as has been communicated in many arenas, we believe that when the portfolio gets to about that $15 billion then the impact will have FICO of economies of scales. So in conclusion 2014 was a great year, we have a strong market position, we have great opportunity and have realized great actuals in regard to growth in our top-line. We have high credit quality and we have a 5% NIM. We have good leverage as I said we're on-target in regards to growth, in regards to credit losses, in regard to EPS. As we enter 2015 it will be our first year of just about over 100% pre-spin, we have as everyone knows a little bit of work to do in the first half of the year in order to finish up completely but it's minimal. Second as we would continue to grow our EPS in that 15% to 20% range. The third is the portfolio will continue to mature through 2015 and 2016 once we hit that $15 billion however we believe that we will be much closer to steady state in all variables. The leverage will be seen in the results, we will be hot in our results, we will be concentrating on our customer franchise and of course we will maintain our strong capital position and our strong funding positions. One item that stands out is a standalone is our gain on sale, we're happy in 2014 to be able to complete an independent sale of over a $1 billion that's 7.5%, we have and are thinking that we would sell $1.5 billion in 2015, we're forecasting that to be at 7.5%. Many of those have thought that we could do better than that, we're trying to be conservative both on the amount as well as on the proportion of premium and Steve can talk about that in greater detail. So with that I will turn over the table to Steve.

Thank you very much Ray, and good morning everybody. I’ll be referencing the earnings call presentation available on our Web site during my prepared remarks and as drive down a little bit deeper into the details of our key financial results which you can find on Slide 4. Outstanding private education loans at December 31st was $8.3 billion up 27% from the prior year and 6% from the prior quarter, over the course of the year, while bank's balance sheet grew 19%. Net interest income for the fourth quarter was $151 million, which was $7 million, or 5% higher than Q3, and 29 million or 23% higher than the prior year quarter. For 2014 net interest income was 578 million versus 462 million a 25% increase over 2013. Growth in net interest income is being driven by the relative increase in our private education loan portfolio. The bank's net interest margin on interest earning assets was 5.01% in the fourth quarter as compared to the 5.25% in the prior quarter and 4.95 in the year ago quarter. For the full year, the net interest margin was 5.26 compared to 5.06 in the prior year. The average yield on our private education loan portfolio in the fourth quarter was 8.07 compared to 8.20 in the prior quarter and 8.17 in the year-ago quarter. For the full year the average yield was 8.16 unchanged from the prior year. Our cost of funds was 1.11 compared to 1.07 in the prior quarter and 1.13 in the year ago quarter. For the full year our cost of funds dropped to 1.04% from 1.14% in 2013. The two main drivers for the bank's lower net interest margin in the quarter were lower yield on our private education loan portfolio and a higher cash balance earning negative carry. The decline in the portfolio yield was driven by lower yields on recently originated loans and a higher accrued interest reserve build as the portfolio seasons. We don't believe this quarterly decline represents a trend, we expect the private education loan yield to remain above 80% over the course of 2015. In the quarter, our cash balances were high as we built liquidity for Q1 dispersings. As our portfolio grows our cash positioning will have a declining impact on the overall NIM, which we expect as Ray mentioned to remain above 5% over the course of 2015. Non-interest income totaled $12 million in the quarter, compared to $96 million in the prior quarter and $79 million in the year ago quarter. In Q4, we did not sell any loans, which was caused by a big decline versus the prior quarter and in the prior year's quarter we sold a portfolio of asset-backed securities in preparation for the spin which had a relatively large gain which also obviously wasn't repeated in the current year. Fourth quarter operating expenses were $77.8 million compared with $75 million in the year ago quarter. In addition there were $11 million in restructuring costs. For the year, operating expenses totaled $278 million plus an additional $38 million in one-time restructuring and reorganization expenses. In the fourth quarter these restructuring expenses were significantly higher than our recent guidance. The separation was a very complex undertaking from an IT perspective. I’ll give you a sense of the size of this project. We invested over 350,000 hours of programming into the asset and completed nearly 100 different project moving nearly 50 bank systems into our new data center. We accomplished all this without impacting our origination goals and maintaining a focus on our customers, final project costs and higher than expected. The majority of restructuring has now been completed, now that we’ve established our independent servicing and collection platform. There will be an additional expense in 2015 of $5 million as Ray mentioned. A majority of the spend will be to complete to build out of our originations platform and the migration of the remainder of our systems principally financial systems for the new data center. In the quarter, we have noticed we experienced a significant increase in the effective tax rate. This was primarily the result of a one-time build of reserves for uncertain tax positions. The tax rate for the quarter was 55% compared to 38% a year ago. The full year ended at 42% compared to 38% in 2014. Needless to say this had a significant impact on quarterly earnings and had a dampening effect on the full year as well. We don’t expect these adjustments to continue to affect future quarters and our tax rate for the full year is likely to be around 40% in 2015. Bank remains well capitalized with risk-based capital ratio of 15.9% at the end of the quarter. Significantly exceeding the 10% risk-based capital ratio acquired by the regulators to be considered well capitalized. In addition, the parent company has excess capital available to the bank as an additional source of strength. We will continue to maintain high levels of capital to support the projected growth of the Company. We don’t anticipate returning capital to shareholders as we reinvest all into our business. On Slide 5 you’ll see a summary of our origination volumes, Ray have already talked about this. We originated $557 million of smart options, private loans in the quarter up 7% from the prior year. In 2014 we originated $4.1 billion 7% gain again, loans in the quarter had an average FICO score of 748, 88% of which were cosigned. Full year average FICO score of 749 and cosigned of rate of 90% compares favorably to an average FICO score of 745 in 2013. And those loans were 90% cosigned as well. Getting into our credit performance on Page 6 we got our performance stats as expected our delinquencies and charge-offs are increasing as the portfolio seasons and loans move into full principle and interest repayment. Loans delinquent to 30 days were 1.2% compared to 0.7% in the year ago quarter. Loans in forbearance has increased to 2.6% from 0.4% in the year ago quarter. This is typical in the fourth quarter as the temporary jump forbearance through the increase in loans entering full P&I. The volume of loans entering forbearance in the fourth quarter was in line with Q4 2013 and we’ve reported our smart option portfolio stats at the end of 2013 and all these stats are well in line with what we have experienced historically in the smart option student loan portfolio. In the fourth quarter and we talked a little about it on the third quarter conference call $900 million of loans entered full principle and interest repayment. This brings a percentage of loans in full P&I to 28% for the full portfolio and 40% of our loans that are in repayment. Charge-offs on end school loans, those loans that are making principle interest-only where there is $25/repayment charge-offs on those loans are very low. Losses typically emerge once a loan enters the full principle and interest repayment. There is a slide on the Investor deck it’s posted on our Web site Slide 7 that has some relevant statistics for the discussion. Charge offs on private education loans are front loaded as you can see from the loss emergence curve. 50% of charge offs occur in the first two years during repayment. Looking at our portfolios in repayment it's very young 28% of our portfolio is in repayment for less than one-year, another 9% has been in repayment between one to two years and just 3% of our portfolio in repayment has been in full principal repayment for more than two years. Based on our expected loss emergence curves charge-offs on our current portfolio to peak in 2016. The allowance for these expected charge-offs will be built over the course of 2015, as we build an allowance to cover one years of expected charge-offs. Our approach for provisioning for loans will continue to be conservative, as our portfolio seasons and we accumulate additional performance history under our 120 day collection policy. Statistics under our new collection policy have been volatile particularly during October and November as we transition through our new servicing and collection platform. In addition, we have very few stats on loans in full principal and interest repayment under this 120 day policy. So, the allowance for loan losses was $79 million or 1.5% loans in repayment at year-end. Provision in the quarter was $30 million versus guidance at the end of Q3 of $35 million, but instead of provisioning we will simply do this active term losses came in better than we thought over the course of the quarter. And I want to repeat what Ray said I wanted to be totally clear that the portfolio was performing exactly as we expect it to and consistent with our expected cumulative charge-off rate over the life of the loans in the neighborhood of 7% for any cohort of loans. Moving on, we’ll talk about our earnings metric, that’s how important for us a metric that we call core earnings, the only difference between core earnings and GAAP net income is that core earnings excludes the mark-to-market on unrealized gains and losses on effective derivatives exclude that from earnings. We use derivatives predominantly interest rate swaps, manage interest rate risks in our portfolio. We believe all of these hedges are sound economic hedges, the core adjustments are very small in the current periods they were larger back in quarter two, but we’ve gained hedges tacking this on most of our hedge portfolio. So this is not a major impact to our earnings in recent quarters. Core earnings for the quarter were $20 million, with recent diluted earnings per share compared with the $64 million or $0.14 diluted earnings per share for the year ago quarter which had an outside securities gain. Our core ROA for the quarter was 0.6% compared to 2.7% in Q3 and 2.3% in the year ago quarter,, while return on common equity was 4.7% compared to 24.2 in Q3 and 18% in the year ago quarter, obviously these stats are going to be very volatile and begin to tackle by gains on our loan sales as we go forward. ROA and ROE are at 1.7% and 15.1% respectively for the full year. Again that brings us to Ray’s comments the bank’s performance was solid in 2014 in an extremely challenging transition year with significant complexity, it executed our business strategy, gained market-share, skewed our originations goal, completed significant capital markets transactions and produced very strong earnings per share. So now we’ll get into -- I’ll repeat the guidance, I’ll make a few additional comments, we expect to originate $4.3 billion in high quality private student loans in 2015, this was a 5% growth rate. Our operating expenses for the full year will be $325 million plus one-time restructuring and reorganization expenses of $5 million to complete the spin. We view a good run rate of operating expenses as we discussed in Q3 as the fourth quarter run rate annualize the $77.8 million as a good number as it now reflects our servicing and collection platform. We view that as we discussed with prior operating expenses in 2015 driven by the growing portfolio of loans as well as certain investments that we’re going to be making to improve our customer’s experience. For example, we’ll have an additional expense of nearly $10 million over our Q4 run rate in our servicing and collection operations. And this is principally driven by increased volume. As we’ll be servicing an additional $4 billion of loan on our platform by year-end this demonstrates the substantial operating leverage that our platform is capable of. On the investment side, we’ll spend just under $5 million to onshore our sales call center and improve our mobile capabilities. We expect that these investments will pay dividends in the form of higher originations and more efficient operations but these benefits are difficult to quantify prior to implementing the change. Loan sales again that will be a big part of our 2015 business plan as we manage the balance sheet growth as Ray mentioned we plan on selling $1.5 billion of loans in 2015. For guidance purposes we're assuming that we will execute these transactions at a 7.5% premium, while it is true that if we were in the market today we think that we would probably receive better premiums for these loans but then we want to be conservative as we won't be doing our first transaction until the beginning of the second quarter and as we all know markets can be particularly volatile. So we will do a transaction early in the second quarter and then we will look to do another transaction in the late third quarter, we have these transactions penciled in at $750 million worth of loan sales. And here it’s important to remember that these loan sales are sensibly to manage our balance sheet in the early days of our operations here as an independent bank it’s in Sallie Mae’s DNA to hold these loans on our balance sheet but with that being said we will take advantage and toggle ourselves up and down if it looks like we could receive a larger premium in the market for these sales in 2015. We expect the provision as Ray has already discussed to be between a $116 million and $130 million for the year as we have reserve for growing portfolio of loans that's entering full repayment. And just to repeat as Ray mentioned we expect our EPS to be between $0.48 and $0.50. That concludes my prepared remarks and operator we will now be happy to take any questions that are in queue.

(Operator Instructions) And your first question comes from the line of Brad Ball with Encore Evercore ISI.

Just starting with the expected gain on sales premium the 7.5% Steve I wondered if you could talk about what gives you confidence that you would be able to do that 7.5% in two transactions in the second quarter and the third quarter. And whether there is any change in the pricing you would expect now that you are retaining servicing as opposed to selling with service retaining -- with servicing transferred?

Sure, Brad. So it's always difficult to get the first transaction off and now with the 1.2 billion that we sold in August we did 400 with the third-party and sold another $800 million to Navient. Private student loan portfolio sales, so far have not been done in the marketplace. So the first transaction is very much price a exploration process, we were very pleased with the 7.5% premium that we received. We spend a lot of time with our ABS bankers as you might imagine and as we look at transactions in other asset classes and how the pricing for typical ABS loans has evolved since we did that transaction there is definite evidence that the premium should be somewhat stronger the next time around. Recent example of that would be the Navient transaction that was recently executed that deal had a mix of smart options and older collateral in it, so our collateral would be somewhat more high quality and let-s say securitized plus a key point was that they were able to get a full 100% release of cash flow on their deal that the recent evolution that tells these loans have been securitized. Over the last three or four years have typically been turbo charges with turbo deals with cash going to pay down the bond freeing up more cash makes these transactions more appealing and more valuable to ultimately the new holders which was what drives the price on these premiums. So there is a lot of supporting evidence in the market that suggests that the pricing should be somewhat better the next time around. But again we’re not coming until late March or early April, so who knows what can transpire between now and then. And I should go to your second question was Brad, oh servicing retained. So I would view that as basically a sweetener I mean the buyer pays the servicing fee regardless of who is servicing, so we will receive the premium and the servicing chain as we go forward in the future.

Great.

The servicing dynamic as you mentioned is similar as identical from a buyers point of view, so the looks under the summer.

And then Ray in your comments, a couple of things you mentioned a gain in market share. I just wondered if you could talk about what do you think is driving that sort of 1% to 2% pickup in market share. And you also noted that you saw that private education loans will reach 15 billion by the third quarter of '16. Does that imply no additional sales beyond the 1.5 billion in '15? As we look at our model it looks like you had have to retain pretty much all of your originations to get that 15 billion by 3Q of '16?

Alright two things, one is via market share and one of the items that had occurred in 2014 of which we are most proud is that while we were doing quite a bit of work that was driven by corporate decisions launching the new company, the spin, the change in the operating platforms all of that. That we were able to successfully finally to isolate those that series of activities from our customer efforts, and so our efforts with the customer in both sales and marketing continued unabated and as you know we are the premier company focusing almost entirely on the student lending market in the private space. And so I think it’s a benefit of that continued focus, the effort on the part of the entire management team but especially those in sales and marketing could not be distracted by what has been happening back at the home. And I think this is a trend that we’ve actually seen in previous years as well. And so while we think our strong market position, our care for our customer basis of which they are several including the financial laid offices, the parents, the students we believe that that constant effort is not interrupting not being flavor of the month that sort of thing has paid us quite handsomely. In regard to your second question and this is a projection based upon current trends we will hit $15 billion and the amount that would be sold in regard to that $15 billion you might say in terms of or one of those 10% to 15% of it so that would be the noise around that number it’s not a very large order of magnitude. So if it’s not 15 in the one quarter it would be in the next quarter so far it is held, but there is important point here so far as servicing because if we continue with our plan to sell assets servicing retained. We will continue to get the operating leverage associated with the larger receivable and so we have an interest in both of those items.

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

The market growth as we’ve said is in aggregate relatively low. So 1% to 2% in new entrants then it’s a question of what the schools charge and then usually the dynamic of the federal program the discounting on the part of the school. Would not be any particular change in -- what we would think of as going to be top of the funnel dynamic of what’s going on in the schools. We have seen that there has been some shift in our originations more concentrated and higher quality traditional four year in not for profit school little bit less than the four profit schools which have lost out given all the noise that has been around certain franchises there. In regard to the competitors we watch them very carefully we have seen no major shifts in behavior of either one of our primary competitors, but they remain organizations of great reputation, extreme capability, lots of muscle power we are the smallest among them but we have the most -- we are most focused on this particular market. But in both of those dynamics, in answer to your question, we don’t see too much of a change in the momentum associated with the basic portfolio of schools and the needs for families to finance the gap that is left after especially France and the federal programs have been exhausted. And we have not as far as we can tell seen any major shifts in the competitive frame.

And then my last question, just I want to clarify the message here on credits, are you saying that there is really no fundamental deterioration in credit in the book. But at the higher provision guidance for 2015 just reflects a higher proportion of loans that are entering repayment. And can you talk about sort of how we should expect 900 billion just entered repayment, how much more over '15 and into '16 will be entering that first phase of repayment that would might over the near-term next couple of years keep provisioning levels at elevated levels?

Sure let me go back to your first point which is as our full year comments no fundamental shift. Let me be more stringent to that there is no shift period it’s not fundamental or otherwise. We’re exactly on the models that we have always talked about the seven year is up for the term of loan with an actuarial loss rate of 1% per annum is still what we are working on we haven’t shifted that one point at all. It is the case as I said that during the first two years of full P&I payment it’s two years of seven that are on the calendar and so that’s 28% of the time at last. During that same 28% of the time we experienced 55% of our losses and so 55 divided by 28 is a nice clean to act. But during the first 24 months portfolio entering full P&I we expect to experience double the rate of losses and we expect that to mitigate after -- during the second year. And so as we grow the portfolio from five, to 10, to 15 we will have a series of those elevated loss curve that will disappear in the same two years that I’ve just mentioned. And then Steve if you can talk a little bit about the number and volumes of entering P&I -- those entering P&I during the next year or two that would be helpful?

Sure. So, Brad our portfolio is going to be very seasonal and the pattern is going to repeat itself. So we have $300 million of loans going to P&I in June and another 1 billion going in December this follows basically the spring-winter graduation pattern. We would expect to have growing cohorts of loans reenter into principal and interest repayments and basically June and December of every year. So the 300 becomes, 350 to 400 and the 1 billion becomes -- the 900 million becomes a 1 billion to 1.1 billion at the end of 2016. And the pattern would repeat itself in '16 and '17 and I guess the key part to note and it’s an obvious one that as the portfolio grows it seasons the provision will be a diminishing percentage of overall net income.

y:

So first on the provision for 2015 just a point of clarification, does that reflect the 1.5 billion of expected loan sales for the year? So in other words, if you sell the 1.5 billion I would assume there would be provision associated with that that would go away are you factoring that in with the 116 million to 130 million of guidance?

Yes, Michael that’s factored into that guidance, we have accounted for that.

Okay. I guess as we think about the provision sort of a long-term reserve that you guys want to hold up -- hold against this portfolio, I know you mentioned attune loss rate of around or an annual loss rate of around 1% is that can we think about that in terms of reserves, I mean are you going to manage longer-term to reserve around 2% is or 1%, how do we think about reserves long, long-term once the portfolio has matured?

So the allowance for loans -- the allowance for the full portfolio at the end of Q4 was 1%. We are reserving for expected losses over the next year, the reserve of incentive loans in repayment both will grow over the next year or so, we would expect the reserve to end 2015 roughly one and a quarter percent of the total portfolio and that translate to one and three quarters of incentive loans in repayment. So, we very well reflect the front loaded nature of our expected charge-offs.

And I guess once the portfolio has matured sort of how should we think about where that 1.75 would go?

So I guess just using '17 as a maturity point when we get out for that $15 billion that we’ve been talking about, the 1.75 it probably plateaus out around that level possibly a little bit higher.

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

First to 2016 in order to get that number you take the fourth quarter expenses that we had multiply that by four take a look at the -- and then take a look at the trajectory expenses for 2015 which are 3.25 and so as we look at that versus the incremental revenue associated with the marginal efficiency ratio associated with the fourth quarter run rate versus the 2015 projection is 22%.

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

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

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

So just to refresh everybody’s memory, the migration models that we use, uses an average of 16 months of low rates through the delinquency buckets. And we have been using pre-split the roll rates from the 210 day collection policy and I know this is kind of hard change stuff but the important fact here is we have been using roll rates in the first four buckets under the 210 day policy where there is very little activity, there is very little effort to collect loans under the 210 day policy most of the activities took place in the last three buckets because delinquencies had a tendency to self cure. So when we have had more time we spent less money in the earlier buckets. We only have 120 days, so we focused more intently obviously on the first four buckets. But the point is we're using very high roll rates pre-split a we expect those high roll rates to migrate down overtime which would result overtime in a lower provisioning. We have as I mentioned earlier even less stats under the full principle on interest repayment model because obviously that those -- they just went through repayment, so what we are using is a blend of old and new rates and as things usually happen this complicating factors took place during the transition where roll rates were a slightly elevated in October and November. So our overall roll rates didn't come down significantly. They dropped quite a bit in December but we aired on the conservative side wanting to see more evidence with how we collect loan during full principal and interest repayment before we take that into a long-term guidance for provisions and allowance. I know it’s a lot of the…

I mean just to sum that up, and may be just to sum that up that means if credit continues to perform as it has been for you guys that that should theoretically take down your provision rate as some of the period points of volatility come off your calculation?

Look I mean that's correct. In the prepared remarks myself and Ray we did say that this provision is conservative, but we don't want to second guess it at this point in time we will continue to report information periodically as the process evolves so we will be in front of investors in February at an industry conference where we can share more detail with how that model is evolving and again we will be communicating again in first quarter conference call. But it is an evolving process. We do think the provision and loan loss allowance is conservative and we do think that the portfolio is performing exactly as we expected it to when it was underwritten.

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

I mean look the curves are informed by both old signature performance adjusted to reflect what smart option student loan would look like, as well as the available smart options data that we have since we have started to originate these things in 2009. But as a point of reference in our investor presentations to-date we've shown how smart option outperforms the legacy signature data. So layering that into the analysis might have a tendency to overstate the charge-off, we do think we're adjusting appropriately for that. As you can see where cumulative defaults are trending towards in our investor presentations and we believe that we're on-track to match that price with performance.

Alright, one final question on credit. Just that 175 that you mentioned towards the end of 2015, did that migrate and I understand some of the other dynamics that we talked about might bring that down in theory. But like does that migrate even higher in 2015 and 2017 all else equal?

The allowance migrates higher into '16 to reflect the new repay wave that's coming in and then into '17 and then we think it will plateau.

But that ratio -- that ratio, does that change, the one that is reported?

The reserve incentive loans in repayment?

Repayment, yes.

Yes, it picks up from '15 and we would expect to pick up from '15 into '16.

And that 175 and then 2015 that's assuming 100% coverage to looses in theory?

Yes.

Okay. Great and then just last question, sorry. I guess to the extent of the gain on sale margin is higher when you are ready to sell, would that perhaps lead you in a direction where you might sell even more than what you are contemplating within your guidance?

Yes I think that's correct. Look if premiums are lower of 108 I think our tendency would be to sell a little bit more, if they are 108 or lower we will stick with our $1.5 billion of loan sales. I don’t see us really in any pricing environment selling more than 2 billion or sell of these loans unless we love these smart option loans we’re in the student loan business and we want to build up a balance sheet that is going to generate future earnings for the Company and shareholders.

And that hypothetical 108 that’s sort of that’s ex-servicing right?

That’s correct.

And your next question comes from the line of Sameer Gokhale with Janney Capital Market.

Just again if you can just remind me the other income 12.3 million I think it’s related to Upromise some of the seasonal bump up in that. But can you just dive into some specifics of what exactly again what that is relate to Upromise that’s driving that increase?

So actually Sameer the increase in other operating expenses from Q3 to Q4, the Q4 number of 11.1…

I’m sorry I meant other income.

Yes that is what I am talking about the other income number was $12 million I think in the quarter. For Q3 comparative number I think it was 5.6 million. But actually it had an impact on it lowered it in Q3 due to a true up on a tax indemnification line that we booked in Q3. So the jump from Q3 to Q4 exaggerates the increase in that line. As the Q4 number was a very good run rate, our Upromise business income that’s generated is essentially from credit card and the Upromise credit card and there is a Upromise online mall that generates revenue basically from advertising and fees from merchandize sold for our audience.

And then just I had a -- sorry if I missed this earlier in your comments. But the 1.5 billion target that you’ve given for loan sales is that predicated in any sort of assumption of securitization of loans which would reduce the need to sell those loans and have you spelled out a dollar amount that you intend to securitize again apologies if you talked about it earlier in the call?

No we didn’t talk about that so it’s a good question. We will be securitizing to fund our private student loans. Our strategy has always been to term out our funding, so we will be doing securitizations that are funding driving that remain on the balance sheet and the volume there I think about $1.5 billion to $2 billion. As it happens to execute our loan sales I think the most efficient message is going to be to securitize the loan and sell the residual. So you will see us doing to attune of 1.5 billion. If it happens that whole loan buyers step in and win an auction we will happy to sell the loans in the form of whole loans. But I think with that would probably come from the structured finance crowd where we sell whole bonds like we did last time all the Triple As Single As and the residuals to one buyer, while we distribute those bonds to different buyers and sell the residual to one investor which would then to consolidate the loans from our balance sheet.

So just to clarify Steven the 1.5 billion I mean that consists of just whole loans sales it loans out of your portfolio it doesn’t include any off balance sheet securitizations that you will do correct?

No, so it will be done entirely like we will sell loans in the form of a securitization. So we will securitize them and then once you sell the residual you consolidate that entire portfolio from your balance sheet.

Okay, but I was just trying to clarify that is part of your 1.5 billion that’s included in that?

That could be with the entire 1.5 billion.

Okay, so then that gets to my question which is -- next question which is and again I don’t know if you addressed this. But your loans sales for this year I think were like 1.8 billion-1.9 billion and the guidance is for a 1.5 billion. So if one were to look at kind of that decline I am not sure exactly what that’s attributable to is there some conservatism built in there again and apologies if you talked about this earlier?

So what happened in Q3 in 2014 was we sold post-spin $1.6 billion of loans, it’s confusing because prior to the spin the old process would give a bank who sell loans to SLM Corp. and SLM Corp. would securitize them into the market. So our $1.5 billion of loans sales that I would say is comparable to the 1.6 billion that we did in 2014 to third-parties.

So then as I look at your guidance I mean you talked about the ceasing of the portfolio and how that’s going to put some upward pressure on provisioning you talked about the OpEx. Where do you think if you were to say this guidance were I mean should we assume this guidance is conservative? Or should we assume that there is any give here or should we just your kind of realistic scenario where the number should take out and I am just trying to get a sense for where there could be some give, I mean you talked about the loan sales and maybe the gain -- the premium coming in a bit higher if that happens that’s a possibility, but elsewhere in your provisions OpEx where do you think there could be any sort of give there is what I am trying to figure out or maybe on net interest margin?

Okay. So, the guidance it is our guidance, but that being said to your question so the $4.3 billion in loan originations I think that’s pretty rock solid without a whole lot of variability, I think our $325 million operating expenses is pretty rock solid, loan sales is certainly a candidate for some variability we could sell more and we could receive a higher price on the loan loss allowance look it is conservative but I don’t want to sit here today and say, encourage people to think that that is going to come down without further evidence of that actually happening over the next couple of months.

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

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

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

Just wanted to follow-up on your EPS growth target, I think during the spin-off road show you talked about 20% plus EPS growth as a longer-term target, and I think ray you’ve mentioned earlier in this call you are looking at 15% to 20%, I’m just wondering I guess what you are actually targeting and what your targets and incentives are based on?

Sure and as I said, the guidance that we’ve given for '15 is clearly 15% to 20% and it is the case that when you look at the dynamic of the origination spreads and so it’s run through the P&L that in the medium-term let's call it within three to first years certainly 20% or 20% plus is possible. And so, as I have said a couple of times in this call we haven’t changed any of our modeling, we still are at that yield of 8% we are still at the growth in portfolio we talked about we are still at the minimum of 5 we are still at the returns we talked about which I believe are 16% ROE or so. And so I think the message for '15 is that we have this maturation of the portfolio, it will cause us to incur higher losses during those first two year periods while large amounts of dollars go into full P&I. So the '15 will be a year that experiences a higher relative credit loss amount and proportion versus the out years once we are past those two years when we’re experiencing the remaining five years of the loans for those vintages which will have losses significantly under 1% after the first two years. And so we have a weighted average heavy year credit cost in '15, but that hasn’t changed any of our medium-term or longer-term objectives, or trend line as we’ve discussed with you.

So, your provision guidance 116 million to 130 million relative to the dollar amount of loans airing full P&I repayment of 1.3 billion that’s a 10% provision to loans than in repayment and I guess as you migrate up to 2% reserves to loans in repayment relative to 1% losses I guess how does that sync up with your reserving methodology for 12 month forward losses?

Well, keep in mind we’re not just reserving towards the loans that are in principal and interest repayment there is also a factor in there for loans that enter TDR where we have a pretty high assumption of loss rates and we are also reserving for loans that are in fixed and interest-only, okay, so.

Is that really 2x, I mean if we’re thinking about this on a 12 month lower basis?

The portion of the portfolio that has just entered P&I and in the period from just entering to up to two years is 2x. And so Steve is saying is that the full loan loss reserve is a weighted average of items that have been in the -- first we ended 2014 with $8.2 billion in private student lending it is the reserve up against that those are long past their peak curves and that’s part of the reserves. Steve mentioned TDR, TDR requires that you reserve 100% of items in TDR so you know that's a factor here. Then we have a higher proportion of accounts entering into full P&I as we escalate from that 28% as Steve mentioned to a more normal portfolio. That has the one year loss projection associated with those loans and that will be over the 1%. And so when we look at the entire loan loss reserve it's a one year outlook but it's for all of those slices.

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

When we think about the private student loans we should just remember this question came up a little bit earlier in the call about how much is that and let's remember the starting point for any projection is the 12/31 number which is $8.3 billion of private student loans owned and serviced by us to zero service for someone else. And so when we talk about 1.5 going into the servicing for someone else but it's owned by us -- by the time we are at that point of ending let's say the 12/15 numbers, well we're going to have the 1.5 that we have put into place again which is the gain on our sale number but the 8.3 well over that period let's just think about it we started 8.3 we originated $4 billion worth of loans, we sell 1.5 the 8.3 turns into 8.3 plus roughly 2.5 and so at the end of the year we're at 12 billion or so in owned and serviced and 1.5 in regards to service for others. And the proportion of service for others will be low. And even if we were to look in the out years it's a number that doesn't really get above 15% in relation to the private student loans held on balance sheet service by us…

It's 15 billion all in including service for others, that's the service portfolio and not what's on balance sheet, okay I just want to clarify that. And then just on the I guess the loss curve I am looking back at an old cohort default triangles for the signature loans with co-signers and the most I am ever seeing here with co-signers is a 2% loss rate periodic default loan repayment in year one. And I guess that's across the whole credit spectrum, if I were just to look at higher FICO scores that are more representative of your loans and against also factoring the smart option. The most I am seeing is 1.5% to 1.7% max, so I guess the 2.5% to 2% expectation that you have is almost 50% higher than the actual cohort default triangles I am looking at for 2008. And even earlier vintages and I guess just having a hard time reconciling that?

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

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

Sorry to revisit the credit issue again but could you just give us some sense of what you are expecting in terms of charge-offs at this point using your more conservative assumptions for 2015 and how much better that could be if you use this the smart option?

So the -- what are you looking for, charge-off rate or a dollar number?

Dollar charge-offs, so you had a little over $10 million in Q4?

So we would expect over the course of 2014-15 to see charge-offs in the vicinity of $80 million.

Gross actually and that doesn't take into account the recovery rate.

And then using your more conservative…

Absent our conservative curve assumption, that's right.

Okay. And can you give us some sense of how loans might perform just as we see…?

We should talk about net, excuse me one second right so it’s 80 gross going into as you know I’d assume 80% recovery and that is a 80 gross 20% recovery it is a number like 65 million?

You got that David?

Okay. Thank you. And I just wondered though layering on top of that that we're seeing a better economic environment, lower unemployment, lower gas prices, rising incomes and then as Eric and others have asked you about I guess the improving quality of the portfolio. It just seems like those forecasts are conservative and then they are kind of gets back to the same issue we've been repeatedly talking about which is just the reserve goal near-term as opposed to spreading it out?

Look, there is no doubt that these -- there is a provision in loan loss allowance estimate is conservative, we've discussed the reasons I mean we ought to be holding to a model the model is I think are into development and probably point to lower provisions requirements in the future but we do need to take our financial statements and our projections on something here and we are airing on the side of conservatism as we sit here today. I mean to your point we do think that there are a lot of supportive factors in the economy and we do think that the smart option student loans would perform very well over the life of the loans that we’re originating here.

And so you have kind of indicated you might give a rise and give updates does that include kind of revised guidance as we through the air going into February and into modeling data.

Yes I mean we always freshen up our guidance quarterly. And we will continue to do that.

Okay, and then yes…

As I have pointed out earlier we were 5 million high on the guidance for Q4 we guided 35 we came in at 30 million. So it’s a roughly a 10% to 20% mix in there so.

Right now we’re going to annualize that the other way. But then could you just explain also the your ability to retain loans and constraints that the regulators have on portfolio growth I think before the spin you talked needing to sell some loans to limit portfolio growth are there any or what are the limits at this point. You’re talking about only selling 1.5?

As with many other pieces of the model that we have communicated over these two months I want to stress it hasn’t changed either. Right so we end the year as $12 billion of balance sheet roughly speaking the FDIC has an upper bound on the growth they will allow for the bank at 20%. So we might think $12 billion, 20%, $2.4 billion in growth. We originated 4.3 and we’d have to do something with the excess because we’re not going to surrender any of our position in the market and because we think even though with assets at attractive rates 4.3 minus 2.4 you lined up with $1.9 billion of stuff has to go somewhere. We decided we want to sell about 1.5 of it and we make the balance sheet a little bit thinner on some of these cash balances as Steve was talking about it having a negative carry in the fourth quarter. And we end up at the 20% as the 1.5 in a more efficient balance sheet.

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

That is correct.

So there is not a constraint on private loans?

It’s not a constraint on private loans, yes that’s correct.

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

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

Right I mean there are few asses as higher returns than your private education.

That’s right I first preference and in our D&A as Steve said earlier is that the whole goes but when prices get over 8% really it’s time to think about it.

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

Taking a slightly different attack on the credit and sales question, I guess first of all if you would originate more than 4.3 is it reasonable that much if not all of that would actually get sold?

Well if raised significantly more than 4.3. We would then probably increase our gain on sales yes and our sold assets.

Right, okay, and just I guess given the fact that you know what the market is today and you don’t know what the market will be in the back half of '15 or at some other time. And you pretty much can essentially -- can't you just prefund some of those sales and do them earlier quicker in '15 as opposed to spreading them over as much out in the future. I mean wouldn’t that lock in more of that gain at those levels?

So there is a process Moshe particularly if we go the securitization way out you need to get these things right and it takes quite a while to get them through rating agencies. So we have already kicked off the process for our first sale and then there is trade-offs if we frontload the whole 1.5 billion it hurts our net interest income over the course of the year. So we do take all those factors into consideration and I think that the best bet is what we’re planning on doing in selling 750-Q2, 750-Q3 there is also demand for manage when we are selling asset backed bond to do straight funding deals were also tapping to a certain extent some of the same buyers and there is a limit to how much ABS you can put into the market at any given time we could easily do billion and a quarter in one sell through. And start pushing the limit to 1.5 billion to 2 billion the market can get saturated. So there are a couple of different factors that we take into consideration on the phasing of these sales as we enter them.

Remembering as we both provided that 85% of these portfolios are floating rates.

I get that I just was -- and I understand that obviously you don’t want to over saturate the market at any point in time. But it seems that there should be some acceleration just given the pricing -- the pricing dynamics that you’ve got which would solve some other problems, as far as give us the net interest income the gain on sales that you're expecting is kind of five times a quarter’s net interest income. So, if you're going to originate the loans at a later date anyway it wouldn’t really have a negative impact on your current year’s earnings, it would have a positive impact on your current year’s earnings and it wouldn’t in any way change your long-term position because you’d have the same amount of assets, anyway that’s just a thought. Thanks.

Well we take that under advisement, I mean look, we will watch the market, we haven’t gone to price and so we know the buyers are listening to this conservation such as it turns out the premiums is higher than what we are suspecting but there are ways that we could increase the size of the sale.

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

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

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