SLM Corporation (SLM) Q1 2015 Earnings Report, Transcript and Summary

Good morning. My name is Valerie, and I will be your conference operator today. At this time, I would like to welcome everyone to the 2015 Q1 Sallie Mae Earnings Conference Call. 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]. I would now like to turn the call over to, Brian Cronin, Senior Director of Investor Relations. Sir, you may begin.

Thank you, Valerie. Good morning and welcome to Sallie Mae’s 2015 first quarter earnings call. With me today is Ray Quinlan, our CEO and Steve McGarry, our CFO. After the prepared remarks, we will open the call up for questions. Before we begin, keep in mind our discussions will contain predictions, expectations and forward-looking statements. Actual results in the future may be materially different 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 conference call, we will refer to non-GAAP measures we call core earnings. The description of core earnings, a full reconciliation to GAAP measures and our GAAP results can be found in the Form 10-Q for the quarter ended March 31, 2015. This is posted along with our earnings press release on the Investors page at salliemae.com. Thank you. And I’ll now turn the call over to Ray.

Thanks Brian. And good morning and thank everyone who’s dialed in. As we have this meeting on April 23rd, I would be remiss if I didn’t note that we’re just about a year from the original launch of the spin which happened at April 30th, May 1st how you count that. And what a difference a year makes. We’ve had very successful 12 months; lots of gratifying points and I guess we discussed this quarter I think you will see that that we have a continuation of the improvements of some of the items that we talked about but along keeping with the original business model. And the audiences to thank are numerous but especially our employees; our Board has been terrific through the first year; our customers have been faithful to us and as everyone knows, we increased our market share during this volatile time. I want to thank some shareholders and you know who you are who have been with us from the very beginning. Our regulators have proven to be very good partners in watching our growth especially for a new company. And I just want to thank Jack Remondi and his team at Navient as we separated, they have been very good partners in many, many areas of activity. As you go back over 2014, we think about the span. Operating day one, operating day two, we had cease-and-desist order in the Bank at this time a year ago; we did issue 425 million shares; we had our first quarter we reported gain in July our first asset sale at 7.5% in August and we did managed to deliver earnings as well as very good ROE and a great aider good ROE 15% last year. As we entered the quarter here as we discuss this quarter, we continue and so we continue to do the separation from Navient; we’re probably 90% done. As has been reported previously, the major outstanding system to be converted is Atlas. We’re scheduled to continue to ramp up the use of Atlas and we should be reaching all our applications on that system by about June 30th of this year. And so that will complete all the major steps as far as separation and depending operating for the Bank. Our team has been rounded out and we continue to -- managers are all in place which was not exactly the case a year ago. In regard to our customer franchise, we continue to enhance our delivery systems. So, as I mentioned, Atlas will be unplaced before the end of the second quarter; we’re upgrading our mobile interface with customers. We completed the on-shoring of all servicing for the private student loans. Over the course of the first quarter on March 31st, we discontinued operations outside of the United States in regards to servicing those private student loans. And so, we’re in the Lower 48 as they say. We’ve expanded the sales force; and as I said we gained market share. The business model is very much intact. And while we’re seeing some small parameters, the underwriting, the NIM, credit, ROEs, leverage, servicing and I should say that our servicing which we were not full executing a year ago, in regard to the asset sale which we’ll talk about here, we sell servicing retained. And our servicing was rated very highly by all the relevant agencies. And our market position remains very strong. It’s also the case that we talked about through ‘14 and into ‘15 the leveraging of infrastructure. And so the fourth quarter run rate for our efficiency ratio that is the fourth part of the company when we were finally more or less on our own platforms and looked at the efficiency ratio in the fourth quarter of ‘14, the number would be 48%. And with the guidance that we’ll talk about in a little bit, 2015 the efficiency ratio will be for all the expenses and revenues incur in ‘15, 20% which is obviously an outstanding number. Back to the first quarter: So, we originated $1.7 billion or this first $1.7 billion for the new loans during the period which is an increase of 9% over the same period a year ago. And so as people know who follow these things, the market is not growing 9%. And so that reflects a position that is still A, very strong; and B, improving, which is consistent with our performance for the first four quarters, that is from 2014. Credit quality remains very high and very stable, 90% cosigned, FICO average through the door, 748. Our credit losses which as everyone knows, have greatly improved during the quarter and represents one of the major deviations in guidance from 90 days ago are gratifyingly one, very good; two, on our model; and three, much better than they were 90 days ago. It’s right to say as we discussed in January that our portfolio is still relatively young. And so, if we look at the nature of the student loan portfolio maturation part, it is the case that the portfolio is lasts the typical loan lasts about seven years. In the first two years, you use up about 28% of the loan time. However, because credit losses are front-loaded, you wind up with exactly 2x, 28% of the time, 56% of the cume losses for the cohort. And so the losses are higher in beginning; that was the discussion we had very much in January but it’s also the case that the volatility is very high during that period of time. And some that we were discussing this little bit earlier and one of these analogies would be if we look at a good life insurance underwriting firm, they would be able to predict with reasonable degree of accuracy, the loss rates for a cohort over 30 years. But if they were asked to do it over 30 days or 90 days that’s not what the model is really set up to do. And so when we look at that and the fact that the P&I portion of our portfolio for ongoing loans to be held at the Bank was roughly about $1 billion in outstandings a year ago. And as we sit here today, it’s roughly $2.6 billion. And so we’ve had a 160% increase in the P&I portfolio that we’re forecasting. And as we said in January and looked at the forecast, we were experiencing some volatility; we took a conservative tactic on that. Volatility has gone our way. We think this it’s much better now that this volatility is lower and the performance is good. And we’ll talk some more about that later. Our NIM in the quarter, 5.6 continues to be very good; it’s an absolute number, up from 5.01 in the fourth quarter and the earnings you know about; the census was pretty much 7; we’re at 10. The ROA was very good; the return on equities look good. Steve will talk about many of these items and of course the new sale has been outstanding for us. And so as we continue to move into the second quarter, we will have more of the same. We’ll finish off the spin items; we’ll have all the servicing of course beyond United States. We expect to maintain our position in the market. We have been able to add two new board members during the quarter, Jim Matheson and Vivian Schneck-Last. Jim Matheson is a 14-year seven-term congressmen previously servicing for Utah; and he has joined our board as a member who can help us out quite a bit in the political arena. We hope so far as is understanding of dynamics there; look forward to Jim’s participation. Vivian has spent over 20 years with Goldman Sachs and is a stellar IT and general manager and expert. So, we’re very gratified with both those people have accepted and that the board is nicely rounded out. And so with those comments, I’m going to turn over the next few minutes to Steve to go through the financials and then we’ll open for Q&A.

Thank you very much Ray. Good morning everyone. Thank you for joining our call. I’ll be referencing the earnings call presentation available on our website during my prepared remarks. And we’ll begin with our key financial results on slide four. Outstanding private education loans at March 31st were $9.7 billion, up 34% from the prior year and 18% from the prior quarter. Net interest income for the first quarter was $171 million which was $20 million or 13% higher than Q4 and $32 million or 23% higher than the prior year quarter. Growth in net interest income is being driven by the increased amount of private education loan portfolio. The Bank’s net interest margins on interest earning assets was 5.6% in the first quarter compare to 5.01% in the prior quarter and 5.5% in the year ago quarter. The change from the prior quarter was driven primarily from lower cash levels in Q1 which reduced the drag on NIM from negative carry. We typically ramp up cash levels in Q4 to prepare for our large origination season and then draw them down as the disperse loans in January for the spring semester. Cash balances will increase in Q2 from proceeds of our loan sale. The average yield on our private education loan portfolio was unchanged in the first quarter from the fourth quarter at 8.07% and compared to 8.14% in the year ago quarter. Our cost of funds was 1.17% compared to a 1.11% in the prior quarter and 1.04% in the year ago quarter. The higher cost of funds in Q1 compared to Q4 is the result of feeds associated with our new secured funding facility which we haven’t yet drawn on. Non-interest income totaled $11 million in the quarter, compared to $12 million in the prior quarter and $41 million in the year ago quarter. Our non-interest income is primarily fees from our Upromise business and late fees associated with loan portfolio. There were no third-party loan sales in the first quarter which account for the decrease from a year ago quarter; in Q1 2014, we had gains on sales of loans to total $34 million. First quarter operating expenses were $81 million compared to $66 million in the year ago quarter. In addition, there were $5 million in restructuring costs. Over the course of the first quarter, we found that operating expenses were running a little bit higher than anticipated. This is a result of a number of different expense lines coming in higher by just a few million dollars for the full year. A few examples of this are higher employee benefit costs and higher data center costs. In addition, we’re going to invest $3 million in the Sallie Mae brand over the remaining course of 2015. As a result, we’re going to increase our operating expense guidance as reported in our press release. But we remain committed to managing our expenses carefully to optimize the efficiency of the organization. And as Ray mentioned, when we look ahead, we continue to expect improvement in our efficiency ratio and we expect to continue to benefit from the scalable servicing platform in future years. In the quarter, the tax rate was 40% compared to 38% a year ago quarter. We expect the tax rate for full year likely to remain around 40% level. The Bank remains well capitalized for the risk based capital ratio of -- total risk based capital ratio of 14.4% with the end of the quarter well above the 10% risk based capital ratio required to be considered well capitalized. And I’ll point out our capital level will increase significantly in the second quarter, once we close our recent loans sales. In addition, the parent company has excess capital that’s available to the Bank as an additional source of strength. We will continue to maintain high levels of capital to support the projected growth of our company and we do not anticipate returning capital to shareholders as we reinvest this capital in our business. Switching to slide five, we find the summary of our originations volume. As you can, see we originated $1.7 billion of Smart Option loans in the quarter, up 9% from the prior quarter. Loans we originate in the quarter have now reached FICO for 748 and 86% of the loans have cosigner. These tasks, particularly the cosigner rates are very consistent with what see in first quarter and we continue to expect the cosigner rates to trend back towards 90%. Keep in mind that the growth rate in the first quarter was closely tied to the growth that we experienced in the peak season of 2014, as this was second disbursements. The guidance for origination growth of 5% from the prior year remains intact. And the marketing to the next academic year will begin shortly and we’ll begin to learn how we are going to fair in that in the upcoming season. On page six, we reported strong performance statistics on the portfolio. As mentioned on our last earnings call, delinquency and charge-offs were elevated in the fourth quarter due to operational changes. We experienced normal transition to our new servicing and collections platform back in October and November. The impact of this is clearly evident in the graphs that we provide on slide seven. The good news is, our collections team got back on track in December lower default rates, the basis of our loan loss allowance model spiked in October and November and then declined sharply during December and remained low through March. Specifically the relative default rate from the last bucket averaging the low 50% in October in November and then dropped to under 30% for the last four months, very significant improvement. And this strong and consistent performance that we’ve seen over the last four months is largely responsible for what led for the change in our provision guidance. Looking at the numbers, loans delinquent 30 plus days were 1.6% compared to 2% in Q4. Loans in forbearance have increased to 2.8% from 2.6% in Q4. This increase in forbearance is very much expected due to largely wave of loans entering full P&I in the fourth quarter. And if you look in our 10-Q on page 46, we published some forbearance statistics that show $171 million of total loans in forbearance, about $102 million of that number had less than 12 scheduled payments. And this is very consistent with what we see when we look at individual cohorts of loans as they enter full P&I, forbearance usage is heavily weighted to the early stages of repayments. Charge-offs in the quarter were just 0.5%. And as you can see, delinquencies and charge-offs decreased from Q4 to Q1 despite the seasonal pressure for them to increase. This demonstrates our ability to execute our default diversion strategy and 120-day charge-off policy. We continue to be very confident in the quality of our portfolio and the life of loan loss expectations that we frequently talk about for the Smart Option loans. We ended the quarter with 26% of our loans in full P&I. So as a result of the strong credit performance, our provision for private education loan losses was $16 million in the quarter and we expect to book an additional $79 million of loan loss provision in the remaining three quarters of the year for the total of $95 million in 2015. On page eight, we report our earnings metrics, that’s how important for us a metric, we call it core earnings. The only difference between core and GAAP net income is core earnings excludes the mark to market on unrealized gains and losses on effective derivatives from our earnings. We used derivatives, predominantly interest rate swaps to manage interest rate risk in our portfolio. And all of these hedges are sound economic values. Core earnings for the quarter were $46 million; $0.10 diluted earnings per share compared with $48 million for the year ago quarter. As Ray mentioned, core ROA for the quarter was 1.5% compared to 0.6% in Q4 and 1.8% in year ago quarter. And return on common equity was 13.1% compared to 4% in Q4 and 16.6% in the year ago quarter. Considering we had no loan sales in the quarter, these are good solid numbers and we expect them, both ROA and ROE to rise over the course of the year as we execute on our business plan. Last Friday, we announced the pricing of our first loan sale of year. This transaction was done as a securitization with the sale of the residual interest in the trust. Important to note that the loan included in this sale was a representative sample of our portfolio; what we sold was very much like what remains on the balance sheet. This transaction was met with very solid demand for both the notes involved in the sale and the residual. We had over 30 investors by notes and more than half a dozen participated in the residual. Also, we saw a number of new investors in our asset backed issuance which was very positive. We received the premium of 10.5% for approximately $740 million in loans that would be in the trust when it closes. This will result in estimated gain on sale of $78 million in the second quarter. And additionally we’ll receive a servicing revenue stream of 80 basis points over the life of this trust. So this transaction is major milestone for Sallie Mae. We will look to do a similar transaction late in the third quarter of another $750 million. So, as you noticed, we also are increasing our guidance for the premium to be 10.5% on our remaining transaction for year, bringing our total loan sales to approximately $1.5 billion of loans. Recap our guidance for 2015; we still expect to originate $4.3 billion of high quality Smart Option loans. We expect our provision for private portfolio to be approximately $95 million for the full year. Our gain on sale is now expected to total approximately $155 million and total OpEx will be $347 million for the year. As a result, we are increasing our EPS range to -- expected range to between $0.57 and $0.59. That concludes my prepared remarks. And we’ll now open the call for Q&A.

[Operator Instructions]. We have a question from the line of Michael Tarkan with Compass Point.

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

So, basically the provision that we provided back in Q4 was based on a lot of uncertainty that we were seeing in the oil rates. Our collection performance began prior the separation as we expected it to, but there was a considerable amount of disruption in October and November. And subsequent to that, the performance has been extremely steady. And what’s important now is that we are dealing with delinquencies that are from our first day principle and interest repays at that one and two repayment in November and December. And it is performing very well and very close to as we would expect it to. So, we feel pretty confident in this $95 million loan loss provision that we’ve guided to is there conservatism in it and as a general rule, we’ve tried to provide guidance that we can meet. And we’re pretty confident that we are going to meet the $95 million if the portfolio performed better than that and it’s also good.

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

There is actually a couple of factors there. We’re very consent with the $1.5 billion through 2015. The 110.5% was a very good result. If we were concerned that that would not be achievable in late 2015 or early into 2016, we might consider to sell more loans sooner. But we’re reasonably confident that these high quality loans will garner the kind of premium that we just realized in the marketplace. And I don’t want to get out over my skis, [ph] but I think as we develop this market and people see the performance that we’re talking about now continues to persist, I think it will be easier to execute additional transactions in the future. And the other thing is it’s kind of operational, so we got a late start here. The gestation period for these transactions is several months. And we would like to also execute at least one funding transaction. So, I don’t know that there would be enough room in the calendar to do additional sales in 2015. But I think the important thing is we like these assets as much as the people that valued in it 110.5% [ph] and we’re confident that we’ll be able to realize value from these loans in future while we’re holding more sales there.

And then last one, real quick. Given that this secondary market for the private assets seems to be developing pretty well, any input is to sell the rest of that health portfolio at this point? Thank you.

The health portfolio provides fairly nice margin to the Company and a very, very strong return on equity. So, we don’t feel compelled to sell that portfolio in the near future. And again, we view it as sort of a component of our liquidity portfolio. So, I think we are going to hold on to it.

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

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

Sure, this is Ray. And one is, we also are gratified by better than expected growth. As Steve says, the rhythm of this particular market is that you sign up customers; over the summer, they have first desperate in September; they have a secondary desperation over the January time period. As you know, we had a very good year last year; we did gain market share which is what you’re alluding to this. In some sense first quarter result reflects many of the activities that occurred last year. We’re having new, what we refer to as busy season occur over the summer. We do think the market is growing slightly. Hopefully we will continue to both hold our current market share as well as improve it. And so we’re comfortable, point three that we have but it’s right to think of the first quarter results as more closely tied to activity in 2014 than in the last nine months of 2015. So, I think they’re still quite bit in front of us but results thus far are quite gratifying.

Just a follow-up on that Ray; I mean have you seen anything from your competitors that would lead you to believe they’re doing anything differently? And you talked about investing $3 million in branding and I am sure other sorts of things that you’re moving forward on. Anything else in the competitive environment you could highlight?

We watched this very carefully. As you know we have a nationwide sales force and we’re in constant contact with our customers who of course have three embodiments, one at the school themselves; the second is the cosigned; and the third is the student. And we’re always alert for anyone’s initiative but we haven’t seen anything from the major players and while they’re at the margin, people come in and go out of the market; we don’t think there is any change in the structure, the pricing and indeed even the product itself.

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

The reason why this is more efficient for us than the whole loan sales is principally because we take all of the pain out of for the people that want the residual. So they don’t have to then go refinance this transaction. And it opens it up to a much wider audience of investors. So, while we had more than half a dozen people actually end up buying residual, there was a field that exceeded 20 as this part of the process. The whole loan sale was, as you’ve added first type of the transaction. But this in a lot of ways was a first also; we were dealing with new investors that were looking at new information and look at Sallie Mae Bank for the first time. So, I think the process should become better and more efficient from this standpoint going forward. The yield on the residual I think was attractive but it depends upon what set of assumptions the buyers valuing it. So, we look at ones that default, the cumulative default rates and prepayment rates, which is probably the two most important assumptions pricing has been. And I would hazard to guess that the people that actually bought the residual would look at those assumptions in a different light than we do. But hopefully down the road, those two outlooks will convert.

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

I think that’s possibly correct.

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

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

So, for 2015 the 341 rate operating expenses we feel very confident about. We learned a number of things over the course of the first quarter, the control if you will is comparing the forecast to the actuals. And we learn quite a bit about the full cost of operating the company as a standalone over the course of the quarter. And we feel very good about the 340 number. And I would be remiss to point out that we also -- if I didn’t point out that we also increased the restructuring costs by $2 million as well. But we have a very high level of confidence that we will meet this guidance and that we will continue to also improve the efficiency of the operation going forward. And we think our unit costs servicing are going to continue to decline over the course of ‘15 and ‘16 and beyond.

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

And as we discussed on prior occasions, it is the case that ‘14 was a year of transformation and lodge; ‘15 is a year of getting our models to where we wanted to be. We have some cleanups to do from, as I said the original spin and so far we’re doing very well in our results in ‘15. Over a period of time, diversification is something we will consider but certainly nothing proximate. It’s the case that our regulators are very happy with our capital ratios but we have to remember that in regard to the regulatory framework, we are one of the fastest growing banks that is larger than $10 billion in the country, if not the fastest. So, we want to have the right balance there. And so I think diversification is something that we’ll talk about in time periods to come, certainly nothing in the closing quarters. And the capital ratios, as Steve has said a couple of times here, both on the maturation of the portfolio as well as watching the performance of the Company in general and its ability to display for the regulators how attractive our assets are, will put us in very good position in all those discussions.

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

And Steve did not speak, it is 2016 as that comes up.

And next question comes from the line of [Indiscernible].

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

So, I would say two things. I think your number is way high; I think the number is probably under 1.5%. I’m not sure how you’re calculating that but we can talk about that offline later on this afternoon or after the call. But one other point that I would make, if we were securitizing loans to fund them as opposed to sell the residual, the structure of the stack of bonds would probably be significantly different, so that we probably wouldn’t have the B and the C bonds. So, we wouldn’t go back into the structure. So, we will then have probably more [indiscernible] and more floating and shorter floating rate promise.

So that would suggest even potentially lower than the 1.5% sort of level.

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

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

Yes, I think that’s right Mike. So, I think you might have been focusing on another slide, so you are looking at the reserve as a percent of loans and repayment incentive versus reserve as a total portfolio balance. So 182 -- I am sorry one and three quarters would come down closer to call it up 1.5%.

Then just quickly last question, obviously a lot of talk in the market last few months about marketplace lenders and a few of them sort of targeted the student loan space. And I’m just kind of curious, doesn’t seem like you guys have seen much of a pick-up in prepayments or consolidation out of your portfolio. But I guess one of the concerns out there is that as loan -- as student center repayment sort of the risk of those loans goes down and so there is potential for some of these guys to pick off some of your better loans, how do you protect against that from happening as guest students into repayment?

Sure. It is the case and when people talk about that one is that one is for generalities typically used in those discussions and two is it typically is asking about exactly what you said which is a student borrower. In fact, our profile is as you know a cosigner borrower along with the student. So, with 90% of our portfolio being originated with an average FICO of 748, we don’t quite set the profile that people think of when they are thinking about consolidation loans. A consolidation loans there as we know dependent upon two factors: One is that the individual who is looking for the consolidation has improved his or her credit profile in such a way that they can negotiate a better rate; and secondarily is that rate is probably best studied if you think you’ve got consolidations as a fixed rate, as supposed to variable. And because we have either one of those characteristics with our average FICO being at 748, most people are not going up from that. So the improvement in the credit profile because of our cosigner doesn’t really occur. And secondarily, [indiscernible] for loans are already variable rates. And so, as rates either go down or they go mildly, the change in the interest rate curve is already built into the product. So we think both on a credit quality as well as on product parameters, we are in very good shape and required to giving our customers the benefit of the consolidation before they actually have to do the consolidation. And to-date, we haven’t seen any change in our prepayments versus the model.

[Operator Instructions]. Your next question comes from the line of David Hochstim with Buckingham Research.

I wonder could you just talk a little bit more about the move to up onshore your customer service and servicing; what is that adding to expense and what benefits do you get? And are you using outside providers for call centers exclusively or your own employees?

What was that last remark?

I wondered if you’re using your own employees or you’re using outside firms only.

The answer is year. We’re using both our own employees as well as outside firms. But let me go back to the beginning of your question, which is offshoring versus onshoring. As we’ve done additional market research in regard to how our customers make decisions in regard to the financing of college education, it is the case that it’s a very important decision for American households and they take it quite seriously. And as with most financial decisions, many families are concerned that they’re going to make either wrong decision or there is a bunch of things going on out there as it were about which they’re uninformed. And so as we seek to be good partners for planning, savings and paying for college with the families with whom we do business, it is obvious to us that the conversations in regard to the loans, especially the setup of those in the evaluation of alternatives are indeed that their conversation. So it’s not just order taking, it’s the question of what is best for the family and how should we accommodate that. In keeping with the fact that American colleges are an American cultural foundation point, as we review the performance of various service providers in regard to the families’ concerns, we thought it’d much better off from both control as well as from a cultural standpoint by having our agents residents in the same market in which our customers are and in which most of the colleges are. And so we think it’s good practice. We think it’s improvement in our service profile to bring all the agents onshore. We do use an outside vendor but we do also use our own agents. And so it’s a highly seasonal business. And so especially when we have the seasonal piece, we think it’s prudent to use some providers of services which we worked all year, but you can get agents more easily at the margin during the peak and we work with Teleperformance, their two sites that we’ve added to our service footprint in United States over these last 40 days, one in Abilene, Texas and the other in Indiana. And we’re working through the partnership with Teleperformance as we speak.

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

When we looked at it for 2014, our original estimate was in relationship to the overall cost, just $20 million to $25 million. And so that was algebra of A to B and operating cost but that did not capture was what we believe to be the better service that we will experience over a period of time by having these service units all onshore.

And then maybe question just about what Steve said about funding cost. Was the increase in the cost of funds from Q4 to Q1 entirely related to one-time charges associated with the new buying or that’s an up sort of step up and that’s the run rate?

It depends David; so, we haven’t used that facility so you pay an unused fee; if we replaced deposit funding for example with that fee, it won’t be incremental there, the one-time fee; you pay and that is one-time and now that I say that we will be reviewing this facility for the foreseeable future. So what really comes down to is are we going to use the facility which would tend to decrease the number of basis points incremental by a handful. And in the future, we will use this facility but we won’t have an opportunity to do so until the second half of the year.

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

I think that’s probably a prudent number.

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

I just have a question about your gain on sale margins and confidence, what level of confidence you have in that level of gain on sale margin for ‘16 as we look out into 2016 or in the higher rate environment. And I also wanted to get a sense for what types of investors invested in that residual piece; were those -- was any pension funds; hedge funds if you can give us some perspective there that would be helpful as well?

So, confidence in the pricing, look, when you look at the interest rate environment, if you look at the LIBOR curve is something along those lines, there does not seem to be anybody that’s anticipating a significant increase in the interest rate environment over the next call it year or two. And what I think we’re seeing happening here with the residual market is it used to be a lot more esoteric than it is today. So, as a function of the search for yield, investors have become more used to investing in residual. So, it has become a more routine transaction. There are regularly residuals sold in the auto finance industry for example. And residuals for student loans have become more common place. So, people become accustom to doing the analysis and investing in residuals. I think it broadens the investor base and it has a tendency to bring high yields down over time. And also this was again sort of a first mover transaction. And I think it would be become, as the investors would look at this transaction who are looking at the student loans for the first time, become more up to speed on how the asset perform, I think that will help broaden the market and hopefully help pricing improve in future. I think you also asked who participated in this transaction; it was actually a pretty diverse group of investors; there was that I would call real prime buy and hold money managers that are by nature of their business investing money for pension plans for example. So I would say that that type of money was involved and there was also obviously hedge funds/alternative investment type of investors participating in the residual as well. So there is a very diverse of our group of investors across the board.

And then, if I heard you correctly earlier when you were talking about the residual, I thought you said that something to the effect of investor expectations or estimates of prepayments, assumptions and other assumptions we have embedded into there, the value of the residual being a bit different than what you were expecting. If you could just clarify, what you meant by that, that would be helpful?

Sure. So, what I meant to say is, the two major -- two of the key assumptions that go into valuing a residual are the prepayment speed and the cumulative default rate. If the assets pay off faster, there is less value in the residual and obviously if more loans default, there is less value in the residual. What we would call Sallie Mae case for example would be a 3% prepayment speed and then 7% cumulative default rate, some of this investing in residual might have an assumption that calls for a 4% prepayment speed and a 9% default rate. If they ran the numbers, they fund their assumptions, they would think that they are going get an IRR in the call it 9% vicinity. If you value it at our assumptions, we would say that they’re receiving an IRR of call it 12%. So, beauty of these things is in the eye of the beholder.

Now, your guidance was great, credit quality clearly trending better than you had expected. And it sounds like from what you are saying that given the newer investors that are now being introduced to these types of asset, the residual and some of the assumptions they’re using relative to yours, you deal, it sound like that gain on sale margin, all else equal should actually improve from here rather than at the field rate off of your guidance. But if I were to just point out one element of this that I think you have to display chart a little bit which is that if you are in an environment like gain on sale margin comes down and credit normalizes, because those two then seem to be compared to what outside of your control. The one thing that could be in your control is operating expense growth and that seems to be higher. And you pointed out some of the reasons for why that’s higher, maybe then you had initially anticipated. How much flexibility have you built into operating expense base in the event that gain on sale margin for whatever reasons come down and/or credit provisions normalize if you see [ph] the macro economy, can you give us the sense of the flexibility related to your OpEx base?

I mean you are asking an interesting question, Sameer. I think you are asking -- we’re not looking at the business by patterning, [ph] so we’re pretty confident in gain on sale. And I think you are asking if the gain on sale declines by 0.5%, so then going to toggle a switch and have reductions in cost at Sallie Mae, I mean look at something extreme was to happen, we might take that tack. But at this point in time, we’re very comfortable with our 2015 guidance. And we are not -- we don’t think we are going to need to toggle back and forth between the three or four variables that are core to our EPS guidance here.

I think another point that Sameer made here is when we talk about credit cost normalizing, models that we have we felt over the course of five years or six years and the projection for the portfolio is a seven-year projection into the future. And so we are looking at credit losses, we’re looking at them always a medium to a long term. This is not the case as we might think of in some other arenas where the benign credit growth portfolio and performance of people have experienced and their current portfolios have caused them to losing credit standards and take advantage of the benign credit environment. We have not done that, we are not a coincident credit opportunist. And so we think that the credit that’s in our models which is multiyear is already normalized. And so this is not a betting on a best case scenario for credit.

So, then my last question which ties into your last commentary, if you were to look at EPS growth for 2016 then, should we assume you can generate a 15% EPS growth rate off of your guidance? Because it sounds like the gain on sale margin to be flat to up, provisioning probably is not more of a headwind, it just probably would be relatively stable and you get operating expense leverage. So, if all those three things are going in those directions, it sounds like you should be able to 15% EPS growth off of your updated guidance, unless we’re missing something else, right?

Yes. And so, we have a strong market position. We have a terrific business model. We’re very optimistic about our multiyear future. 2016 will be amongst those items on which we are optimistic. But we’re not in a position to give guidance on 2016 in this session.

[Operator Instructions] You have a question from the line of Eric Beardsley with Goldman Sachs.

Just back to the charge-offs expectations. So, I presume your longer term expectations of charge-offs didn’t change even when you had that hiccup in October, November. So just curious given that you’re just talking about how you have a long-term model that you don’t look at things coincidently. And I guess can you just give us a little bit more context of what’s you were seeing and based upon that October, November data might be hypothetical. But what would cume charge-offs have implied if performance went down at that?

Eric this is Ray. One is, let me not miscommunicate while the model is multiyear, the idea that we wouldn’t pay attention to what’s happening each day would be enrolling as d the conclusion. And we’re very much on top of these numbers every single day. It is the case though that the model is a long-term relatively smooth curve and that if we have a big month or two may affect guidance for the next quarter or two but it’s not affecting the model. And so it is the case as I said, a little bit earlier that when you’re probably and our full P&I portfolio is growing over 100% from a year ago to the year down. Two things to true, one is it’s a higher concentration of losses in the relatively early parts of the life of those portfolios and two is as people come into full P&I, the volatility in the early months is very high. And so I think forecasting of any one of those for a medium term or long term model would be an error in quantitative method. But it’s right to say that we expected a reasonable amount of noise. We think it’s incumbent upon us to guide our investors to as Steve said earlier is a deliverable set of quantitative goals. We did that in January; we’re doing it again now. But neither one of those points are significant enough to effect any model conclusions that are relevant in a period that’s certainly as well.

Well, I guess within seven years, you’d be able to choose upfront and so the provision came out, just curious, so what was that provision implying for charge-offs as you guys were running that?

Well, I think we can look at that but the two different questions, one is what is the calculation of that and then second is whether that has any impact on the model. The answer to second is no. I don’t know Steve, if you have that handy so far as on the provision front, the provision guidance from January and what the implication on that would have been. But remember that the provision has a one year outlook horizon of 12 months.

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

So, you heard that it’s 15 basis points and 20 basis points, what Steve said.

That’s on loans and repayment or the total book?

That was on total book.

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

So it’s probably applied more to loan originations and that should be coming down now that we have this additional $750 million in secured funding available to us. So, you will see our cash coming down relative to the total balance sheet size and with relative to originations as well in Q2 here. Right now hands are somewhat tied because we have -- we don’t have major maturities of liabilities until the second half of the year.

So from a liquidity perspective, say 15% the right level going forward, is that something that regulators would be comfortable with?

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

And now on the tier one common ratio, you were able to bring that down now below 15%. Is there a level, I guess you mentioned the stress test in 2016; is there a certain level that you’re not comfortable going below in the near-term?

So, we continue to target total risk-based capital due to nature of our asset base here. And our target there is 14% where obviously we’re going to be well above that as of the end of the second quarter, once we adjust our portfolio for the capital we generate through the sale and I believe we get some loans coming off the balance sheet. And we will probably end the year closer to 15% and 14%. So we have a lot run rate, given our capital levels to support the growth in the portfolio over the next several quarters and years.

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

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

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