Good morning. My name is Krista and I will be your conference operator today. At this time, I would like to welcome everyone to the 2016 Q3 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-answer session. [Operator Instructions] Mr. Brian Cronin, Senior Director of Investor Relations, you may begin your conference call.

Thank you, Krista. Good morning. And welcome to Sallie Mae’s third quarter 2016 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 our conference call, we will refer to non-GAAP measure we call our core earnings. A description of core earnings, a full reconciliation to GAAP measures and our GAAP results can be found in our Form 10-Q for the quarter ended September 30, 2016. This was 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. And good morning to everyone. This is our report that follows the busy season in student lending. And as you know, that goes from roughly the end of June to about the third week in August. It is what we refer to as our busy season. This is our third busy season since the [indiscernible] and is also our third successful one. We had a very good period. We originated $1.8 billion, up 7.14% from the prior year. We believe that is a growth rate that is faster than the market has grown. We’ll wait for the final numbers to come in from independent sources on that. And as you all know, we are targeting $4.6 billion in full – for the full year in total disbursements and we are sticking by that. That will be a 7% increase year-on-year. Happy to say the quality of the new customers is extremely high and consistent with prior periods. During this year, we’ve 7.49 average FICO score for those [indiscernible] and a 90% co-signing level that we experienced last year is identical to what we’re experiencing this year. These seasons are starting to add up. The average private student loan balances for the quarter were $12.9 billion. That’s a 30% increase from 2015. The ending balance was $13.9 billion. That, if we look year-to-year total balance sheet growth, the increase in the private student loans outstanding is responsible for 92% of the balance sheet growth. So we will cover a couple of years. Our assets in total will grow 73% from January of 2014 to December 2016. And the private student loans, while the balance sheet is growing 73%, will grow 117%. And so, our balance sheet is becoming more efficient with each passing quarter. NIM, in the quarter, was…

Thank you very much, Ray. I’m just going to provide a few more details on the quarter before we open up the call for Q&A. As Ray mentioned, the bank’s net interest margin on earning assets was 5.58% compared with 5.84% in the prior year and 5.36% in the prior-year quarter. The improvement year-over-year is based on the increasing mix of our private student loans as a percentage of the balance sheet. The decrease from the prior quarter was driven by a pretty large $621 million increase in average cash balances that were held to meet our peak lending season demands. These balances will remain elevated in Q4 as we prepare for second semester lending, which will take place in Q1 of 2017. Our NIM has been strong all year long as a result of improving private student loan yields and stable cost of funds. So as a result, we think that the full-year NIM will be slightly higher than what we’ve been talking about and come in in the high 560s for the full year. The average yield on our private education loan portfolio was 8% compared with 7.98% in the prior quarter and 7.87% in the year-ago quarter. And our cost of funds was 140 basis points, up 6 basis points from the prior quarter and 20 basis points from the year-ago quarter. This year, we actually originated loans out of yield that was slightly higher than the prior peak season, so we feel very good about that. We do continue also to access the ABS market on an opportunistic approach. Last week, we closed on a transaction that raised nearly $700 million of long-term funding at a weighted average spread of LIBOR plus 115 basis points. This transaction, SMB 2016 C, achieved the tightest pricing spreads and…

[Operator Instructions] And your first question comes from the line of Eric Beardsley from Goldman Sachs. Your line is open.

Hi, thank you. And nice quarter. Just a follow-up question on the credit trends. I think, last quarter, you had said that the second quarter would be the peak charge-off quarter in terms of ratio. Just also want to confirm that that would also just be the peak charge-off dollar quarter as we look forward on a seasonal basis.

Yeah. I think that’s right, Eric. Continues to be the case.

Got it. I guess you mentioned some more continued investments in OpEx, but you also had the efficiency coming through. As we look forward, just relative to the balance sheet growth, how should we expect the OpEx to trend as we look out towards next year?

So, look, what we expect to continue to recur here is for our efficiency ratios to continue to improve. So we’ll end the year right around 42%, I want to say. This year, we’re putting up a very strong improvement of our efficiency ratio. We’re going to exceed 10% this year. I think, looking ahead, we can probably get that efficiency ratio down into certainly the high 30%, 38%, 39%, kind of percentage level. As we look forward, we’re going to see the book of business continue to grow. So, this year, I think operating expenses are benefiting from the investments that we made in 2015. I think the rate of change, the acceleration improvement will probably stay down somewhat. We are not giving guidance for 2017 at this point in time, but the balance is going to grow in the mid to high 20s. I think it’s fair to assume that OpEx which includes things like [indiscernible] expenses are going to grow in the 10-plus-percent [indiscernible].

Great, thank you.

And your next question comes from the line of Moshe Orenbuch with Credit Suisse. Your line is open.

Great, thanks. Ray, you had mentioned that 2.6% of your applications were for the parent loan. Can we – is there any way to talk about how that might develop kind of over the next year and what it might do to your growth in 2017?

Yes. It's a brand new product. It was initiated by some request that we received from universities who wanted to have another means for families who wanted to assist their children in going to school, in addition to the private student co-signed loan. It was well received by the universities, as well as by the families. We did get up to 2.6% in applications. The actual volume will be below that, probably closer to 1-plus-percent of the executed volume because of changes in both the credit as well as in the average ticket, that sort of thing. We expect this to become a regular part of our portfolio going forward. We think it incrementally improves our position in the market, but we’re not counting on it for any dramatic changes in our – either our growth trajectory which has been, as you know, a couple of percentage points over a period of time, faster growth in the market and we will expect to stay on that trend in a market that, as you know, is highly competitive.

Okay, thanks. And, Steve, just the – kind of the key financial metrics shows the cost of funds rising. But your deposit costs actually, second or third quarter, were pretty flat. So I am assuming that's a function of kind of broadening your funding base. Could you talk a little bit about that? I know you mentioned the deal that you did early in Q4?

Sure, Moshe. So average balances of term securitization funding increased from under a $1 billion in the second quarter to I think $1.7 billion in the third quarter. And then although the average rate that we paid on that declined I think from $2.90 to $2.75 or something in that vicinity. That big chunk of funding add significantly higher costs helped bring our cost of funds up. But I want to remind you of one thing that – in that ABS funding is also six to eight funding. So when you see on our average balance sheet the cost of 2.7%, that is actually – in our minds, it’s being used to apply to our fixed rate loan portfolio which carries a yield of like 9.5%. So the net interest margin is still very significant on that.

Obviously, you spoke to kind of extend that funding in this environment. I just wanted to make sure it wasn't really the deposit cost which seemed to be kind of very, very stable.

The deposit costs are behaving very well. What we’re doing in the brokered market, what we’re doing in the retail market basically flat year-over-year.

Great, thank you.

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

Thanks. Good morning. I guess first question, you guys alluded to growing origination faster than the market. Any thoughts on kind of what the success points have been? Is it the new products that you have launched or just the brand?

Well, first off, I would say that we have to wait for the market results to come in in order to ensure ourselves that – or ensure the fact that we have grown faster than the market. Well, we fully believe that the market is growing approximately 5%. And as you can see, our numbers are about 7%. And we think this is a cumulative effect of an across-the-board effect. As you know, about a year-and-a-half ago, we made a decision to increase our field staff, and so our representative at the universities have much better coverage. We’re able to divide the country into smaller regions as a result of the increased staff. Our feedback from the university is on the specialized number that they have in trying to reach us in the event they need to have a service solution delivered. It has been excellent. The average speed of answering that is less than 10 seconds. As you’ve heard, we improved our online application. We’ve improved our service. We’ve improved the circuit work for certification and lower the turnaround on that dramatically. We introduced the parent program for additional option for families that seek college financing as a joint responsibility between the parents and the students. But there is no doubt that the competition is very stiff. Discover, Wells, whatever their difficulties, are still a very capable competitor. We do have Citizens. We have others. It’s an attractive market and it’s a market, as with many others, that you have to improve in order to stand still. So I think deciphering that in a percentage basis is very to untangle. But we do know it’s a full mix across the board from the in-the-field pressing to the delivery on the phone is a mix that has received good responses from the schools, the families, and the students. And we think that if you have a 50% market share and you hold it, that’s a good day. You have a 50% market share and you improve, that’s an excellent day. We happily have had three great seasons in a row.

No, absolutely. And, I guess, when we think about the future opportunities to take additional share with the issues that you kind of alluded to with some of your peers, does that give you another opportunity to take more share?

Well, far be it from me to be – not to be optimistic in regards to a question like that, and I'm sure that in other conference rooms are competitors having the same conversation. So we have respect for them and we hope they do very well and we just hope we do slightly better.

Understood. I guess, second question, you talked about the elections and the setup. Have you guys done any specific outreach to these elected officials or the potential officials just to kind of explain your positioning in the market?

As you know, we’re very focused on events that happen in all the legislative bodies around the country, in particular in DC. And we have full-time people who are working to make sure that, one, we’re not surprised by any initiatives; two, that the appropriate people have been informed of the facts that they are in the ground, sometimes different so-called and in quote facts that are delivered from a podium during an election. And so, we have made and will continue to make efforts in order to ensure that the facts are understood. And we also have a regular program of meeting with elected officials, both who are local to where our operational sites are, as well as in DC, in order to keep them informed of the possible implications of some things which can be overly simplistic. And so far, we have been very successful at keeping people’s feet on the ground.

Final question. Steve, could you help us with the tax rate for next year? What's a good tax rate to use? Thanks.

Sanjay, we think that our run rate for taxes, excuse me, is going to be in that 38% zip code. There’s just going to be noise going through on a quarter-to-quarter basis. This quarter, if you look at the tax rate, year-to-date, and take out that $9 million, we’re basically right bang on the screws, that 38%. So I think that’s a good number to put in your model.

All right. Thank you.

Your next question comes from the line of Mark DeVries with Barclays. Your line is open.

Yeah, thanks. I think, Steve, you indicated you expect the deposits to be the core source of funding. But can you just give a sense of – as we look at, what percentage of funding we should expect to come from ABS?

So at the end of 2018 4, when I look at our longer-term plans, we’re probably still in the just the high teens, approaching 20%. Look, Mark, we’ll do $1.5 billion to $2 billion of ABS a year if it is offered at very attractive prices like it is here today. The fact of the matter is that is, if you take a look at, say, retail money market deposits where we’re paying just about 100 basis points, when you fully load the cost of that for things such as servicing operations and the reserve that we have to hold against short-term deposits, the cost of those – of that funding isn’t all that much cheaper than the ABS market. So we’re going to approach this to maximize the profitability of the operation here. I think getting to that sort of a level makes sense, particularly when you have an asset that has an average life out of the shoot six years. We think it made sense to lay in some conservative longer-term funding. But, first and foremost, we are a bank and we have access to very broad and deep deposit funding market and we will continue to talk advantage of that as well.

Okay, got it. And for the adjustable rate portion of the liability structure on those ABS deals, is there any basis risk there between where the liabilities and the assets are repricing?

There is almost none. If you look at the disclosure that we published in our 10-Q, so if we have 100 basis point shock to interest rates, our net income is going to go up about 2.3% over the course of the next two years, which is [indiscernible].

Okay, got it. And then, just finally, on your reserves, I think your allowance on loans is up 30 basis points year-on-year, whereas your delinquencies are only up 10 basis points. At what point should we expect, unless we start to see some material erosion here, that your reserves move more in line with your delinquencies?

So, look, give the2 massive growth that we expect in this portfolio and we’re going to continue to have something like $3 billion of loans entering repayment every year, for the next two years, we do expect the reserve as a percentage above loans in repayment or total loans to continue to grow. So looking out a year, if our loan loss allowance today is 117 basis points, maybe that gets to 125, 140-ish basis points a year from now. If you want to take heart in something, every time I look at a forecast, the allowance for loan losses, we don’t achieve it because credit continues to perform somewhat better than we expect and that’s what we’re seeing now as our cure rates and roll rates that exceed our migration model, continued to perform very well. But the long and short of it is we do expect that loan loss allowance to continue to grow given the use of our portfolio.

Okay, thank you.

The next question comes from the line of Arren Cyganovich with D.A. Davidson. Your line is open.

Thanks. Just looking at the outlook for the overall private student loan origination growth for the entire industry, is that expected to continue to be around 5% for the next year as well? And how are you thinking about how that will evolve, given what you're seeing in terms of pricing at different schools, et cetera?

So we’ve looked at that trend over a period of time. The schools continue to have total cost increases, and this is tuition plus room and board and other ancillary expenses, some of which are not so ancillary like text books, in a range that has been running at 3.7% or so. And we don't see any change in that trajectory. It’s also the case that American families are buying more education, more years of college per student than they had previously. And so, as we have tried to compile that, taking into account the demographic flows associated with graduates from high schools, we are in the ballpark. That 5% number going forward looks like a reasonable estimate.

Thanks. And, I guess, just thinking about the potential for another raise in December in interest rates, I think it was a fairly slow reaction from your retail deposit base, which was, I think, consistent with the industry. Would you expect that to have any kind of near-term benefit to the net interest margin over the coming quarters if we see a raise?

We have no reason to think – if there’s another 20 basis points, 25 basis point raise in the December meeting, the post-election meetings, we would expect it to follow the same pattern that the prior one had.

Okay, thank you.

[Operator Instructions] Your next question comes from the line of Michael Tarkan with Compass Point. Your line is open.

Thanks. Just a couple quick ones for me. Given the increase in demand on the ABS side, I'm just wondering if anything has changed regarding your appetite to revisit any loan sales? I know you would rather hold loans on balance sheet at this point. I'm just wondering where you think the market is if you were to come with a deal today.

So looking at where the ABS market and the residual market might be, it’s recovered quite a bit. Some are between 8% to 9% premiums. We’ve talked about 8% being a breakeven. I think we’ve also said that in order to move us off of the hold-for-sale position, we have to see premiums somewhere probably north of 10%. I continue to believe that everybody is best served if we stick to one business model, which is the originate and hold rather than – changing that business model brings an awful lot of uncertainties with it and we get back to the how-much-you’re-going-to-sell, when-are-you-going-to-sell, creates difficulties for models and shareholder expectations and so on and so forth. So long story short, unless we see a significant improvement in the underlying margin, premium, we’re going to greedily hold on to all of our student loan assets.

I like that. Thanks. And then, just lastly, I know you guys have talked about a new product at some point. Any color as to what you may be looking at or maybe timing on that? Thanks.

So the product that we talked about introducing first would be a personal loan. We have looked at various partnerships with fin-techs and other providers in the marketplace. We haven’t had any success to-date of partnering up with anybody. We are in the process of developing our own personal loan product. That probably won't be rolled out until early 2018, but we will look for opportunities to maybe acquire some assets between now and then in a very modest way.

Thank you.

Your next question comes from the line of Michael Kay [ph] with Citigroup. Your line is open.

Hi. Thank you. Just had a quick question. I know you've been saying that you don't anticipate returning capital. But as we look ahead, how should we think about when the company could be ready to institute a capital return, either a dividend or a share repurchase? Like, are there any metrics we should look at or could it be possibly when the growth starts leveling off?

It’s the case that as we’ve looked at this over the last couple of years and the metric that we tend to focus on is return on equity. And so, we view this as a competition among opportunity costs for various techniques. And so, as long as we continue our growth trajectory, as long as we continue the margins that we’re having and, in fact, improving and as long as our return to our shareholders on the balance sheet is a very attractive number, which, as you know, it is, we will continue to believe that the best use of our shareholders’ money is to invest it in this high return and high growth business. We don't have a foreseeable when that curve is different from our expectations.

Okay, thank you.

Your next question comes from the line of Rick Shane with J.P. Morgan. Your line is open.

Sure. Steve, I'd just like to ask two questions. One, when you talk about selling loans, what I am hearing is, yes, from a pure economic standpoint, once gain on sale gets above 10%, it starts to make sense economically. But there is an internal recognition that that will create volatility, uncertainty, diminish sentiment that presumably is reflected in multiple. And that the standard to do this really has a little bit less to do with where the economics are, but more your recognition of how it impacts the way investors look at the stock?

Yes.

I think we can put that one to bed, in my mind. The second thing is, looking at the tax – and I know you’re kind of like, ‘is there a question here, Rick?’ And, I guess, there was. But maybe the answer really was that one-word answer. The second thing is that I'm not sure – and perhaps other folks on the phone get it and I just don't. I want to make sure I understand the tax issue for the quarter, in that I understand that there was a $9 million incremental tax. That essentially raised the tax rate to about 45% or 46% from 37.5%. You also make the comment that there was an offsetting other income line. And what I want – so the impact on EPS during the quarter was de minimis. I am assuming that, over time, if there was incremental $9 million of taxes that must be paid that it has to have an EPS impact. So how should we think about that? Was this just a delay and a signal that this is coming and how will that play out?

So, Rick, here’s why this uncertain tax position has no impact on our earnings per share. We put up a receivable of income taxes payable. Offsetting that is an indemnification in asset. This whole situation has to do with a pre-split situation and it’s 1048 position for uncertain taxes. Every company has them. Very few companies discuss the details with the public. What we would expect would happen is, at some point in time, this uncertain tax position will be settled either favorably or unfavorably, as in no taxes payable or taxes payable. And at that point in time, we would look to our indemnifier, and if taxes were payable by us as a taxpayer, we would look to the indemnification and there would be no impact on their own.

Okay. That's helpful, except for now I don't understand one more thing, which is what is the nature of the indemnifier? Why would someone else pay your taxes? And can I sign up for that?

So simply put, this is related to pre-spin activities. SLM Corp. is the taxpayer for pre-spin activities. If this had to do with anything that took place at the bank prior to the spin, we would be taxpayer, dare I say it, as it’s related to companies that were spun off with the Navient businesses, they are – they would be taxpayer. And this is all spelt out in public documents. There’s a tax sharing agreement, a separation and distribution agreement. And if you have some spare time, you can take a look at a Navient 10-K where they spend a significant amount of time talking about indemnifications for pre-spin business activities.

But the basic dynamic here is, when we did the spin, we thought it was a good idea for the Sallie Mae name to be carried forward. And when we made that decision, we also took the legal vehicle associated with that, which is also the tax filer for IRS purposes. We had an agreement at the time that activities that occurred prior to the spin would be on Navient’s ticket. Bank-related activities post-spin will be on Sallie Mae’s. Having said that, we filed a return for 100% of the activities there were extant before the spin and for the bank activities post-spin. So if that were to occur prior to the spin, as Steve says, one is, we have to pay it, so we have set it up as a payable on our tax reconciliation. And secondarily, to the extent it was not associated with bank activities, but associated with other activities which are related to Navient, Navient would be the indemnifier for that, which closes the loop.

Got it. And at the risk of annoying all my peers who are listening, there is – what you are suggesting is the way that you've set this up that it is very unlikely that this would be a tax attributed to the bank, and so that's why you are comfortable putting the indemnification on, because if it were to be resolved adversely, it looks like it’s a pre-spin issue, not a post-spin issue.

At this point, we can safely say that you have the picture.

Thank you very much. That doesn't always happen. Appreciate it, guys. Thank you.

Your next question comes from the line of Jordan Hymowitz with Philadelphia Financials. Your line is open.

My questions have all been answered. Congratulations on a great quarter. The only comment I'd make is I would like you to continue to keep the reserves at the current level. There's been many times in the past we've had to decrease reserves, saying that they were enough. And I think in this uncertain environment, I think you can never have too many reserves.

If you want to have a follow-up question, we’ll take it.

No, but it was an excellent question – excellent quarter.

Thank you, Jordan.

There are no further questions at this time. I would like to turn the call over to Mr. Quinlan for closing remarks.

Okay. One, thank you all very much for your time and attention this morning. And secondarily, in closing remark, I do want to summarize. It has been a great quarter for us. It is also a great quarter that occurred during our busy season and it’s the third straight busy season during which we've experienced wonderful success. It is the case that service quality is one of the major stories for us in this quarter, which, as I noted, we’re now in a virtuous cycle, in which better service, a friendlier, more efficient interface for our customers yields higher satisfaction with our service and results in a lower cost trajectory as we head into the future. In summary, our prospects are very good for 2016 and beyond. These results have all been brought to you by our talented team, with whom I had the privilege to work. And it’s a pleasure to report on these accomplishments delivered by that talented focused team. So thank you very much. I’ll talk to you soon.

Thank you for your time and your questions today. A replay of this call and the presentation will be available on the investor page at sallymae.com. If you have any further questions, feel free to contact me directly. This concludes today's call.