SLM Corporation (SLM) Q4 2017 Earnings Report, Transcript and Summary

Good morning. My name is April and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter 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-answer session. [Operator Instructions]. Thank you. I would now turn the call over to Brian Cronin, Vice President of Investor Relations. Sir, you may begin.

Thank you April. Good morning and welcome to Sallie Mae’s fourth quarter 2017 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 than 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 our core earnings. A description of core earnings, a full reconciliation to GAAP measures, and our GAAP results can be found in the earnings supplement for the quarter ended December 31, 2017. This is posted along with the earnings press release on the Investors page at salliemae.com. Thank you. I will now turn the call over to Ray.

Good morning all and thank you Brian. Today what I will do is run through some of the performance indicators for the year, talk a little bit about the outcome, and then focus on some of the tradeoffs that we have made as we look at 2018 especially in regard to investments. So, as we start the income statement we always think about volume first. The volume came in at $4.8 billion of newly dispersed private student loans on target to our guidance which had been adjusted back in the -- after the end of the third quarter. We did gain market share. Our acceptance rate by customers has remained steady so and so if we approve them they take our product at about the 81% level. We look at that as an indicator for both our pricing efficiency and regard to pricing elasticity as well as a competitive indicator. Particularly gratifying is as we have moved through the year and through the years I should say and thought about moving from one product to multiple products the first step that we took as you all know was about a year and a half ago we introduced parent loan. Parent loan now got off to a reasonable start, particularly high volume last year about $31 million of dispersed and this year more than doubled to $77 million of dispersement to delta, increase of 46 million which was fully one third of our total increase in a market that did not have good growth characteristics this year. And so gratified that we are able to introduce new product, get it into the hands of the right people, good coordination between sales and marketing, and the over 100% increase shows that maturation has occurred and is still in progress. This gives us some confidence as we look to the next busy season and the introduction of the six graduate products that we've talked about. And so we're thinking that there's an opportunity and wide space on all of these and question is can we get those into the right hands and handle the distribution in a world where we think that our product is more than competitive with the current government offerings. As we look to next year as you know we expect total disbursements to go up from the 4.8 billion to 5 billion about a 4% increase. Second, we look at credit quality which remains high. 747 average FICO or approval rates remain in the mid 40's. We're turning down more people than we are accepting. We're not looking for that last piece of volume and we have kept a high quality both front end as well as portfolio which we'll talk about through the morning. Our take rate here as I said remains at 80%. Always in credit one looks to see whether or not if you are getting anti-select we certainly are not. Next is our NIM, so the pricing and yield of the portfolio for both our customers as well as their shareholders at 6% is extremely attractive, very high level. The balance sheet is more efficient. We have multiple funding sources, we have a rich source of funding from a portfolio standpoint. We have improved cost of funds and as Steve will discuss that 6% looks to us like a fairly sustainable level. Then when we try to measure the overall efficiency of the company as its growing I will talk but growth characters but think about one third in terms of EPS each year we used the operating efficiency ratio as a guide to make sure that we are within the guardrails and that being misled by growth. As you know our efficiency ratio has a very attractive track record. Going back to 2014 and through 2018 we had 51% efficiency ratio in 2014, 47% in 2015, 40% in 2016, 38.4% in 2018, and we're guiding to a 37% to 38% number in 2018. So over the course of five years we've made continuous improvement on this particular measure which we think is a key one for us. In 2017 in particular operating expenses were up 16.3%, the increase in expenses. Revenues however were up 20.2% and obviously the math of a fraction allows us to have an improved efficiency ratio despite a 16% growth in OPEX which is clearly warranted given the growth of the portfolio. In regard to credit performance we have steady performance. As you know the delinquency improved from 2.6% to the end of the third quarter which we discussed at that time talking about the operating issues that we had over the summer as well as weather disasters that occurred in several areas of the country but especially Texas and Florida. And so the ratio has gone down as we thought it would. Of course it is lifted by the fact that the portfolio continues to mature and $2.5 billion of funding or $2.5 billion of receivable entered full P&I needed this year. And so the maturation continues and as people get into that we will see the delinquency move along with it but the delinquency is right on our models. In regard to both be efficiency ratio, the delinquency as well as the growth in the balance sheet from 2015 to 2017, just a matter of perspective the balance sheet grew from $15.1 billion to $21.6 billion, an absolute increase of $6.5 billion. The private student loan portion as a subset of that grew from 10.6 to 17.5 or an increase over two years of 6.9 billion. So the growth in the private student loan was 106% of our balance sheet growth which continues to show the efficiency that we have over a period of time on a balance sheet which is also growing from when we spun $10 billion to ending this year very close to $22 billion. All this comes out through the strainer of EPS. Our EPS story is similar to our efficiency ratio story, a very good and consistent one over time with excellent results. So that over the period from 2015 to 2016 our EPS on ongoing basis was up 36% from $0.39 a share to $0.53 a share. From 2016 to 2017, the next year EPS went from $0.53 to $0.72 another 36% increase. And while our guidance is a range where we did hit the high 90's even, let's say 98 that also would be a third 36% increase compounding over 100% over three years. Consistent, good levels, and we expect to realize them going forward. ROE as we've told you is consistently in the teens. We had another good year with this. The increase in efficiency in the balance sheet will allow us to maintain that high level of ROE even while the company is growing and diversifying. In regard to regulatory relations we have chief regulators or the FDIC, The Utah Department of Financial Institutions and the CFPB. I'm happy to say we have very good relationships with all and we have shared our forecast for the bank and with the horizon over the next three years with our key regulators both the FDIC as well as the UDFI. We are 100% transparent with them. They have been good partners and on a regulatory front we regard that partnership as a positive for us despite the fact that there's lots of carping in the industry. In a market frame which includes the customer, the competition, and evolution I'm happy to say we're doing quite well. Our customer service continues to improve at dramatic levels so that the customer calls per serviced account are down 30% in absolute terms and whilst as you say in per account terms, from 2015 to 2017. The calls that are required in order to bring in application to fruition have actually dropped more dramatically, down 40% per application while our customer satisfaction is going up. We will do 20 million customer transactions in 2017, 92% of them will have no human intervention. We are a highly automated Internet driven Fin Tech in that sense. So, as we look to the outlook then we will continue. Our story line over the last four years has been first separation, two establishment of the company, three refinement of that operating piece, four growth, five expansion, and now diversification. We end this year with a strong market position. We have an extremely valuable customer segment which we'll talk about. We have a very strong balance sheet which has allowed us to venture into the purchase of personal loans from other originators and we'll talk about that in a minute. We have proven delivery capabilities, we have had controlled growth as the balance sheet has gone from 10 billion to the end of 2018 approximately 25 billion with excellent margins and profitability. We have great customer service and improving. We will be building on these years of success to realize a promising future. As you know the guidance is for EPS to increase to $0.97 to $1.01 for the private student loan originations to go to $5 billion and for the efficiency ratio to continue its downward trajectory dropping from 37 to 38 range for next year. In regard to this a major change since the last call has been the tax change. Tax change has hit us very positively and is a 14% reduction. It has allowed us to look at the growth in earnings as well as the ROE that are consistent with that more efficient income statement and to evaluate a series of investments within the firm. We've chosen to focus on three. First, is approximately $10 million in bringing an operating IT infrastructure to be more geared to the cloud. This is an ongoing migration, it's a new technology as you all know. We're working closely with both the vendors as well as with our regulators to do this in a controlled way. The $10 million looks as though it has a payback to us of approximately $5 million going forward in perpetuity and so it will pay back in two years and after that if you look at an ROE over a long period of time you would see that the ROE on it is measured in triple digits. Second $10 million to continue to expand the personal loan. Our personal loan is an important feature for our customers. When we meet the customers and when they are 18 to 19 years old actually 0% of the population has personal loan. But five years later 30% of them have a personal loan. People use this. We are basically in the personal loan business because private student loan is a personal loan, it is particularly geared to a particular environment and a particular audience. Having said that we have accelerated our thinking onto personal loan by using our balance sheet to invest in others originations of personal loans. This has given us one year of experience this year, we are having second year next year, and by the time we're doing any serious volume in regard to personal loans we will have had three years of market intelligence by virtue of using our balance sheet to give us a lens into the current market. And so as we look at that we will have good returns over time, we will invest money this year. As you all know what happens in any of these consumer businesses that have built on the credit side of the ledger is when you have a customer segment P&L. In the first year the acquisition cost cause you to be negative, in the second year credit losses and maturation cause the profits to be negative, in the third year we typically break even, by the fourth year we're getting good returns and the returns usually last for several years thereafter. So these investments being held to the same level of ROE scrutiny as our other activities. The third $10 million is in the credit card business. We are not in the credit card business so when we look at the personal loan business we have an infrastructure and a customer service and a credit origination that can be leveraged. In regards to credit cards it's a very different business. We will work with the partner there so it's not to replicate fixed cost in a business that is already in the industry. I should say that it's really over capacity. We will work our way through that this year, the same dynamics that I just alluded to apply here as well. All three of these investments we think are very good. They have been made while we maintained our commitments to the shareholders to continue to increase EPS at a very attractive rate, 36%, continuing to originate loans and gain market share, and thirdly to continue with a high ROE. Having said all that in a moment I'll turn this over to Steve. But first it's a sad day at Sallie Mae. Yesterday our long time Head of Sales and Marketing, Charlie Rocha passed away after a long battle with cancer. And so we're all stunned by his passing, grateful for his friendship and participation, and struck with both admiration and inspiration for the courageous and highly -- high quality life that Charlie led before he was taken away from us too soon. With that I'll turn the floor over to Steve.

Thank you very much Ray, good morning everybody. I'm going to fill in a few more details around the quarter before we open it up for Q&A. So we will start with some details on net interest margin. Again it came in very strong at 6% in the fourth quarter compared to 5.85% in Q3 and 5.55% in the prior year quarter. The net interest margin increased 45 basis points year-over-year driven by the increase in the private education loans, the percent of private education loans in our portfolio and we continued to manage cash reserves on the balance sheet more tightly. The change in LIBOR rates which increased the yield on our variable rate private education loan portfolio much more than it increased our cost of funds. These favorable drivers more than offset a 5 basis point reduction in our NIM due to the unsecured debt that we have issued which of course is more than offset by a reduction in after tax preferred dividend expense at nearly 7% coupon or another line item on our income statement. NIM for the full year was 5.93 versus 5.68 and as Ray alluded to we think that the NIM can remain at or above the 6% level in 2018 which is a big positive for the company. Looking at the other income line, we recorded a loss there of $21 million in the quarter compared with income of $4 million in the prior quarter and $13 million in the year ago quarter. A lot of noise goes through that line. In this particular quarter the loss is attributable to the Tax Act as a result of the revaluation of our indemnified tax receivables with our old buddies at Merion [ph]. So this mark-to-market was $23 million and unrelated to the Tax Act we actually had a lapse of an uncertain tax position which went through that line item as well and totaled $9 million loss. By the way both of these items were offset in our tax expense line by a reduction in our tax expense so they had no impact on EPS. But excluding this noise other income would have been $11 million in the quarter despite the small size of that one we do get quite a few questions from our panelists. So $11 million which is pretty consistent with our quarter in, quarter out activity. Fourth quarter operating expenses were $119 million compared with $116 million in the prior quarter and $98 million from a year ago. FDIC fees were up $1.8 million a 33% increase. Excluding FDIC core operating expenses were up $19 million or 20%. Roughly half of this expense increase was driven by volume but we still see big increases and repayment volume which were up 19% in the quarter and of course our portfolio is still growing, rapidly it grew 22% year-over-year. The balance was driven by our continued build out of our personal loan platform which Ray just discussed. Our new graduate school products which we think are going to be an important offering as we enter 2018 and investments in our brand and consumer experience to support not only our diversification efforts but our core business where we continue to be the dominant player in the private student loan business and we continued to gain marginal shares in the market despite the competitive nature of that particular industry. So our market share was up to 55% as we measure it in the fourth quarter. The investments we make today are of course laying the groundwork for future returns from both our course loan products and our diversification efforts. Couple of additional points on credit, Ray mentioned that delinquencies were very consistent with our expectations at 2.4% down from 2.6% in the prior quarter. We also saw forbearances pick up to 3.7% from 3.2% in the prior quarter and 3.5% in the year ago quarter. Delinquency and forbearance rates are very seasonable and they're high this quarter due to the size of the November December repay waived that we see every year. And this year that repay rate was $2.2 billion. Net charge offs, very steady at 1.07% down from 1.08% in prior quarter and up from 0.95% in the year ago quarter due entirely to the seasoning of the portfolio increase. Looking at another measure and that's charge offs as a percentage of loans and full P&I. Again very consistent there. There are 2.06% in Q4 down from 2.11% in Q3 and also down from the prior quarter which came in at 2.08%. So the credit story no matter how we measure it is very steady and performing exactly as we would expect it to. Pending loans and full P&I are now at 7.1% up about 41% of our total loan portfolio. So, as the balance continues to grow our performance remains very steady and we view that favorably. Provision for private education loans was $49 million in the quarter compared with $43 million in the year ago quarter. Again this increase was a result of $2.5 billion of additional loans in repayment in fourth quarter of 2017 versus the prior year. Allowance for loan losses came in at 1.4% of total loans and 2% of loans in repayment. Allowance coverage ratio very solid at 1.9 times annual Q4 losses. Looking ahead to 2018 the question always comes up where is our allowance headed? We think it will increase by over 1.5% over the course of the year as the portfolio of loans and P&I continues to grow. Talk a little bit about our personal loan portfolio, we are purchasing personal loans as I mentioned and as you can see by the balance sheet we are targeting roughly $100 million a month. At the end of Q4 we had $394 million net of loans on the balance sheet. These are high quality loans, average FICO score of 722 and the debt to income level excluding any mortgages under 20%. So very solid stock. Difficult to measure charge offs and delinquencies because the portfolio was very young but I'll give you an indicator, taking a look at delinquencies and charge offs on the loans that we are on as of June 30th. So holding that portfolio steady what was in delinquency rate at the end of Q4 came in at 1.5%, cumulative charge offs on that portfolio were 1%. So it is performing very well and doing exactly what we expected to do. We've got a few questions last night on the increase in the allowance for that portfolio, story there is pretty straightforward, we thought it was a prudent thing to do to increase our loss emergence period from eight months to 12 months so that accounted for the vast majority of the increase in the loan loss reserve there. Let's talk a little bit about consolidation activity that's picked up in the quarter to $209 million from roughly $150 million in the third quarter. Again this is as expected as loans going to full P&I that is when people are incented to consolidate. That is what we saw happen in 2015 and -- began in 2017. The delta is declining which is a positive so we continue to watch that. Again the rate of increase is very consistent with our prepayment forecast. What we are observing is the vast majority of prepayment activity occurs in the first four quarters of P&I and then declines substantially after that. Looking ahead to 2018 I'm sure it will [indiscernible], I am guessing -- I am not guessing I am forecasting that probably about $900 million of our portfolio will consolidate in 2018. And I will go out on a limb and suggest that that number could be lower if interest rates continue on their current path. So we will watch that very carefully. Turning to capital, the bank remains very well capitalized with a total risk based capital ratio of 13.3% and a common equity tier one to risk graded assets level of 12% for the fourth quarter. These ratios significantly exceed the requirements to be considered well capitalized both now and after possible three [ph] is fully phased in at the end of 2019. In addition the parent company has excess capital available to the bank which is an additional source of strength and that's not reflected in these numbers. While we are on capital let's talk briefly about CECL, favorite topic in finance circles these days. The long story short here as we project that after the implementation of CECL which as a reminder requires us to build a life of loan allowance or capital ratios particularly common equity tier one to risk weighted which I think will become more important measure as the amount of loan loss allowance you can include in capital. So that ratio we project to be significantly above the fully phased in Basel III capital ratios that banks are required to hold. So, very good outcome there. Wrapping up, Ray mentioned core ROA and ROE came in at 1.7% and 16.3% 2017, solid numbers that are of course heading higher as we benefit from the Tax Act. So that completes our prepared remarks and we are more than happy to take questions now.

[Operator Instructions]. And your first question comes from Sanjay Sakhrani with KBW.

Thank you. Good morning. I guess my first question is on the roughly $20 million you got there, are spending on the incremental loan products, could you just talk about maybe the specific returns you expect to realize over the next several years and maybe how much growth we should expect in those asset classes?

Sure, the two are different. As I said the personal loan is much closer to what we're doing now, the cluster is relatively low. We actually have the capability and are piloting loan offers and applications and balance growth while we are talking in a very limited sense. We expect that the returns on the personal loan business over time will be consistent with our other ROE efforts that is mid-teens or thereabouts. The question as to how they will pay back over time is going to be somewhat determined in 2018 because as I said it's not the ROE of a particular cohort that matters, the question is how large do you want this effort to be and as you add on additional vintages which have high acquisition cost in the first year and losses in their second year. The weighted average of the entire portfolio will be dependent upon the expansion path as well terminus point. Suffice it to say though that on a account by account basis we expect the returns to be positive by year three and we expect them to be consistent with our other ROE that is mid teens over a period of time. The growth I don't want to get ahead of ourselves. We are appropriately testing and we will be bound by cost benefit associated with that. And as I indicated and Steve said we have $400 million of personal loans on the books already so we have very good lens into the current pricing elasticity and the current credit market for those so that we won't be quite as naive and going forward in personal loans as we would have been had we not had that exercise which is actually accelerating our learning about the industry by two years.

Okay, and maybe a question on the consolidation activity. Steve thank you for all the color you provided in terms of your expectations for this year but I guess what is happening still is that the rate of consolidation seems to be increasing even when you look at the ratio of loans that are in repayment right, so consolidation of loans and repayment at what point does that ratio level off because it seems like you guys have talked about how there's diminishing returns for your competitors but it's still happening at a quite a brisk pace, your guidance suggests that and then now you have this tax benefit that could also help the economic equation for your competitors, can you just talk about that a little bit, thanks?

Yeah sure Sanjay, so obviously we have a lot of information on what's going on in the world of consolidations. But in terms of the rate of change so we've just had our biggest ever principal and interest repay wave go through and in the fourth quarter 60% of our consolidations came from that repay wave and roughly 10% came from 2015 wave. And our future repay waves are going to be pretty big relative to our total P&I portfolio but I do think we are at the point where it is going to start to tip over and level off. Now the interesting thing is and I know I probably said this three quarters ago and you can say well [indiscernible] so far is going to be wrong or it is going to be right. Consolidations is very much an interest rate play. People undercut current market based interest rates, consolidate the loans and fund them in the wholesale markets and move on. So we have seen a continued increase in base market rates. I think they're up another 20 or 30 basis points since the middle of December. So it is going to start biting I think our competitors who have not raised their rates yet. Now what I will share with you is there's probably a half a dozen people that consolidate our loans and they go from Fin techies to real publicly traded companies that have return requirements and so on and so forth. What we are seeing is the pace of consolidation from publicly traded companies that have to answer the shareholders and produce returns is leveling off and declining as I would expect it to given the funding markets, the fin techies are still charging forward. We'll see where it all plays out. And as the portfolio matures even if its impact continue to consolidate they are after a very particular segment of our portfolio and the activity curtails very quickly. So we should see the impact decline overtime even if they continue at the current pace.

Okay, and then final question on originations, when we think about the 4% growth that you guys are estimating, how much of it is work in the market, first in the market share gain?

It is evenly split. Market should grow 1% or 2% and we should pick up market share 1% to 2%.

Okay, alright, great. Thank you very much.

Okay, thanks Sanjay.

Your next question is from John Hecht with Jefferies.

Good morning guys, thanks very much for taking my questions and I guess just a little bit of clarifications from one of Sanjay's questions, you reported the $20 million of investments in new products but $10 million of incremental expenses in technology, for this $30 million of incremental expenses this year do I look at this as a onetime kind of project that will go away the following year and you will start reaping the benefits of these in the following year, are there other projects in the following year that replace these and really asking this just in the context of trying to figure out how we kind of think about the efficiency ratio through 2019?

Sure John, and we had the opportunity here and as many of you know because you've been following us for several years we've often thought that we have an opportunity with our customer base to do more business with them and they certainly do buy lots of products so that for instance in the credit card business when we meet our customers at the age of 18 actually coincidentally 18% of them have credit cards at that time. Usually a name signor or a household card. By the time they're 27 over 90% of them have credit cards and we're with them during that period and we think that there's a very attractive change in their lives that we are present for and that we have not taken advantage of. Having said that in regard to your question about 30 million, what we did was only look at the tax change. We said here's an opportunity for us to accelerate our diversification while still having a 36% EPS growth for the third year in a row and maintaining high ROEs while lowering the efficiency ratio. So there's no doubt that the tax return, the tax change allowed us to move more investments into 2018 than we had previously thought about. And so when we looked at those we took a full inventory of investments around the company as to which ones would qualify from an ROE stand point and ended up with these three. The nature of the infrastructure and the cloud is an ongoing efficient operating platform which will continue. The nature of the other two investments is to get started with new opportunities that we think we have every right and legitimacy with our customers to offer them additional products based upon what we think is good customer service and good product offering to begin with. Having said that these are not to be followed in Q3 or Q4 other investments in the following year in 2019. So in answer to your question there's not a line outside the door of which we didn’t cut off at 30 and we have another 30 in line for something new and interesting in 2019. So, this is the beginning, middle, and end of this type of $10 million investment. We believe it was accelerated into 2018 by virtue of the tax change. We believe it allowed us to keep a consistent record with the company and the shareholders while at the same time accelerating diversification which we think will accelerate the benefit associated with that. In regard to the other two investments credit card and personal loans there is very small revenue dollars associated with them in 2018 and naturally as those portfolios mature there would be higher revenue and the cost will move along with it as we go to a three year cycle on moving from acquisition to profitability with customers.

That's very helpful, appreciate the color. The second question, in your -- excuse me, your deposits to earning asset has been really stable in the 90% to 91% range, should we think about funding this year with the consistent deposit dates and then can you guys give us an update on how you see where the deposit date and kind of as we stretch in the year?

Sure, look our approach to funding is not going to change. We will continue to grow our deposit base and we will continue to access the asset backed market as a means of extending the duration of our liability portfolio. You can think about it as sort of an 80% deposit, 20% ABS funding model. We will be more opportunistic when opportunities do present themselves. In terms of our deposit data we like very much what we're seeing in the money market deposit product. We're actually funding at LIBOR less 10 as opposed to LIBOR plus 30 to 50 which we do on some of our other products. In terms of the beta, it has turned out to be better than we expected. We pencil then something along the lines of an 80% beta and I think it's got a 40 handle on it.

Actually we started at 1, we dropped to 80 and now we're down to 40.

So the retail deposit market also known as the Internet deposit markets is performing very well. It's where people with deposits go to shop and we're able to access deposits very efficiently without spending a whole lot of money on marketing, etc. So we like what we see there.

Thanks for answering the question guys.

Your next question is from Steve Moss from B. Riley FBR.

Good morning. I was wondering if you could just give some color around what your expectations are for fixed versus bullion rate originations this year and what are you thinking the potential pricing for fixed rate loans is?

So what we saw in the peak season I think 45% of our borrowers took fixed rate loans that was up from the high teens call it a year ago and that was a pretty consistent level. We will price our fixed rate loan product in the spring. I have no reason to believe at this point in time that based on what I see in terms of cost of funds and spreads that the price is going to increase significantly. We're probably looking at maybe a 30 to 40 basis point increase as we sit here today. I think the average yield on our fixed rate product is 9.5% today and you compare that to our average spread to LIBOR variable rate product is around 7.25% one month LIBOR at 1.5 so they're roughly similarly priced products today. They weren’t a year ago as well as the yield curve flattening has sent a lot of people go into the fixed rate and we will continue to obviously watch that trend play out.

Okay, and then with regard to the personal loans that you are originating purchasing, what are the structure in terms of -- or the term here is it typically three to four years or is it a longer than five?

It is about 60% three years, 40% five year multiples of 65, 35, the three year product is a lot more popular than the five year products. We look at an average life of under two years 1.8 kind of year so it is a short lived product.

Okay, and my last question with regard to the 5 billion in originations you expect for 2018 does that include graduate loan originations?

Yes, it does. But we expect the loans are -- I should say we think -- just to give you a flavor for the pasting on that. We think we do some business with graduate loans today which are relatively minor. We've developed six tailored products for graduate, a couple in the medical and health along with MBA, legal, and other. And so as we look at these we think that the current state of play in that market is heavily dominated by the federal government's grant plus loan which has a 4.1% origination fees associated with the 7.1% APR. And so we believe that that is way off market and we can actually price a lower total cost for loan to these target audience. Having said that the graduate schools are as you know many, many small ones and the uptake rate on this requires a reasonable amount of education and a financial aid office in the graduate space that is not identical as most schools to the undergraduate space. And so we want to be conservative in our passing to maturation. We think this has great long-term prospects and we just don't know exactly what the take rate will be in the opening season. As I said when we introduced the parent loan, word of mouth got around relatively slowly and in the second year we doubled the volume associated with parent loan. We expect to have a similar slow uptake rate in an ongoing high rates of compounded growth for the grad products.

Okay, thank you very much.

Okay, thanks.

Your next question is from Arren Cyganovich with Citi.

Thanks, I know this is already asked but the question of the 30 million how much of that is going to be recurring after this year, I'm still not quite clear on the ongoing spend of that 30 million going forward?

Okay, there are two questions inside of this, right. So the previous question not identical to one you're asking Arren was after these three at least the way I understood it, after these three efforts of 10 million is there a queue after that of a another five efforts that are all $10 million as well. The answer to that was no, as we said. A separate question is within the areas that we're talking about is the 10 million associated with each one of the three investments a repeatable number or will it grow over time. The answer is it varies. For the first ten which is related to infrastructure and IT will not be repeated next year or next year being 2019. The other two may well have an increase in expense base but they will be offset by the revenue which is zero in 2018 for all practical purposes so we may spend more money on personal loans in 2019 but the net contribution of the activity will be muted by the fact that we expect to end 2018 with a portfolio of approximately $300 million.

Okay, that's helpful, thank you. And in the -- thinking about the diversification efforts you talked in the past about taking a very measured approach to this and now we're talking about accelerating the investments here, can you talk about balancing those two because obviously people get a little bit more scared off by new personal loan products and in credit card products with respect to the loss expectation of your student loan business?

Okay, Arren, yes thank you for picking this up. And so as I said these are two difference, let's take the IT and put it aside. Now we will talk about the personal loans and the credit cards, right. Personal loan is very different to credit card for us because as you know and as I stated earlier we are in the personal loan business, right. We have a portfolio that is a personal loan, it is unsecured, it has a six to seven year actuarial life and we are in this business to the tune of about $18 billion. We take the specifics associated with the student loan and we turn them into different parameters for the non-student personal loan. So it makes it easier for us to have a lower infrastructure cost in the delivery of this, it also fits quite nicely with some of the credit models that we already have. Having said that we are cautious about this which is why Steve initiated the purchase program of personal loans in the first quarter of 2017 and as he said we had reasonable portfolio as of 6/30/2017 that will be two years old by the time we're talking about adding any volume. And we will work our models both internally as well as in parallel for that extra experience in order to mitigate the risk that you're addressing. And so it'll be on a cost benefit basis, 2018 will be a year of experimentation. We will as we go into 2019 refine from a both a marketing acquisition cost standpoint as well as a credit loss expectation standpoint what we're doing in personal loans. Credit card is following more slowly, alright. So that project is not quite where the personal loan business is where as I said earlier the ability to deliver the personal that we are talking about through general market is extend as we speak and we are originating loans. We're doing our first mail drop of 300,000 pieces within the next 10 days and we will start learning about that. Credit cards we are in the process of working through our relationships with a couple of partners. We will not build an infrastructure with regard to that and we will probably have our first credit card offer in the field in the first quarter of 2019. So then we will take in 2019 a year for experimentation and then build that portfolio against the same ROE guidelines that we have for everything else we do as we go forward.

Thanks, that's very helpful. And just I guess lastly, the prosper act maybe some facts on how that might progress through the year, potential for it to get done and that's always a dangerous thing to talk about? And then the thing that I guess was surprising to a lot of folks was that the discussion of increasing loan limits on the undergraduate side, if you can just kind of touch them on the prospect?

So Arren just for clarity, the prosper act was for Virginia Foxx proposed legislation to reauthorize AGA, alright. So, since I started I will continue and then I will give Ray a chance to add, so we do not believe that as Congress sits here today that the prosper act has a lot of chance of being has a high probable chance of being picked up in the Senate as well and passed. However in the prosper act we do like what we see, it curtails Parent Plus and Grad, eliminates Grad Plus. It does increase undergraduate and graduate Stafford loans but as we measured it, it would expand our addressable market by 30% to 50% so $3 billion to $5 billion. So it would be a big positive should it be inactive.

Yeah, the one thing I would add to that is forecasting in regard to what goes on in DC. It is obviously a fool's errand and so we don't have anything associated with this opportunity baked into any of our numbers. And having said that we want to -- when an act occurs, were it to happen all of a sudden as let's say the tax act occurred in the fourth quarter of this year we don't want them to start to take advantage of what we think are likely outcomes. So as you may recall in 2017 we spent an additional $7 million on projects we referred to as Nike that anticipates the growth that Steve talked about in such a way that our capacity while we're sitting here can accommodate that 30% to 50% increase in volume. We did spend the 7 million, it's done and we have the benefit of having a stronger platform that is leveragable in the anticipation of that act. So we believe we have the in some sense expense covered and the opportunities in front of us and we'll see what happens with that.

Thank you.

Your next question is from Moshe Orenbuch with Credit Suisse.

So to put that 30 million in perspective it looks like just over a third of maybe the tax savings. How should we think about that use of the tax savings kind of longer term after that 30 million has been invested?

Well I think we should think about the tax as part of the woodwork at this juncture and of course you're right. If we were to just do the simple algebra on what had been I think in everybody's model as a previous thought for 2018 for EPS, you may call that some number like $0.85 and then you just laid on the 14% delta in the taxes you would come one, two, three here. We are 105. Delta between those is about $85 million pretax and so it implicates that we invested about 30 of the 85. So your number is approximately correct. Going forward we will take the Tax Act as given and we will keep ourselves within the same parameters that we have consistently promised to shareholders and delivered upon over these last four years which include healthy EPS growth and as I said 36, 36, 36 the last three years have been very impressive. We expect that to moderate but still expect to be way all of this, so far as their passing on the EPS. Have ROEs that are consistent with what our ROEs have been the last couple of years which as you know as Steve said last year was 16%. We expect that to be at or higher than that as we go forward. And to continue to improve our efficiency ratio so that shareholders can gain some comfort that while we're expanding our operating base we're doing it constant in fact better than the growth in our revenue. As I said last year revenues grew by 20%, expenses grew by 16%. 16% is a big number but 20% of course is its guiding light.

Great, and I guess that your expected tax rate for this year is 26% are there are things going on in eighteen or uncertainties that would make that, is it a touch higher than we might have thought it would come out based upon your kind of state and local tax burdens before. Are there any other things in that number that would change in future years?

Yeah, there are some. Steve why don’t you walk through a couple of them.

Well so Moshe we are 21% settled and we are running between 4 and 5. So 26 seems like a good place to start and then a 25% absolute positively. We are just began our efforts to fill for example a low income housing tax credit portfolio and make other investments that will ultimately bring our tax rate down to the enviable level of JP Morgan talked about 18% and 19% of tax rate. That is an aspiration we certainly want to head in that direction but it will take quite a while for us to complete such a journey.

Understood and then the last question from me is reacting to your 900 million comment and more asking about how do you think about that level, is it at a level where you think that you don't need to kind of do anything from a defensive standpoint or is it something -- is that something that you are planning to put in place?

So thank you for bringing that up. We are basically building the infrastructure, altering our systems to put us in a position in the second quarter to start to offer consolidation opportunities to our borrowers as they call and talk about such things. And we do get a heads up obviously through our very effective and efficient call centers. On the drawing board right now as we speak was to offer a product that extends term and we've approached the bar with the same coupon payment given the results of the Tax Act and things that are going on in the market. If we're able to sweeten that by lowering interest rates and obviously depending upon the circumstantial bar and maintaining a healthy borrowing we will bring that as well. But we will be in a position in the second quarter to start to be much more defensive and proactive on that front.

Great, thanks very much.

Yeah Moshe, one thing we got to mention is, Steve alluded to this that our customer service as I've said a couple of times here has been upgraded not only in the service side of provide but in the MIS around it. And we have facility which is called a call monitor and that allows us to search every conversation that has happened in our call center. And so we're in the midst of modeling right now anyone who calls and mentions interest rate change, consolidation, getting a different loan and it's an interesting analytic piece which will allow us to target individual at risk customers from a standpoint of consolidation in such a way that we don't put our NIM to the entire portfolio at risk by responding with a meat cleaver when a scalpel is called for. And so that's a work in process. As Steve says during the second quarter we expect to execute both on the targeting associated with it as well as on a counteroffer on a product sense.

And Moshe just one final point. I didn’t add, no level of consolidation was successful but obviously we have to balance the ROEs on maintaining versus retaining.

Clearly, thanks guys.

Thank you.

[Operator Instructions]. And your next question is from Mark DeVries with Barclays.

Hi, thanks. In the past you've talked about an efficiency targeting kind of the mid 30s longer-term, but if we take the guidance today of 37 to 38 and back out that $30 million in incremental investment would appear you actually be there in 2018 kind of ahead of schedule, is that a fair statement and if so can you just talk about what's driving that kind of operating leverage is it your upside to the NIM you have experience that are expense management or something else?

Thanks for the question Mark and it is true that you are at risk at continuing on a landing path that has been 30's. It is also true that we have 30 million investment we would be approximately 35% in 2018. It is true however though that as we think about the net present value associated with the franchise that the investments are in one sense optional that are introductory products. In another sense it is defensive because as the portfolio naturally liquidate, forget about consolidations for a moment, we are paying a high acquisition cost for these customers and we are bereft of the ability to offer them additional products which we know they will buy from someone else. And so in order to both capitalize on the portfolio that we have and the position we have with younger people as well as to mitigate any loss in balances and therefore revenue associated with them, we view that 30 million and especially the two 20's for the product increment as part of the maintenance of the franchise. And so there will be ongoing investment in any business but you're absolutely right that the pure let's not invest a significant amount in this business in 2018 efficiency ratio would have been 35. So we're capable of delivering that but we don't think it's in the interest of the shareholders to deliver that because we think it too much compromises the future and then one day may force us to be acting in a reactive mode which would put too much at risk. We much likely -- we much prefer to be able to invest in a leisurely way in the sense of gathering intelligent information before we bet any significant dollars and we think this is in fact both the warranted path from defensive standpoint, an optimal path from an opportunity standpoint, and a prudent path from a trajectory standpoint.

Okay, thanks and then Steve, I was hoping you can give us some of the assumptions tying your NIM guidance in terms of rate increases and also deposit betas and kind of outside of that guidance in fact your betas tend to be lower than what you've been assuming?

So in terms of rate increases we basically pretty much follow the euro dollar curve and we have two additional rate increases baked into 2018. Our beta is our expectations on the cost of our $3.5 billion of retail money market deposits that is outside of the north of LIBOR as opposed to south of LIBOR. So there is some upside there. The other moving pieces are pretty steady. Well we will see some improvements in ABS cost of funding as the market remains where it is right now although we don't plan on initiating until early spring and then again in the fall. And the broker deposit market has been pretty steady. So if there is upside it comes from the component of our funding, it comes from the retail deposit market.

Okay, got it, thank you.

Your next question is from Henry Coffee with Wedbush.

Yes, good morning everyone and thanks for taking my call. A couple of questions and I just didn't understand it the 8 to 12, the shifts from an 8 month to a 12 month loss emergence, can you just explain that to me?

Sure so, a key component of your loan loss allowance is how many months of losses are you reserving for. In our private student loan we maintain a loan loss reserves for one year of expected losses. In our personal loan as we start acquiring -- introducing them, it's a shorter lived product and typically lawsuits do emerge much quicker in that product. So we initially went with an 8 month loan loss emergence period so we were reserving for 8 months as opposed to 12. As we set our accounting and credit policies we thought that it would be prudent to extend the 8 months to 12 months. It does not change whatsoever our outlook on losses for that product, if anything it front loads the credit expense and once you get through the peak loss period you basically are earning more as opposed to less on the product as that makes sense.

And thank you and then on the consolidation loan, I mean a lot of other people are looking at it as sort of a total customer value, so and I'm just going to make up some numbers here, if a customer has $8 million worth of loans with Sallie Mae maybe they have $20 million of total student loans and the refinance rates not what you want but you have just theoretically could double the size of your business with that particular customer, is that how you're thinking about it or is it just purely defense, defense, defense?

I think there is opportunity both ways. And so one is increasing the balances of the current customer and the other is again protecting those balances from they being stolen away. And so we have them as we said throughout this conversation now pretty much one note sort of disperse to the college, that's the only way we're doing things. And recall that while we're in the personal loan business and the unsecured personal loan business our product is quite unique as they say. And so it is from graduates for the most part, it is dispersed to the school 100% of our balance is originated that way. And as we think about the next several quarters as Steve mentioned we're looking at change in terms of whether they focus on cash flow for consolidation defensive purposes clearly introducing the personal loan which is unfettered from the schools, will give us much more flexibility in being both defensive as well as offensive. And yes we do look at the total relationship of the customers which is how we reached personal loans and credit cards as our two areas of diversification.

And then finally I know you don't want to predict on the political front but is -- if the Prosper Act is not the final form is it logical -- is there something compelling Congress to do something this year or is it just you know they'll do it if they want?

AGA [ph] reauthorization had been kicked down the road five and six times in the past and I don't see any reason why this year could be any different. And there is nothing urgent in the AGA [ph] that needs reauthorization at this point in time. So, that can continue to roll.

I think that is true but the obvious poor performance of the federal portfolio with 40% delinquency rates had tragic losses that are involved in that which actually can students' lives. Well over a period of time cause people to want to look at that program and therefore make some changes to it both in its original underwriting as well as in the limits that have been mentioned as well as in whether or not the federal government should be subsidizing Parent Plus and Grad Plus which is a position many people disagree with. But I do think it's the constant drumbeat associated with the $1.4 trillion portfolio that will drive them to act but it will not be a gee, we have to do it by midnight on Saturday type of act. It will happen over time it will gain momentum.

Great, thank you very much.

I will add one more thing to that. If there is in fact a budget reconciliation bill at some point in time in 2018, the AGA reauthorization could actually be passed through a given current composition of the center.

And it has the positive impact on a deficit so it's helpful from that standpoint.

Your next question is from Michael Tarkan with Compass Point.

Thank you, I know it is getting late, so I will be quick, just on graduate loans can you just remind us what percentage of the overall graduate market you think hits your credit box? And then I know it is going to start off slowly but just big picture if Grad Plus is a $10 billion program per year, is there any reason to think the private market couldn’t originate 30% to 40% on an annual basis once you're fully up and running?

No.

Okay, and then in terms of the percentage of sort of under writable loans sort of in that sort of 40% to 50% range?

Yeah, I think so. We've looked at this not with the amount of detail that would be required to have a credit model but we have looked at the overall piece. So we think you have 30% to 40% consistent with our current approval rate would be appropriate. The backdrop for your question is do we think it is a big opportunity. Yes, we do think it's a big opportunity.

Okay, thanks and then competitively you talked about picking up a couple more points of share, I know well as in contraction mode but how sustainable is that and are you seeing any recent entrants heating up a bit more and getting more aggressive in the end school channel, thank you?

Yes sure, Mike. As we have looked at that and we have a full listing of who the competitors are and as you know the market is still somewhat oligoplistically structured with ourselves and Wells and discoveries. And those share even though Wells is in contraction mode it had such a great distribution that their portfolio hasn’t suffered as much as it would for the long distance providers such as ourselves and Discover. So that's more inertia and the nature of their business. Having said that as we look at detail and the amount of originations that are done by the last ten or so competitors remains very much a small percentage. We don't see anyone gaining market share of anything that would be measurable above 22% kind of thing. And so I think the industry right now is relatively stable.

Thank you.

Your next question is from Melissa Wedel with J.P. Morgan.

Hi, Melissa for Rick. Again I will be quick on this, the pace of the $30 million investments in 2018, do you expect much of that to be front-end loaded or fairly evenly distributed throughout the year?

We think the 30 million has three different dynamics to it and I think it is a rough approximation I would say, that balance through the quarters.

Got it, thank you.

And your next question is from Anne Masic [ph] with Roth Growth Capital.

Hi, good morning. Can you quantify what a continued rise in one month LIBOR might mean for your earnings, it went from 125 to 155 in Q4 and can you just give me a chance for what the impact might be for Sallie Mae earnings if it reached 2% in 2018 which is a pretty conservative market estimate at the moment?

Sure, Steve.

I think in our sensitivity disclosures we show that we -- our earnings will increase roughly 2% for a 100 basis point shock in interest rates. So with basically not a material increase especially the way math calcs are happened.

But Anne if we had this bracketed and so at one end of the bracket was the 100 basis point instantaneous shock which Steve references and the other is the increases that Steve mentioned earlier which are more gradual. And as you heard him say we're at a 6% NIM and we expect that level to continue through 2018. So the gradual pieces answered in that comment at the 6% NIM and the short piece is positive as Steve says but I think that brackets the question.

Okay, perfect and then I know this is -- I have asked this before I'll ask it again whether or not you have any plans to instate a common dividend?

You can keep asking and we will continue to have the same response which we believe to be appropriate that we think at this juncture based upon what we see in the business today and for the foreseeable future and we have forecasted out seven years when we looked at this, we believe that our shareholders are better served by our reinvesting all of our profits into the company as we have done the last five years.

Okay perfect, thanks so much.

And there are no further questions at this time. I would like to turn the call back over to Brian Cronin for closing remarks.

Okay, thank you very much. Thanks for all the questions and they have all been helpful in teeing more precise responses to particular areas. As we end I want to thank everyone for their attention and obvious work that has been done to know the business so well. And just to remind that this is a wonderful franchise with a strong market position, a highly valued customer segment. Our strong balance sheet continues to have unanticipated benefits for us of which the personal asset purchases are just one piece of that. We do have proven delivery capabilities at this juncture having doubled the size of the business in four years while maintaining good control and having good relationships with the regulators. Our controlled growth from 10 billion to 25 billion over that period as far as our balance sheet is concerned is a very impressive compounded growth rate. We continue to have excellent margins, profitability, and good returns. We continue to improve our customer service, and we expect that over the next three to five years we will be building on these last four to five years of success to realize a promising future. So thank you all for your attention and look forward to 2018. Great, thank you for your timing and questions today. A replay of this call and the presentation will be available on the Investor site of salliemae.com. If you have any further questions feel free to contact me directly. This concludes today's call.

Thank you for joining today's conference call. You may now disconnect.