SLM Corporation (SLM) Q1 2018 Earnings Report, Transcript and Summary

Good morning. My name is Angela and I will be your conference operator. At this time, I would like to welcome everyone to the 2018 Q1 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]. I would now like to turn the call over to Mr. Brian Cronin, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Angela. And good morning. And welcome to Sallie Mae's first quarter 2018 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 discussion will contain predictions, expectations and forward-looking statements. Actual results in the future may be materially different from those discussed here. This could be due to a variety of factors. Listeners should refer to the discussion of those factors on the company's Form 10-Q and other filings with the SEC. During this call, we will refer to non-GAAP measures we call our core earnings. A 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, 2018. This is posted along with the earnings press release on Investors page at salliemae.com. Thank you. I'll now turn the call over to Ray.

Thanks, Brian. And thank you all for your attention this morning. And I want to extend a special thank you to our team for delivering a great quarter. It was a good quarter on all cylinders. By my lights, volume was up higher than expectations. It looks as though we have very good competitive market performance. That as we think our originations grew most likely faster than the market. Our yield and NIM are at outstanding levels. Come back to those as we talk. We had better than model performance in credit. New customers are at a very high-quality level. And we have continued progress on efficiency ratio, which we've all discussed over these last many quarters. The 22.7% ROE is a testimony to the fact that these good results do show up in the bottom line. In addition to that, we had very good and gratifying results in several strategic areas. We've introduced personal loan with a 300,000 test mailing in January and we have followed it up with a 2 million piece mailing in March. The volume is where we want it to be. The quality of customers applying is very high. And we've also the tested the Sallie Mae brand and initial results are very good in relationship to that brand extending to non-student financing products. Our cloud migration is going well and we are fully embedded now in the Agile methodology, which is starting to show good results. We've been doing this now for three quarters. Our progress on credit card evaluation continues and that stays on track for 2019 initial product launch. Our grad products are in the field. We expect them to do very well. They are not part of the 7% volume increase that we've experienced so far. And so, we have high hopes for that additionally. In addition to that, our consolidation response product which we talked about on several calls, which has been put in place selectively for term extension, and as we go through the second quarter, it will also include APR reductions. It's up and we're evaluating initial one by one results. In addition to that, our team has experienced a very gratifying low turnover rate for our non-operational areas, what we would think of as management. It's running at 5% and good feedback from our employee survey results. Our customers continue to receive enhanced satisfaction levels and extension of our service. Most recent innovation that we have, which is following the lead of any others, is to introduce chat as an alternative for our customers to speak with us. And the chat results at satisfaction level are at 96% so far as we continue to experiment with the best way to have that as an ongoing additional option for our customers. With regard to our community, we've recently expanded our Delaware workforce and had a very successful opening of a second site here for collections operations and underwriting. And it was well attended by all the top elected officials in Delaware, including the governor, both senators and our congresswoman. It's a very good result for both us as well as for our relationships in community. And so, as we turn to the results, volume of first quarter originations were $2 billion. You'll recall that we have a $5 billion goal for the entire year. So, 40% of the year is in. The busy season, of course, looms in front of us. We're up 7% in originations from 2017. And as I said, we believe the market to be growing slower. Of course, the obvious implication is that our share is up. When we receive those numbers, we will certainly report out on them. With volume up, you always worry about credit quality through the door. That continues at the same high level that we've experienced these last couple of years. Our FICO, as you saw in the printed material, is at the same level. 748 last year; 746 this year. Our cosigner rate 89 plus versus 90 last year. Same level. And 79% of our loans have FICO over 700 by the primary borrower. In addition to that and stand out for the quarter is the results that Steve and his team were able to deliver on NIM. The NIM at 6.17 is the envy of the industry, up from 5.96 last year. And that continues to be the beneficiary of both the management of the yield on the portfolio, the efficiency of the balance sheet in regard to revenue producing assets as a proportion of the total and, of course, our funding mix. The OpEx, you know we focus on the efficiency ratio, continues to improve. The absolute level of 36.5 in the first quarter is a very good level, down from 36.8% last year. Our revenue is up 24%. Our operating expenses are up 21%. So, they're both in growth mode at this particular point. The question is how to control that growth, so that we prudently both service the existing business as well as make appropriate investments for the business over time. Credit, as I said, continued. Great performance. Better than our model thus far. Early days so far as the first year is concerned, but all the indicators are pointed in the right direction. Our balance sheet continued strong. 22% growth in the overall balance sheet and our capital to risk-weighted assets remains at 13%. EPS, the bottom line in one sense – ROE is the other sense – EPS at $0.27, up from $0.21 from last year, reflects all of these good performance indicators that I'm mentioning. 29% increase. We're quite proud of that. The ROE at 22.7% is extremely gratifying and certainly talks to the continued investment in the business that we've talked about on many calls as well as individual meetings. Our regulatory relations continue to be great. The CFPB, the FDIC, the UDFI were all aware of our plan and we're in constant conversation. The results of all their field audit have been very good and we are gratified to have them as a partner. So, the market frame, we are making progress on the areas in which we focus in relationship to the customer, the competition and our evolution. Steve, of course, will talk about this in more detail, especially around the NIM. And our outlook, as you all saw in the guidance, we've tightened up the EPS. The originations, we're staying at $5 billion. We're optimistic after the first quarter. But as I said, 60% of the volume is yet to come in this year and continued progress on the efficiency ratio. So, very good quarter. Balanced good performance on every major indicator. Good start to the year. And with that, I'll turn now this meeting over to Steve.

Thank you very much, Ray. Good morning, everybody. I'm going to provide a little bit more detail on the quarter's number. And if I repeat a stat or two, please forgive me. So, jumping into the NIM, as Ray mentioned, we did post a very strong NIM of 6.17% in the first quarter, up from 6% just a quarter ago and 5.96% in the year-ago quarter. The NIM increased by 21 basis points year-over-year, driven by the increase in the percent of student loans and personal loans in our portfolio. We also continue to benefit from the low spread environment as we benefit from sub-LIBOR pricing on our retail money market deposits and very good spread environment, brokered CDs and asset-backed departments – markets. Assuming those markets remain stable, we think that our NIM is going to remain above 6% for the full year. As those that follow us know, as we build cash balances for our peak disbursement seasons, the NIM tends to decline and then rise subsequent to disbursement. So, we think that the NIM should come in right around 6.1% for the full year. Talking about rising interest rates, since our last call, the three-year swap market is up a full 50 basis points, but we remain very well positioned for a rising rate interest rate environment, with very minor impact to our earnings at risk and economic value equity, given a shock in interest rates of 100 basis points. In the quarter, we did complete another ABS transaction, 2018-A, where we raised $670 million of term funding at at LIBOR +78 basis points. That is our all-time low as a standalone bank and it's down some 50 basis points since we started issuing ABS out of the bank. We will continue to use the ABS market as it's a great way for us to diversify our funding and also extend our liabilities' duration and fund fixed-rate assets. So, as an example, the most recent bond reissued included $244 million of fixed rate bonds with a six-year weighted average life. That's important, because as you will see in the details of our release, in the first quarter, 48% of our originations were fixed rate. That's up from 16% in the year-ago quarter. So, in this rising rate environment, our customers are choosing the smart thing, and that is to lock in rates on their borrowings. Just a little bit more detail around OpEx. It was up $125 million compared to $103 million in the year-ago quarter. FDIC fees which are included in that number were up a sharp 22%. But maybe more importantly, in the quarter, we accelerated $5 million of expense related to the vesting of executive stock compensation. And in addition to that, we incurred costs of $2 million for payments related to the passing of one of our officers in January. If you back this out of the operating expense numbers, our efficiency ratio would actually have been 34.5% and our OpEx growth would've been 14%. And we think that's a reasonable thing to point our here because that was an acceleration of expenses into this one period. I will also mention that, of the $30 million of diversification investment – we mentioned in the last call, we got off to a slow start. We only spent $600,000 of that in the first quarter. I think if you want for modeling purposes, you should expect us to spend the balance of that evenly over the next three quarters of the year. Effective tax rate in the quarter was 24.5% compared to 35% in the year-ago quarter. obviously, a big benefit from the recently passed tax act. And you can think about our tax rate being right around that 25% rate for modeling purposes. I'll give you a few more stats on credit performance. Loans delinquent 30 plus days were 2.5%, up from 2.4% in Q4 and up from 1.9% in the year-ago quarter. First quarter delinquencies are typically higher than the fourth quarter as a result of the big repay wave that hits in November and December of the fourth quarter. And a lot of these loans flow directly into the delinquency buckets. It is a fact that delinquencies were somewhat lower than expected and we feel we're positioned for Q2 charge-offs based on the way our delinquency buckets are stacking up. Net charge-offs for average loans in repayment were 1.01% down from the prior quarter and up slightly from the year ago quarter. the increase year-over-year is simply due to the fact that we have more dollar volume of loans in slow P&I. Charge-offs measured as a percentage of loans in full P&I were 1.93% in the quarter and that is also down from 2.06% in Q4 and 1.73% in the year-ago quarter. We had a total of $7.13 billion of loans in full P&I. That is 38% of our total loan portfolio. Personal loans, we ended the quarter with $675 million of personal loans on the balance sheet. We view these to be high quality loans. They had an average recent FICO score of 723. And incomes of our borrowers are just under $100,000. This portfolio is young. We monitor it very carefully and it is performing well within our expectations. A few comments on the provision to credit losses, came in at $54 million compared with $25 million in the year ago quarter. $13 million of this provision was personal loans, 24% of the total provision for the quarter. The increase was simply due to the rapid increase in the personal loan portfolio from Q4 to Q1. We ended the quarter with an allowance for loan losses of 1.34% of total loans and 1.95% of loans in repayment. Our allowance coverage is very solid, almost two times charge-offs. And I will repeat that our portfolio is performing probably slightly better than our expectations. So, things are very solid on both fronts [ph]. Turning to capital, the bank remains well-capitalized with total risk-based capital ratio of 13% and common equity Tier 1 of 11.7%. We expect these ratios to be right around these levels at year-end, demonstrating that our earnings is now covering our balance sheet growth, which is sort of a change from prior years. These ratios are significantly in excess of the requirements to be considered well-capitalized, both now and after Basel III is fully phased in. And, of course, we continue to have excess capital at the holding company that is available as a source of strength for the bank in the unlikely event should we need it. Couple of comments on CCEL before I wrap up here. Work on CCEL continues to move forward. As a reminder, CCEL requires us to build a life-of-loan loss allowance for a loan portfolio. But, interestingly, just under two weeks ago, a new joint proposal from the Fed, the FDIC and the OCC is giving banks the option to phase in the day one regulatory capital effects at CCEL over a period of three years. Now, in prior calls, we've clearly stated that implementing CCEL would not result in our capital falling below well-capitalized levels. But then, the last capital phase-in is a welcome development and it looks pretty certain that it will be adopted. That pretty much wraps up my commentary. So, we would be very happy to open up the line for calls at this point in time.

[Operator Instructions]. You first question comes from the line of Mark DeVries with Barclays.

Yeah, thanks. Sorry if I missed this. But could you just update on your guidance, your expectations for consolidation activity. And also, Ray, it would be helpful if you give us a little more detail on the product you mentioned rolling out, kind of early signs and hopes for the ability of that to really kind of mitigate that consolidation activity.

Sure. Consolidation, you should know, was running at about 223 in the quarter. We have guidance out there for $900 million. Of course, we're exactly on the run rate. One might think that there's either a positive slope to the volume there or one could also forecast that given the rate increases that are both embedded as well as the loans that are forecasted that the overall consolidation efforts will mitigate. And I think some information has come out in the last week or two about volumes of some of the consolidators and what they're doing with their mail bases. And that seems to be consistent with the closing window of the arbitrage opportunity that we've experienced over these last couple of years. Having said that, we think that we are right in where we want to be from a zone standpoint. And we don't think that we are in danger of having that continuing to increase it leaps and bounds. If it's up, it's probably gradual. We'll see, though. In regard to the consolidation response, early days. We, of course, don't want to turn higher-margin loans into lower margin loans. And so, we are very much in a wide net, customer by customer, let's learn about this, with the focus so far on term extension. And as we look to the remainder of the second quarter, by June 30, we will have a report back to Mark, you, as well as others as to the effect of moving APR as customers credit quality improved after graduation as well as the efficacy of the term extension which, as you know, both of those are focused on reducing the cash flow, which customers have told us is their primary focus. They're not particularly rate hunters. What they are is lowering the requirements for servicing these loans [indiscernible]. So, our early days of consolidation product on the run rate for the overall consolidation. And we think that the interest rate environment continues to take the oxygen out of some of the people who are specializing in regard to this.

Okay, got it. And second question, is the roughly $300 million or so in personal loan originations this quarter indicative of kind of what your expectations are for quarterly originations for the rest of the year and how should we think about that growth into 2019 and beyond?

Okay. As we looked at it, there's the purchased personal loans and then there's the organic fees. And so, for the purchase, we're thinking about a billion dollars for this year. So, that would translate into roughly $100 million per month. Obviously, I won't hit that like clockwork, but it will be in that range. And in regard to the organic, as I said, we've done – first, we did the IT shakeout. The product appears to be working effectively. We're still making some improvements in that. We did a test mailing in January of 300,000 pieces, 2 million in March. We're up to about $30 million outstanding. These are all test mailing. So, once again, we're looking for learning as opposed to efficiency. So, it's a little more explore than exploit in management lingo. We're looking for that to be about $300 million in receivable as we leave the year. So, we're looking for about a billion dollars in the purchase piece, about $300 million in organic build.

Okay. And as you go forward into 2019 and beyond, you'd expect that to accelerate?

We're testing. So, we will do things that meet our ROE targets, as you know. But from what we can see of early days, we're starting to go ahead of the model [indiscernible], but, yes, we would expect that to accelerate. The organic fees, the purchase fees, I think will be at a level that we're currently experiencing.

Okay, got it. Thank you.

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

Thanks. Good morning. The disbursement growth was pretty strong. Could you just talk about what that was attributed to and perhaps the competitive environment because you've had some players shifting around share?

Sure, Sanjay. Pretty strong, I think. Why don't we modify that – actually, the 7% growth was outstanding. We're in a market that we have tried model so far as what the total wallet of the market is. We continue to think that that growth is in the 2% to 3% level overall. 7%, obviously, puts us in a position where you know 7 being greater than 2 or 3, we think that market share is up. We don't have a full documentation of what the market did in the first quarter. You know that information comes at a lag. And I think what you would see so far as why we think we're up faster than the market without commenting on the competitive frame other than to say that it's fairly stagnant, that is the competitors who were there – Wells Fargo, ourselves, Citizens, Discover – are all, one, continuing to play their games the way they have; two, continuing to be effective. We don't really see any new entrants who are changing anything in regard to volume. But in answer to your question as to why we think we would be up faster than the market, at this particular point, for this part of our business, which is the core business that we have, we believe that improving consistently at the margin, consistent quality improvements, extension of lines, watching how people go through, where they follow-up, how we do sort of results process and business process mapping in order to make our applications more efficient has yielded some very good results for us. We're going to have fewer applications per loan. We have faster turnaround on it. We have more options for people as they go through the process. We've improved our website. And so, we think it's a game of incremental efficiency and mild extension of the options to the customer in a market where we already have 54%. And so, incremental improvement and consistent improvement is the name of the game there for us.

All right. Thank you. My follow-up question for Steve on CECL. You mentioned a three-year phase in. Does that change your capital management expectations then because you don't have to expend as much capital as you thought you might have under the previous scenario?

So, at this point in time, I think it's a little premature for us to change our capital management approach. Our capital levels have really just bottomed out now. And relative to our peer group and relative to our conversations with our regulators, we think they are about appropriate. They would grow a little bit in 2019 and then probably decline slightly in 2020 and significant capital generation will come after CECL's implementation. And, of course, we also have the diversification efforts that we are developing that will also consume some capital. So, I think it's a little early to change our no dividend, no shareholder buyback position at this point in time.

Two things on that I'd like to comment, Sanjay. One is, this three-year phase in essentially came in quickly over the transom, as Steve said about two weeks ago. And so, that's one. Directionally good. But, two, it reminds us how uncertain the regulatory framework is for the implementation of CECL. And so, I think it behooves us to be cautious in regard to that because we didn't really see the three-year phase-in coming. People had been adamant that it was instant implementation on January 1, 2020. And so, that had us very concerned. Now, all of a sudden, it looks like three years. We're not exactly sure where it's going to land. And so, we want to be cautious because if the capital goes out the door, it's very hard to get it back. And the second thing here is that we will always be looking for the combination of the capital that we're provided with by our shareholders and the appropriate return on that. And so, as we sit here, the 22.7% ROE gives us the confidence that we can make efficient use of the capital we have. So, in part, it's the regulatory frame, but it's also bounded by – we believe we owe our shareholders a decent return on any capital that we hold as an ongoing stance.

Okay, that's fair. Ray, another question is on this personal loan portfolio. As we think about testing and as you roll it out across your platform, who are you targeting to make these personal loans to?

It’s actually a wider range than we originally thought. And so, as we discussed many times, there is a consolidation set of activity for Americans in their 20s. And those are people who have gotten out of school, they have student debt with us, with the federal government. They are looking to get their life on track. They have to put the pre-existing debt into a box that allows them to think about other purchases, especially automobiles, I'm going to say, and maybe later on housing. And so, the early stage of Americans' lives as they graduate and form households is the key target. Having said that, we are, as I said, not trying to overplay our knowledge of the area. And as you can see with our purchases of others' personal loans, we're trying to accelerate our knowledge, but we believe that there is several pockets where people can use this product effectively, but all those are in early testing stages and we remain committed to following our customers as they go through their lives. But we will not leave untouched areas where we think we can profitably play for parts of that portfolio. So, roundabout answer. Early days. We are certainly casting a wide and we will report back both on the results of that as well as the implications for the target audiences going forward.

All right. Thank you.

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

Great, thanks. So, Ray, you talked about the competitive environment and your fundings, having done 40% of your target for the year. Are there – anything coming from any new products within the student to maybe talk about whether you're seeing anything that you might be preparing for in terms of expanding your product set based upon things that might come down from Washington?

Right. Good question, Moshe. And as you know, a year ago, we thought that Washington might actually – how should I frame it – make some progress in regard to this area. But we have been disappointed. And as you know, last year, we spent $7 million increasing our capability of processing. That was our Project Nike hitting its objective and it was successful in realizing it. It was to increase by 100% our ability to execute the basic product frame of student financing. That was implemented in regard to it. So, we're trying to be ready. A second step of being ready is from the way we understand things as they are developing in Washington. One is we continue to think that there is a mood to cut back on the federal dominance of the student lending market. So, we think that we're tilting the right way. Having said that, we think the focus of those people who are looking at higher education act as well as changing the current funding is on grad and parent plus. And so, grad, as opposed to undergraduate where if we were to take what we're currently being told, we might think the federal piece will increase the limits for undergraduate, but will curtail both the parent and grad plus. In particular, the grad piece. And as you know, 16% of the students of the United States are graduate students and comprise 40% of the borrower. So, the average ticket is larger. They're older. They less a little bit of – all Americans have a right to higher education regardless of the economics of their household. So, we believe that the best place for us to concentrate our efforts at the margin is to be ready for changes in the grad program. So, as a result of that, as you heard in prior quarters, we've introduced six new products targeted to the graduate students as we think appropriate because those segments are not homogenous and it's a long way from funding for doctorate, even to other health professionals, and a very long way from graduate arts and sciences, MBAs and legal. And so, we've tailored our product for each one of the major professions. We've had constant conversations with the school financial aid offices. Each one of the graduate centers is a smaller environment than the undergraduate in the typical university. We think that we have a competitive advantage in moving this forward because of our sales force, the largest in the industry. We believe that the introduction of this requires handholding explanation and average tickets, as I said, are much higher. But the financial aid offices in graduates – in the grad districts [ph] are much more involved with the individual tailoring of financing for each, let's say, doctor today. And so, in response to your question, one is, we see the current market as sort of relatively stable, especially around price competition which is gratifying. Two is that there are changes in Washington. We expect them to be favorable. Three, we'd expect that the major changes would be grad. And four is we are anticipating that by introducing our products. And by the way, the graduate schools are also concerned about this because they get most of their funding from the federal government. And to the extent that is even being debated, the schools find that to be quite threatening, and so they're more open to a conversation with us about possible alternatives.

That sounds good. Just wanted to follow up quickly on the personal loan. I mean, given that you're probably buying, as we stand here today, well over $700 million in that product for the loans that you purchased, it seems like the capital commitment was more or less there and it's not going to be a big capital drag in 2019 as you start to kind of ramp up the stuff you're doing organically. Is that a fair comment? And I also notice the big reserve build that you did this quarter. So, I guess, a lot of the capital and reserving is likely to be setting – you're setting the table here in 2018 for what would come in 2019.

Look, I think that's right, Moshe. But as we see the product rolling out over the next two years, 2020 is when it really starts to grow in terms of volume. A quick word on the personal loan P&L. We are building the provision in 2018 for that portfolio based on the way the income statement sets up. It'll be slightly positive in terms of earnings contribution in 2018, but should really start to contribute to earnings in 2019. But the way we see the timeline rolling out for the personal loan product, it really starts seeing some traction in 2020 in terms of the size of the loans on the balance sheet.

The organic piece.

The organic piece.

Thanks very much.

And your next question is from the line of Arren Cyganovich with Citi.

Thanks. Looking at the private education loan yield at – I think it increased about 23 basis points quarter to quarter. Can you talk about what – if that was mostly from benchmark rates or was the portfolio – how do we think about the private education loan yield going forward?

Yeah. So, look, Arren, the increase in student loan yield this quarter was pretty much based on changes in LIBOR. It's pegged to one month LIBOR and rounds up to the nearest eighth and it sets on the – we could probably give you more details than you really want here, but it resets on the 25th of every month. So, we think based on where LIBOR is today, it will step up another 10 or 11 basis points at the end of the month. But the increase in the cost of funds and the loan yield was almost directly correlated to the increase in LIBOR. I did mention that we have an increasing portfolio of fixed-rate loans which will temper that somewhat, but that's really a brand-new phenomenon. It hasn't really impacted the percentages of the portfolio just yet.

Okay, thanks. And then, on the consolidation loan side, you kind of have, I guess, in my view, a little bit of a conflicting comment about the higher rates driving a little less opportunity on that for competitors to take away your loans, but at the same time those customers not being that rate sensitive. But I just want to understand how those two work together.

Sure. And so, when we talk about the customer is not being rate sensitive, they're not, in our experience, overtly rate sensitive, right? But the implication of lower rate for the customer is, when they do a projection, a lower cash flow requirement in order to service that loan. And so, we don't find customers looking for a particular number insofar as the APR. But they are looking for how do I get the cash flow demands associated with servicing my debt to be lower. Now, that's on the customer side of things. So, they're focused on how much do I have to pay each month. On the other hand, on the provider side of things, the question is, given I've accomplished the fact of helping the customer have a lower cash flow, what is my spread? And so, the spread on the provider side of things is driven by the deltas we've been talking about, which is the pre-existing loan APRs versus their ability to fund at the margin, which, as you know, for the last two years has been extremely favorable, especially in spreads on credit quality. And so, I don't need to say that the APR is unimportant. It is just not the major decision factor. So, if the APR was low, but the customer wound up having to pay more in cash flow per month, the consolidation mark would be zero. And so, they're looking for cash flow, but the provider needs to have the delta between, obviously, what they bill the customer and their cost. And so, as Steve and I have both said over the last several quarters, that delta is decreasing as rates go up.

Got it. Okay, thank you.

[Operator Instructions]. Your next question is from Michael Kaye with Wells Fargo.

Hi, good morning. I know Washington is very challenging to predict, but I wanted to get your thoughts on the potential impact of the upcoming midterm elections, meaning how much of a setback would it be for a positive development on potential private student loan expansion if the Republicans lost control of Congress, but this basically just perpetuates the status quo or is there a risk of something negative developing?

From what we can see and, of course, it's widely heralded that the Republicans will lose seats in the 2018 election and maybe lose the House. It seems less likely they will lose the Senate. And so, either way, things will be fairly close. And if we have a House that is dominated by Democrats, they still have to deal with the other two arms of the government. And so, as I said, we felt there'd be much faster progress in DC over the last year-and-a-half. That has not occurred. To the extent that the power structure is further fragmented, we would expect that if we had slow progress in mud [ph] over the last 18 months, we would expect slower progress, more mud going forward. But that doesn't represent a threat from what we can see.

Okay. That's very fair. Just gain back to that new defensive consolidation product, how much do you think that could prevent from consolidation going away from your portfolio? Like, how much is that included in that $900 million estimate and how do you think about that product that's giving you optionality to go on the offensive, meaning starting to consolidate loans outside your portfolio?

Right. And so, first off, to answer Steve's question, in regard to the consolidation number that we have guided to, the $900 million, there is no factor in that estimate for our consolidation activity. So, zero. And I think that's appropriate given we're in test mode. In answer to your question of when you talk to customers, are they interested only in refinancing our loans or others, we clearly in the early days are finding that they, of course, think of all their debt together. And the more they can put into something that's an attractive bucket versus what the preexisting bucket was they're open to. And so, we are not really in a position at this particular moment given how early this is and their progress of that to be able to articulate, one, the opportunity of consolidating other loans on to our balance sheet that are away from us today or, second, what it would do to the $900 million estimate for the consolidations. So, I think we need another quarter on that and I don't want to overplay what we're doing. So, I think I'd just back off of responding to that anymore crisply. Sorry, Michael.

Okay, thank you.

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

Hey, guys. Thanks for taking my question this morning. When we go through the numbers, it really looks like the variance to us was on the NIM side. And if that persists over the next year, that's probably going to be the factor that really drives the stock. Could you go through the asset liability and hedge mix? Walk us through what the benchmark rates are for each and also with the periodicity of the reset balance?

Sure. So, we have a pretty straightforward portfolio. Today, it's about 75% variable rate directly tied to one-month LIBOR and 25% fixed rate. Our funding matches pretty closely to the mix of the assets. We have $3 billion of money market deposits. We have another – we have another $3 billion of ABS that is tied to one-month LIBOR. And the vast majority of our brokered CDs are swapped into LIBOR. So, the mix of fixed to variable is pretty well matched. We also have put on some pay fixed, received flow swaps to hedge our fixed rate portfolio. So, Rick, I think if you take a look at our interest rate sensitivity disclosures, it captures pretty well our sensitivity to interest rates, although I will say one thing. It's probably a little bit conservative on the beta. I think we have modeled in there a beta of 80 basis points for the money market deposits when it's running probably closer to 60 these days. Moving forward, on both – and actually this gives me an opportunity to put some information out that I neglected to in my prepared remarks, so our NIM is going to decline over the next two quarters and then stabilize. Our EPS will decline from the first quarter. In the second quarter, we are ramp up our direct-to-consumer marketing spend [indiscernible] decline in EPS into Q2 [indiscernible] and then a very strong finish to the year in Q4. So, there's seasonality in both our funding and our earnings per share metrics.

Hey, Steve. I think the lawyer started rattling the phone when you were providing that guidance. It was a little bit hard to hear. Could you repeat that again please?

That was actually the SG&A guidance and he has been reprimanded. So, the EPS will decline in the second quarter as we ramp up our direct-to-consumer marketing for peak season and it increases slightly in Q3. Q3 is hit not only by continued marketing costs, but the cost to process the large volume of loans that we originate in Q3. And then, we end strongly. It was a very strong Q4. And that has been a pretty persistent pattern, but analysts do miss it from time to time.

Got it. Okay, that's very helpful. Thank you.

You're welcome.

Your next question comes from the Henry Coffey with Wedbush.

Good morning, everyone. And thanks for taking my call. When we analyze your cohort data, we see the kind of stability in loan quality that you're talking about? And then, when I look at the year-over-year trend in net charge-offs, you are up above 12 basis point. Is that within the in-full payment? Is that a seasoning process where you've got more loans in full repayment that are into their sort of second and third year or how should we be thinking about charge offs for the rest of the year?

So, the stats that we filed in our SEC disclosures, both the charge-offs and the delinquency numbers are over total loans in repayment. So, it's not just loans and principal and interest repayment, it's also loans that are in school, but making an interest-only for what we call the fixed payment, which is a nominal $25 a month interest payment. The delinquencies and the charge-offs on loans in full P&I are certainly much more significant than that they are in school. And as that mix has changed, so the year-over-year increase in both delinquencies and charge-offs is strictly related to the fact that we have significantly more dollars in full principal and interest repayment, which is when they tend to go delinquent or charge-off. I also gave the stats for loans in full P&I. So, charge-offs measured for loans in full P&I were 1.93 in the first quarter, down from 2.06 in Q4. Granted, to your point, they were up from 1.73% in the year-ago quarter. There are probably $3 billion or $4 billon more loans in full P&I Q1 of 2018 than they were in Q1 2017. And our loss emergence period covers – really the bulk of the charge-off happen in the first three years after loans go into full P&I. So, that is why you see the year-over-year increases. For the rest of the year, there should not be a significant increase in either delinquency or default stats. The delinquencies by the end of the year could be hovering up closer to 6 to 7. We do expect to see an increase in defaults in Q2 as loans that are just recently entering full principal and interest repayment tend to roll through the buckets and charge-off and then they should be stable for the third and the fourth quarter.

Thank you. And then, on the origination front, obviously, you're hesitant to jump forward. But the 7% number, was there anything unique about that makes you think that you won't see the same thing in September?

Well, as we look at it, it was progress across many different pieces of things, right? As I said, the application pull through, our take rates remain high. We had good follow-on for serialization from prior year. And so, I would say that there wasn't anything we would say, gee, because of this particular new and different factor, we expected the numbers to be upgraded to market. I think I've said before that what we're seeing is we're becoming more efficient at dealing with customer interest in regard to us. And so, I think that we were faster in turn around, better experience for the customer. We take better advantage of the people who have applications with us. And so, I think what you're seeing is efficiency at the margin for a 54% market share player. As we introduce the grad products over the busy season, that will be a different story. And graduate loans are about 10% of our volume, and so that will be different as we have our second and third quarter investor calls, but not so much in evidence in the first quarter.

Great, thank you. And excellent quarter.

Thank you. Can I record that?

And your next question is from the line of John Hecht with Jefferies.

Thanks, guys, for taking my questions. Actually, most of them asked and answered. I guess one question I have is just with respect to ALL levels. Steve, you talked about the Qs [ph] trending a little better in the private student lending portfolio and then we're also layering in a personal loan portfolio that I assume will start seasoning this year. You're taking those two things together. How should we think about ALL levels as we step through this year?

We were actually joking about this last night as we were preparing for the call. I think I have suggested at least twice that our allowance for loan losses will trend toward 1.5% at the end of the year and that it hasn't gotten there yet on either statements. We do expect the allowance will trend towards 1.5% of the portfolio. But as you can see, it's hovering down around 1.34%. Now, clearly, personal loans as that portfolio grows will require a larger allowance for loan losses than the private student loan portfolio does. So, the trend should be higher.

So, is that 1.5% that you'd advocate reported still or reasonable target throughout the course of this year?

Yes. That's where we expect it to end the year.

Okay. Thank you, guys, very much.

And your next question is from Michael Tarkan with Compass Point.

Thanks for taking my questions. A lot of the focus on the consolidation activity has been with the refinance players, but I'm just wondering are you seeing any incidence of higher CPRs associated with employer-sponsored benefit programs for student loans? We've seen those pick up recently over the past couple of years.

No. Look, we haven't, Mike. And some of the widely advertised companies that have programs like that, we see very, very little consolidation to programs along those lines.

Does your data show you whether there are students that are making more principal payments than is required? Are you able to see that?

Yeah. Look, we see curtailments. We see full pay-downs. We see consolidations. We have all the details. We have not seen a significant rise in prepay speeds that we can identify as a result of those programs.

Okay, thanks. And then –

[indiscernible].

Yeah, got you. And then, just big picture with more students taking out fixed rate loans, does that impact sort of how you think about funding the business or maybe some of your assets sensitivity? Just how do we think about that. I remember back in the day where there was sort of 15% of your portfolio was taking out fixed and now it's creeping up. So, I'm just kind of wondering how you think about that.

Look, so it's absolutely changing the way we think about how we fund the portfolio, including fixed rate charges to ABS. We're in the brokered retail deposit market and we swap for less of our production. We're out there at any given time issuing 3, 5, 7-year brokered CDs. And we have also done derivatives where we paid a 6, received a flow to offset some of the LIBOR index and money market type deposits that we have on the book. So, it definitely is a little more complex funding fixed rate assets than it is a variable rate book. But we don't see any of the real volatility that you see on mortgage products or things of that nature. CPRs are pretty steady. Convexity isn't really an issue.

And we're still at 75% variable.

Yeah. There's still some 5% variable. And as our sensitivity disclosures show, we think that we're doing a very good job of funding the portfolio, given its current index.

Are you looking at securitizations a little bit more with that fixed rate component? We only saw a couple of deals last year.

So, we're coming out of more from. We think that spreads are probably bottoming. I mentioned in my prepared remarks that the cost of ABS funding has declined a full 50 basis points since we started out here at the bank. And by all indications, the volatility that's shown up in the stock markets as well as the high yield unsecured debt market seems like it's bleeding into the ABS markets while spreads are down here. We will probably end up issuing three deals this year as opposed to two. And we will include more fixed rate tranches in those transactions.

Thank you very much.

You're welcome.

And we have no further questions.

Okay. Well, thank you all for your participation. And as Steve and I have both recounted, we believe we had a terrific quarter. And as you look at the major variables associated with the business, volume and market share, yield and cost of funds, credit quality and performance, operating efficiency, the earnings up 29%, ROE at 22-plus level, the customers are increasingly satisfied, we're introducing new tools. As I said, chat is the latest. The employees are experiencing a low turnover, which we think is very helpful for the continued improvement of the company. And we are making significant strategic progress on new areas of activity. And I want to reemphasize on Agile and cloud migration. Of course, the personal loans, we talked about. The grad products, we have high hopes for the next six months. We'll see how that does. And as we also look at the consolidation product, we think we'll get more on the field in combating people who are nipping at the portfolio. And it is the case that across all the areas that we see, we think the performance of the franchise, very solid, very gratifying. And I have to say, just to reiterate it, we didn't expect the plus 7%. And so, that was not in our forecast and we are ahead of it. And that's especially gratifying because the market, as you all know, is, one, not growing spectacularly and, two, is filled with significant competitors. So, we think that in particular is a mark of all the changes and investments that we've done in quality of service, credit more finely tuned are paying off and paying off for our shareholders. So, thanks very much for your attention. If Steve and I could just take a copy of this portfolio that we have today and the performance that we had in the first quarter and replicate it into the future, we would be very happy people. So, thank you all for your attention.

Great. Thank you for your time and your questions today. A replay of this call and the presentation will be available on the Investors page at SallieMae.com. 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. You may now disconnect.