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SLM Corporation (NASDAQ:SLM)

Q4 2008 Earnings Call

January 22, 2009 8:00 am ET

Executives

Steve McGarry - SVP of Investor Relations

Al Lord - Chief Executive Officer

Jack Remondi - Chief Financial Officer

Analysts

Lee Cooperman - Omega Advisors

Matt Snowling - FBR Capital Markets

Michael Taiano - Sandler O'Neill

Moshe Orenbuch - Credit Suisse

Kevin Ing - Columbus Hill Capital

Jordan Hymowitz - Philadelphia Financial

Matt Burnell - Wachovia

Ryan O'Connell - Citigroup

Operator

Good morning. At this time I would like to welcome everyone to the SLM Corporation's fourth quarter 2008 Earnings Call.

(Operator Instructions).

I would like to turn the call over to Steve McGarry, Senior Vice President of Investor Relations. Thank you. Mr. McGarry, you may begin your conference.

Steve McGarry

Thank you, Katrina. Good morning, everybody. Welcome to Sallie Mae's 2008 fourth-quarter and full-year earnings conference call. With me today on the call are Al Lord, our CEO, and Jack Remondi, our Chief Financial Officer. After they finish their opening remarks, we will open up the call for questions.

But before we begin, let me remind you that we may discuss predictions and expectations and may make other forward-looking statements. Actual results in the future may differ from those discussed here, perhaps materially based on a variety of factors. Listeners should refer to the discussion of those factors on the company's Form 10-K and other filings with the SEC.

During the course of this conference call, we will refer to non-GAAP measures that we call our core earnings presentation. The description of core earnings, a full reconciliation of the core earnings presentation to GAAP measures, and the GAAP results can be found in the fourth-quarter 2008 supplemental earnings disclosure accompanying the earnings press release, which we posted on the Investor page at our website, salliemae.com.

Thank you. I will now turn the call over to Al.

Al Lord

Good morning, everyone. As Steve said, we're going to review our results for our fourth-quarter and our full-year results with you and later answer your questions. As you may well guess, Sallie Mae is not well pleased with the quarter's results or with the full year's bottom-line results.

The decline in those results, either against last year or against expectations, directly or indirectly relate to the economic downturn and the credit crunch. Maybe, I guess the credit crunch came first. We will discuss the quarter and its implications for '09.

As you are probably all well aware, the credit markets remain highly unsettled, and in some markets without government involvement, they are largely closed. We're heartened from time to time when we see a few narrow market openings, and we hope that those occur more frequently in '09, and we hope to take advantage of them.

Our reported results for the fourth quarter were $0.08 and for the full-year $0.89. As I said, they are not good numbers certainly by our standards, and I'm sure not by your own. Overall, 2008 results were adversely affected by higher interest costs, and mostly by higher interest costs, and higher bad debts. Our higher interest costs are principally related to the $28 billion asset-backed commercial paper facility that we have, which I guess began the year roughly at $34 billion.

For perspective on our interest cost, it is worth noting that the company grew its assets by $24 billion during the year 2008. The net interest that was generated by those assets, which would typically be in the $300 plus million range, was more than negated by our overall higher borrowing costs.

As I mentioned, bad debt costs were high, so the nontraditional loan costs, nontraditional borrower of loan costs as we have defined them, were generally expected. The economic environment obviously worsened during the course of the year and added costs as delinquencies grew, particularly late in '08.

I will make just a few comments about the fourth quarter, and I will move back to the credit cost or the bad debt cost. Our provision in the fourth quarter, as you have probably seen for private credit, is $348 million. The $348 million is roughly double the average of the first three quarters of 2008 and had the effect of reducing our earnings versus the third quarter by $0.20.

You know, or you will recall, that we began building the reserve at year-end 2007 and through the year 2008 largely for nontraditional loans, which are now moving rapidly into repayment status. We see an acceleration of nontraditional losses in 2009 even somewhat beyond what we were expecting. We also believe the year 2009 will be the peak of such losses, and the acceleration of those losses may well be precipitated by the company as it further refines its forbearance requirements.

We expect the 2009 provision to be in the realm of $1 billion. I would suggest that you not annualize the fourth quarter's provision.

Obviously, as I mentioned, delinquencies increased during the year and reached 4% in December. I would ask you to note, because it is very important, that though delinquencies in total reached 4%, our nontraditional loans have a delinquency rate in roughly the 12% range, and our traditional loans, even though they are higher, are in the 2.6%, which is up but hanging in pretty impressively.

The quarter was also affected by higher than average index basis exposure. I'm referring specifically to what we refer to as the CP LIBOR spread. It is typically 8 basis points, and we have had it for over 10 years or roughly 10 years. It has been so reliable over that time period that we have not really even tried to hedge that risk. The fact is, we borrow based on LIBOR, we earned based on commercial paper. Only government intervention in those marketplace and other market dislocations have changed the stark relationship between these indices and other indices as a matter of fact.

Anyway that wider spread, even though there was a major fix in the commercial paper index during the quarter, was still much wider than the historic average and cost the company at least versus historic standards $0.06. Our industry is seeking legislation to try to remove this basis risk and put the student loan return on a more reliable basis.

One other factor during the quarter was the further write-down of our GRP purchase distress mortgage assets. We did not quite finish the job in the third quarter as a consequence of a variety of reasons, some technical, some otherwise that Jack Remondi will cover with you later. But that write-down cost us roughly $0.05. That was a pretty quick and dirty version of our fourth quarter.

Let me give you a few words about '09. We entered '09, 22 days ago, with financing lined up for our asset growth during the year, a very different picture than where we sat last year at this time. We will largely use the Department of Education and Treasury's participation and put agreement to finance our new FFELP loans. We again want to say thanks to the legislation that was passed by Congress in the spring. You've heard of just in time inventory. There was just in time legislation and a very timely legislation, and its effects were recently extended through the year 2010. This allows us to meet our promise that we will finance every eligible student with a FFELP loan. That promise remains operative, and we hope it remains operative for a very long time.

Every dollar of this participation financing program finances an education and it does so instantly. Also our calculations show that the participation agreement actually saves the tax payer money as compared to the programs that existed before the participation agreement was created and while the returns are not as wide as previous returns for this company, Sallie Mae believes they are fair.

The private loan side of our financing is now done with deposits that are drawn at our Utah Industrial Bank. The company's goal is to acquire deposits with maturities at three years plus and try to keep the cost of those in the LIBOR plus 200 basis points range. Those deposits allow us to achieve the desired loan volume and meet our return goals.

As you may know, we are restructuring our private credit product to make it more financeable and to strengthen the credit worthiness of the asset. We will strengthen the credit with greater cosigner participation. We're going to shorten the term of the asset and while students in school are going to require interest only payments so that loan balances do not grow as a consequence of negative amortization.

Our major objectives for the year 2009, certainly my first objective and I think everyone else's is to reduce our borrowing costs. We need to reduce the amount of our ABCP banking facility. It is too expensive to finance FFELP, which is a very narrow margin product as you are well aware. It also requires collateral levels that are too high for us. Another objective, obviously, is to grow assets at a higher pace than we did in '08, and we are quite pleased with '08's asset growth, by the way.

Of course, we want to exit the year 2009 with a lower charge-off outlook than today's. As I mentioned before, we expect that 2009 will be the peak charge-off period. There are several government financing vehicles in which we intend to participate. Each will be cheaper than the bank ABCP facility. We also expect that that facility will be rescheduled for refinancing or renegotiation from February to April. In the meantime we will be participating in these new government financing vehicles.

We will continue to participate in the participation and put agreements with the department, and will look to utilize two other government-sponsored financing programs. One is a DE conduit facility that is backed by the federal financing bank. Another is TALF, which obviously is in creation at the moment to help to liquefy the asset-backed market.

We see our 2009 earnings in a range between $1.45 and $1.65. I know that is lower than some estimates we have seen; it is higher than others; and in conversations with investors, I know each of you have your own expectations. Those numbers will depend very significantly on our success at getting our borrowing costs down. Obviously, in the direction of the economy and what effect it may have on bad debts. Although, we believe we have been very conservative in our provisions and in our reserves, we are not seers here and don't know precisely what the economy is going to do. Although, we expect that throughout 2009 it will continue to deteriorate.

I think other variables Jack Remondi will cover in more detail. Before I finish on a slightly different note, I think we don't feel like we have to reach too far for better news. The company expects good 2009 earnings growth. We are lending. In '09 and '08, we lend almost $24 billion. If we were having this conversation a year ago, I nor my colleagues I think could even had predicted a $10 billion year in '08. We expect that $24 billion number to grow nicely in 2009.

Again, as I mentioned before, we see financing sources available for us to lend in 2009. In '08 we hit our expense targets that we promised to you in January of '08. All the while that we paring cost, we're still investing for measured growth, and we're investing nicely for measured growth, particularly in the private credit and particularly in the asset quality area.

At this point I'm going to turn it over to Jack Remondi, and then when he finishes, we will take your questions. Thank you very much.

Jack Remondi

Thanks, Al. Good morning, everyone. I'm going to take the next few moments to review our operating results for the quarter and the year on both the GAAP and core earnings basis in a little bit more detail. In addition, we will talk about our funding activity and liquidity, provide an update on our lending businesses and review the performance of our private credit portfolio. I will end with a little bit more detail on our outlook for 2009.

2008 brought significant challenges, challenges that few of us could have really foreseen. Yet despite the most difficult financing and credit environment, thanks to Congress, the Departments of Education and Treasury, we were not only able to lend, as Al said, but we, more importantly, delivered on our commitment that any student who requested a federal student loan received one.

I think the most important piece here is, bottom-line, these programs work. They worked as Congress expected them to work, and they worked as we expected them to work. As a result, education lending in this country actually increased in 2008 versus 2007.

As Al said, we're not happy with the results that we produced in either the fourth quarter of 2008, but we did remain profitable during this timeframe. For the quarter core earnings, including nonrecurring items, were $65 million or $0.08 per share, compared to $117 million or $0.19 a share in the prior quarter. We had a loss in the year ago quarter of $139 million or $0.36 per share.

This quarter's results were particularly impacted by the $146 million increase in our private loan provision and by a wider than usual commercial paper LIBOR spread, which reduced our net interest income by approximately $41 million. For the year, our core earnings, including nonrecurring items, were $526 million or $0.89 a share compared to $560 million or $1.23 a year ago.

The nonrecurring items in the quarter include a charge of $4 million or $0.01 per share for restructuring expense and a net loss of $22 million from impairments in our purchase paper business of $0.05 a share. Excluding these items, earnings for the quarter were $0.14. The nonrecurring items for the year include a charge of $57 million or $0.12 a share for restructuring expense and a net loss of $199 million or $0.43 per share, primarily from impairments in our purchase paper businesses.

These items were partially offset by some accounting adjustments due to the lengthening of our student loan portfolio of $22 million or $0.05 a share. In addition, our 2008 results were lower due to higher funding costs, including our asset-backed CP program where the tax-effected fees alone totaled $225 million or $0.48 a share.

Net interest income was $553 million in the quarter versus $612 million in the prior year. The net interest margin decreased to 1.15% from 1.32% in the year ago quarter. Our net interest income and margin for the full year were $2.4 billion and 1.3% respectively. During the quarter the spread between commercial paper and LIBOR was unusually wide.

The disruption in the funding markets caused the historically stable spread between CP and LIBOR to break, and this break in relationship was made worse by the lack of issuance of CP on many days in the quarter. To address the lack of issuance, the department used the financial commercial paper rate on days when the rates were posted and an alternative rate, the commercial paper funding facility rate with the 2% surcharge, when they were not. This approach produced a CP LIBOR spread of minus 21 basis points compared to the historical average of 8 basis points, which was also the spread in the third quarter. This reduced the margin we earned on federal loans funded with LIBOR index funds by 13 basis points over Q3.

Our loan loss provision in the quarter was $392 million versus $750 million in the year ago quarter and $1 billion for the full year. $33 million of the provision in the quarter and $127 million of the provision in the year were for federal loans. At December 31, our allowance for federal and private credit loan losses covered approximately two years of expected losses.

We increased our private loan provision by $146 million to $348 million as a result of the continued weakening of the US economy. In addition, we increased the provision to reflect our changing forbearance policies. We believe that forbearance is useful and an effective tool in helping borrowers gain the ability to service their student loan data, and our actual performance reflects that.

Based on increasing data, however, we changed some of our forbearance policies to reflect our actual experience. As a result, we have reduced the availability of forbearance in certain cases, and we expect these borrowers will charge-off earlier as a result of that, and we have reflected this in our current provision. To be clear, we view this change as an acceleration of future charge-offs versus an overall increase in the expected cumulative default rate of the portfolio.

Our fee income in the quarter totaled $200 million compared to $64 million in the third quarter. Fee income for the full year decreased $395 million to $778 million. Impairments, primarily in the purchase paper business, included in fee income, were $45 million, $242 million, and $368 million in the fourth quarter, the third quarter and 2008 respectively.

Our operating expenses, excluding restructuring charges, were $270 million in the quarter, a 26% decrease from the fourth quarter of 2007, well in excess of our 20% cost reduction target. Operating expenses for the year decreased 11% to $1.3 billion compared to $1.4 billion for 2007, and during 2008 we incurred cumulative restructuring expenses of $84 million, the majority of which were severance related.

Total equity at December 31, was $5 billion, resulting in a tangible capital ratio of 1.8% of managed assets, compared to 2% a year ago. With 81% of our managed loans carrying an explicit government guarantee and with 70% of our managed loans funded for the life of the loan, we believe our capital levels are appropriate given our asset and funding mix.

The credit markets continue to present unprecedented challenges, yet despite these challenges, we're addressing our liquidity needs. First and most importantly, we have secured access to stable and profitable funding sources for our new private credit and federal lending activities. The Kennedy, Miller bill has provided federal student loan lenders with access to unlimited funding to ensure that every student who needs the federal loans gets one. We're using the source exclusively to fund new federal loans, and the terms of this program were recently extended to the 2009 and 2010 academic year.

For private credit loans, we're using deposit growth from our bank, Sallie Mae Bank. We have successfully implemented this approach in the fourth quarter, and we're targeting longer-term certificates of deposit with an average life north of three years to finance this new lending.

Our primary remaining funding challenge is replacing our short-term funding sources, principally our $28 billion asset-backed CP facility, with longer-term, lower-cost funding. Two federally sponsored programs, the Department of Education Conduit Facility and the Federal Reserve's Term Asset-backed Liquidity Facility, or TALF, are under development and offer significant potential.

At December 31, we had available almost $30 billion in student loans that are eligible for either the Conduit, TALF or both, and we expect both of these facilities to be operational in February. As a result, we have been working with the bank group and our asset-backed CP facility to secure a 60-day extension to allow the Conduit and TALF to get up and running. Once operational, we plan to materially reduce the size of the asset-backed CP facility and seek a longer-term extension on the remaining balance if any.

We continue to work closely with Congress, the Department of Education, the Federal Reserve and Treasury to implement these programs, and I would like to thank them for their hard work and positive results that they have produced in moving these programs forward.

In 2008 we issued almost $26 billion in term funding, including $18.5 billion in Term FFELP ABS, which carried an average spread of 125 basis points over LIBOR. In years earlier those decimal points would have been moved far to the left.

In early January we announced the closing of a $1.5 billion 12.5 year asset-backed securities facilities with Goldman Sachs. The cost of this facility is expected to average LIBOR plus 5.75% and will fund our private credit loans. Though significantly more expensive than historical transactions, this facility demonstrates the term funding capability and availability for our private credit portfolio. We continue to work to develop other term sources for funding this asset class.

Finally, in the fourth quarter, we sold or agreed to sell approximately $1 billion in federal loans to the Department of Education. The proceeds of these sales will be used to make additional, more profitable loans, generate additional liquidity and to repurchase our debt securities.

Our conservative approach to funding has served us well in this environment. At the end of the quarter, 70% of our managed student loans were funded for the life of the loans, and another 12% are funded with fixed spread liabilities with an average life of 4.3 years.

At quarter end we had just over $11 billion in primary liquidity, consisting of cash and short-term investments and committed lines. In addition, we have $5.2 billion in standby liquidity in the form of unencumbered FFELP loans.

In 2008 we refocused our FFELP originations on our internal lending brands. Our loan volume from our internal brands academic year-to-date was up 57%. In addition, we originated federal loans for our servicing clients of just under $0.5 billion in the fourth quarter, up 14%. We expect federal loan application volume to exceed $20 billion in the '08/'09 academic year, and our service volume to exceed $4 billion.

Our private education originations declined 46% to $851 million in the quarter and declined 20% to $6.3 billion for the year. In 2008, we significantly increased the quality of the loans we are underwriting. In the most recent quarter, for example, the average FICO score was up 26 points to 738, and over 74% of the loans we made had a co-borrower.

For the quarter our core student loan spread was 149 basis points, a decrease of 7 basis points from a year ago, and for the full year, the spread was 163 basis points, a decrease of 4 basis points from '07. The decline here is due to the higher cost of funds and an increase in lower yielding FFELP loans originated after October 2007, in our overall portfolio.

During the quarter we earned $44 million in floor income versus $50 million in the year ago period, and for the full year, we earned $171 million in floor income.

In our traditional portfolio, our 90-day plus delinquencies increased 2.6% from 2.3%, while total forbearances at quarter end declined to 6.7% from 11%. Our new forbearance policies are reducing both the term of the forbearance granted and the usage. The net charge-offs increased to 2.5% from 2% in the prior quarter. Our reserves at December 31, for our traditional portfolio equaled 4% of loans and repayment, up from 3.5% a year ago.

In our nontraditional portfolio, 90-day plus delinquencies during the quarter increased to 12.7% from 11.9%, while total forbearances declined to 9% from 14.4%. This portfolio continues to present challenges for us, and we saw net charge-offs increase to 16.1% from 12.9%. Reserves at December 31, for the nontraditional portfolio equaled 26% of loans and repayment.

For our entire private credit portfolio, our gross reserves at year-end are expected to cover projected charge-offs over the next two years. At quarter-end we had $3 billion of nontraditional loans in repayment. 2008 was the peak year for nontraditional loans to enter repayment, and we see a significant decline over the next level years. This portfolio accounted for more than half of our total charge-offs in 2008, despite being only 14% of our total portfolio.

Loans in forbearance as a percentage of loans and repayment declined sequentially this quarter, as we recently implemented a risk-based eligibility model to assess the potential effectiveness and benefit of forbearance for individual borrowers. This change will result in incrementally higher charge-offs in 2009 as previously discussed. Specifically, we expect this change to accelerate approximately $225 million of charge-offs into 2009.

Operating expenses in our lending segment declined significantly to $129 million in the quarter and $589 million in 2008 or 28 and 34 basis points as a percentage of our average managed student loan portfolio. This compares to 42 and 45 basis points in the year ago quarter and prior year. The decrease is the result of our efforts to improve our industry-leading efficiency. Our scale and efficiency are a significant competitive advantage, helping us to secure profitable market share, and we will continue to improve in this advantage in 2009.

Last week the Department of Education issued an RFP for servicing FFELP loans. We expect the Department to invite a limited number of qualified companies to submit final bids, and they expect the final selection will be made no later than April. We believe we are well positioned to participate in this contract.

In our asset performance group segment, we had net income of $10 million versus net income of $33 million in the year ago quarter. And for the full year, the group had a loss of $106 million. Within this segment our core student loan contingent collection business generated net income of $33 million in the quarter, while our purchase paper business generated a $23 million loss, primarily due to a $50 million impairment charge in our purchase mortgage portfolio.

Revenues in our guarantor service business totaled $26 million in the fourth quarter and $121 million for the year, compared to $41 million in the fourth quarter of '07 and $156 million in the prior year. The decrease is due to the legislative changes that reduce the account maintenance feet paid to guarantee agencies by 40%. Total other fee income decreased $3 million in the quarter to $52 million and decreased $19 million to $199 million year-over-year.

For GAAP, we recorded a fourth-quarter net loss of $216 million or $0.52 per diluted share. For the full-year 2008, we recorded a GAAP net loss of $213 million or $0.16 of diluted share. Our GAAP results include the net impact of derivative accounting that reduced net income by $442 million in the fourth quarter and $560 million for the year 2008. The net impact of derivative accounting is recognized in GAAP, but not in our core earnings results.

The GAAP provision for loan losses was $252 million for the quarter and $720 million for the year. The GAAP net interest income was $211 million for 2008 fourth quarter and $1.4 billion for the year. Under GAAP accounting, the provision for loan losses and net interest income are based only on on-balance sheet loans, whereas the core earnings figures are based on total managed loans.

For 2009 there remain many variables that could have a material impact on our results. These include the CP LIBOR spread, funding availability and costs, credit costs, and whether or not we put the 2008/2009 federal loans to the Department of Education. Our assumptions for these variables are as follows.

We expect the CP LIBOR spread to average 10 basis points. Charge-offs are expected to peak in 2009, including charge-offs for our nontraditional loans, though we still expect that they will account for more than half of our expected charge-offs in the year. Our provision will approximate our actual run-rate for charge-offs until we see a clear turn in performance.

We expect this will produce a private provision in 2009 of just north of $1 billion. Funding spreads will remain elevated in our assumptions, though we expect significant relief in liquidity from the federal programs I described earlier.

Finally, given the current environment, we do expect to put all eligible loans to the Department before September 30, 2009, and we expect this will generate approximately $250 million in revenue. Combined, these assumptions will produce core earnings between $1.45 and $1.65 per share.

At this point we now take the opportunity to open up the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Lee Cooperman with Omega Advisors.

Al Lord

Good morning, Lee.

Operator

Go ahead with your question

Operator

The next question comes from Matt Snowling with FBR Capital Markets.

Al Lord

Good morning, Matt. Now we know we have a problem here.

Steve McGarry

We are not getting the questions.

Operator

Okay. We will go back and revisit the question from Lee Cooperman with Omega Advisors.

Lee Cooperman - Omega Advisors

I was curious if you fellows have a view of normalized earnings and how you view the range of $1.45 to $1.65 that you put out for 2009 relative to your normalized earnings? Secondly, I realize this is not on your agenda, but kind of talk about runoff value, because ultimately, if the government doesn't provide an environment that the shareholders could prosper and get a reasonable return on their investment, we have this view that the assets are worth substantially more than they are selling for in the market. If we were to take the approach of saying, look, if we're not appreciated, we would return the money to shareholders and let somebody else do our job? Two different questions.

Al Lord

I think in terms of run-rate earnings, Lee, when we look at the $1.45 to $1.65 numbers, those numbers clearly include elevated losses given the current economic environment and the runoff of the nontraditional portfolio. As I pointed out, the nontraditional portfolio is roughly 14% of our total book in the private credit space, yet accounted for 54% of charge-offs in 2008, and we expect it to be north of 50% in 2009.

This portfolio, however, is in a runoff mode, and as that portfolio declines and loans entering repayment in 2009, by example, are expected to decline by about 30% over what went into repayment in 2008, we would expect provision loss rates and, therefore our earnings to improve.

In terms of the runoff environment, clearly we are not in a business to lose money for our shareholders. If the business model no longer works, that is certainly a direction that would need to be considered. I think you are correct in pointing out that the earnings profile of this company in a runoff mode creates a net present value in excess of the share price, though.

Lee Cooperman - Omega Advisors

Thank you. Good luck. Appreciate your efforts.

Jack Remondi

Thanks Lee.

Operator

Your next question comes from Matt Snowling with FBR Capital Markets.

Matt Snowling - FBR Capital Markets

I will try this again. Can you hear me? It looks like Fitch came out this morning and assigned an F1+ plus rating to the government loan conduit. Can you just help us think about where you are, what more do you need before you can actually start going live with the conduit, and give us a gauge in terms of investor demand and pricing on the assets and the securities?

Jack Remondi

Sure. The conduit, the development of the conduit moved rapidly over the last couple of weeks, and the Department of Ed published the final terms and conditions of that program in the Federal Register last week. Some press releases came out earlier this week. At this stage in the game, the work that remains is operational. We are continuing to work with the rating agencies to get the actual securities that will be issued rated. We have to develop the marketing materials and prospectus offering documents for our investors and begin to educate them on that process.

One of the reasons why some of this has been delayed is there was a significant development in the last couple of weeks of who provided the ultimate liquidity for securities issued under this program. Previously, it was expected that we would get that liquidity from commercial banks, and instead we have substituted the federal financing bank for that process. That is, in our view, a material improvement in the facility process and should help make the paper much more attractive to investors, particularly investors who would otherwise buy government-related securities.

So we still have a little bit of operational issues to work out on some things, but we expect this program to begin funding over the next, say, three to four weeks.

Matt Snowling - FBR Capital Markets

Do you have a sense at what level the securities will be priced at?

Jack Remondi

Well, in normal times you would expect a security issued with a federal financing bank, which is a direct obligation of US government, to trade well below LIBOR. The problem is LIBOR is not very big these days. So we are looking in to see what that would trade at. In other normal times as well, you would be able to pretty clearly predict what those spreads will be, but until investors actually buy the product in this marketplace, it is more speculation then anything else.

As Al indicated though, we expect the all-in funding cost of this facility to be substantially below our asset-backed CP facility.

Matt Snowling - FBR Capital Markets

Got it. Understood.

Jack Remondi

Just to point one last thing out, the target is that the Fed, the Treasury and the Department of Ed had here was to create a funding vehicle with a cost approximately equal to what we would have funded at historically. So you're looking at something like a LIBOR plus 10 target number.

Matt Snowling - FBR Capital Markets

Right. My understanding is that anything below LIBOR you have to rebate 80% back to the government?

Jack Remondi

There is a veritable fee in that process for that fee. That is correct. When I say LIBOR plus 10, too, remember in an environment where one month LIBOR is in the 30 basis point range, it is tough to get substantially below LIBOR.

Operator

Your next question comes from Michael Taiano with Sandler O'Neill.

Michael Taiano - Sandler O'Neill

Thanks. Couple of questions. Just to clarify on the pending $26 billion conduit coming due at the end of February, you're seeking a 60-day extension on that so that you will have time to put the loans that will go into this government backed to that conduit facility, is that how it works, and then you will look to extend whatever is remaining?

Jack Remondi

That is correct. It is not a put. You are funding them through the conduit, though. We still will retain all the economic benefit of the loans and the margin associated with them.

Michael Taiano - Sandler O'Neill

Right. Okay. Given that the establishment of this government back stop facility and I guess you claimed that the guidance that you gave, that the intent was to at least for now put all the loans that were originated this year to the government before September 30. I mean would most of those loans also be eligible for this conduit facility or am I mistaken on that?

Jack Remondi

No, that is correct, and the question that the ultimate decision will be based on whether or not funding for these assets is available at an attractive enough rate? Our concerns at this point in time or our focus is an assumption that the conduit doesn't have the ability to be unlimited in size. If there is limited capacity there or until the concept is proven with the exact funding cost known, we have to assume we're going to put those loans.

Michael Taiano - Sandler O'Neill

I see. Okay. But if in the event there was the capacity to do it, you would look at what is the best in terms of NPV for those loans in terms of value creation?

Jack Remondi

Absolutely. It becomes a pure NPV analysis at that point, absolutely.

Michael Taiano - Sandler O'Neill

Okay. The second question I had with respect to the roughly $1 billion that you sold to the Department of Ed in December and January, you mentioned potentially using that to repurchase debt. So, first of all, to what extent do you think you would be able to do that? And how do you go through that process? Do you look at like what is the cheapest debt that is trading out there? Do you go by duration, like how do you make that analysis? More broadly speaking, will you be more aggressive in buying back debt this year given liquidity seems to be improving?

Jack Remondi

We would certainly love to be repurchasing debt at the levels that it is trading at, particularly in the longer maturities. Little is available, little trades I should say in the '09 maturities, and so it is tough to get hold of any additional volume there. In the calendar year, we did buyback about $1.9 billion face of our debt, including for total gains in our core [accounts] of just under $69 million. In the fourth quarter, that number was $127 million at a gain of $27 million. We look at opportunities therein to the extent that we can execute on something that makes sense while still maintaining fortress-like liquidity, we would do so.

Michael Taiano - Sandler O'Neill

Okay. And then just final question, the RFP you mentioned from the Department of Ed on to service FFELP loans, is that for loans that are being put under the conduit program, or would that also include loans that are currently I guess being serviced by ACS for the direct loan program as well?

Jack Remondi

It is not particularly clear at this point in time, but we expect it to be the former. The FFELP loans that are put to the department under the Kennedy, Miller bill.

Michael Taiano - Sandler O'Neill

Okay. Thanks a lot.

Operator

Your next question comes from Moshe Orenbuch with Credit Suisse.

Moshe Orenbuch - Credit Suisse

Great. Two separate questions, one on the outlook for private credit losses in '09. I guess you ended last year with delinquencies on the traditional book I think of about $660 million. You got probably a little less than double that at the end of this year, and they were up probably $300 million in the quarter. Can you relate given the changes in the forbearance policy, how your expectations for charge-offs in '09 relate to that?

Jack Remondi

What happened in the fourth quarter of 2007 is, for the nontraditional portfolio, we looked further into the in-school portfolio for expected losses than we typically do. Normally, under GAAP accounting, you kind of have to wait until the student shows some related issues before you start booking reserves, but given the significant issues we were facing there, we got to take a look at almost like a four-year expected loss cycle for that portfolio.

I will say in 2008, we had an estimate for what our charge-offs would be in our portfolio, and we did do better than expected there, despite a significant worsening economy, and one that we clearly did not forecast, particularly the fourth quarter's levels.

On the nontraditional side of the equation, and particularly on the forbearance changes, what we are looking at here is there are segments of the population who don't benefit from a forbearance. They are relatively small. They comprise about 17% of the total forbearances that we grant, don't benefit to the same degree as the other side of the equation. When we looked through the data and at the actual experience, and remember you need time to be able to evaluate this and see the trends and develop models to approach this, we see that that 17%, looking back over the last couple of years, accounted for roughly 97% of the charge-offs that we incurred for loans who received the forbearance.

So by ending that practice and pushing those borrowers into repayment sooner, what you're doing is accelerating charge-offs that would have occurred in future years, in a part of our default calculations, in part of our reserve calculation, but they will result in higher charge-offs in 2009 as a result.

I'm going to say it again, it is not a forecast that our cumulative default rates are going higher; it is just the shifting of the time of when they are recognized.

Moshe Orenbuch

Just to follow up on that Jack. I guess what I was saying is, if you are saying $1 billion in charge-offs and less than half of that coming from the traditional book, you've got $1.260 billion of delinquencies on that traditional book at the end of this year. With less use of forbearance, it seems like the loss rate on that should be higher than in prior years, not lower. I guess how do you get that less than $500 million losses from that? That is the disconnect.

Jack Remondi

If you look at the history of the portfolio, we look at the roll rates from delinquency class from one bucket to the next and we expect through a combination of things. One, we are expecting higher charge-offs in the nontraditional portfolio in 2009, but we do expect our collection activities to continue to be successful as well in this area.

Operator

Your next question comes from Jay Sheth with Columbus Hill Capital.

Kevin Ing - Columbus Hill Capital

Hi. It is Kevin Ing. Just a couple of questions for you. When you referred to LIBOR on the conduit program, in that LIBOR plus 10 target, is that monthly LIBOR or three-month LIBOR?

Jack Remondi

Three-month LIBOR.

Kevin Ing - Columbus Hill Capital

Three-month LIBOR. Can you confirm I was not sure if we heard it, did you buy any bonds back in the fourth quarter?

Jack Remondi

Yes, we bought back just under $127 million worth of bonds at a gain of just over $27 million.

Kevin Ing - Columbus Hill Capital

When do you expect details of the TALF to be released, and do you expect that you would potentially be able to borrow directly on the TALF as opposed to the investors borrowing directly from the TALF?

Jack Remondi

The Treasury and the Fed has said that the TALF program is expected to be operational in mid-February, and that is probably the best insight that we have at this stage in the game. We have certainly requested the ability to borrow directly from the TALF, recognizing that student loan assets have a duration that is longer than the three-year timeframe of the facility. We had extensive conversations with the Federal Reserve on this topic, and we think we have made an effective case here, but we do not have any decisions at this stage in the game.

Kevin Ing - Columbus Hill Capital

Have they given you a sense of what the haircuts would be for the private loans?

Jack Remondi

No, they have not released any indications on haircuts or rates at this stage in the game.

Kevin Ing - Columbus Hill Capital

Another question on deposit growth, can you talk a little bit about the trajectory of deposit growth and what you estimate that trajectory to be?

Jack Remondi

First of all, it is not cost-effective to raise a huge amount of deposits well in advance of what the needs are. So our deposit issuance is really tracking our new private credit originations and funding needs there with some advance notice. As I said, our goal here is to raise longer term deposits. We're targeting north of three years. In the last couple of months of the quarter, we were almost at 40 months in terms of average life. We have not experienced in any period a challenge in terms of raising the amount of deposits that we are looking for with those maturities.

When we look at the overall size of the broker deposit marketplace, we feel very comfortable that we could easily fund the next three years worth of private credit originations entirely in that marketplace without difficulty and could probably go beyond that, but that is kind of the outlook.

Clearly, we want to be able to finance these assets in the term ABS market. I think the Goldman Sachs transaction that we announced is an indication that there will be availability for this asset class in the ABS market. Our securities that we have issued in the past continue to perform extremely well. We have had no downgrades, no expected issues in those securities that investors should be concerned with.

So, overall, I think the issues are very positive here, and we see deposits as not only a stable funding source for the future growth but a relatively cost-effective funding source as well. The cost of deposit in that maturity range, range from 150 over LIBOR to about 200 over LIBOR.

Kevin Ing - Columbus Hill Capital

Do you have a target for deposit balances at the end of 2009? Is the strategy on the private loan side to originate out of the bank and then sell whatever demand is into the TALF financing market?

Jack Remondi

We have over the last several years that we have had our Sallie Mae Bank originated all of our private credit loans through the Bank. Those loans were then sold to Sallie Mae parent and then financed in the ABS market. Today, we're retaining those loans in the Bank for funding and will do so until we can permanently fund them in the Capital Markets. I'm not sure that TALF would be a great place for us to go with these assets at this stage in the game, but we will certainly look at that.

Kevin Ing - Columbus Hill Capital

Okay. My last question is regarding the bank and the temporary loan guarantee program, which is a program the FDIC has initiated. Certainly, you guys are not a bank holding company, but as some of the other brokers and the research have pointed out, there are non-bank holding companies that have issued successfully under the loan guarantee program. Any sense of whether or not that's a program that you guys are considering issuing paper under?

Jack Remondi

We would certainly love to have the ability to access that program and they've been pursuing that. However, there have been two entities that have issued under that program that were not bank holding companies. One was a technical waiver issue and the other was GE who got their own special exemption there.

We'd certainly love the opportunity and are pursuing it. But at this point, we don't have any clear guidance that that will be available.

Kevin Ing - Columbus Hill Capital

Thank you.

Operator

(Operator Instructions). Your next question comes from Jordan Hymowitz with Philadelphia Financial.

Jordan Hymowitz - Philadelphia Financial

Hi, guys. Can you just discuss your current capital allocation between FFELP, private and the debt collection, which I know has kind of been run-off?

Jack Remondi

Sure. In the FFELP business, we have historically allocated 50 basis points of capital to those assets. As we're looking into the future here, we think that there's going to need to be some refinement in that model. Clearly, FFELP loans that are funded to term are funded in the DOE facility where we have no liquidity issues and can put loans at any time at a profit, have a different capital requirement than loans that might be financed in something like an asset-backed CP facility.

On private credit, we have historically allocated 8% capital to that portfolio. Again, here, I think those numbers go north, but we're continuing to evaluate that based on the current climate. In the purchased paper business, we have typically looked at a 50% kind of capital requirement in that space. Both of those, however, are in significant runoff at this stage in the game.

Jordan Hymowitz - Philadelphia Financial

I guess my question is, because of the "freed up" capital from your debt collection and that's going to be allocated more towards the private side, I would imagine because of the dollar numbers. I guess, it all depends on how high you have to raise the capital on the private to see what type of cushion you then have, you see what I'm getting at?

Jack Remondi

When you look at our earnings forecast in our plan, the capital generation is sufficient to meet the capital requirements for further growth. I think at this stage in the game as we look at what is going on in the capital markets; it's clearly not normal times. What we need to evaluate is what capital levels would look like in this environment versus what they might look at and be adjusted to in a more normal environment.

Jordan Hymowitz - Philadelphia Financial

Got it. Do you have any sense when there would be some sort of thoughts as to what capital you're going to allocate for specifically the private side?

Al Lord

We've been allocating 8%.

Jordan Hymowitz - Philadelphia Financial

Right. But you said it was probably going to go north. Is that something that will be done by the --

Al Lord

I think in the future we're probably looking at 10% to 12%.

Jordan Hymowitz - Philadelphia Financial

Okay. Thank you very much.

Al Lord

You're quite welcome.

Operator

Your next question comes from [Peter Manico with Raptor Group].

Unidentified Analyst

Good morning. Thanks for your time. A couple of quickies. In terms of normalized operating expense go-forward, Jack, should we think in terms of annualizing the fourth quarter? Can we take it a little bit lower notwithstanding the fact that you exceeded the target you set out a year or so ago? Separately, given the evolving status of the mix of fee businesses, what can you say there?

Jack Remondi

I think on the operating expense side of the equation, first of all, a little bit of seasonality in the numbers. So, if you look at our overall efficiency in our lending and in our fee-based businesses, we'll continue to improve in 2009. The total dollars that we spend though will very much be dependent on the volume that we are generating.

As Al indicated, we expect good growth in our lending activities in 2009 versus 2008. And so, those will drive some numbers. As a target, I would look for 2009 to be at about $1.2 billion or a little bit less for the full calendar year.

Al Lord

I think, Peter, if you wanted to be conservative, you'd annualize the fourth quarter. Our goal is to get the number under that but not significantly under it.

Unidentified Analyst

And with respect to the fee businesses?

Jack Remondi

On the fee businesses, the big issue that we are looking into is the contingency collection side as it relates to some collections on defaulted federal student loans and the ability to capture some of that revenue because of capital market limitations. We are looking at alternatives there. We do see lower growth in those businesses as a result of that in 2009. Then, of course, we have got the purchased paper business in complete run-off. So, you'll see continued declines in those revenues as well.

Unidentified Analyst

Okay. Thanks.

Operator

Your next question comes from Matt Burnell with Wachovia.

Matt Burnell - Wachovia

Thanks, gentlemen. My questions have been asked and answered. Thank you.

Al Lord

Well, thank you, Matt.

Operator

Your next question comes from Ryan O'Connell with Citigroup.

Ryan O'Connell - Citigroup

Thanks. I think this is probably for Jack. Could you just give us an update on your outlook for free cash flow? Last quarter, as I recalled, for the quarter we just went through and '09, it was about $8.4 billion. So, maybe, if you could just give us an update on that.

Jack Remondi

Yes. Our forecast for free cash flow continues to be in excess of our debt service requirements. In that end, we were putting the number at about $8 billion for the course of the year. We've done some things to improve funding. The sale of the Department of Ed, the $1 billion for the Department of Ed loans and the Goldman Sachs deal add $2.5 billion to at least our cash generation activities. In the Department of Ed numbers, only half of those loans were actually closed in 2008. So there is a $2 billion increase of cash as a result of those two financing transactions by themselves.

Overall, just as an editorial comment, we look at our liquidity position here, and you know, in any way, shape or form you would look at this, we are in a far better position today than we were at almost any other point in time in 2008. The big challenge for us really is, and we sometimes say it's a big single issue, the $28 billion asset-backed CP facility.

At this stage based on where we stand on the conduit and what we see coming from the TALF, we see very significant opportunities there to generate liquidity from longer term financing sources, and more importantly, cheaper financing sources to materially reduce the asset-backed CP facility very quickly in 2009.

Ryan O'Connell - Citigroup

Okay. Thanks.

Operator

At this time there are no further questions.

Al Lord

Thank you, everybody. That concludes this morning's call. If you have any follow-up questions, please call myself or Joe Fisher. Thank you.

Operator

Thank you for participating in today's conference.

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