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SLM Corporation (NASDAQ:SLM)

February 13, 2013 9:30 am ET

Executives

Albert L. Lord - Vice Chairman, Chief Executive Officer, Member of Executive Committee and Member of Strategy Committee

Analysts

Moshe Orenbuch - Crédit Suisse AG, Research Division

Moshe Orenbuch - Crédit Suisse AG, Research Division

Across the room next door just finished. But in the interest of time, I'll do my intro and let people filter in. If you think about it, I think really the only constant thing for Sallie Mae over the last 5 years or so really has been the amount of change in their business model and how the company has been able to react. It's been truly remarkable. Company's continue to evolve. It's positioned itself right now as the largest servicer of government-guaranteed loans and is expanding that business aggressively while working diligently to deploy its cash flow in the most optimal fashion. Significantly restructured over the last year or 2, the private loan offering and now pursuing that as a growth business, something that's likely to continue and likely accelerate given the pressures on the federal budget. Sallie is also a beneficiary of the current low interest rate environment and we believe has locked in a lot of that benefit for a number of years.

We've got a number of people from senior management here today, including Al Lord, CEO of Sallie Mae, who has been with Sallie for more than 30 years and clearly a key figure over that period. Al has recently announced that he will be retiring this year and the board is in a search for his successor. We've also got Jon Clark, the CFO, with him up on the podium; and in the audience, Steve McGarry from Investor Relations; and Joe Depaulo, the Chief Marketing Officer.

So we've got actually some audience response questions that we'll -- I will put to you at some point here. But I'm going to turn it over to Al, and we're looking forward to it, Al.

Albert L. Lord

Good morning. Good morning. Thank you. So thanks, Moshe. It's a good morning, or it's a better morning in Miami than it is in New York, I'm sure. And as Moshe mentioned, this may well be my last Credit Suisse, CS, I guess we call it, Miami conference, at least behind the microphone. It may be. Certainly, my personal timeline in the Sallie Mae's timeline are, in my view, in very clear sight. I have managed her, as Moshe mentioned, the better part of 30 years anyway keeping my personal and Sallie Mae goals very much in sync.

My return to -- I've actually had -- this is my third coming to Sallie Mae and we won't go through all that. But I returned to the company 5 years ago. With the goal of the working about 1 year and getting the stock back to $30, 5 years later, I have the same goal; about 1 year to go and $30. So this is not designed to be a nostalgia trip, we've got a lot to do and not so much time.

I will -- I'm going to focus today more on value, anybody who's seen me or heard from me in the last 5 years know it's -- I think that the company has a valuation issue not unlike an awful lot of companies these days. And it's a show-me investment world, so that's what we're trying to do is to show you. We are on a path to better valuation. I think the path is clear and it's straight. We're very much on it. I think of it as a 2-point or a 2-part path. First part, and these are, I think, pretty close to equal parts is to grow our private credit business, that's our franchise; and accelerate the cash distribution of our legacy business.

We've experienced about 50% valuation improvement since we began distributing cash in early to mid-2011. We started that distribution slowly and my goal, to accelerate that and to continue to accelerate it. So I really looked at the company and we describe ourselves in our SEC filings as a 3-part company. I think it's evolving very rapidly to a 2-part company.

As I said, we're -- I think we're really 2 businesses, a wind-down business and a growth business. Growth business being -- I only have one slide, let's see if I can do it right. No. That's our lawyer's slide. That's the slide. We're really 2 businesses, the legacy wind-down business and the private credit business. I actually think of our private credit business as what we referred to as Smart Option. It's a series of products that we've developed over the last several years. One of these businesses is moving down, that's the legacy business, although it's moving down slowly because we continue to buy -- to create assets or buy assets in the marketplace, trying to keep up with its amortization. And the private credit business on the right is -- or what I refer to often as the Smart Option business, is headed north. You might -- one might ask, should these businesses be split? And it's not a totally academic question and probably, the right answer is, yes, maybe it should be split. We certainly operate it as if they were split.

This slide shows the 2 businesses. On the left side is the legacy and it's -- you see the intrinsic value of $22, that's a number that I've been talking about for at least 4 years. By June of this year, we will have distributed over $4 a share since 2011 and the value is still $22. We will be updating that intrinsic value computation and the disclosure probably around the end of this quarter. And you will hear today, if you're paying attention at all to Sallie Mae, that we're -- we will announce a transaction that finally sells one of our ABS TRUST. It's a trust that represents about 3% of the FFELP assets that we own. All in, counting the servicing income, it represents a single-digit discount rate. It easily substantiates the $22. It also begins to create a market and we hope better -- even better pricing.

Market price, and we've been -- well, we've been looking at this for a better part of 4 years since 2009. Market has moved a long way since 2009 and there's a marketplace out there pretty hungry for yield, as I'm sure you all are well aware. This transaction will remove roughly $3.5 billion, somewhere between $3.5 billion and $4 billion from our balance sheet, both assets and liabilities, of course. There'll be a more small accounting gain and I think that we've calculated it at around $0.08. It generates far more cash than it does earnings. I -- it would be an understatement to suggest that we intend more such sales.

The legacy business also includes our private credit business and the more mature part of our private credit business. In fact, the private assets that you see up here of $31 billion, are at least 4 years old. These assets tie up something close to $6 billion of the company's capital and reserves. The credit quality in that $31 billion, for the most part, is very high and getting better. It's also become much more predictable. The capital and reserve levels in that business are on a decline and it is those that we will and have been distributing. We've just really begun to look into the market for private loans to sell residuals in the private loans and we'll see how that goes.

Managing the legacy company is really financial engineering. The object obviously is to maintain the value and distribute. The company, Sallie Mae, is a FFELP acquirer and I think, to this point, we have acquired something like $4 billion in the last 12 months, roughly equal to what we just sold. We -- the company has strong internal talent to manage that business. That's what we've been -- we've been a buyer of these assets for a long time. It's exactly the same arithmetic on the sell side.

Let me now talk about the growth part of the company, the Smart Option growth business. And you see $10 billion -- we don't have $10 billion yet, we have something probably closer to $9 billion, but we're adding these assets in 2013 at the level of about $4 billion. So that's a pro forma slide. I don't want you to make you any more of it than that. But basically, $10 billion of Smart Option assets generate those numbers.

This business is the company's franchise. Moshe was describing the transitions and gently describing the excitement we've been experiencing over the last several years. That's what it's about too. It's Sallie Mae's future, it's a wonderful business. It is a worthy descendent of the 40-year business that we've managed. We operated out of our Utah ILC. An ILC, for those of you who are unfamiliar, is a bank. We cleverly name it Sallie Mae Bank. We've developed this institution and these assets in the current marketplace basically, a highly regulated and highly publicized student loan environment. The assets that we've designed are designed for that marketplace. We've got far and away the widest array of products in the competitive space. Our products engage the family, roughly 90% are cosigned, not just the student.

Smart Option loans in their various forms are the definition of responsible lending. We measure the risk and we price the risk. The assets are fairly priced. On average, we have 750 FICO scores in that portfolio and 90% cosigners. The $8 billion of assets that we ended the year with incurred losses during the year 2012 of $22 million, roughly 2% of all of the company's losses and 20% of its portfolio.

We finance these assets initially with deposits and then -- and move them into ABS. Our ABS financing right now is somewhere inside 150 basis points, couple hundred basis points where it was a couple of years ago. We were competitive when we were financing 200 basis points above this. We've shared a lot of these basis points with our customers. We dominate this market. Although it's a very small market, it is a market that's growing and has enormous potential to grow.

So I said these numbers are pro forma numbers. The $10 billion right now is roughly $9 billion, that will be $12 billion by the end of the year. A 2.5% ROA, that's after tax just in case you were not aware of that. And we expect credit losses of 1% or less annually. OpEx running at about 1.5%.

We will heavily capitalize and reserve these assets. I'm a strong believer in a fortress balance sheet, particularly since this is a monoline business as it stands. The bank has other -- has a few other assets but not very many. The ROE in this company will be -- in this pro forma illustration, I should say, will be somewhere between 15% and 20%. It's pushing 20% right now. You see a growth rate of 20% up there right now. These assets are growing at the rate of 50%. Obviously, if you've got $8 billion on the balance sheet and growing it for 1 year, we will -- because it's a bank, we will obviously have to manage its growth. We intend to manage it by either originating assets for the legacy company or to sell them.

It's -- I like this business, I've always liked it. It's got very nice ROAs and Es. As you can see, $10 billion of assets at 2.5%, I think we got 2.4%, generate $240 million or roughly $0.55 in earnings. That's roughly 1/4 of our earnings right now. But it's growing, it's growing rapidly. Let me just say it one more time, it is -- this business represents Sallie Mae's future, as Sallie Mae.

Let me update and finish. We're -- while I've shown you 2 companies, just let me mention that we still got a $2.30 number on the company this year. That's still the official number until -- I guess, until we change it. Certainly, the asset sales we mentioned -- I mentioned earlier, I will add to that number. And as I said, I expect there will be other asset sales as we move forward. The $2.30 assumes a $400 million share repurchase level. We'll see how that number changes as we move through the year and add capital and cash through asset sales.

As I suggested, we will add $4 billion in originations this year. That's very much on track. We had a great January, and January matters in this business because it represents the second half of the 2011 disbursements. But we are well on our way to making our $4 billion number. Our $2.30 includes a $900 million provision or thereabouts. I think that's a good number. I think it's a pretty conservative number. We squeezed our forbearance accounts very hard in 2012, and I'm starting to like the way 2013 looks.

We will meet our fee income targets. I will tell you though that we're looking very closely at each source of fee income right now. Certainly, the growing part of the top line or at least a large part of the growth is coming from direct lending. It grows a lot faster on the top line than it does on the bottom. And I think we have to look at that very closely as we move in the next couple of years.

If you've thought about operating expenses, think of the 2012 levels, something under $1 billion. I'll also tell you this that these legacy company assets go down and the related cost must go down and that is very much a focus right now. Certainly, the last 60 days or so have clarified a lot of the macro outlook for Sallie Mae and for other companies. Whatever strategic uncertainty we felt in the -- before 2013, has cleared itself up, some for the better, some not for the better. But whatever strategic uncertainty we might have been sensing last year, we no longer have. I think the direction is clear and it's immediate.

2013 is going to be a very good year for EPS, there's no question about that. I think it's going to be a better year than one might expect for cash receipts by shareholders.

I -- so I think I'll wrap up there, although I have one more thing I want to mention to you. You'll -- since I have this opportunity, you'll see soon an announcement from Sallie Mae that I'm -- that I've filed some form to sell some shares in Sallie Mae, something less than 3% of what I own. I have some fairly significant bills that come due in July and this is the last window before July. So I need to get something done and I'd rather tell you about it than have you read about it and I'd be very happy to answer any questions that anyone has about it. But I like Sallie Mae shares a lot more in the mid to upper 20s than I do here at whatever it is at $18. I'll leave my comments at that. Thank you.

Question-and-Answer Session

Moshe Orenbuch - Crédit Suisse AG, Research Division

Al, before I actually get to the audience response questions, I mean, you made some provocative statements there at the beginning and you obviously -- you had talked a little bit a couple of months back about starting to sell FFELP assets. And to be honest, I'm not sure I thought that was coming this fast. Could you talk about -- obviously, the $0.08 gain isn't the reason you're doing this. Could you talk about what -- how much cash that freeze up and what you would be thinking about doing with the cash.

Albert L. Lord

Provocative?

Moshe Orenbuch - Crédit Suisse AG, Research Division

It's my -- I mean, that's my observation, yes, okay?

Albert L. Lord

We could debate it after. Yes, I'm going to answer your questions, but without telling you the price, so -- and my mind doesn't work so quickly. I want to answer your question. As I said, it generates a lot more cash than earnings. And you're absolutely right, we're not doing it for earnings. If it's $0.08 in earnings in Q1, it's minus 1 or 2 [ph] somewhere else for some period of time. It just forwards earnings, and you're not paying for the earnings you already have. So we don't expect you to pay for these. It's -- this transaction is at a price very, very, very significantly, probably 50% of the numbers we saw just 3 years ago. It's a large, roughly $3.7 billion trust. It's -- I think it was 2007, '04, is that it? The fourth -- does that mean -- that means it was done in the fourth quarter of 2007. It's a large, bulky, confusing trust and I was very pleased with the price we got for it. It represents about 3% of everything we have. As I said, it generates -- we retained the servicing and I think it's important to understand that 40%, roughly 40% of the cash flow in this trust comes through the servicing contract that we have on this. So -- and we retained that servicing and that remains marketable, that was not the point of this transaction.

Moshe Orenbuch - Crédit Suisse AG, Research Division

So it -- is it the overcollateralization in that transaction that creates the cash that comes back to you then? Is it -- I mean, how should we think about it? Or maybe I'll just say it bluntly, how should we think about that relative to the $400 million of distribution that you've set out so far?

Albert L. Lord

Well, look, it's creating $0.08 of earnings and it relieves us of the capital requirement on the $4 billion that come off the books. So I mean, in round numbers, that probably makes $50 million or something additional. It's not -- it is not a totally representative trust and so I don't want people extrapolating too much from it. But because -- again, I would not focus on the earnings piece of it. It actually has a very low earnings component compared to what other trusts will have.

Moshe Orenbuch - Crédit Suisse AG, Research Division

And yet you said you're still in the market to buy other portfolios? Is that still the case?

Albert L. Lord

Yes, yes. We're very good at buying. We're just -- we're trying to get better at selling.

Moshe Orenbuch - Crédit Suisse AG, Research Division

Let's open it up to the floor. I've got more but let's kind of see what we've got in the room. We've got a mic coming.

Unknown Analyst

So in your description of kind of the new Sallie Mae with these 2 components, I thought the servicing business was noticeably absent from that description. Is it just -- it's still part of the go-forward Sallie Mae business model as you see it, the FFELP servicing?

Albert L. Lord

Yes. Yes, it is. These slides are noticeably absent of a bunch of other things. We have any number of fee businesses that are not shown here. This is really to kind of split up the assets for you.

Unknown Analyst

Okay. So just basically, from a balance sheet perspective, this is how you're thinking about it?

Albert L. Lord

Yes. I mean, to -- maybe to Moshe's earlier question, he asked the question about why -- or had implied maybe why are we buying while were selling. We're buying to build servicing, the servicing revenue.

Moshe Orenbuch - Crédit Suisse AG, Research Division

Just to look at these numbers kind of in a little more detail, the -- you said that you've got in the neighborhood of $9 billion to $10 billion, kind of the Smart Option loans right now and you'd be adding about $4 billion a year. And the repayments on that will be fairly low for a couple of years. So, I mean you'd probably get $7 billion or $8 billion of growth over 2 years kind of, maybe kind of $10-ish billion over to 3 years, so that -- is it fair to think that, that number and its earnings contribution could kind of double over a 3-year period?

Albert L. Lord

Yes.

Unknown Analyst

Just a question on your private credit growth business, what loss ratio should we think about in terms of reserving or what reserve ratio should we think about? Or is that embedded in your capital...

Albert L. Lord

We are -- we underwrite it to about a 7% loss -- life of loan loss rate, comes down to about 1 point a year.

Unknown Analyst

[indiscernible]

Albert L. Lord

Around 7 years. They tend to run longer than that but...

Unknown Analyst

I have a question, a 2-part question. You certainly have strong capital. You certainly have strong liquidity right now.

Albert L. Lord

Louder.

Unknown Analyst

You certainly have strong capital, strong liquidity. 2-part question, how will the capital structure change through the business change that's going to be coming? And you did mention fortress balance sheet. And how would you reconcile that with your corporate bond ratings, as low as they are?

Albert L. Lord

I can't reconcile them. It's a question better asked of Moody's than us. When we talked to Moody's, they talked to us about such things as what we're going to do when we grow up. That's what we're going to do when we grow up. We actually think we're fairly well grown. That's the issue. I don't -- I mean, I really can't answer the question. I think they should answer that question. I agree. And the company on the right side would not manifest itself. The bank does not look like that, but it looks a lot like that. That's -- again, I'll mention it, it's just a pro forma of what $10 billion of these assets would do wherever they are. It is a monoline and of course, that's something -- that's a hot button word for rating agencies and regulators, and so we would propose to capitalize it. The bank capital requirements are basically 8% for risk assets. You can see, we're talking about bigger numbers than that, 12% to 15%. Look, I personally believe in fortress. We've all watched the behavior of the capital markets in the last 5 years. I'm old enough to remember the capital markets in the early '80s as well with different issues, but also with severe problems. And you don't run a first rate financial institution with inadequate capital and reserves, so -- but you should also not run them with excess capital and excess reserves. That is pretty much the financial structure that we contemplate for our growth business. And we assume that at some point, Moody's will come around.

Moshe Orenbuch - Crédit Suisse AG, Research Division

Al, maybe a little less fun to talk about the legacy business. But the private -- the $31 billion of private loans, and you talked a little bit about in your opening comments about the loss rates there, kind of performing well post the squeeze you did on forbearance. I mean, that's still a business that could earn or, I mean, should be earning a reasonable amount of money. Could you talk a little about, maybe a little more detail about the credit performance over '13 and what that might mean for your ability to generate earnings and cash?

Albert L. Lord

Look, I have -- Sallie Mae has tried to maintain its provisions very close to its charge-offs. And reserving in a financial institution is a perpetual conversation with your accountants and others about how many months or years of bad debts one gets to reserve. We've got something like a $2.2 billion reserve and I would venture to say that's close to 2.5 years' worth of losses and maybe more. We have -- just because of the economic uncertainty that we've seen over the last 4 years, 5 years, whatever it's been, and still see, I just -- I'm uneasy about bringing reserves down. But we're getting close. We're getting close, the $2.2 billion of reserves against less than $1 billion a year of charge-offs. And frankly, I think the $1 billion is a pretty conservative number at this point. Embedded in that $31 billion is $3 billion of what we call nontraditional loans there. It's for -- I think, the miracle, the lows in the fish [ph] is in the New Testament. These things -- these are loans that never stopped giving charge-offs. They started out at $6.5 billion, they ended at $3.1 billion and still go bad. So that is where a full 1/3 of our charge-offs come from, $3 billion out of a $40 billion portfolio between the 2 sides. If we could -- if we were able to put that behind us, you'd be looking at $500 million to $600 million of annual charge-offs for this company.

Moshe Orenbuch - Crédit Suisse AG, Research Division

So you mentioned a $22 kind of valuation -- I mean, it happens to coincide with our price target, which -- I know how I got there. Maybe you could talk a little bit about how you got there and what things might be changing as a result of this new focus.

Albert L. Lord

Well, I look at the company, the value of the company, I look at it as 3 things. It has net assets, it has net worth, and our core capital, something like our core capital something like $6 billion, a little more than $6 billion. We -- and then we -- that's earnings and value that are -- were created in the past. We have earnings that we will create in the future, the cash flows -- and I'm talking only about the legacy side, the cash flows that will come off that $155 billion. And then there's a component that we'd -- that is not in the $22 a share and that is what we referred to as floor [ph] income, which is likely to be a several billion dollar number.

Unknown Analyst

Al, just a follow-up on the private credit growth in terms of how you're going to fund that growth going forward. You talked about that a little bit. But wasn't sure what all the different options are for funding that growth there.

Albert L. Lord

Well, it's $4 billion a year. You can figure 500 or so million dollars in capital. A $3.5 billion differential would be initially deposits and then ABS. We've never done a pure Smart Option-ABS deal. We're already financing at -- I don't know, 125 to 150 basis points over LIBOR for our ABS pools. I'd like to see that number down obviously, but it's come down very nicely in the past couple of years. I'd also like to see the overcollateralization levels down in those pools. I haven't thought what level of subordinated debt it might have or unsecured debt at this point. We're pretty happy with the performance of the ABS markets. But we all saw what happened a couple of years ago.

Moshe Orenbuch - Crédit Suisse AG, Research Division

Maybe to kind of bring it back to one of the concerns that we hear from investors from time to time. I think that, I mean, just I guess maybe, do you kind of agree with this statement; given that the prospective, this $9 billion kind of Smart Option portfolio is over 90% cosigned, is that -- part of the reason for separating it out, I guess, it would be more resistant to change should Congress decide to enact any changes with respect to bankruptcy. Could you talk about your thoughts on that process?

Albert L. Lord

Well, I mean, the bankruptcy provisions are things that I've heard about for 30 years and continue to hear, and politicians continue to talk about it. I do not see it coming. But you don't need my political predictions. You can make all your own. I don't -- I just don't see it as a significant -- if it were enacted in any rational form, of course, if it was enacted, it wouldn't be rational at all, would it? But in some form, I just don't see it as a significant financial event for us. One, because all our new assets are largely cosigned and high credit quality. The old assets are pretty high credit quality at this point and have been paying or they wouldn't be on the books for 4 years, 4 or 5 years. I try to remind people that the company has endured some $5 billion of losses over the last 5 years without a bankruptcy provision. I mean, in the end, people either pay or they don't pay, whether they file for bankruptcy or they don't file for bankruptcy. And their choice ultimately is whether they have a bankruptcy on their credit report or they have a default on their credit report and I don't know how one makes those choices. But I really don't -- anyway, it's an issue that won't go away. But I don't -- I just don't think -- see it having any significant effect at all.

Moshe Orenbuch - Crédit Suisse AG, Research Division

Maybe just -- we've got a couple of minutes left. Could you maybe give us just your thoughts on Sallie Mae over the next couple of years, you're in the search for a CEO, talk about when we might hear about that, and what -- how you see the company progressing once you take your retirement?

Albert L. Lord

Boy, that's -- now that's a provocative question.

Moshe Orenbuch - Crédit Suisse AG, Research Division

Okay. So I wasn't completely wrong.

Albert L. Lord

No, I said that. Look, Sallie Mae is a 40-year-old company, we -- I appreciated Moshe's earlier comments about our ability to transition and be -- we've had to be pretty light on our feet, manage our way through some interesting times. Whoever it was that said live through interesting times is an idiot, at least as it relates to 2008 and 2009. We've -- I have a -- my view about the company is that we've got ample talent to run the company, inside the company. How the board chooses to move forward is on the board. And frankly, I think they're being very diligent in the process that they're going through and we'll see how it turns out. If you ask how it's going to do for the next couple of years, well, I hope it keeps doing what we're doing right now. That to me is the path and I want to be sure it's on that path.

Moshe Orenbuch - Crédit Suisse AG, Research Division

Great. So please join me in thanking Al, Jon and Joe. And in this room next, in about 5 minutes, would be Northern Trust and Invesco Mortgage in Salon 2. Thanks, very much, Al.

Albert L. Lord

Thanks.

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Source: SLM Corporation Presents at 2013 Credit Suisse Financial Services Forum, Feb-13-2013 09:30 AM
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