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Executives

Steven J. McGarry - Senior Vice President of Investor Relations

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

Joseph A. Depaulo - Principal Financial Officer

John F. Remondi - President and Chief Operating Officer

Analysts

David S. Hochstim - The Buckingham Research Group Incorporated

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division

Eric Beardsley - Barclays Capital, Research Division

Bradley G. Ball - Evercore Partners Inc., Research Division

Moshe Orenbuch - Crédit Suisse AG, Research Division

Michael Tarkan - Compass Point Research & Trading, LLC, Research Division

Sameer Gokhale - Janney Montgomery Scott LLC, Research Division

Scott Valentin - FBR Capital Markets & Co., Research Division

SLM (SLM) Q1 2013 Earnings Call April 18, 2013 8:00 AM ET

Operator

Good morning. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to Sallie Mae's 2013 First Quarter Earnings Call. [Operator Instructions] Thank you.

I'd now like to turn the call over to our host, Mr. Steven McGarry. Please go ahead, sir.

Steven J. McGarry

Thank you, Brent. Good morning, everybody, and thank you for joining us for our First Quarter Earnings Call. With me today are Al Lord, our CEO; Jack Remondi, our President and COO; and Joe Depaulo, our EVP of Banking and Finance. After their prepared remarks, we will open up the call for questions.

But before we begin, please keep in mind that 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-K and other filings with the SEC.

During this conference call, we will refer to non-GAAP measures we call our core earnings. A description of core earnings and a full reconciliation to GAAP measures, as well as our GAAP results, can be found in the First Quarter 2013 Supplemental Earnings Disclosure. This is posted along with the earnings press release on the Investors page at salliemae.com. Thank you. And I'll turn the call over to Al.

Albert L. Lord

Thanks, Steve. Good morning.

So I think we are off to a good start in 2014 (sic) [2013]. No financial surprises in the quarter. I believe we've made some progress on the valuation of the company's equity. I also still believe there is significant distance to cover on that front. Our credit quality is looking better, and it gives us some reason for optimism. We had a good quarter in the capital markets, which are substantially more liquid than they were just last year.

And before I make more comments, I'm actually going to ask our new EVP of Finance and Banking; and Jack Remondi, who you all know as our Chief Operating Officer, to cover the quarter as they saw it from their perspective. And then I'll make some comments when they're finished. Now I'll turn it over to Joe.

Joseph A. Depaulo

Thank you, Al. Good morning, everyone. I'll be referencing the earnings call presentation available on our website during my prepared remarks, beginning with Slide 3. At the end of my remarks, Jack Remondi will make a few comments on credit quality and business operations.

In the first quarter, we delivered consistent earnings. And the fundamentals of origination, credit and funding all worked well, so we grew our loan originations by 22%, maintained high credit standards for those new loans, and we saw improvements in delinquency, forbearance and charge-offs across the portfolio.

We took advantage of the favorable credit markets, in part reflected by the successful sale of our residual interest in a $3.8 billion trust. And we returned capital to shareholders by purchasing nearly $200 million of shares.

Slide 4 provides a high-level summary of our results. For the quarter, core earnings were $283 million or $0.61 per share compared with $284 million or $0.55 per share for the year-ago quarter. Our operating expenses were $270 million versus $262 million in the first quarter of 2012 and $252 million in the fourth quarter. The increase versus the prior year quarter is the result of an $8 million gain we booked last year related to the termination of our pension plan.

Operating expenses were up $18 million in the fourth (sic) [first] quarter versus the fourth quarter as a result of stock compensation payment to retirement-eligible employees, as well as severance costs. We expect full year expenses will be lower than $1 billion.

I'm going to turn to Slide 5 to discuss our consumer lending metrics. As we grew originations in this segment, we maintained our loan spread within our 4.5% to 4.6% target range. We also reduced our expense ratio, and we saw improvements in delinquency rates and forbearance rates over the fourth quarter and the year-ago quarter. Losses declined since the fourth quarter and we expect losses to continue to decline. Our balances per account are remaining stable, and we continue to attract more strong borrowers. As the graph at the bottom of the page shows, both 30-day and 90-day delinquency rates are now less than half the levels they were just 4 years ago.

In Slide 6, you could see our student loan portfolio is dominated by high-quality loans. The green bars and green line represent the highest-quality and lowest-risk business. These assets now account for 70% of our portfolio. They are growing, and they are the Smart Option product. The highest-risk segment, what we now -- what we call nontraditional, is down to 8% of our portfolio. Balances and losses are declining in this segment, and we do not originate these loans anymore.

The high-quality loans are what we originate, as you could see on Slide 7. This quarter, we originated $1.4 billion of Smart Option private credit loans in the quarter, an increase of 22% from the first quarter of 2012. The loans we originated had an average FICO score of 744, and 86% of the loans had a co-borrower. These loans continue to increase the high-quality loan segment that we referenced on the prior page.

Smart Option loans also continue to be an attractive product that offers both competitive pricing and repayment choice. 58% of our customers elect to make a payment in school, 32% choose what we call our Fixed Pay and 26% choose full interest payments in the -- as their option, so that leaves 42% who still choose the Deferred product.

Our business services segment is covered on Slide 8. In this segment, core earnings were $124 million in the quarter compared to $137 million in the first quarter of '12. The company now services 4.8 million accounts under the Department of Ed servicing contract. Servicing revenue from this contract was $23 million in the quarter compared to $17 million in the prior year.

As I turn to Slide 9, we'll summarize our FFELP segment. Core earnings were $104 million for the first quarter compared to $80 million for the first quarter of '12. Other income as the result of a $35 million gain from the sale of the residual interest in the FFELP loan securitization trust. The company will continue to service the student loans in the trust. And the sale removed assets of $3.8 billion and related liabilities of $3.7 billion from our balance sheet. This sale will add $0.06 to the share for 2013.

The FFELP student loan spread decreased to 93 basis points from 100 basis points in the prior quarter. This quarter's FFELP spread is lower as a result of seasonal factors that impact components of the spread in the first half. This is reversed in the second half. We expect the run rate going forward to be in the mid to high 90s.

We turn to Slide 10. We'll highlight some of our financing activity for the year. In the first quarter of 2013, we issued $1.4 billion of private credit ABS, $1.2 billion of FFELP ABS and $1.5 million of unsecured debt. Our recent private credit transaction marked the first SLM private loan ABS to issue a subordinate tranche since 2007. The advance rate in this transaction was 85% versus 77% for our prior transaction, as I mentioned, a reflection of improving credit markets. So as the ABS market continues to strengthen, it enables us to execute our long-term funding strategy of originating new loans in our bank and term-funding more seasonally. We will continue to regularly issue FFELP ABS to meet the wind-down of the Straight-A FFELP facility. This facility had $7 billion of FFELP loans at quarter end, down from a high of $24 billion.

Finally, on Slide 11 is our GAAP earning summary. We recorded GAAP net income of $346 million or $0.74 a share compared with net income $112 million or $0.21 per share in the year-ago quarter. The primary differences between first quarter 2013 core and GAAP results are the marks related to our derivative positions. Finally, our guidance for the full year is $2.49. This includes the gain on sale, as well as the reduced NIM going forward, from the 2 residual sales we have completed this year.

I will now turn the call over to Jack Remondi to discuss credit and operations.

John F. Remondi

Thanks, Joe, and good morning, everyone.

As I think you have seen from the summary statistics that have been reviewed so far, we're off to a very good start with our first quarter performance. We originated $1.4 billion of high-quality education loans, a 22% increase year-over-year. Importantly, our growth in loan volume this quarter and our targets for the year will be achieved without any changes to our credit criteria. Our focus is to offer the right set of products with features like fixed interest rates, incentives for good payment behavior and payment flexibility to help graduates get started on the right foot.

Along with strong quality metrics for originations, our overall portfolio is stronger each quarter, with an average FICO score of 720 and 66% of our loans including a co-borrower. When we segment our portfolio by risk tiers: 70% of our loans fall into the low-risk segment where charge-offs fell to 1.6% in the quarter from 2.1% in the fourth quarter. 100% of our originations fall into this risk tier. Charge-offs for our moderate- and high- or nontraditional-risk tiers also fell to 5.0% and 8.7% from 7.1% and 13.2%, respectively.

Over the past few years, we have continuously worked to refine our repayment practices to help our borrowers successfully manage their education loan payments. This has led us to reduce the use of forbearance where ineffective and to help borrowers avoid the needless compounding of interest on their loans. As we saw last quarter, this led to a temporary increase in charge-off rates in 2012, particularly in the fourth quarter, as we pulled forward loans likely to default.

Although our forbearance offerings are more constrained, we continue to offer our borrowers who are experiencing financial hardship more options to help them successfully manage their loans. These options may include reduced interest rates, extended repayment terms and, if appropriate, payment relief. The programs are designed to help borrowers reduce their principal balance, successfully manage their loans and avoid the devastating consequences of default. Our results clearly point to the success of these efforts as we continue to see improvement in delinquency rates, much along the lines we expected.

At March 31, our 90-day-plus delinquency rate fell to 3.9%, the lowest level since 2008. At the same time, loans in forbearance fell to $1.1 billion of loans in repayment, half the levels of 2008 when delinquency rates were last at this level. Assuming the economy remains in a similar or better position, the performance of our loan portfolio and the success of our collection strategies will lead to continued improvement in our loss rates.

On the operations side, our focus has been on productivity, performance quality and compliance. For example, productivity improvements in the past 2 years have reduced our operating expenses by over $170 million annually. At the same time, we've raised our quality standards. Both of these items remain in our top objectives for 2013. And like other financial institutions, we've also increased our focus on compliance. Today's regulatory environment is more intense and exacting. And we've devoted not just the required resources to the challenge, we've also created an environment that emphasizes the importance of these efforts and the responsibility for it that we all own and share.

We're off to a strong start in 2013 and we're pleased with our results. More importantly, we're excited about our prospects.

With that, I'll turn it back to Al.

Albert L. Lord

Okay. So see, you've heard from Jack and Joe. They are the guys that make things happen around here. So let me just comment on some of the things that they talked about and maybe a couple of other things. And in fact, Joe and Jack both commented on the better credit news.

I mention them again largely because the -- because some of the underlying statistics are starting to feel a lot better, and particularly delinquencies which are notably better. Our recoveries are very strong in the quarter as well. And while recoveries don't directly affect EPS, they are in cash and they ultimately do affect EPS. Nonetheless, we held our reserve at very conservative levels and flat as we move into the second quarter. Second quarter can hopefully confirm our optimism, but I would say, I guess, for at least the last 3 or 4 spring-summer, we've experienced economic swoons, and so we'll see how it turns out.

You also note, I'm sure, that we had a little operating expense slippage. Joe mentioned that we're going to reduce those costs over the balance of the year and 2013 will be below 2012 numbers.

Joe mentioned the capital markets being very accommodating. There's a fair amount of liquidity, and it seems that everybody is -- virtually all participants are looking for yield. While these markets are as liquid and active as they are, Sallie Mae will continue to be active. Joe mentioned the ABS pricing. That was very heartening, particularly our ability to move the subordinated piece. We also did 2 FFELP residual sales, ABS residuals, the second transaction price substantially better than the first. And we have another transaction in the market, and that's likely -- very likely to close in the quarter.

As you know, and I always get questions about this, that it's Sallie Mae's policy to distribute its excess capital from its legacy businesses to our shareholders. And in fact, when we became able to do that back in 2011 and since we've been able to do that, we've returned near -- through this -- at least through June 30 of this year, we will have returned some $5 a share since mid-2011. All the while, we've reduced leverage, and the company still maintains in excess of 20% capital and reserves against its risk assets, risk assets which have less risk today than they did yesterday and the day before. It's likely that the board will evaluate our second half capital needs and then -- and the distribution situation at the May meeting.

I think it's worth noting that, during the quarter, I and my colleagues met with each of the rating agencies and had very meaningful conversations with each. I would encourage you, to the extent you're interested in our relationship with the rating agencies or our current state of the -- the current state of the art with the rating agencies, to read -- S&P recently put out a note about its view of the current situation of Sallie Mae. And while I can say I wasn't even close to being ecstatic about what they wrote, they made their position very clear, and frankly, I believe the position to be very constructive. I believe our conversations were constructive. I understand that some of our unsecured debt investors and our equity investors are somewhat indifferent to the ratings, but I still retain hope that not only will we retain our investment-grade rating but that we will in time improve it.

In terms of valuation, we're obviously trading nearer our intrinsic value than we once did. And I refer to our intrinsic value and our "drop dead" value as basically the same numbers. That's just the cash value of the business as it stands without any value for the franchise. I'll note that, that number actually goes up, is going up, and that's after $5 of distributions over the last couple of years. It's going up because the discount rate continues to drop for our cash flows, as has been manifested in the residual sale transactions. And our private portfolio continues to grow and its asset quality grows.

You're well aware that the company reports its results in 3 segments. I will tell you that, as we operate, we're gravitating from 3 to 2 segments. And the segment may be -- may not be a perfectly appropriate definition, but it -- we manage ourselves really in respect to the 2 stated goals of the company. One is to return the earnings and the excess capital that are freed in the legacy wind-down operation, and the second is to build our private loan franchise. Those are the 2 primary goals of the company. We have a variety of other goals, but these are the 2 primary ones, and so it's largely how we describe the business.

I'll remind you that the legacy business is the FFELP portfolio, and we define it as well to include $30 billion of loans originated before 2009 in the private side. And the other part of the private loan franchise or the -- or that [ph] part of the private loan franchise is the Smart Option loan growth activity. And that -- today, that's originated in our ILC bank.

And just to give you 1 more minute on the Smart Option growth. As you heard, we're looking at a $4 billion of origination in that product. That's something in excess of 20% growth from last year's originations. We expect similar growth, it's -- and we'll talk about that at some point for 2014. I will remind you that the Smart Option product is today's franchise. More importantly, it is Sallie Mae's tomorrow franchise. We do not count it, it's value in intrinsic value. The Smart Option business is the market leader at roughly 50% of the market. In aggregate, by June 30, we'll have a $10 billion Smart Option loan portfolio, again growing with originations of $4 billion a year, so you can do the arithmetic at the pace of growth of that $10 billion entity.

You heard the FICO scores. I think they're down to 746 from 750 and just slightly under 90% cosigned. These loans are underwritten to have less than 1% losses per year, and are -- as they mature, they are beginning to demonstrate that that's an appropriate loss rate. They have asset returns of 2.5% and equity returns something in excess of 15%. I would say and do say that the Smart Option product and business is a very worthy descendant of its 40-year Sallie Mae parentage.

You heard our EPS guidance. It's -- you can go back to the $2.30 that you heard at the beginning of the year and add and subtract the gains and losses from various sundry balance sheet restructurings. Obviously, at this point, we've done a couple of ABS transactions or maybe more, and so we may be adjusting that number, but the core earnings of the company remain about as we predicted.

With that, I'm going to finish my comments. And I guess, we'll take questions. Steve?

Steven J. McGarry

Thank you, Al. Brent, we're ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of David Hochstim with Buckingham Research.

David S. Hochstim - The Buckingham Research Group Incorporated

I wonder if you could talk a bit more about the prospects for selling more of the residual cash flows. And maybe give us a sense of how much the markets improved from a few years ago when you tried this and the buyers were giving you ridiculous bids. And then what would -- what do you think is realistic, if you think out over the next year or 2, in terms of additional sales?

Albert L. Lord

David, this is Al. We're -- we will continue to explore this market. And you're correct: The demand has ticked up very nicely. The change from the first transaction to the second was startling. I'm really -- we put 2 transactions out that were kind of bite-sized, and the third one is relatively bite-size as well, trying to establish this market. I think we'll then step back a little bit maybe and take a look at what we want to do next. Just as a financial marker, I -- and when -- I know that -- the sell side community, and I've read the reports just on our earnings release last night of our parsing $0.01 and $0.02 a share from this or from that. The company's shares are trading at something less than 10x earnings, which implies something like a 10% -- actually, it's more like a 12% after-tax return. These transactions are considerably well inside the cost of capital. And so they -- and so while they remain well inside the cost of capital, they will obviously be transactions that we'll continue to consider seriously. But I'm not really prepared to give you a number at the moment, David.

David S. Hochstim - The Buckingham Research Group Incorporated

Okay. And then can I just ask you about on the private loan originations? So the -- you had a big increase in the Deferred payment loans. And I just wondered, what -- how different is the expected loss rate on those or the expected ROA relative to the interest-only and the Fixed Pay options?

Joseph A. Depaulo

David, this is Joe. Our loss rate expectations are very similar across those 3 products. And one of the reasons why we'll see a slight uptick in the Deferred is that customers take second and third products. They often don't want to make the payments on all 2 or all 3 loans. So as we market to our base and continue to penetrate those customers who have loans, with more loans, as they go through school, we typically will see the Deferred piece increase a little bit relative to the first time they took a loan.

David S. Hochstim - The Buckingham Research Group Incorporated

Okay. And so is there any difference in the credit characteristics or the rates on those loans, relatively?

Joseph A. Depaulo

Well, we do -- we encourage customers to make the payment while they're in school because we know it leaves them with less debt when they graduate and it's a better proposition for them and the schools. So the way we do it is, based on your risk segment, if you take the interest-only option, which of course is the highest payment, we price you at our base price. So let's say you're LIBOR, plus 5%. Then when -- if you choose a Fixed Pay, we add 50 basis to it -- basis points to that price. And if you choose the Deferred, we add about 100 basis points. So what we're trying to do is encourage the customer to graduate with the least amount of debt. And again, it works for the customer, it works well for the schools.

David S. Hochstim - The Buckingham Research Group Incorporated

Okay. And then just finally, Discover recently eliminated some fees on their private loans. Are you guys seeing any impact from that on your -- on demand? Or are there -- I mean, do you view that as a pricing cut that you'll have to match to make any difference?

Joseph A. Depaulo

We -- well, we haven't seen any impact on it yet. We -- obviously, our results speak for themselves in the first quarter. We don't -- we position our product for all the customers, not for the ones we expect to go delinquent. And we think that positioning -- as I mentioned a moment ago, encouraging the customer to make the payment in school is very attractive to obviously our customers. And we -- and remember, we have the parents involved, they're the cosigners, and we have the schools involved. So all 3 of them like the way we position it. And we like looking at sort of all the customers versus those we think might go delinquent.

Operator

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

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division

I just had a couple of questions. One was just on the FFELP portfolio -- I'm sorry, the private student loan portfolio. Could you just talk about how you expect credit quality to progress for the remainder of this year and kind of into next? And then secondly, just within your guidance for EPS, I was wondering how much in terms of debt repurchases you guys are assuming and if that stepped up relevant to the previous time you guys provided guidance.

Joseph A. Depaulo

So let's start with the credit quality piece of your question. We -- so we see the leading indicators on our portfolio as all positive. You see the delinquency rates are lower across the portfolio year-over-year, quarter-over-quarter, and you see that both in the total delinquency and the 90-plus. You also see significantly less forbearance. We're down $270 million in loans in forbearance since the first quarter of last year, that's a 20% decrease. So those leading factors would lead us to the confidence that we will see lower losses this year than obviously last year. Longer term, what we're putting in the portfolio are loans that we're writing to a 1% to 1.25% annual charge-off rate or 7% life of loan losses. And those are the Smart Option loans. So as they enter the portfolio, they continue to bring down the expected long-term loss rates. I think your second question was about guidance relative to debt repurchase. Our -- we had an assumption of debt repurchases in our original guidance of $2.30, and it remains there today.

Sanjay Sakhrani - Keefe, Bruyette, & Woods, Inc., Research Division

Okay, great. And that -- did that change in any way? I mean, I'm just trying to scope kind of the impact.

Joseph A. Depaulo

Well, we had -- I mean, you could compare -- you can compare our first quarter debt repurchase gains of $29 million to the prior quarter and the prior year's quarter. We were obviously down $14 million from first quarter '12. But we don't disclose how much we will buy the rest of the year, obviously, but when we see opportunities, we'll continue to take advantage of them.

Operator

Your next question comes from the line of Eric Beardsley with Barclays.

Eric Beardsley - Barclays Capital, Research Division

What would you attribute the strong improvement in delinquencies to? Or is there anything that changed in terms of your workout strategies or repayment plans that you're putting students into?

John F. Remondi

This is Jack. So a couple of things, I think, are going on here. One is, the balance of the portfolio that is in the low-risk segment has continued to expand. So when you look at that portfolio: We finished at 65% at the end of 2011. It's 70% today. That portfolio has substantially lower loss levels. Even during the crisis, it had substantially lower loss levels and delinquency levels. I do think our forbearance practice changes have been a big contributor as well. Our focus is to get borrowers on payment plans so that they are -- develop a pattern of making payments each month rather than taking a break of 3 or 6 months through the use of forbearance, and that has had a positive impact as well. And when you look at a combination of those things, that -- those are the big drivers. And to the point that Joe was making earlier, when you look at the 90-day delinquencies in percentage, they're down, but they're also down in absolute dollars $92 million compared to a year ago and $200 million compared to the fourth quarter. And that ultimately is what's going to drive the lower charge-off rates coming into the balance of this year. You also see a $270 million decrease in forbearance, the amount of loans that are in forbearance. And the loans that we have been -- we've pulled forward out of that are really the ones where our borrowers show the least likely ability to benefit from a forbearance. And that's been -- I think both of those are going to lead to lower charge-off rates going forward.

Eric Beardsley - Barclays Capital, Research Division

Got it. I think, last quarter, you talked about potential charge-offs and provisions somewhere between $900 million and $1 billion for the year. I guess, with the improvement in the dollar amount of delinquencies you saw in first quarter, could you be trending below that now?

John F. Remondi

We are slightly ahead of plan in the first quarter, but I think the economic environment is really going to be the key thing that we will focus on. As Al indicated, for the last, I think, 3 years now, we're seeing a summer swoon. And although that's not in most economists' forecasts, there are a couple of indicators that are starting to show the same thing.

Operator

Your next question comes from the line of Brad Ball with Evercore.

Bradley G. Ball - Evercore Partners Inc., Research Division

In your guidance for -- of $2.49 for this year, are you including the third FFELP residual transaction that you referenced in the call?

Joseph A. Depaulo

No.

Bradley G. Ball - Evercore Partners Inc., Research Division

So any gains from that may be additive to that $2.49.

Joseph A. Depaulo

Yes.

Bradley G. Ball - Evercore Partners Inc., Research Division

Okay. And then the FFELP residual sales are giving you a lot of added flexibility in terms of managing the cash flows of the runoff book. I wonder if you can give us a sense as to how you're thinking about those accelerated realizations and its taking gains in earnings today versus the loss of the earning stream that they would have thrown off over time. So how should we think about the earnings in the out-years 2014 and beyond? And also, are you still in the market to buy FFELP residuals?

Albert L. Lord

To buy -- did you say to buy FFELP residuals?

Bradley G. Ball - Evercore Partners Inc., Research Division

Yes.

John F. Remondi

FFELP portfolios [indiscernible].

Bradley G. Ball - Evercore Partners Inc., Research Division

FFELP portfolios.

Albert L. Lord

Well, yes, look, if we can buy low, sell high, that's not a terribly bad strategy. Yours -- I think your question is, do we -- what's our view of the fact that we are accelerating earnings by bringing these transactions forward? I would -- I'd just point out that these earnings are going to decline, anyway, and that what we're doing is making a judgment about the use of capital from those earnings. And as I said earlier, to the extent that we're able to return capital on equity that's got pretty close to a pretax cost of 20%, I think that's a rational financial transaction. That it may subtract $0.01 or $0.02 from out-years is that -- is not really the issue. The out-year earnings are going to decline from FFELP, anyway. So when you ask about what you should look at in terms of the out-years, I would be paying a far greater attention to the growth part of the business, not the shrinking part of the business.

Bradley G. Ball - Evercore Partners Inc., Research Division

Great. And then one last question, on the expense targets. So getting your costs back to below -- or to below $1 billion for this year implies significant reduction in the next couple of quarters. Are there specific areas where you've marked for cost savings? And sort of how are you getting that run rate down to below the $250 million per-quarter rate?

Albert L. Lord

Let me try that. I think a fair amount of it will happen naturally, Brad. There are a lot of things in Q1. The so-called onetime items that seem to repeat themselves are maybe are not onetime, but there are quite a number of them in the first quarter. And I think we may have taken our foot off the brake a little bit, but I don't think we're going to need to do anything particularly dramatic. We still have to crack the overhead nut in this company as the -- related to the FFELP portfolio, and we are working diligently at that. But I don't think there's anything noteworthy in our plans over the next 3 quarters or so that you would find, you or the outside world would find, particularly noteworthy.

Bradley G. Ball - Evercore Partners Inc., Research Division

You're retaining servicing in these transactions, right, so there's no real cost savings from these sales?

Albert L. Lord

But there's no -- there is none, but there is a revenue decline, and so we've got to find cost cuts, but yes, you're right. And in fact, what we're selling in -- with these residuals, at least on average, is about 65% of the cash flow of the pools of assets that we're selling.

Operator

Your next question comes from the line of Moshe Orenbuch with Crédit Suisse.

Moshe Orenbuch - Crédit Suisse AG, Research Division

I mean, you talked a little bit about the impact on the charge-offs. Could you talk a little bit about the reserving for the private student loans? Because you've got, I don't know, roughly 10%, even a little less than 10%, of your loans kind of in the nontraditional, but it's probably somewhere between 25% and 30% of your credit metrics in reserves, and that should be coming down. And how that -- how we should think about that versus the reserve you've put on for new loan growth?

Albert L. Lord

What is the -- are you asking indirectly the direction of the reserve?

Moshe Orenbuch - Crédit Suisse AG, Research Division

Well, I mean, by how -- well, more specifically than that, by how much could we expect the reserve to be less than -- the provision to be less than charge-offs as you have those phenomena going on?

Albert L. Lord

I think, Moshe, as I said in my prepared comments, I like what's going on underneath the big numbers. But the Q1 was not a particularly great quarter for charge-offs. They were -- I thought they were pretty high. They were down from the fourth quarter, but we've flushed a lot of forbearance through in last year. And so the encouraging part to me is the improvement on the delinquency front and the forbearance front. Those -- and they're in all the buckets, and our entry rates seem to be slowing. So I'm happy with those numbers. I just -- I -- but I recall being almost this happy last year about the same time. And so -- but if those underlying numbers stay as they are or further strengthen, we will be harder pressed to keep our $2 billion reserve. Although, I -- it gives me a great deal of comfort to have this kind of coverage.

Moshe Orenbuch - Crédit Suisse AG, Research Division

Great. Then separately, you mentioned that there was about a 5-basis-point drop on the margin on FFELP for the unhedged floor income. Was that something specific to the transactions? Did that have more to do with the way interest rates moved? What was that about? And does that bounce back or not?

Joseph A. Depaulo

It -- this is Joe. That's really -- that's driven by seasonal factors that reverse themselves in the second half of the year. You saw some of it probably last year, but we still think the FFELP spreads are going to be in the high -- in the mid to high 90s.

Moshe Orenbuch - Crédit Suisse AG, Research Division

Great. And then just a comment, kind of putting together a whole -- a number of the previous questions. Al, you made a bunch of comments about these transactions being well inside your perceived cost of capital. I think -- and this is really not a question, more of a statement. I think that it's -- you -- I mean, you've done a great job returning capital thus far, but what -- until that cash that's generated is actually deployed, it actually kind of is slightly dilutive to earnings estimates. And it's true, over time, the earnings from the FFELP portfolio are going to go down, anyway. So I get it. But the sooner we can get more clarity as to your plans for that would be just helpful to us, I think.

Albert L. Lord

The plan for that and other is about the rapidity with which we might sell residuals.

Moshe Orenbuch - Crédit Suisse AG, Research Division

And -- right. And priorities, I mean if there are acquisition -- portfolio acquisition opportunities or debt buyback or stock buyback, yes.

Albert L. Lord

Yes, okay.

Operator

Your next question comes from the line of Michael Tarkan with Compass Point.

Michael Tarkan - Compass Point Research & Trading, LLC, Research Division

Just back to the private originations, for a second. I was wondering if you could just provide some color as to where the growth is coming from. Is it primarily just overall industry growth? Are you taking more market share these days? Just any kind of color on that.

John F. Remondi

This is Jack. I think it's a little bit of both. We are seeing more families take advantage of the interest rates that we can offer in our private education loans compared to what's available in the federal space. And I think a big feature of our products is that this is a family loan. It is the parents and the child, whereas the federal loans are one or the other and not a shared obligation. And I also think we are taking market share, so although the market is growing, we are clearly growing faster than the overall market pace.

Michael Tarkan - Compass Point Research & Trading, LLC, Research Division

And then I guess, on the servicing side on the ED servicing contract. So you have 4.8 million borrowers now. Can you kind of ballpark for us how many of those 4.8 million are currently in repayment versus in school? And I guess what I'm getting at is, as those students go into repayment, are you expecting a decent increase in revenues associated with them?

John F. Remondi

So it's -- this is a -- we have a little bit of an interesting mix issue here. Today, our most profitable segment for servicing in the ED loan is actually in school borrowers, and that has to do with the fact that our repayment portfolio is heavily weighted towards for-profit schools which are more highly delinquent and at more highly delinquent portfolio. That mix is going to change over time. And we've been working hard to reduce our costs in that side of the equation while, at the same time, dramatically reducing the default levels that occur there. And we have -- in the 3 years that we've been servicing loans for the Department of Ed, our default loans that we service default at a substantially lower rate than loans that are serviced by the other key reservicers.

Michael Tarkan - Compass Point Research & Trading, LLC, Research Division

Are you doing anything internally to maybe improve some of the survey results? It look -- the default statistics look good, but it looks like, the survey, you consistently rank towards the bottom of the pack.

John F. Remondi

It is, and that's an unfortunate item. When you look at those survey results, though, the 14 is on the subjective measures where they're measuring satisfaction. The 3 of us are really lumped very closely together and, in some instances, well within the margin of errors, but we -- where there's a significant difference in performance, it's on the default side. And just as through the first 3 years, our default rates are 10% better than the next best player in the contract.

Michael Tarkan - Compass Point Research & Trading, LLC, Research Division

Okay. And then one more, I guess, on the contingency side. And I know there were recent changes that allowed you guys to use IBR to rehabilitate loans. I'm wondering if you see maybe a meaningful increase in recovery rates as a result that would potentially offset some of the fee cuts.

John F. Remondi

Well, we've always been the leader in rehabilitation in the previously defaulted federal student loan collection business. And well, certainly, getting -- allowing borrowers an easier path to making their 9 on-time payments can help on that area. The fee cuts are proposed, and there's been a significant opposition to them in Congress, so we're hopeful that they don't kind of take a penny-wise, pound-foolish approach here.

Michael Tarkan - Compass Point Research & Trading, LLC, Research Division

I think -- and I guess, along those lines, even if fees were cut a little bit, the ability to rehabilitate through IBR, do you expect that would overshadow any kind of cut at this point?

John F. Remondi

Well, as I said, it is a proposal. And so we're -- we don't think that cut is a responsible way to address this portfolio, but the objective here is to get borrowers who have defaulted back into repayment and to eliminate the financial incentives to do so. And I mean, these are not easy things to do, it takes a lot of work. And if you reduce the revenue associated with that so that it -- you're going to reduce the number of borrowers who benefit from rehabilitation. There's no question.

Joseph A. Depaulo

That's right.

John F. Remondi

And there's an -- where we've argued this and presented the facts, people in Congress understand that.

Operator

[Operator Instructions] Your next question comes from the line of Sameer Gokhale with Janney Capital Markets.

Sameer Gokhale - Janney Montgomery Scott LLC, Research Division

So just one question, was in terms of the sale of the FFELP residuals versus purchasing opportunities. And I think, Al, you spoke about this, but I just wanted to flex that out a little further. Does this change your outlook as far as purchasing opportunities? Because it strikes me that, if the pricing is really good for these types of FFELP residuals, then why shouldn't anybody else that owns a FFELP portfolio and has outsourced the servicing also considering the same? And along those lines, have you been marketing the opportunities to buy these portfolios differently now in terms of saying, "We'll buy them in bulk amounts," if you will, and then package them so that the residuals retain the servicing. So just some thoughts there as far as maybe changes to how you're approaching potential sellers of the FFELP portfolios and also what you think in terms of the outlook for being able to buy these portfolios given the attractive opportunities to sell your residuals. So could you talk about that a little bit?

Albert L. Lord

Sure. Sameer, I don't -- philosophically, I don't think it changes anything with respect to our propensity to buy. If there are assets out there that we can buy at an economic advantage, we will do that. I don't see them at all as mutually exclusive. I don't see them at odds with one another. It's what we do, it's what we've done for 40 years. We have acquired FFELP assets either by originating them or by acquiring them in the secondary markets. So -- and we're still looking. Of course, if we popularize a marketplace around the sale of residuals, then others will likely explore that marketplace. The fact is that we saw that there were a couple of these transactions done before we did any, that were notably smaller, of course, than ours. But that marketplace is there, and of course, it could compete with our own ability to buy. I -- there are a variety of other places where we hold advantages there, both in servicing -- obviously, in servicing and in -- and just in critical mass. So that's the nature of markets.

Sameer Gokhale - Janney Montgomery Scott LLC, Research Division

Okay, that's helpful. And then just the other question I had was, in the present, the fiscal year 2014 budget and the income-based repayment limit being proposed at 10% versus 15%, can you just talk about the implications for, say, the valuation and cash flows of your FFELP portfolio? Because one of the implications, I think, is, to the extent that the limit goes to 10% and payments are smaller, it should increase the duration of your portfolio potential, unless I'm mistaken. And then I think the proposal may somehow extend to all borrowers currently, as opposed to a subsegment, currently. Can you just talk about it a little bit and how you think about the implications for your cash flows in the FFELP portfolio, your thoughts on valuation? I mean, it seems like it's clearly designed to help borrowers as well, with the payments. So can you talk about that a little bit?

John F. Remondi

So -- it's Jack, Sameer. I -- this is primarily targeted to borrowers who are in the Direct Lending program who are entering repayment. IBR is really a benefit for kids coming out of school who have larger debt burdens relative to their income. Our portfolio of FFELP loans is highly seasoned at this point. And although it could have some impact. And it would -- and you're right, it would extend cash -- extend duration and, therefore, cash flows, we don't expect it to have a meaningful impact.

Operator

Your next question comes from the line of Scott Valentin with FBR.

Scott Valentin - FBR Capital Markets & Co., Research Division

Just with regard to the consumer finance -- CFPB. They put out a request for comment on servicing. I'm just wondering how you view that. Do you see that requiring -- or resulting in wholesale changes? Or do you think it's more at the margin type changes?

John F. Remondi

They -- we did respond to their request. The CFPB has spent a fair amount of time here at Sallie Mae looking at our private education business. And I think we have done an excellent job. And they have walked away looking at our practices as being industry leading and would expect nothing different on the services side.

Scott Valentin - FBR Capital Markets & Co., Research Division

And then just as a follow-up. I guess, the subsidy, the issue comes up again in July, with the government loan rates. I just wonder if you have a view, this could probably be again a last-minute decision, but your view if it stays at 6.8% or goes to 6.8% from 3.4%, assuming it has a positive impact on the origination outlook.

Albert L. Lord

Oh boy. I think we'll just leave that alone, if you don't mind. You had at least Economics 1 or 2, you know what a rate increase should do in terms of the overall marketplace. But we're not part of that whole decision process.

Operator

Our final question comes from the line of Eric Beardsley with Barclays.

Eric Beardsley - Barclays Capital, Research Division

Just a really quick follow-up on the FFELP margin. You talked about a rebounding in the second half, but how should we think about that out 2, 3 years from now in terms of what the trajectory is of the FFELP loan spread?

Joseph A. Depaulo

Yes, I don't see it moving significantly over the next few years. The only long-term piece is obviously we got a lot of floor income. So if rates were to go up over time, the value of that piece declines. So that's the only thing I would say is significant, with most of this stuff term-funded.

Eric Beardsley - Barclays Capital, Research Division

Yes. I guess, in terms of some of the older loans being slightly higher yield in terms of the previous Special Allowance Payment calculations, does that have an effect as your portfolio seasons further and some of the older loans run off?

Joseph A. Depaulo

Yes, that -- certainly, depending on what your time frame is, it would be. I mean, in the next couple of years, I don't see that 2 or 3 years, but I think over, a 5- to 10-year period, that's going to happen.

Operator

Sir, we have no further questions in the queue. Are there any closing remarks?

Steven J. McGarry

No, Brent. That concludes our conference call this morning. Thank you, everybody, for joining us. And if you have any follow-up calls, please call me or my colleague, Joe Fisher. Thank you.

Operator

Thank you. This concludes today's conference call. You may now disconnect.

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