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SLM Corporation (SLM)

Q1 2010 Earnings Call Transcript

April 22, 2010 8:00 am ET

Executives

Steve McGarry – Managing Director, IR

Al Lord – Vice Chairman and CEO

Jack Remondi – Vice Chairman and CFO

Joe DePaulo – EVP and Chief Marketing Officer

Analysts

Michael Taiano – Sandler O’Neill

Sameer Gokhale – Keefee, Bruyette & Woods

Lee Cooperman – Omega Advisors

David Hochstim – Buckingham Research

Daniel Kim – J.P. Morgan

Brad Ball – Ladenburg

Matt Snowling – FBR Capital Markets

Eric Beardsley – Barclays Capital

Ed Groshans – Height

Jordan Heimwoods [ph]

Operator

Good morning. My name is Terry and I will be your conference operator today. At this time, I would like to welcome everyone to the Q1 fiscal 2010 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator's Instructions) Thank you. I will now like to turn the call over to Mr. Steve McGarry. Mr. McGarry, you may begin.

Steve McGarry

Thank you, Terry. Good morning, everybody, and thank you for joining us for 2010 first quarter earnings call. With me today on the call are Al Lord, our CEO; and, Jack Remondi, our CFO. After their prepared remarks, we will open up the call for questions.

But before we begin 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 that we call our core earnings. The description of quarter earnings for full reconciliation to GAAP measures and our GAAP results can be found in the first quarter 2010 supplemental earnings disclosure. It's posted along with the earnings press release on the Investors page at salliemae.com. Thank you. And now, I'll turn the call over to Al.

Al Lord

Good morning, everyone. So this is our first quarter earnings call. At least as I read so far in the last several hours, we're reporting better earnings than you thought we were going to have. And frankly, they're better than we thought they were going to be. I think you also learned when Jack Remondi's finished talking with you that they're better than – our earnings are better in the first quarter. And we expect now that they'll be better in 2010 than we originally thought.

This is our first opportunity to speak with you since the student loan legislation passed. As you are well aware, it's not good news for the company, and it's certainly not good news for our employees. As you might guess, emotions among the 8,500 of us are wide-ranging, mostly they've gone from mad to sad. I can assure you they're still a long way from glad. This company has been through a great deal. The company is also populated with a lot of professionals. These emotions aren't surprising. We've been in this business for 38 years. We take great pride in who we are. And long before this program was called FFELP, Sallie Mae made it work. The loss of the business is – will cause Sallie Mae to reduce its employee number by approximately 2,500 persons. We expect that will be done by the end of the year 2011.

Yesterday, we announced the closing of two service centers, one in Killeen, Texas; one in Panama City, Florida. And this starts the unfortunate process of the 2,500 person reduction. There are 1,200 people in those centers and other locations informed yesterday.

We expect that our run rate for operating expenses will be roughly in the billion dollar range by the end of the year 2011. For those of you who have been with us for a couple of years, you'll recognize that – that by the end of 2011, we will have cut operating expenses by approximately $0.5 billion in four years.

As I said, Jack will talk to you and cover the quarter very well. I'm going to give you some random thoughts on – on where I think we stand financially with the results of the quarter. We're pleased, I can't say I'm ecstatic, but I'm pleased with the quarter. I'm particularly pleased with our increasing balance sheet strengths. I have to say I'm very proud and maybe just a little bit amused at the strength of our numbers in the first quarter, particularly in FFELP originations. Our numbers in the first quarter are another record for the company. We are in the next of our last quarter of originating FFELP loans, and we've set another record. I can’t help but tell you and remind you this – this is a great company. And it’s growing out of this business with a great deal of style.

We’re building liquidity. We continue to build liquidity. We’re also better positioning our long term debt maturities. As many of you have known and have reminded us that there are a fair number of debt maturities inside the 2010 to 2014 period. And we are reducing that number and spreading those maturities. That activity will continue.

I’d say if there’s a – a not so great spot in the first quarter picture, it would be with private credit volume. Private credit demand remains weak. And I’ll tell you that our new credit quality – and when I say new, I mean particularly in 2008 and 2009 and mid-2009s over – to today, credit quality is solid gold. There's just not enough of it. It’s becoming clear – clear as we get more and more information that 2010 will show an enormous increase in Federal lending, both in FFELP dollars, direct loan dollars, and in total grant dollars. Those dollars obviously reduce demand for private credit.

We introduced a new product a year ago. We are pleased with that product. We are adjusting that product and introducing new products. And we’re adjusting our pricing. But I think the larger picture is that the overall demand is just down for that product.

With respect to our older assets, our private credit asset quality is slowly, but very surely, improving. Our charge-off numbers are better. I remain, and many of us remain, still quite concerned about the very high unemployment rate, which doesn’t always auger well for new college graduates. And so, we again added to our bad debt reserve. But I must say that our assets are performing very well, very well indeed. Cash collections in the quarter were surprisingly high. And frankly, on the collection front, we’re – we are substantially more optimistic.

Like I said, net income looks – is better than we expected, 2010 looks better. You’re well aware we bought in a significant level of debt. We booked some substantial gains and added – added significant level of equity capital during the quarter. We've retained earnings. Our margins are better. Our fee income business came in about $10 million, much better than we expected, collections leading the way. Our operating expenses were up. That is largely in investment spending and higher collection expenses. The collection expenses are paying off. I would suggest to you though that I wouldn’t spend too much time analyzing operating expenses because they are again headed down much as they were the last two years.

I’ll just wrap up by saying we've reached another threshold in Sallie Mae history. Best changes have and will take place. The capital market and political turmoil has taken a high toll, but they seemed to have passed. Capital markets certainly feel a lot more comfortable to us. And we’re getting – we’re getting some needed financing and restructuring accomplished in this marketplace. Politics have been very distracting. And we hope they’re over. We hope it’s – actually hope I it’s somebody else’s turn for a while. We performed well over the recent period. We’re highly cognizant that our shareholders have not done particularly well and the – that share price has not performed particularly well over the past couple of years. It is very much our intention to achieve an appropriate value without getting too precise so I can tell you that an appropriate value is significantly above $13.

I’m going to turn it over to Jack now. Thank you.

Jack Remondi

Thanks, Al, and good morning, everyone. As Al said, I’m going to take the next few minutes to review our operating results for the quarter on both the GAAP and a quarter earnings basis. I’ll also review our funding activity, liquidity; and provide an update on our lending business; and, review the performance of our private credit portfolio. And at the end, I’ll provide an update on our outlook for the remainder of 2010.

For the quarter, core earnings were $212 million or $0.39 a share. And that compares to $249 million or $0.41 a share in the prior quarter. This quarter’s results include restructuring and asset impairment charges related to the new legislation of $30 million or $0.04 a share, and debt repurchase gains of $90 million or $0.11 a share.

Net interest income for the quarter was $702 million versus $429 million in the prior year period. And the net interest margin increased to 1.46% from 89 basis points in the year ago quarter. The changes in net interest income and margin were primarily due to the improvement in the CP LIBOR spread, which was five basis points in the first quarter, 47 basis points better than the year ago period, and the refinancing of our asset-backed CP facility, which has a significantly lower cost of funds.

The provision for private credit loan losses in the quarter was $325 million, a decrease of $2 million from the prior quarter. And the total loan loss provision for the quarter was $359 million, compared to $365 million in the prior quarter. At March 31st, our allowance for private credit loan losses was equal to 8.2% of loans in repayment. And our allowance for both our FFELP and private credit portfolio is sized to cover an expected eight quarters of charge-offs.

Private credit loan charge-offs declined $14 million in the first quarter from $298 million in the fourth quarter. And charge-offs on an annualized basis within our private credit portfolio totaled 3.2% of traditional loans, unchanged from the fourth quarter; and, 15.9% in the non-traditional portfolio, an improvement from 18.6% in the prior quarter. Non-traditional loans today represent 12% of total loans and repayment, but nearly 40% of charge-offs. Within our traditional portfolio, the charge-off rate for loans with a co-borrower, which is the primary focus of our new lending activity, the charge-off rate there was 2% this quarter, compared to 2.4% in the prior period. Overall, our private credit portfolio characteristics continue to improve. At March 31st, 88% of loans were traditional loans, 58% of loans had a co-borrower, and the portfolio have had an average FICO score of 714. This compares to 87% of loans being traditional loans, 55% having a co-borrower, and an average FICO score of 711 at one year ago.

Performance statistics also improved with loans and forbearance at 5.1% of the portfolio, compared to 5.5% at December 31st, and 6.7% a year ago. The 30-day delinquency rate decreased to 3.4% from 4% in the fourth quarter. Our 60-day to 90-day delinquencies increased to 2.3% from 2%, and 90-day-plus delinquencies increased to 6.4% from 6.1% at December 31st. The increase in delinquencies is principally driven by seasonal factors as the new class of graduates enters repayment. Over $3 billion were since the third quarter of 2009. The increase that we are seeing in delinquencies is within our range of expectations for the quarter and significantly lower than the levels reached in 2009. Based on the activity we are seeing in our collection centers, we are confident in our outlook for charge-offs and provision.

Other income in the quarter totaled $336 million, compared to $503 million in the fourth quarter. Included in this quarter’s results are $90 million in gains and debt repurchases; $80 million in revenue from our contingent collection businesses; and, $133 million in revenue from our processing businesses, including loan servicing. Fourth quarter results included $271 million in gains from the sale of FFELP loans under the ECASLA facilities and $73 million in gains from debt repurchases.

Operating expenses, excluding restructuring charges, were $315 million in the quarter, compared to $293 million in the fourth quarter of 2009. The increase in expense was due to a variety of factors, including a reversal of an accrual for fraud losses in the fourth quarter, higher collection costs, and our contingency and purchase paper business as a result of higher collection results and investments in our IT infrastructure.

Restructuring in asset impairment charges related to the new legislation for the first quarter of 2010 totaled $30 million. In March 31st, 87% of our managed assets were funded to life up from 72% a year ago and as Al said, we continue to see improvements in the capital markets and most importantly our cost to capital. On the ABS side, we completed a private credit FFELP deal for $1.6 billion, and after quarter end we completed a $1.2 billion FFELP loan securitization. Both of these facilities came at a tighter spreads, some that we haven't seen for almost two years.

During the quarter, we returned to the unsecured debt market for the first time in almost two years with the $1.5 billion 10-year unsecured note. Demand was strong and the notes price that are spread up to LIBOR of $465. We've used a portion of these proceeds to repurchase debt with shorter maturities at a discount effectively extending the duration of our unsecured debt maturities.

During the quarter, we retired $2.5 billion of unsecured debt including the repurchase of $1.3 billion in notes with maturities in 2010 through 2014 generating the gains of $90 million. In January, we replaced our existing Asset Back CP facility with a multiyear facility that allows us to fund Federal loans at a much lower cost. The new facility provides funding of up to $10 billion in the first year, $5 billion in the second year and $2 billion in the third year. The one-time fees and ongoing rate associated with this facility were $4 million and CP plus 50 basis points respectively, a sharp reduction from the fees and rate associated with the prior facility.

At quarter end, $8.3 billion was outstanding under this program. Also at quarter end, we had $12.5 billion in primary liquidity consisting of cash and investments in committed lines unchanged from December 31st.

On the lending side, we originated a record $7.7 billion worth of FFELP loans in the quarter, an increase of 16% over the year ago period. Through the first three quarters of the 2009-2010 academic year, we originated 26% of all Federal student loans. Despite the shift to schools to direct lending, we continue to see strong growth in our Federal originations in market share, a strong statement of the school’s – of schools customers’ preference for our services.

The FFELP student loans spread in the quarter was 90 basis points compared to 89 basis points in the prior quarter. In that quarter end, 92% of our FFELP portfolio was funded for the life of a loan or long-term in the straight A conduit facility up from 91% at year end.

We're working on a number of opportunities in the student loans base as participants exit the business as a result of the new legislation. We believe we are well positioned to pursue these opportunities as we have both excess servicing capacity and ample liquidity. This year or this quarter we've agreed to purchase three portfolios totaling $1.5 billion worth of FFELP loans, and we expect to see more opportunities to purchase loan portfolios, and to take on additional loan and guarantor of servicing.

We originated $840 million in private credit loans in the quarter compared to $1.5 billion a year ago. Loans underwritten in the quarter remained at very high quality with an average FICO score of 740 in 85% of the loans made had a co-borrower.

There are several factors that are impacting our private loan originations this quarter including tighter lending standards and increased Federal loan limits. In addition to the increase in Federal loan limits, we are seeing more students applying for Federal loans, for example, faster applications nationally were up 21% year-over-year, with applications for independent students, students who can borrow an additional $5,000 for academic year, up 29%. Finally, FELL grants are expected to expand by $11 billion this academic year. All of these factors serve to reduce demand for private credit loans.

As we begin the 2010-2011 academic year, we continue to promote the benefits of our Smart option loan product. We also plan to expand our offerings with the new low fixed-rate payment option for in-school periods and add more loan options for independent students.

Total equity at March 31st was $4.8 billion, which resulted in a [ph] tangible capital ratio of 1.7% of managed assets compared to 2% in the prior quarter. The decline in the tangible capital ratio is driven by the impact of the adoption of ASCA10 [ph], which brought our off-balance-sheet assets on to the balance sheet and eliminated the residual interest asset.

As we allocate capital on a managed asset basis, this accounting change had no impact on our assessment of capital adequacy. With 81% of our managed loans carrying explicit government guarantee, and with 80% of managed loans funded for the life of the loan, more importantly not subject to any additional collateral posting requirements, we believe our capital levels are appropriate.

The gap we recorded the first quarter – we recorded first quarter net income of $240 million or $0.45 a share compared to a net loss of $21 million or $0.10 a share in the 2009 first quarter. The primary difference between our core earnings results and our GAAP results is the mark-to-market pre-tax gains and losses on derivative hedging activity that are recognized for GAAP but not for core earnings. For GAAP this resulted in a net gain of $122 million in the first quarter of 2010. The GAAP provision for loan losses this quarter was $359 million and net interest income for the quarter was $854 million.

As Al said, the passage of staffers [ph] both disappointing and painful, as it requires us to undertake a significant reduction in our workforce. These dedicated employees served students in schools faithfully and skillfully. Our continued growth in FFELP originations this quarter in the face of the tremendous pressure schools received to convert to direct lending, underscores the value of the services our employees continue to deliver to students in schools right up to the end.

In 2011, we’ll no longer originate Federal loans, and the fee income earned under the ECASLA program and from our guarantor origination business will end. Gradually and over many years, our FFELP loan book and our guarantor book will wind down as well.

At Sallie Mae we did not shy away from change. We've successfully transformed ourselves several times to adapt to changing legislation and economic forces, we will do so again. Our tasks for the next year are very clear. We need to execute on multiple fronts. That said, Al said, we’ll reduce our operating expenses by at least $200 million to right size our operations to the new environment. We will maximize the earnings and cash flow generated from our legacy student loan portfolio, and implement a structure that generates value for our investors. We will capture value from the loan portfolio purchases, loan servicing and guarantor-servicing options as others exit this business as a result of the new legislation. We will continue to lead the private credit market and grow market share and we will grow and expand our contingency and processing fee businesses.

Our outlook for 2010 is as follows, we expect to sell $21 billion in FFELP loan under ECASLA, generating $300 million in revenue. We expect to see a private credit provision of $1.2 billion for the year, and a student loan spread in the 160’s, which is based on a FFELP spread in the mid’90s and a private credit spread of approximately 4.5%. Combined, we expect to generate core earnings including restructuring charges in debt repurchase gains of $1.60 plus per share.

And now, I’d like the turn the call over to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll pause for a brief moment to compile the Q&A roster. Your first question comes from the line of Michael Taiano of Sandler O’Neill.

Michael Taiano – Sandler O’Neill

Hey, Good morning. Just a few questions, first on the private student loan business in terms of the origination volume. Is that – first off, is that – it seem like it’s going to come in below your initial $3.5 billion guidance earlier in the year. And then just secondly, what are you seeing in terms of the competitive dynamics in that space? And we’ve been hearing more about others getting more aggressive, such as discovering Wells Fargo. If you could, maybe just comment on that?

Al Lord

I’ll take the first part of it. Maybe somebody can take the competitive side. You asked before and I – if we're going to hit our $3.5 billion. At the moment it does not look that way. We would have to have a – we’d have to have a huge second and third quarter to achieve $3.5 billion. With a – and whether we're able to achieve that, it is not likely.

The competitive dynamics are – I don't mean – every piece of information we have, and this is an area that we're seeking information all the time – market information all the time. Every piece of information we have is that that no one – no one is achieving market share gain, and in fact they're suffering market share losses very similar or greater to the ones where we are – I guess the word is – not achieving.

Joe, you have a thought on it? Is that about right?

Joe DePaulo

Yes, I think that’s right. And we checked [ph] the point of that, the market being flooded with Federal dollars under this program.

Al Lord

We think the longer issue is just the absence of demand. We’re seeing – there are a lot of things in the statistics here. We're also seeing young people applying at lower rates to the high cost schools, or moving across the food chain into public schools and into two-year schools, into community colleges. There’s a great deal of movement – dynamics beneath the surface that we've seen as well. If you’re trying to put your mileage [ph] together, I would put the number less than $3.5 billion, but I’m not going to tell you what number to put in it.

Jack Remondi

If you just look at the data on the dollar side of the equation and we don't have a – the department hasn't published the third quarter’s statistics yet on all factors. But in the first half of the academic year between Federal loan increases and Pell Grants is an additional $17 billion of Federal money in the system compared to the year ago period. And we strongly advocate that students take advantage of grants first – re-money first and Federal loans second. And they are doing that appropriately, and as a result private credit demand is down.

Michael Taiano – Sandler O’Neill

Okay. And then just secondly, obviously I guess you've got a lot to work through the next several months to wind down some of the FFELP operations, but, you maybe give us a sense of both the timing over when you think you’ll have some more clarity in terms of how you’re going to proceed with the legacy FFELP portfolio in terms of structuring the balance sheet? Do you sell it? Do you spend it out? Do you apply for a bank holding company status? All those things? Do you think that that’ll be something that will be resolved over the next three months or so?

Jack Remondi

Al?

Al Lord

Quite a bit. It will be risk – but I think and certainly in the next six months, we'll – we can add a great deal of clarity to that. You’re really talking about structural change, corporate structural change. I think that’s what you’re talking about.

Michael Taiano – Sandler O’Neill

Yes.

Al Lord

We are pursuing all the things that we've talk about it, and whether it’s spin-off sale, or retaining the company in its current form. The objective here obviously is to get our $13 stock a lot closer to what we think its real value is. And if we can achieve that by structural change, we will move forward with it.

Michael Taiano – Sandler O’Neill

Okay. And then just lastly, in the updated guidance does that include any assumptions about acquisitions at this point?

Al Lord

It does not.

Jack Remondi

No.

Michael Taiano – Sandler O’Neill

Okay. Great. Thanks.

Operator

Your next question comes from the line of Sameer Gokhale of Keefee, Bruyette & Woods.

Sameer Gokhale – Keefee, Bruyette & Woods

Thank you, and good morning. Just a few questions, the first one was – as it relates to the bills in the House of the Senate on the private student loans side. Do you have an estimate for how much you think that those bills, which would make private student loans dischargeable in bankruptcy? How much of an impact that will have on your credit loss rate prospectively? We've estimated somewhere in the ball park of maybe less than 30 basis points, maybe 20 basis points or so. Is that in the ball park of how you we're thinking about it? Or could you quantify that for us?

Al Lord

Sameer, you need to stop writing about this stuff because you encourage them. I don't know the precise number. Maybe Jack knows more precise numbers. But I think the numbers are small, and your number sound pretty small. So it’s not something at least that – particularly given the structure of the lending that we do that is particularly troublesome. I think it is very troublesome for young people, ultimately, the availability of credit. But on the bad debt side and how it might affect our provision, we don’t see anything catastrophic there.

Sameer Gokhale – Keefee, Bruyette & Woods

Okay. And then–

Jack Remondi

A presentation has been presented before. And I think when people look at why it exists, we’ve been able to demonstrate that making this type of change is inappropriate. When you go back to the 1970s when they actually put this legislation in place in the first place, it was designed to eliminate some abuses that were going on in the system of people – of students graduating with high debt. They're just filing for bankruptcy and walking away from their burdens. To think that the legislation should be passed to allow bankruptcy dischargeability for one type of loan, which is made to the exact same borrower in the exact same purpose as federal loans, is an argue inappropriate. And as Al said, it will very much constrict the supply of credit to students only.

We are protected, I think as you pointed out, in terms of where we think some losses would be here by the fact that 85% of the new loans we’re making have co-borrowers. And clearly, it would be highly unlikely for both the parents and the borrower – and the student borrower to be filing for bankruptcy simultaneously. But it is something we’re working on and trying to educate Congress as to why they – remind them why they put this legislation in place in the first place in the 1970s.

Sameer Gokhale – Keefee, Bruyette & Woods

Okay. Thank you. I mean, it does seem like Congress can pass legislation regardless of the merits. But it’s helpful to put some numbers behind it.

The other question I had was in terms of the loss reserves, Jack, can you give some commentary on this? But what would you need to see before you actually start growing down those loss reserves? I mean, I don’t see any of those with an impact on the delinquency rates even though you have a year-over-year decline in the delinquency rates. But is there something specifically you're waiting for before you start to draw those down?

Jack Remondi

I think we would like to see how the balance of 2010 trends. We've been performing better than planned for the last year and a half now on terms of our forecast. And that’s obviously very encouraging. We’re still at elevated levels from where we’d like to be, particularly as a result of our non-traditional portfolio. But I think if you’ll look at our charge-off rate this quarter for loans with a co-borrower, which was 2%, that had a very, very strong number in an economy with a 10%-type unemployment rate. So we definitely see opportunities for this number to come down materially over time as the portfolio mix shifts and as – and if the economy improves, we get an even greater lift in that.

Sameer Gokhale – Keefee, Bruyette & Woods

Okay. And then just my last question, in your supplement, you provided some color as to how you think the guarantor servicing and some of those key income items are expected to trend lower with the elimination of the FFELP. And you’ve talked about how you have some opportunities to maybe takeover some additional guarantor servicing. But in terms of the contingency collections business, how do you see that potentially trending now that all the loans will be made through the FDLP and you’re one of the collectors in that part of the business? Do you see that over a number of years offsetting the loss of your fee income from the guarantor servicing side and income related to the FFELP? How should we think about that and the earnings growth for the contingency collections business?

Jack Remondi

We are the largest contingency collector on both – for both guarantee agencies in the country as well as the Department of Education. We do, however, have a larger market share in the guarantor market because they frankly distribute volume to the top performers in a more concentrated fashion.

We certainly hope to be able to and know that we can – if the Department of Ed took the bottom 20% of volume that they allocate to collectors and gave it to the top performing 20%, it would collect billions of dollars more each year in revenues. So I think as we continue to demonstrate our performance in that space, we will continue seeing freeze market share. But we are the largest and the best performing for both customer types there.

Sameer Gokhale – Keefee, Bruyette & Woods

Thanks, Al. And thanks, Jack.

Operator

Your next question comes from the line of Lee Cooperman of Omega Advisors.

Lee Cooperman – Omega Advisors

Hi, good morning. I’m on a vacation so forgive the sophomore question. Opinions are like those, as everybody has one, two or three times in the call you have mentioned that you thought the $13 did not, in any way, reflect the undervalue – underlying value of the business. But it is generally our responsibility to figure out the value. I’m curious, if you could put some hair on that number in the sense of that view as to how you approach the business between the runoff portfolio of the operating business, et cetera.

And secondly, I think you had a conference about four months ago, Al was quoted as saying that, “(inaudible) earnings in ‘10, ‘11, and I think ‘12.” Without getting into specific numbers, from what you're expecting to earn in 2010, you think you have a better year in 2011, just directionally? Thank you.

Al Lord

Lee, I’m always at risk that my Alzheimer’s is checking in on me. But I don’t remember talking about 2012.

Lee Cooperman – Omega Advisors

How about ’11?

Al Lord

Yes, okay, ’11, yes. And so the first question was a valuation question. The second question is related to earnings in 2011.

Lee Cooperman – Omega Advisors

Just the direction, not a specific number.

Al Lord

Look, I’m just going to stick my neck back out on 2011 and say we’re going to be up. And that is really all a matter of offsetting the draconian drop in the origination income that we have from our FFELP origination business. And I’m probably not going to get much more precise on that.

With respect to valuation, look, I know you, Lee, have – you guys have – and probably everybody on this call, has its own valuation methods and have done any number of just net – essentially their own version of net asset value approaches to the company. And I heard numbers, generally in the high teens. My own number, and I have my own methodologies, obviously, probably 10% to 20% higher than some of the ones I’ve seen. But the fact is, even those numbers are substantially higher than the $13 value that we have. I expected you and the rest of them – the capital markets will appropriately value our stock over a period of time. I believe that there’ve been any number of overhangs and event risks hanging over this company for the past two years, whether they are related to survival, or political survival, or just the – the play of issues that have affected this company.

The fact is that many of those things have in fact – have receded and it’s time to pay a little bit of attention to the value of this company. And for us to – for us to do what it is that we can do to make our investors understand the nature of the value of the company and the nature of its earnings stream and without all the political distraction that we’ve had, I think we’re going to do a better job at that. And I know that I am personally focused on trying to get our shareholders to get a feel closer to the value of this company and the value of its cash flow.

Lee Cooperman – Omega Advisors

Can just elaborate on one question? Again, just to–

Al Lord

I know, Lee, whenever I’m finished, it won’t be enough. But go ahead.

Lee Cooperman – Omega Advisors

No, I’ll make it easy on you, so a touchy-feely kind of stuff.

Al Lord

All right. Thank you.

Lee Cooperman – Omega Advisors

You can get to valuation by just doing the blocking and tackling, and the everyday work and working very hard. And your team has worked very hard and come through reasonably well in a difficult environment. You think there are initiatives that are likely to be undertaken in 2010 that would be different in just running the business day-to-day, restructuring things, creating vehicles that might surface value quickly? Or you think it’s going to be the blocking and tackling that’s going to get us the valuation?

Al Lord

Well, yes. Blocking and tackling always works and builds the foundation. I try to tell our guys if we think this company’s worth $20, the market will figure – sooner or later will come to that number. Our job is to make that number higher and not just to add to runoff value of our portfolios, and so, one – or the blocking and tackling and any number of operating initiatives that we’re trying to undertake.

Second part of it, and I think what you’re really referring to is my earlier comments about what the structure looks like. And to some extent, it’s a little bit of financial engineering. I think there is any number of financial engineering opportunities. And I don’t think any of them are particular surprises. And again, with some of the distractions over, maybe not well over, but over, we can – we can focus and get on to some of that. As I tell our guys, we’ve been talking about a lot of discussions last August. And some of the same questions keep getting asked. I’d like to get them to answer now, if they get them answered soon.

Lee Cooperman – Omega Advisors

Good. Thank you very much and all the best. Appreciate your hard work.

Al Lord

Thanks so much.

Operator

Your next question comes from the line of David Hochstim of Buckingham Research.

David Hochstim – Buckingham Research

Thanks. I wonder, can you breakout or have you broken out servicing revenue from the government contract? Could you look at the income statement and tell what the change in the increase in that is over the last quarter?

Jack Remondi

We aren’t in the quarter, just over $9 million in revenue under that contract, about the same as the fourth quarter. The volume closed right now were principally coming – for loans that we’re servicing are coming from loans we sold to the Department of Ed in 2009. We will begin to service direct loans for the Department of Education this summer. And we’ll also see an increase in loan volume from loans that are sold to the department in the fall of this year. So these numbers should begin to grow rather rapidly in the latter half of 2010 and into 2011.

David Hochstim – Buckingham Research

And the servicing that you purchased in the quarter, can you give us a rough idea what that might generate in revenues?

Jack Remondi

We purchased the – we purchased $1.5 billion of – or will purchase $1.5 billion of federal student loans. Some of these loans were already on our system and some were off-system. But it’s the opportunity here, and the yield that these loans will generate is certainly better than anything we’ve seen in a number of years. But I don’t have a specific number for you.

David Hochstim – Buckingham Research

Based on normal fees?

Jack Remondi

Yes, that’s right.

David Hochstim – Buckingham Research

Okay. And just in terms of the prospects for additional acquisitions, are you in discussions with–?

Jack Remondi

Well our view here is just that there’s nothing worse than a servicing business that’s in runoff mode. And so we think there’s only four entities that picked up servicing capacity going forward under the Department of Education. So we see a number of opportunities here. I think everyone was very much waiting for the legislation to pass before they decided what to do. We certainly had the community proposal passed as we hoped. I think their decisions would be very different. So we’ll have to wait and see what we – what will come about, but we’re very confident that we shall see some good opportunities in this space.

David Hochstim – Buckingham Research

A general question, the servicing that was – or the loans that were sold to the Department of Education last year, you said a few times that you’re servicing primarily what you originated. So you didn’t really gain share on that and the other services aren’t all originating as much as you. But what happened to the originations from the entities that aren’t servicing that don't – that aren't servicing? I mean, how’s that been allocated and why didn't you end up getting more of that so far?

Jack Remondi

Part of the reason is because we originated about 45% of all loans that were put to the Department of Education, so we got a disproportionate share. The Department of Education is focused on distributing loan volume through the four entities in some smooth fashion here. So part of the reason why – we have converted loan portfolios onto our system. But we have not converted as much as others because we started with such a large number to begin with.

David Hochstim – Buckingham Research

Okay. Thanks. (inaudible) other people hadn’t solved.

Operator

(Operator Instructions) Your next question comes from the line of Daniel Kim of J.P. Morgan.

Daniel Kim – J.P. Morgan

Good morning, guys.

Al Lord

Good morning.

Daniel Kim – J.P. Morgan

So just a quick question on how you see your funding strategy for private loans is going to be in the future, is it mainly a securitization market completely opening up? And what’s your opinion on that?

Al Lord

Today, well, for the last two years, we’ve been funding new origination growth through our bank, Sallie Mae Bank, and principally doing that with Birchwood [ph] deposits. In the first quarter of this year, we launched a retail deposit initiative targeting our 20 million-strong Sallie Mae customer base, half of which are working with us to save for college. And so we see those two as a significant source of funding for new originations long term, and we do expect and plan to securitize those assets in the capital market to provide life of loan funding.

And the $1.6 billion ABS deal we did this quarter did finance – that was substantially financing loans that were held by Sallie Mae Bank. And we saw for the first time in that transaction a number of cash investors in that deal. And so we're very much optimistic that the private credit ABS market is returning with investors and both – from both the supply as well as the cost of fund base of things. You should expect to see us return to that market in a non – with a non-FFEL deal sometime in the second half of 2010.

Daniel Kim – J.P. Morgan

Thank you. And second question is, of the cost there being made of 2,500 employee reduction, where is that mainly made? Is that mainly in the origination or the unknowns – general loans? And how will that affect your ability to grow your private loan portfolio in the future?

Jack Remondi

The reductions are principally as a result of the fact that activities that we perform today won’t be there tomorrow. Clearly, that starts with originations. And originations people are dealing with both customers on phone calls as well as processing applications. And that’s why you see the centers in Killeen and Panama City, unfortunately, being – bearing the brunt at the start.

Over time, there're other businesses. The FFELP loan side of the equation and the guarantor servicing lying down, that’s where the job reductions will occur. We don’t expect to see job cuts taking place in our private credit because we expect that to grow. And some of the losses on the FFELP side are offset by our forecast for increased servicing under the Department of Education contract. But it’s not just becoming more efficient, it is the vast majority of jobs are being lost because the programs have been pulled away from us.

Daniel Kim – J.P. Morgan

Got it. And the last question, what is the – what do you see as the run rate of the restructuring cost will be? I think you posted about $20 million. And how long do you see that going through, just this year or–?

Jack Remondi

It should be – the vast majority should be this year. We booked $30 million of restructuring and impairment related charges. We would expect to incur probably something in the $45 million to $55 million range for the balance in 2010.

Daniel Kim – J.P. Morgan

Great. Thank you very much.

Operator

Your next question comes from the line of Brad Ball of Ladenburg.

Brad Ball – Ladenburg

The $60 new guidance for 2010 is $0.10 above what your guidance was a quarter ago. What’s the main driver of that $0.10 improvement this year. Is it related to FFELP volumes this past quarter or is it debt repurchases? What’s in there?

Jack Remondi

It’s a combination of factors. It's the debt repurchase gains that has been – being substantially higher than what we've been guided to at the beginning of the year. They have actually occurred. It is higher volume on the FFELP side of the equation and more revenue from the sale of those loans to the department later this year. And it is an improvement in the CP LIBOR spread. We’re running at 5 basis point in the first quarter, compared to what would typically be an 8-basis point to 10-basis point range under normal interest rate environments.

Brad Ball – Ladenburg

Okay, so no assumed reserve reductions under provision or anything like that?

Jack Remondi

We kept our guidance there at $1.2 billion unchanged.

Brad Ball – Ladenburg

Yes, got it. Now the impairment charges you just mentioned, I'm referring to the last question, are those included in the $ 60?

Jack Remondi

Yes.

Brad Ball – Ladenburg

They are, those charges. Okay. And then in terms of the pace of expense reductions that you talked about, is that going to be more front-end loaded since you’ll be, I assume, making most of the layoffs this quarter?

Al Lord

We’re still doing – we're still doing business.

Jack Remondi

The announcement was this quarter, but the actual reductions will take place in the second half of the year.

Brad Ball – Ladenburg

And so, do you think the bulk of the expense reductions would be apparent in the third quarter? I’m just trying to get a sense as to how to scale it in.

Jack Remondi

You’ll see the first half of them occur in the fourth quarter, and the balance in 2011.

Al Lord

Hey, Brad?

Brad Ball – Ladenburg

Yes? Yes, Al.

Al Lord

This is tough enough.

Brad Ball – Ladenburg

Yes, I know. I’m not trying to make it–

Al Lord

Don’t rush these terminations, all right?

Brad Ball – Ladenburg

Not at all, not at all.

Al Lord

Thanks.

Brad Ball – Ladenburg

Just a follow-up on the private loan question that came up earlier, just to clarify, so the discussion about taking away the private loan non-dischargeability has been around. I think it was a couple of years ago, or seven maybe, when it first was introduced. So it's not a new issue for you guys to think about. When you respond by saying you don’t expect a big impact on your credit, is that because all the new private loans you're making have a high proportion of co-borrowers – co-signors?

Jack Remondi

The bankruptcy issue is still in evaluation. And what we need to know is how many people would, in effect, use the ability to file for bankruptcy upon graduation, right? That's the piece we don’t know. We have been – I want to be clear, we’ve been supportive of this bankruptcy reform provided that borrowers make – have some obligation after they leave school to make payments. And we’ve said five years. And then, if there is a hardship-related issue, we would be supportive of that.

But it's a little hard for us to understand how the same – the same borrowers borrowing for the same purpose in one program should be allowed to discharge when they graduate and not in another. It doesn’t make economic sense to us. It doesn’t sound fair in any way, shape, or form. And clearly, as you can see, no one's proposing dischargeability for federal loans.

So we will continue to try to educate people as to what’s going on here. There's no question that if – if bankruptcy were allowed, the fact that loan – 85% of the loans we made this quarter has co-signors associated with them decreases any impact dischargeability perspective. But what it does mean is that it's going to be harder for us to make the loans to the 15% that didn’t have a co-signor, right. If we think that people with – that persons could file for bankruptcy and discharge their debt, discharge their private credit debt, it's a little hard to make a loan until you see some of the evidence as to how behaviors change.

Brad Ball – Ladenburg

Got it. I appreciate that color. Thank you.

Operator

Your next question comes from the line of Matt Snowling of FBR Capital Markets.

Matt Snowling – FBR Capital Markets

Yes, good morning. I guess two quick questions, one, can you update us on the pricing of this new smart option loan. I think maybe a year ago, you mentioned pricing was around (inaudible) a $1,000. Has that come down any?

Jack Remondi

Yes, it is coming down, and it’s coming down as our cost of fund decreases. We've seen probably a 200-basis point improvement in our funding costs over the last six to nine months. So you can look at more – and that's basically how we're pricing. We’re not pricing it to a yield or pricing it as a margin to our funding costs. And one of the things that we are looking at also doing as credit performance in that portfolio class is becoming substantially better is tightening a little bit on the margin targets as well.

Matt Snowling – FBR Capital Markets

Good. I guess another quick question. It's my understanding that the direct lending portfolio being serviced by ACS, that contract expires in August. Is that correct? And if it is, will that portfolio just fold into the Department of Ed servicing contract that you have along with the other three services?

Jack Remondi

The contract with these – the two components to the contract, Matt, one is the new originations. And that's the piece that expires in August. So for new loans made, that volume – the expectation of that no new volume will go to the old party to that contract. We certainly expect, although the department has not announced plans yet, to – that the balance of outstanding loans will eventually transfer to the four other services as well.

Matt Snowling – FBR Capital Markets

And you don’t have any borrowers in that contract or the balance of existing ones?

Jack Remondi

I think it's – we're expecting that – I think the outstanding balance is somewhere around $115 billion to $120 billion outstanding. I don't know the borrower account.

Matt Snowling – FBR Capital Markets

Okay. Thanks a lot.

Operator

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

Eric Beardsley – Barclays Capital

Hi, thanks. I'm just wondering if you could provide an update on your plans for the purchased paper wind down that you're pursuing to sell or just going to wind that down internally.

Jack Remondi

We've certainly looked at opportunities to sell that portfolio from time to time. Yes, the market conditions generally don’t – don't provide a whole lot of opportunity for that. But that balance is declining rather rapidly. It’s the carrying value of purchased paper at quarter end was down to $245 million versus $459 million a year ago. And the collection results to date have been exceeding – for the first quarter had been exceeding our expectations. So at this stage in the game, it looks like a wind down versus a sale.

Eric Beardsley – Barclays Capital

Okay. Great. And secondly, I just have a question on operating expenses. You guided to $1 billion as a run rate for the end of 2011, I believe. And I guess just looking at your current OpEx of $318 on a quarter basis, and if you take out the $30 million and the write downs in I guess somewhere around $288. So just comparing those numbers, it looks like a 15% reduction OpEx to slightly below we’ve been expecting. I'm just wondering if you have any updates there or clarity on that number.

Al Lord

How did you get that $318 million to $288 million?

Eric Beardsley – Barclays Capital

You start with the $30 million in write downs in terms of impairments after the–

Al Lord

Oh no, no. There’s $30 million – there's $30 million, what we'll call restructuring, which includes I think $3 million of impairment. The $30 million is essentially severance estimates and probably some real estate costs, and a variety of other things. But that $30 million goes – takes you from about $345 to $315, which is – I mean I think our run rate of – at least as I look at it month-to-month and line item to line item, is about $310.

Eric Beardsley – Barclays Capital

Okay. That’s great. I just wanted some clarity there.

Al Lord

The $250 is 20%. Actually it’s more than that.

Eric Beardsley – Barclays Capital

Okay. Terrific. I just wanted to – okay. I just wanted to make sure I understood that properly. I guess on the $1.5 billion in additional portfolio that you guys are picking up, going forward, do you have a preference whether you buy whole portfolio or whether you just service them?

Jack Remondi

We would look at both opportunities as equally interesting. And obviously, it all depends on terms and conditions, and funding capabilities. But we're eager to do both.

Eric Beardsley – Barclays Capital

All right. Great. Thanks so much.

Operator

Your next question comes from the line of Ed Groshans of Height.

Ed Groshans – Height

Good morning Al, Jack, and Steve. I wanted to say congrats, very nice quarter in a volatile environment.

Al Lord

Thank you.

Ed Groshans – Height

I do want to – I guess just going back to David’s questions on the servicing. I guess, can you just discuss, once we get into the SAFRA programs starting this July, what your expectations are for servicing allocation. And then, will that change a year out or two years out after people shows how well they're doing on the servicing?

Al Lord

I think our – Jack commented a little bit about this and suggested that we would like – we would love for the Department of Education, in its allocation endeavors, to allocate on the basis of merit. And we hope they’ll do that. We expect though, that they're going to allocate proportions probably more related to the respective size of the entities that they're servicing. And I think our expectations are that there might be a maximum allocation in the range of about 40%.

Jack Remondi

That is the contract terms. That's correct. But they have not – to answer the question, the department has not spelled out exactly how they planned to allocate. They have measurements or categories that they will measure against one another. But they don’t say if you are in the top category, you get X percent better.

Ed Groshans – Height

Okay. But roughly, if we target like 40% maybe two years out that would be a good place to look?

Jack Remondi

Forty percent is the maximum under the contract as it exists. Could the department waive that? Yes. But I think that will be the high end, obviously.

Ed Groshans – Height

But if I understand you’re servicing platform relative to most of your peers, the – you should excel and be closer to 40% than not.

Jack Remondi

We certainly expect to get more than 25% share. I just think – what do you guys – I mean to be right at the top of the contract, I just think it's a high expectation. That's all.

Ed Groshans – Height

Okay. All right. Fair enough, Jack. Thank you. Then the other thing and just following up on the bankruptcy and when the dischargeability comes in, can you just – right now, when you look at – when you get a bankruptcy notice on either – FFELP doesn't matter, so. But if you get bankruptcy in those and the private loans, whether it's on balance sheet or off balance sheet, can you just walk us through how you account for that? And then, would that change if dischargeability can enter fruition?

Al Lord

Yes, it would change. I mean today, the loans – the loan basically goes into a forbearance-type status as it awaits the outcome of the bankruptcy process. Once the bankruptcy is lifted, then the loan goes back into repayments. If the loan were discharged, obviously, the loan would – would be reduced or – proportionally or some – whatever the bankruptcy decision happens to be. Now remember, at a co-signed loan, if one party files for bankruptcy, the balance of the loan is not impacted nor the obligation of the other party.

Ed Groshans – Height

Right. So those currently – if I just – if I understand this. If there's a loan on balance sheet, you just put in the forbearance when you get a bankruptcy notice, and then continue to work it out as opposed to charging off the balance.

Jack Remondi

You go into a stay while the bankruptcy process is – takes place. And then after the bankruptcy process is resolved, the loan goes back into repayment.

Ed Groshans – Height

And is that for the pools?

Jack Remondi

Yes.

Ed Groshans – Height

It's the same for the pools. Okay. Great. Thank you very much.

Jack Remondi

Yes. You're welcome.

Operator

Your next question comes from the line of Jordan Heimwoods [ph].

Jordan Heimwoods

Hi, guys. Thanks for taking my call.

Jack Remondi

Sure, Jordan.

Jordan Heimwoods

Two questions, the three portfolios that you bought for $1.5 billion, what was the premium or discount you made for that?

Jack Remondi

We're not prepared to talk about that at this point.

Jordan Heimwoods

Can you say if there was a premium or discount?

Jack Remondi

No. No, there was not a premium.

Jordan Heimwoods

There was not a premium. Okay. Okay, second question is the – the servicing contract, do you have any estimate range of what margins will be on that on either a pre-tax or EBITDA?

Jack Remondi

We're also not – probably not ready to talk about that margin yet. I think that's something to come in the next – in the next couple of quarters.

Jordan Heimwoods

Well what's the servicing margin on your current business? How about that question?

Jack Remondi

Well today, on our current business, we obviously aren't in our servicing cost – I mean, it depends on what your revenue metric is, right? We earn it through net interest income. And so we're earning 90 basis points yield on our FFELP portfolio from which we have to pay servicing costs. And our servicing cost is clearly not 90 basis points or anything close to it. Under the Department of Ed contract, it's a little bit different. What we have said today and we'll repeat is that this contract is profitable. It's attractive on a margin basis. And we think we have the scale to – and efficiencies to improve on that over time. We are larger than the three other services combined and expect to benefit as a result of that scale process.

Jordan Heimwoods

What's your current margin on third party servicing today? And I realize the FFELP business would be less profitable.

Jack Remondi

It varies with – the business there is very small to date. But the margins are significantly into the double digits.

Jordan Heimwoods

Okay, so somewhere between 10 and 20?

Jack Remondi

Yes.

Jordan Heimwoods

Okay. Thank you very much.

Jack Remondi

I'll tell you, aren't you? Thanks, Jordan.

Operator

Ladies and gentlemen, we ended the allotted time for questions. Are there any closing remarks?

Steve McGarry

No, Terry. That concludes our call. Thank you, everybody, for joining us this morning. And if you have any follow-up questions, please contact myself, Steve McGarry, or Jill Fishman [ph] in the IR department. Thank you.

Operator

This concludes today's conference. Once again, thank you for your participation. You may now disconnect.

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