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SLM Corp. (NASDAQ:SLM)

Q3 2010 Earnings Call

October 20, 2010 08:00 am ET

Executives

Steve McGarry - MD, IR

Al Lord - Vice Chairman & CEO

Jack Remondi - VC & CFO

Analysts

Sameer Gokhale - KBW

Mike Taiano - Sandler O'Neill

Lee Cooperman - Omega Advisors

David Hochstim - Buckingham Research

Matt Snowling - FBR Capital

Moshe Orenbuch - Credit Suisse

Eric Beardsley - Barclays Capital

Operator

Good morning. My name is Regina and I will be your conference operator today. At this time I would like to welcome everyone to the third quarter 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 Instructions). Thank you. I would now like to turn the conference to Steve McGarry. Sir you may begin the conference

Steve McGarry

Thank you Regina. Good morning and welcome to Sallie Mae's 2010 third quarter earnings call. With me today are Al Lord our CEO, and Jack Remondi, our CFO. Before we begin, keep in mind that our discussion will contain predictions, expectations and forward-looking statements. Actual results in the future maybe materially different from those discussed here. This could be due a variety of factors and listeners for a 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. And description of core earnings, a full reconciliation of GAAP measures and our GAAP results can be found in the third quarter 2010 supplemental earnings disclosure. This is posted along with the earnings press release on the investor's page at salliemae.com. Thank you and now I'll turn the call over to Al.

Al Lord

Thanks Steve, good morning everyone. Thanks for your interest. I am going to cover briefly our third quarter earnings and a couple of items that I want to cover with our shareholders and now I'll turn it over to Jack.

So we reported $0.35 per share in earnings from the third quarter 2010, up from $0.26 a year ago. There really weren't a lot of so called one time items in our $0.35 in earnings and so it's actually a fairly reliable indicator of where we are.

The net interest income in this preceding quarter was better than a year ago better because CP-LIBOR normalized over the past year and we have higher private credit yields and very, should I say very, very slight asset growth on the private credit side.

We had a significant year-over-year reduction in our charge-offs and private credits some $95 million versus the year ago quarter, through there was a slight seasonal up tick from the second quarter. I'll talk a little more about credit quality in a minute and Jack Remondi will also talk about credit quality and the seasonality of credit quality in a minute.

Our operating expenses were up very slightly from 2009 and while I don't hear the questions so I can sort of feel them and I know the question is why aren't they down, so first on there is a variety of reasons for that. I think our time is probably better spent on talking about the quest levels for today and tomorrow. Costs are coming down. They are in fact coming down gradually in a variety of areas.

For the year 2010, full year 2010, operating expenses will be about $1.3 billion. You can expect expenses in quarter four 2011 to be about $250 million; that's one year from now. We will enter the year 2012 with less than a $1 billion per year run rate.

I just want to make this clear so I'll say it again. So beginning this quarter Q4 2010 through Q4 2011, that's five consecutive quarters, you will see reductions in operating expenses. We will reduce operating cost to an annual level going into 2012 of less than $1 billion.

Talk about private credit; again in the third quarter demand was weak. Our volume was about flat for the year ago. I'd like to think that it's bottomed out. Certainly it's an important question for us whether it's bottomed out but I can honestly tell you we don't really know that it has. Families remain very cautious, there is still a lot of federal money in the system, but we did notice that tuition and fees have begun growing again after a couple of flat years. We expect volume for the full year to be about $2.25 billion dollars.

I mentioned the charge-off decline from the year ago quarter. Not only did the charge-offs go down but our delinquency stats are better, our forbearance statistics are better. Forbearance levels are now well below the 2000 levels before 2007. Our 30-day delinquency level is the lowest it's been since December of '08.

This is good news, its good news in a very tough environment. Nonetheless, charge-offs are naggingly high as unemployment levels seem stuck. We know that our portfolio of loans and repayment, our customers have jobs and keep their jobs, we are graduates obviously to get jobs. And this is a tough environment.

While we are not forecasting any improvement in the economy, we do expect again a significant reduction in charge-offs going into 2011. That's really based not on the economy but on the improving quality of our existing assets, and particularly in the quality of assets that are moving into the repayment status from school status.

So I'm going to wrap up by talking to you about; over the course of the year as we contemplated losing FFELP, we have talked to you about a variety of strategic options that both the Board and management have been considering. You'll recall we've talked to you about spin-offs in certain parts of the business. We've talked about deleveraging our balance sheet by selling our remaining financial interest in our FFELP portfolio.

Those strategies that they were contemplated were contemplated really to try to hasten the shareholders realization of value we believe is pent up in our balance sheet and in our operations. I've not been shy about talking about the value of our company or the intrinsic value of our company as we measure it, being some 50%, 60%, 70% above the market value, and we obviously would like for our shareholders to realize some of that value.

We also looked at some of these possibilities, strategic possibilities to avoid possible regulatory issues that have been discussed over the past couple of years and frankly even taxes that might be based upon total assets. The tax and regulatory matters seem less likely now, I say seem less likely, no one ever knows for sure. We have also learned that it is virtually impossible to actually deliberate assets off your balance sheet no matter how many times you sell them and so long as we service the assets even if we don't own the assets they will remain on our balance sheet.

So maybe there's another way of just saying that you are not going to see any dramatic balance sheet actions from the company at least anytime soon. I would also tell your Board of Management remained very committed to delivering the value that we see in the company and we will move timely to do that, timely but not hastily.

The company has significant, ample cash flow both from FFELP and private credit and its other operations we have actually shared those cash flows with our shareholders recently and are prepared to share them with anyone who remains interested. Those cash flows are spread over 20 years and we have got two-thirds of our unsecured liabilities or unsecured debt maturities mature over the next four years so it's a bit of a mismatch. We have been working on that mismatch and in fact we have retired some $9 billion of unsecured liabilities over the past couple of years and we believe we are really only months away from a much better match of our cash flows of assets and liabilities. And that's really took to me, that's really a precursor for us to any specific actions we might take with respect to delivering shareholder value.

I think and I expect a fair number of questions on this but I'm going to turn this over to Jack to discuss in more detail our quarter and then we will talk to you in a few minutes. Thanks.

Jack Remondi

Okay, thanks Al, Good morning everyone and I'm going to take the next few minutes to review our operating results for the quarter on both the GAAP and core earnings basis. We'll take a look at our funding activity and liquidity providing update on our lending business and review the performance of our private credit portfolio. And at the end we'll provide an update on outlook for the remainder of 2010 and a first look at 2011.

For the quarter, core earnings were $189 million or $0.35 a share that compares to $164 million or $0.26 a share in the year ago quarter. This quarters results included debt repurchase gains of $18 million or $0.02 a share. Net interest income was $756 million for the quarter versus $690 million in a prior year period and the net interest margin improved to 1.52% from 1.32% in the year ago quarter. The changes in net interest income and the margin from one year ago or primarily due to improved basis spreads principally CP LIBOR spreads increased floor hedge income and lower funding cost.

The provision for private credit loan losses in the quarter was $330 million, a decrease 19 million from the prior quarter and the total loan loss provision for the quarter was $358 million compared to $382 million in the second quarter.

At September 30th, our allowance for private credit loan losses was equal to 7.9% of loans and repayment. Including the provision, net interest income totaled $320 million from FFELP and $73 million from private credit loans in the quarter compared to $333 million from FFELP and $45 million from private credit in the second quarter. Seasonal factors drove an increase of private credit loan charge-offs of $12 million to $348 million in the third quarter from $336 million in the second quarter. Charge-offs however declined by $95 million from the year ago quarter even as loans and repayment increased by $4 billion or 19%.

The annualized charge-off rate for the quarter declined by 33% to 5.4% of loans and repayment from 8.1% a year ago. Non-traditional loans represent 11% of the total portfolio and repayment, a nearly 35% of charge-offs. There are significant seasonal trends to our private credit delinquency and charge-off statistics. Each year, the majority of loans entering re-payment do so in December. As a result, early stage delinquencies increased in the first quarter moving to later stage delinquencies in the second quarter and finally to a seasonal charge-off peak in the third quarter of each year

Although changes to our forbearance practices muted some of the seasonality in the past two years, this quarter's experience largely reflects the seasonal nature of delinquencies and charge-offs. When taking these seasonal aspects into account, the performance trends in the portfolio are quite positive. Delinquencies are down on both a sequential quarter as well as a seasonal basis and charge-offs are down significantly from the prior year seasonal peak.

And that's a trend we expect to continue into next year. In addition to seasonal factors the performance of our student loan portfolio also varies based on the portfolio mix, traditional, non-traditional, cosign, non-cosign in the overall seasoning of the borrower after they enter repayment. For example, approximately 80% of our charge-offs occur before a borrower makes 12 payments. The mix and distribution of the portfolio are therefore key indicators of future loan performance.

For 2010 and in particular this current quarter the quality of loans that are entering repayment is superior to the loans that entered repayment in 2008 and 2009. For example, loans that went into repayment in the fourth quarter of 2008 were originated with an average FICO score of 710, 10.2% of them were non traditional loans and 54% were cosigned. By contrast, loans that will enter repayment this quarter, the fourth quarter of 2010 were originated with an average FICO score of 719, 7.5% of them are non-traditional loans and 62% of loans are cosigned.

Subsequent repayment cohorts have even stronger statistics. In addition, once the borrower has made more than 12 payments, the incidents of delinquency and default decreased significantly. At September 30, a larger and growing portion of our portfolio, 64% has made 12 or more payments compared to a year ago of 57%. For these borrowers the 30-day plus delinquency rates are more than 10 percentage points lower. This quarter we provided more detailed statistics on the seasonal and seasoning aspects of our portfolio in the third quarter review package that was released this morning.

Other income in the quarter totaled $226 million compared to $308 million in the second quarter. And this quarter's revenue included $18 million in gains and debt repurchases, $84 million in contingent collection fees and $104 million from our processing business which includes loan servicing.

Second quarter results included $91 million in gains from debt repurchases, $88 million in contingent collection fees and $111 million from our processing business. Operating expenses excluding restructuring charges increased to $319 million in the quarter compared to $303 million in the third quarter of 2009.

As Al indicated we're fully focused on right sizing our operating budget, we believe the right operating expense is less than $1 billion a year and we expect to see sequential quarterly decline and to reach this run rate by the end of 2011.

At September 30th, 89% of our managed assets were funded to life up from 86% a year ago and during the quarter we completed several secured financings including $760 million FFELP loan securitization at a cost of LIBOR for 51 basis points. And two term private loan ABS transactions totaling $2.5 billion. The private credit transactions both refinanced an existing private loan securitization and securitized previously unencumbered private loans.

Improved market conditions allowed us to refinance the $1.5 billion deal we did in 2009 improving both the overall advance rate and lowering the cost of funds. The end result of these transactions is that we raised additional liquidity of $1 billion at a cost well below the yield on our unsecured debt and lowered our overall cost of funds. During the quarter we retired $2.6 million of unsecured debt including repurchases of just under $900 million in notes with maturities in 2010 through 2014. We continue to create and utilize excess liquidity to generate value through debt repurchases.

Total liquidity at quarter end was $11.5 billion consisting of cash investments and borrowing capacity from committed facilities. Our securitized FFLEP portfolio generated $444 million in excess cash to the company in the third quarter and to put that into some perspective, our FFELP servicing costs in the quarter were $52 million.

During the quarter we reached an agreement to purchase $28 billion of securitized federal student loans and related assets from the student loan corporation and this transaction is expected to close by year end 2010.

We expect this transaction will be accretive to earnings in 2011, by $0.13 on a core basis, floor income would add to this. More importantly it will generate substantial cash flow immediately and over the life of the trust. This is a great example of the industry consolidation opportunities we thought we would see as a result of the change in legislation.

On the lending side, we originated $853 million worth of FFELP loans in the quarter and before you say we thought FFLEP ended, these originations were second disbursements on previously originated loans and were included in the loan sale to the department of education in October.

The FFLEP student loan spread in the quarter was 99 basis points compared to 104 basis points in the prior quarter and at quarter end 94% of our FFELP portfolio was funded for the life of the loan or long-term in the straight A conduit facility up from 93% in the second quarter.

We originated $835 million in private credit loans in the quarter, a decrease of 6% from $893 million in the third quarter 2009. The small decrease as we think a first time at the sharp decline in private loan demand of the last two years may have run its course.

Loans underwritten in the quarter we are of very high quality, they had an average FICO score of 740 and 92% of the loans we made had a co-borrower. As a reminder loans with a co-borrower defaulted less than half the rate of loans without.

Total equity at September 30 was $4.6 billion resulting in a tangible capital ratio of 2% of managed assets an increase from both the prior and year ago quarters.

For GAAP, we recorded a third quarter GAAP net loss of $495 million or a $6 per share compared to net income of a $159 million or $0.25 per share in the year ago quarter.

Our third quarter GAAP results include a $183 million unrealized mark-to-market pre-tax loss and hedging activities and a $660 million pre-tax goodwill and intangible asset impairment charge. These items are recognizing GAAP but not in our core earnings results.

On the impairment charge as a result of new market data and new legislation we evaluated both the goodwill and certain intangible assets in our Asset Performance Group, our Guarantor Servicing segment and our Upromise Operating segment and determine that these assets were impaired and rowed off the entire balance of goodwill in these segments. This non-cash charge does not impact our tangible capital, our tangible capital ratios or our view on capital adequacy.

Our financial outlook for the remainder of 2010 includes the fact that we will generate $315 million in revenue from the sale of $21 billion worth of FFELP loans. The sale actually took place over Columbus Day weekend in October in a full year private credit provision of $1.3 billion, leaving us with over $2 billion in reserves for private credit loans losses as we enter 2011. Combined, we expect to generate core earnings including restructuring charges in debt repurchase gains of more than $1.70 a share.

The 2010 forecast includes $0.39 from federal loans sales and $0.26 in debt gains. For 2011 these items will not repeat. As a result we see earnings in 2011 at $1.50 per share.

At this point I'd like to open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line Sameer Gokhale with KBW.

Sameer Gokhale - KBW

My first question Jack was more for you, I think you talked about the trust data and some of the statistics there and your private student loan data, and I guess I was curious why it seemed like there was more of a divergence between the trust charge-off metrics and your reported metrics? It seemed like there was more of a divergence than you've seen in prior quarters. Was there any sort of change to the way you estimate recoveries or anything of the sort that might explain that difference this quarter compared to prior quarters?

Jack Remondi

There were no changes in the assumptions on any of those categories. The difference between the trust portfolio and the managed book really relates to the fact that the non-traditional loans are principally on balance; they are not in securitization trusts and so you see a significant divergence there. The charge-off rate for traditional loans in the quarter was 3.9% of loans in repayment compared to almost 18% of the non-traditional book, and that really is what drives the different performance statistics.

Sameer Gokhale - KBW

I'm sorry, I should have clarified. I was comparing the trust to the traditional loan performance only so because keeping aside the non-traditional loans. It just seemed like there was still more of a divergence there than we've seen in prior quarters.

Jack Remondi

To that extent it would be a function of where the loans are in the repayment cycle. If you refer just some of the slides that we released this morning you can see that you know if the loans that are in the first year of repayment in the traditional book, we had a charge-off rate of about 6.4% compared to loans that are in subsequent 12-month buckets that are substantially lower than that. So that seasoning, obviously loans that are in the securitization trust are more seasoned than loans that are on balance sheet, and that's a big driver of performance.

Sameer Gokhale - KBW

And then, I just want to get a sense for earnings expectations. I know you've given us guidance for 2011. I am not asking for specific guidance looking out to 2012 at this point but just to try to think through this a little bit; if your guidance is for $1.50 next year, you are expecting these operating expense improvements and you'll realize most of them in 2012 onwards because by then you'll be done with all your expense reduction initiatives of most of them and then you add on top of that the fact that could experience a much more normalized loss rate, charge-off rate in 2012. Is it reasonable to think when you factor those numbers in there that your EPS could be north of $2 in 2012 or am I missing something there?

Jack Remondi

We're not prepared to give specific dollar ranges directionally though 2012 will be higher than 2011. You are correct in the positive fact just that you mentioned. On the opposite side of that is you do have one-off or the amortization of your FFELP book. And so that's a pretty steep hill decline. But earnings will be higher in 2012 than it will be in 2011.

Sameer Gokhale - KBW

And then, just a last question Al. I think in your comments you talked about being months away from a better matching of assets and liabilities and I just wanted to get a better sense for what you meant by that. Is it something like you intend to issue unsecured debt, use the proceeds to maybe even out your debt maturities and then have more free cash flow you can give to equity holders? Is that what you are envisioning or is it something else?

Al Lord

I think the bottom-line, Sameer, is that we want to extend our liabilities. I think we have some $22 billion in round numbers of unsecured liabilities. In total, about $14 billion of them mature in the next four years. We would like to spread that out a little bit better. As I said, we have managed that number actually very aggressively over the past couple of years and literally taken almost $10 billion of unsecured debt off the books. Now it's just a matter of spreading a little bit more smoothly against the cash flows that we have.

Operator

Our next question comes from the line of Mike Taiano with Sandler O'Neill.

Mike Taiano - Sandler O'Neill

Just the follow-up on the sort of the strategic initiative; I guess now that it's been out, looks like it's off the table, sale of the residual. Looks like that's not going to happen. So I guess at the end of the day, it’s more or less status quo and just trying to get a sense of the capital return or the cash flow return to shareholders and you mentioned that asset liability is mismatch. I mean, as it stands now, it seems like it will be difficult to initiate a significant dividend or share buyback given where you’re liquidity is. I think you have like X within the bank, roughly $3billion or so of cash available and you have I guess over $5billion of debt maturing through 2011. So can you help us maybe understand what your thought process is in terms of the timing there. Does something else need to happen and correct me, is dividend and share buyback what you are thinking about at this stage?

Jack Remondi

I think on a cash flow side of the equation, we’ve tried to lay that out, the substantial components of that particularly from our FFELP book by year for investors and we look at those numbers and we look at cash that’s generated from other components of our business relative to our unsecured debt maturities. We are in a good position through 2014 which is when our peak liabilities, maturities occur. Our challenge as we want to have financial flexibility to do different things and I think the student loan corp deal is a good example of that.

We are able to work that transaction out with a seller financed note, but those aren’t necessarily things that will always be available and having greater access to liquidity and financial flexibility would be important. You hate to have lost a deal like that because of some other commitment on the returning capital to shareholders. We are committed to that, that is our goal and objective to get there. As a financial services company, we certainly I think expect to be in that position but would like to see a little bit more time and a lot more flexibility on our debt maturity structure first.

Mike Taiano - Sandler O'Neill

Okay and then I guess switching to another topic, the Department of Education, on the servicing contract I guess was a little bit disappointing, you know 22% for you guys, can you touch on how and do you expect to get up to the level I think you would initially thought you would be closer to 35% and then second to that I am just curious as to your thoughts on, you've got a lot going on but in terms of other businesses related to processing, loan servicing, things like that. Company went public Tier 1 recently and the market is signing a very high multiple to that business. So I was just curious as to, are you thinking or looking at opportunities like that or like you would have capabilities that align pretty well with those sorts of things?

Al Lord

On the Department of Education contract we were clearly disappointed with the score. There were components where we did very well. We received a top ranking for the service we provided to borrowers, albeit one of the more important metrics that we measure ourselves against. Unfortunately where we didn’t stack up, where we fully expect to be is on the default side of the equation and I would describe that. I hate to be complaining about technical issues, but it was a technical issue. We actually had loans that could default and others got their portfolios later in the cycle and so therefore defaults didn't have time to materialize, but the department did not adjust for those factors. We fully expect given our strong history of out performance or virtually everyone else in the FFELP area that we will have better default statistics and leave that group overall. We refer to working with the department and making sure that we have a good relationship and capture the disproportionate share that we desire there.

On the higher one side of the equation, you are right, we actually compete with these guys today on the refund side of the equation. What we don't do is kind of connect that far or back to a more longer-term relationship overtime and we see a significant opportunity in that space to expand our presence with colleges and universities. This is a good space for us to be in. The customer base, the customer that we have worked with for years and years on the FFELP side of the equation private credit side and you're going to expect to see us do more in that area going forward.

Operator

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

Lee Cooperman - Omega Advisors

I am listening carefully to the call; basically it seems that you have to do something with that maturity schedule before shareholders start to see money. So my first question would be how are things running in the credit markets such that you'd have the opportunity to extend maturities to share some of this $50 and rising earning power with the shareholders. And secondly are there other FFELP portfolios out there you could purchase as you did with Citicorp?

Jack Remondi

On the first question Lee, I think our credit spreads were stuck for quite a period of time over the last four to six weeks that moved in quite a bit. They are still higher than we'd like to see them but we're working very hard to address that back. We're also seeing improvements in credit spreads in the ABS markets and particularly on the private credit side and in our view we've got multiple tools available to us to build and enhance our liquidity position and make sure that we've got both the financial flexibility to manage the company as well as return capital to shareholders.

On the loan portfolio side of the equation, I think our biggest challenge to acquiring more portfolios is what the folks do with the proceeds. There is a real absence of opportunity for them and I think that has slowed down some of the potential loan sales that we would otherwise see. That said we still expect them to come most of the institutions that are holding FFELP portfolios that we expect to sell. It's a very small portion of their book of business and a run off-book just becomes more of an operational distraction and so we do expect them to sell.

That said The Student Loan Corp. deal was by far the largest transaction available out there by multiples.

Lee Cooperman - Omega Advisors

We are not trying to put you in a spot, do you think that before 2011 comes to an end you guys will be in a dividend paying status or is that uncertain at this time?

Al Lord

I think it's certain, it's possible.

Operator

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

David Hochstim - Buckingham Research

Thanks. I wonder, could you just give us a sense of how much seasonality there is or was over the course of the quarter in terms of private loan charge-offs or maybe where of the $348 million you had in Q3 was sort of 40% of it in July and then it just dropped gradually.

Jack Remondi

We had $4 billion more loans in repayment and they entered repayment about a year ago, and it takes about a year for those loans to kind of cycle through the various delinquency buckets and reach charge-offs. In virtually every calendar year, our peak charge-off month is in July, and rates drop off of that. In the slides that we've provided to you this morning, our release this morning, we show the components of loan that enter repayment by quarter. And you can see from those statistics kind of what drives the delinquency trends. There is no question that there is a big seasonal component as we kind of laid out in the first quarter for early stage delinquencies, second quarter for later stage delinquencies and third quarter for charge-offs. And we expect fourth quarter charge-offs as a result will be lower than the third quarter as that seasonal peak passes.

David Hochstim - Buckingham Research

All right, so I guess I was just trying to get how much lower could Q4 be and could your $1.3 billion guidance be maybe too pessimistic at this point.

Jack Remondi

Well as we've said at the beginning of this year, we wanted to be in a position where we were not growing down reserves based on just kind more the economic outlook. I would describe our portfolio… Our future credit performance is really driven by two things. Its one you take a look at just the overall mix and seasoning of the portfolio. Those statistics are clearly getting better. When you look at the quality of loans that are entering repayment this quarter which will drive defaults in July of next year, they are substantially better than they were a year ago or two years ago.

When you look at the balance of loans that are entering repayment this fourth quarter, they are down about $0.5 billion from last year. So just on a pure volume basis, we should see better charge-off rates as well. The wildcard is really the economy. When we get past and we talk to you again in January, we'll have much better ideas to how last May and June's graduating class has weathered this economy, what their job prospects look like and what their ability is to pay loans. But overall the trends here are positive and we expect those trends to continue to be positive going forward.

David Hochstim - Buckingham Research

Could you just comment a little bit or an update on how much of the private credit volume came from four profit institutions this quarter and is there any real risk unless companies go out of business that volume goes away?

Al Lord

There is something less than 17-18% I think.

Jack Remondi

For this quarter was even lower. I think that was the second quarter number.

David Hochstim - Buckingham Research

Second quarter is a little higher than that.

Jack Remondi

So where we look at on the private and we look at the four profit schools, you know that's a very broad range of different types of institutions in that category. There are schools that focus on traditional degrees, full year and graduate programs, and then there are schools that focus on more certificate types of programs. We are focused on the full year and graduate degree lending segments and we don't see the pressure points quite as large in that area as you see in some of the other areas.

David Hochstim - Buckingham Research

Is your borrowers there also getting federal money or not necessarily?

Jack Remondi

Yes, most of them are getting federal money. I mean that's been the biggest pressure point on demand in the private credit loans is that several dollars available to undergraduates and graduates students is substantially higher than it was now a year two years ago that has to decrease demand and overall and decrease even the dollars for people who are borrowing then the amount they need in the private credit side.

Operator

Next question comes from the line of Matt Snowling with FBR Capital.

Matt Snowling - FBR Capital

Just to be cleared, the 2011 guidance include the increases from the student transaction?

Jack Remondi

Yes.

Matt Snowling - FBR Capital

It does, okay. And can you help us think about what a $36 billion seen in the private loan portfolio looks like in terms of normalized provision?

Al Lord

Well I think it’s our function of what the mix is between traditional and non-traditional but I think if you look at the loans that we are originating today more than 92% co-sign rate versus something in the 60's and higher FICO scores you should see substantially lower default rates. We talked about the fact that we expect the life of loan default rate on loans were originating today to be about a 6% range and that compares to base of what we are seeing today is almost 4% [charge-off] rates annualized in our traditional book.

Matt Snowling - FBR Capital

Well Jack, doesn't that imply kind of may be $400 million and $500 million annual provision on that type of product on $36 billion portfolio.

Jack Remondi

Yes, but it takes.

Matt Snowling - FBR Capital

Yes, I understand it takes six years to get there. And one other quick question the $300 million of cost sales that you are targeting how much of that is directly related FFELP originations, and therefore we'd kind of fall out from the expense line fairly quickly here.

Jack Remondi

There's about $100 million in FFELP origination related expense, and so that will fall away fairly quickly. And then there's also activity associated with the servicing side of the equation on the FFELP related that will come out in that process as well.

Matt Snowling - FBR Capital

So does that mean we could see maybe a third of the cost saves in the next quarter or so?

Jack Remondi

That would be a little aggressive.

Operator

(Operator Instructions) Your next question comes from the line of Moshe Orenbuch with Credit Suisse.

Moshe Orenbuch - Credit Suisse

Jack did you just talk about the relative attractiveness of purchasing portfolios versus debt, or is it just the reason to repurchase debt is it because just of availability versus portfolios, how do we think about those two choices for you?

Jack Remondi

We would prefer to be purchasing portfolios, particularly at similar terms to what we did on this most recent transaction. But the issue is more supply on that side of the equation. We do expect it to come, but it is coming in our view a little bit slower than otherwise would be the case of if folks had opportunities to reinvest the money.

On the debt repurchase side of the equation, a lot of this is just due to the simple fact that these notes have near term maturity dates. And so to some extent we're sitting on cash in anticipation of having to pay the notes off that maturity. If that cash is earning 15, 20 basis points and we combine debt back earning, yielding 4% or 5%, it's obviously a really simple analysis and we should be doing that. You notice that we are buying most of the debt we are repurchasing is from 2014 and even the tenders that 900 million we repurchased this quarter was principally focused in 2011. Those are all near-term maturities that are basically or holding cash for. So it just makes tremendous economic sense to take that off the table.

Moshe Orenbuch - Credit Suisse

In terms of the reserve on the private student loans, given what you said about the phase in and the expected performance up to new originations, I guess I am a little surprised but there wasn’t more of a drawdown in the reserves, is it really just waiting to see how this year is kind of crop going into repayment are treated by the economy, is that the fact?

Jack Remondi

That is the factor and at September 30th we still had a $1billion of non-traditional loans in that first year of repayment and another $1billion to come into repayment. So it has been a little bit conservative perhaps, but we think it’s the appropriate thing and so until that the older loans underwritten in 2006-2007 timeframe, kind of clear through the season.

Operator

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

Eric Beardsley - Barclays Capital

I was wondering if you could give any guidance on the private loan margin, little bit surprised to see it up so much quarter-over-quarter?

Jack Remondi

We target a pretax way in this business depending on the risk factors somewhere between 3% and 4% on newly originated loan. The margin, the net interest margin on the private credit book increased this particular quarter principally due to a favorable spread in the prime LIBOR area. Most of our older private credit loans are indexed to prime and as LIBOR has been coming down, prime of course has been stuck for more than a year now, so the spread had widened there, that’s the principal factor.

Eric Beardsley - Barclays Capital

And then just related to your disclosure on the goodwill impairment, just related to the Upromise segment, what are your thoughts for growth there, it sounds like you are tied up in a potentially challenging environment.

Jack Remondi

I think the Upromise acquisition which took place in 2006 always had a very steep growth curve associated with it and we moderated that somewhat. It come from, maybe step back. The impairments in this quarter for the Upromise segment was really driven by two things. One is new loyalty customers are coming in heavily from our student loan book and with the change in the FFELP legislation, that raises some question as to how much we can grow that particular side of the business.

On the 529 side of the equation there is much more significant pricing pressure going on in that space and it was really just a reflection that this business is going to grow at more normal rates versus kind our hockey stick growth rates and that began to tap into the value of the goodwill. Our view is once you kind of hit that number, we were far better off just bringing it down to zero and so we got perhaps aggressive in some assumptions to bring those numbers down as you put the issue just completely behind us.

Eric Beardsley - Barclays Capital

Okay, great. So in terms of growth rate, so you're talking 3% now as opposed to 10% and also on APG, what’s your outlook is there?

Al Lord

We think long term, the growth rates in the Upromise segment can be in the high single digits to low double digits, but this would be a little bit more of a re-trenching year for that. What was your second question again?

Eric Beardsley - Barclays Capital

On APG growth.

Al Lord

APG, the APG unit is a great business. The issue that we have in this particular space is that is we dominate the guarantor collection business that have a significant market share and we have a significant market share because we do a better job than anyone else in this space. In the Department of Ed, we’re also the number one performer, but the way they allocate volume to us, they allocate less than the market share we have on the guarantor sides. So as volume shifts from FFELP to direct lending, that’s the principal driver of the impairment charge there.

We fully intend to convince by performance that we deserve, the department that we deserve a higher market share in that space and we’ll continue to work on that front.

Operator

And at this time, there are no further questions. I would now turn the conference back over to management.

Steve McGarry

Thank you very much. That concludes this morning’s call. If you have any follow-up questions, please call me, Steve McGarry or Joe Fischer. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s conference call. Thank you all for participating and you may now disconnect.

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