SLM's (SLM) CEO Ray Quinlan on Q4 2015 Results - Earnings Call Transcript

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SLM Corporation (NYSE:SLM)

Q4 2015 Earnings Conference Call

January 21, 2016 8:00 AM ET

Executives

Brian Cronin – Senior Director-Investor Relations

Ray Quinlan – Chairman and Chief Executive Officer

Steve McGarry – Executive Vice President and Chief Financial Officer

Analysts

Moshe Orenbuch – Credit Suisse

Sanjay Sakhrani – KBW

Mark DeVries – Barclays

Eric Beardsley – Goldman Sachs

Michael Tarkan – Compass Point

Rick Shane – JP Morgan

Operator

Good morning. My name is Jacquie, and I will be your conference operator today. At this time, I would like to welcome everyone to the 2015 Q4 Sallie Mae 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-session. [Operator Instructions]

Thank you, Brian Cronin, Senior Director of Investor Relations. You may begin your conference.

Brian Cronin

Thanks so much, Jacquie. Good morning, and welcome to Sallie Mae’s Fourth Quarter 2015 Earnings Call. With me today is Ray Quinlan, our CEO; and Steve McGarry, our CFO. After the prepared remarks, we will open up the call for questions.

Before we begin, keep in mind our discussions will contain predictions, expectations and forward-looking statements. Actual results in the future are different than those discussed here. This could be due to a variety of factors. Listeners should refer to these discussions of those factors on the company’s Form 10-Q and other filings with the SEC.

During this conference call, we will refer to non-GAAP measures we call our core earnings. A description of core earnings, a full reconciliation to GAAP measures and our GAAP results can be found in the earnings supplement for the quarter ended December 31, 2015. This is posted along with the earnings press release on the Investors page at salliemae.com.

Thank you. I’ll now turn the call over to Ray.

Ray Quinlan

Good morning, and thanks for your attention. Today we’ll discuss the quarter that just ended, will discuss 2015 as a total and we will discuss our change, as we move into 2016. So I’ll talk about 2015 and 2016, and then I’ll hand the call over to Steve, who will concentrate on the quarter and then we will both answer any questions that arise.

So 2015 in total has – a very good year for us. And sort of marching down the income statement, our volume was slightly in excess of our guidance at 4.33 billion new originations, plus 6% for the year. It rendered us with a 54% market share, up from last year, which is very good. And that is net of several relationships that we had specifically with four profit firms, where we discontinued new originations. The result of this volume is that our private student loan portfolio over the course of the year has increased from $8.2 billion to $10.5 billion which of course is the earnings engine going forward. That’s an increase of 28% in the last 12 months, in keeping with our volume goals. While we were doing this, our credit quality has been both consistent as well as excellent. For the year, our average FICO was 748, a mild change from last year’s 747, essentially the same number, very high.

And our approval rate, during 2015 actually went up to 40% with that same profile. The clear mathematical implication and reality is that we are getting a higher quality through the door population, by increased serialization that is more than one loan with us. And a concentration in higher quality originations from more – a four year not for-profit schools, the traditional colleges. After doing that, we marched down to NIM. Our NIM for the year is 5.48%. We had discussed this in our October call and both Steve and I said, we were at 5.50 and we will stay at 5.50 until the end of next year, which was just the end of a planning horizon, as opposed to we expected a change thereafter.

At the end of this year, we increased our cash balances anticipating disbursements during January and February. So in the fourth quarter, the 5.48 is on an ongoing basis, the same as 5.50, which is what we are forecasting for the next year. It’s also the case that the 5.48 is versus a 5.01 in the fourth quarter of 2014, so up significantly a 5.36 in the third quarter of 2015 and the sequential quarters and up from the full-year of 2014 5.26. So just not that, very people is rattling off numbers. Last year in 2014, 5.26 in 2015 the year just ended 5.48. I know there has been some concern that that might go down and in fact it has gone up.

In regard to our operating expenses during the fourth quarter, we were slightly better than the consensus. We ended the year at 356 in total operating expenses. The expectation at what we had communicated was that we have $353 billion in ongoing expenses and $7 million in conversion expenses, associated with the separation of Navient. So the expectation was $360 million in total, we in fact hit 356.

So we’re happy to see that settle down as you know there has been a threefold amount of volatility in that, mostly associated with the spin. Credit performance for the year has been on-balanced studies, moved around a little bit as we’ve gone quarter-to-quarter, the provision which we guided to the third quarter at 83, we wound up at 89 and last year in 2014, that year and a half ago, we had quite a bit of noise in our delinquency roll rates associated with operating in day one which occurred in October of 2014.

As we try to use that history for forecast in 2015, there was some co-mingling of noise in the system, because the operational variance as well as seasonality associated with both the fact that students graduating in May will be making their first payments in November. So there is – these ways of graduates that come-in, in the fourth quarter as well as the fourth quarter’s all-in indigenous seasonality.

And so as we’ve sorted that through, we are where we were, which is our credit models are consistent and we are right on the long-term life cycle of credit versus buy segment. And so if the case that as I said with the increase in full P&I which was $1.3 billion in the fourth quarter, we believe that we are exactly where we expected to be.

All these results and in EPS for 2015, that was $0.59 versus $0.42 in 2014, that’s a clean increase of 40%. It’s very satisfied that – as we approach the bottom line, nothing got lost underway. It is also the case from an ROE standpoint, the results are stellar, 18.3% ROE. As a last note on 2015, we have had and continue to have very good relationships with all of our regulators, specifically the FDIC and the UDFI. In turning to 2016, we’ve given guidance for EPS to be $0.49 to $0.51 per share, $4.6 billion in originations and an improvement in the operating efficiency ratio of 8% to 10%.

Let’s start with the $0.59 going to $0.49 to $0.51. As we have gone through our maturation period with 2014 being the year of the spin, 2015 being our first full year of operations and 2016 being our first year of in some sense, adulthood as a new company. We’ve been in close contact with our regulators. It has been the case that as you all know, over the last year and a half, we have sold $2.5 billion worth of assets and we’ve done that in three separate events. And the premium associated with those three events were 7.5, 10.4, and 7.78.

The volatility from 7.5 to 10.4 is roughly 40%. We’ve never like this volatility because our franchise inherently is a study franchise built upon, spreads built upon assets that have on average a seven year life.

We’ve done this as people know, in order to meet some guidelines that we had with the regulators. As we have discussed with them, now that we are a fully operating company, now that we have been audited, we moved a number of employees from the original booking center of 35 employees to roughly 1,300 today. And we didn’t care for the volatility that was introduced to our P&L by the asset sales.

We have worked through with them, what is appropriate and it will be the case that we will not force ourselves to sell assets or anything that we would regard as an unattractive price. Now in prior calls we have defined, what is unattractive price would be from a range. And we have used 8% premium as a breakpoint. And so as we’ve discussed this internally 8.5% is probably a better number because the transaction costs associated with asset sales.

So, 8.5% people we have to tell what’s the breakeven. What’s best we can calculate, we’re making proximately 2% a little over 2% on these assets, pretax it’s held on the books. 38% is somewhere between a three and four year breakeven for any particular tranche. And so far, assets price less than 8.5%. We will not sell any asset in 2016. And so we will move forward as I said with that $4.6 billion in origination that will be entirely balance sheet by us. We have no plans to sell any assets. We have no plans to cut back on origination. We are, in fact, in full bloom, as a mature company.

So, if it were to be the case that the credit markets would return to a period such as April of 2015, during which we did get that 10.5% premium at that point we would have an option as to whether to sell or not. We’re not on autopilot in regard to this, we’re looking at it with just in our great preferences to hold the assets, but when somebody starts to talk about premiums over 10%, you have to take that quite seriously.

So for 2016, 4.6 in originations all three balance sheets, no asset sales forecasts, and we’re doing this in-keeping with conversations of all – with all the relevant audiences. Talking about the $0.59 – $0.49 to $0.51, the $0.59 in earnings per share is the best of our ability to calculate this, has two components.

One is $0.39 per share which is the ongoing balance sheet franchise contribution. And then in 2015, $0.20 per share attributable to the $1.5 billion of assets that we’re sold during that period. And so as we move from 2015 to 2016, the $0.39 is exactly comparable to the now forecast earnings per share of $0.49 to $0.51. So $0.39 will turn into $0.49 to $0.51 per share that the range of percentage increase from 25% to 31% increase in keeping with all the models that we have and in keeping with our conversations with each of you. The $0.20, as I said will drop to zero and so we will lose $0.20 of EPS by choice in 2016, which we believe is a very good thing. It speaks well for our credibility with our regulators, the break-even on hold versus buy for the entire portfolio is somewhere between two and three years. And so we think this trade-off is excellent for seven year asset.

And so we are thinking that $0.39 should be compared to the $0.49 to $0.51. 25% to 30% increase, $0.20 drops out by our choice. The originations at 4.6 will be a 6.25% increase, that’s within the market. So we are implying that we expect to continue our market share gains. And so, robust front end, good balance sheet management, third factor that we’ve talked about is leverage. We are now measuring our efficiency ratio, in keeping with our peers, which is the revenue and expense before credit costs and we are at 47% today. We are expecting that we will improve that by 8% to 10% and so that’s a number that’s roughly 4%.

And it is the case that while we are doing this, the backdrop, as I said, the private student loan portfolio is up 28%. This year, we expect it to be up in the 28% to 30% range, next year. And so volume servicing costs, sales costs, maintenance are all up 30%, expenses were up materially less than that resulting in the improvement in the efficiency ratio. And so it is the case that we had in 2015 a great year. As we leave 2015, we have a solid foundation, more solid than we have ever had. We had always talked about the day, when we would be free of the volatility of assets sales.

We had thought that day would be two years in the future. In fact, through the terrific work done by all the managers here. We have accelerated that date of independence from high volatility to today. And so it is a great day for us, the balance sheet going forward will continue to concentrate on the PSL balances. As we look at them, they have a very high likelihood of doubling over the next three years or so.

And so, as we wrap up, the market share is up. We have a strong national sales force. We have a well-established brand. We have targeted products for our targeted audience. We have the opportunity to introduce adjacent products. We have high quality, consistent credit. We have leveragability, which is now obvious in the metrics. We have good regulatory relationships and we are grateful for that. We have as a franchise, excellent and now coming to a theater near you, we have lower volatility. And so 2014 launch, 2015 platform, 2016 maturity, we’re two years early.

Thank you for your attention and I’ll turn it over to Steve.

Steve McGarry

Thank you very much, Ray. We’ll take a closer look at a couple of these numbers before we turn the call over for Q&A. Looking at our student loan asset, the average yield on our private education loan portfolio, and the fourth quarter was 7.84%, compared with 7.87% in the prior quarter and 8.07% in the year-ago quarter.

Spreads will remain relatively consistent going forward. I’d like to point out that the recent increase in LIBOR, do not impact our portfolio which is approximately 90% variable rate until the very end of December. So I think what you’ll see is a higher yield in Q1 2016 on our student loan asset, in 2016 and beyond assuming a steady LIBOR rate.

Looking at our funding, our cost of funds was 1.18%, down two basis points from the prior quarter and up seven basis points from a year-ago quarter. We were active in the deposit market in Q4 where we raised $1.2 billion. The market for retail deposits was not impacted whatsoever by the first fed rate heights. We saw no increase in our cost of funds, there.

While our term ABS remains one of our core funding vehicles. We will only access that market if the pricing is attractive. After all we are bank and we can fund our growing student loan portfolio with deposits.

Non-interest income totaled $72 million in the quarter, compared with $10 million in the prior quarter and $12 million in the year-ago quarter. Of course increase this quarter was driven primarily by the $58 million of gains as a result of the loan sale in the quarter.

As Ray mentioned, and I guess it’s worth repeating, if you tuned in late we are no longer required to sell assets to meet our capital levels and restrict our balance sheet growth. This is a big positive for the long-term earnings power of the company. Our break-even price of hold versus sell is basically 8.5%. And selling loans with a premium below that level which is where we are today due to shareholder value.

And obviously by holding these loans, we filled a bigger asset base and generate significant future earnings. In fact we don’t even have to wait that long to see the contribution to earnings. When we model hold versus sell, the EPS generated by holding loans exceeds to gain on sale model within short three year period of time. Our long-term business model has always been through originating calls, and the company and its shareholders are better off when the company is not depending on the capital markets to generate earnings.

Fourth quarter operating expenses excluding restructuring costs were $85 million compared with $93 million in the prior quarter and $78 million in the year-ago quarter. Expenses in the fourth quarter are typically lower than the third quarter through the seasonality in our marketing and servicing expenses. Full year operating expenses were $351 million with an additional $5 million in restructuring expenses.

Our full year expenses came in better than our expectations. Principally as a result of a heightened focus on our expense base here. It’s worth noting that our restructuring expenses were $1 million lower in the quarter, primarily through the release of a reserve that was established at the time of the spin that is not materialized. And going forward, we will no longer report restructuring expenses as a result of the spin. Ray covered operating efficiency ratio, so I won’t comment any further on that, we’ll jump down to our tax rate in the quarter, a quick comment there.

In the fourth quarter, the tax rate was 37.9% compared with 55.4% a year ago. The tax rate was higher in the fourth quarter of 2014 as a result of a reserve build for uncertain tax positions. The tax rate for the full year was 37.5% and our expectation because that’s the ongoing tax rate will continue to be around 39%. The bank remains well capitalized with the risk-based capital ratio at the end of 2015 of 15.4%, which exceeds – significantly exceeds the 10% risk-based capital ratio as considered to be well capitalized.

Our total risk-based capital ratio will approach 13.6% as the portfolio grows in 2016. In addition, the parent company has excess capital available to the Bank as an additional source of strength that is not reflected in this number. And as in the past, we still do not anticipate returning capital to shareholders, as we reinvest in our business. Taking a quick look, a closer look at credit card quality, loans delinquent 30 plus days about 2.2% compared with 1.9% in Q3 and 2% in the year-ago quarter.

Loans in forbearance was 3.4% compared with 3.1% in Q3 and 2.6% in the year ago quarter. Net charge-offs for all loans and repayments were 1.08%, which was up from 0.84% in Q3. Net charge-offs for all loans and repayments in 2015 came in at 0.82%.

In our service portfolio, gross charge-offs for loans in full P&I were 2.2% in Q4, up from 1.4% in Q3. The uptick in all of these credit performance statics from Q3 in the prior year is driven principally by the May, June repayment rate and the overall seasoning of the portfolio.

We now have $3.8 billion of loans in full P&I, which is up 35% from Q3 and 65% from a year-ago. In fact 85% of the loans that are in repayment have been in repayment for one year or last basically. So given the freshness of the portfolio, it is performing well within our expectations and within our long-term cumulative default expectations.

We ended the quarter with 35% of loans in full P&I. So just a quick word on where you talked about the provision and what’s drove in the current quarter, and just a quick word on – the outlook for 2016, we expect the provision is going to an increase as a result of growth and the seasoning of the portfolio. And in fact, we’ll see an additional $2.2 billion of loans enter full P&I over the course of 2016.

A quick word on our core earnings. SLM core reports, the metric, that we call core earnings. The only difference between core and GAAP is that core excludes the mark-to-market on unrealized gains and losses and the fact that’s derivatives from earnings we use derivatives predominantly interest rate swaps to manage the interest rate risk our portfolio and all of these hedges are good, sound, economic hedges. The fact of a matter is that core and GAAP earnings were identical for the quarter and the full year because there has been no major impact from this derivative portfolio. A quick word on our ROA for the quarter was 2.5%, compared with 1.3% in Q3 and, six ten to the percent in the year-ago quarter. Full-year ROA came in at a solid 2%, compared with 1.7% in 2014. Return on equity in the quarter was 22.5% compared with 11.7% in Q3 and 4.7% in the year ago quarter. And of course the increase from the prior quarter and the year-ago quarter, were due to the big loan sale gain that we reported in the quarter. Full-year return on common equity was 18.3%, compared to 15.2% in 2014. That completes our prepared remarks.

And at this time, I'd like to open the line for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Moshe Orenbuch with Credit Suisse. Your line is open.

Moshe Orenbach

Thanks. First of all, the 4.6 origination target is pretty good number, maybe just talk a little bit about the competitive environment, what you are seeing and what could cause that to be better or worse, as we go through 2016?

Ray Quinlan

Sure, thank you for the question. $4.6 billion, let me go ahead and agree with you, that’s pretty good number.

Moshe Orenbach

Yes.

Ray Quinlan

And we are very happy with it, We see the market itself expanding by about 1%. We review competitive position school by school, as you might imagine it varies quite a bit as we go across the country and across types of schools. We see the market has been relatively stable, with our normal competitors there wells and discover. We're watching and we develop with some of the syntax both on find there in market share they typically a little more concentrated with aftermarkets consolidation loans things of that nature.

And so we don’t expect great movement in the market, at this particular point. There has indicate the market is relatively stable market as we look back over the last – whatever number you like in 50 years.

Moshe Orenbach

Great, thanks. And separately you talked about the core growth, pulling out the gains in both 2014 and 2015. As we go into 2016 though, what you have is not just pulling out the gains. But you will actually have more assets right. So I mean all things equal, it’s reasonable to believe that would be stronger on a core basis correct?

Ray Quinlan

That’s correct and so, when we talked about the $0.39 which is the balance sheet income statement just to use one monitor, and we look at what that equivalent would be including the fact that we are not selling assets in 2016. That turns into the $0.49 to $0.51 that we have been talking about. And that as I said is a 26% to 31% increase and that reflects our holding those assets on the balance sheet.

Moshe Orenbach

Thank you.

Operator

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

Sanjay Sakhrani

Thank you, I guess you guys are very clear on your sale intentions. Number one, I was just wondering, I assume you guys have gauge the market and at this point in time the market just isn't robust enough to meet your hurdles. Could you just talk about what might be driving that, did this occur even before all the turmoil in the capital markets was driven by some of the stuff that's happening in the FFELP market and when that kind of gets fixed in some capacity, perhaps the market will clear better for private student loans. And then the second question on that same topic is as you guys are retaining more of these loans, how should we think about capital adequacy?

Is it at some point, you get to the point if you are retaining all these loans that you might need more than just capital that’s being generated off the portfolio to support the growth? Thanks.

Steve McGarry

Yes, Sanjay. So first of all in the ABS market. The market is open and functioning very well, since the start of the New Year. There have been a number of transactions that have gotten done, particularly in the auto sector and the spreads in that market have not widened materially since, you know, we last transacted in October/November timeframe. We could certainly do a transaction today and our premium would probably be in the 7% vicinity. The market has backed up, as yields across all asset sectors have moved up.

So the high yield debt market yields have increased. Yields have increased in the commercial mortgage-backed market and in the residential mortgage-backed market. And the student loan both federal and private namely auto and equipment markets have followed along with that fund phenomenon. So it's been federal credit spread widening in all asset classes.

We do think that if the market will recover, we have seen many cycles with spreads widened tightened and I think all the markets, are kind of that extremes today. And in fact, it's pretty encouraging if the asset-backed market is functioning well given what we've seen, in terms of volatility in the capital markets. The point is we really would prefer to hold these loans, as opposed to selling them. As Ray pointed out, if the market gets really strong and premiums rise to 10% again, we might very well consider selling additional assets.

In terms of our capitalization, we have ample capital to grow in 2016 and 2017 in a way that I think will – and generate the kinds of capital levels that will satisfy all of our regulatory agencies. So I mentioned earlier that by the end of the year, our total risk-based capital will approach 13.6%. We do have additional capital at the core – couple of 100 basis points worth but it is a fact that as we model our company over the next several years. We do start to become self-sufficient in capital generation, capital returns, and it starts to grow again in 2018 and beyond.

Sanjay Sakhrani

Grow as a percentage…

Steve McGarry

Yes, so we feel very good about the way we’re positioned today. And it is the case that selling assets over the course of the last year and a half to $2.5 billion that we have sold has generated significant amounts of capital that has put us in this position, where we can now, ease back on the loan sales.

Sanjay Sakhrani

Got it. I guess one follow-up question, and it’s probably related to the question asked before on – just the competition in online players. I guess that’s a question I get a lot from investors, because the online players are out there talking about how they’re taking share. I guess as it relates – it doesn’t seem to be affecting you on originations. But when we think about like consolidations away from you guys, I mean are you guys seeing anything that’s a noticeable from a consolidation standpoint?

Steve McGarry

We track consolidations every month and we track who we are writing checks to, as well. So we have a pretty good idea of what's going on in our portfolio for consolidation. The number has been and is de minimis, from what we can see. And so when we think about market share, we think that the originations primarily, but we’re protective of the asset that we have – we expect them to go for seven years. We shared with you models in regard to that and as we track this, it has been quite steady and the models haven’t changed at all. So we’re not forecasting increased liquidations of any material amount. And I agree with you that we hear quite a bit about start-ups to FinTech, people in consolidation loans and we are looking at all of that because, these are very smart fellows, you know have good franchises and it is the case that there has been to learn from every competitor.

Having said that when we look at market share it’s the traditional people that – the names you all know that – are who are there, who are aggressive in regard to this market, who are good competition and we don’t see the people who are grabbing the headlines.

Sanjay Sakhrani

All right. Thank you very much.

Operator

Your next question comes from the line of Mark DeVries with Barclays. Your line is open.

Mark DeVries

Yes. I just wanted to clarify a point around the listing of the growth cap – is that listed without any kind of qualification or might the regulators want to see you sell some loans potentially if – it gets above pricing gets above your break-even?

Ray Quinlan

It’s a case that the regulators are very practical people. We have open discussions with them. They see what we’ve been discussing here, which is a market that, we have – that there will be spreads that we have received move from 7.5% to 10.5%, 40% increase. No one like that kind of volatility, we don’t like it, we don’t think the shareholders like it and regulators certainly don’t like it. And so their great preference is that we hold the assets on the balance sheet, assuming that we can have proper coverage of the capital which they are responsible for.

And so in discussions with them, we are all same mind. One, if we can avoid capital markets altogether, that would be the preferable course. We will not go to capital market if it is below our break-even, and above our breakeven, we will have optionality, not requirements in regard to this. And we have shared that with them, of course everything if any regulator appropriately is, steady as she goes and if there are adverse developments somewhere either in the company or any environment.

They have reserved the right as we all do – to address those as they occur but for what we know of the markets today and for the foreseeable future. We will have as I said optionality, not required action.

Steve McGarry

Mark as Ray says, as we model it out, we're only going to very modestly exceed our 20% growth rate. So we don’t think it’s…

Ray Quinlan

Only in the fourth quarter.

Mark DeVries

Got it. That’s helpful. And then finally is there any color you can give us on the outlook for the provision this year and also kind of where you – do you still think you’re writing new loans in the 100 to 150 basis points annualized charge-off range?

Ray Quinlan

Yes. I mean absolutely, better thing and we see the way the quarter is performing, we still think that our 7.5% is cumulative life of loan, charge-off rates are intact. But as you know, charge-offs are higher in the first, call it, 36 months when they are in the subsequent 48 months. So we do see higher charge-offs earlier in the life cycle of the private student loan. We will see growth on our provision of course from 2015 level. I think I detailed the amounts of growth that we’re going to be saying in our loans entering full principle and interest in our – in my prepared remarks. But we ended the year, the loan loss allowance, the loan loss reserve for the full portfolio nearly is 1.03%, up from 0.93% in the prior year. You will see that reserve level creep up as the portfolio grows and seasons over the course of 2016.

Mark DeVries

Okay. Thanks.

Operator

[Operator Instructions] Your next question comes from the line of Eric Beardsley with Goldman Sachs. Your line is open.

Eric Beardsley

Could you just talk a little bit about how you plan to fund the incremental growth, as they’re going to be a step-up in retail or brokered CDs and just in light of your commentary that you’d like to avoid the capital markets. Does that also mean that you won’t be doing ABS deals to fund?

Ray Quinlan

Sure. I mean, over the course of 2016, I think you’ll see us use all of our funding tools, certainly our deposit base is going to increase. We’ve had some success with expanding our core deposit base. Recently we start a new relationship with the health, savings account that’s going to bring in multiple hundreds of millions of dollars. We will look to expand certainly our retail deposit base, both the money market and our termed CDs. We haven't ruled out the capital markets, completely. We do have a securitization in our plans. If we were to issue today, the market would give us funding at a price that’s not significantly higher than what we have in our plan. So we will be opportunistic and wait for the spread in the market to commit a little bit. If that is not happened, we can certainly access both the broker and the retail deposits base to fund our growth going forward.

Eric Beardsley

Got it. So I guess as we think about that composition of your deposit base do you think that mix will change significantly from where it is today?

Steve McGarry

No, we are pretty comfortable with the 60:40 and I think you can see that continue….

Eric Beardsley

Okay.

Steve McGarry

And all these comments are consistent with the NIM 55 that we discussed earlier.

Eric Beardsley

Sure. I guess – just as a follow-up on that NIM, I guess given that you will be retaining more private loans, now, I guess could we see that NIM trend up even higher?

Steve McGarry

Yes. It’s 5.5, would probably be more of a base level and I think we can certainly see expansion in the NIM, particularly with the growing components of private student loans on the balance sheet.

Eric Beardsley

And I guess how do you think about your ability to lag on deposit pricing, if you are going to get a step-up in loan yields in the first quarter, I mean, should we actually get some asset sensitivity start to roll through then?

Steve McGarry

Yes, I mean obviously it all depends upon what the Fed does and given the way things are looking now. I think additional rate hikes are probably less than more likely. But we were very hardened by what we saw in a retail deposit market. We’re all waiting to see, if there is increased competition amongst the internet banks. So what we actually saw was that several banks were lowered their retail deposit rates.

So I guess a lot of the anticipated Fed rate hike was priced in. I don't want to promise a whole lot of asset sensitivity. But certainly what our asset we set in the last week of December and a big chunk of our deposits did not follow that move. So we are improving position there.

Eric Beardsley

Got it. Now I guess with the incremental growth, is there any need to drawdown cash or even self FFELP loans to accommodate the increase in private loans?

Steve McGarry

No, that’s not on the table at all. We’re in very good shape from a front-end perspective.

Eric Beardsley

Okay. Great, thanks so much.

Operator

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

Michael Tarkan

Most of my questions have been answered. But just getting back to the credit question, it looks like provisions becoming a little higher than implied guidance for the quarter. Just curious, if you’re seeing any kinds of signs of early stress on the portfolio. And then along those lines is there sort of a targeted reserve level that you’re hoping to get to – either 2016 or beyond. Where you can level off that, thank you?

Steve McGarry

Yes. So Mike the portfolio is performing as I said earlier, pretty much well within our expectations. So seeing increases in charge-offs of the magnitude that we did 0.83 to 1.08 and so the full P&I from 1.9 to 2.2. Given the amounts of loans that we have now in full P&I, it’s up 65% from the year-ago and 35% from the prior quarter, that significant growth and seasoning. The provision mix, as Ray explained was principally due to the over discounting of the seasonality in roll rates and if anything we were factoring and probably superior performance and what we’re seeing here – portfolios performance as expected.

Michael Tarkan

Okay. And then just – is there a targeted level of reserves that you expect to compound out of the percentage of loans?

Steve McGarry

No. I mean, again, if it grew from 0.93 to 1.03 it’s going to be obviously higher than math over the course of the year. But I don’t want to throw out a specific number, at this point in time.

Michael Tarkan

Okay. Fair enough, and then, on the origination front, Ray, I think you mentioned in your prepared remarks that you stop lending to for-profit schools. Did I hear that right and then, if so can you just remind us what percentage of your existing portfolio comes from the for-profits?

Ray Quinlan

It is the case that we are constantly looking at the performance by school and in particular the for-profits. Over the course of the last three years, have called that down significantly. In the schools that we currently have in our portfolio of new sales, our schools where they have good graduation rates, good placement to student after. But the percentage of our total volume that is related to for-profit is less than that.

Michael Tarkan

Okay. But nothing where you’re turning off the switch at all. You’re still lending, but just very, very targeted?

Ray Quinlan

I think category, we are lending to that category, as these schools that is depended upon their proposition with students and with their results.

Michael Tarkan

Okay, thanks. And then last one, I believe you guys have your formal stress test submission coming in July. Just to given that, that you received this approval to hold more loans on balance sheet. Is there anything we should be contemplating as we head into that or concerned about heading into that exam? Thanks.

Ray Quinlan

When we share our forecast with our regulators, we have – for the last two years in a row we have done simulated stress test, knowing that the DFAST requirement is not upon us until July of 2016. We have used these assumptions that are the assumptions in DFAST as far as environmental change consistent with the Federal Reserve guidelines. We show that to our regulators in all cases, for any stress level, for any year, we had very good results. We continue to make money, we continue to have capital ratios that are well above, well-capitalized. And so, what we tried to do is to make these events of July 2016, when they occur, to simply be the next turning page in regard to this type analysis, which we’ve been doing for two years, now. We are trying to make that and we believe it will be a non-event.

Michael Tarkan

Thank you.

Operator

And your next question comes from the line of Rick Shane with JP Morgan. Your line is open.

Rick Shane

Thanks, guys for taking my questions. This has been very helpful. I just wanted to walk through provisioning and again we’re little bit newer to the story. So it will be helpful for us. If we take a cohort of $1 billion of loans, and we think about it over time as it moves into full principal and interest repayment. How front loaded is the provisioning over that the life of those loans?

Steve McGarry

So Rick, you might be well serve to look at a default emergence curve that we put out one year ago, today or maybe, was in the second, first quarter earnings call. But typically you see, I want to say 60% of the defaults are going to emerge from the portfolio, and really, the first two and a half to three years. So charge-offs are going to be – put a handle on it above 2% in the first year or two and then decline significantly and at low 1% in pretty short over. So there is significant…

Rick Shane

Steve, sorry to interrupt you. Go ahead please.

Steve McGarry

There is significant frontloading of defaults and any repayment cohort.

Rick Shane

Got it. And so we should think about that as you move towards repayment that you are targeting 12 months of forward reserves against that?

Steve McGarry

That’s correct. We have greater allowance for one year of expected reserves…

Rick Shane

Thank you, guys.

Operator

I would now like to turn the call over to Ray Quinlan, CEO for closing remarks.

Ray Quinlan

Thank you and thanks for your attention and for your questions. And so this is a very good day for us. As it announces that we are moving to a different level of maturity as a new company. And it is the case that we maintained all of the virtues that got us here, including a very good market share, a terrific group of people who are national sales force, a great brand that is a core brand for the entire industry. Our products fit our audience well. We have opportunity in adjacencies. Our credit is unchanging and a very high quality. I'll remind people that 748 through the door FICO for approvals is an excellent number. You're starting to see now in our projections, that the franchise is leverageable, as the improvement that we’re forecasting in the efficiency rate clearly given the entire cause of this conversation, we have very good and valued relationships with our regulators. We have as we model it forward and already built into our market share and the development thereof. Excellent growth prospects for the P&L going forward with concomitant excellent returns.

The lower volatility that the chapter that we're moving into here from the funding standpoint will take significant noise out of our communications going forward. And so it’s a very good day. Thank you all for your attention. Thanks for your faith and staying with us over these first couple of years. And we look forward to the next chapter. Thank you.

Brian Cronin

Thank you for your time and your questions today. A replay of this call and the presentation will be available through February 3 on our Investor Relations website salliemae.com/investors. If you have any further questions, feel free to contact me directly. This concludes today’s call. Thank you.

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