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SLM Corporation (NASDAQ:SLM)

Q3 2007 Earnings Call

October 11, 200712:00 pm ET


Albert L. Lord - Chairman of the Board

Charles E. Andrews - Chief Executive Officer, Chief Financial Officer, Executive Vice President


Tim Wilson - Credit Suisse

Good afternoon, everybody. Welcome to Sallie Mae’s shareholder meeting. Before we get started, I have to read the following statement: please note that during this meeting, we may discuss predictions and expectations and may make other forward-looking statements. Actual results in the future may differ from those discussed here, perhaps materially based on 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 the course of this conference call, we will refer to non-GAAP measures that we call our core earnings presentation. The description of core earnings, a full reconciliation of the core earnings presentation to GAAP measures, and our GAAP results can be found in the third quarter 2007 supplemental earnings disclosure accompanying the earnings press release, which was also posted under the investors page at our website,

That being said, let me now turn the meeting over to our Chairman, Al Lord.

Albert L. Lord

Good afternoon, all, those of you in the other room and those of you on the phone. We did get to see one another at our shareholder meeting a couple of months ago, although given the turnover in the stock, I’m not sure you are any of the same people.

I feel a little bit like this is a coming out party. We were on our way to being private and your presence here is a vivid reminder that we are a public company. We are a public company engaged in what appears to be an extremely uncertain transaction.

We are here to talk to you a little bit today about the current events of the company and then I will go on to talk a little bit more about how I see things as they are. I have to confess that we’ve not paid a great deal of attention to shareholder reporting of earnings and other items over the last six months because under the merger agreement that we signed in April, all of the economics of the company accrued to our buyers.

Just for your information, those earnings at this point aggregate something in excess of $1.50 since we signed the agreement, so one might say that that $60 purchase price is now effectively $58.50.

Over the last six months, we have been working internally to transform the company to a private company. That is an interesting process. I’ve not been totally a part of it because I’ve not been inside the company for the last six months. The fact is, it’s a bit of a cultural change. Actually, it’s a fairly large cultural change. My interaction with people in the company makes it quite clear that that change has been transpiring.

It’s a cultural change. Also, our buyers have done virtually 100% of the company’s financing over the last six months at a higher cost than we would otherwise have. They have earned some fairly large fees over that time but more importantly, they approve all significant decisions. That remains true as of today. And that’s not unreasonable, so long as the economics are theirs, and that seems to be a bit of the issue.

I can see that huge light in the back but I can barely see this far here, so you may see me squinting a bit. In any event, as I said, it’s not unreasonable that those decisions are made by them because the economics that accrue from those decisions are the buyers, unless they breach.

Certainly the process of going private affects the mindsets of the people that work in the company. Just as an example, even as of now the buyers have not approved the incentive compensation plan that we have for management in the company for the year 2007.

So it is clear that at least over the past six months, we’ve been pretty much dancing to the buyer’s tune, most of which is played on a piano.

The deal distractions are significant. They’ve cost us earnings momentum. You may have already seen we are in the process of reporting $0.70 of earnings in the quarter. That’s roughly a two -- not roughly, it’s exactly a $2.80 run-rate. That’s very disappointing to me and to our board. Frankly, we figured we would be running at about $3, $3.20 right now but we are not.

But we are where we are and where are is solid asset growth and very strong fundamentals in the company, just as they’ve been for the last 25 years.

Our goal obviously is to get back to the 15% earnings growth rate that we’ve had over the years.

I am going to hand this off to C.E. Andrews, our CEO at the moment, to cover in some detail the third quarter and then I will give you a little bit more of the picture as I see it at this point.

Charles E. Andrews

Thank you, Al and good afternoon, everyone. It’s a pleasure to be here with you and hopefully everyone in the outlying areas, the other room and on the phone can hear me and I’ll do my best to be clear to those that can’t see me as well, but it’s a pleasure to be here.

What I want to do is spend a few minutes to quickly highlight the quarter, as well as it’s context for the future. As Al said, this last several months has been one of a unique experience. There have been a lot of moving parts, a lot of disruptions, not only with the transaction but also with legislation and other things that are going on in our industry, so there’s been a lot of challenges and we’ve been operating the company in that environment.

But what I want to do today is spend some time talking about the third quarter but frame that in the context really of what the third quarter means to the future, so you can get I think a good understanding of how we feel about our fundamentals and where we believe we are going in the future with them.

And the best way for me to do that is really to talk about the real drivers of our business. First, I am going to spend a few minutes talking about the loan side, the loan drivers, the loan volume and the loan mix as a driver of the business. Then I’ll talk a little bit about the pricing side of the house and what drives that, and then cover with you our fee business, comment briefly on our expenses, and then talk a little bit about the funding side of our business and liquidity, certainly which is important as we look ahead and certainly important in this environment of other market disruptions that have occurred as well.

And then I will close out, I’ll frame what we think the legislation means from a competitive landscape standpoint, which I think is essential to understanding the future as well.

I am going to skip by this because Steve read them to you, but I do call your attention to them, and I will start off with, as Al mentioned, our earnings for the quarter before what we consider non-recurring and transaction related items were $0.70 a quarter. Al mentioned that that was something less than we’d hoped but nonetheless, we believe it is a good foundation to build off of and I will give you some color on what led to the $0.70 for the quarter.

The non-recurring items that are there are simply related to us booking the catch-up reserve that’s necessary because of the new legislation under the FFELP program and it’s a one-time cumulative catch-up, as well as transaction related costs. From a run-rate standpoint, you should think about this quarter as a $0.70 quarter.

The first thing I want to do is just talk, understand where we are from a loan portfolio standpoint and the growth opportunities that are there and really what’s driving the business.

First of all, the government portfolio itself; the government portfolio is not the profit driver of our business but it is the strength of our school channel, which is a huge competitive advantage that Sallie Mae enjoys. That’s where we made the investment in relationships, technology, infrastructure, networking, et cetera. It’s really our sweet spot and our competitive advantage and it is the source from which we grow and drive the school channel. So it is very important to see this channel grow and grow at robust rates.

During the quarter, this channel grew by 15%, which we believe is a real strong start to the academic year. We are very pleased with the 15% growth rate. It is sound in its fundamentals and where it is occurring and gets the academic year off to a good start.

Being in the school channel not only gives us the organic growth that we have but we also think there’s going to be a lot of change and disruption in that channel as schools and lenders react and implement the results of this legislation. We think our presence in the school channel, our strength in the school channel will serve us very well as we grow and gain market share, and I’ll talk about that a little bit later.

No one has a presence in the school channel like Sallie Mae.

Another big factor that is occurring in this quarter and generally when you see something being down, that’s not a good sign but consolidation loans are down nearly 50% over the prior period and that is very good news. The last two years, we’ve had unprecedented churning of our portfolio and the portfolio turning into consolidation loans. That being done by really its own industry group, if you will, who were the loan consolidators, a bunch of marketing companies that really churned that activity.

So that activity is over and the decline in consolidation activity is a very positive sign. It means that we are able to hold on to our Stafford assets for much longer lives and period of time, so that’s a very positive event to see happening. We think not only has it declined 50% at this point but that decline will continue because the competition in that space and the incentive for borrowers to consolidate is much less than it was in the past. So that’s a very positive development.

When you put all this together on the FFELP portfolio and that school channel, we believe we are very well poised for mid to high -- certainly high teens type of growth in the future, very well poised to take advantage of the market disruptions that are occurring there and to strengthen, if you will, our presence in that all-important school channel.

The next area of lending is the private sector. This is essential to us. This is our economic engine on the loan side of the business. We drove our private business through two channels and we think we are strong in both of those channels. One is the school channel I just talked about, so that’s the reason we want to have a strong presence in the school channel because the bulk of our private portfolio grows naturally through that channel.

The second channel is our direct-to-consumer channel. Direct-to-consumer channel grew at a very healthy 48% growth rate over last quarter and it is doing and we’re finding real good traction and brand identity with our name brand recognition in that market space.

In the on-campus and the school channel, we had a lower growth rate. There are two things taking place in that space that affect that growth rate in the current quarter. One is legislation of last year basically transferred graduate students from private lending into a government program. There was a new program identified last year or passed last year by legislation, and not in the current legislation but last year that allowed graduate students to borrow under the government program. So it migrates, it is migrating a lot of the private volume out of the graduate space into the government program. That transition continues this quarter and it was a significant effect on our volume.

But actually two very positive things, signs that occurred there as well. One is we are growing that grad plus government volume at a much faster rate than the decline of the corresponding private graduate volume, which is very positive. We are gaining more obviously than we are losing.

And secondly, we are actually retaining a higher volume of private volume in that space than we had projected, so we think that’s a positive sign that has occurred there.

When you put it all together, the private portfolio grew at 8% for the quarter but the key driver, which is the undergraduate, four-year institutions grew at 18% because there we get serial loans and subsequent periods and everything. That’s a very important measure for us.

When you put all that together and all the noise that’s in that private space of transitioning from one program to another and that sort of thing, we believe that the private volume in the school channel and in the direct-to-consumer channel has solid long-term growth expectations and certainly in the high-teens to 20% for the future.

The third area that I would comment on as it pertains to the loan volume is credit quality, and we’ve had a rocky year from a credit standpoint and loan loss provision, as you know. We see the right trends and the right signs occurring there. We actually in the third quarter, our loan loss provision was some $90 million less than in the second quarter, and we see that the charge-off rates and levels and the delinquency rates are trending in a direction that we had expected.

I think probably some of you know but in case you don’t, we had a large operational disruption in our collection side of private credit last fall and early in 2007. It created disruption that got us behind in some of the collection process and we’ve continued to try to correct those issues and we believe all those changes and the implementation of the impact of those are right on target now, but it has taken us the better part of this year to get that back on track. But we are starting to see the results of that now in our delinquency trends and charge-off numbers. We expect in the near-term our delinquency levels and charge-offs to hover around that 3% level.

So that’s kind of the portfolio look. Net of all that is that our portfolio we think has strong growth metrics to it. The economic engine that’s in our portfolio, which is the private portfolio, we see strong growth metrics.

Now I would like to cover the second piece of that, which is the margin, the pricing side of the loan portfolio.

Again, this we find to be very positive. What we are showing and what we are being able to do is essentially hold our margin in the face of headwinds of price competition as well as the legislative reductions.

For the quarter, our student loan spread was 1.81, which actually is 2 basis points higher than we had in the second quarter, and we had a very positive private loan spread at 5.43%, and of course that’s really the spread that drives and maintains and allows us to hold our overall spread with the growth of the private portfolio.

So that’s very, very positive, and our private spread is still trending up and that again is I think bodes well for the future. We expect to be able to have, to hold the student loan spread in the high 1.70s to low 1.80s through next year, even as we face and digest, if you will, the changes of market compression and -- I mean margin compression in the sales portfolio caused by the legislation.

And why are we able to do that? The reason we are able to do that is that we are growing, relatively speaking, our private loan volume. We are actually gradually increasing the margin on our private loan volume and we are eliminating some of the benefits that we -- we will be eliminating some of the benefits that we offer on our FFELP program.

Net of it all, it is going to allow us to maintain we believe our margins in this territory. So that is very positive from a pricing standpoint.

The next area is a fee income, which for the quarter had a -- reflected very strong metrics in terms of the portfolio growth. The earnings growth in the quarter was less than we had hoped it would be, largely driven by some portfolio adjustments we made in the purchase area. But we are finding that the portfolio -- and the portfolios are available both in our credit card space as well as other consumer asset classes, and we expect that volume to continue to grow in the future and we believe that this will be an area for us that again will grow in the mid-teens from this point forward. Still very positive on that from the collection side.

On the government side of that, which is our guaranteed services business, is another fee income, that’s been affected by the legislative changes so there will be modest reductions that will occur there that will be somewhat of a limiting factor in the overall growth rate of the income, but we still, when you combine the two, we believe we will be able to grow the income at a double-digit level.

Turning now to expenses, which is an all important thing for us, to be ever vigilant on, our expenses for the quarter grew at about a 6% rate, which is consistent with our targets in that area. Again, we should always, because of our scale and our size and our leverage, be able to control and limit our expense growth to a level much lower than our asset growth, and that in fact is what we were able to do for the quarter as well.

An we expect, and do not see any reason why we shouldn’t be able to maintain solid expense control in the future and generate similar levels of growth, if you will, that you saw in this quarter.

Finally, turning to liquidity and funding of our business, which also has faced an unusual quarter in a period here as the market itself was disrupted, and as Al referenced, we really have been funding our business through arrangements of our buyers. So it’s been a different funding environment.

But what I want to do is illustrate for you where we are and where we are going with that. We have, from a liquidity standpoint, have put the company in a position to have significant liquidity as we faced the market conditions that are out there.

We have today over $29 billion of what we would consider primary liquidity, as well as $16 billion of what we would consider secondary liquidity, and the secondary being government assets, unencumbered government assets that we have on our balance sheet.

So when you put the two of those things together, as we sit here at the end of the quarter, we have what we believe is $45 billion of liquidity with which to manage the company, to be able to time how we, when we enter the market for permanent financing for these assets, and to put us in a position to be able to really manage this in a way that’s most beneficial to the company and to shareholders.

There’s been disruption certainly in the credit markets. That has occurred. There’s been disruption from a pricing standpoint. In the short-term on new production, we’ve actually, in order to finance some of the assets, there’s been as much as a 30 basis point disruption in some of our ABS type products for new production.

But bear in mind substantially all of our assets are already financed to term, so we only face interest rate issues related to new production, and we believe that the markets for the securitization, for student loan assets will return to reasonably normal levels before long. We in fact are expecting to get back into the market here very shortly. We have consciously held out waiting for the right timing to reenter the market and we are poised to reenter it soon.

I think some of the external measures around this and around the quality of our assets, Fitch recently upgraded 12 of our trusts about a week ago. I was also, if you follow this, Moody’s Research recently said that they believe that the student loan ABS market would return to normalcy and not really be affected by the disruption of the sub-prime mortgage industry, if you will. So there are very good signs, we believe, in terms of the long-term funding and financial opportunities for us to fund and finance the portfolio.

So we’ve positioned ourselves to be able to time this in the right way. The cost of carrying it certainly has been a burden because we’ve been, had the increased cost of funding it through the buyer’s arrangements for the last three months, but in fact we are well-positioned to reenter the permanent market here soon.

Now, from a legislative and market standpoint, what does all this mean as we go forward? Because there’s been much written around the legislation and how do we see this really affecting the prospects for our future growth?

With the changes in the legislation, we believe that the price competition that has been present over the last several years will actually be reduced. Basically in the student loan, the federal student loan end of the business, the margins have been compressed to the point that you really -- lenders can’t afford to give significant borrow benefit. As a result, that was the price competition tool. We think to some extent the price competition has now been neutralized a great deal.

The effect of some of this, we believe that those lenders that certainly concentrate only in the [south end] of the business are going to be hit hard by that, and those that are not diversified and don’t have the strength and presence and scale that we do. As a result, we believe there will be competitive disruption. There will be fewer people, fewer entities entering the industry. Those that are in the industry, there’s going to be some shakeout as well. We believe the competitive landscape actually will reduce.

Thirdly, with the changes in legislation, the cost debate over whether or not even at the federal level, whether or not FFELP or direct lending is cheaper to the taxpayer really has ended. They have now brought the FFELP program in alignment with the government’s own measures of costs of the two programs.

We really think that as a result of that, we are certainly well-equipped to compete on a direct lending front and with direct lending schools as we move ahead here. So it has changed that.

The benefit of this and the upshot of it is that with the scale and depth that we have at Sallie Mae, the turmoil that is taking place in the marketplace we believe will afford us opportunities to actually growth the business, not just at normal organic rates but in fact to be able to grab and attract additional market share that will put us in a position to grow at a faster rate than we have in the past couple of years.

We have positioned ourselves to take advantage of this legislation. Good companies that face -- where the industry they operate in face market turmoil, the challenge of a good company is to take advantage of that turmoil and to seize upon those opportunities and that’s what we are positioned to do.

We believe the net of the legislation, we will be able to hold our margins as I discussed before, and it is going to create market share opportunities for us that we are poised to take advantage of and we’ll intend to do that over 2008 and beyond.

With that, I will turn it back to Al.

Albert L. Lord

Thanks, C.E. So that’s the third quarter. The third quarter is -- what is it, 11 days old now? Old news. Where do we go from here?

You guys are the shareholders. I actually own less than 1% of the stock, although I oftentimes treat the company as if it is mine. I guess 25 years will do that to you.

What I would like to do is review a few of those years, just to give you a little bit of a backdrop where we. Sallie Mae is now a 34-year old company. Its first 10 years, we were 100% financed by the government. We borrowed our first $5 billion from the U.S. Treasury and about 10 years later, the company went public in the equity markets. We’ve been a public company for 24 years.

Shortly thereafter, we paid off the $5 billion to the federal government and cut our creditor/debtor relationship. And then in 2004, some 30 years after the company was created, we also ended our GSE status. So the company is a totally -- I hate to call it government free because it doesn’t seem that way, company.

During those 34 years, the company has gone from zero to $160 billion in assets. In the last 20 years, just to give you some perspective, this special allowance, which is called a subsidy from the government has gone from about 350 basis points to about 150 basis points, almost a 200 basis point reduction over the last 20 years. If you do that arithmetic, it doesn’t happen in 10 by 10 bp increments, or decrements, in this case, but it happens.

For us, declines in the special allowance don’t change as a material adverse change. They don’t change our business -- they are our business and we’ve undergone 200 basis points of change over the last 20 years and averaged 15% earnings growth during that same time period. We’re accustomed to the government changing its mind about what it’s worth to do this business.

On a personal side, my tenure time began in 1981. I went on to become the Chief Financial Officer and the Chief Operating Officer. 12 years after that, in 1993, I got fired. That was the first half of our Sallie Mae career. I told you it was going to be brief.

In 1995, I returned with seven others in a proxy contest and actually some of the survivors of that proxy contest are here with me right now. In fact, I’ve been -- well, let me finish this history. They’ll wait.

Anyway, in 1995, the company’s common stock traded for $2.95 on a split-adjusted basis. I became the CEO in 1997, left in May of 2005. The stock was $53 when I left. It ran up to $58 on news of my announcement and departure. And actually, rose again to $58 in I think roughly June of this year on the news of our merger.

In anticipation of and the actual results of the 2006 election took the $58 stock price in ’05 down to the low to mid $40s, and now we’ve come back to $58. And you’ve kept track of it, I’m sure, quite closely ever since.

Before I move on, let me just identify the board members who are here: you’ve got Wolf Schoellkopf -- you guys just stand, you don’t have to say anything; Diane Gilleland; Benny Lambert; Ron Hunt; Charlie Daley; Bill Diefenderfer; I was going to say Alex Porter. He’s probably watching on TV in the next room; and me, so I think I count eight. That’s eight out of 13 and I think almost all these eight are with me, okay?

You guys didn’t think that’s that funny. I thought it was pretty good.

In any event, like I said, the stock returned to $58 in June on the announcement that we are going to do a $60 deal. Most of my long-term shareholders sold stock during the run-up period. They were very well-rewarded. I know our board feels personally very good about the returns that we were able to generate for that set of shareholders over 10 years.

It is now October 2007. We only have a few long-term holders left but today we have a very large gathering of our new shareholders and our fiduciary responsibility now runs to you. I can tell you I take it very seriously, as does the rest of the board.

I will say to you that you guys are very new to me. I have to say that I would characterize you as guys that call a lot and you have lots of advice. It’s an extraordinary amount of advice I’m getting. You’d think for a guy this old, you wouldn’t need that much advice.

Anyway, we’re hear today to inform you as well as we can about what is going on as best we know it. I worry a little, as I’ve told some of you by phone, that my comments may not be exactly what you want to hear and I just kind of relate it to the advice I get. Most of the advice I get takes the direction of playing poker and how to play poker.

I think it’s important that you understand that I’m not playing poker. The board is not playing poker. We are trying to do what we’ve always done and that’s create value by running the company well.

It may well be that our outlook is a little longer than some of yours. You have to excuse me. I can barely see this, but if I see you, I won’t be able to see this at all. I hope that the length of our outlook isn’t a major disappointment and I guess while I’m disappointing you, I do want to mention other possible disappointments.

I don’t play chess. I play golf -- poorly. I don’t play the piano, but we have a piano and if you put CDs in it, it plays itself.

You guys are pretty serious today, I can see. In any event, I said our goals are maybe a little longer than you’d like but let me tell you about some of the short-term objectives of mine and the board’s.

Last week, the board, bless their hearts, returned me to Sallie Mae day-to-day operations as the so-called Executive Chairman. That’s a new role for Sallie Mae’s Chairman. I’ll be working with C.E. who, just in case he’s not aware of this, is going to do all the work, to pick up the pace a little bit.

As I acknowledged, I think our pace has not been quite what we want it to be. It’s kind of tough to serve two masters. We’re not going to be serving two masters anymore.

That’s good news -- I hope it’s good news for you. I’m not so sure it’s good news for me because my attorneys tell me it’s maybe an unpaid position because we have to get Chris’ permission to pay me. That’s Chris as in Flowers.

So objective one is to return our earnings growth to where it’s been in the 15% plus range. Second objective, and C.E. touched on this and this is maybe more subtly than I’m thinking about it and that is taking advantage of the opportunities that are out there to increase our market share. Increasing our market share may not do wonders for our ’08 earnings but it will do wonders for long-term earnings.

Every legislation I’ve seen since 1973 has created incredible opportunities for us, even though they create short-term challenges and a lot of aggravation in the process. But we look to vastly enlarge our market share right now, as in today, and as C.E. said, it should create opportunities. We are already hearing about opportunities, so that’s objective two.

The third one is we’ve got to decide on an operating strategy, working with Mr. Flowers and actually seeing the business plans of other buyers in this process has opened our eyes a little bit to other ways of running the business. I mean, there’s question on whether we make and hold loans or sell them or some combination of the two. We’ve got to replace this expensive funding that the banks have provided us, at least in the near term, reevaluate our capital structure. As C.E. mentioned, we want to return to credit markets and that’s all credit markets.

We would like to consider buying the company’s stock. It’s been trading very inexpensively in our opinion, compared to where it should be. And this whole process has created some pretty inexpensive debt instruments out there that are trading at less than 100 cents on the dollar and we think that might be a pretty good buy.

One of the advantages of running your own company is that you know what it’s worth and when things are less expensive, you don’t have to guess. You don’t have to consult with Jim Kramer or anybody else.

Those are pretty much the operating priorities. In the meantime, we’ve got to sort out this merger mess that we’ve got. It’s gone on long enough and as I said, it’s very difficult to try to run on two tracks. It’s even more difficult for the guys that aren’t talking; namely, our management, to run on two tracks so we’ve got to get it sorted out and either the buyers are going to execute this contract or they are not.

I can tell you personally and speaking for the board and our transaction committee for sure that we are not trying to achieve a world record in a break-up fee, and $900 million might be the largest one ever paid -- I’m quite certain that it is -- that’s not the goal. Actually, it’s not a break-up fee; it’s a breach fee. Similar spellings.

As a board, we are mindful of our fiduciary responsibility to all of you. Today, we clearly interpret that as meaning we should enforce the contract.

The buyers have repudiated the contract. I’ll get into some iffy language here because I am not a lawyer and I don’t know the rules here but they’ve clearly repudiated the contract because they said they are not going to honor it. They are not going to pay us $60.

So we are already down to $59.99 and the fact that they’ve repudiated the contract doesn’t mean we don’t have to abide by it. It still binds us. It ties our hands and as I told you before, it ties our hands on day-to-day activities. We’ve got some people actually call lawyers before they go to the bathroom.

We cannot talk to other buyers -- well, we can listen. The buyers are running all of our liabilities, basically and they are getting paid very nicely for it.

We can’t repurchase shares. We can’t make acquisitions. We can’t repurchase debt. Those are all the thing that make running a business fun and they are in somebody else’s hands. Today they are Chris’ decisions under the contract.

I think on the other hand, Chris Flowers wants to own Sallie Mae. I firmly believe that. Unfortunately, he wants a wholesale price, doesn’t want to pay the retail price that he signed up for. But it is still possible for him to execute this contract as he signed it.

And Chris, I know you are here somewhere. I know you’re here. You can still do it.

I believe, and I’ve believed from day one, that his group, with himself -- Chris can run finance, and two strong banks, two of the three strongest banks in the country particularly faced with even better market conditions than yesterday, an improving market, remain the most logical owners for the company. But they are not the only possible owners.

And so if Chris’ deal doesn’t go, so be it. As you’ve heard and anybody that has known this company at all, knows we are the most dominant player in higher ed finance and we intend to become much more dominant. This company is a predictable and safe source of cash flow and large amounts of cash flow. It remains a superb candidate to be a private company.

Personally, I strongly believe that the company’s future is as a private company. This is clearly the wrong environment to restart that operation, if we need to, but as I’ve said, today is a better day to start it than yesterday was, and tomorrow is a better day than today.

If any of you guys want to put your heads together -- actually, your money together and finance me, I would love to buy this thing for $61 a share.

Now, I am happy to take your questions. Sir.

Question-and-Answer Session

Unidentified Analyst

-- you were disappointed in the quarter and what the run-rate is and how you need to pick up the pace. I just wondered if you could clarify something for me; is your view that since the results aren’t quite what you expected, there is no negotiation on your point of view on price? Is it the $60 or no deal, given your comments? And has anyone contacted you?

Albert L. Lord

The question, if I can restate it, is that do I feel differently about the $60 price in light of the quarter’s earnings?

Unidentified Analyst

-- run-rate predictions of $2.80 versus $3 to $3.20.

Albert L. Lord

Well, we’re at $2.80, but we’re going to grow. No, I don’t think -- one doesn’t have anything to do with the other, in my opinion.

I think the second question is have I talked to anybody? I assume you mean the buyer? Oh, any buyer? Well, we get calls. We get calls but it is kind of hard for me to talk about them. I am actually not allowed to talk about them.

Yes, sir. That’s you, Doug.

Unidentified Analyst

You might not be able to answer this, but these constraints that you are operating the company under because the buyer is making the decisions, what is the timeframe, assuming the deal didn’t go through? When would you be able to come back and make these changes to run the business the way you’d like to?

Albert L. Lord

We’re working on that. Soon, very soon. As I said, the goal is to get this thing sorted out fast.

Yes, sir.

Unidentified Analyst

If you would like to sort it out fast, why haven’t you made a motion for expedited hearing yet in Delaware?

Albert L. Lord

Well, that -- I mean, I would like to short it out fast and the shareholders would like to sort it out fast, but I don’t think that’s going to give a judge a reason to short it out fast. The way I understand that, there has to be something of an emergency and there has to be some immediate harm to somebody or some thing to get expedited treatment.

You are probably a lawyer and you are going to disagree with me. I’ll sick my lawyer on you, okay?

Yes, sir.

Unidentified Analyst

You said that JPMorgan and Banc of America are providing you very expensive financing. Can you quantify that, either in basis points or in numbers, how much is it costing us and -- I guess in basis points and how much are they making in dollars?

Albert L. Lord

How much they make? That depends on their cost of funds.

Unidentified Analyst

I understand that, but if you were to dump JP and Banc of America and go back and finance your own business your own way, what would that do to you operations?

Albert L. Lord

I don’t know. It’s about 25 basis points maybe. I think this is -- I would guess that you are talking about a three- to six-month process to unravel what they’ve done and to get either additional liquidity from elsewhere. And we are conducting conversations about that as we speak.

I think it’s roughly a 25 basis point differential, plus fees that we pay them. Keep in mind, this was the game plan for the company. That was how it was going to finance itself, that we finance itself through those banks forever so this was really just starting that process and the economics of that were theirs anyway, so if they charge us 50 basis points higher, it wouldn’t really matter because they were the beneficiaries when they owned it.

I am not complaining about it. It’s just a fact. Okay.

Unidentified Analyst


Albert L. Lord


Unidentified Analyst


Albert L. Lord

Well, it’s always been your money until they made it their money. We are very much in the process of changing that. I mean, that’s really where we are right now.

Unidentified Analyst

What I’m really interested in is how much more of the banks taking out of Sallie Mae now that would not go out of the company were it not tied up in this preposterous financing scheme?

Albert L. Lord

It sounded like you might be a little annoyed at these guys.

Unidentified Analyst

I don’t play chess either.

Albert L. Lord

What they are doing -- I don’t view what they are doing as preposterous. It’s a fact. It’s as they designed it and it reflects -- my guess is it reflects the split of the economics among the buyer group between Flowers and the two of them.

Unidentified Analyst


Albert L. Lord

Well, I’m not going to give you the number now because I don’t know the number now, but we would be happy to give it to you. Obviously it is going to require a little bit of estimation but we would be happy to furnish it to you.

Yes, sir.

Unidentified Analyst


Albert L. Lord

You’re not with a union, are you? Last time it was a prepared statement, there were three of them and they kept going on and on and on. Go right ahead.

Unidentified Analyst

Let me qualify; it’s a statement of support.

Albert L. Lord

Support? Take your time.

Unidentified Analyst

Mr. Lord, members of the Sallie Mae board, I am hear on behalf of the Heyman Companies, holders of the Sallie Mae shares and derivative contracts, representing more than 30 million shares, constituting more than 7% of the company’s outstanding equity.

I have several comments. First, as a substantial investor in the company, we’ve done a careful analysis of the recently enacted student loan legislation, which demonstrates that the legislation has no more than a nominal incremental effect, if any, on the company. In short, there is nothing here vaguely resembling a material adverse change.

Under what we regard as the most likely scenario, we calculate that the legislation will have no effect on the company over and above that of the legislation referred to in the merger agreement as the base case.

Under a worst-case scenario, assuming a slightly different interpretation of the agreement, the incremental adverse effect would equate to approximately 1% of the total equity value of the company, which is, of course, nowhere near what the law requires to show a material adverse change.

Incidentally, our calculations do not purport to take into account a not insubstantial offset associated with what we and other knowledgeable observers believe to be the likelihood that the legislation will inevitably bring about further consolidation of the student loan industry, which should in turn result in increased market share for Sallie Mae.

Second, it is important to bear in mind that despite the posturing, Mr. Flowers has yet to commit himself. Although he has protested that there has been a MAC and he is entitled to a price reduction, and has even proposed a lower price, he has yet to take a definitive position.

In refusing to do so, he has refrained from exercising his right to terminate, which would carry with it a $900 million liability. He has not invoked a MAC, which would similarly expose him, his investors, and partners to the $900 million liability, should a court determine, which is most likely, that there has been no MAC; nor, of course, has he indicated his willingness to go forward with the terms of the existing merger agreement.

What Mr. Flowers prefers is a “free call” to explore with Sallie Mae the opportunity to obtain a lower price through discussions with the company, while at the same time preserving his rights under the agreement.

Third, under the circumstances, for the company to engage in such discussions would be silly. First, there is simply no reason or basis for the company to reduce the price. Moreover, to engage in discussions with Flowers with respect to his recent, clearly inadequate offer, valued by most market observers at little more than $51 per share, would be tantamount to negotiating with ourselves.

And so, given the circumstances, we fully support the actions of Al Lord and the company’s board.

Finally, we have a conviction that, even in the event that the Flowers group decides to walk away or breach from its obligations, Sallie Mae will continue as a highly profitable company and that it’s competitive position, if anything, has been enhanced by the recent legislative developments.

We are similarly confident that this may in turn attract other interested buyers or, in the alternative, will result in the company’s trading on a standalone basis within say 12 months or so at a price well in excess of the current level.

In short, while we originally acquired Sallie Mae shares as a short-term investment, if the transaction fails to close as a result of the Flowers breach, we are fully prepared to be long-term holders. In fact, successful recent investments involve short-term investments, such as the London Stock Exchange and Qantas Airways, where as evolving circumstances changed, it made sense for us to hold them for the longer term.

We continue to have every confidence in Sallie Mae and its board to continue to do the right thing for shareholders.

Albert L. Lord

Thank you. If you want to speak again, you just raise your hand, okay? It is not a democracy up here.

Yes, sir.

Unidentified Analyst

Are you aware among the buyout group whether there are certain members who are more or less willing to or wanting to negotiate?

Albert L. Lord

The actual honest answer to that is I am not aware. I have lots and lots of thoughts on it but I think they are probably pretty good at passing the -- there are three of them. It’s a little like the shell game -- who’s under the white hat at any point in time and the black hat. I really don’t know.

Are there any questions on the phone, or in the other room?


(Operator Instructions)

Albert L. Lord

While we wait, go ahead, sir.

Unidentified Analyst

[inaudible] -- this quarter, just a brief look at this, it looks like the loans are [inaudible]. What’s the cause of that and how does the loans for forbearance move into the provision for loan losses?

Albert L. Lord

I’ll let C.E. handle that.

Charles E. Andrews

They have -- actually, is this on? -- increased, ticked up in the quarter. Actually, a couple of things are going on: one, we had done some things last year when we encountered, some of the problems we encountered in the Fall, they kind of pushed them down. So last year and I think we are returning to something that maybe is a bit more of a normal level.

But secondly, one of the things we’re finding in our collection process that had some effect on it is that we are able to do better skip tracing and other things that we do today, so we are actually connecting with borrowers better than we used to in the past. That’s one of the changes and successes we’ve had, which we believe has caused some up-tick in the forbearance.

As far as what we do with them though, it’s a conscious decision whether a loan goes into forbearance. They do receive higher provisioning. I mean, our historical analysis of loss experience of loans that are in forbearance has a higher provision, loan loss provision rate to it. So if the loan is there, it’s receiving, if you will, a provisioning burden. It’s greater than loans in other categories, so we take that into account when we quantify our loan loss reserve and our loan loss provisions.

Unidentified Analyst

What do you expect going forward with the forbearance? Do you expect it to keep ticking up like it has been, or --

Charles E. Andrews

No, I would not. I mean, I think we should see that it remains reasonably stable. There is some seasonality to it at points in time when loans go into repayment, et cetera. So it does have some seasonality but aside from that, it ought to sustain some relative stability to it. We shouldn’t see it continuously tick up, certainly.

And the other thing we look to --

Albert L. Lord

The answer is no.

Charles E. Andrews

Yeah. The other thing, we monitor the age of it as well, which also affects provisions, so we monitor it closely.


Unidentified Analyst

Two question; one, you mentioned the FFELP loans were kind of put in the door and the private loans were the economic driver of the business. In your view sort of post benefit retraction and the new legislation, will the FFELP business be a profitable business for you, a business that is substantially above your cost of capital?

And then, just to follow up on one question or comment you made about not asking for an expedited process because there was no emergency, but it sounds like actually the company and shareholders are currently being harmed by this current situation. Why wouldn’t you ask for an expedited process?

Albert L. Lord

C.E. will answer first. Let me think about it.

Charles E. Andrews

In terms of the school channel and the FFELP business, with the margin compression, basically what we will do over time, we haven’t done all this yet, we will adjust the benefits we offer to borrowers, which will offset some of the reduction, not all of the reduction. That’s kind of the pricing or economic change that we will make and we will do that and time that when we think it makes sense from a business standpoint, recognizing one of our objectives is to use our school channel to capitalize on the market share growth.

Once that’s done, we think it will remain a profitable business. It won’t be as profitable as it was obviously with the margin compression, but we think the school channel is essential to generate the growth.

Even though I mentioned the tuition -- our direct consumer grew at 48%, it still is a modest fraction of our total portfolio, private portfolio growth. The school channel is essential and it’s a huge competitive advantage we have, so we really need to continue to build upon that and we will make the government loans profitable, just not as profitable as they have been obviously in the past.

Focus on the margin, though. We try to manage to where we can hold that margin and that kind of collapses everything into one measure.

Albert L. Lord

No, that was ample. I’m going to have to -- I’m not really able to answer your question. My understanding of this is that somebody’s got to be, for emergency, were it an emergency, not an injured shareholder.

There’s no question that with the economics of transaction skewed the way they are based on the direction we were headed, that current shareholders are harmed. Current shareholders were harmed when they announced the MAC in July, right? Shareholders have been in and out of this stock at various prices and there is no question harm has transpired.

But the company is not in any kind of difficulty and I don’t think anybody else is in the kind of difficulty I understand it would take to get a judge to move more quickly than judges normally move, unfortunately.

Let’s try this gentlemen over here.

Unidentified Analyst

Just curious, given the loss of some of the guaranteed FFELP dollars, do we need to revisit any of our relationships on the private loan side? Say, for example, some of the riskier assets, maybe the for profit career tools? Do we need to be more conscious of those relationships going forward now that we lost some guaranteed FFELP dollars?

Albert L. Lord

I never thought of any dollars of earnings as there to cover dollars of loss. If we have dollars of loss in some of our borrower classes, we’re always looking at that and to your specific point, I think which runs to certain schools, we are looking very carefully at some of our relationships.

The first six months loan losses was a bit of an eye opener for some of us.


Unidentified Analyst

[inaudible] -- why, not that I disagree with you, but why would this be an ideal company private?

Albert L. Lord

I think it would be run -- could be run a lot differently without having all of its negotiations on sensitive subjects like students. Having the shareholders, really the detail of those conversations. Also, I think the financial structure of the company is such that it has a high cash flow, which can service the debt and provide delightful returns to the investors.

But I think as an operation for the company, I think the lower its profile, the better. That’s having been through four reauthorization processes and any number of political changes in Washington, and the loser is always the shareholder. We come out of every one of these exciting time periods, political time periods probably with a stronger operation but shareholders lose a ton of money. It really seems a little silly.

Unidentified Analyst

So the disadvantages of staying public? Just the opposite?

Albert L. Lord

Are you in a public company?

Unidentified Analyst


Albert L. Lord

Well, try it sometime. Try it sometime. Yes, sir.

Unidentified Analyst

Are the decisions being made right now as far as the company’s future, such as suing the buying group, is that being made by the entire board or just the transaction committee?

Albert L. Lord

It depends on the significance of the decision, whether the transaction committee does it or fully engages the board. The transaction committee has been delegated a great deal of authority in this transaction.

Unidentified Analyst

And just a quick, separate question; as part of the proposed merger, the banks were I think going to do a $28 billion ABCP conduit facility. Given what’s happened in the ABCP market, do you know if that type of facility is even feasible today?

Albert L. Lord

I don’t know.

Unidentified Analyst

Thank you.

Albert L. Lord

There’s a guy in the back. I’m afraid he’s going to say something. Do you want to say something, Oliver? Or are you scratching your ear? Oh, I’m sorry. I thought he had the ABCP answer.

Is there a question on the phone?


Yes, your first question comes from the line of Tim Wilson with Credit Suisse.

Tim Wilson - Credit Suisse

Mr. Lord, you’ve got a lot of stakeholders other than just shareholders and we happen to be an unsecured bond holder, along with 50 billion others. And this transaction effectively has picked off the short-term bond holders and monetized that value to enable the buyer to increase the purchase price. You’ve now got a very hostile bond market. How do you anticipate dealing with that, either in a situation where the deal falls apart or in a situation where you have to sell secured bonds to that audience?

Albert L. Lord

I didn’t hear the last part of your sentence -- in a situation where we have to?

Tim Wilson - Credit Suisse

Sell your secured product to some of those same bond holders. In other words, the bond holders have been severely punished by this transaction. The bonds are trading typically around $0.90 on the dollar and that had entailed in huge losses for people who have been financing you for 10 years, loyally, I might add, and some of those buyers are the same buyers who are buying the secured debt. How do you anticipate dealing with that situation?

Albert L. Lord

I think we’ve talked about re-entering the credit markets. We fully expect that we try to enter the unsecured market, that we’ll be dealing with different covenants than we’ve dealt with in the past. I think we are working on a program right now literally as we speak to issue debt and reemerge in the debt markets.

We recognize that damage has been done to the market values of secured debt. I would say if they are trading at $0.90 on the dollar, they are a very good buy. The company has been around 34 years and has always honored its obligations.

Tim Wilson - Credit Suisse

Thank you.

Albert L. Lord

You’re welcome. I think I see a hand back there. Go ahead.

Unidentified Analyst

Are you able to give any guidance for 2008? I mean, the proxy had core EPS of $3.66 per share. Is that realistic, given the run-rate that you described earlier?

Albert L. Lord

The proxy?

Unidentified Analyst

The proxy statement in management projections [inaudible] .

Albert L. Lord

That was designed under a different operating model, which was make and sell loans, not under -- I don’t know that we did it. There’s not anything equivalent to core earnings under make and hold, right? $3.66 does not look to be in the cards, though. I would say we try to get that run-rate up well past 70 and shoot at say $3.25 next year, but we are not at $3.65.

All right, if there aren’t any questions on the phone or in the other room, we’re about done.


There are no further questions.

Albert L. Lord

No further questions. Okay, I see some of you guys are getting ready to rush up here. Is there a back exit? All right, I’m finished. Thank you very much.


This concludes today’s conference call. You may now disconnect.

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