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SLM Corporation (NASDAQ:SLM)

Q3 2007 Earnings Call

December 20, 2007 9:30 am ET

Executives

Steve McGarry - IR

Albert L. Lord – Chairmanand CEO

Analysts

Jason Miller

Bill Cavalier—Société Genéralé

Sameer Gokhale - Keefe, Bruyette & Woods

Christina Amon - Merrill Lynch

Operator

Atthis time I would like to welcome everyone to the SLM CorporationShareholder Conference Call. (OperatorInstructions) I would now like to turn thecall over to the VicePresident of Investor Relations, Mr. Steve McGarry.

Steve McGarry

Thank you very much, Hilary. Good morning, everybody andthank you for tuning into our conference call today. Firstwe’ll start by reading abrief Safe Harborstatement. Please note that during theconference call we may discuss predictions, expectations and may make otherforward-looking statements. Actualresults in thefuture may differ from those discussed here -- perhaps materially -- based on avariety of factors. Listeners shouldrefer to thediscussion of those factors on thecompany’s Form 10-Kand other filings with theSEC.

During thecourse of this conference call, we will refer to non-GAAP measures that we callour core earningspresentation. Thedescription of coreearnings, a fullreconciliation of the coreearnings presentation to GAAP measures and our GAAP results can befound in our 10-Qs,10-Ks and supplemental earnings disclosures, allof which are posted onthe investors page atour website, SallieMae.com.

After Al’s remarks, we will open up thecall to Q&A, but I would ask that due to theoverwhelming interest in the call this morningthat you limit your questions to one percaller. Thank you.

Albert L. Lord

Good morning. I haveto say, this is aunique experience and I’ve learned that we have arecord number of participants on one of our conference calls. Let mefirst apologize for asking you to sit induring the marketopening, I wasn’t quite paying attention to that and I doapologize; itcertainly was not intentional.

I amtalking to you today as your CEO and Chairmanfor the firsttime. I’ve been inthis seat officially three full days. Thepurpose of this call really is to reacquaint myself with you and you with me,and try to create some transparency by meas CEO and not part of theLBO transaction committee team.

Thepoint of my coming back to this chairis to engineer theSallie Mae transition from what is frankly deal limbo to begin to regrowearnings, which we’ve not done insome period of time.

I will confess to you that theExecutive Chair rolethat I had occupied for abrief period was confusing internally, sowe bumped along to finally getto the position whereI am theCEO.

I amnot going to take agreat deal of your time today; probably 30 minutes or less. I amhere to talk about some broad issues that we arelooking at right nowand my goals. I amnot going to begetting into basis points and FICO scores and modeling and that sort ofthing.

I thank you again for listening. I amquite aware that on theback end of a failedtransaction that there area lot of unhappypeople on the otherend of this call. Itis ironic, because itwas unhappy shareholders who originally put me in this seat in the first place. I’ll talk to you today about therecent past and thenear future.

Let mefirst talk about thedeal; I am not goingto talk very much about it. As you arewell aware, it’s not adeal any longer, it’s litigation. I amgoing to attempt to engage ina little self-defense,hopefully not defensively.

I and thecompany and the boardhave gotten some bad press for not doing atransaction. I know there aremany disappointed recent shareholders. Again, theirony is that my objective over a30-year career representing public companies hasbeen to reward investors -- particularly inthis company, which I hold very dear.

As I have told you before, I fought and wona proxy contest in1995 when the shareprice was $2.95. There area lot of shareholdersrewarded with those results and quite frankly I hope afew of them arelistening.

There hasbeen a lot of finger-pointingabout who is responsible. I would justsay, for that matter, to credibly point atme, our committee or our board you actually must believe that theother side wanted to doa deal and we did not;the exact reverse is thefact. About the deal,I’ll say no more.

I amgoing to mention few words about my stock sale. My bank sold meout, on Friday, of 1.2 million shares. Iwill mention that it’s embarrassing and troublesome to mepersonally. Itis not a sign of mydisillusionment with thecompany; in fact, theexact reverse is thecase. It’s ashort term cost, in myview, of my own belief inmy company. I suppose you might sayone more victim of anunfinished deal.

I can assure you that I amproperly incented to create theearnings growth that this company hasbeen known for and I have no more margin stock -- no more margin.

On apersonal level, I’ve been working full-time for along, long time; 40years or more. In the last couple ofyears at Sallie Mae Ihave not been hands-on, but I can tell you I’ve been working on Sallie Maeevery single day since this deal first cracked inJuly.

This is avery challenging time. Thegoal here is to getout of deal mode and into thegrowth mode; the samegrowth mode that we’ve been infor the last 25years. I have very, very specificgoals. They aregoing to take a littletime. For what its worth – and I have had this question asked to mea number of times --this very, very much feels right to me. I feel like I amin theright place at theright time.

I can assure you also, while it’s not forever, you’ve got mefor at least twoyears.

My immediate plans? As I said, I’ve just become CEO onFriday -- it’s Wednesday, I think. Myfirst goal -- probably my first goal and second goal -- is to strengthen ourbalance sheet. Theunfinished deal costus a single-Arating. We arenow BBB. Thefirst objective is to solidify that BBB; thenext goal is to improve itfrom BBB to single-A. This is very much my first priority.

Inorder to do that,obviously, we aregoing to add capital, we aregoing to need to add capital. Inthis marketplace capital is king and frankly only recently have I begun tobelieve that capital may beking in almost alleconomic environments.

Thecompany needs to diversify its funding base, putting ourselves indeal mode put us on avery specific path that was very consistent with theway this company was going to berun; we need to getoff to that path.

I’d like to sign atruce with theunsecured lending community, and I very much understand that is likely to becovenant-heavy, not covenant-light as in the past; and infact, we may very well beprepared to talk with some of our existing creditors in the unsecuredcommunity to help pave theway for thefuture.

We have to disarm our equity-forward contracts. Those equity-forward contracts were struck ina way that wereextraordinarily accretive to thebuyers who didn’t buy, but they aredilutive to our current owners when thestock price goes down. We aredealing with that immediately.

Another keyobjective is to build off-balance sheet capacity. We obviously offload assets through thesecuritization route. We need otheravenues as well, as we moveinto the future.

Theobjective of more capital, obviously, is to strengthen thebalance sheet. It is alsoto reduce our funding costs. I’ll talk ina couple of minutesabout our current earnings situation, but clearly higher funding costs inthis tighter credit environment arecausing some of that downturn. Thecombination of thedeal, and having funneled our funding through thebuyers channel has bumpedour funding costs.

Theother immediate goal -- and it’s already been started by thecompany -- is to focus directly on thehighest quality private credit asset channels.

Intermediate goals: intermediate for memeans -- I guess you’d call itthe ‘08 lending season,it begins in the summer of ‘08 sowe’re really talking about maybe July. Itis at that point thatI hope we begin to restore aviable, long-term earnings growth ratefor the company.

We’ll continue to capitalize on our on-campus strength andbuild that private credit channel. Thereare numerousopportunities to consolidate theindustry. We have to bevery discriminating inthat effort, but I seemassive opportunity for us to increase share. Again, to acquire that capacity we will likely use stock. We will not dodilutive transactions. We will notincrease our goodwill and these opportunities will betaken also to build capital.

When people think about this company interms of its earnings growth rate--and we’ve had apretty impressive growth ratefor 25 years – it comesdown to very simple, simple basics: itis the growth in the number students, thegrowth in thecost of schools andour ability to growmarket share.

Our focus, particularly now inlight of events, including legislation will beto focus our growth targets even more directly on thefour-year schools where we want to build market share.

Sallie Mae hashad a strongdouble-digit growth ratefor 25 years. We first listed thiscompany in 1983 when Iwas the CFO. Thesuccess we’ve earned over that period hasbeen as a consequenceof what I just mentioned: thegrowth in higher ed,our market share growth. We’ve achievedthose double-digit growth rates in the face of 25 yearsof margin cuts. This recent round ofmargin cuts was significant, but is not new. It changesthe landscape for usbut if anybody is prepared to deal with that, we are.

These macroeconomic facts did not changejust because of afailed deal.

You folks have raised issues with meover a period of time;in themost recent period of time I’ll try to deal with those issues and then I’lltake some of your questions.

Recently we restruck or reforecast or reguided -- or whatever itis, the language weneed to use -- our fourth quarter earnings and our 2008 outlook. I ambeing asked, “why?” I amnot going to getprecise, but the issueis predominately funding costs.

Our securitization market costs areout over 25 basis points; access there is not as free or infinite as itonce was. We have discovered anindex mismatch between commercial paper on which thestudent loans earn their interest, and LIBOR. This credit crunch hasexposed that mismatch which had never opened in the roughly tenyears we’ve had this commercial paper index, but it’s widened out into double-digits.

Theinterim financing facility provided by thebuyer has highfinancing costs. Replacing itwill probably involve higher financing costs. This is not agreat time to befinancing.

We made adecision on the basis oftrying to increase market share, not to knock out our borrower benefits inresponse to the recentlegislation; the originalforecast had us knocking our benefits out. We’ve moved our private credit provision up alittle bit since we’ve talked to you inOctober. Since we talked to you inOctober this credit crunch re-emerged, and sobe it.

As I said, I don’t want to getinto FICO scores and basis points. Stevecan help you guys with your models with respect to these issues, and hewill.

Of course I hear alot of questions about private credit quality. I would direct you to our securitization data which is actually showingmild improvement, atleast on a delinquencydata versus prior quarters. Itseems to be moving in the right direction. Iam not theleast bit Polly-Annish because of thosenumbers.

This is adelicate economic environment, atleast it seems to be, sowe are watching themvery closely. I ampleased they are goingin theright direction but I also would tell you they are-- we are comparingthem to first half statistics which bear thecost of some operationalissues and make it alittle bit difficult to fully analyze that data.

We have analyzed our defaults and we have ahighly sophisticated and professional group of collectors inour collection function and they have analyzed these defaults and we areon them. We’ve moved quickly to cut off those loans, themost difficult loans, attheir source and I believe we have avery good understanding of that. This is avery high priority of mine inmy new seat.

Thevery good news is thedemand for this product is as strong as ever and itgrows. Almost allmarginal funding student borrowing is in the private creditarea. Almost every student hasused up whatever guaranteed loans areavailable, so whatevergrowth and whatever demand increase there is is typically in the private area. I saythat’s good news. Itgives us the luxury ofapplying a little morecare in theselection of these assets.

I hear noise from avariety of places, some of which make meless than happy, about our refinancing our interim facility. That facilitycomes due in May,although in February itbecomes much more expensive. As I said, there seems to bea lot of interest inthis facility. We need to remember that this is afully secured facility and while it’s abad time to benegotiating interest rates, we arevery much in thatprocess. We have agreat deal of interest inthis and in my view,it’s a matter of cost.

Thelong-term, I think it’s worth noting that thecompany has never had aninterim facility inits 30-year history. This is aby-product of a deal. Thegoal will be of courseto have back-up facilities insufficient amount long-term, but obviously thelong-term goal as we build capital is to reduce thesize of it andcertainly the costof it.

I’ve been CEO and CFO of this company for 24 years. I think thelargest that underlying facility had ever been was $6 billion. That wouldclearly beinsufficient today but this is aunique situation.

Our other goal, as I said earlier, I think is to have -- isto build other avenues to moveour assets off balance sheet.

I’m going to wrap up. As I said, this company hasbeen around for 35 years. It has led thefinancing of higher education for 35 years. Themacroeconomics of this industry remain thesame. There have been avariety of changes,particularly in thelegislative area and in the credit marketsunderlying all ofthis, but we aretalking about acompany that seeks to lead and does lead thehigher education finance industry and hasbeen in effectwandering off in adifferent path for thelast nine months now.We need to get offthat path and get backon the right path and getback to thedouble-digit earnings growth that we’ve had in the past.

I’ve had a26-year -- of thecompany’s 35 years, I’ve been associated with itfor 26 years. I’m extraordinarily proud of it. This is just one more majorchallenge for this company. We will exceed that challenge. There arelots of worriers inthis environment. Just remember, those of you who areworrying, that this business is one of thevery few that has --it’s not totally recession proof but itis virtually recession proof.

I will now take afew of your questions.

Question-and-AnswerSession

Operator

(Operator Instructions) Our first question comes from JasonMiller. Your line is open, sir.

Jason Miller

Yes, I wanted to ask -- you’re going to shore up thebalance sheet. Does that mean you aregoing to be sellingequity?

Albert L. Lord

Themost preferred type of equity is common equity. I’m not going to -- atthis point, I’m not going to getvery precise with you. Theidea is to strengthen theequity, the capitalcount with financing somewhere beneath thelong-term credit lines.

Jason Miller

Doyou think you’d need to raise to getback to the creditrating you would like and what areyour thoughts about thedividend?

Albert L. Lord

Allright. This is thelast question I answer that’s more than one part. We will look at the dividend in the second half of theyear.

Jason Miller

Okay.

Albert L. Lord

Thank you.

Jason Miller

And you didn’t mention how much equity you were going toneed to get back up tothe single Arating.

Albert L. Lord

You’re talking to thewrong guy. I don’t know that answer.

Jason Miller

Thank you.

Operator

Our next question is from Bill Cavalier.

Bill Cavalier—SociétéGenéralé

Can you talk alittle bit about thepass-through market? Clearly there’s pretty much no appetite for student loanpaper at this point.What are you beingtold about when you think there will bea market for yourpass-through notes sothat we can start to --

Albert L. Lord

You’re talking about our securitizations, I assume? Look,we’ve not been -- we’ve not done as much as we’d like to do. We’d like to doall of our currentproduction and actually liquidate even some of our inventory but we’ve done asecuritization this month. We did asecuritization inseveral preceding months. They’ve been maybe 60%, 70% of what we wanted to do.

My own view, and this is where I usually getin trouble, but my ownview is that that market -- that, along with alot of other markets, is shut down for theyear 2007 until people take alook at their 12/31balance sheets and figure out what they aredoing. But I don’t have thebottom line answer to your question.

Bill Cavalier—SociétéGenéralé

Okay, but clearly you’ve been talking to thearranging banks and they must betelling you something.

Albert L. Lord

I’m not sure what you’re talking about. I’ve been talking towhom?

Bill Cavalier—SociétéGenéralé

When you doa securitization, youhave a bank thatarranges -- that actually does thearranging, right? You have anarranging bank and somebody must betelling you something about what themarket is looking like, what their expectations arefor next year. We’re trying to put together projections here, Al. We’re tryingto make -- we’re trying to figure out what your stock is going to beworth and you’ve got to give us some guidance, you’ve got to give us somenumbers. I don’t even seea margin number herefor the stuff thatyou’ve done. Can you give us some handle on what your stock is worth?

Albert L. Lord

You should give Steve acall.

Bill Cavalier—SociétéGenéralé

But you’re theCEO. You’re the guywho just took over thecompany.

Albert L. Lord

Yeah, that’s exactly right. I’m theCEO. You should give Steve acall. Next question.

Operator

Our next question is from Sameer Gokhale from KBW. Your lineis open.

Sameer Gokhale -Keefe, Bruyette & Woods

Thanks. I just had aquestion, Al. You talked about opportunities to buy portfolios in the market. Have youbeen seeing any early signs of smaller competitors exiting with thenew legislation that’s come, that was enacted as well as some of thefunding challenges that you mentioned but presumably thesmaller companies arefacing those as well. Is ittoo early to tell yet or areyou seeing or hearing about any signs of smaller companies exiting? That would behelpful. Thank you.

Albert L. Lord

Thank you for thequestion. Yes, we’re seeing quite afew signs. This will bean overstatement butit’s a little bit -- Ithink everybody is looking attheir plans in thisbusiness and we have heard from anumber of players, small, medium, and large, to talk about what we might doin thefuture. And it is oneof the reasons whyI’ve come so quicklyto the realizationthat we need to bump our equity capital sothat we can play inthat marketplace as we rollinto 2008.

Sameer Gokhale -Keefe, Bruyette & Woods

That’s helpful and just aquick follow-up, if I may; doyou have a sense forwhat kind of return hurdles you would expect on portfolio purchases versusissuing stock and thereturn that investors expect? I don’t know if that’s something you can answer atthis point but I was just curious if you have any thoughts on that.

Albert L. Lord

You know what, I failed to mention -- I don’t know how Imissed it inmy notes -- look, I’m going to put myself infront of you folks inJanuary, inmid-January in NewYork and I would really like to use that occasion to getinto more specificity with respect to different -- any returns that may differfrom what we’ve tried to achieve in the past and morespecific plans.

As I said, I’ve been inthis seat for three days. I wanted to getto you guys -- look, I have along history ofdealing with shareholders openly. I’ve been very much under wraps for thelast nine months and Iwanted to get beforeyou today and so whenI stand before you inJanuary, I will beprepared to take allof your questions and I would suggest maybe you getthere early because I can assure you, you’ll begoing through a metaldetector.

Sameer Gokhale -Keefe, Bruyette & Woods

Thank you.

Operator

Our next question is from Christina [Amon] from MerrillLynch. Your line is open.

Christina Amon -Merrill Lynch

Good morning. Thanks for thequestion. I just wanted to follow up quickly on the$30 billion facility that had been associated with thedeal, now that that’s going to begoing away, I’ve been reading inyour recent releases that you aresoliciting interest from other financial institutions and itseems like there was pretty good interest insecuring some funding either to the$30 billion mark or inexcess of that. I just wondered if you could provide us with some updates orcomments on that, please.

Albert L. Lord

Those conversations go on. I think interms of substantive movement, you aretalking about early next year and I’m quite pleased with theprogress and the tenorof those conversations. So-- I mean, it’s inappropriate for meto give any further depth than that.

Christina Amon -Merrill Lynch

Okay. Thank you.

Operator

(Operator Instructions)

Albert L. Lord

How good is this? Steve, let’s go. There’s no -- noquestions. Let’s get thefuck out of here.

Steve McGarry

Okay, Hilary, if there areno more questions, we’ll end thecall. Thank you, everybody for tuning inand if you do havefollow-up questions, please feel free to call myself or JoeFischer. Thank you. That ends thecall.

Albert L. Lord

Goodbye. Thank you.

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Source: Sallie Mae/SLM Corporation Shareholder Call Transcript
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