SLM Corporation Q4 2007 Earnings Call Transcript

| About: SLM Corporation (SLM)

SLM Corporation (NYSE:SLM)

Q4 2007 Earnings Call

January 23, 2008 10:00 am ET


Steve McGarry – Vice President Investor Relations

Tony Terracciano – Chairman

Al Lord – CEO

Jack Remondi – CFO


Matt Snowling – FBR Capital Markets

Cyril Battini – Credit Suisse

Don Jones – Credit Suisse


Good morning, my name is Janice and I’ll be your conference operator today. At this time I would like to welcome everyone to the SLM Corporation’s fourth quarter 2007 earnings call and shareholder meeting conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Now I would like to turn today’s conference over to Mr. Steve McGarry, Vice President of Investor Relations, please go ahead sir.

Steve McGarry

Thank you very much. Good morning everybody and thank you for joining us here in person this morning and via the telephone. Before I turn the conference call over to Mr. Tony Terracciano our Chairman, Al Lord, our CEO and Jack Remondi our CFO, I would like to read this Safe Harbor statement.

Please note that during the conference call, 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 a discussion of those factors on the company’s form 10K and other filings with the SEC.

During the course of this conference call and meeting 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 on the fourth quarter 2007 supplemental earnings disclosure accompanying the earnings press release which was posted on the investor’s page at our website, Thank you and now I’m going to turn the call over to Tony.

Tony Terracciano

Good morning. It seems to be getting harder and harder to remember what a normal operating environment is. If you look back over the past several years you see periods of euphoria and periods of adjustment, panic and almost despair and it’s ironic in a way that what both types of periods have in common is that differentiation of risk sort of evaporates and value becomes elusive.

I’ve looked over the past cycles, past events, going all the way back to the LDC debt crisis of the early 80’s to real estate crises, the HLT LBO problem, the Asian crisis, the tech problem and one thing you learn from going through that list is that it’s a little bit difficult to forecast the duration. And therefore and I think you’ll hear this today, when you make your operating assumptions, it pays to some extent to be defensive until you have a better understanding of all the corollary potential, risks involved and the duration of the period and for you in your work it’s very hard to look at an individual franchise in an environment like this and estimate the franchise value coming out of that type of a period.

And then of course you always have specific issues involving any company and for us we had the transaction that didn’t happen, we have changes in the legislative environment and we’re a company going through a transition in the types of asset creation that we do and all of that makes your job very, very difficult. And I think at the very least you have a right to understand the nature of the response that management and the board thinks is appropriate for this type of an environment. And that’s what we’re going to try to communicate today, how are we responding to all this fogginess surrounding the value of the franchise.

If you go back and look at that list that I mentioned earlier, there is one thing I think you can learn from it and that’s financial firms that can establish that they are among the most productive and clean in terms of asset quality tend to come out of this fog first, certainly, among the earliest. And therefore, whatever we do has to be done with a pace that is almost maniacal, that we have to get everything done as quickly as possible and of course it’s bad to have a wrong strategy and spend a lot of work and get nothing for it, but to me it’s even worse when you have the right strategy but you just don’t execute it well enough or quickly enough.

And so I hope today you can get an understanding of what we think is the appropriate response and how quickly we are and intend to continue to move. And I guess what I’m saying is it pays to be defensive in some of your operating assumptions but it also pays dividends to be very, very aggressive about achieving and communicating the justification for convincing you all that we’re coming out of the fog as quickly as anybody else.

And I mentioned that to come out you have to be among the most productive and you have to be the cleanest. Obviously with the issues facing us, it’s necessary that we go through a significant substantive change in the expense burden that we’re carrying in the company. We’re not talking about something around the edges, we’re talking about a very substantial decrease in operating expenses and not only that but once you get to a level you have to focus on the fact that because of our critical mass at the margin, our operating expenses per average asset created is very low and therefore the productivity gains year after year should be built into the planning.

Now we’re at the very early stages of this expense analysis. You’re going to be hearing a lot more of it over the next several months. It’s my experience that if you have a target, what you achieve in the first 12 months is the bulk of what you’re going to save, so you have to try to front load these expense savings to whatever degree possible.

I’d also like to point out that although people talk about them as if they’re separate variables, there is a relationship obviously between productivity and asset quality. Financial firms that are the most productive tend to have the least reason to reach for the higher risk activity. And so the more productive you are, the less need you have to push against that risk profile.

The second issue is clean asset quality. In a period like this you have to quickly recognize those instances where your own experience plus the changes in the operating environment have indicated a need for rapid increase in reserves and exit of certain types of activity. We also have to take advantage of the time that the market disruption will give us to go back and re-review all of the analysis that was done about each segment of the business and each product of the business and look at them from a risk adjusted return on equity.

That process is at the beginning stages and it has to be done rapidly. We’ve already obviously made some decisions about reserve increases and we’ve already made some decisions about pullback and exit but this risk adjusted return on analysis will take us a little bit longer and that has to be done.

Also, to reflect the change in the nature of the portfolio from guaranteed to an increasing percentage of private loans, it’s logical to create the role of the chief credit officer in the company. And that’s because the firms that tend to do the best in periods of adversity have this creative tension between the asset creators and the people that are guarding the underwriting standards and profile and you need that type of healthy tension. And we will be creating this role. And it goes without saying that a financial firm’s asset quality is also a key productivity variable.

So the next issue is how do we make it easier for you to track what we’re doing and to measure the progress? And the way I think that should be done is to lay out for you specifically what we think the financial performance objectives or financial performance variables are that will create or dilute shareholder value over the next several years. Now all of you have your own slight differences in how you look at different aspects of that. Everybody agrees that productivity is important, analysts don’t always use the same measure of it.

I’ve started to reach out to members of the analyst community to get their perspective on this but very shortly we will tell you, here’s what we think the variables are, here’s where we are against each one and here’s our target. And once we do that, we’re sort of naked because every quarter you can look at what we’re doing and how quickly it’s working.

This also helps prevent the temptation to fall into the trap that gets financial firms in trouble and that’s excessive focus on any one of those variables. Our objective is not to maximize any one of those variables but to come up with the most intelligent sub-optimization amongst them. Alright, if all you focus on is growth, you’re going to have asset quality problems. If all you focus on is asset quality, you’re going to give up the opportunity for reasonable growth. So we will work in making sure that we have the proper balance among them.

Now I understand in your job there are times when you only want to talk about one of those variables. And sometimes that variable changes after six months, alright. When you speak with us, we will tend to want to go through all of them and to keep explaining to you how we’re trying to balance them.

And finally, if you’ve got the right strategy it means that there’s at least two ways for the shareholder to win, not one. If we move steadily towards those financial performance targets, the shareholder will win. But we also have to be willing to recognize a good deal when it comes along and if that’s the right thing to do for the shareholder we’ll do it.

Now the first time I said this, people didn’t believe me. The second time I said it, they believed me because I had already sold one but they didn’t believe the Board that I was getting involved with because they had never sold one. In this case there’s no burden to prove, alright. The Board has already demonstrated its willing to sell and I’ve demonstrated I’m willing to sell so that’s not an issue where we have to establish credibility. Alright, we will make sure there are two ways for the shareholder to win. Al?

Al Lord

Good morning. Well we have a large turnout here in the room and I understand we’ve got several hundred people on the phone, I like Tony thank you for your interest in Sallie Mae. It’s been suggested that I’d be happy to see the year 2007 over although I have to say I’m not particularly impressed with the capital markets at the beginning of ’08. As you’re well aware at the end of ’07 we added some capital, that was obviously something that we felt essential at that time.

The other thing that was essential at that time and not just the only thing essential but it was to bring some talent into the company and we did that, we did that at the very beginning of January and the new talent is sitting at this table. You’ve heard from Tony, you’ll hear from Jack Remondi. Tony’s nickname is Tony T, Tony’s got an impressive resume, it’s reasonably long resume but what’s impressive about it is it’s accomplishment and not just accomplishment but accomplishment on behalf of shareholders. I’m not quite sure that the T presumably stands for Terracciano, I think it may also stand for talent and for sure it stands for tough.

Next to him is Jack Remondi, as you guys probably know, Jack was a CFO some number of years ago, he’s back in the CFO role, although his role is going to be far larger than CFO. Jack brings a lot of intelligence, financial acumens, he’s a student loan veteran, his principle attribute is commons sense and reliability.

The three guys on the platform, actually there’s four guys, that’s Somsak Chivavibul, he’s the guy that creates all the numbers for us. But the point was that the guys on the podium are finance guys. Tony mentioned to you that we’re not finished adding talent as the talent search continues and our most obvious need and we’re well under way trying to find a chief credit officer.

My focus, Tony’s focus and Jack’s focus today is going to be on the future. As you’re well aware it’s been an eventful ’07, the last 100 days I would call it have been particularly eventful, some might say, I would say reasonably painful. Certainly my December 18 conference call did not improve that situation. I did not answer your questions that day, we will answer them today. I recognize that day that my closing comments were offensive, they frankly weren’t meant to be closing comments but for that I apologize and I can’t say that it’s the first time I’ve used bad language, it’s the first time I did it in front of 500 people.

I last spoke in front of you guys in October of ’08 and we were looking at ’08 earnings in the $3-$3.25 range, we’re not looking at $3.00 anymore and sadly or frankly or both, today we’re looking at probably less than $2.00 in ’08. Our goals are higher than that and frankly it’s very hard for us to pin that number down because it is at this point totally dependent on our cost of funds. We told you that raising the money in this liquidity facility financing was more a matter of cost than the level of principal, that continues to be the case and while we’re very close, the cost has gotten, even in the last several days and weeks, vastly more expensive.

And so while ’08 is a transition year, I’m sure there are other people calling ’08 a transition year, it will lead us into what we believe a strong ’09 and frankly I expect the second half of ’08 to be far better than the first half. I’ll leave it there.

As much as I’d rather not go through a short summary of the last 100 days, just if you’ll allow me to look back a little before we move forward, give us a little bit of a perspective to understand where we are and where we’re going.

As Tony mentioned, we had a deal in ’07 and then we didn’t. That transaction is terminated, but also in the second half of ’07 and early here in ’08, we’ve watched the evaporation of at least 60% of the ABS market and I’m talking about ABS for triple A rated assets. We were typically issuing $3-$4 billion a month, we’re now doing about $.5 billion. The 40% of the market that remains, again this is for triple A assets, is costing us 40-50, 55 basis points more than it cost before and I’m talking before about LIBOR kind of LIBOR plus ten in spreads and now I think our last deal was LIBOR plus 55 or something in that range.

So the fact is and this is not any secret, we see it on the news and people are screaming at each other on CNBC and other channels all day long about this but liquidity even for triple A assets is tight, no question about it. We added $3 billion, actually it’s probably closer to $3.2 billion of equity capital a couple weeks ago. Closed the equity forward contract and added another 12-15% equity. And in the last several weeks as you may have read the results of this morning, Jack and I have been trying to unravel and isolate the cause of the previous three quarters loan losses that were so far in excess of what they had been in previous years.

We have very closely identified these assets and the assets are basically, were created in a way that’s a little different than what we believe is our lending philosophy and certainly is now our lending philosophy and that is that, education builds creditworthiness. I mean that is clearly our philosophy, we’ve seen it for 35 years in the guaranteed side of the business. We’ve seen it very much even on the private side, but we have over the past several years violated that policy.

Creditworthiness for young people tends to be very independent of standard measures, including things like FICO, although we obviously look at FICO and if there’s one single variable that’s critical, it’s graduation. I’m sure there are a lot of people in this room that remember that their creditworthiness, although they might not have been told this at the time, changed dramatically when they got out of college, especially if you went into college, well never mind.

Graduation is critical. Sallie Mae has lent too much money to students who have gone to schools without very good graduation records. Such students at such schools are virtually singly responsible for 60% of the ’07 credit losses. Our methodology in creating loan loss provisions tend to look backwards because that’s the information that we had. But we have specifically identified the borrowers who are not likely to graduate and provided for them this quarter as it’s frankly a different reserving methodology, but we know those assets are going to default and so we’ve reserved for them.

Jack will get into far more detail and lay this out in a way that’s comprehensible shortly. I believe our long term charge off numbers will be less than 3% and in fact the relevant numbers for ’07 for the assets that we would say are traditional school assets are something less than 2%.

We are, as I mentioned early, working on our credit facility, we were working on it day and night, in fact Jack Remondi’s, I think totaled about an hour’s sleep last night, so we are moving very rapidly to getting that issue resolved. The cost of that facility will reflect today’s credit market. As I said we are financing triple A assets, I don’t know that there’s any better indicator of where today’s credit markets are than the nature of that facility which you will see soon enough.

But that’s the story of where we are in January 2008 and as I said earlier I think it’s really going to be the story of 2008’s earnings that will be very cost of funds dependent. And so I’m reasonably well into my presentation and I know you’re asking, where is the good news? The good news is our business is the good news. It’s a great business. The business has led Sallie Mae for 35 years, it’s led double digit growth for virtually every one of those 35 years. That business leads us and we lead that sector and we lead it and we expect to build that lead in ’08.

Sallie Mae’s franchise is its market position. That is what our franchise is all about. We’ve added capital, we’ve added debt capital, we’ve added equity capital, convertible preferred capital. The point of all that was to solidify and build the franchise and make sure that we are the reliable player we’ve always been through a difficult year.

There’s more good news, assets and the related top line income, I mean the very top line, not after interest expense, but our interest revenue lines growth are very strong and are strong in a way that would support much stronger bottom line growth were there not a few lines in between. Quality assets grew in 2007, they will grow in 2008 and they’ll grow in 2009 and in 2008 and 2009 they will be far higher quality. The top line is not our issue. The issue is getting the top line to the bottom line and as I’ve said repeatedly, the issues we’re dealing with right now, forget all of ‘07’s events, are cost of funds related and bad debt related.

Cost of funds will improve, the timing of that is not in our hands. Loan losses will also improve. In fact, despite the fact that we are staring into the face of what looks to be a deteriorating economy, we believe, I’m sure you’ve heard this 1000 times, we have our arms around this major issue. We expect loan loss provision reductions, we’re going to be very careful about that obviously because this economy maybe hasn’t quite found its way yet, but I would hope that as early as mid year 2008 you’re seeing that.

The company has stopped making loans that were predictably not collectible. You may have seen the announcements, I think three of our major customers and unfortunately what was bad news for us in this quarter turned out to be very bad news for them as well. You may have seen the announcements that we’ve notified them that we’re just not making those loans anymore.

Our FFELP franchise is obviously what we’ve built this company around, FFELP loans. As I’ve said it started 35 years ago. Companies evolved a great deal over that time, the evolution of the company picks up pace virtually every year, it got seriously rapid in 1997, it’s changing everyday at this point. But FFELP remains a very major piece of our franchise. As you’re aware the economics of that changed even again in the fall and frankly in this credit environment, in this money market environment, the loans that we will make and we virtually made none at this point, but the loans that we make post 101 Legislation can be made barely profitably in today’s capital market. Jack will get into that shortly.

We expect those markets to change, we’re long term players, we’ve been at it for 35 years and we intend to be the leader in this market as well and we expect that with regularized credit markets and with some serious cost cutting that the FFELP asset will continue to provide very acceptable long term returns.

We see major industry consolidation opportunity, frankly I see it quite first hand because I get the calls. We’d like to capitalize on that opportunity. First things first, we’ve got a few other things we’re working on at the moment. We are specifically looking for quality asset generation platforms again and particularly in the private space as much as the FFELP space.

The price of those kinds of assets at the moment are not going up, we think they may continue to go down. We’ll fund those types of acquisitions if and when we get to them with equity and we’ll do it with, you may find this hard to believe that, non dilutive PE multiples.

Tony referred to the cost reduction and we’re talking about a 20% cost reduction, that’s one-fifth of our costs, it’s a massive change but we have to match our costs to the relative contribution of our assets and particularly our FFELP assets. It’s creating and will create, we’ve got a small piece of it done that was well under way really as I came in the door, whenever that was, December 14 or something. This change will create a massive cultural shift at the company. Sallie Mae’s major investments for 35 years have been directed at the guaranteed student loan business. The business won’t afford that spending any longer.

We expect those cost reductions to contribute to our earnings probably in second, well certainly in the second half and even greater in ’09. We expect our fee businesses to provide low teens growth, this economy should provide opportunities for the bad guys in the collection business. We’ve got very, very strong management in that business.

And our private loan business is now obviously our principle business. It’s got very attractive long term spreads. As I said we’ll have lower defaults, I think we might even characterize them as low defaults in the absolute because we will remain consistent with our lending philosophy that we’re investing in completed educations, graduates.

I mentioned we were looking for a chief credit officer, we really need to get a little more scientific about our approach to the market, so we’ll look for somebody who’s got some higher ed experience but principally credit experience and frankly can identify the demographics that we’re looking at and even improve our returns.

So I think I’m about finished, Tony told you that he has credibility in selling companies, certainly his resume would show that and he’s actually sold some, I want you to be aware that the three of us ultimately think very uniformly about what our role is here and that is to generate returns for shareholders. It’s been my career which is now at 40 years, but we will choose a path that provides the best return for shareholders and as I said earlier, we will answer your questions today, I’d like for your to hold your questions and have Jack come up here and we’ll talk to you guys later, thank you.

Jack Remondi

Good morning, it’s been about a two and a half year absence for me being on this side of the table, I’ve spent the last two and a half years sitting in the audience like you. I’m glad to be back on this side of the table today.

My presentation this morning is going to cover five different areas, I’m going to give you an overview of our 2007 operating results, I’m going to spend an awful lot of time on private credit to help you better frame, give you the perspective of what’s going on in that portfolio and how we have identified the loans that are the major driver of our credit losses in 2007, we’ll talk about our business strategy, what we need to do to change the way we operate in order to return this business to the high growth high quality earnings capabilities that we saw in the past.

Given the funding environment, I’m going to spend some time there as well, let you know where we are in our financing vehicles, what our plans are for 2008 and what we have for some spread expectations and the cost and then finally we’ll go through an outlook for 2008 and beyond. The takeaways I’d like to leave you with are you know a clear framing of the issues that we’re facing, not just in private credit but across the funding side and the operational challenges that we have to deal with, the steps that we are taking today to address those issues where some of the big things are easy and have been announced already such as the school issues that Al mentioned but some of the other ones maybe a little bit less obvious and then finally as Tony said to give you a sense of the pace and the quality of the execution that we’re going to bring to this strategy.

2007 was a year of challenges for Sallie Mae, a year of challenges for lots of places in the financial services space. We were moving away from a broken deal, we had to address the new, significantly different economics of Federal student loan lending as a result of new legislation. A realization came upon us of the difference in the credit profile of the different types of private credit loans that we were originating and how we needed to deal with that. And not least here the very difficult capital markets environment that we’re in and frankly one that doesn’t seem to be catching a bottom yet. It would continue to see wider spreads as we move into 2008. Hopefully that is something that will correct relatively soon.

And then the big piece of course is how do we change that business environment, how do we change our operating structure to address these conditions. The financial results of 2007 do reflect all of these. Our core earnings for the year totaled $560 million, a 57% decrease on earnings per share to $1.23. The decrease here was primarily driven by the large increase in our loan loss reserve, our provision for loan losses on our private credit portfolio. Our provision increased by $1.1 billion over 2006.

We had higher funding costs reflective of the poor credit environment, not so much in the beginning of the year, in fact as recently as July we executed our tightest spread ever on our Federal student loan asset backed securities and in January we did the widest ever on the Federal student loan asset backed securities. So a very rapid deterioration there.

And then there were also some onetime items in 2007, charges associated or costs associated with the transaction. Both the development of it as well as the termination of it, the severance and then some items reflecting the new legislation that took away some components that previously existed in the Federal student loan program and I’m going to cover each of these in more detail as we go through the presentation.

On the positive side, our originations in the Federal loan programs grew 10%, more importantly our originations at what we call our internal brands, our most profitable channel within Sallie Mae, grew 35% and that’s the area that we’re going to be focusing on in our new strategy. Our private credit grew 7% and again here more importantly it grew 17% in terms of volume at our traditional schools. This is the portfolio that Al mentions as charge of rates that have been under 2% in 2007.

Combined, these originations helped grow our managed assets by 15% this year. Our student loan spread in 2007 fell to 1.77% from 1.84%, a big driver of this, almost all of this decrease is actually due to the provision, the increased provision that we took. When we do that, we identify those loans, we reverse out the interest that has accrued on those assets and because we picked up more in school loans in this provision, with the change in approach here for the non-traditional portfolio, there’s a significant component of interest that was reversed in 2007 compared to other years. That impacted the spread by 7 basis points in 2007.

The higher funding costs and in particular a very negative CP LIBOR spread in the last half of the year, really the last couple of months of the year impacted the spread by another 3 basis points. So there were actually some positive aspects going on in the spread, principally coming from the private credit side of the portfolio, but were more than offset by some of those negative issues.

As I mentioned we recorded a loan loss provision that was $1.1 billion higher in 2007, it totaled $1.4 billion. $121 million of this was related to our FFELP assets and this really just comes from the elimination of the exceptional performer designation. In prior years if a student loan servicer was designation an exceptional performer, despite the 2% risk sharing on such loans, the Department of Education paid you 100%. With the change in legislation, the ability to benefit from that was removed and we needed to establish reserves on our existing portfolio to basically put us in a position where we were adequately reserved from that day forward, that’s in effect a catch up provision.

The bulk of the reserve though was driven by the private credit portfolio with $961 million increase in the private loan provision. This increase was driven by worse than expected default trends in a very limited segment of our overall portfolio, it’s a portfolio that we’ll refer to as our non-traditional loans. These are loans that are made to lower tier credit borrowers and are attending for the most part schools that have a different profile than other institutions. Mostly due to types of degrees that they offers, more associate versus bachelors as well as the type of students that attend those institutions.

I want to be clear here that it’s not as easy to say as I think some people have said, for profit, non profit, those are not distinctions that adequately describe the areas of concern here. This is really a segment of the schools that for one reason or another are bringing in students but not producing graduates, or if they are producing graduates, their graduates haven’t gained a sufficient economic benefit to generate the earnings to pay off and meet the debt obligations associated with their loan and that’s the business that we will be exiting.

Given the deteriorating economic environment and the loss events for this segment of the portfolio, the fact that the loss events for this segment of the portfolio become more evident earlier in the life cycle of the loan, we took this opportunity to take a look at our reserving methodology and really in effect what’s happening is we are recognizing that certain segments of our loan portfolio have loss characteristics more visible to us today. This is really driven by the change in the economic environment as it tends to hit people at the lower tier credit qualities hardest and earliest.

We did increase our loss expectations on these types of loans earlier this year but the fourth quarter charge is principally reflective of the earlier loss recognition rather than a significant change in expectations as to gross defaults going forward. And a few slides later I will go into the private credit portfolio in more detail.

Our net income and our asset performance group decline 26% to $116 million. There were several changes in the legislation affecting the principle business here which is contingency election revenues on Federally guaranteed loans, both in 2006 and 2007. That swung earnings, swung revenues in this portfolio by about $46 million. When you take that into account, this business continues to grow and show very good risk adjusted returns.

Our operating expenses in 2007 increased 15% to $1.4 billion. The increase is primarily due to expenses associated with the buyout transaction and severance costs which totaled $78 million during the year. Excluding these expenses and also including the increase in operating expenses associated with our acquisition of UPromise which closed in late 2006, our operating expenses were up just 9%.

And finally as a result of our equity raise in December, our capital ratio improved to 2% at year end, up from 1.84%. Most importantly here, concurrent with the equity raise we closed out 100% of our equity forward position and so there are no more transactions outstanding and that is all reflected in the 12/31 results.

Moving on to the private credit portfolio, as we’ve kind of hinted here, our defaults are highly concentrated among a small set of our borrower population. And in 2007 we experienced a significant decline in credit quality associated with that segment of the portfolio. These loans today equal about 15% of our managed private credit portfolio but they generate 60% or contributed 60% of our total charge offs in 2007, obviously a business model that does not make sense.

We’re taking steps to cease lending activity in these segments of the population and we expect as Al said in 2008 we will see better loan loss provisions, although because we are looking forward here, higher charge off rates until these loans fully enter the repayment cycle.

From our long history, we know that graduation is the key to credit quality in the student loan space. People who generate, who get a degree improve their economic and employment prospects materially and thereby generate the means to repay their loans. Our default experience in 2007 supports this. Over 65% of our charge offs in 2007 were from borrowers who withdrew early from their program of study or dropped below less than half time status and that’s important because the less than half time is the trigger that throws the loan into repayment.

This chart shows you how divergent the experience is amongst the different segments of our portfolio. You can see how much higher not only are delinquency rates associated with these loans which run more than six times higher the delinquency rates of our traditional loan portfolios and these are delinquencies over 90 days, but that they also experienced even higher default or charge off rates. These loans default at almost eight times the rate that we see in the traditional portfolio.

As a result of the increase provision for loan losses in our non-traditional portfolio, our allowance at year end is a very healthy 37% of the remaining balance of our non-traditional loans in repayment. Combined, our allowance for this segment of the portfolio covers more than three times our charge off rates in 2007 which we think was accelerated also due to some operational issues but primarily due to credit and economic factors.

Just to be clear, once again, with these changes we would expect the provision in 2008 to decline, we’ll see how much that actually improves given the economic environment and how that drives portfolio performance particularly in the remaining portion of this non-traditional loan portfolio, but we do expect charge off rates to continue to rise in the non-traditional segment as this portfolio transitions from the in school status where charge offs are obviously zero to the repayment status and once that portfolio moves into those segments then we’ll begin to see the charge off rate decline for that area.

We did, before I leave that, we did make some changes in 2007 regarding the underwriting aspects associated with these loans. We implemented programs that delayed the disbursement of loans between 60 and 90 days after enrollment in order to capture early withdrawal events at these institutions and we also implemented in 2007 some significant risk sharing agreements with students attending certain schools in this category that had those institutions pick up a material portion of what we would expect to be the default exposure on those loans. That would lead one to believe that our 2007 vintage portfolio as it enters repayment will see better default trends than earlier segments of the portfolio, but we still believe they represent an unacceptable level of default losses and was a factor in why we are exiting this business.

This chart is something that the people who have followed Sallie Mae would have seen before, but it really is the story associated with education lending and it bears repeating multiple times. In education, a degree and the higher that degree, generates higher levels of income and lower levels of unemployment. Those two factors mean our borrowers by the type of lending that we do is to help people generate an improvement in their economic capabilities and it’s that improvement that in turn allows them to meet the debt obligations associated with their loans.

If kids don’t graduate, it’s very difficult as we saw earlier, 65% of our charge offs came from students who withdrew, it’s very difficult to collect on that loan over time. What this charge also shows is that it helps to prove here is that with our traditional loan portfolio, where graduation rates are high, our performance has been exceptional in the past and we expect that to continue going forward. Our charge off rates for this portfolio, this segment of the portfolio which is again 85% of our total managed book is well under 2% in 2007 and we expect those kinds of numbers to continue in that low 2’s kind of range over the life of the portfolio.

Our repayment tools on these loans also help tremendously and help us work with students who are having difficulty making repayment, this is where the forbearance tool is such a critical component to managing the ultimate loan performance on our private credit assets. Students generate this higher earnings capability and lower unemployment levels but there are bumps in the road for them and that’s where forbearance comes into place.

If they’ve graduated, they’ve generated the means, they might just have a temporary experience that requires some relief but once they get beyond that, once again we can expect repayment on their loans. Clearly for students who withdraw, forbearance is really only a viable option to the extent that we think it’s a bridge to getting them back into an enrollment status. Without that, life becomes very difficult for both us.

So when we look at 2008, we recognize that the events that we’re facing here, the legislation, the private credit performance, the funding spreads, our operating structure, requires a significant revision in our business strategy. What we plan to do and what we are doing as we speak in 2008 is concentrating on our traditional schools and this will be for both FFELP as well as private credit loan generation. We’re working to have those relationships directly with schools to generate loans, again the most profitable components of our underwriting criteria.

We will curtail and exit unprofitable business lines, some of the most obvious in here are our wholesale loan consolidation activities that took place over the last couple of years. Loan consolidation is a marginally profitable product and if you’re buying loans in the secondary market at premiums it doesn’t even meet the definition of marginally. We have exited that business and you will not see any more acquisitions of that type going forward.

We will also exit the low tier credit components of our private credit portfolio and those non-traditional schools where the schools are not generating graduates or generating the economic benefit for graduates. We also need to take a look at how we price our private credit products to reflect the current economic and credit spread environment. That doesn’t mean we price it for what we think are unusual spreads in the credit markets today, but it does mean we have to reflect that it’s unlikely to go back to the best periods in terms of credit spreads that we saw in early 2007.

And finally on our Federal student loan programs, we need to reduce our borrower benefits. We don’t have pricing power on the yield side of the equation, where we have control is on the borrower benefits side, the discounts that we provide to students as well as our operating expenses.

And this next chart is designed to show you where those numbers fall. As you can see from here we list the student loans, a typical Stafford loan that in the spread or yield that we generate off of that asset prior to the recent legislation and what that looks like under the new legislative environment. We do have a higher cost of funds assumption in here than what we experienced in those periods, but the real big things I would have you focus on are the borrower benefits and the operating costs.

As a result of the legislation, our yields had been cut by 70 basis points on these loans. Our opportunity here is to look at the borrower benefits and operating expenses which together are 90 basis points of cost and figure out how we can reduce both of those items through operating efficiencies, right sizing the types of services and features that we offer to students and schools and pricing the private credit that the Federal student product properly so that we can earn an attractive risk adjusted return on this asset.

Clearly it’s capable of being done. There is enough margin, there is enough room that we can address these issues with 90 basis points to offset a significant piece of the 70 basis point reduction in yield, we just need to get there quickly, we need to do it such that we maintain the existing relationships with the traditional schools and students that we value.

Some of the immediate changes of the reductions that I mentioned and the change in strategy will see a modest reduction in our loan origination activities and part of this is due to the fact that we began some of these cut backs in 2006. In the Federal student loan business, we expect our preferred channel originations will decline by 6% in ’08 to $16.4 billion, although we expect our originations at our traditional schools and our internal brand channels to grow at a very healthy rate in the mid teens.

On the private credit side of the equation, we expect originations will fall 4% but again all of this decrease will occur in our non-traditional channels. We expect on the traditional lending of the private credit portfolio that we will see growth of 15% in 2008.

On the operations side of the environment, we need to take a look at adjusting the operations structure to match the economic potential that exists in both our Federal and private credit lending. We’re going to undertake and have begun undertaking a complete review of all of our business activities to make sure that what we’re doing is a necessary feature, a necessary product or service that we’re offering, that it can be justified by the profitability associated with that business activity and if it doesn’t produce the appropriate risk adjusted returns for us, it’s a business we will have to exit and we’re prepared to do that.

When you combine these things, when you look at what we’ll do on the private credit side in terms of credit, improving the credit quality, looking at the pricing side of both the private credit and FFELP, where we can make improvements there and then the operational efficiencies we expect and know we can achieve, we think we can reestablish a strong, high quality growth trend for this company once again.

On to funding. Sallie Mae, like every other financial institution out there, is feeling the impact of the current funding environment, the current credit spread environment. Its two issues, it’s not just spread, it’s also availability. The good news here is that a huge portion of our balance sheet, 88% of our balance sheet at year end was funded with term debt facilities. Now unfortunately, as a result of the transaction, we are sitting on a rather large short term funding structure which we call the interim asset backed facility, that is presently stands at $26 billion and that is the facility that we need to refinance over the very near term.

In a marketplace like this, when you’re trying to raise that amount of money in a relatively short period of time, cost spreads and availability become far more important and become far larger factors in how you get that deal done. Interestingly here, 88% of our managed student loan portfolio is a government guaranteed asset, it’s not just a triple A asset, it carries an explicit government guarantee.

In normal environments that means these assets price at very, very tight spreads to any other asset class out there and in fact even in this environment that continues to be true, even though we’re paying our last FFELP student loan asset backed deal went out at 60 basis points, over LIBOR, it was still tighter than any other strong asset quality or asset class that was issued in the same timeframe including a high quality auto issuer and a credit card issuer, we did price at tighter spreads.

What we expect here and the good news from a funding perspective is that these are assets that should be financeable in any economic environment, alright, where is the credit risk? The credit risk doesn’t exist. 100% of these loans could default and our credit exposure is somewhere between 2-3% maximum, so we need to make sure that investors understand that, they hear that story from us again, they recognize that this is the asset class in troubled times that their capital should be seeking and we believe as we tell that story and the markets tend to, the fear tends to settle down a little bit and maybe some of the particular fears associated with mark to market risks settle down, we expect strong demand to return to this component of our portfolio.

On the private credit side of the equation, it’s a story we’ll need to retell as well. I think the most important part that we have and the most fortunate part of what’s going on in this space is when we entered this non-traditional lending component, we were making these loans based on what we thought were reasonable expectations as to loan performance, but because we didn’t have the data yet, we didn’t have a history of making these loans, a long history of making these loans, we did not feel that we could put these loans into our asset backed securities and so although the company is reporting a large loss in our private credit portfolios today, in reserving for what we expect the long term loss expectations associated with them, we are not seeing the same levels of performance in our asset backed securities.

And so we don’t have to tell investors why is this different from the one we [audio interrupt] in 2006. Those securities are performing exceptionally well and in fact as recently as mid 2007 the subordinate tranches were in fact getting upgraded on those deals.

So what’s our funding plan in 2008? I highlighted this earlier, at least I said earlier we need to refinance first this $26 billion line that we have associated with the transaction that we entered into. We were working very hard at this. We are very, very close, we’re pounding out the last details associated with this facility and expect to be able to announce something to you very, very soon.

As Al said, the current market environment is very difficult and spreads have been, costs have been going up and it’s no different in this component as well, despite the high quality of the asset class, there’s just a limited amount of supply in this area, particularly in asset backed CP conduits, facilities and as a result we expect to pay dearly for replacement facility. It is however, we fully expect, a one year cost and we will work extremely hard to make sure that we replace this with how we would have financed it in any other environment with term asset backed securities, not with short term funding vehicles.

In addition to this, we expect to issue $28 billion of term ABS in 2008, the vast majority will be in the Federal student loan asset backed market. Obviously if market conditions improve and access is more visible we will do more than these levels, particularly in the private credit side, but this is right now reflective of what we expect to be able to get done and our best estimates of where those levels will be in 2008.

Just as a point of reference, our last deal, or our most recent deal in the FFELP student loan market that took place in July before credit markets started to unravel came in at an all in cost of 11 basis points. Our last deal in January was 61, you can see how much wider those moved and our private credit, we did a deal in March that was just 25 basis points over LIBOR on an all in funding basis so you can just see how materially spreads have moved for triple A rated and in the vast majority of cases here, government guaranteed triple A rated securities.

In addition to this, we expect to and our long term objectives are to return to the term unsecured debt markets, we have a modest amount planned in 2008, just $1 billion, the spreads today are obviously completely unattractive to us, frankly they’re unattractive even at this level here, but we do recognize that we need to provide some liquidity in this marketplace to start the benchmark, get people following the story again and drive that rate down as we did several years ago when we were winding down the GSC.

Over the course of 2008, we’ll continue to diversify our funding sources and as I said most importantly, extend the duration of those liabilities so we’re not in the position we’re in today.

Despite all this and despite the fact that we have this $26 billion facility that needs to be replaced, we are in a very, very strong liquidity position, you can see here that we have $26 billion, just over $26 billion of primary liquidity, these are near term, very cash equivalent type vehicles. Cash, being the first, but committed bank lines and availability under existing asset backed CP programs, not the interim facility, a second asset backed CP program.

We also have importantly just under $19 billion of unencumbered Federally guaranteed student loans and although these are not as readily transferable to cash as a short term investment might be, the fact that these are government guaranteed assets do make them liquid and there is an active secondary market and we do plan to test those in 2008 to continue to show capacity there.

On the capital side of the equation, this is how we allocate capital. We take a look at our various asset classes and allocate the appropriate level of capital based on the loss given expected default risks that exist in each of these components. This is unchanged from what you’ve seen over the past few years. We think it’s still appropriate, we do need to make sure that our fixed income investors and the rating agencies also agree with us here and will be spending time to make sure that we can get them to those points.

Frankly I think on the Federal student loan side of the equation, it’s not so much a question of what is the appropriate default risk capital that one needs or credit risk capital that one needs but it’s more of a liquidity issue of capital associated with those loans whereas private credit is more driven by the credit risk portfolio.

As I said we do plan to return to the unsecured debt markets, our goal is to get back to our single A rating that we had earlier in 2007 and we will work with the rating agencies and investors to get there.

When you look at the business, and Al said this in his remarks, you know that is the good news. Our business prospects or the industry in which we operate is very strong. It’s healthy, there are more students in the pipeline coming up who will need to attend higher educational institutions in order to compete in this economic environment and we stand ready and available to help them finance that and if we do it right and we know we can because we have the history, we know what the credit criteria that needs to be in the private credit space, we can make very attractive risk adjusted returns in this business.

In terms of outlook for 2008, we expect to see 10% growth in our FFELP originations over the year and 15% growth in our private education programs. This is volume coming from our traditional schools. We expect to improve the profitability of our lending by lowering borrower benefits, re-pricing some of the private education products we offer and more importantly exiting those schools where we have no business making loans to students.

We will focus on these traditional schools and we will see lower delinquencies and charge offs on these assets as we move forward consistent with a very strong exceptional performance we showed you on the traditional portfolio. We’ll also work to reestablish our diversified funding sources by tapping into different markets, including unsecured, our asset backed and also take advantage of our industrial loan bank in Utah to access bank deposits.

2007 was a year of challenges and 2008 will be the year of transitions As we adjust our model, our operating structure, we believe will put the building blocks in place to return to strong high quality growth in both earnings and assets. Some other metrics to take a look at here is we do expect our student loan spread to decline, principally due to the higher funding costs associated with this short term facility that we are using to temporarily refinance the prior interim facility.

We expect that number to drop to the mid 140’s in 2008 before rebounding dramatically in 2009. We expect our loan loss provision to be somewhere between $625-$700 million in 2008 and as Al said this is taking a very realistic conservative look at what we think the economic environment will mean to both our traditional and non-traditional loan portfolios.

And the bottom line is we expect our core earnings per share to end up in a range somewhere between $1.70-$1.80, obviously the current spread environment is a significant factor here to the extent we see improving spreads, those numbers will be higher, to the extent we are exceptional in our execution against our operating structure, we’ll see higher numbers as well.

I’ve talked way too long here at this point and at this stage in the game we’d be happy to take any questions that people may have. Thank you.


At this time I would like to remind everyone, in order to ask a question please press star then the number one on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster.

[Unknown Analyst]

[Inaudible question]

Jack Remondi

The question really had to do with is that as the non-traditional loan portfolios are concentrated on balance sheet, what does that mean for capital and risk adjusted related issues associated with that?

I think the good news is the rating agencies and our fixed income investors look primarily at our core cash related earnings and in particular the rating agencies and we show them capital allocation models on a managed student loan basis so that they are not segregating between on balance sheet and off balance sheet items. In effect the rating agencies say those securitizations are nothing more than secured financing transactions.

Obviously to the extent that we are concentrated in a particular area, you know the risk falls just as proportionately to the unsecured debt holder and that is not what the plan was of course but that is the outcome as a result of the poor performance in this asset class, much poorer than we expected. The good news is we’ve identified that risk, curtailed future lending activities and we believe we are entering 2008 very, very strongly reserved against potential losses in that component.

[Unknown Analyst]

[Inaudible question]

Jack Remondi

8% is not the right capital allocation associated with the non-traditional loans but when you typically look at this you would look at 8% against your net student loan portfolio which is how it’s allocated and that I believe would be appropriate.

[Unknown Analyst]

The cost reduction guidance of 20% that you gave, is that off of the current expense [unintelligible] market expenses this year or some sort of lower base number the only 9% top one you mentioned?

Jack Remondi

We’re looking at 20% off of the $1.4 billion of operating expense.

[Unknown Analyst]

Including the [unintelligible] expense.

Jack Remondi


[Unknown Analyst]

Thank you.

[Unknown Analyst]

Just in terms of your plans on accessing the unsecured debt markets, LIBOR plus 250 is a way away from where your credit swaps are right now, so are you looking to do that in the back end of the year?

Jack Remondi

The question was, we had on our slide we would do a billion in the term unsecured debt market at a spread of LIBOR plus 250 and the question was, that’s certainly not reflective of where our credit default swaps are today and that is absolutely true, we’re probably more in the LIBOR plus 500 range with the new issuance premium. It is expected, that is targeted to happen in the fourth quarter of 2008. It’s more of a placeholder for us. If the markets stay where they are, it doesn’t make any sense for us to fund at LIBOR plus 500, you know that’s not, we would look stupid frankly if we did that.

LIBOR plus 250 doesn’t frankly make a whole lot of sense either but as credit spreads start to tighten you have to start showing some liquidity in the marketplace and this is frankly what’s going on in our FFELP securitization strategy. If we are regular issuers each month we believe it attracts investors into the security because they see fresh prints, they see trading activity going on and we’ll adopt that similar strategy in unsecured if credit spreads get to those levels.

[Unknown Analyst]

Thank you, you’ve mentioned on talking about the outlook for ’08 as in the first half a lot of work to do, cost reduction and then the second half, post that, can you give us a sense of your forecast of $1.70-$1.80, how does that [unintelligible] between the first half and the second half?

Jack Remondi

The question relates to how we expect, given our earnings per share guidance of $1.70-$1.80, how we expect to exit the year. Several positives of course, I mean our hope and expectations are that we’ll see a substantially better credit market in the second half of 2008 than what we have today and so funding spreads and profitability associated with new activity going on there will be better.

The way our business works from a business cycle or seasonal cycle here, most of our loan origination activities are coming in the second half of the calendar year as students enter school in the September timeframe and so a lot of the improvements that we’ll see on the yield side of the equation and the asset quality performance side won’t be readily apparent in 2008. You’ll see those in future years.

On the cost side of the equation, we expect the first half and on the provision side of the equation, we would expect the first half to be a whole lot less interesting or illustrative of our execution risk, our execution quality here and the back half is where you’re going to see exceptional performance against that, so we will be heavily weighted towards the back end of the year.

[Unknown Analyst]

Hi, in the December guidance that was given obviously the loan loss provisioning was not that we took today was not part of that guidance and then we had the share capital issuance in December and our firm participated in that and I don’t think at the time we were led to believe that there would be this sort of loan loss provision and I understand the need to get the balance sheet clean, but could you give us some color on whether we had an inkling of an idea that we might need to do this cleanup or did something materially different develop adversely on those core profit loans that you talked about that have been costing 65% of the problem between the capital issuance in December and now.

Jack Remondi

There’s lots of issues that go on here but clearly the changing economic environment was a big driver. You also have to take into consideration the constraints of GAAP as it relates to loan loss provisioning activities. You know in an ideal world we would be able to establish, particularly on this kind, when we’re exiting a business, a life of loan reserve estimate associated with these loans, but unfortunately that’s not consistent with GAAP.

We need to take a look at what kinds of events are occurring on the portfolio and whether those events are triggering likely loss exposure on those loans and in 2007 the economic environment, the deterioration in the economic environment, the deterioration in the economy, allowed us to make that case and recognize those losses earlier than we would have otherwise.

In our old model, those losses would have been recognized still, they just would have been recognized further our in future years rather than in 2007. I think if I haven’t conveyed this message I’d like to do it now, it’s not that we expect these loss rates, we adjusted these loss rates in early 2007 and it’s not that we expect these loss rates to be materially higher as a result of this provision taken in the fourth quarter, it’s just that the evidence of that loss exposure is more clear today than it was under our old methodology.

[Unknown Analyst]

You had a slide up on the screen about college enrollments going up and given how unprofitable FFELP lending has become, we’ve read stories of people pulling out of this space and private lending becoming clearly more risky, how do you expect those enrollment numbers will come to fruition, who’s going to make the funding gap for students and will that become possibly an issue back half when funding [unintelligible] this spring?

Jack Remondi

First, I would not say that FFELP lending is going to become unattractive going forward. We just have to make sure we are pricing that product right in the forms of discounts we applied or make available to students in the past and the operating cost environment. We fully expect that the loans we will be originating going forward will produce very healthy risk adjusted returns, primarily because little capital is needed against these student loan assets. That’s kind of one piece.

There are however going to be FFELP lenders who will exit the business in 2008 and beyond and they’re going to exit the business because they don’t have the scale to operate efficiently the way Sallie Mae does and more importantly they will not have access to the capital markets the way a company like Sallie Mae does and those two factors, we’ve already seen it, has had people exiting the business, there’s virtually no one making loans in what was the direct to consumer consolidation space, that’s all be re-trenched and we will expect to see a lot of those players move further off of that space.

On the private credit side of the equation, the portfolio’s a tale of two cities, right I mean you’ve got this non-traditional lending that has very high default exposure associated with it because the kids don’t graduate at the rates they need to. On the traditional side of the equation, these schools turn out graduates year after year on a consistent basis. They get an economic benefit from the education and the amount of money they borrowed to pay for that education.

You know there may be difficult times in the economy where job prospects are lower, but over the life of that loan, the collectability of that asset is going to be extremely high. You see it consistently across the FFELP portfolio history and you see it consistently in our traditional portfolio.

The Department of Ed published a study earlier this year that took a look, it’s the first time I’ve seen this from the Department, a cohort life of loan analysis on a portfolio of loans that was originated in 1985 and looked at how those loans performed over the next 20 years. And what they found was that the kids who borrowed and graduated, the cumulative default rate on FFELP loans, and remember these collection processes in FEELP are compliance driven, they’re not collection driven, was 2%.

For those students who borrowed and didn’t graduate, the cumulative default rate was 22%, so 11 times higher. This is the critical component. If we can identify schools and identify borrowers who are likely to graduate, the private credit business is going to be an extremely profitable business for us.

We’ll take one more question from the audience and then we got to take some questions from the people on the phone as well I think we’ve got 700 people I’m told.

[Unknown Analyst]

Thank you for the comprehensive presentation and the contrast between FFELP before and FFELP after. I wondered if you have to, and if you want to, can you add these to the FFELP program, either at the school level or to the consumer or is that precluded under the Title IV rules?

Al Lord

The short answer is very, very little, I mean there’s some back end, you can charge collection fees associated with delinquent accounts but very small and we already frankly do that already. Our job is going to be to demonstrate to Washington that they cut too far and there is going to be an access issue for some types of borrowers and some types of lenders who just can’t compete in this space and they’re hearing that story today, they’re hearing it from lenders, obviously. They’re hearing it from schools as well which is more important.

[Unknown Analyst]

And just a follow up. You talked about the non-traditional schools and how unfortunate the credit performance is there, is FFELP lending attractive at non-traditional schools or will it be necessary to step back, even on the FFELP front from some of those schools.

Al Lord

Whereas it’s clear cut on the private credit side, there’s a little bit of grey area on the FFELP side. But look the bottom line here is if we’re lending money and earning a 60 basis points reduced yield from what you saw in there during the in school period and that borrower leaves school early, goes through a six month grace period and defaults, there’s very little any kind of credit spread environment where that’s an attractive asset today.

[Unknown Analyst]

Thank you.

Al Lord

Operator, we’ll take some questions from those on the phone.

Question-and-Answer Session


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

Matt Snowling – FBR Capital Markets

Yeah, hi guys, I was just wondering beyond the moves you’re making in the non-traditional schools, are you able or are you at a point now that you can start raising pricing on some of the other private loans?

Al Lord

Yes, we believe that for a combination of reasons the credit spread environment but probably more importantly the competitive landscape and the availability of capital to support competitors in the private credit space will be limited and we will have pricing power capability there.

Matt Snowling – FBR Capital Markets

To the extent you could offset your prior funding costs?

Al Lord

Well, as a business person, I would never say you should take a look at the current spread environment which I think almost everyone in this room would say is temporary, some might say it might get worse before it gets better, but it’s hopefully temporary, and we should never price a long term business relationship off of short term credit spread environment, we need to take a look at what we think the spreads will be over the long term. We know they’re not going back to 25 anytime soon that I showed you earlier but I don’t expect them to be in the 100 plus range that we’re seeing today either.

Matt Snowling – FBR Capital Markets

Okay, one quick question, it looks like you have about $1.1 billion of purchase mortgage paper on balance sheet, are you seeing any sort of deterioration in the collection rate on that?

Jack Remondi

The performance in that portfolio collection was actually very strong in the fourth quarter and we do every quarter end a detailed valuation analysis of those loans. At year end in fact we hired an outside firm to do that for us and our valuation that came back was well within the range of what we’re carrying those assets at today.

That is an attractive business, what’s happened with it is the collection process has become a little bit more elongated as you would typically see work outs arranged when you dealt with these troubled mortgage assets and now more of it turns into REO.

Matt Snowling – FBR Capital Markets

Well how much of that paper was purchased in 2006?

Jack Remondi

That, I don’t have the answer, we’ll have to get you that offline.

Matt Snowling – FBR Capital Markets

Okay, thanks.


Your next question comes from the line of Cyril Battini with Credit Suisse.

Cyril Battini – Credit Suisse

Yes, hi, thank you for the conference but my first question is just to get, what’s the size of your balance sheet and IO strip exposure to the non-traditional portfolio and what’s your loss assumption from this asset class?

Jack Remondi

Excellent question, thank you. As I mentioned earlier, we don’t securitize, we securitize very little of our non-traditional portfolio so although we took a large core cash provision associated with these loans in the fourth quarter and during the course of the year of 2007, the GAAP provision was substantially smaller because these loans are not in the asset backed trust, the IO or the residual which first of all does carry a life of loan default expectation assumption in it, was no materially impacted at quarter end.

Cyril Battini – Credit Suisse

So what was the balance sheet size of the exposure to non-traditional assets?

Al Lord

I think the non-traditional loans and most of these are just more of the schools than they are the lower tier credit from the trust, is probably on average around 5% of the portfolio, maybe a little bit higher. 15% was the right number there, but that’s a school type not a non-traditional. We’re mixing pieces here, we’ll have to get back to you with exact percentage on the non-traditional component.

And the reason this is important is as I said, there are for-profit schools that are very attractive businesses that generate college degrees, generate graduates with college degrees that have very good earnings and credit profile, so the largest for-profit university in the country is a good example of that. We’re not saying for-profits are a segment we’re exiting, we’re exiting those schools within both the for-profit as well as the non-profit that don’t generate graduates.

Cyril Battini – Credit Suisse

Okay and the other income line in your core earnings schedule, what does that include?

Jack Remondi

In the other category is the business lines that are not in our segment reporting, so things like our guarantor servicing related activities and our late fees associated with both our Federal and private portfolios. Those are the principle drivers. Also in 2006 the acquisition of UPromise comes into that component as well. That’s probably what’s driving the significant increase in ’07 versus ’06 is UPromise came in the fourth quarter I believe of 2006.

Cyril Battini – Credit Suisse

Okay thank you very much.


Once again, ladies and gentlemen, if you would like to ask a question, please press star one on your telephone keypad. Your next question comes from the line of Don Jones with Credit Suisse.

Don Jones – Credit Suisse

Good morning and thanks for hosting this call. A couple questions on the liquidity side. The sources of liquidity seem to include the remaining balance of that ABC [unintelligible] facility through a couple of banks. What sources are you looking to use possibly to replace that and or to the effect of replacing that facility, how successful are you getting in negotiating similar forward levels in terms of committing assets? Are your counter parties accepting the collateral that’s currently in that asset back commercial paper facility or are you looking to commit additional assets?

Al Lord

Well the existing $6 billion asset backed program has fixed terms and criteria associated with it and those don’t change during the life of that transaction. As we are developing our funding plan to replace the $26 billion in outstandings under the interim financing vehicle associated with the [audio interrupt] transaction, that is going to be an asset backed conduit vehicle. There will be two separate vehicles, one for Federal loans, one for private. Advance rates and funding levels, et cetera, are the types of things that get negotiated here and this kind of credit environment, credit departments look not only at pricing fees and interest rates but also advance rates.

There’s nothing kind of worse that’s happened to the asset backed world than the complete collapse of the super senior tranches that were marketed so heavily over the last couple of years. People believed these things had virtually no credit risk and of course they do. And so credit departments today are, you told me this had no credit risk and so I don’t believe you now, but now you’re coming to me with a FFELP student loan asset backed transaction and you’re telling me there’s no credit risk, why should I believe you this time when I made a mistake and believed you last time?

It’s those kind of discussions and issues that are going on frankly and the environment that we’re in, no one is standing up to be a hero. That’s why this pricing is going to be very expensive for us. The answer of course is to do it in a short term or shorter term facility at 364 day facility so that we can recover for this as we move our business forward in 2009 and beyond.

Don Jones – Credit Suisse

Okay, secondly on your cash position, it looks like it has gone up quite a bit year over year, how much of that $7.5 billion in your funding would you actually say, given it’s about $5 billion more than it was a year earlier period, how much of that would you say is part of your funding strategy going forward, because you can’t obviously draw down on all of that, but what would you [overlay].

Al Lord

That’s correct, I mean look in this environment, liquidity is kind and we are conducting a funding plan in 2008 that doesn’t say, we have just enough liquidity to make our plans work, we want to demonstrate in size facilities that say we have more than enough liquidity to make things work and if something doesn’t happen, a term ABS transaction can’t take place, there’s enough in the plan to absorb that and deal with it.

In addition, we have a significant number of steps that we can take that would reduce our funding even further in 2008 and those again are another form of kind of reserve if you will in the liquidity equation to make sure that we maintain adequate cash balances, adequate credit line availability. So for example in 2008 we would expect the cash balance position to hold relatively constant during the course of the year. And the $6.5 billion of uncommitted lines that we have with banks will remain undrawn during the course of the year so that will always be there as sort of standby liquidity.

Don Jones – Credit Suisse

Okay and lastly, how much traction would you say, I mean you can just characterize without giving specific, how much traction are you getting with rating agencies? It seems like they all have credit watch negative on the ratings and S&P actually gave a time line from December 14 when they did the report, about 45 days they were going to meet with you guys and so on, I mean are you getting positive traction with the three agencies or how would you [overlay].

Al Lord

We are just going to have our first, we’ve obviously been in regular almost daily contact with them to update them as to what we’re doing, particularly on the liquidity side of the equation. On the private credit reserves that we took, that’s all been discussed and reviewed with them, but over the next couple of days we’re going to spend much more significant time with them, walking them through our business strategy and funding plans, then we’ll see what comes out.

Remember though the ratings actions that are still outstanding on the company do reflect the merger transaction, the buyout transaction that was on the table. Now, we’re under no allusion that we’re ready [packed] with single A anytime soon here and we need to re-earn that letter. We’re just committed to getting there.

Don Jones – Credit Suisse

Great, thank you.


And there are no further questions at this time sir.

Al Lord

Great, I think we have time for maybe one or two questions here in the room if there are some, in the back there.

[Unknown Analyst]

How much of a facility is flowing through the income statement for the $25 billion plus in financing in ’08 and how do you see that shrinking as we go into ’09?

Jack Remondi

Unfortunately it won’t be shrinking going into ’09 because the replacement facility that will take that deal out will be more expensive than the interim facility is today. I mean that deal was priced in March-April timeframe when credit spreads were at all time lows. There’s about $44 million running through that line item in 2007 for the fees, it’s a one year transaction so basically all amortized during the course of the year. But it’s going to be more expensive, the replacement is going to be more expense.

No one’s doing deals like they did in July and earlier. And you’re seeing that in our earnings forecast. That’s fully accounted for. And I’m sorry in 2009 you were saying going forward. Well again that will be a function of what the credit environments look like at the end of 2008 as we get ready to replace this and we do expect to do that with term financing predominately and there will be some carryover in the short term market but very little expense will show up in ’09 as a result of what we do in ’08.

[Unknown Analyst]

Jack can you talk about some of the other sort of for lack of a better way of saying it, ancillary opportunities that you might have to leverage Sallie Mae’s platform potentially doing servicing for other lenders?

Jack Remondi

Sure, we think that’s a significant opportunity for us but in the current credit markets that we’re in, those players that would want to take advantage of that are having difficulty funding themselves and so once those markets return, we would expect to be able to do that. Now in an event that liquidity in the Federal student loan business becomes an issue, we do expect and have made clear that Sallie Mae stands ready to lend operational support to the Department of Education or other entities that need it to make sure that students get loans in 2008.

[Unknown Analyst]

Thank you.

[Unknown Analyst]

Jack, I wonder if you can take us out to after this transition year, when the dust settles, we’ve sort of worked in the implications that the legislative changes, we’ve gotten past this dislocated credit environment. How do you see the industry shaping out, how do you see Sallie Mae’s position and you know you talked about having a greater focus on the private loan side, you know the private loans become 20%-25% of managed receivables going forward, when you look at your FFELP business you predominately relied on the school channel. Is the school channel still a competitive advantage?

You talked about 140 basis points forecast spread in 2008, that’s going to rebound hopefully when financing costs stabilize but do we get back to 180 basis points which used to be the normalized? So just give us a view of where you see things going with a slightly longer term outlook. Thank you.

Jack Remondi

We see, I mean the business strategies that I’ve outline as how we plan to compete in the FFELP student loan marketplace and the private credit student loan marketplace, we think in a 2009 environment we’ll generate very attractive risk adjust returns. We think the advantages that we bring to that space are numerous, our operating structure is already today if not the most efficient, probably number two in the industry overall but I think its number one.

And we’re going to make it more efficient going forward. Our funding capacity and capabilities are going to be far greater than anyone else out there. Frankly in 2006 and 2007 you get these newly created loan consolidation shops that had an 18 month life cycle history, were issuing ABS transactions that might have been 5 wide as Sallie Mae and it’s a disturbing trend, how can that possibly be true, someone with a 35 history doesn’t get more credit than that in that credit environment. We think that’s going to be far more reflected in spreads for competitors in future years.

And on the private credit side of the equation, Sallie Mae is unique in how we manage this portfolio. We manage it as a credit exposure portfolio. Virtually everyone else in this space manages it in connection with their FFELP student loan assets and as a result collection activities and performance tend to be compliance focused versus collection focused. We think those advantages are very strong, our school relationships will continue to allow us to capture market share at those institutions and be viewed frankly as one of the strong entities that stood up and performed during adverse times.

[Unknown Analyst]

I’ve got two questions. One, can you give us at least some color on what kind of financing costs the $26 billion facility is baked into your $1.70-$1.80 guidance and I have a follow up.

Jack Remondi

It’s a rapidly moving target to some extent but it is you know the numbers right up until 8 o’clock this morning are fully reflected in there is probably the best guidance I can give you. We don’t believe we’re missing where the deal will ultimately price in that financial forecast. Once the deal closes we’ll be able to provide you with a little bit more guidance as to what exactly it cost.

[Unknown Analyst]

Alright, my longer term question which hopefully you can give us a good answer for is a key to your future is going to be the private credit business and as I think both Al and Tony mentioned, an important part of that is developing a credit culture to be able to do that well and to forecast where the good schools are and so on. Can you give us a better feeling for how you’re going to make that big cultural change at this organization?

Jack Remondi

Well, I think it’s begun already, its already happened. I mean the business in the last couple of years was focused more on volume, less on quality. That has already changed. It was changing, the process of changing began in 2007 and we’ve accelerated it in 2008 with the termination of some of those schools that Al referred to. It’s moving forward. Everyone is 100% on top of this, it is not a sales driven process, it’s a financial return driven process.

And the numbers are here, it’s not one that one can argue with, it’s just gee we think these loans are going to default at only X percent, no, they’re defaulting at much higher levels than that and it’s no longer a guess based on relationships to FFELP, to more traditional schools, it’s based on actual experience.

Tony Terracciano

As Jack said, the process has already begun. You’ve probably seen a fair number of senior executives at the company, some have left and some are in the process of leaving and frankly they are people whose entire career were devoted and were incredibly in many cases, incredibly good folks, who were dedicated to generating FFELP volume. Obviously, one of the parts of the culture that has to change is that FFELP volume was unilaterally profitable, we made loans, we bought loans, we bought loans retail, we bought them wholesale and we processed them.

We’re still good at processing, just less balance sheet than we had before. But the issue is in the end is an execution issue and we’ve got to execute this plan and the heart and soul of it in my view is going to be a change in specific people and then change in approach from everybody else and the precise steps that need to be taken, little difficult to enumerate now, but it is very much underway. And the cost cutting that we’re talking about is going to be, I think a word that comes to mind is wrenching, we’re talking about 20%.

Jack Remondi

I think that allocates the time, it takes up all the time we allocated. Thank you all very much for coming, we appreciate your interest, look forward to working with you going forward.


Ladies and gentlemen, this concludes today’s conference call, you may now disconnect.

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