Sallie Mae Q3 2007 Earnings Call Transcript

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SLM Corporation (NYSE:SLM) Q3 2007 Earnings Call October 11, 0000 12:00 PM ET


Albert L. Lord - Chairman of the Board

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


Tim Wilson - Credit Suisse

Good afternoon, everybody. Welcome to Sallie Mae’s shareholdermeeting. Before we get started, I have to read the following statement: pleasenote that during this meeting, we may discuss predictions and expectations andmay make other forward-looking statements. Actual results in the future maydiffer from those discussed here, perhaps materially based on a variety offactors. Listeners should refer to the discussion of those factors on thecompany’s Form 10-K and other filings with the SEC.

During the course of this conference call, we will refer tonon-GAAP measures that we call our core earnings presentation. The descriptionof core earnings, a full reconciliation of the core earnings presentation toGAAP measures, and our GAAP results can be found in the third quarter 2007supplemental earnings disclosure accompanying the earnings press release, whichwas also posted under the investors page at our website,

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

Albert L. Lord

Good afternoon, all, those of you in the other room andthose of you on the phone. We did get to see one another at our shareholdermeeting a couple of months ago, although given the turnover in the stock, I’mnot sure you are any of the same people.

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

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

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

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

It’s a cultural change. Also, our buyers have done virtually100% of the company’s financing over the last six months at a higher cost thanwe would otherwise have. They have earned some fairly large fees over that timebut more importantly, they approve all significant decisions. That remains trueas of today. And that’s not unreasonable, so long as the economics are theirs,and that seems to be a bit of the issue.

I can see that huge light in the back but I can barely seethis far here, so you may see me squinting a bit. In any event, as I said, it’snot unreasonable that those decisions are made by them because the economicsthat accrue from those decisions are the buyers, unless they breach.

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

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

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

But we are where we are and where are is solid asset growthand very strong fundamentals in the company, just as they’ve been for the last25 years.

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

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

Charles E. Andrews

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

In the on-campus and the school channel, we had a lowergrowth rate. There are two things taking place in that space that affect thatgrowth rate in the current quarter. One is legislation of last year basicallytransferred graduate students from private lending into a government program.There was a new program identified last year or passed last year bylegislation, and not in the current legislation but last year that allowedgraduate students to borrow under the government program. So it migrates, it ismigrating a lot of the private volume out of the graduate space into thegovernment program. That transition continues this quarter and it was asignificant effect on our volume.

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

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

When you put it all together, the private portfolio grew at8% for the quarter but the key driver, which is the undergraduate, four-yearinstitutions grew at 18% because there we get serial loans and subsequentperiods and everything. That’s a very important measure for us.

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

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

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

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

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

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

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

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

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

Net of it all, it is going to allow us to maintain webelieve our margins in this territory. So that is very positive from a pricingstandpoint.

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

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

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

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

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

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

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

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

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

But bear in mind substantially all of our assets are alreadyfinanced to term, so we only face interest rate issues related to newproduction, and we believe that the markets for the securitization, for studentloan assets will return to reasonably normal levels before long. We in fact areexpecting to get back into the market here very shortly. We have consciouslyheld out waiting for the right timing to reenter the market and we are poisedto reenter it soon.

I think some of the external measures around this and aroundthe quality of our assets, Fitch recently upgraded 12 of our trusts about aweek ago. I was also, if you follow this, Moody’s Research recently said thatthey believe that the student loan ABS market would return to normalcy and notreally be affected by the disruption of the sub-prime mortgage industry, if youwill. So there are very good signs, we believe, in terms of the long-termfunding and financial opportunities for us to fund and finance the portfolio.

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

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

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

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

Thirdly, with the changes in legislation, the cost debateover whether or not even at the federal level, whether or not FFELP or directlending is cheaper to the taxpayer really has ended. They have now brought the FFELPprogram in alignment with the government’s own measures of costs of the twoprograms.

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

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

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

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

With that, I will turn it back to Al.

Albert L. Lord

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

You guys are the shareholders. I actually own less than 1%of the stock, although I oftentimes treat the company as if it is mine. I guess25 years will do that to you.

What I would like to do is review a few of those years, justto give you a little bit of a backdrop where we. Sallie Mae is now a 34-yearold company. Its first 10 years, we were 100% financed by the government. Weborrowed our first $5 billion from the U.S. Treasury and about 10 years later,the company went public in the equity markets. We’ve been a public company for24 years.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

That’s good news -- I hope it’s good news for you. I’m notso sure it’s good news for me because my attorneys tell me it’s maybe an unpaidposition because we have to get Chris’ permission to pay me. That’s Chris as inFlowers.

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

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

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

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

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

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

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

As a board, we are mindful of our fiduciary responsibilityto all of you. Today, we clearly interpret that as meaning we should enforcethe contract.

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

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

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

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

I think on the other hand, Chris Flowers wants to own SallieMae. I firmly believe that. Unfortunately, he wants a wholesale price, doesn’twant to pay the retail price that he signed up for. But it is still possiblefor him to execute this contract as he signed it.

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

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

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

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

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

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


Unidentified Analyst

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

Albert L. Lord

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

Unidentified Analyst

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

Albert L. Lord

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

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

Yes, sir. That’s you, Doug.

Unidentified Analyst

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

Albert L. Lord

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

Yes, sir.

Unidentified Analyst

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

Albert L. Lord

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

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

Yes, sir.

Unidentified Analyst

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

Albert L. Lord

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

Unidentified Analyst

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

Albert L. Lord

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

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

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

Unidentified Analyst


Albert L. Lord


Unidentified Analyst


Albert L. Lord

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

Unidentified Analyst

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

Albert L. Lord

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

Unidentified Analyst

I don’t play chess either.

Albert L. Lord

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

Unidentified Analyst


Albert L. Lord

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

Yes, sir.

Unidentified Analyst


Albert L. Lord

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

Unidentified Analyst

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

Albert L. Lord

Support? Take your time.

Unidentified Analyst

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

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

Under what we regard as the most likely scenario, wecalculate that the legislation will have no effect on the company over andabove that of the legislation referred to in the merger agreement as the basecase.

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

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

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

In refusing to do so, he has refrained from exercising hisright to terminate, which would carry with it a $900 million liability. He hasnot invoked a MAC, which would similarly expose him, his investors, andpartners to the $900 million liability, should a court determine, which is mostlikely, that there has been no MAC; nor, of course, has he indicated hiswillingness to go forward with the terms of the existing merger agreement.

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

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

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

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

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

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

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

Albert L. Lord

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

Yes, sir.

Unidentified Analyst

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

Albert L. Lord

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

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


(Operator Instructions)

Albert L. Lord

While we wait, go ahead, sir.

Unidentified Analyst

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

Albert L. Lord

I’ll let C.E. handle that.

Charles E. Andrews

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

But secondly, one of the things we’re finding in ourcollection process that had some effect on it is that we are able to do betterskip tracing and other things that we do today, so we are actually connectingwith borrowers better than we used to in the past. That’s one of the changesand successes we’ve had, which we believe has caused some up-tick in theforbearance.

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

Unidentified Analyst

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

Charles E. Andrews

No, I would not. I mean, I think we should see that itremains reasonably stable. There is some seasonality to it at points in timewhen loans go into repayment, et cetera. So it does have some seasonality butaside from that, it ought to sustain some relative stability to it. Weshouldn’t see it continuously tick up, certainly.

And the other thing we look to --

Albert L. Lord

The answer is no.

Charles E. Andrews

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


Unidentified Analyst

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

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

Albert L. Lord

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

Charles E. Andrews

In terms of the school channel and the FFELP business, withthe margin compression, basically what we will do over time, we haven’t doneall this yet, we will adjust the benefits we offer to borrowers, which willoffset some of the reduction, not all of the reduction. That’s kind of thepricing or economic change that we will make and we will do that and time thatwhen we think it makes sense from a business standpoint, recognizing one of ourobjectives is to use our school channel to capitalize on the market sharegrowth.

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

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

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

Albert L. Lord

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

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

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

Let’s try this gentlemen over here.

Unidentified Analyst

Just curious, given the loss of some of the guaranteed FFELPdollars, do we need to revisit any of our relationships on the private loanside? Say, for example, some of the riskier assets, maybe the for profit careertools? Do we need to be more conscious of those relationships going forward nowthat we lost some guaranteed FFELP dollars?

Albert L. Lord

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

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


Unidentified Analyst

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

Albert L. Lord

I think it would be run -- could be run a lot differentlywithout having all of its negotiations on sensitive subjects like students.Having the shareholders, really the detail of those conversations. Also, Ithink the financial structure of the company is such that it has a high cashflow, which can service the debt and provide delightful returns to theinvestors.

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

Unidentified Analyst

So the disadvantages of staying public? Just the opposite?

Albert L. Lord

Are you in a public company?

Unidentified Analyst


Albert L. Lord

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

Unidentified Analyst

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

Albert L. Lord

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

Unidentified Analyst

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

Albert L. Lord

I don’t know.

Unidentified Analyst

Thank you.

Albert L. Lord

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

Is there a question on the phone?


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

Tim Wilson - CreditSuisse

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

Albert L. Lord

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

Tim Wilson - CreditSuisse

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

Albert L. Lord

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

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

Tim Wilson - CreditSuisse

Thank you.

Albert L. Lord

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

Unidentified Analyst

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

Albert L. Lord

The proxy?

Unidentified Analyst

The proxy statement in management projections [inaudible] .

Albert L. Lord

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

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


There are no further questions.

Albert L. Lord

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


This concludes today’s conference call. You may nowdisconnect.

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