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Edited Transcript of SLM earnings conference call or presentation 24-Apr-18 12:00pm GMT

Q1 2018 SLM Corp Earnings Call

RESTON Apr 25, 2018 (Thomson StreetEvents) -- Edited Transcript of SLM Corp earnings conference call or presentation Tuesday, April 24, 2018 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian Cronin

SLM Corporation - VP of IR

* Raymond J. Quinlan

SLM Corporation - Executive Chairman & CEO

* Steven J. McGarry

SLM Corporation - Executive VP & CFO

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Conference Call Participants

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* Arren Saul Cyganovich

Citigroup Inc, Research Division - VP & Senior Analyst

* Henry Joseph Coffey

Wedbush Securities Inc., Research Division - MD of Specialty Finance

* John Hecht

Jefferies LLC, Research Division - Equity Analyst

* Mark C. DeVries

Barclays Bank PLC, Research Division - Director & Senior Research Analyst

* Michael Matthew Tarkan

Compass Point Research & Trading, LLC, Research Division - MD, Director of Research & Senior Research Analyst

* Michael Robert Kaye

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Moshe Ari Orenbuch

Crédit Suisse AG, Research Division - MD and Equity Research Analyst

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* Sanjay Harkishin Sakhrani

Keefe, Bruyette, & Woods, Inc., Research Division - MD

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Presentation

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Operator [1]

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Good morning. My name is Angela, and I will be your conference operator. At this time, I would like to welcome everyone to the 2018 Q1 Sallie Mae Earnings Call. (Operator Instructions)

I will now like to turn the call over to Mr. Brian Cronin, Vice President of Investor Relations. Please go ahead, sir.

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Brian Cronin, SLM Corporation - VP of IR [2]

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Thank you, Angela, and good morning, and welcome to Sallie Mae's First Quarter 2018 Earnings Call. With me today is Ray Quinlan, our CEO; and Steve McGarry, our CFO. After the prepared remarks, we will open up the call for questions.

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

During this call, we will refer to non-GAAP measures we call our core earnings. A description of core earnings, a full reconciliation of GAAP measures and our GAAP results can be found in the Form 10-Q for the quarter ended March 31, 2018. This is posted along with the earnings press release on the Investors page at salliemae.com. Thank you.

I'll now turn the call over to Ray.

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [3]

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Thanks, Brian, and thank you, all, for your attention this morning. And I want to extend a special thank you to our team for delivering a great quarter. It was a good quarter on all cylinders. By my lights, volume was up higher than expectations. It looks as though we have very good competitive market performance, that is, we think our originations grew most likely faster than the market. Our yield in NIM are at outstanding levels. Come back to those as we talk. We had better than model performance in credit. New customers are at a very high-quality level, and we have continued progress on the efficiency ratio, which we've all discussed over these last many quarters.

The 22.7% ROE is a testimony to the fact that these good results do show up in the bottom line. In addition to that, we've had very good and gratifying results in several strategic areas. We've introduced personal loan with a 300,000 test mailing in January, and we have followed it up with a 2 million piece mailing in March. The volume is where we want it to be. The quality of customers applying is very high. And we've also tested the Sallie Mae brand, and the initial results are very good in relationship to that brand extending to nonstudent financing products.

Our cloud migration is going well, and we are fully embedded now in the agile methodology, which is starting to show good results. We've been doing this now for 3 quarters. Our progress on credit card evaluation continues, and that stays on track for 2019 initial product launch.

Our Grad products are in the field. We expect them to do very well. They are not part of the 7% volume increase that we've experienced so far. And so we have high hopes for that additionally.

In addition to that, our consolidation response products, which we talked about at several calls, which has been put in place selectively for term extension. And as we go through the second quarter, it will also include APR reductions, is up, and we're evaluating initial one-by-one results.

In addition to that, our team is experiencing very gratifying low turnover rate for our nonoperational areas, what we would think of as management. It's running at 5% and good feedback from our employee survey results. Our customers continue to receive enhanced satisfaction levels and extension of our service. Most recent innovation that we have, which is following the lead of many others, is to introduce chat as an alternative for our customers to speak with us. And the chat results at satisfaction level are at 96% so far as we continue to experiment with the best way to have that as an ongoing additional option for our customers.

In regard to our community, we've recently expanded our Delaware workforce and had a very successful opening of a second site here for collections operations and underwriting, and it was well attended by all the top elected officials in Delaware, including the Governor, both Senators and our Congresswoman. It's very good results for both us as well as for our relationships in community.

And so let's return to the results. Volume. The first quarter originations were $2 billion. You'll recall that we have a $5 billion goal for the entire year, so 40% of the year is in. The busy season, of course, looms in front of us. We're up 7% in originations from 2017. And as I said, we believe the market to be growing slower. Of course, the obvious implication is that our share is up. When we receive those numbers, we will certainly report out on them. With volume up, you always worry about credit quality through the door. That continues at the same high level that we've experienced these last couple of years. Our FICO, as you saw in printed material, is at the same level, 748 last year, 746 this year. Our cosigner rate 89-plus percent versus 90% last year, same level and 79% of our loans have FICO over 700 by the primary borrower.

In addition to that, on standout, for the quarter, is the results that Steve and his team were able to deliver on NIM. The NIM at 6.17% is now the envy of the industry, up from 5.96% last year and that continues to be the beneficiary of both the management of the yield on the portfolio, the efficiency of the balance sheet in regard to producing -- in revenue-producing assets as a proportion of the total, and of course, our funding mix.

The OpEx, you know we focus on the efficiency ratio, continues to improve. The absolute level at 36.5% in the first quarter is a very good level, down from 36.8% last year. Our revenue is up 24%. Our operating expense is up 21%. So they're both in growth mode at this particular point. The question is how to control that growth, so that we prudently both service the existing business as well as make appropriate investments for the business over time.

Credit, as I said, continued great performance, better than our model thus far. Early days so far as the year is concerned, but all the indicators are pointed in the right direction.

Our balance sheet continued strong. 22% growth in the overall balance sheet. And our capital to risk-weighted assets remains at 13%.

EPS, the bottom line in [$0.01], ROE (inaudible) in the other cents. EPS at $0.27, up from $0.21 last year, reflects all these good performance indicators that I'm mentioning. 29% increase, we're quite proud of that. The ROE at 22.7% is extremely gratifying and certainly, talks to the continued investment in the business that we've talked about on many calls as well as individual meetings.

Our regulatory relations continue to be great. The CFPB, the FDIC, the UDFI were all aware our plans. We're in more or less constant conversation with them. The results of all their field audits have been very good. And we are gratified to have them as a partner.

So the market frame. We are making progress on the areas in which we focus in relationship to the customer, the competition and our evolution. Steve, of course, will talk about this in great more detail, especially around the NIM. And our outlook as you all saw in the guidance, we've tightened up the EPS. The originations were staying at $5 billion. We're optimistic after the first quarter, but as I said, 60% of the volume has yet to come in this year and continued progress on the efficiency ratio.

So a very good quarter. Balanced, good performance on every major indicator. Good start to the year.

And with that, I'll turn this meeting over to Steve.

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [4]

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Thank you very much, Ray. Good morning, everybody. I'm going to provide a little bit more detail on the quarter's numbers, and if I repeat a stat or two, please forgive me.

So jumping into the NIM. As Ray mentioned, we did pose a very strong NIM of 6.17% in the first quarter, up from 6% just a quarter ago and 5.96% in the year-ago quarter. The NIM increased by 21 basis points year-over-year, driven by the increase in the percent of student loans and personal loans in our portfolio. We also continue to benefit from the low spread environment as we're -- as we benefit from sub-LIBOR pricing on our retail money market deposits and a very good spread environment, brokered CDs and asset-backed departments -- markets. Assuming those markets remain stable, we think that our NIM is going to remain above 6% for the full year as those that follow us know, as we build cash balances for our peak disbursement seasons, the NIM tends to decline and then rise subsequent to disbursements. So we think that the NIM should come in right around 6.1% for the full year.

Talking about rising interest rates. Since our last call, the 3-year swap market is up a full 50 basis points, but we remain very well positioned for a rising rate -- interest rate environment with very minor impacts to our earnings risk and economic value equity given a shock in interest rates of 100 basis points.

In the quarter, we did complete another ABS transaction, 2018-A, where we raised $670 million of term funding at LIBOR plus 78 basis points. That is our all-time low as a stand-alone bank, and it's down some 50 basis points since we started issuing ABS out of the bank. We will continue to use the ABS market as it's a great way for us to diversify our funding and also extend our liabilities duration and fund fixed rate assets. So as an example, the most recent bond we issued included $244 million of fixed rate loan bonds with a 6-year weighted average life. That's important because as you will see in the details of our release, in the first quarter, 48% of our originations were fixed rate. That's up from 16% in the year ago quarter. So in this rising rate environment, our customers are choosing the smart thing and that is to lock in rates on their borrowings.

Just a little bit more detail around OpEx. It was up $125 million compared to $103 million in the year ago quarter. FDIC fees, which are included in that number, were up a sharp 22%, but maybe more importantly, in the quarter, we accelerated $5 million of expense related to investing in the executive stock compensation. And in addition to that, we incurred costs of $2 million for payments related sadly to the passing of one of our officers in January. If you back this out of the operating expense numbers, our efficiency ratio would actually have been 34.5%, and our OpEx growth would have been 14%. And we think that's a reasonable thing to point out here because that was an acceleration of expenses into this one period.

I'll also mention that of the $30 million of diversifications investment, we have mentioned -- we mentioned in the last call, we got off to a slow start. We only spent $600,000 of that in the first quarter. I think if you want to think for modeling purposes, you should expect us to spend the balance of that evenly over the next 3 quarters of the year.

Effective tax rate in the quarter was 24.5% compared with 35% in the year ago quarter, obviously, a big benefit from the recently passed Tax Act. And you can think about our tax rate being right around that 25% rate for modeling purposes.

I'll give you a few more stats on credit performance. Loans delinquent 30-plus days were 2.5%, up from 2.4% in Q4 and up from 1.9% in the year ago quarter. First quarter, delinquencies are typically higher than the fourth quarter delinquencies as a result of the big repay wave that hits in November and December of the fourth quarter. And a lot of these loans flow directly into the delinquency buckets. It is a fact that delinquencies were somewhat lower-than-expected, and we feel we're well positioned for Q2 charge-offs based on the way our delinquency buckets are stacking up.

Net charge-offs for average loans in repayment were 1.01%, down from the prior quarter and up slightly from the year ago quarter. The increase year-over-year is simply due to the fact that we have more dollar volume of loans in full P&I. Charge-offs measured as a percentage of loans in full P&I were 1.93% in the quarter and that is also down from 2.06% in Q4 and 1.73% in the year ago quarter. We had a total of $7.13 billion of loans in full P&I. That is 38% of our total loan portfolio.

Personal loans. We ended the quarter with $675 million of personal loans on the balance sheet. We view these to be high-quality loans. They had an average recent FICO score of 723, and the incomes of our borrowers are just under $100,000. This portfolio is young. We monitor it very carefully, and it is performing well within our expectations.

The comments on the provision for credit losses came in at $54 million compared with $25 million in the year ago quarter. $13 million of this provision was personal loans. 24% of the total provision for the quarter, increase was simply due to the rapid increase in the personal loan portfolio from Q4 to Q1.

We ended the quarter with an allowance for loan losses of 1.34% of total loans and 1.95% of the loans in repayment. Our allowance coverage is very solid, almost 2x charge-offs. And we'll repeat that our core portfolio is performing probably slightly better than our expectations. So things are very solid on the credit front.

Turning to capital. Bank remains well capitalized with a total risk-based capital ratio of 13% and common equity Tier 1 of 11.7%. We expect these ratios to be right around these levels at year-end, demonstrating that our earnings is now covering our balance sheet growth, which is sort of a change from prior years. These ratios are significantly in excess of the requirements to be considered well capitalized, both now and after Basel III is fully phased in. And of course, we continue to have excess capital at the holding company that is available as a source of strength for the bank should in the unlikely event, it should be needed.

Couple of comments on CECL before I wrap up here. Work on CECL continues to move forward. As a reminder, CECL requires us to build a life of loan loss allowance for our loan portfolio. But interestingly, just under 2 weeks ago, a new joint proposal from the Fed, the FDIC and the OCC, is giving banks the option to phase-in the day 1 regulatory capital effects at CECL over a period of 3 years. Now in prior calls, we've clearly stated that the -- that implementing CECL would not result in our capital flowing below well-capitalized levels. But nonetheless, capital phase-in is a welcome development, and it looks pretty certain that it will be adopted.

That pretty much wraps up my commentary. So we would be very happy to open up the line for calls at this point in time.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Mark DeVries with Barclays.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [2]

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Sorry, if I missed this, but could you just update us on your guidance, your expectations for consolidation activity? And also Ray, if you -- it would be helpful if you give us a little more detail on the product you mentioned rolling out kind of early signs and hopes for the ability of that to really kind of mitigate that consolidation activity?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [3]

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Sure. Consolidation, as you know, is running at about $223 million in the quarter. We have guidance out there for $900 million. Of course, we're exactly on the run rate. One might think that there is either a positive slope to the volume there or one could also forecast that given the rate increases that are both embedded as well as the ones that are forecasted that the overall consolidation efforts will mitigate. And I think some information has come out in the last week or 2 about volumes of some of the consolidators and what they're doing with their mail basis. And that seems to be consistent with the closing window of the arbitrage opportunity that we've experienced over these last couple of years. Having said that, we think that we are right in where we want to be from a zone standpoint. And we don't think that we are in danger of having that continued increase in leaps and bounds. If it's up, it's probably gradual, we'll see though. In regard to the consolidation response, we -- early days, we, of course, don't want to turn higher-margin loans into lower-margin loans. And so we are very much in a wide net customer by customer. Let's learn about this with the focus so far on term extension, and as we look to the remainder of the second quarter, by June 30, we will have report back to Mark, you as well as others as to the effect of moving APR as customers' credit quality improves after graduation as well as the efficacy of the term extension, which as you know, both of those are focused on reducing the cash flow, which customers have told us is their primary focus. They're not particularly rate hunters. What they are is lowering the requirements for servicing these loans searchers. So early days for the consolidation product on the run rate for the overall consolidation, and we think that the interest rate environment continues to take the oxygen out of some of the people who are specialized in regard to this.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [4]

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Okay. Got it. And second question, is the roughly $300 million or so in personal loan originations this quarter indicative of kind of what your expectations are for quarterly origination for the rest of the year? And how should we think about that growth into 2019 and beyond?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [5]

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Okay. Well, as we've looked about -- at it, there is the purchase personal loans and then there is the organic fees. And so for the purchase, we're thinking about $1 billion for this year, so that would translate into roughly $100 million per month. Obviously, it won't hit that like clockwork, but it'll be in that range. And in regard to the organic, as I said, we've done -- first, we did the IT shakeout. The product appears to be working effectively. We're still making some improvements in that. We did a test mailing in January of 300,000 pieces, 2 million in March. We're up to about $30 million outstanding. These are all test mailings. So once again, we're looking for learning as opposed to efficiency. So it's a little more explore than exploit in management lingo. We're looking for that to be about $300 million in receivable as we leave the year. So we're looking for about $1 billion in the purchase fees, about $300 million in the organic build.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [6]

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Okay. And as you go forward into 2019 and beyond, would you expect that to accelerate?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [7]

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You know, we're testing, so we will do things that meet our ROE targets as you know. But from what we can see of early days, we certainly don't have the model all baked here, Mark. But yes, we would expect that to accelerate, the organic fees. The purchase fees, I think, will be at a level that we're currently experiencing.

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Operator [8]

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

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [9]

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The disbursement growth was pretty strong. Could you just talk about what that was attributed to, and perhaps, the competitive environment because you've had some players shifting around share?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [10]

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Sure, Sanjay, and pretty strong. I think, why don't we modify that as the 7% growth was outstanding. We're in a market that we have tried to model so far as what the total wallet of the market is. We continue to think that, that growth is in the 2% to 3% level overall. 7%, obviously, puts us in a position where you know 7% being greater than 2% or 3%. We think that the market share is up. We don't have a full documentation of what the market did in the first quarter. You know that information comes at a lag. And I think what you would see so far as why we think we're up faster than the market without commenting on the competitive frame other than to say that it's fairly stagnant, that is the competitors who were there, Wells Fargo, ourselves, Citizens, Discover are all, one, continuing to play their games the way they have; two, continuing to be effective. We don't really see any new entrants who are changing anything in regard to volume. But in answer to your question as to why we think we would be up faster than the market, at this particular point, in this part of our business, which is the core business that we have, we believe that improving consistently at the margin, consistent quality improvements, extension of lines, watching how people go through where they fall off, how we do it sort of results process and business process mapping in order to make our applications more efficient, has yielded some very good results for us. We have fewer applications per loan. We have faster turnarounds on it. We have more options for people as they go through the process. We've improved our website. And so we think it's a game of incremental efficiency and mild extension of the options to the customer in a market where we already have 54%. And so incremental improvement and consistent improvement is the name of the game there for us.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [11]

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All right. My follow-up question for Steve is on CECL. You mentioned the 3-year phase in. Does that change your capital management expectations then because you don't have to expend as much capital as you thought you might have under the previous scenario?

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [12]

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So at this point in time, I think it's a little premature for us to change our capital management approach. Our capital levels have really just bottomed out now and relative to our peer group and relative to our conversions with our regulators, we think they are about appropriate. They will grow a little bit in '19 and then probably, decline slightly in '20. And significant capital generation will come after CECL's implementation. And of course, we also have the diversification efforts that we are developing that will also consume some capital. So I think it's a little early to change our no-dividend, no-shareholder buyback position at this point in time.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [13]

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Okay. And one...

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [14]

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Two things there I'd like to comment, Sanjay, is...

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [15]

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Sure.

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [16]

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One is, this 3-year phase-in essentially came in quickly over the transom, as Steve said about 2 weeks ago. And so that's one, directionally good. But two, it reminds us how uncertain the regulatory framework is for the implementation of CECL. And so I think it behooves us to be cautious in regard to that because we didn't really see the 3-year phase-in coming. People had been adamant that it was instant implementation on January 1, 2020, and so that has very concerned. Now it suddenly looks like 3 years, we're not exactly sure where it's going to land. And so we want to be cautious because if the capital goes out the door, it's very hard to get it back. And the second thing here is that we will always be looking for the combination of the capital that we're provided with by our shareholders and the appropriate return on that. And so as we sit here, the 22.7% ROE gives us the confidence that we can make efficient use of the capital we have. So in part, it's the regulatory frame, but it's also bounded by, we believe, we owe our shareholders a decent return on any capital that we hold as an ongoing stance.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [17]

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Okay. That's fair. Ray, one other question is on this personal loan portfolio. As we think about testing and as you roll it out to your -- across your platform, who are we -- who are you targeting to make these personal loans to?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [18]

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Let's say -- it's actually a wider range than we originally thought. And so as you -- as we discussed many times, there is a consolidation active -- a set of activity for Americans in their 20s. And those are people who have gotten out of school. They have student debt with us, with the federal government. They are looking to get their lives on track. They have to put the pre-existing debt into a box that allows them to think about other purchases, especially automobiles, I'm going to say. Then maybe, later on housing. And so the early stage of Americans' life as they graduate and form households is a key target. Having said that, we are, as I said, not trying to overplay our knowledge of the area, and as you can see with our purchases of others' personal loans, we are trying to accelerate our knowledge. But we believe that there are several pockets where people can use this product effectively, but all those are in early testing stages. And we remain committed to following our customers as they go through their lives. But we will not leave untouched areas where we think we can profitably play for parts of that portfolio. So a roundabout answer, early days. We are certainly casting a wide net, and we will report back, both on the results of that as well as the implications for target audiences going forward.

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Operator [19]

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And your next question is from the line of Moshe Orenbuch with Crédit Suisse.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [20]

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So Ray, you talked about the competitive environment and your fundings, having done 40% of your target for the year. Are there any -- anything coming from any new products within the student? And maybe talk about whether you're seeing anything that might -- that you might be preparing for in terms of expanding your product set based upon things that might come down from Washington?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [21]

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Right. And so one -- good question, Moshe. And as you know, a year ago, we thought that Washington might actually, as I frame it, make some progress in regard to this area, but we have been disappointed. And as you know, last year, we spent $7 million increasing our capability of processing, that was our project, Nike. It's subjective and it was successful in realizing it, was to increase by 100% our ability to execute the basic product frame of student financing. That was implemented in regard to it. So we're trying to be ready. A second step of being ready is from the way we understand things as they are developing in Washington, one is, we continue to think that there is a mood to cut back on the federal dominance of the student lending market. So we think that we're tilting the right way. Having said that, we think the focus of those people, who are looking at higher education act as well as changing the current funding is on Grad and Parent PLUS. And so Grad as opposed to undergraduate, where if we were to take what we're currently being told, we might think, "Oh the federal piece will increase these limits for undergraduate," but we'll curtail both the Parent and Grad PLUS, in particular, the Grad piece. And as you know, 16% of the students in United States are graduate students and 40% -- they comprise 40% of the borrowing. So the average ticket is larger. They're older. They're less a little bit of all Americans have the right to a higher education regardless of the economics of their household. So we believe that the best place for us to concentrate our efforts at the margin is to be ready for changes in the Grad program. And so as a result of that, as you heard in prior quarters, we've introduced 6 new products targeted to the grads -- the graduate students as we think appropriate because those segments are not homogeneous, and it's a long way from funding for a doctor either even to other health professionals at a very long way from a graduate arts and sciences, MBAs and legal. And so we've tailored our products for each one of the major professions. We've had constant conversations with the school financial aid offices. Each one of the graduate centers is a smaller environment than the undergraduate in the typical university. We think that we have a competitive advantage in moving us forward because of our sales force, the largest in the industry. We believe that the introduction of this requires handholding explanation. An average ticket, as I said, are much higher, but the financial aid offices in graduates -- in the graduate space are much more involved with the individual tailoring of financing for each, let's say, doctor to be. And so in response to your question, one is, we see the current market as sort of relatively stable, especially around price competition, which is gratifying; two is, that there are changes in Washington, we expect them to be favorable; three, we'd expect that the major changes would be grad; and four is, we're anticipating that by introducing our products. And by the way, the graduate schools are also concerned about this because they get most of their funding from the federal government and to the extent that is even being debated. The schools find that to be quite threatening, and so they're more open to conversation with us about possible alternatives.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [22]

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It sounds good. Just wanted to follow-up quickly on the personal loan. I mean, given that you probably by -- as we stand here today, you know, well over $700 million in that product from the loans that you purchased. I mean, it seems like the capital commitment is more or less there, and it's not going to be a big capital drag in '19 as you start the -- as you start your -- to kind of ramp up the stuff you're doing organically. I mean, is that a fair comment? And I also noticed the big reserve build that you did this quarter, which -- so I guess, a lot of the capital in reserving is likely to be setting -- your setting the table here in '18 for what would come in '19?

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [23]

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Yes. Look, I think that's right Moshe. But as we see the product rolling out over the next 2 years, '20 is when it really starts to grow in terms of volume. Quick word on the personal loan P&L. We are building the provision in 2018 for that portfolio. And based on where the income statement sets up, it'll be slightly positive in terms of earnings contribution in '18, that should really start to contribute to earnings in 2019. But the way we see the time line rolling out for the personal loan product, it really starts to gain some traction in 2020 in terms of the size of the loans on the balance sheet.

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [24]

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The organic piece.

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [25]

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The organic piece.

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Operator [26]

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And your next question is from the line of Arren Cyganovich with Citi.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [27]

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Looking at the private education loan yield at -- I think, it increased about 23 basis points quarter-to-quarter. Can you talk about what -- if that was mostly from benchmark rates or was it portfolio mix? How do we think about the private education loan yield going forward?

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [28]

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Yes. So look Arren, the increase in the student loan yield this quarter was pretty much based on changes in LIBOR. It takes the 1-month LIBOR and rounds up to the nearest 8th and it sets on -- I think we're probably getting into more details than you really want here, but it resets on the 25th of every month. So we think based on where LIBOR is today, it'll step up another 10 or 11 basis points at the end of the month. But the increase in the cost of funds and the loan yield was almost directly correlated to the increase in LIBOR. I did mention that we have an increasing portfolio of fixed rate loans, which will tamper that somewhat, but that's really a brand-new phenomenon, hasn't really impacted the percentages of the portfolio just yet.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [29]

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Okay. And then, on the consolidation loan side, you kind of, I guess, in my view, a little bit of a conflicting comment about the higher rates driving the little less opportunity on that for competitors to take away your loans, but at the same time those customers not being that rate sensitive. So I just want to understand how those 2 work together?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [30]

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Sure. And so when we talk about the customers not being rate sensitive, they are not, in our experience, overtly rate sensitive, right? But the implication of lower rate for the customer is under your projection a lower cash flow requirement in order to service that loan. And so we don't find customers looking for a particular number as far as the APR, but they are looking for, how do I get the cash flow demands associated with servicing my debt to be lower? Now that's on the customer side of things. So they're focused on how much do I have to pay each month. On the other hand, on the provider side of things, the question is, given I accomplish the fact of helping the customer have a lower cash flow, what is my spread? And so the spread on the provider side of things is driven by the deltas we've been talking about, which is a preexisting loan APRs versus their ability to fund at the margin, which as you know, for the last 2 years, has been extremely favorable, especially in spreads on credit quality. And so I don't mean to say that the APR is unimportant, it is just not the major decision factor. So if the APR was low, but the customer wound up having to pay more in cash flow per month, the consolidation mark will be 0. And so they are looking for lower cash flow, but the provider needs to have the delta between, obviously, what they bill the customer and their cost. And so as Steve and I have both said over the last several of quarters, that delta is decreasing as rates go up.

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Operator [31]

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(Operator Instructions) Your next question is from Michael Kaye with Wells Fargo.

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Michael Robert Kaye, Wells Fargo Securities, LLC, Research Division - Senior Analyst [32]

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I know Washington is very challenging to predict, but I wanted to get your thoughts on the potential impact of the upcoming midterm elections. Meaning, how much of a setback would it be for a positive development on potential private student loan expansion if the Republicans lost control of Congress? Would this basically just perpetuate the status quo? Or is there a risk of something negative developing?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [33]

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From what we can see, and of course, it's widely heralded that the Republicans will lose seats in the 2018 election and maybe lose the house, seems less likely they will lose the Senate. And so either way, things will be fairly close. And if we have a house that is dominated by Democrats, they still have to deal with the other 2 arms of the government. And so as I said, we thought there'd be much faster progress in D.C. over the last 1.5 years. That has not occurred. To the extent that the power structure is further fragmented, we would expect that if we had slow progress in mud over the last 18 months, we would expect slower progress, more mud going forward, but doesn't represent a threat from what we can see.

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Michael Robert Kaye, Wells Fargo Securities, LLC, Research Division - Senior Analyst [34]

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Okay. That's very fair. Just -- again, back to that new defensive consolidation product. I mean, how much do you think that could prevent from consolidations going away from your portfolio? Like, how much was that included in that $900 million estimate? And how do you think about that product that's giving you optionality to go on the offensive, meaning starting to consolidate loans outside your portfolio?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [35]

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Right. And so first off, in answer to your question, in regard to the consolidation number that we have guided to, the $900 million, there are no -- there is no factor in that estimate for our consolidation activity. So 0. And I think that's appropriate given we're in test mode. In answer to your question of when you talk to customers, are they interested only in refinancing our loans or others, we clearly, in early days, are finding that they, of course, think all they've had together, and the more they can put into something that's an attractive bucket versus what the preexisting bucket was, they're open to. And so we are in -- not really in a position at this very particular moment given how early this is and the progress of that to be able to articulate, one, the opportunity of consolidating other loans on our balance sheet that are away from us today; or second, what it would do to the $900 million estimate for the consolidations. So I think we need another quarter on that, and I don't want to overplay what we're doing. So I think I'll just back off of responding to that anymore crisply. Sorry, Michael.

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Operator [36]

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Your next question is from the line of Rick Shane with JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [37]

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When we go through the numbers, it really looks like the variance to us was on the NIM side. And if that persists over the next year, that's probably going to be the factor that really drives the stock. Could you go through the asset liability and hedge mix, walk us through what the key benchmark rates are for each and also, what the periodicity of the reset balance?

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [38]

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Sure. So we have a pretty straightforward portfolio. Today, it's about 75% variable rate, directly tied to 1-month LIBOR and 25% fixed rate. Our funding matches pretty closely to the mix of the assets. We have $3 billion of money market deposits. We have another $3 billion of ABS, that is tied to 1-month LIBOR. And the vast majority of our brokered CDs are swaps into LIBOR. So the mix of fixed to variable is pretty well matched. We also have put on some pay fixed received flow swaps to hedge our fixed rate portfolio. So Rick, I think, if you take a look at our interest rate sensitivity disclosure, it captures pretty well our sensitivities to interest rates, although I will say, one thing, it's probably a little bit conservative on the beta. I think we have modeled in there a beta of 80 basis points for the money market deposits when it's running probably closer to 60 these days. Moving forward, on both and actually this gives me an opportunity to put some information out that I neglected to in my prepared remarks. So our NIM is going to decline over the next 2 quarters and then stabilize. Our EPS will decline from the first quarter. In the second quarter, we ramp up our direct-to-consumer marketing spend. There is a decline in EPS into Q2 (inaudible) and then a very strong finish to the year in Q4. So there is seasonality in both our funding and our earnings per share metrics. So...

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [39]

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Steve, I think the lawyer started rattling the phone when you were providing that guidance. It was a little bit hard to hear. Could you repeat that, again, please?

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [40]

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Yes, that was actually the FPNA guy, and he has been reprimanded. So the EPS will decline in the second quarter as we ramp up our direct-to-consumer marketing for peak season, and it increases slightly in Q3. Q3 is hit not only by continued marketing costs, but the cost to process, the large volume of loans that we originate in the Q -- in Q3. And then, we end strongly, end with a very strong Q4. And that has been a pretty persistent pattern, but analysts do miss it from time to time.

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Operator [41]

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Your next question comes from the line of Henry Coffey with Wedbush.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Specialty Finance [42]

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When we've analyzed your cohort data, we see the kind of stability in loan quality that you're talking about. And then when I look at the year-over-year trend in net charge-offs, you're up about 12 basis points. Is that -- within the in-full payment, is that a seasoning process where you've got more loans in full repayment that are into their sort of second and third year? Or how should we be thinking about charge-offs for the rest of the year?

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [43]

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So the stats that we file in our SEC disclosures, both the charge-offs and the delinquency numbers, are over total loans in repayment. So it's not just loans in principal and interest repayment, it's also loans that are in school by making an interest-only or, what we call, a fixed payment, which is a nominal $25 a month interest payment. The delinquencies and the charge-offs on loans in full P&I are certainly much more significant than they are in school. And as that mix has changed, so the year-over-year increase in both delinquencies and charge-offs is strictly related to the fact that we have significantly more dollars in full principal and interest repayment, which is when they tend to go delinquent or charge-off. I also gave the stats for loans in full P&I. So charge-offs measured for loans in full P&I were 1.93% in the first quarter down from 2.06% in Q4, granted to your point, they were up from 1.73% in the year ago quarter. There are probably $3 billion -- $3 billion or $4 billion more loans in full P&I Q1 of '18 than they were in Q1 '17. And our loss emergence period covers really the bulk of the charge-offs happened in the first 3 years as the loans go into full P&I. So that is why you see the year-over-year increases. For the rest of the year, there should not be a significant increase in either delinquency or default stats. The delinquencies by the end of the year could be hovering up closer to 6 to 7. We do expect to see an increase in defaults in Q2 as loans that are just recently entering full principal and interest repayment tend to roll through the buckets and charge-off, and then they should be stable for the third and the fourth quarter.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Specialty Finance [44]

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And then on the origination front, obviously, you're hesitant to jump forward, but the 7% number, was there anything unique about that, that makes you think that you won't see the same thing in September?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [45]

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Well, as we look at it, it was progress across many different pieces of things, right? As I said, the application pull-through, our take rates remained high, we had good follow-on for a serialization from prior year. And so I would say that there wasn't anything we would say key because of this particular new and different factor, we expected the numbers to be upgraded in market. I think, I've said before, that what we're seeing is, we're becoming more efficient at dealing with customer interest in regard to us. And so I think that we're faster in turnaround, it's better experience to the customer. We take better advantage of the people who have applications with us. And so I think what you're seeing is the efficiency at the margin for a 54% market share player. As we introduced the Grad products over the busy season, that will be a different story. And graduate loans are about 10% of our volume, and so that will be different as we have our second and third quarter investor calls, but not so much in evidence in the first quarter.

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Operator [46]

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And your next question is from the line of John Hecht with Jefferies.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [47]

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Actually most of them have been asked and answered. I guess, one question I have is just with respect to ALL levels. Steve, you talked about you trending little better in the private student lending portfolio, and then you were layering in a personal loan portfolio that I assume will start seasoning this year. So you're taking those 2 things together. How should we think about ALL levels as we step through this year?

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [48]

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So it's -- we were actually joking about this last night as we're preparing for the call. I think I have suggested at least twice that our allowance to loan losses will trend towards 1.5% at the end of the year, and it hasn't gotten there yet on either statements. We do expect the allowance will trend towards 1.5% of the portfolio. But as you can see, it's hovering down around 1.34%. Now clearly, personal loans, as that portfolio grows, will require larger allowance for loan losses than the private student loan portfolio does. So the trend should be higher.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [49]

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So that 1.5% that you've advocated before, that's still a reasonable target throughout the course of this year?

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [50]

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Yes. That's where we're expected to end the year.

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Operator [51]

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And your next question is from Michael Tarkan with Compass Point.

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Michael Matthew Tarkan, Compass Point Research & Trading, LLC, Research Division - MD, Director of Research & Senior Research Analyst [52]

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A lot of the focus on the consolidation activity has been with the refinance players. But I'm just wondering are you seeing any incidents of higher CPRs associated with employer-sponsored benefit programs for student loans? We've seen those pickup recently over the past couple of years.

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [53]

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Okay. No, we haven't, Mike. And some of the widely advertised companies that have programs like that, we see very, very little consolidation to programs along those lines.

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Michael Matthew Tarkan, Compass Point Research & Trading, LLC, Research Division - MD, Director of Research & Senior Research Analyst [54]

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Does your data show you whether there are students that are making more principal payments than is required? Are you able to see that?

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [55]

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I mean, yes, look, we see for [talents], we see full pay downs, we see consolidations. We have all the details. We have not seen a significant rise in preface fees that we're going to identify as a result of those programs.

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Michael Matthew Tarkan, Compass Point Research & Trading, LLC, Research Division - MD, Director of Research & Senior Research Analyst [56]

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Yes. Got you. And then just big picture, with more students taking out fixed rate loans, does that impact sort of how you think about funding the business or maybe some of your asset sensitivity? Just how do we think about that? I remember back in the day where there was sort of 15% of your portfolio was taken out fixed. Now it's creeping up. So just I'm kind of wondering how you think about that?

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [57]

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Yes, look, so it's absolutely changing the way we think about how we fund the portfolio. Hence, including fixed rate tranches to ABS, we're in the broker retail deposit market, and we swap far less of our production. So we issue -- we're out there at any given time issuing 3, 5, 7-year appropriate CDs. And we have also done derivatives where we paid a fixed, received a flow to offset some of the LIBOR index and money market-type deposits that we have on the book. So it definitely is a little more complex, funding fixed rate assets than it is a variable rate book. But we don't see any of the real volatility that you see on mortgage products or things of that nature. CPRs are pretty steady, convexity isn't really an issue, so...

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [58]

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And we're still at 75% variable.

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [59]

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Yes, we're still at 75% variable. And -- as our sensitivity disclosures show, we think that we're doing a very good job of funding the portfolio given its current mix.

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Michael Matthew Tarkan, Compass Point Research & Trading, LLC, Research Division - MD, Director of Research & Senior Research Analyst [60]

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Are you looking at securitizations a little bit more with that fixed rate component? We only saw a couple deals last year.

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Steven J. McGarry, SLM Corporation - Executive VP & CFO [61]

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So we're coming out of more from -- we think that spreads are probably bottoming. I mentioned in my prepared remarks that the cost of ABS funding has declined a full 50 basis points since we started out here at the bank and, by all indications, the volatility that's shown up in the stock markets as well as the high yield unsecured debt markets, seems like it's bleeding into the ABS market. So while spreads are down here, we'll probably end up issuing 3 deals this year as opposed to 2. And we will include more fixed rate tranches in those transactions.

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Raymond J. Quinlan, SLM Corporation - Executive Chairman & CEO [62]

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And as Steve and I have both accounted, we believe we had a terrific quarter. And as you look at the major variables associated with the business, volume and market share yield and cost of funds, credit quality and performance, operating efficiency, the earnings up 29%, ROE at 22-plus level, the customers are increasingly satisfied. We're introducing new tools. As I said, chat is the latest. The employees are experiencing low turnover, which we think is very helpful for the continued improvement of the company. And we are making significant strategic progress on new areas of activity. And I want to emphasize on agile and cloud migration. Of course, the personal loans, we talked about. The Grad products, we have high hopes for the next 6 months. We'll see how that does. And as we also look at the consolidation product, we think we'll get more on the field in combating people who are nipping at the portfolio. And it is the case that across all the areas that we see, we think the performance of the franchise, very solid, very gratifying. And I have to say just to reiterate it, we didn't expect a plus 7%, and so that was not in our forecast, and we are ahead of it. And that's especially gratifying because the market, as you all know, is, one, not growing spectacularly; and two, is filled with significant competitors. So we think that, in particular, is a mark of all the changes and investments that we've done in quality of service, credit more finely tuned, are paying off and paying off for our shareholders.

So thanks very much for your attention, as Steve and I, could just take a copy of this portfolio that we have today and the performance that we had in the first quarter and replicate it into the future, we would be very happy people. So thank you, all, for your attention.

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Brian Cronin, SLM Corporation - VP of IR [63]

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Great. Thank you for your time and your questions today. A replay of this call and the presentation will be available on the Investor page at salliemae.com. If you have any further questions, feel free to contact me directly. This concludes today's call.

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Operator [64]

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Thank you for participating in today's conference. You may now disconnect.