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Edited Transcript of SLM earnings conference call or presentation 20-Apr-17 12:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 SLM Corp Earnings Call

RESTON Apr 22, 2017 (Thomson StreetEvents) -- Edited Transcript of SLM Corp earnings conference call or presentation Thursday, April 20, 2017 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian Cronin

* Raymond J. Quinlan

SLM Corporation - Executive Chairman and CEO

* Steven J. McGarry

SLM Corporation - CFO and EVP

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Conference Call Participants

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* Arren Saul Cyganovich

D.A. Davidson & Co., Research Division - VP and Research Analyst

* Henry Joseph Coffey

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

* Mark C. DeVries

Barclays PLC, Research Division - Director and Senior Research Analyst

* Michael Matthew Tarkan

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

* Michael Robert Kaye

Citigroup Inc, Research Division - VP and 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

* Stephen M. Moss

FBR Capital Markets & Co., Research Division - SVP

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Presentation

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Operator [1]

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Good morning. My name is LaShana, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sallie Mae First Quarter 2017 Earnings Call. (Operator Instructions) Thank you.

I would now like to turn the conference over to Mr. Brian Cronin, VP of Investor Relations. You may begin.

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Brian Cronin, [2]

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Thank you. Good morning, and welcome to Sallie Mae's First Quarter 2017 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 from 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 to GAAP measures and our GAAP results can be found in the Form 10-Q for the quarter ended March 31, 2017. 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 and CEO [3]

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Thanks, Brian, and good morning. Thank you, all, for your attention. And as we go through our report today, couple of things are notable: One is we've had a very good quarter, we believe, exactly on our plan. And we'll talk about some onetime adjustments as we go through. And as we've done in prior calls of this nature, I will go down the profile of our business and talk about the key variables as I do that.

Starting with volume. So volume at $1,847,000,000 is up 2.5% from the prior year, and that is despite the fact that we continued to deemphasize for-profit schools, which are down in the first quarter. We are on track for $4.9 billion for the full year.

As we look at volume, we're always sensitive to credit quality, and so we continue to have terrific stability in regard to the through-the-door population of approved applications with 90% of our new loans having a cosigner and a 748 FICO, which has been steady for several years now.

NIM has improved quite a bit -- Steve will talk about that in detail -- but in the quarter it was 5.96%, up from 5.77% a year ago, 19 basis points, and it continues to reflect the efficient treasury work that we're doing both in liquidity as well as rate, along with the fact that our balance sheet is becoming more focused -- or more weighted to higher-earning assets. I'll talk about that in a couple of minutes.

In regard to the operating expenses. In the absence of -- let's take away the FDIC sort of uncontrollable increase, and if -- with -- in the absence of that, we're up 8% in operating expenses which, of course, takes our core efficiency ratio down to 36.8%, a new low for us versus 40.2% a year ago. And while there'll be some seasonality in that, we will continue to be under 40% for the full year.

Credit performance was very good in the quarter. Our net charge-offs were 89 basis points, down from 95 basis points last year and that, of course, happened despite the fact that the new business, which is inherently more risky as it goes through its normal life cycle, has expanded by $4 billion over that time.

And so as we look at the balance sheet, the private education loans are now up to $15.5 billion. They were $12 billion a year ago, 29% increase. The entire balance sheet, now at $19.2 billion, is up 26%. So I'm looking at the changes from last year to this year. The private student loan's $3.5 billion increase is $3.5 billion of a $3.9 billion total increase. So at the margin, our balance sheet is 90% -- 90% of the balance sheet growth is attributable to the high-yielding, high-quality private student loan portfolio.

EPS at $0.20 versus $0.14 last year is up 43%. And so we have guidance that will reflect the full year, but we will continue that trend. And last year, we were up 36% '16 over '15, so we're looking at some very heavy compounding in regard to that.

ROE at 20.7%, benefited from some of the onetimers in the quarter; last year at 15.9%, a 30% increase but continue to be in the range of the teens that we've talked about in prior periods.

Our regulatory relations. The FDIC, the Utah Department of Financial Institutions and the CFPB continue to be very good. We get good feedback from all 3 organizations. The consent order, as noted in the announcement, has been lifted without any caveats. And our balance sheet, as some of you will recall, growing in excess of 20%, reflects our continued good relationship with the FDIC.

Our guidance on EPS will go to $0.70 to $0.72. At $0.71, that would be a 34% increase from the prior year, if we hit the midrange on that. As I mentioned, the efficiency ratio is now under 40% on an ongoing basis, although some of the quarters will bounce around. Originations, on track for the $4.9 billion.

The market frame continues to be steady. We don't see any dramatic changes from our competitors and the outlook continues to be consistent with what we've told you in prior periods and consistent with our forecast.

I should mention a couple of things in regard to our service. We've dramatically improved our customer service as well as our technology that interfaces with customers. And so as we look at satisfaction, it continues to be up across all contact points and the efficiency that's associated with looking at the end-to-end process is becoming dramatic.

So in sales, our calls for new application -- how many people have to call us to clarify something about the application process -- are down 39%, calls for application from 2015 to the first quarter of 2017. And our calls from borrowers servicing in the portfolio and driven, of course, by -- when people get into full principal interest, there's a bump-up of contacts that are, you know, people trying -- digesting our information. Our calls for borrower are down 44% from 2015 to the first quarter of 2017. Obviously, this is very good. It reflects the fact that despite our volume increase, something that we call the customer [ ease score ], which was developed by Forrester, I believe, but we have worked it -- for us in conjunction with them. And what it says is, how does the customer want to interface with you? And they typically would like to just self-service, online servicing, native app. And so we look at how many calls we get per total interactions and take it that the customer would prefer the faster self-service. And we are now up to 92% of our interactions with customers in the first quarter occurred with their doing self-service. And so we took 7.9% of all of our contacts with customers required a human interface. The remainder were done in higher-satisfaction channels more quickly and less expensively, which is part of why our efficiency ratio continues to improve.

It's also worth noting that we take our competition to be those who are interfacing with younger people across all bands of competition, not just in student lending. So we're looking at other fintechs, people like that. And it's gratifying to say we've won a series of awards over the last 12 months as people become aware of how cutting edge our new technology is, including the AVA Digital Awards, where we received a Gold Award for the Sallie Mae mobile app, a Gold Award for the Sallie Mae mobile watch app and we received honorable mention for our website redesign, Internet Advertising competitive awards. We won best bank site, best bank mobile application, best online videos, the Shorty Awards, best finance applications, Sallie Mae mobile watch app. And Temeka Easter of our marketing department won the Movers and Shakers Award, which is distributed by The Social Shake-Up Show group. And so this is just a sampling. We've got a bunch more, but it does show the outside world is looking at us as a current innovative company, which is also reflected in our customer satisfaction being up, our efficiency ratio being down and all of our efforts go across the spectrum of the entire business, not concentrated on just one.

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

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Steven J. McGarry, SLM Corporation - CFO and EVP [4]

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Thank you very much, Ray. Good morning, everybody. We'll drill down a little bit deeper into the details of the quarter before we open it up for Q&A.

As Ray mentioned, we reported GAAP earnings of $0.20, but probably more importantly, we reported core earnings of $0.21, which excludes a $5 million mark-to-market loss that we experienced in our GAAP accounting reports.

There are a couple of items that I want to call out that contributed to EPS this quarter. First of all, we updated our life-of-loan loss model for TDRs, and this reduced our provision by $8 million on a pretax basis.

There are 2 components to this model change. The first is that based on updated performance information that we now have on our Smart Option Student Loan portfolio, we pushed out the expected timing of defaults, and this simply reduces their present value. We also reduced our default expectation related to moving from a 210-day collection period to a 120-day collection period. All of you that follow us probably remember this. We adopted this after spin and we grossed up our defaults by 15% to account for this factor.

Now with a little bit more experience, we're realizing that this overestimated the impact, so we've adopted 11% in our model. It's important to note that this change was in our original guidance, so it is not a variance from the guidance.

The second change that we made was the fact that the March fed increase had the impact of also reducing our required TDR reserve by an additional $4 million. The increased yield amount of the portfolio as a result of the fed rate hike has the impact of generating additional cash flow over the life of that TDR portfolio that offsets future charge-offs. This, obviously, was not in our guidance, as it was driven by the fed rate hike that took place in March.

The third item that I'd like to call out is that we had a tax benefit from a change in the way that equity compensation grants are accounted for that provided an additional $6 million benefit after tax. Because this item was dependent on the market price of our equity, it was also not included in our guidance. And I'll talk a little bit more about this one in a couple of seconds.

Finally, we did see small improvements across the board in net interest income, our credit performance and operating expenses, that also contributed to the quarter's earnings strength and factored into our increased guidance of $0.03 a share -- of the range going up by $0.03 a share.

Net interest income for the quarter was $268 million, $23 million or 9% higher than Q4, and a strong 28% higher than the prior year quarter. As Ray mentioned, the increase from the prior year is driven by the growth in our private education loan portfolio.

We also saw a solid net interest margin in the quarter of 5.96%, which compares to 5.55% in the prior year quarter and 5.77% in the prior year quarter. The year-over-year improvement was driven by a couple of factors. Ray called out the continued increase on our private student loans as a percentage of the total portfolio, but we also benefited from tighter management of our cash balances as a percentage of total assets. And finally, we are seeing an improving cost of funds.

I want to point out, though, that our NIM will not maintain this level of increase from the prior year for the balance of 2017, but we do think, for the full year, it could very well be several basis points higher than 2016's NIM of 5.68%.

Tempering the gains for the remainder of the year is the fact that we don't have much more room for further gains in cash management and the unsecured debt issue that we did in the second quarter will offset some of our cost of funds improvement.

But I do want to point out that a significant portion of the proceeds of the unsecured debt deal will be used to retire our Series A preferred in early May. This security has a coupon or a dividend of 6.97%. While the issue does increase our marginal cost of funds, it is approximately $0.05 accretive for 2017, and it'll be $0.01 accretive for future years.

The Series A preferred was not a component of our capital, and we felt that this transaction was important from a balance sheet efficiency standpoint. Going forward, unsecured debt won't be a core component of our funding program, but we will issue, from time to time, as our balance sheet grows, to demonstrate funding diversification to regulators and rating agencies and also that the holding company is a source of strength for the bank.

We believe that we're running an investment-grade company here. We hold sufficient capital and liquidity and have a high-quality balance sheet, so we expect, over time, our ratings to improve and the cost of funds from this component to decline over time.

A little bit more about funding. During the first quarter, we were active in all components of our program. We issued retail, broker and core deposits at favorable prices. We were also active in the capital markets, where we raised $772 million in ABS funding, put market improvements in perspective. This deal was done at LIBOR plus 93 basis points. And in 2016, the range of prices on ABS was between 115 and 138 basis points over LIBOR. So the deposit market and the ABS market are continuing to experience favorable conditions from a cost of funds perspective.

Other income in the quarter totaled $11 million compared with $13 million in the prior quarter and $21 million in the year-ago quarter. As a reminder, Q1 2016 benefited from a $10 million change in reserve estimates at our Upromise rewards business.

Talking about taxes here. The effective tax rate in the first quarter was 35% compared to 37.1% in the year-ago quarter, driven by the $6 million benefit discussed earlier. Basically, simply put for OpEx purposes, we expensed equity grants at the grant price. But for tax purposes, we account for them at the market price at the time of investment. So that's basically what drove this improvement. The tax rate will continue to move around quarter-to-quarter. However, we expect our effective tax rate for the remainder of the year to come in around 39%, excluding any unusual items that might pop up for the balance of the year.

Ray talked about our strong performance on the OpEx front. FDIC fees have been running at a pace of 73% higher than the prior year. And excluding that, our OpEx for the full year increased just 7.4%, despite the fact that total customer accounts were up 17% and accounts in full principal and interest repayment were up 21% year-over-year.

The bank remains well capitalized. We have a risk-based capital ratio of 13.3% at the end of Q1, significantly exceeding the 10% total risk-based capital required to be well capitalized. We do have additional capital up at the parent company that can be used as an additional source of strength, if necessary. We obviously don't expect to need that capital, and we do think that the total risk-based capital ratio will drop down into the mid-12% as we grow our balance sheet over the course of the year.

As usual, we do not anticipate returning capital to shareholders at the present time. We're in a medium-term future as we expect to reinvest in our business.

Talk about provision for private education loan losses, came in at $25 million in the quarter, compared with $33 million in the year-ago quarter. We ended the quarter with an allowance for loan losses of 1.18% of total loans and 1.76% of loans in repayment. We would expect this to gravitate slightly higher over the course of the year, as our portfolio grows and seasons.

And let's see -- okay. Finally, I would like to call out that we did end the first quarter with $55 million of personal loans on our balance sheet that we acquired in the marketplace. We began purchasing high-quality personal loans in December. We believe that purchasing personal loans, as we prepare for our own personal loan product launch in early 2018, enables us to deploy excess capital and learn about the asset class in a low-risk way. The loans we purchased have terms between 3 and 5 years, with an average FICO score of 715, and we expect very moderate losses on this portfolio.

Before I wrap up here, I will call out our core earnings metric. The only difference between core earnings and GAAP net income is that core earnings excludes the mark-to-market on unrealized gains and losses on ineffective derivatives. We use derivatives predominantly, interest rate swaps to manage risk in our portfolio. We do believe all of these hedges are sound economic hedges. And we've mentioned this because if rates do continue to rise as expected, we will see a continuing variance between our GAAP and core earnings.

Finally, ROA for the quarter was 2.1% versus 1.6% in Q4, and ROE was 20.7% versus 15.4% in Q4.

That does conclude the prepared remarks. And we'd be very happy to take any questions now.

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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 Moshe Orenbuch with Crédit Suisse.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [2]

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I guess, Steve, I recognize that given the changes that you made in terms of kind of the TDR reserve, the impact is not as large going forward. But I'm sort of hoping, especially given the fact that the bulk, the vast majority of your TDRs are actually current, how do we think about that development going forward? And the impact on the company and the reserve, and think about -- can you just talk through that a little bit?

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Steven J. McGarry, SLM Corporation - CFO and EVP [3]

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So -- sure, I mean our TDR portfolio does perform very well. We expect life-of-loan losses on our TDR portfolio in the low 20% vicinity. The reserve for that, due to the discounting, the present valuing runs in the 12% vicinity. It is the case due to GAAP accounting policies that we do need to hold a life-of-loan loss on our TDR portfolio. So you will continue to see a very large chunk of our allowance allocated to that TDR portfolio. But, look, we have seen improvements in our portfolio as the Smart Option Student Loan portfolio seasons and we gain more historical data with which to model. So it wouldn't surprise me if in the future we do see some changes in expectations on the TDR portfolio, but we think we have a pretty good handle on it as we sit here today.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [4]

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Okay. And the other question that I had is your expectations for origination growth for the full year are slightly faster than they were this quarter. Talk a little bit about maybe what you kind of see coming down the pike the rest of the year.

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

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Sure. And the first quarter at $1.8 billion is relatively light in regards to the $4.9 billion for the full year. The first quarter has a different characteristic than other quarters. It's driven, in part, by the serialization of people who started in the fall, and have a follow-on but pre-committed loan disbursement in the spring semester. And it's also because it's not a heavy season for the traditional 4-year not-for-profits. The for-profits are typically a higher proportion of the originations in the first quarter. As you know, we've been deemphasizing for-profits for 3 years now, and they continue to drop, including the first quarter. As we look forward, and we do a forecast, that is school by school, loan by loan, we are on track for a $4.9 billion. And it has been the case in prior periods, prior years, that when we have looked for a correlation between the first quarter and what we refer to as the busy season, in fact, the correlation is very low. And so we are where we want to be, and the $4.9 billion looks to be on track.

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Operator [6]

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Your next question comes from the line of Mark DeVries with Barclays.

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Mark C. DeVries, Barclays PLC, Research Division - Director and Senior Research Analyst [7]

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I was hoping you could give us an update on anything you're hearing out of Washington, whether it's from the administration or anyone out of Congress, on student loan-linked policies, kind of what's being discussed? What's being advanced? And particularly, what do you see is the outlook for anything to get done, such as like a dialing back for the PLUS program?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman and CEO [8]

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Sure, Mark. Thanks. And it is the case that I think predictions in regard to what would develop in Washington -- let's put it this way: don't have a great track record, either for us or for other people, and so I think forecasting what will happen, and especially the timing of that, is something one should do at one's peril. And as we have looked at it, there is certainly enthusiasm for taking a look at the federal program and trying to make it more efficient for both students as well as for the government. We've been in touch with most of the people who have direct impact in regard to either the Higher Education Act or any rethinking on the federal program. There's a series of work being done, both by principals as well as by staff work, and it's just very hard for us to handicap that. We are not in any way counting on an increase in volume for -- hitting any of our guidance numbers for this year. And I do think that we should appropriately wait and see. We believe there are several areas where the federal program could be improved. We're in conversation about that with others, and we will just have to figure out, over a period of time, where in the parade of proposed legislation the student lending fits as a priority. And I need to lecture you that the Affordable Care Act and the income tax cuts are in the front of that particular queue, and lots of other things, including student lending, are in the middle of it. So we think we are in an area where there's probably more opportunity than risk for us, but very difficult to specify either the amount or the timing.

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Mark C. DeVries, Barclays PLC, Research Division - Director and Senior Research Analyst [9]

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Okay. Got it. And Steve, I think you indicated on the NIM that your expectation is not to sustain the current level, but full year you could end up a few basis points higher. Could you just talk through what that assumes in terms of fed rate increases this year? And, therefore, what upside or downside there may be if we get more increases than what you're anticipating?

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Steven J. McGarry, SLM Corporation - CFO and EVP [10]

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Sure. So we've got, in our forecast, another 50 basis points of fed rate increases. I'm sorry, so from here, we've got -- we had the March, we have another 25 basis points of fed rate increases in our forecast. And one of the assumptions in there is that money market deposits would rise 85% of that fed rate increase immediately. We've got $2.5 billion of money market deposits, so whether or not that does happen might impact the NIM on a go-forward basis. Everything else, Mark, is pretty much why we have -- we have another $1.5 billion of fixed rate CDs that, obviously, shouldn't -- won't rise with fed rate increases. But otherwise, everything else is variable rate, so the impact should be pretty minimal.

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Mark C. DeVries, Barclays PLC, Research Division - Director and Senior Research Analyst [11]

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Okay. But if we get 2 increases this year, it could be a little bit more upside than you're discussing here.

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Steven J. McGarry, SLM Corporation - CFO and EVP [12]

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Yes, absolutely.

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Operator [13]

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

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [14]

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I guess the charge-off rates did better than our expectations and obviously improved year-over-year as a percentage of loans and repayment. Can you just talk about what's driving that outperformance?

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Steven J. McGarry, SLM Corporation - CFO and EVP [15]

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Sure, Sanjay. Basically, our high-quality credit is performing a little bit better than expected, and I'll give a shout-out to our collections group. They are doing an excellent job in curing delinquencies and we're seeing low rates in recent months and quarters outperforming low rates in prior months and quarters. And if that continues, obviously, that'll have a beneficial impact on our need to provide allowance for loan loss reserves. So the portfolio is -- I'm going to knock on the mahogany table here -- performing very well.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [16]

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All right. Well, that's good to hear. And I guess you guys talked about entering into the personal loan space. Could you just talk about the nature of these loans that you acquired? Was it from a third-party? I mean -- and who might that third-party be, if you're at liberty to say? And then when we think about you guys getting into that business next year, what's the game plan in terms of the origination strategy?

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Steven J. McGarry, SLM Corporation - CFO and EVP [17]

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Sure. So look, we are purchasing from one of the marketplace lenders. We are not at liberty to disclose that. The purchases are coming in, quite frankly, slower than we would have expected. But that's okay; it's not a main line of business. But we do want to diversify our consumer product offering, and we think that the personal loan makes great sense. Basically, a private student loan is an unsecured personal loan, so we think we have the marketing, underwriting savvy and the ability to collect and service these loans, so it's a natural extension of our core competencies. And we think it levers very well to our current and future client base. So we will roll out a program probably first quarter of 2018. I don't think it will be ready in Q4 2017, but we will lever our direct marketing skills to originate and -- originate personal loans.

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

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Just to append that, as we do that, as Steve said in a very measured way and we do it late this year as we get the mechanics up and pilot it next year, there is no positive EPS impact in 2018 in our models. So we're not counting on this.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [19]

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Got it. And how large do you guys anticipate it becoming? Like, what kind of origination target do you have when we look out to next year?

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Steven J. McGarry, SLM Corporation - CFO and EVP [20]

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So it'll be a rounding error on our balance sheet. We're going to do this very slowly and methodically. This is not a transformative exercise whatsoever.

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Operator [21]

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(Operator Instructions) 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 for Specialty Finance [22]

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Following on some of Sanjay's questions, with these marketplace loans, are you buying them sort of on a statistical basis? Or are you re-underwriting each credit as it's presented to you?

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Steven J. McGarry, SLM Corporation - CFO and EVP [23]

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We are -- so look, marketplace lenders have credit quality grades. We've grown comfortable based on the due diligence that our credit group has done on the underwriting approach of our counter-party. And we do, obviously, set parameters based on FICO scores, expected default rates, expected ROEs, et cetera, so we do set up a very specific [ buy box ]. But through our due diligence, we've grown comfortable with the underwriting approach of our account quality.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD for Specialty Finance [24]

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Then -- and when you look at the big horizon, several years out, is this going to be part of a product set that you focus in on, that you've got a customer who -- where you've -- their -- one of their key products is the fact that you've got them through college? And now is this going to be part of a product set focused in on that key customer? Or is it going to be more of a broader consumer lending effort?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman and CEO [25]

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As you correctly point out, it is the case that we are doing a very good business with a highly desirable group from a demographic standpoint, but we're only doing 1 product with them. Over a period of time, as you know, we've spent quite a bit of effort in setting up the business and realizing the efficiencies that we've been discussing. As we think about going forward, we believe there is an opportunity, both with our current customers as well as others who are similar to them in the same age and demographic cohorts for us to do more business with them, building off the good service and high quality that we have with the private student loan business, both for our own internal expertise as well as in fashioning offers for others. So to answer your question, yes, the personal loan will develop over several years. Yes, we expect to expand our product set, and it is an opportunity that, as Steve mentioned, we will walk into as opposed to dive into.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD for Specialty Finance [26]

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And one day, you could be a full-service bank for that consumer?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman and CEO [27]

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Full-service is probably an overstatement. We will be a -- we hope a high-quality provider of selected products.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD for Specialty Finance [28]

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So you don't have to have branches. They're only good for cookies and coffee. When you look at the...

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Raymond J. Quinlan, SLM Corporation - Executive Chairman and CEO [29]

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I won't have you running down banking distribution on our calls.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD for Specialty Finance [30]

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When you're -- when you look at the profitability of the business, it looks like you're set up for ROEs of 15% to 18%. Is that the proper way to really think about where the business is going?

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Steven J. McGarry, SLM Corporation - CFO and EVP [31]

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I think that's definitely the right ZIP Code. You might have the high end a little inflated but, yes, we're definitely a mid-high teens kind of a ROE here.

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Operator [32]

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You have a question from the line of Arren Cyganovich with D.A. Davidson.

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Arren Saul Cyganovich, D.A. Davidson & Co., Research Division - VP and Research Analyst [33]

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Just following up on the net interest margin conversation. Is the first quarter higher than what you had anticipated or more in line? And I think in the last call, you said that the full year you expected to be kind of roughly flat with 2016. Is that still consistent with your outlook?

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Steven J. McGarry, SLM Corporation - CFO and EVP [34]

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So as I said in my prepared remarks, we do now think that we're going to beat 2016's NIM of 5.68%, but we were 20 basis points higher in Q1. We are not going to be coming in at 5.88%. I want you to think we're going to come in somewhere around the 5.70s, low 70s.

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

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As you said earlier, 5.68% last year, plus half a dozen points.

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Steven J. McGarry, SLM Corporation - CFO and EVP [36]

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So we ratchet it down cash as a percentage of our total balance sheet significantly from Q1 '16 to Q2 -- I'm sorry, Q1 '17. We also just did an ABS, which will have an impact on the full quarter -- full second quarter and the remainder of the year. And I also mentioned that we did the unsecured debt, which has the impact of increasing EPS overall because we retired our preferred debt, but it does have the impact of increasing cost of funds at the margin. So all in, stronger '17, but by 3 or 4 or 5 basis points, not 20 basis points, like we saw in Q1.

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Arren Saul Cyganovich, D.A. Davidson & Co., Research Division - VP and Research Analyst [37]

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Very helpful. And in the -- in terms of the loan consolidations to third parties, it was somewhat elevated again this quarter compared -- still not very large, but still somewhat higher than it has been in prior quarters. Is there anything else that's going on from a competitive dynamic that you're seeing from the portfolio, where there's a little more coming out?

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Steven J. McGarry, SLM Corporation - CFO and EVP [38]

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I mean now, look, we don't think so as loans don't consolidate until they go into full P&I. And we have had some pretty significant growth in loans going into full P&I. In Q4, we had another $1.7 billion, and we're tracking the timing of those consolidations. So it's something that, obviously, we pay very careful attention to. But to put it into perspective, if the 100 becomes 400 over the course of the year that's, at a 2% ROE, we're talking about $8 million pretax. So obviously, it's earnings that we hate to part with. But to prevent those loans from going away, we would have to take some pretty radical steps in pricing. That being said, we are carefully assessing the types of loans that we're seeing consolidating away based on pricing, school type, et cetera, to see if there are some preemptive actions that we can take on that front. I will also say that consolidations is very much an interest rate game. It was a huge industry in the early 2000s. It went completely away. It's had a resurgence here. I know that hope is not a strategy, but I do think that interest rates rising will take sort of the edge off of the consolidation business. But while we wait for interest rates to rise, we are carefully scouring our portfolio and taking a close look at those loans that are consolidating away to see if we can be proactive and preemptive on that front.

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Operator [39]

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Your next question comes from the line of Steve Moss with FBR.

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Stephen M. Moss, FBR Capital Markets & Co., Research Division - SVP [40]

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I was wondering, with regard to the personal loan mix, if you could -- if you have any targeted mix in terms of what's prime, near prime and/or subprime?

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Steven J. McGarry, SLM Corporation - CFO and EVP [41]

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Yes. That's a simple question to answer: prime. Look, we're targeting '17, 720 type of average FICO score. We will not be doing subprime lending in the personal loan space as we do not do it in the student loan space.

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Stephen M. Moss, FBR Capital Markets & Co., Research Division - SVP [42]

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Okay. And then my second question, I believe, if I heard correctly, you expect risk-based capital to head towards 12% or 12.5% by the end of the year given growth. I was wondering at what point would you expect to issue subdebt? Or if there are any floors around how low you're willing to let risk-based capital go?

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Steven J. McGarry, SLM Corporation - CFO and EVP [43]

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Sure. So let me be perfectly clear on this front. We believe the 12% is the minimum capital that we require to support the Smart Option Student Loan portfolio and the personal loan portfolio. And what we have seen happen here is we have consumed a significant amount of capital, but we are on the tangent here, where we go from a capital consumer to a capital generator in the very near term. So we are not going to have to issue any type of capital instruments to support our business on an ongoing basis anytime soon. That being said, I will say if we did have a major change in the PLUS loan market and our originations were to go from $4.5 billion to $6.5 billion or $8 billion, we would probably need to raise capital. But given our current business model, there's no need to raise capital to support our growing balance sheet.

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Operator [44]

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

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [45]

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Two questions this morning. Can you just talk about what is going on in the competitive landscape? Obviously, there's been some, at least brand dislocation from one of your major competitors and also with the potential for significant expansion of the addressable market. Just curious if you're seeing new entrants.

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Raymond J. Quinlan, SLM Corporation - Executive Chairman and CEO [46]

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As you know, the market is highly concentrated with ourself, Wells and Discover having close to 80% of the market, to the best of our ability to estimate that. And the impact that we have seen, either positive or negative, for each one of our competitors works out to be fairly trivial in regard to our market expectations. And so we are not seeing any change in entrants, we're not seeing any change in pricing, nor are we seeing any change in positioning with Wells, driven by their 5,000 branch distribution system; Discover, driven more by advertising. Entrants that have been around, Citizens, are there and continue to be a respected competitor. But we have not seen any new entrants. And let's remember that the schools also maintained a recommended list. And we are on -- for a list that is almost 1,000, it's 970 something, we are on all but 7 of those. And so as new entrants are coming on, it is the case that the schools provide some sort of guidance to people as they think about the entire product set. But the volatility in the market thus far is very low.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [47]

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Got it. Second question, just related to personal loans. I'm assuming that these loans are targeted for college graduates at this point, that these are not loans for students, but it's really more traditional consumer loan?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman and CEO [48]

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Yes, it is. At least 2 tranches of that, Rick. One is the assets that we're currently purchasing from others who are not primarily in the student loan business. And so there, we're looking at the independent quality assets that are all prime, as Steve has pointed out. And at $55 million, a relatively low number thus far, and we expect it to grow through the year, but that'll be significant to either our balance sheet or income statement this year. As we look forward to our own personal loan, we will target that. We believe that the cohort of younger Americans, where we will spend the bulk of our activities and targeted to them, many of which would be, of course, our own customers, but it'll be a broader exercise than just that as we step into it. And it's right to think of 2018 largely as a year of introduction, evaluation and checking out.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [49]

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Got it. I mean, I think you guys sensed the skepticism or concern from the analysts on this call about this potential product given the history.

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Raymond J. Quinlan, SLM Corporation - Executive Chairman and CEO [50]

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Yes. And there have been people who have done personal loans very successfully and some not so. And so we think that you do have to be careful with this. As Steve has pointed out, it's right to say that we are in the personal loan business at the 100% level while we're sitting here because a student loan is a special-purpose, closed-end personal loan. And so we're moving to a cousin of our current product set. We intend to do it cautiously. New always carries with it some concern, and we fully respect that, which is why you see us moving so slowly here.

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Operator [51]

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Your next question comes from the line of [ Ann Masek ] with Rose Grove Capital.

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Unidentified Analyst, [52]

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With -- if rates continue to rise, is there additional earnings contributions to be had with respect to the life of loss on the TDRs?

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Steven J. McGarry, SLM Corporation - CFO and EVP [53]

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Yes. Ann, if rates do continue to rise, we will see a benefit in our life-of-loan TDR loss model. And you can use...

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Unidentified Analyst, [54]

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And is there a way... if it's 25 -- is there any way to gauge it, like 25 basis points equals $4 million? Or is there some metric to use to get a sense for how big that might be?

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Steven J. McGarry, SLM Corporation - CFO and EVP [55]

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I think that 25 basis points equals $4 million is a pretty good proxy.

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Unidentified Analyst, [56]

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Okay. And is that -- is it -- does -- is it based on the fed move? Or is it based on the live market?

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Steven J. McGarry, SLM Corporation - CFO and EVP [57]

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So our loans are indexed to 1 month LIBOR, and there's a pretty darn close correlation between the fed effective rate and the 1 month LIBOR rate. So I kind of view them as one and the same. But if there is any diversions, obviously, that would have an impact on that calculation.

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Operator [58]

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Your next question comes from the line of Michael Tarkan with Compass Point.

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Michael Matthew Tarkan, Compass Point Research & Trading, LLC, Research Division - Director of Research and Senior Research Analyst [59]

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And most of my questions have been answered. Just a quick follow-up. I think, Steve, in the past, you've talked about ending 2017 at 140 basis points in reserves to loans with, I guess, charge-off delinquencies kind of tracking below our expectations. Is that 140 the number that we should probably be thinking about?

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Steven J. McGarry, SLM Corporation - CFO and EVP [60]

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Look, it's a very good question, Mike, and I think I have also joked on this call that we've set -- we lay out these objectives and we never quite reach them because credit has been performing well. But when I look towards the year-end, that is exactly where I see our reserves for loans ending as a percent of total loans. So, yes, that's still sort of the target.

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Michael Matthew Tarkan, Compass Point Research & Trading, LLC, Research Division - Director of Research and Senior Research Analyst [61]

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And then as a percentage of the total portfolio now, (inaudible) I don't know if you can provide any thoughts there.

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Steven J. McGarry, SLM Corporation - CFO and EVP [62]

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So we have, I want to say -- hang on, I have that handy. We've got $5.2 billion in full P&I at March 31, so 1/3 of our portfolio.

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Raymond J. Quinlan, SLM Corporation - Executive Chairman and CEO [63]

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5 and 15.

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Michael Matthew Tarkan, Compass Point Research & Trading, LLC, Research Division - Director of Research and Senior Research Analyst [64]

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Okay. And then last one for me, the move to take down the preferreds this quarter, I know there's still some preferreds out there, I know you still have sort of a [ subsale ] portfolio. And any thoughts on cleaning up the rest of the balance sheet, maybe either later this year or into -- in 2018?

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Steven J. McGarry, SLM Corporation - CFO and EVP [65]

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So the 6.97% was a cumulative preferred and very expensive, and we can replace that better, we thought, and we did replace that with cheaper unsecured debt. The Series B is a LIBOR plus 170 noncumulative. That's a pretty attractive security still today. And I think -- and don't run away with this one: If we were ever to become a bank-holding company, I think that would qualify as capital. That is not something that we're contemplating now, but that's a pretty decent security to have on our balance sheet as part of our capital structure. In terms of the [sales] portfolio, we do on again, off again think about selling that portfolio. How do you feel about giving up $0.02 a share, is one of the questions that we ask ourselves from time to time. But it's obviously a high-quality portfolio, but we do consider selling it from time to time.

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Operator [66]

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Your final question comes from the line of Michael Kaye with Citigroup.

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Michael Robert Kaye, Citigroup Inc, Research Division - VP and Analyst [67]

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Just wanted to take your views on free tuition programs like that Excelsior Scholarship that was passed in New York recently. Do you think these types of plans could proliferate across the U.S.?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman and CEO [68]

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Yes. The New York plan acquired a bunch of activity around it from people who were supportive of free tuition, but felt that the PR associated with the term free tuition, well, wasn't, in fact, what that plan is turning out to be for New York State citizens. And so we do think that these things warrant careful watching. New York plan, you will note, does have lots of strings attached, only addresses tuition, not the full cost of college. It's, of course, restricted to New York State residents and has a clawback for anyone who might want to leave the Empire State over the course of 4, 5 years after graduation. So I think it's highly caveated. We do think it is an attractive billboard for politicians in particular. We do think that we'll see other states consider that. But it's right to say that if you were to look at public colleges across the United States and the amount of subsidy that they have received from their state governments, that's down 16% since 2008. And so I don't want the headline to miss the overall tide there. There's much lower support by each of the states for their public colleges than there was 5 years ago. And that's what people have to finance. Occasionally, someone will come up with something like the New York Sate piece, but as you saw, it was picked apart quite actively. We respect it, we'll work around it. It will have some impact on us; we believe it to be very small. And from time to time, we will see other schools and other states try to develop innovative programs, many of which we support.

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Michael Robert Kaye, Citigroup Inc, Research Division - VP and Analyst [69]

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Okay. Just another follow-up question on the loan consolidation. I know Navient has talked about their desire to refinance private student loans. Just want to see if you could clarify. Could Navient refinance Sallie Mae's private student loans, given the noncompete? Just wondering, is that prohibited?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman and CEO [70]

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Go ahead, Steve.

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Steven J. McGarry, SLM Corporation - CFO and EVP [71]

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I think the answer to that question, Mike, is no, they cannot until the noncompete is...

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Raymond J. Quinlan, SLM Corporation - Executive Chairman and CEO [72]

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Probably until the end of '18.

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Steven J. McGarry, SLM Corporation - CFO and EVP [73]

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End of '18.

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Operator [74]

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There are no further questions at this time. Mr. Quinlan, do you have any closing remarks?

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Raymond J. Quinlan, SLM Corporation - Executive Chairman and CEO [75]

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Thank you for the opportunity to make closing remarks. Thank you all for your attention, and thank you for your insightful questions. Hopefully, we've answered them. We remain ready, Steve, myself and Brian, to answer any questions that were not fully clarified or that might come up after the call. And I want to say that it's a pleasure for us to conduct this call as we have another milestone met, consistent with our business proposition, allowing us to have a strong base as we move into '17, so that we can continue to upgrade the customer experience and the quality of our franchise, while still delivering attractive, both earnings and returns, with relatively low volatility to our shareholders.

So thank you very much for your attention. It's a pleasure to get the year started, and we look forward to the next 3 quarters.

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Brian Cronin, [76]

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Great. Thanks, Ray, and thank you for your time and questions today. A replay of this call and the presentation will be available on the Investors page at salliemae.com. We have no further -- if you have further questions, please contact me directly. This concludes today's call. Thanks.

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Operator [77]

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Ladies and gentlemen, this does conclude today's conference. You may now all disconnect.