SLM Corporation
Q2 2008 Earnings Call Transcript

Published: 24 Jul 2008

[Operator:]

Welcome to SLM Corporations second quarter 2008 earnings conference call. (Operator Instructions) I will now turn the call over to Steve McGarry, Senior Vice President of Investor Relations.

[Steve McGarry:]

Good morning everybody and welcome to Sallie Mae’s 2008 second quarter earnings conference call. With me today are Al Lord, our CEO and Jack Remondi, our Chief Financial Officer. After they finish their prepared remarks, we will open up the call for questions. Please note that during the conference call, we may discuss predictions and expectations and may make other forward-looking statements. Actual results in the future may differ from those discussed here perhaps materially based on a variety of factors. Listeners should refer to the discussion of those factors on the company’s Form 10K and other filings with the SEC. During the course of this conference call we will refer to non-GAAP measures as well call our core earnings presentation. For the description of core earnings, full reconciliation of the core earnings presentation to GAAP measures and our GAAP result can be found in the second quarter 2008 supplemental earnings disclosure accompanying the earnings’ press release which was posted under the Investors page at our website SallieMae.com. Thank you and now I’ll turn the call over to Al.

[Albert L. Lord:]

I, particularly in these times, appreciate the opportunity to engage this broadly with our honors and others of you who are interested in our performance. I will present to you my brief thoughts on the second quarter and matters in general and then Jack Remondi will help you understand what actually happened in the second quarter. As you’re all well aware by now, our second quarter results were maybe, I’d call them mediocre, as our funding costs continue to squeeze our margins. I would say, and I’d like this to characterize the call, that I see an improvement in management’s level of optimism about where we’re going. We see each of the next three quarter’s results improving slightly principally, as a result of private loan growth and operating expense reductions. We believe that you will see marked improvement after the first quarter of 2009. I have to say that notwithstanding anything I say today my outlook is guarded. Given the environment that we’re in we think that’s probably the best approach. Things that are getting better are getting better in baby steps, but they are getting better and I’ll tell you that our optimism, certainly my optimism, moves up and down as credit spreads move up and down. It’s been an eventful quarter, it’s been an eventful six months, and it’s been an eventful year. It’s about exactly one year since our ABS funding for AAA student loans stopped being a monthly auto-pilot exercise. There is no longer anything like an auto-pilot exercise. Nonetheless, through July we’ve issued nearly $14 billion of ABS in 2008, not a bad record. It’s been expensive, I might say very expensive funding, but this is also the toughest market that I’ve ever seen. Second quarter story has what I’ll say are several chapters. As I’ve noted, second quarter has continued our high funding costs. During the quarter the management and board have concluded that the purchase of distressed assets as a business is not really core to our business and not core to our APG business. Our folks here at Sallie Mae work with the industry during the quarter, work with the industry with Treasury, the Department of Education, to find a viable short and long term answer to the entire FFELP funding issue. Congress gave the Department of Education wide latitude. The solution that is now nearly implemented for the coming year, and perhaps for longer term, is nearly implemented and we find that quite helpful. On the funding side, to repeat, and Jack will cover this in much more detail, the higher costs of funds dominates any of our inner period comparisons so on earnings or earnings per share. Just the ABCP facility alone in the second quarter cost the company and the shareholders $0.15. Each of the next three quarters will bear that cost. The wide ABS spreads that we’re incurring on our 2008 deals has the effect of neutralizing earnings on the FFELP growth that we are experiencing. We had a decent origination quarter in the second quarter, although it was down in total from a year ago. We anticipate higher student loan volumes in this quarter, that is the third quarter. And we believe legislation and market turmoil reduced our second quarter volumes. The fact is, during the second quarter, Sallie Mae brand origination has increased. It was our lender partnership volume that was down. Not really surprising given what was going on in the market during those three months. That said, we expect our third quarter volume to pick up as competitors leave and the market settles and volume that some of the students have deferred from the second to the third quarter comes in. Our private loan demand is high. Of course, private loans remain a financing challenge but at least on private loans we can adjust our pricing to absorb most of our incremental funding costs. I mentioned earlier APG and our purchased asset business. We’ve concluded that buying distressed assets is just not a core business for our company. We’ve had excellent management teams running those businesses and those businesses, as you may recall, buy and collect unsecured consumer credit and mortgage loans. Among the reasons that we don’t deem it as core is that its operating results are really very unpredictable and it consumes precious capital, with very high capital requirements. The third quarter will reflect the cost of either selling or our projected cost of winding down these assets. We will, of course, manage these business to minimize the effect of those results. The contingent collection business remains a core strength. We see reasonable economic growth opportunities there. We see it as a predictable earnings source and we’ve got broad in-house expertise in the collection business. You may recall in the first quarter call that one of the principal questions was whether we would continue to lend in the FFELP business. The Department of Education has relieved the pressure that we and other lenders felt. They’ve given the lending community the option to borrow at 50 basis points. It’s an option that we will likely take. They’ve also given us a put option through September of 09 for assets originated in this fiscal year. That’s also an option that we will likely utilize given the state of the current financing markets. Because of this fix that’s been implemented, or is in the process of being implemented by the Department, Sallie Mae will lend and meet market demand, whatever it may be. We expect our origination efforts to accelerate. The put option effectively pays $75 a loan, which we believe is a reasonable compensation for that effort, but it certainly encourages Sallie Mae to even greater operating efficiency. I think you’ll see the second quarter shows the beginnings of our cost cutting efforts taking hold. There is clearly a lag effect in that effort. The company is now down roughly 20% in head count after eight months and by early 2009 we’ll pass 25%. The Private credit business, we are building our management strength. As I said before, it is funding challenged but the loan yields can cover most of the increased costs. Since December of 07, we put very strong focus on enhancing our underwriting and collection skills. And so notwithstanding what you see as cost reductions, there are fairly major investments in that business. We will continue to strengthen this business which is today, almost the source of almost all of our earnings growth. Our credit quality measures in that business have been surprisingly steady. The key statistics that we measure, delinquency and forbearance levels, have shown some improvement. Again, our optimism on this point is guarded. It’d be a little silly to be Pollyannaish in this marketplace. We watch general consumer market trends closely. We watch our own consumers even more closely. In summary, our lending business remains very strong. I, and I’m sure all of you, and I know the people in this room are unhappy with today’s share price but I’m a firm believer that share prices take care of themselves and in our case, it’s a function of the financing markets. And when we are able, again, to post earnings growth as commensurate with our strong asset growth, as I said, the share price will take care of itself. That concludes my comments. I’m going to turn this over to Jack Remondi at this point.

[John F. Remondi:]

I’m going to take the next few moments to review our operating results for the quarter on both a GAAP and core earnings basis. In addition, we’ll review the performance of our private credit portfolio, our outlook for new loan originations, our funding activity and liquidity, including a status update on the Department of Education proposals and our progress for our cost reduction efforts. In addition, I’ll provide some more details on our asset purchase business. And finally, I’ll provide an update on our outlook for the remainder of the year and our prospects for 2009. For the quarter, core earnings including non-recurring items were $156 million or $0.27 per share, compared to $189 million or $0.43 per share in the year ago quarter. During the quarter, we incurred non-recurring charges of $53 million or $0.08 per share for restructuring expense and other reorganization related items and net loss of $26 million or $0.05 a share in our purchased paper businesses. Excluding these items, earnings were $0.40 per share. In addition, as Al mentioned, our second quarter results were lower due to higher funding costs, particularly from our asset backed commercial paper program where the fees alone totaled $109 million in the quarter or $0.15 per share, that’s up $0.11 per share from the first quarter. Net interest income was $587 million in the quarter versus $635 million in the prior year, with the net interest margin declining to 1.28% from 1.52% in the year ago quarter. The decrease is primarily the result of those $109 million worth of fees which reduced the net interest margin by 24 basis points in the quarter. Our loan loss provision was $192 million in the quarter versus $181 million in the first quarter. The results included a $6 million increase in the federal loan provision and a $3 million increase in the private loan provision as performance was stables and charge offs came in significantly below expectations. Current economic conditions, however, require us to remain cautious and our provision, this quarter reflects this caution. Our fee income in the quarter was $242 million compared to $296 million a year ago and the decrease was primarily the result of the impairments taken in our purchased paper portfolios and due to the impact of some legislative changes from last fall, which reduced our gallant core services business revenues. I’ll discuss these issues in further detail shortly. Operating expenses, excluding restructuring and reorganization items, were $333 million in the quarter compared to $345 million in the year-ago period. Almost all of this decrease occurred in the month of June. We fully expect the pace of realized cost reductions to accelerate over the remainder of the year and that we will meet our 20% cost reduction goal. Total equity at June 30 was $5.5 billion and our tangible capital ratio at quarter end was 2.1% of managed assets, up from 2% at March 31. With 82% of our managed loans carrying an explicit government guarantee and with 67% of our total managed portfolio funded for the life of the loan, we believe our capital levels are appropriate for our asset mix and funding mix. There’s been a great deal of concern in the markets in the last few weeks concerning the impact of FAS 140. First, the statement is not yet finalized so the actual terms and implementation date remain uncertain. That said, based on the current draft we would not expect any negative consequences to either capital or capital requirements. We have consistently looked at capital on a managed basis. This is how we manage it internally and how we report it externally, including to the rating agencies. Through the first six months of 2008, we issued $11.8 billion in term FFELP asset backed securities, including $7.1 billion in the second quarter. The all in cost of this issuance in the quarter was 140 basis points over LIBOR. This for a structure where the AAA tranche investors get paid in full even if we assume 100% default rates. Since the close of the quarter, we securitized an additional $1.6 billion at an all in cost of 85 basis points over LIBOR. In year-to-date, we have issued $13.4 billion in term asset backed securities. In the second quarter, we returned to the unsecured debt market, issuing $2.5 billion of 10 year unsecured notes at an all in cost of LIBOR plus 400. This represents our first unsecured note issued since early 2007. And, access to this market is an important source of funds for our business. This transaction is not a one-time event and we expect to be regular issuers in this market in the future. And importantly, as Al mentioned, as we have the ability to adjust our pricing on the private credit side, this funding is capable of generating mid-teens return on equity and on newly originated private credit loans. We also plan to reestablish our private credit term ABS program. And although market conditions remain difficult and volatile, we hope to re-establish this important source of funds in the near-term. I’m happy to report that S&P recognized the superior performance of our private credit securitizations and upgraded the subordinated tranches of our 2002 A deal. The continued strong performance of our existing ABS trust will help make our return to the term private credit ABS market easier. Spreads on student loan asset backed securities and Sallie Mae unsecured debt declined significantly during the second quarter. In recent weeks, they have retraced some of these gains as the financial sector has come under renewed scrutiny. Access to reasonable cost funding remains a challenge. Investors are still approaching all financial issuers with extreme caution. We remain optimistic that investors will begin to better distinguish between those entities with strong credit and financial performance. At quarter end, we had $19.5 billion in primary liquidity, consisting of cash and investments and committed lines, up from $18.4 billion in the prior quarter. In addition, we have $14.1 billion in standby liquidity in the form of unencumbered FFELP loans. At the end of the quarter, 67% of our managed student loans were funded for the life of the loans and another 17% are funded with fixed spread liabilities with an average life of 4.5 years. Perhaps the most significant development in the quarter was the passage of the Ensuring Continued Access to Student Loan Act. Under this authority, the Department of Education has created two programs to enable the origination of FFELP loans this academic year. One facility provides short term funding for lenders and the second facility provides lenders with a put option on the same loans. Although we are disappointed that these programs are not yet operational, we expect them to be up and running shortly. We will take advantage of the funding program provided by the department and this will allow us to reduce our reliance on our asset backed financing facility and ultimately replace it with a smaller and significantly less costly facility in the future. The combination of the legislative reductions and the credit markets is creating significant changes in the student loan marketplace. In the past few months, we’ve seen we’ve seen over 160 lenders exit the business and others announce significant cutbacks in what lending they will do. During this time, we remain committed to FFELP despite the obvious challenges. This commitment was the right thing to do for students, schools and our shareholders. As a result of these changes we’ve refocused our FFELP originations on our internal lending brands. Our loan volume here was up sharply increasing 44% to $1.9 billion. Our lender partner originations to offset these gains declining $618 million or 56%. Of this decrease, $338 million was converted to servicing relationships. Consistent with our announcement in the first quarter that we were tightening our private lending standards including ceasing non-traditional lending completely, private education loan originations declined 24% to $891 million in the quarter. The next three months are the most active of the year for loan originations. We are prepared for a significant increase in FFELP loan applications. We expect new application volume to exceed $20 billion for federal loans in the 08-09 academic year. Our total loan acquisitions in the quarter were $6.1 billion compared to $9.7 billion last year and $8.4 billion in the year ago quarter. At quarter end $8.2 billion of our managed FFELP portfolio had reduced yields from the change in legislation last fall. For the quarter, our core student loan spread excluding the asset backed financial facility fees was 165 basis points, a decrease of 3 basis points from a year ago. The decrease was driven by higher cost of funds and the decreased spread we earn on newly originated FFELP loans. In our traditional private credit portfolio, 90 day delinquencies declined by .2% to 1.6% and our forbearance usage at quarter end declined to 12% from 15.5%. Our net charge offs increased a less than expected .3% to 2% from the prior quarter. Reserves at June 30 were 1.7 times annualized net charge offs. In our non-traditional portfolio, 90 day delinquencies also declined by .9% to 9.8% and forbearance usage declined to 18.5% from 21.4%. Our net charge offs also increased less than expected to 15% from 12.9% and our reserves at June 30th for this segment of the portfolio stood at 2.3 times annualized net charge offs. As expected, our charge offs in our private credit portfolio are increasing in 2008. The increases however are significantly below our original expectations and our provision in the fourth quarter reflected this outlook. As these charge offs materialize we would expect our coverage ratio to decline as well particularly as our non-traditional portfolio runs off. Overall, the performance of our private credit portfolio has exceeded our expectations year-to-date. We believe, and the evidence supports the view that student loans perform better than other consumer asset classes over the long run. College graduates which represent 27% of the adult workforce have significantly higher income and experience materially lower levels of unemployment compared to the workforce as a whole. Loans to these borrowers produce consistent and predictable seasoning patterns. Charge offs occur early in the repayment cycle, primarily due to the failure to graduate. If a borrower makes 12 payments once they enter repayment the likelihood of charge offs decrease dramatically. Similarly forbearances typically peak within a year of entering repayment and what we are seeing in our portfolio is consistent with these patterns based on the seasoning and the macroeconomic environment. Our operating expenses in our lending segment declined significantly to $151 million in the quarter from $182 million a year ago or 36 basis points as a percentage of average managed student loan assets down from 48 basis points in the prior year. This decrease is the result of our efforts to improve our industry leading efficiency and given the change in economics in the student loan business. We will continue to improve our operating efficiency and use this advantage to improve our profitability. We earned $44 million in floor income this quarter versus $39 million in the year ago period and we earned an additional $25 million in floor income that is excluded from core earnings. In our asset performance group segment, we had a net loss of $10 million versus net income of $33 million in the year ago quarter. Within this segment, our core student loan contingent collection business generated net income of $16 million while our purchase paper business generated a $26 million loss. We evaluate our portfolio of non-mortgage and mortgage purchase paper each quarter. Our valuations are accessed on the estimates of future collections for the non-mortgage paper and are primarily a function of the estimated value of the underlying real estate asset for the mortgage portfolio. Historically, and at June 30, the book value of the mortgage related assets was 77% of the current estimated collateral value. Revenues in our guarantor services business totaled $24 million in the second quarter versus $30 million in the year ago period. The decrease in revenue is due to the legislative changes that reduced the account maintenance fee paid to guarantors by 40%. Total other fee income including that from Upromise and our loan servicing activities declined $4 million to $45 million in the quarter primarily due to seasonality in the revenue sources. The changes brought about by the legislation last fall and the challenges we are facing in the capital markets require us to rationalize our business operations and reduce our costs. We have completed a review of our business units with the goal of achieving appropriate risk adjusted returns and providing industry leading cost effective services. As part of this review, we have refocused our lending activities, exited certain customer relationships and product lines and are on target to reduce our operating expenses by 20%. In addition, we’ve concluded that the purchased paper business is no longer producing a mutual strategic fit. As a result, we are currently pursuing alternatives for our purchase paper businesses including potential sale, wind down and other options. The book value of our non-mortgage and mortgage portfolios was $633 million and $1 billion respectively. Again, the mortgage related portfolio is carried at 77% of the current estimated market value of the properties. Second quarter 2008 GAAP net income was $266 million or $0.50 a share compared to net income of $966 million or $1.03 diluted earnings per share in the year ago quarter. The largest difference between GAAP and core earnings this quarter is the net impact of derivative accounting which resulted in a $447 million unrealized mark-to-market pre-tax gain recognized in GAAP but not in core earnings. The GAAP provision for loan losses was $143 million down from $148 a year ago and GAAP net interest income was $403 million in the quarter compared to $399 million I the second quarter of 2007. Under GAAP accounting, the provision for loan losses and net interest income are based only on balance sheet loans and the comparable quartering figures are based on total managed loans. As 2008 is unfolded, we have seen several positive developments like the Department of Education funding proposals and better than expected performance in our private credit portfolio. At the same time, the credit markets have continued to weigh on our results. We expect strong performance in our student loan originations combined with the continuation of high funding costs to generate core earnings in the $1.60 area for 2008 excluding the results of our purchased paper businesses. For 2009, much depends on the funding environment for student loan assets. Given current market conditions and without any further policy changes, we would have little option but to put all eligible loans through the Department of Education. With the additional fee income from the put, the earnings prospects for 2009 including the impact of higher funding costs should grow 30% to 40% over 2008. I’d now like to open the call up for questions.

[Operator:]

(Operator Instructions) Your first question comes from Sameer Gokhale – Keefe, Bruyette & Woods.

[Sameer Gokhale:]

Jack, I just had a question on the comments you made about the pricing of the unsecured debt vis-à-vis the profits on new private student loan originations and you mentioned that you would expect to generate a mid teens ROE in that business. I was wondering if you could just provide some commentary on how the pricing on those loans would look because to get to a mid teens ROE it seems like you probably have to price those loans at LIBOR plus say 800 or so and I was wondering how that works relative to plus loans which maybe are at lower yields? So, could you just walk us through how you’re thinking about that from a pricing perspective?

[John F. Remondi:]

I think the pricing ranges that you are referring to are approximately right. It’s a function of the economics. If we can’t borrow at cost effective rates or if we have to borrow at – let me say it another way, if we’re borrowing at LIBOR plus 400 we have to pass some of those costs on to our customers. In many instances, students choose to borrow private credit loans for different reasons. In some instances it may not be the parent who is available to co-sign for the student on a private loan and so therefore they’re not eligible for PLUS or the student is an international student, or students in some cases the parents just choose not to take advantage of the PLUS program. In addition, the interest rate on PLUS loans is fixed and right now at 8.5% it is relatively high compared to short term funding rates and that also causes people to move in to private credit. But, those are the factors there and we would certainly hope that has credit spreads return to a more normalized environment that we would be able to make our private credit loans more price competitive in the marketplace. I will say however, that our pricing, we don’t believe our pricing is out of line with what any of our competitors are doing in the marketplace for private credit loans, if they’re making loans at all.

[Sameer Gokhale:]

Can you remind us again what percentage of your private student loan originations are attached to FFELP loans? Is it roughly about 50% or so?

[John F. Remondi:]

I don’t have that exact number. We’ll get that for you. The estimate in the past had been more in the 60% range but I don’t know where it is as of June 30.

[Operator:]

Your next question comes from Matthew Snowling – Friedman, Billings, Ramsey & Co.

[Matthew Snowling:]

The origination volume seemed a little light versus what we were expecting. Is this just mainly a function of waiting until the government funding facility is in place before you actually close those applications?

[John F. Remondi:]

Well, when we talk about new loan originations in the quarter, those are loans that are actually dispersed and those activities are taking place principally for the academic year that begins prior to July 1. So, it’s always a light volume period for the quarter. In terms of application flows that we are seeing in to our centers today, historically July is one of our busiest months and it’s been much lighter than expected principally because of the increase in loan limits that took place in the schools needing to update their software and their financial aid management systems to accommodate that higher loan level increase so we’ve seen a number of schools who have been late in terms of processing applications. Everything here, everything we’re seeing, all the indications from schools are pointing towards a significant increase in demand for federal student loans this upcoming academic year. Its coming from higher loan limits both last fall as well as that were passed and effective July 1. It’s coming from the reduction in alternative sources like home equity lines and it’s just coming from the fact that people who previously paid with cash now need to borrow. So, all of those items combined we would expect to see a material increase which is where we get to our $20 billion worth of federal loan originations for this upcoming academic year.

[Matthew Snowling:]

Jack, I think you mentioned earlier in your remarks, I think $338 million was the number you used of preferred volume moved to a servicing contract. Can you give us a little more detail about that?

[John F. Remondi:]

As a result of the credit markets and the change in the spread that we could earn, we could no longer justify paying premiums to lenders to originate and sell loans to the company. Many of those lenders decided to exit the business as a result of that, some of them continue to sell us loans at par and a few others, the $338 million converted to servicing contracts and to some extent they may decide to just wait this out or are evaluating their decisions. Our expectations is that the majority of that volume would likely be put, given current market conditions in September as well.

[Matthew Snowling:]

So you’re doing the upfront distribution servicing?

[John F. Remondi:]

We’re doing the upfront origination and interim, or in school loan servicing for the clients until they dispose of the asset.

[Operator:]

Your next question comes from [Seral Battini] – Credit Suisse.

[[Seral Battini]:]

I see that you have short term borrowing of $37 billion and the total primary and standby liquidity of $33.6 billion. My question is how do you plan to fill that liquidity gap?

[John F. Remondi:]

Well, the lion’s share of that is related to our $34 billion asset backed commercial paper program and our goals here is that between now and year end that we will continue our pace of securitization activity to minimize the amount that we have borrowed under that facility and then renew that or roll that facility for a significantly smaller dollar amount than the $28 billion that’s allocated to federal loans. We expect the $6 billion piece that’s allocated to private to be about the same size. The remaining piece is short term or previously long term unsecured debt that is now short term in nature and we have been active buyers of that debt in the secondary market and we’ll be looking to redeem that over time. I also think it’s important to note that from a new funding perspective all new FFELP loans are financeable through this Department of Education facility so the demand for liquidity to fund our business is going to be limited to our private credit portfolios which we would expect to originate about $7 billion in total this year and to our debt maturities this year which were about $7 billion as well.

[Operator:]

Your next question comes from Michael Taiano – Sandler O’Neil & Partners.

[Michael Taiano:]

I just want to make sure I understand the guidance, the $1.60. Does that include the $0.48 in the first quarter and $0.40 in the second quarter?

[John F. Remondi:]

Yes.

[Michael Taiano:]

Jack, could you maybe just walk me through the utilization on the ABCP conduit? It looks like it went up about $1.5 billion this quarter versus last quarter and I would have thought it would have went down given the $7 billion in securitizations and I think you only added about $6 billion to the balance sheet. Could you maybe clarify how that increased? Then, maybe talk about plans for securitization in the back half of the year, is $7 billion a good run rate and do you have a set amount for where you’d like that ABCP conduit to be down to by the end of the year?

[John F. Remondi:]

The reason the asset backed CP facility didn’t decrease at quarter end is more due to the timing of closing of some of the financing transactions and the moving of loans in and out of the conduit facility. We would expect that balance to decrease, or that balance did decrease in July and we would expect it to continue to decrease, particularly on the FFELP side over the balance of the year. Where we would like it to be, I’d like it to be zero. I’d like it to be a liquidity facility not a funding facility and how we get there or how close we get to that number is going to be dependent on what we can do in the term ABS market between now and year-end. We were optimistic in early July in terms of where our funding spreads were going. Unfortunately, they did back up significantly, some due to credit market conditions in general, others due to there was a student loan issuer that was trying to get a deal done that was just not working and that caused the spreads to back up. We would expect them to improve over where they looked like they were last week. On the private credit side, it’s really a function of getting back out in to the marketplace and demonstrating to investors that this asset is performing exceptionally well in this marketplace. Far better than other types of consumer assets are performing. We have the data, we’re seeing the performance of what’s going on and you also have six years of trust performance data out there that people can see and there again, the credit performance has been exceptional.

[Michael Taiano:]

I know you have had conversations with the Department of Education about what could the longer term solution be for the FFELP industry. Could you maybe share what some of your thoughts are in terms of what’s the longer term answer here?

[John F. Remondi:]

At this stage in the game the balance here is do you pay enough of a margin on the FFELP loans to be able to accommodate market disruption periods that exist like today or even just normalized levels. Our view at this stage in the game is first, the tax payers already assume the risk on a federal student loan, and they’re already guaranteeing the performance of that loan through guarantee agencies and the directory insurance by the Department of Education. So, coming up with some form of structure that creates a greater awareness or confidence or valuation of that guarantee by investors in student loan asset backed securities would probably be the best thing that could happen. There you would have no incremental costs to tax payers because they’re already taking this risk and yet you benefit from the investors perception of the value of that guarantee, something that we’re not getting full credit for today. If you look at federal student loan asset backed securities, our securities trade pretty comparable to credit card asset backed securities despite the fact that one asset has a government guaranty and the other doesn’t. We need to get a little bit to improve that recognition and that valuation of that guaranty and I think that is where the long term solution lies.

[Operator:]

Your next question comes from Bruce W. Harting – Lehman Brothers.

[Bruce W. Harting:]

Jack, can you give a little more disclosure on how you determine the impairment of $51 million? Just any guidance for future quarters understanding that you’re saying that’s not a core part of the business but just to get a sense of second half. Then, if I may, when you’re looking out to 09 and the earnings growth, is that assuming that the put is used? Any clarification on assumptions used to get to growth next year? And, are you benchmarking off the operating of $0.40 or $0.27 for this quarter?

[John F. Remondi:]

On the impairment charge, each quarter we take a look at the underlying collateral value of the market value of the properties in the distressed mortgage business. Then, our impairment, if any is an adjustment to book value from that to keep the differential to be a discount of market value of 23%. So, if you look back in the supplemental you’ll see that we’ve historically carried, our book value has been consistently marked to about 77% of the current market value of the underlying assets. So, that’s where the impairment is coming from. Now, the goals in this business is we typically buy distressed paper, first of all we’re buying it at a discount to the unpaid principal balance of the loan and normally those loans we get resolved in some form of work out with the customer or a short sales or something along those lines. More recently, more of it has been pushed in to foreclosure and becomes REO and then we’re in the real estate business of managing properties and disposing of them. We’ve become much more active in this space and pushing through and increasing the pace of turnover of those properties and that’s a pace that’s actually been accelerating and was extremely high in June. It was about 25% of all of our resolutions in this mortgage portfolio took place in the month of June for the first six months of the year and we’re hoping that pace will continue to accelerate as we move forward. If that happens, the average life of this portfolio is around about two years in timeframe. In terms of 09 earnings, it does assume that we put these loans through the Department of Education. At this stage in the game, the current market conditions would say that you couldn’t take $20 billion worth of loans and refinance it in the term securitization market cost effectively relative to the value of the put and so those loans would be put. We would certainly hope and we’d even expect that we’ll get some attempt at addressing this issue between now and September of 2009. The government I don’t think wants us to put the loans and we wouldn’t want to put them either if we have a viable alternative. What was our last question Bruce?

[Bruce W. Harting:]

Is there any discussion with the government on longer term [inaudible] spread adjustments of [inaudible] plan? Maybe a little bit of a read through on the loans through the next year. I know you talked about it a little already.

[John F. Remondi:]

You’re a little tough there to hear but I think you’re saying is there a follow up for a long term solution with the Department?

[Bruce W. Harting:]

Yes.

[John F. Remondi:]

There is discussion on that issue. Unfortunately, I think some of the other issues going on that the government has been working on the last couple of weeks have distracted them particularly those more in the treasury side but we continue to have those discussions both with the Department of Education, Treasury and members of the hill.

[Bruce W. Harting:]

I don’t know if people have queued but just one last one, can you just give any read through on what conversations are like on campuses right now in terms of your ability to generate new business with the large number of companies that have exited the business versus the federal direct?

[John F. Remondi:]

I think in terms of, if you look at volume on campuses a couple of things have been happening. First of all, the legislation last fall required that schools put multiple lenders on lists so on a number of campuses where we were more or less the exclusive lender, there was more competition introduced in to that space. In addition, about $1.7 billion of our volume that we originated last year has left FFELP for direct lending. Now, the two pieces of positives on volume forecasts are higher demand from higher loan limits and the other factors I mentioned earlier and then reduced lenders in the space. A number of lenders have exited the business completely. The 160 I mentioned, and then there have been those that have remained, the largest of those have stated publically and announced to schools their intent to significantly reduce the amount of lending they will do in those campuses. We on the other hand, have said and as Al mentioned earlier, we’re going to lend to all students at all schools this academic year. As a result, I think we’ve earned a good market reputation as a result of that and also would expect to see significantly higher volume.

[Operator:]

Your next question comes from Analyst Shane Wilson – QVT Financial.

[Analyst for Shane Wilson:]

The impaired mortgage assets, I think you’ve stated that you carry them at a 77% of our current estimate of fair market value. But, can you give us a little bit of color as to how that current fair market value compares to outstanding principal amount and/or purchase price just for us to get a sense of how big our fair value discount is already?

[John F. Remondi:]

The market value of the property is of course going to be lower than unpaid principal amount of the note. As property values have declined, that has gone with it. Right now, the unpaid principal balance to us is just not a particularly meaningful number because we’re not going to get paid based on the note value we’re going to get paid based on the property value. We have historically, like I said, carried at these discounts. The resolutions, when we resolve these things, we are making a profit at those kinds of prices and so the volume that we resolved in June was a profitable book of business. It had about a 12% margin for us. Stuff is moving and getting done. The valuation that we’re using is a broker estimate. So, brokers are giving us information on the specific properties as to what they think a market trade would occur at and so it’s not an appraisal so it’s not inflated by all the other issues that impacted the real estate market in the past.

[Operator:]

Your next question comes from Moshe Orenbuch – Credit Suisse First Boston.

[Moshe Orenbuch:]

The 30% to 40% earnings growth, what base actually is that based upon for the first half?

[John F. Remondi:]

$1.60.

[Moshe Orenbuch:]

The question really has to do with the securitization markets both FFELP and private as you see it right now. You made a lot of comments about the performance both on the government guaranteed side and the private student lending being better than other asset classes but, if you actually look at things like credit card securitization, what issuers are doing is they’re doing shorter dated securitizations on a revolving asset you have that flexibility. Can you talk a little bit about the length of time, the life of those securitizations and how important a factor that is you think in terms of liquidity in that market?

[John F. Remondi:]

It’s a good question and it is probably the issue on our FFELP transactions is the long average life of the majority of the dollars that are financed here and it’s particularly meaningful for private credit as well. The back tranches on the private credit deals typically have average lives of about 14 years and there’s no question that that’s a challenge and we need to look at better ways to manage that process. Examples would be where we have co-borrowers, getting co-borrowers during the in school periods to keep the interest from compounding and lengthening the duration. On the FFELP side of the equation, the issue is really more profound on consolidation loans than it is on Stafford but to date we continue to be able to securitize them, it’s just at a higher cost. But, when I said that we were comparable to credit cards I was going more of an apples-to-apples of similar duration tranches.

[Operator:]

Your next question comes from Brad Ball – Citigroup.

[Brad Ball:]

With respect to the business that you’re getting out of, the collection of the purchase paper business, what capital free up should we expect? Do you hold 8% against the assets there or do you hold the higher amount of capital against that business right now?

[John F. Remondi:]

We do hold a higher level of capital against that business. But, I think in terms of what capital free up, that’s going to have to be based on how we deal with these businesses going forward and that’s not clear at this point in time. Obviously, if we were to sell the businesses, that would happen quickly. If we were to wind them down, it will happen slowly.

[Brad Ball:]

So you’re still at the stage of considering your options to either sell or wind down?

[John F. Remondi:]

Correct.

[Brad Ball:]

But sale is an option that you think is feasible in the next couple of quarters?

[John F. Remondi:]

It’s always an option, yes.

[Brad Ball:]

With respect to your guidance for next year, 30% to 40% upside, that implies like $2.10 to $2.25 or $2.30 EPS for next year. You addressed the question about how you plan to fund the FFELP originations but what does that assume for the replacement cost of the private loan securitizations or private loan funding? And, what does it assume with respect to unsecured issuance? You did an unsecured deal at L plus 400 would you be doing deals at that level going forward?

[John F. Remondi:]

We are assuming at this stage current market spreads for those forecasts. So, L plus 400 is a good number for private credit funding.

[Brad Ball:]

You’ve mentioned a couple of times that the credit performance has been better than your expectations. It’s not entirely clear to me what your expectations have been. If you could just clarify what the outlook has been? It sounds like you’re still pretty cautious on credit for the balance of this year and maybe in to 09 so what’s the assumption there?

[John F. Remondi:]

Well, obviously remember in the fourth quarter we took a very big provision, $750 million and that $750 million of provision eventually have to roll through the charge off lines if we’re right. So, charge offs are going to be increasing just as that bubble works its way through particularly on the non-traditional side of the equation. Year-to-date through the first six months when we say charge offs are below our expectations, they were about $50 million below our expectations and the trend lines, it’s very difficult to be optimistic in this marketplace just given everything that’s going on external to the company in terms of the economic environment. But, where we stand in terms of delinquencies, forbearances and other early indicators of problems that students might be having or borrowers might be having on the private credit side, we’re pretty good and when you look at it compared to what has been released this quarter on credit card portfolios or auto, it’s really good.

[Brad Ball:]

So would the provision this quarter be a good run rate to work with as we model provisioning going forward?

[John F. Remondi:]

I don’t think we should be. We provided guidance earlier in the year as to what provisions would be and we have not changed that at this stage.

[Brad Ball:]

Is it still your expectation that private loan net charge offs over those in collection would be in the 3% range?

[John F. Remondi:]

We would break it out between traditional and non-traditional and like I said charge offs here, at $750 million of provision in the quarter eventually has to flow through and in the non-traditional side as the portfolio enters repayments, we would expect those numbers to remain elevated in terms of charge offs through 2009.

[Brad Ball:]

That’s what’s elevating that ratio, the private loan charge offs in repayment?

[John F. Remondi:]

Yes.

[Brad Ball:]

I think its $392 this last quarter.

[Operator:]

Your next question comes from Sameer Gokhale – Keefe, Bruyette & Woods.

[Sameer Gokhale:]

I know you said you’re going to exit the debt recovery business but the question I had was on the non-mortgage side, I understand it’s not a core part of your overall operation which is why you’re exiting but if you look at that business as a standalone fundamental business, it seems like pricing has come down for purchases of say credit card receivables. But, I was curious if you were seeing any other structural issues with that business or that industry overall going forward that’s also playing in to your decision to exit that business?

[John F. Remondi:]

I think as Al said, first of all we think these businesses are attractive businesses, the challenges are that they have very lumpy returns, right. And you in certain marketplaces you want to be out of the market like 2007 in terms of buying stuff and in 2008 you want to be in the market base. The lumpiness of the return, the very high capital levels associated with that and frankly there’s just not – we didn’t see that the transfer of benefit from our contingency business over to our purchase portfolio business or vice versa and so the mutual strategic fit we thought existed in these entities just isn’t there.

[Operator:]

Your next question comes from Michael Cohen – SuNOVA Capital.

[Michael Cohen:]

Would you anticipate taking any charge to wind down the mortgage purchase paper business?

[Albert L. Lord:]

Let me try that. Under the current account rules, those businesses are valued at what the accountants thing they’re worth on a going concern basis. We are looking at the relative economic return of selling the businesses or running them and I think that by the end of the third quarter we’ll have pretty well sorted out what we think the returns on this business are going to be from now until the time that they’re either sold or wound down and that the third quarter will reflect whatever one-time effect there might be with respect to that. That’s a long winded way of saying that yes, it’s possible that there will be a one-time charge for either or both of those businesses.

[Operator:]

There are no further questions at this time.

[Steve McGarry:]

I’d just like to close by saying thank you everybody for joining our second quarter earnings conference call.