SLM Corporation
Q2 2010 Earnings Call Transcript

Published: 21 Jul 2010

[Operator:]

Good morning. My name is Cynthia and I’ll be your conference operator today. At this time I would like to welcome everyone to the Sallie Mae Q2 Fiscal 2010 Earnings conference call. (Operator Instructions). I would now like to turn today’s call over to Steve McGarry, Senior Vice President of Investor relations. Pleas go ahead, sir.

[Steven McGarry:]

Thank you, Cynthia. Good morning everybody and welcome to Sallie Mae’s 2010 Q2 earnings call. With me today on the call are Al Lord, our CEO, and Jack Remondi, our CFO. After their prepared remarks we will open up the call for questions. Before we begin now keep in mind that 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, and listeners should refer to the discussion of those factors on the company’s Form 10K and other filings with the SEC. During this call we will refer to non-GAAP measures that 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 Q2 2010 Supplemental Earnings Disclosure. This is posted along with the earnings press release on the investor’s page at salliemae.com. Thank you, and I’ll now turn the call over to Jack.

[John Remondi:]

Thanks, Steve, and good morning everyone. I’m going to start by taking a few moments to review our operating results for the quarter on both the GAAP and a core earnings basis. In addition we will review our funding activity and liquidly and provide an update on our lending business, and review the performance of our private credit portfolio. And at the end I’ll provide and update on our outlook for the remainder of 2010. For the quarter our earnings were $209 million or $0.39 a share. That compares to $212 million or $0.39 per share in the prior quarter. This quarter’s results include restructuring and asset impairment changes related to the SAFRA legislation of $23.5 million, or $0.03 a share; a reserve for a litigation contingency of $0.02 a share; and debt repurchase gains of $91 million pretax or $0.11 a share. Net interest income was $759 million for the quarter, versus $457 million in the prior year period. The net interest margin increased to 1.54% from 91 basis points in the year ago quarter. The changes of both net interest income and the margin from the prior period were primarily due to improved basis spreads, principally CP-LIBOR, increased floor hedge income and lower funding costs. The provision for private credit loan losses in the quarter was $349 million, an increase of $24 million from the first quarter; and the total loan loss provision for the quarter was $382 million compared to $359 million in the prior quarter. At June 30th our allowance for private credit loan losses was equal to 7.9% of loans in repayment, and after the provision net interest income increased to $377 million in the Q2 including $333 million from the FFELP portfolio and $45 million from the private credit portfolio, compared to $343 million in the first quarter which included $280 million from FFELP and $69 million from private credit. Our private credit charge offs increased in the quarter to $336 million, up from $284 million in the first quarter; and charge offs on an annualized basis totaled 3.7% of traditional loans, up from 3.2% in the first quarter, and 18.7% of nontraditional loans compared to 15.9% in the prior quarter. Nontraditional loans now represent 11% of the total loans in repayment but contributed nearly 37% of the charge offs. The increase in charge offs this period is largely due to seasonal factors, though current economic conditions continue to negatively impact results. Our private credit portfolio characteristics continue to strengthen. At June 30th 89% of loans were traditional, 58% of loans had a co-borrower, and the portfolio had an average FICO score of 714. This compares to 87% traditional, 55% with a co-borrower, and an average FICO score of 711 from one year ago. Due to seasonal factors the 31 to 60 day delinquency rate increased to 3.7% from 3.4% at March 31st, while the 60 to 90 day delinquency rate remained unchanged at 2.3%, and 90 day plus delinquencies decreased to 5.8% from 6.4%. Overall, delinquencies in our private loan portfolio declined to 11.9% of loans in repayment from 12.2% at March 31st. In addition, loans in forbearance remained relatively stable at 5.3% of loans in repayment, compared to 5.1% at March 31st, both down from 6.5% a year ago. Other income in the quarter totaled $308 million compared to $336 million in the Q1. This quarter’s numbers include $91 million in gains from debt repurchase, $88 million in revenue from our contingent collection fee business, and $111 million from our processing businesses which include phone servicing. Q1 results included $90 million from gains of debt repurchases, additional seasonal revenue from our guarantor servicing business, and an $11 million gain from the sale of securities. Operating expense this quarter, excluding restructuring and other one-time charges, increased to $312 million compared to $298 million in the Q2 of 2009. The increase this quarter is partially due to several investments to improve operating efficiencies and grow revenue. That said, we still have significant work to do to reduce our overall expenses. Restructuring and asset impairment expenses for the Q2 of 2010 totaled $23.5 million. At June 30th 88% of our managed assets were funded to the life of the loan, up from 82% a year ago. During the quarter we completed a $1.2 billion FFELP loan securitization at a cost of LIBOR plus 40 basis points, and that will contribute to an improved cost of funds going forward. Also during the quarter the company retired $1.8 billion of unsecured debt, including the repurchase of $1.4 billion in unsecured notes with maturities in the 2010 to 2014 range. These generated gains of $91 million in the quarter. We continued to utilize excess liquidity to generate value through debt repurchase. In the past two weeks we completed two private loan ABS transactions. These transactions both refinanced an existing private loan securitization and securitized previous unencumbered private loans. Improved market conditions allowed us to refund a $1.5 billion deal we did in 2009, improving both the overall advance rate and lowering the cost of funds. We placed the additional bonds with new investors. The end result of these transactions is that we raised additional liquidity of $1 billion and improved our overall funding mix. At quarter end we had just under $12 billion in primary liquidity consisting of cash and investments. On the lending side we originated $3.1 billion of FFELP loans in the quarter, including our last FFELP loan, a decrease of 16% over the year-ago period. This strong showing in the face of an eliminated loan program is a testament to the value of the products and services we offer to students, parents, and schools. The FFELP student loan spread in the quarter was 104 basis points compared to 90 basis points in the Q1, and at quarter end 93% of our FFELP portfolio was funded for the life of the loan or long-term in the straight A conduit facility, up from 92% at March 31st. We originated a disappointing $219 million in private credit loans in the quarter, compared to $387 million in the Q2 of 2009, as loan demand remains low. Private loan demand continues to be impacted by increased federal loan limits, more students applying for federal loans, and students switching to lower-cost institutions. Loans underwritten in the quarter remain of very high quality, with an average FICO score of 735, and 77% of the loans we made had a co-borrower. As we begin the 2010-2011 academic year we’ve expanded our private credit offerings with a new, low fixed rate payment option for in-school periods and more loan options for independent students. We are starting to see signs of increasing demand with new application requests for this academic year increasing above the prior year period. Total equity at June 30th was $5.1 billion resulting in a tangible capital ratio of 1.9% of managed assets, up from 1.7% at March 31st, and with 81% of our managed loans carrying an explicit government guarantee and 88% of all loans funded for the life of the loan and not subject to any additional collateral posting requirements, we believe our capital levels remain appropriate. We recorded Q2 GAAP net income of $338 million or $0.63 a share, compared to a net loss of $123 million or $0.32 diluted loss per share in the 2009 Q2. The primary difference today between our core earnings results and our GAAP results is the marked to market pretax gains and losses on derivative hedging activity which are recognized for GAAP but not core earnings. This results in a net gain of $301 million in the Q2 of 2010. GAAP net interest income for the quarter was $896 million. Effective July 1st we no longer originate FFELP loans. At June 30th our FFELP portfolio balance was just under $150 billion. This portfolio will amortize over more than 25 years and as an average life of almost 8 years. Our guarantor book, including origination fees, will wind down over a similar period as well. Our financial outlook for the remainder of 2010 is as follows

[Albert Lord:]

Thanks, Jack. Jack and I are a little bit like golfers – we decided to change up the order to see if we could improve our luck a little bit. I will be hopefully mercifully brief, but with some 200 interested Sallie Mae investors and others on the phone, I couldn’t resist a few words. Let me cover a couple topics before we move to Q&A. You’ve seen our earnings of $0.39. They’re certainly better than they’ve been. We expect to do better. The recent quarter and recent six months certainly measured against the challenges we’ve faced over the last two years I think are worth noting, cause we’ve emerged from that period with significantly stronger capital and growing capital, significantly stronger bad debt reserves and growing. Our liquidity is stronger, our cash flows are strong, and maybe even more important than the strength of our cash flows is the predictability of them. It’s worth noting that over the last 18 months we’ve prepaid $8 billion of unsecured debt and immensely lengthed the liabilities of the company, which were frighteningly short a couple of years ago. I will tell you I don’t like the debt discount and what I consider to be the discount on our common stock any more than many of you. I only like them as a buyer and we will continue to be a buyer. I want to cover a couple areas with you

[Steven McGarry:]

Cynthia, are you compiling the Q&A queue?

[Operator:]

(Operator Instructions). Your first question comes from the line of Michael Taiano with Sandler O’Neill.

[Michael Taiano:]

Hey, good morning, guys. A few questions. I guess first in terms of the guidance, you took up the EPS guidance to $1.70 but you took up the private credit provision by $100 million. In terms of what the offset through the difference, is that just more gains from debt repurchases and a better CP-LIBOR spread that basically reconciled those two going in different directions?

[John Remondi:]

Yes, Mike – that's right.

[Michael Taiano:]

Okay. And then just in terms of the spread this quarter, you had, it looked like $90 million from the floor hedges. Can you explain what caused that to go up so much relative to last quarter, an whether that should be relatively sustainable here over the next few quarters?

[John Remondi:]

Sure. We, as you know, embedded in our fixed rate consolidation loan portfolio is a floor option that lasts for the duration of the loan. And what we did this quarter and last is sold floor, basically hedged that floor interest rate option for our multiple years, and what you do is you sell the floor contact and receive cash. That cash is then amortized over the course of the contract so it is sustainable over multiple years, not just multiple quarters.

[Michael Taiano:]

Gotcha. Okay, and then in terms of the two sort of ongoing businesses, on the private student loan side demand still seems weak and you’ve made some changes and introduced some new products. I guess one question was one of the reasons why I think you introduced the Smart Option Loan was because it was easier to securitize because of the cash flows that you receive while in school. Do these new products also, are they sort of well suited for securitization? And then you know, on the Department of Ed servicing contract, it looks like it was relatively flat versus last quarter. I would have thought you would have had started to see some increase but is that more of a Q3 event or how should we read that?

[John Remondi:]

Well, to take the private credit loan products, you know, certainly the loans by requiring borrowers to pay interest while they’re in school does make the loans easier to securitize, but it was also the right product for students and families. It significantly lowers the overall interest charges that they’ll pay over the life of the loan, thereby making the loan more affordable. It also I think from a performance perspective gets borrowers- One of the challenges you have when you put a loan into deferment is students sometimes forget that they borrowed this money and the fact that they borrowed $10,000 four years ago is now all of a sudden more than $10,00 because interest has accrued and capitalized. This helps offset that. The change of the additional product that we are offering this academic year is really designed to appeal to borrowers who are willing to make payments during the in-school period but want some certainty over the specifics of their cash flow requirements during that time frame. And so by fixing the payment instead of having a variable interest payment, it allows them to know exactly how much they will have to pay each month during that in-school period and they can better plan for their cash flows. We do believe this loan product will remain securitizable. And I’d also just point to the last two deals we did in the last couple of weeks in the private credit space. All of these are deferred product loans. So we are securitizing old loans as well as, certainly not at the levels we did a couple of years ago, but we are still securitizing older products as well. On the DL servicing contract, it is a seasonal issue here. The cutover from the prior servicer for DL loans began this academic year, July 1st, and we just started to see those loans. There was very little put activity to the department from last quarter to this, so that is why you saw a very stable volume there.

[Michael Taiano:]

Great, thanks a lot.

[John Remondi:]

You’re welcome.

[Operator:]

Our next question comes form the line of Lee Cooperman with Omega Advisors.

[Lee Cooperman:]

Yeah hi, can you hear me?

[John Remondi:]

Yep.

[Lee Cooperman:]

Okay, good morning. I guess I have a direct question. I don’t know if I have, do I have you on speakerphone? I’m trying to get off it, hold on. Okay, you’re off. Al, you mentioned in your prepared remarks that "We hope to have an answer regarding FFELP portfolio in the coming months," "...within the next year," and then "...by the end of Q3." So two out of three suggest this year. But my first question is is it realistic to expect that the shareholders will get a sense of the direction we’re going to take before the end of the year, number one? And number two, on many of these calls over the last couple of years we talked about underlying asset value, runoff value, you guys expressed a value of high teens kind of number. As you’ve gone through this process with your financial advisor, your Board and management, is what you’re seeing supportive of that view that you’ve had of the value in the high teens?

[Albert Lord:]

Yes, yes. Actually, if anything, and without being precise it has actually enlarged the values with each valuation. And I sense from your question that you’d like us to be a little more precise on the timing.

[Lee Cooperman:]

Only because I’m 67 and I’m getting old, Al. I’m not buying ripe bananas anymore.

[Albert Lord:]

Well, let me know when you don’t fill the gas tank each time. Yeah, you’ll definitely know by the end of this year where we’re going. Again, I don’t think that the drums necessarily need rolled here. It’s just, what we’re going to do with this company is to change the structure a little bit but it it’s not going to be, in the end it’s not going to be more than it is now. It’s just going to try to make a lot more clear the underlying values of the company.

[Lee Cooperman:]

And you did answer my question. You’re saying there based upon the work you’ve done with your advisors thus far you feel comfortable with your views as valued and adjusted before; it sounds like you’re even getting a bit more optimistic about that.

[Albert Lord:]

Yes, I am more optimistic. That’s quite right.

[Lee Cooperman:]

Thank you, good luck.

[Operator:]

Your next question comes from the line of Sameer Gokhale with KBW.

[Sameer Gokhale:]

Thank you and good morning. I just had a question on the nontraditional portfolio. I know, Jack, your referred to some of the seasonal trends overall that affected your credit quality in the quarter. And your trust data, which I think largely consists of the traditional loans seem to indicate also the seasonal increase in defaults and charge offs. But in terms of the nontraditional portfolio, I think you know, the hope was that you’d have seasonal weakness that’s more than offset by declining underlying charge offs, just because you know, you mentioned that 80% of losses come within the first two years of those loans coming to repayment. So we were looking for like a steep drop off in those charge offs. So is it just the economy that’s weighing on those nontraditional charge offs as well, or is it kind of a continued expectation that we should see a fairly significant drop off in those charge offs going forward, especially as we look out into ’11 – that’s going to drive the decline in provisioning, because again the provisioning was slightly high this quarter.

[John Remondi:]

That’s right. What we’re seeing here is you know, a year ago we had a little over $1.5 billion in our nontraditional portfolio not yet in repayment, and that has dropped to about $1 billion at June 30th. So as those loans move into repayment we certainly experience substantially higher charge offs at the front end of the process than we do at the back end. And historically about 80% of all defaults occur within that first 12 months of required payments in that cycle. The good news in our nontraditional portfolio is that the portion of the protocol that has made more then 12 payments, which in our experience demonstrates substantially better performance going forward – which means the incidence of default drops dramatically – has been expanding and that number is over $1.6 billion at this stage of the game, and up from about $1.3 billion a year ago. So I do think as time progresses here and the amount of loans that enter repayment move on we will see a significant drop in charge off rates in the nontraditional book.

[Sameer Gokhale:]

Okay, that’s helpful. And then just a question as we think out longer-term in terms of the private loan originations and you mentioned, also the impact that the increase in loan limits has been having on your growth and private loan originations, that’s a fact of the industry as well. But one of the things that was also referenced, and this is something that people have been talking about for some time, which is that students are now increasingly opting to go into in-state schools and taking advantage of lower tuition costs. And they seem to be making decisions about the tradeoff between the costs of tuitions between lower- and higher-cost institutions relative to income levels. So as you look out a few years in the longer-term growth of this business, this the expectation where this is a business wher originations, I mean at one point were growing at 20% a year, but now it’s going to be more of a mid- to high-single digit growth in the industry over the longer term, or intermediate term, five years to seven years? Is that how you think about it? I mean how do you guys look at it from a strategic perspective?

[John Remondi:]

Well we have seen, there is a shift going on in terms of students who are applying for financial aid is increasing faster at public institutions than at private, but enrollments in private institutions are not dropping. I guess when we look at the marketplace for the private education demand, we spend in this country a little over $300 billion a year on higher ed, and the college tuition costs go up about 4% a year. That drives additional spend of about $11 million per academic year. So you can easily see, and federal loan limits f course and federal grants don’t’ pace with that $11 million increase or even proportional with that. So we definitely see that as you absorb increases that take place in that space, that private credit demand recovers and follows and grows with that. So we would definitely see double digit kind of growth opportunities organizationally in the private credit marketplace as a whole. This go round with the FFELP federal loan limit increase that took place over the last two years is a little different simply because consumers, you have to layer in the economy and some changes in consumer behavior. But as we’ve said, both Al and I have said, the good news is we’re starting to see applications for this upcoming academic year for the first time increase over the prior academic year, and that’s a very good sign.

[Sameer Gokhale:]

Okay, thanks. And just my last question, I mean you know, in terms of regulation by some sort of consumer protection bureau, maybe it’s a little too early to tell but are there any changes you’re contemplating in response to that oversight that your industry might have? It seems to be targeted more at the for profit programs and lending to students there, but I just went to get a sense of how you think it might impact your business at this point.

[John Remondi:]

Well clearly this is a provision of the Frank (sp) bill that has not been written, right? It just says that his will be established, so we’ll have to wait and see. In our view the private loan space has been under intense scrutiny now for a couple of years, and a lot of practices have changed including our own. So we believe what we are doing today is lending, we’re lending appropriately and we’re doing the right stuff in terms for educating stands and parents about their debt burdens, and requiring school certification before all those issues became mandatory. So we think we’re in a decent position at this stage of the game.

[Sameer Gokhale:]

Okay, thank you.

[Operator:]

Your next question comes from the line of Matt Mowing (sp) with SBR.

[[Matt Mowing]:]

Yeah, hi. Good morning. Mainly the question’s for Jack but can you give us some more details on the $2.6 billion of private loan ABS that you issued in July in terms of maybe all-in pricing and advance rate, and how that compares?

[John Remondi:]

Well, what we did is back in 2009 you may recall we entered into a long-term 12 year credit facility with Goldman Sachs, which we called our TRS facility. And that allowed us to finance AAA and lesser-rated private credit ABS bonds in that facility. We had structured a deal and put it into that at that point in time to obtain the AAA ratings. What we were able to do is buy those bonds back out of that financially, collapse the deal, and then restructure a deal to get better advance rates. The short traunches of the bonds were sold into the marketplace and the long traunches were old back into the TRS facility, which is where we got, is what you want to do because the higher costs of that transaction. In the public space we sold about $1 billion worth of bonds. They had anywhere from a 1- to a 3-and-a-half year average life and were sold at spreads of about 165 to 265 over LIBOR.

[[Matt Mowing]:]

Okay. And the financing rate that you’re paying on the Goldman’s facility, that hasn’t changed?

[John Remondi:]

No, that did not change.

[[Matt Mowing]:]

Okay. Yeah, and one other question in terms of your guidance for this year, are you still looking for targeting about a $50 million restructuring charge?

[Albert Lord:]

It’s more than that, isn’t it?

[John Remondi:]

It should be a little bit higher than that, probably closer to $65 million, $75 million.

[[Matt Mowing]:]

And that’s in the $1.70?

[John Remondi:]

Yes.

[[Matt Mowing]:]

Okay. Thanks

[Operator:]

Your next question comes from the linen of David Glick with Buckingham Research.

[David Glick:]

I was just wondering, can you give us some sense for how much of the funding benefit there is as you continue to repurchase $1 billion or $1.5 billion of debt each quarter? I mean how much is that contributing to margin improvement?

[John Remondi:]

Well, it’s not, what it improves, it improves the net interest margin for sure; it doesn’t really contribute to the student loan spread. I mean basically what’s happening here is the company is collecting its cash flows from its student loan trust and the student loan portfolios, and to a large extent because we’re not refinancing those deals in the marketplace we’re sitting on cash earning as you know in the short markets basically nothing. And if we can turn around and buy back bonds that are yielding LIBOR plus 300 to 400 basis points, that’s the pick up. And so that’s what makes it attractive. It’s really just, it’s the negative carry of short term cash versus the longer-term liabilities.

[David Glick:]

Okay, so you can think of that as return on each incremental $1 billion. Is that 400 over LIBOR?

[John Remondi:]

Well, it’s all captured in the discount immediately. So it doesn’t extend periodically over time.

[David Glick:]

Okay. And then I guess related, how much is the resecuritization of floor income or the floor hedges adding? I mean if we look at the Q2 how much of a benefit was there to the margins?

[John Remondi:]

It was about a $16 million pick up from the prior quarter, and that process kind of continues for an extended period of time. Obviously hedges are entered into at different periods and have different maturity rates. We don’t book everything at once and then get re-exposed all at once as well. S O tuff moves in and out in that category. Clearly the absolute levels, the low absolute levels of interest rates contributed to the value of those floor options, which made the dollar amount on proceeds a little bit higher than usual.

[David Glick:]

Then another question which is just on the repositioning of the nontraditional loan balances, and I guess the inclusion of the partially charged-off loans, when you think about the amount of charge offs in the quarter can you just talk about why balances don’t look like they’re declining very quickly, kind of even in line with charge offs? I guess maybe something’s flowing through the partially charged-off category but…?

[John Remondi:]

I’m not sure what you’re asking here.

[David Glick:]

So it looks like if you had an annualized charge off rate of 18.5%, 18.7 % in this quarter that’s something like, I don’t know, a couple, over I guess $100 and some odd million in charge offs in the quarter on those balances. And the reposted balances, I guess the loan balances are down. It seems like the loan balances are declining more slowly than the amount of charge offs. I mean you’re obviously not making new nontraditional loans.

[John Remondi:]

No, we’re not. What’s happening here is as the $500 million of loans are so moved from in-school status to repayment status, the interest is actually capitalized on that loan at that point in time, and so the principal balance grows beyond that dollar amount, which is why you don’t see the, you know, the decline that you might expect otherwise. But the portfolio, the nontraditional portfolio has declined in balance from $4.7 billion a year ago to $4.1 billion today.

[David Glick:]

Great. And then just on the guarantor fees, those went down some partially for seasonality so they could go back up a little bit in the…

[John Remondi:]

Well normal that would be the case. Normally that would be the case but the FFELP program terminated. The seasonality is on the origination component of our guarantor service business, and so what we- We earn a fee when we process a new guarantee on behalf of our guarantor client. And with the end of the FFELP program on June 30th that revenue source ceases on that date. The account maintenance fee and the default diversion transactions that we do for guarantors will continue over the life of the loan, and will mirror to a large extent kind of the amortization structure of our portfolio as a whole.

[David Glick:]

So basically those fees are trending down only.

[John Remondi:]

Yes.

[David Glick:]

They’re not in other recovery from the…

[John Remondi:]

Right. They’re now in amortization mode like the FFELP portfolio.

[David Glick:]

Okay. Thank you.

[Operator:]

(Operator instructions). Your next question comes from the line of Ed Groshans with Height.

[Ed Groshans:]

Good morning, Jack and Al. How are you?

[John Remondi:]

Good morning

[Ed Groshans:]

So I guess FFELP is over but there was some concern that there would be schools who may or may not be able to transition to Direct Loan and then could possibly leave some students in the lurch as to whether they could get funding before the start of the school year in September and that that would be a benefit to Sallie Mae, that they could step in and originate those loans. Do you have any update on that? Are you seeing some of those issues with some of the schools that could benefit Sallie Mae?

[Albert Lord:]

Only anecdotally. We don’t at this point expect that it’s going to create financial opportunities for Sallie Mae. We very much expect that the Department of Education will manage to get cash to the universities and in a reasonably timely fashion, and at some point then match their loan records to the cash dispersed.

[Ed Groshans:]

Alright. So that opportunity seems like if anything it would be a little bit of a cleanup but…

[Albert Lord:]

I don’t, quite frankly I never thought of it as much of an opportunity.

[Ed Groshans:]

Okay, well great. That was my only question. Thank you so much.

[Albert Lord:]

Sure.

[Operator:]

Your next question comes from the line of Moshe Orenbuch with Credit Suisse.

[Moshe Orenbuch:]

Great, thanks. I was kind of a little confused by the private student loan loss discussion. Awhile back you had said that you thought the private student loan losses had peaked, now they’re higher. I mean you knew before those loans were going into repayment. What’s the current expectation kind of as we go forward? And I’ve got a follow up also.

[Albert Lord:]

I think we said they peaked a year ago, and I don’t think we ever said that there wouldn’t be quarter, sequential quarters where one exceeded the last. But and so I think having said they will peak was trying to make a point in time that really reflected one, the quality of the assets, and secondly the termination of the forbearance phenomena, if you will, where we were- We just had concluded that the forbearance methodology was not anywhere near as effective as it needed to be, particularly in the environment we were in. And so we really cut back on the use of forbearance. And so there was a little bit of a mathematical phenomena last year where the level of charge offs exceeded what we think they would have naturally been without the termination of forbearance. And so we were trying to mark a point in time; weren’t trying to make any kind of economic or any other kind of commentary. I think you may have heard my comments earlier – I do believe the quality of our portfolio gets better with, I would say almost more than believe that it gets better with each passing quarter. The question marks today really relate to the economy.

[John Remondi:]

And there’s definitely a season- I mean you should expect and will continue to see seasonal swings in our charge off rates simply because loans enter repayment in lumpy segments of the calendar, and for borrowers who go to default, that tends to process or follow through from the first time they enter repayment. But charge off rates as a percentage are down dramatically from that Q3 of 2009, where charge off rates for the traditional portfolio were 5.1% for that quarter versus 3.7% this quarter, and 28.5% for the nontraditional portfolio versus 18.7% this quarter.

[Moshe Orenbuch:]

Okay, just as a separate question

[John Remondi:]

Sure. I mean the CP-LIBOR spread was very favorable in Q2 and as we started Q3 that has reversed a bit. It’s obviously early. This is an area that we continue to have some concern, not because- Well, simply because the 90 day financial commercial paper marketplace is shrinking and that just raises a fair amount of concern as the amount of paper that’s being issued is low. And in some days there’s none issued, and so you have a carryover rate. LIBOR’s been a little bit more volatile in this marketplace the last couple of weeks simply because of what’s going on in the economic markets and in Europe. It’s something we are paying close attention to. We’ve addressed this as best we can by hedging to different indices than 3-month LIBOR, particularly 1-month LIBOR where the variability has not been as great. So we’re decreasing our exposure there. But we would very, very much like to see a permanent fix to this and are continue to work in that direction.

[Moshe Orenbuch:]

But the expectation going into the Q3 you said was still for a better spread?

[John Remondi:]

Better- We are assuming, in our forecast for the year we’re assuming a CP-LIBOR spread of 10 basis points for the second half of the year. So worse than what it was in the Q2, which was 3.

[Moshe Orenbuch:]

Okay. Thanks.

[Operator:]

Your next question comes from the line of Eric Beardsley with Barclays Capital.

[Eric Beardsley:]

Hi, thanks. Just wondering if you could update your guidance or provide any color on your OPEX. You talked about it potentially being a $1 billion run rate by the end of 2011. Has that changed at all?

[Albert Lord:]

I think the guidance aws for $1 billion in the year 2010.

[Eric Beardsley:]

Yeah. I think you said by the end of 2011 we could expect a run rate of $1 billion. I was wondering if that was still the goal.

[Albert Lord:]

Yes.

[Eric Beardsley:]

Great. And I just was wondering if you could provide an update on your direct to consumer initiative for private loans and also on the online savings product for deposits.

[John Remondi:]

I think that yes, we can do that. But when we look at operating expenses for entering 2012, we just want to be clear that that’s based on the business mix we have. And as we continue to undertake new initiatives in different areas that number, that doesn’t contemplate growth in other words, from new initiatives, which hopefully we’ll see some more of that, the core acquisitions that might take place in that category. On the DTC side and the consumer deposit side, we’ve had, we did spend a significant amount of dollars investing in that space this year. With private loan demand begin relatively low we certainly did not get the results we would have expected or would have liked to see in the direct to consumer marketing for private loans. You do learn form that process, though, and are able to model and redirect your activities going forward, and so we’d expect to see better results in the upcoming academic year, the ‘10-‘11 academic year. On the consumer deposit side of the equation we’ve achieved actually very good success in that area of attracting deposits from our, particularly from our existing customers and potentially new costumers to Sallie Mae. And we view that as an important step to diversify our funding sources within Sallie Mae Bank and we’re happy with the progress that we’ve made year-to-date in that space.

[Eric Beardsley:]

Okay. Ultimately do you have any idea of what percentage of your deposits that could represent?

[John Remondi:]

Well, our target was to raise $250 million from retail side and we’re a little bit above that in this stage in the game. It’s really going to be a function of what loan demand is for this upcoming academic year.

[Eric Beardsley:]

Okay, great. Thanks a lot.

[Operator:]

Your next question comes from the line of Michael O’Dell with AIG Asset Management.

[Michael O’Dell:]

You guys, I have a particular question in regards to restructuring. There’s been some discussion in the marketplace that there’s a potential for a spin-off of the bank and servicing businesses, that subsequent jamming of the bondholders into a runoff entity with the FFELP loans. Is this an option on the table? And if it is so, how would you expect to fund the bank/servicing business going forward?

[Albert Lord:]

I think you used the term “jamming” with respect to- I assume that you are referencing the entity that would remain after a spin off?

[Michael O’Dell:]

Right.

[Albert Lord:]

Which is where the debt is already. A spin-off of the servicing and the bank, the servicing business and the bank itself is among the things that we are contemplating. We believe the entity that was spun off will finance itself with deposits and would have access to the capital markets, just as we do.

[John Remondi:]

And just to be clear, the debt, the unsecured debt that has been issued to date and is outstanding was issued to support loans on the books, not to support future originations. And so the repayment of that debt was always expected to come from cash flows from existing assets, which if we were to pursue that spin that’s, the sources and uses do not change.

[Michael O’Dell:]

Okay.

[Operator:]

Your next question comes from the line of Michael Taiano with Sandler O’Neill.

[Michael Taiano:]

I just had a follow-up, it hasn’t come up in the discussion in terms of acquisition that are out there in terms of the servicing side and the portfolio acquisitions side. Is that, first off, what are you seeing on that front? And second, is doing anything on that front sort of predicated on you completing the restructuring first?

[John Remondi:]

We see opportunities in the shelf space in three segments

[Michael Taiano:]

Okay, thanks.

[Operator:]

At this time there are no further questions. I would like to turn the call back over to Mr. McGarry for closing remarks.

[Steven McGarry:]

Thank you very much, Cynthia. We do not have any closing remarks. If anybody has any follow-up questions please feel free to call myself or Jill Fischer. Thank you for joining us.

[Operator:]

Ladies and gentlemen, this concludes today’s Sallie Mae Fiscal Q2 2010 earnings conference call. You may now disconnect