SLM Corporation
Q3 2014 Earnings Call Transcript

Published: 23 Oct 2014

[Operator:]

Good morning. My name is Toni, and I will be your conference operator today. At this time, I would like to welcome everyone to the 2014 Q3 Sallie Mae Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-session. (Operator Instructions) Thank you. I would now like to turn the call over to Mr. Brian Cronin, Senior Director, Investor Relations. Sir, you may begin.

[Brian Cronin:]

Thank you, Toni. Good morning and welcome to Sallie Mae’s 2014 third quarter 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 discussions 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 discussions of those factors on the company’s Form 10-Q and other filings with the SEC. During this call, we will refer to non-GAAP measures we call our core earnings. A description of core earnings, a full reconciliation of GAAP measures and our GAAP results can be found in the third quarter 2014 Form 10-Q. This is posted along with the earnings press release on the Investors page at salliemae.com. Thank you. I will now turn the call over to Ray.

[Raymond Quinlan:]

Okay. Thank you, Brian. Good morning and I thank all on the phone for joining us. This is our second quarter report as a standalone company. And I’m fortunate and glad to report on significant progress in all major areas on which we’re focused. And I will recall that when we first did our split, which was back on May 1 or legal day 1, prior to that we had a series of meetings with investors and since that time we’ve continued to do the same. And even in the last quarter’s meeting, we outlined five goals and we will keep those goals and so let me briefly summarize both the goals as well as our progress in regard to them. The first was to prudently grow the private loan assets and revenues, and we are doing very well against that goal. We originated $1.6 billion of new loans in the quarter, an increase of 8% from the prior year. We are on track for the previously stated goal of $4 billion in originations for 2014. We have grown our portfolio on the books even after the asset sale by 26% to $7.8 billion. We are at $3.5 billion year to-date, also plus 8% from the prior year. And against that goal, it’s steady progress in line with what we had communicated in the prior periods and we continue to be confident that the full year number is obtainable and in fact, recent events have made us more comfortable with that. The second goal was to maintain a strong capital position. Our capital ratios are all significantly above what a well-capitalized institution would have as sort of promulgated by our regulators. Our Tier 1 to total average assets is 12.3% against the guideline for well capitalized of 5%. Our Tier 1 divided risk weighted assets is 15.8% versus a target of 6%. And total capital divided by risk weighted assets of 16.5% for us is greatly in excess of the well capitalized number of 10%. Our third goal was to complete the necessary steps to allow the bank to independently originate and service the private student loan business. This is a continuum that goes back to 2013, but in 2014 a series of major milestones have been both focused upon and as well as accomplished. So even prior to our legal day 1 back in May, we were moving into the bank, so the infrastructure would be in place as we prepared for the separation. We did successfully have our spin on 5/1, also at that time we started to move some of the operations into the bank including importantly collections. We had talked about the necessity of proving the ability of ourselves to manage our growth in the balance sheet. Part and parcel of that particular objective was the ability to sell assets at an attractive rate so that, one, we could manage the growth in the balance sheet; two, is we could get verification at the quality of your assets is shared by others in addition to ourselves; and three, that we have the executional capability to bring that about. That was accomplished in August. Steve will talk more about that. We had an operating day 1, which is the conversion of the service platforms, which occurred on October 13, that has been very successful and we are now moving into the sixth step associated with this transference, and that will be the clean-up of a couple of systems which were not moved over on operating day 1 and in keeping with our plan. So we’re well on our way to independence and providing our own customer service experience. Our fourth goal is to expand the bank’s capability and to enhance risk oversight and internal controls. We continue to make good progress here as well. As reported in the last quarter meeting, our cease-and-desist order which was extinct since 2008 has been lifted. We do have a consent order that was promulgated in 2014. We are on track to meet all of the conditions associated with the consent order. We have completed our annual safety and soundness report from the FDIC. We’re in the process of sharing with our regulators our plan for the next several years and we are making good progress both in our ambitions as well as in our day to day activities with them. Our fifth goal, to manage the operating expenses while improving efficiency and customer service. And as we gave a goal for the – or guidance for the operating expenses for this year to be $280 million base and $32 million associated with restructuring and the separation expenses. We are very much on target for those numbers and so we’d like to reinforce that. So those are five goals. We will keep those. We will continue to focus on them, so there’ll be no change in our continuum of management activity here. But just a walk down the income statement and how those goals reflect themselves in the financial, so I’ll take a minute to do that. So if we were to think about this, the gross volume of the $4 billion is very much on track. The second piece associated with that is the profile of the new acquisitions. And as you know, we've been comforted by the fact that, in prior periods we have communicated that, we have a 745 average FICO score for our new applicants. During this quarter, even while we were hitting those attractive numbers, we have increased the quality of the through-the-door population, so that for the $1.6 billion in originated loans during the third quarter, the average FICO score was higher than our previously experienced 745 and, in fact, it's 750. And so, while we're increasing volume, we're also increasing quality, which we believe is a virtuous cycle. The yield at 8.2% still very attractive, down a couple of basis points but, of course, higher FICO's will give you lower yields as is appropriate. And so, it’s very consistent so far as a risk weighted or a risk adjusted revenue number right in line with our business model. Our NIM is 5.25% continues to be extremely attractive and, in fact, is an improvement from last year's NIM of 5.14%. As I noted earlier, as we move to OpEx, we are on target. And just to talk about the pre-tax income dynamics, and not to lose forest for the trees, because sometimes these published numbers are a little difficult to wind one’s way through. If we were to both compare our nine months for 2014 versus 2013, on a pre-tax number, all these numbers are straight from the 10-Q. Pre-tax this year is $138 million year-to-date, last year it was $79 million. As I said, Steve, will talk about the gain on sale, but let’s remove that from both numbers. $85 million this year, giving you pre-tax adjusted for $53 million; $43 million last year, with the $79 million reduced by $43 million to $36 million. This year in our income statement, we have as noted in the 10-Q, $14 million in restructure expenses. And so, the $53 million we would increase by that $14 million in order to get to a more normalized run rate. So this year's number for pre-tax income would be the $138 million less the gain on sale of $85 million plus the $14 million of restructured, which are non-recurring or $67 million. Last year $79 million as reported, less the gain on sale of $43 million, $36 million, so underlying income statement dynamics are $67 million in pre-tax income this year, $36 million last year, an increase of 86%. And that reflects all of the numbers that change in the portfolio that we talked about, the change in the balance sheet, our balance sheet is up $1 billion year-over-year. Of that $1 billion, $1.1 billion more than a 100% is reflected in the balance associated with private student loan business. In addition to that, we've made as I said, great progress on gain on sale and the management team has been in place now for, at least, well more than a full quarter than we rounded it out with the hiring of Jeff Dale as a Chief Risk Officer late in July. And so, as we go forward as we will talk about this more, the guidance will be that $4 billion for originations, the $312 million for operating expenses, $0.42 to $0.43 heightened by a $0.01 on EPS guidance and loan loss reserve increases of $35 million. As we entered the fourth quarter and indeed as we enter 2015, we will then recur to these five goals, we have consistent focus, we have made consistent progress, and I have the base of pleasure to be able to report it. So thank you very much. And I will turn this over to Steve.

[Steven McGarry:]

Thank you, Ray. Good morning, everyone. We will take a closer look at the financials now, I will be referencing the earnings call presentation available on our website, and we'll be starting out with Slide 4. Outstanding private education loans at September 30, 2014 was $7.8 billion, up 26% from the prior year and 5% from the prior quarter. Net interest income for the second quarter was $144 million, which was flat to Q2 and $27 million, or 23% higher than the prior year quarter, primarily due to the increase in our portfolio of loans. The Bank's net interest margin on interest earning assets was 5.25% compared to 5.33% in the prior quarter and 5.14% in the prior year. The average yield on the education loan portfolio was 8.20% compared to 8.23% in the prior quarter and 8.22% in the year-ago quarter, so pretty steady there. Our cost of funds was 1.07% compared to 94 basis points in the prior quarter and 1.11% in the year-ago quarter. As you may recall from Q2, we reported a large ineffective hedge, because this swap was ineffective, the cash flows associated with it ran through the other income line instead of net interest income in Q2. Now that that swap is effective those cash flows ramp through the net interest income line in this quarter. On this swap we pay a fixed rate and receive LIBOR to convert our fixed rate loans to variable. This had the impact of increasing our reported cost of funds by 16 basis points from Q2 to Q3. This was offset somewhat by the new funding that we raised in the quarter which was significantly cheaper than the maturing funding if replaced, which reduced the overall increase in cost of funds to up 13 basis points for the quarter. Other income totaled $96 million in the quarter, an increase of $43 million from the prior year, the increase was driven primarily by a gain on loan sales of $1.2 billion. We recorded a gain of $85 million, $42 million higher than the previous year. But let’s drill down into that number a little bit further. In August, we sold $1.12 billion of loans through the whole loan sales and the securitization transaction with third parties that generated gain of $86 million. On August 8, we announced our first loan sale in the form of an asset-backed securitization. In this transaction all securities including the entire residual in the loans were privately placed with a single third-party investment manager. Additionally, we announced an agreement to sell Smart Option Student Loan to Navient Corporation. The loans included in these two sales were primarily split loan customers, meaning they were customers who had a loan owned by Sallie Mae and a loan owned by Navient. These split loans will now be entirely owned or service by Navient which will provide a consistent servicing experience to these customers going forward, now that we’re two separate companies. While it took longer to close these transactions than we would have liked, this is not unusual for a first transaction. Now, as we’ve established our ABS program and executed the whole loan sale, we think future transactions will be much easier to close. We’re confident that there is robust demand from a variety of investors for whole loans as well as residual sales based on the feedback we received subsequently closing these transactions. Looking forward, we do not expect to be selling loans until late in Q1 2015 at the earliest. And we know how important these transactions are to investors’ model, so we’ll make every effort to provide details on our loan sale program in our Q4 earning earnings call we set for 2015 year. Third quarter OpEx were $73 million compared with $70 million in the year-ago quarter. In addition, there were $14 million in restricting costs, primarily related to the roll-out of our new servicing platform which Ray mentioned, we completed just two weeks ago. Year-to-date, we spent $28 million in one-time restructuring and reorganization expenses as a result of the spin. We received many questions from investors about how operating expenses will grow in future years, so I’d like to provide a framework for this line item here today in the call. We talked about our efficiency ratio in the queue. Our efficiency ratio to the first nine months of the year is 38%. We expect to end the year with an efficiency ratio closer to 43%.It suppresses this quarter and year-to-date because of the loan sale revenue that we booked so far. We define those efficiency ratio as operating expenses excluding restricting costs divided by net interest revenue asset provision plus other income. And other fact to consider is well in excess of 50% of our operating expenses today are fixed rate. So as we grow our top line by adding assets over the next several years we can significantly lever our cost structure. It’s our goal to achieve an expense ratio – an efficiency ratio approaching the mid-30s over the next three years. Turning to tax rate for the quarter, tax rate year-to-date was 40% compared to 38% a year-ago. As we discussed in the past higher tax rate is driven by higher state tax rates post spin transactions. Our expectation is that our tax rate for the full-year will be pretty close to 40%. Ray talked about our capitalization, the bank remains well capitalized with the risk based capital ratio of 16.5% at the end of the quarter, significantly exceeding the 10% risk-based capital ratio, which what we require to be considered well capitalized. In addition, the parent company has $431 million of capital available to the bank is an additional source of strength. We will continue to maintain high levels of capital to support the projected growth of the company. We do not anticipate returning capital to shareholders as we reinvest in our business. Turning to Slide 5, you will see a summary of our origination volume. Ray already mentioned that we grew our loan originations 8% in the quarter. Year-to-date it originated $3.5 billion of private education loans. The loans we originated in the quarter had a FICO score of 750 on average and 92% of these loans had a cosigner. This compares to 746 and 92% in the prior year originations. There is seasonality in cosigner rates. They are typically higher in the first and third quarter because this is when loans for more traditional students are dispersed. And we continue to expect that originations for the full year will be 90% cosigned. As you remember from our comments last quarter the timing of charge-offs has changed post-spin loans are now charged-off at 120 days of delinquency from the bank when they used to be charged-off after 212 days of delinquency at the core. In addition, prior of the spin our policy was to sell delinquent loans and loans that used forbearance from the bank to the corporation. For all these reasons historical credit indicators and period over period trends are not comparable and may not be indicative of what our future performance maybe. We report our current performance statistics on page six. As you can see, loans delinquent 30 plus days, where 1.3% compared to 1.5% in the year-ago quarter. And loans in forbearance have increased to 1.63% from just 0.13% in the year-ago quarter. Charge-offs in the quarter were 0.4%. So these numbers were all well within our expectations for this young portfolio. Our loan portfolio is seasoning and this process will continue over the next several months. But we will establish meaningful performance on this portfolio within the next six months. Currently, 19% of our loans are in full principal and interest repayment. In June, we have a large cohort of $366 million of loans have entered full principal and interest repayment. Loan from this cohort that becomes delinquent are working their way through the pockets now and are likely to charge-off in the fourth quarter. And in the fourth quarter, we will have an additional $875 million of loans enter full principal and interest repayment. This will bring our sensitive loans in full PNI up significantly to 28%. Loans from this cohort that become delinquent will charge-off early in Q2 of 2015. We’re going to be following the progress of these cohorts very closely and reporting to you on the performance of these loans. This pattern of loans entering full PNI will repeat itself in 2015 and beyond, so we will see seasonality begin to be present in our performance statistic, so keep that in mind. Because the bank’s portfolio is comprised of high-quality loans that has demonstrated very strong performance in the past and our underwriting practices have not changed subsequent to the spin. We are confident that this portfolio will continue to perform very well. Our expectation continues to be that our Smart Option Loans will have cumulative cohort default rates in the neighborhood of 7% and annualized loss rates will fluctuate around 1% depending upon the quarter and the seasoning of the portfolio. To-date we have classified $13 million of loans as TDRs. Moving forward to talk about the allowance, the allowance for private education loan losses increased from $54 million to $60 million in the quarter. It stands today at 1.3% of loans in repayment. Self-allowance was unchanged at $6 million. The increase in the allowance is primarily a result of the increases in TDR balances and the impact of an increase in loans entering full principal and interest repayment. We will continue to build our loan loss allowance to reserve for an emerging TDR portfolio and the seasoning of our loans as we just discussed. We expect the provision to be around $35 million in Q4. We will continue to take a conservative approach to our provision for two main reasons. First, we have significant volumes of loans entering repayment and second, we are still monitoring our roll rates as we build our collections experience under our new charge-off policy. SLM has historically reported core earnings. We will continue to provide core earnings with a revised definition. We use derivatives, predominately interest rate swaps to manage our interest rate risk in the portfolio. We believe all these hedges are sound economic hedges. As we discussed earlier in August we received hedge effectiveness on the hedge that was causing the vast majority of the ineffectiveness. So we do expect future derivative volatility and the difference between cap and core to be minimal core earnings. Core earnings factor on Slide 7. Diluted earnings per share compared with $49 million, or $0.11 this quarter compared with the year-ago quarter, core 1.7% in Q2 and 2.1% in the year-ago quarter, our core was 24% compared to 15.4% in Q2, and 16.3% a year-ago quarter. A large gain on sales is the primary driver for our rates this quarter. Our expectation is that ROE and ROA is 7.7% [ph] and 15.7% respectively for the full year. Ray talked about our guidance, so I won’t reiterate it here. That ends my prepared remarks and now we will open up the call for questions.

[Raymond Quinlan:]

Okay, Toni. We are ready for questions.

[Operator:]

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

[Mark DeVries:]

Hey, thanks. I know, it may be early and hard to answer, Steve, but any thoughts on whether kind of the weakness we see in the credit markets may impact how robust that demand is for the private student loan sales?

[Steven McGarry:]

Mark, there hasn’t been any major impact on the ABS market, I think it’s backed up a little bit. Navient actually did a deal on the midst of that some turmoil in the credit markets and that deal actually went very well. And I think the back side of that is there has been a big decline, there was big decline in the credit markets in terms of the yield as a result of what went on in that period. So I think that more than anything else is the kind of thing that’s been feeding demand for our private student loan sales. So I would say at this point in time I think the market would probably be a little bit better than where we sold our loans back in August as opposed to having declined at all.

[Mark DeVries:]

Okay, and that’s helpful. Now given how strong that market is being, can you give us some thoughts on how you are thinking about potentially selling down the piece which may sell down to $1.3 billion of FFELP assets as a way to kind of offset some of the need you have to sell private student loans to remain within your kind of your 20% asset growth limit?

[Steven McGarry:]

Yes, I mean Mark, we kind of view the FFELP portfolio as an adjunct to our liquidity portfolio, depending upon the market prices for private versus FFELP we might consider selling that FFELP loans prior of doing the private loans. But I think the bigger question that’s going to govern the pace of our loan sales will be the actual price of what we can receive for these assets versus what we think our break-even pull rate would be on them. So I know it doesn’t really answer the question, but there are lot of variables that are going to go into the decision to decide which assets we sell at any given moment.

[Mark DeVries:]

Okay, got it. And just one last question, what if any implications can you think of for your loan sell efforts could there be from the recent finalization of the risk retention roles?

[Steven McGarry:]

So the risk retention roles have been kicking around for many years as you know. I guess they were finalized this week. I don’t think that it really changes our ability to sell loans versus via the securitization transaction will be requiring the whole 5% of each slice of the structure of the bonds. And that should not change our ability to deconsolidate these loans and it shouldn’t change the pricing or demand dynamic for product yield.

[Mark DeVries:]

Okay, great. Thank you.

[Operator:]

Your next question comes from the line of Brad Ball with Evercore.

[Brad Ball:]

Thanks. I appreciate your comments about OpEx and your targeted – longer-term targeted efficiency ratio. But if you look at your fourth quarter implied OpEx based on guidance it’s about $80 million. Is that an appropriate run rate as we look out into 2015?

[Steven McGarry:]

Brad, I think if you annualized the $80 million. It is a pretty good proxy for where we might end-up for the full-year of 2015 on a run rate basis, excluding any additional bandbox or costs along those lines. There are some gives and takes. I mean the fourth quarter is not one of our peak spending quarters in terms of loan origination with direct to consumer spend, but there are some minuses that we see, that are going to happen in the fourth quarter. So the short answer is, yes, we annualize that $80 million and come out to $320 million rate. That is a good as starting point as anything.

[Brad Ball:]

Great, that’s helpful. And then, on the credit side, so your new guidance for the fourth quarter provision, $35 million, together with what you reported for the third quarter. So that’s below, I think you had said $60 million for the second half of 2014. Does that suggest that credit is performing better than you had expected that were coming in with a lower provision for 2H 2014 than you previously guided?

[Steven McGarry:]

I think that’s a fair conclusion, Brad. We saw that the emerging TDR portfolio that was lower than we had prior, previously forecast and delinquencies and charge-offs came in somewhat lower. And I would balance that or caution that with looking forward into the fourth quarter. We do have those big slugs of loans entering full principal and interest of repayments. So we will continue to be somewhat conservative, but yes, we are very happy so far with how we’re seeing the portfolio perform in these early stages as it starts the season.

[Brad Ball:]

And the tick-up in the average FICO to 758, somewhere in that range. Does that suggest that the competitive environment is still rational that you’re able to tighten credit, be more strict with your underwriting and therefore bring on better loans and more broadly can you talk about the credit environment, or sorry, the competitive environment vis-à-vis the parent plus offering that’s out there from department of ed.

[Raymond Quinlan:]

Sure, this is Ray. One is in regard to the profile change, I want to say this is not a staggering change well in terms of 745, 750. It is a gratifying change. And it does reflect the fact that the combination of our service and our products are remained attractive to audiences that clearly at a 750 FICO have additional credit options available to them. And so it is this case that the environmental dynamics one might intuit from that are fairly stable and if anything marginally more attractive than they have been I suppose to one might think of in more to the hostile environment. And so that’s very good. Our audience is a group that, those of other options available, if you’re indicating, but thus far as I said, with the combination of our sales effort on campuses, our attractiveness as a product offering and our throughput, we’ve been able to not only maintain the credit quality, but we’ve also in our early indications that our market share is if anything up from an already high level. So we’re quite happy with the way things have gone. And rationality is a little bit in the eye of the beholder, but that’s a point I would say stability in the market dynamics is closer to accurate than any other word.

[Brad Ball:]

Great, thanks. And then, last quick one, Steve. Could you reconcile in the gain on sale, I think in the queue you had indicated $1.2 billion of sales versus the $1.1 billion that you mentioned in August and $85 million of gains versus the $86 million that you mentioned relative to the August sales. What – were there other small transactions in there that drove the difference?

[Steven McGarry:]

Yes, I can Brad, and I apologize for any confusion that that may have created. What also ran through that line in the third quarter was the sale of some non-performing loans that occurred at a discounted price so that lessened the gain and increased the sales volume.

[Brad Ball:]

And those NPLs made up the difference again between the $1.1 billion and the $1.2 billion as reported?

[Steven McGarry:]

That’s correct.

[Brad Ball:]

Okay, that’s perfect. Thank you.

[Operator:]

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

[Michael Tarkan:]

Thank you. So, back on credit for a second, I know you’re being conservative at this point. But I did hear that you will have experience established within the next six months. Is it possible that you’ll revisit how you’re provisioning at that point?

[Steven McGarry:]

Yes, Michael, as you recall, we have a pretty long discussion about this on the second quarter conference call. Basically, what we are using is a migration model we track how loans migrate through the delinquency pockets. And because we don’t have any real history with our 120 day collection policy, what we’re using as a hybrid of roll rates under the old 210 day charge-off approach and roll rates under the 120 day charge-off approach. So we’ve now got 10 months of roll rates in the early pockets under the 210 day charge-off approach when – just the point I want to make is under that approach not a lot of collection activity took place between day zero and 120, so they tend to be very conservative and lead to a higher estimate. Our new role rates under the zero to 120 day charge-off policy are lower than we experienced under the prior policy. Does that make sense, you’re able to follow-on on the point I made here.

[Michael Tarkan:]

It does, it does actually, but…

[Steven McGarry:]

So what’s going to happen with the passing of every quarter, we have three new and we dropout three old. And we will revisit the models at the end of year and determine if it makes sense to continue with that or if there any enhancements that we need to make based on what we learned over the course of the first seven months of operating the company under the new charge-off policy.

[Michael Tarkan:]

And I understand that it’s still early days there, but would you say that the, your ability to sort of cure or – rehabilitate loans, modify loans within the earlier buckets, is that sort of trending ahead of your expectations?

[Raymond Quinlan:]

Yes, yes, all the credit metrics are running positively. We've got a very strong team and it’s a group with – it has a lot of leaders from the previous company that are working our private credit default conversion strategies and they're definitely not unhappy with the success we are having so far.

[Michael Tarkan:]

Okay. And then last on the credit side, should we think about sort of provisions for 2015 more in line with the $50 million back-half of the year run rate, or is that $35 million in the fourth quarter a better sort of estimate on a quarterly basis, another some seasonality for loans coming into repayment, but just trying to get a sense for, maybe 2015 at this point?

[Raymond Quinlan:]

Michael, I'm going to respectfully hunt the answer to that question. And so we get together again in three months when we sit down and talk about where our 2015 guidance are going to shake out.

[Michael Tarkan:]

Understood. Last one, on the expense side, I believe you are still using them into origination platform. So I guess, as you build out capability there in the first-half of 2015, are you expecting any kind of meaningful uptick in expense associated with that?

[Raymond Quinlan:]

No, we're not. The PSA that we had with Navient restructured such that, I think, it reflected pretty accurately across that we expect to incur now that we're up and running under our own servicing platform. So there should not be an uptick related to higher servicing costs, obviously operating expenses are going to grow as the volume increases, because there will be variable components of that. But over the long run, we look forward to the day that our servicing platform is established that we can begin to see the benefit of scaling the operation in the out years.

[Michael Tarkan:]

Got it. Thank you very much.

[Operator:]

Your next question comes from the line of Sameer Gokhale with Janney Capital Markets.

[Sameer Gokhale:]

Good morning. I had a question firstly about operating expenses, and Steve, you talked about perhaps half of your expense base being fixed cost and the other half variable cost. And I'm trying to think about the interplay between the two that there are several moving parts here, but you have given a sense for where your efficiency ratio could go over the next three years. But within the three-year period, I'm trying to get a sense for how that ratio should trend from the standpoint of post-default collections to the extent that your portfolio seasons and then you have more upward pressure from not a pre-default servicing standpoint, but a post-default collection standpoint. It seems like, there is probably some disproportionately higher upward pressure over the next, say, 12 to 24 months, and after you get through maybe that seasoning bulge if you will then you see more of an improvement in the year three. Is that the right way to think about it from a timing standpoint, or do you think that, we should see more of a straight line decrease in your efficiency ratio over time?

[Steven McGarry:]

Now, I think, you're pretty spot on Sameer. I mean, we'll finish the year at 43%. It is not concluded, out of the question and in fact it could tick-up before it begins to tick back down in 2016 and 2017. I mean, we really start to hit our stride post-2015 and into 2016 and 2017 when we look at our longer-term projections.

[Sameer Gokhale:]

Okay. And then on a different note, as we think about origination volumes looking out the next 12 months or couple of years, I'm sure you are having discussions with schools on an ongoing basis and have a sense for tuition increases based on what they've either spoken with you about or more generally what they are talking about? And can you share with us, sense for where those tuition costs increases are headed, at least, from what you are sharing, should we expect stabilization relative to where we are at now or continued growth in kind of the 2% to 5% range, how should we think about that, because clearly, I think that has an impact on your origination volumes?

[Steven McGarry:]

Yes, clearly that is true. And as we've tried to catch – capture that dynamic, there is a couple of pieces to start off with so far is that the definition of tuition. And so there is the post-tuition and then there is the realized expense for the household, and so as has been well publicized in many journals. Through the last two years, colleges have, one, try to create a better cost curve for the top line increase, which as you are indicating a 3% to 5% and in an inflationary world, we could estimate 3% currently, 1% to 2% will be 2x the rate of inflation. And so that has been the rearview mirror of view of things. Colleges have tried to get that under control. They have in fact been somewhat successful in that. But they've also at the same time increased their discounting. And so when we look at our piece in this particular market, we are funding what households typically have to pay. And so that talks about the net increase, not the gross. So our general thinking on this is that by the time we get to what's available for us to offer families on a financing standpoint, we're probably about some rate of inflation, and so that’s a 1% 2% rate that seems to be about the best indicator for what we will see the increase in our market value today.

[Sameer Gokhale:]

Okay. So then would that suggest, I mean, clearly, there is a loss of large numbers as you continue to originate, but the expectation will be some moderation the growth rate of your originations as we look at the next year or two relative to what you are expecting for fiscal year, correct?

[Steven McGarry:]

Well, for this full-year if we look at what we originated when we go back to the slide presentation, we are forecasting a 5% increase for the full-year from 3.8% last year to 4% this year. We are running slightly ahead of that as we end the third quarter. And so a 5% increase going forward is a number that reasonable people could think is a good barometer in a world that has reasonable amount of noise in it. But I would say, that’s about as good a number as they need to start with.

[Sameer Gokhale:]

Okay, perfect. Thank you.

[Operator:]

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

[Unidentified Analyst:]

Hi, thanks. This is actually Steven filling in for Sanjay. Most of our questions have been answered. But just want to touch base around the servicing aspect given that now you have the platform up, how should we think about the benefits of it going forward?

[Raymond Quinlan:]

The benefits of the servicing platform going forward, Steve? I mean, first and foremost we are now a standalone independent company. It helps us on loan sales and asset-backed runs, and it’s very important and as a lender, you service your own loans. Since the inception, we have controlled the collections of it, so we certainly want to be running our own default version programs. And going forward, we think that we're going to be able to take advantage of scale and lower our operating costs as we move forward.

[Unidentified Analyst:]

Got it. And then is there any potential to service other assets as well?

[Raymond Quinlan:]

That’s certainly not a strategy that we are considering at this point in time. And servicing student loans is much different than servicing other consumer asset classes. And I think we will stick to the business that we know the best for the foreseeable kind of longer-term future. We might at some point look to originate other consumer loan products, but that’s going to be a 2016 or 2017 event as I refers to 2015 event.

[Steven McGarry:]

So it’s right to say that in keeping with the conversation that we've had since pre-spin and those FICOs I mentioned before, we are looking for consistency and our focus in consistency and our performance deliverables. And so as we look at the near-term future, Steve is indicating, we think that proposition that we basically have in front of us, with the market share that we have, the quality of portfolio that we have, the significant resources that we have that allow us to maintain that market share and increasingly our tailored service platform as you talked about is just fine. So we will stick to the core plan for the foreseeable future and we think the results associated with that will be very attractive.

[Unidentified Analyst:]

Got it, great. Thanks for taking my question.

[Operator:]

(Operator Instructions) Your next question comes from the line of David Hochstim with Buckingham Research.

[David Hochstim:]

All right. Thanks. I’m wondering – could you talk about any difference in the credit profile of borrowers who choose interest-only or fixed pay loans rather than fully deferred loans? Are you still doing over – little over 50% to borrowers who choose to make payments. It’s obviously good in terms of credit performance subsequently. But I just wondered, if you see anything at origination there would – just as a difference in the borrower characteristics.

[Steven McGarry:]

No, there is no meaningful difference between loans – between borrowers that select the deferred product as opposed to fixed pay with a full interest-only pay. And we don’t really see any difference between. I think you also talked about fixed versus variable. Our – the customer profile is pretty steady across the different product selections.

[Raymond Quinlan:]

Yeah.

[David Hochstim:]

Okay.

[Raymond Quinlan:]

And I try to say that (inaudible) add up the raw numbers and say to you. Let’s look at the entire population and often to make one of the in-school payment fees, the fixed or the interest-only, which as you’re indicating. Yes, it was running about 57% of our new applicants as they’re new loan originations. We would say (inaudible) mildly better, but let’s remember that the area that we’re in which is the 750 FICO on average and so it’s a very good neighborhood to begin with. And the differences are quite slight. So we’re not reading anything into that.

[David Hochstim:]

Okay. And then, if you end up originating more than the 5% you’ve targeted the…?

[Raymond Quinlan:]

We’ll return it.

[David Hochstim:]

Okay. So…

[Raymond Quinlan:]

No.

[David Hochstim:]

We’d be able to put those loans in here, or do you have cut off – you have to cut off originations in the first quarter?

[Raymond Quinlan:]

No. And…

[David Hochstim:]

What happens?

[Raymond Quinlan:]

So this is on the point of our 20% growth target. And so the 20% is for the balance sheet and one of the reasons that we’re anxious to get the asset sale done, one is to show our execution ability, two is to show the attractive pricing that’s associated with it. But three is to start to create a market that gives us additional flexibility. And so it is our goal to in no way restrict our position in the marketplace or any of our efforts in regard to originating loans. And so we’ve calibrated the rest of the balance sheet and the business model to, one, maximize our services, and then two, to no way have any inhibition on our position in the marketplace. So any loans or disbursements over the 5% will be greatly welcomed.

[David Hochstim:]

Okay. Great. Thank you.

[Operator:]

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

[Moshe Orenbuch:]

Great. Thanks. I guess, first of all, in terms of the gain on sale, the two pieces that you sold, obviously, it would seem that the gain to – on the piece to Navient given that they – that you weren’t able to sell those with the servicing would be lower and seem from their numbers that that was substantially lower than the average that you talked about. And then mathematically it would mean that a gain on the rest of the sale was actually substantially larger, probably above the range that you had previously said. Does that math make sense?

[Steven McGarry:]

I don’t know how you arrived at that conclusion, Moshe, but the answer is absolutely not. The prices on both tranches were very similar.

[Moshe Orenbuch:]

Got it. So…

[Steven McGarry:]

And you know…

[Moshe Orenbuch:]

Yes, yes, I’m sorry. Go ahead.

[Steven McGarry:]

The servicing issue was not a major component of the price for the piece that we sold into third-party market. And those loans had to be serviced one way or another; so couldn’t end up being a major determinant. But I’d be curious for you to walk me through, because the math not necessarily right now as that would be wise at the conclusion that there was a big disparity between the pricing on the two loan sets.

[Moshe Orenbuch:]

Okay. We could take that off-line. Separately on – just on the idea of kind of the inflation in tuition. I mean, isn’t it fair to say that some of the federal programs and loan programs don’t have their limits increasing and so for any given percentage increase if you will and the parents obligation it kind of gets, grows a little bit faster than in terms of what they might need to find from other sources.

[Raymond Quinlan:]

Certainly that’s true and if we were to look at how America pays for college as you would know it’s about $400 billion a month each year and the federal government provides about 25% of that, right. And we will be expecting the full part to be growing at 2% or thereabout. And one of the players is at 0% – the one– it will increase the burden on household so far as their funding, so far as out of savings that sort of thing, and should provide some upward lift to the basic private student loan market. And so mathematically that would be true. Predicting politics has been a difficult sport in the past and I suspect it’ll be difficult in the future.

[Moshe Orenbuch:]

Right. And then just lastly in the – just to kind of not to beat the roll rate discussion any further. But I mean it sounded like the premise that you’re operating under is that the roll rates that you’re seeing from your new kind of shorter earlier collections are as good or better than what you had previously expected. I mean is that fair statement?

[Steven McGarry:]

Yeah. That’s absolutely a fair statement, but don’t forget Moshe when you’re putting together financial statements you have to be able to document the models that you’re using to arrive at the entry, so you do put things such as the loan loss allowance and the provision, and because we did not have a – we didn’t really have any history of collecting under the 0 to 120 policy we had no other option but to go back use the history of what occurred between 0 and 120 days under the old 210 day collection policy.

[Moshe Orenbuch:]

Right. I got that. It’s just – I’m trying to say like as we’re progressing, we have every reason to believe that the – that your earlier expectations will be realized and so…

[Steven McGarry:]

Yeah. And look, absolutely. And it’s based on a reasonably substantial history of Smart Option Student Loan performance. We started originating this product in 2009 and as you know the characteristics of each cohort has been spot on. It’s basically been 90% cosigned and 746 FICO each and every year. So there’s been a lot of – the loan cohorts has been very homogenous so from the work that we do, tracking the performance of those loans, we’re very confident that our current portfolio is going to perform in a very similar fashion.

[Moshe Orenbuch:]

Great. And just the very last thing from me is did you mention how much the loss on the NPL sale kind of hit the gain on sale, dollars at all?

[Steven McGarry:]

No, but I mean, between 86 and 85 and it’s basically loan.

[Moshe Orenbuch:]

Got it. Okay. Thanks very much.

[Operator:]

Your next question comes from the line of Eric Beardsley with Goldman Sachs.

[Eric Beardsley:]

Hi, thank you. Just another question on the expenses, if we’re to look at the progression over the last, I guess, couple of quarters and then your guidance for the fourth quarter, as you’ve seen a relatively steady ramp up in OpEx excluding the restructuring, and just on the commentary of potentially annualizing the fourth quarter run rate, I guess, that will be, I don’t know, on my math, it’s somewhere between 14% and 15% year-over-year growth rate. And your OpEx if you’re to do that, I guess, that sounds either quite conservative relative to the asset growth or I guess is there something else going on and how – everything about the seasonality of those expenses going forward?

[Steven McGarry:]

So I mean, the seasonality of the expenses is going to be very similar what it’s been in the past. I mean, our peak season is third quarter and we also passed a heck of a lot of loans in the first quarter. So those would be certainly your peaks, but I think your growth rate that you’re talking about is pretty much what we’re expecting and certainly not going to be disappointed if our OpEx growth rate is substantially lower than our portfolio and top line growth. I mean…

[Eric Beardsley:]

What’s driving the OpEx higher in the fourth quarter relative to the third given that third is the peak for origination?

[Steven McGarry:]

Yes. And I mentioned earlier when I was answering the initial question that there are some gives and takes. And I did point out that typically the fourth quarter is one of our lower OpEx run rate quarters because we’re not spending much on direct to consumer. We’re not processing huge amounts of loan disbursements. The fact to the matter is, there are a couple of one-time or type of things that are going to occur in the fourth quarter. So it’s more happenstance than the fact that it’s a pretty good quarter to annualize for a run rate.

[Eric Beardsley:]

Okay. But otherwise excluding those, you would have expected to be less than the third quarter?

[Raymond Quinlan:]

Yes, we are still trending a little bit for the extra money on IT expenditure related to the separation of restructuring program and we are ramping up some of the expenses in our collection center that’s causing Q4 to be a little bit higher than it would otherwise be from a seasonal standpoint.

[Eric Beardsley:]

Okay. And on the MPL sales, is that something you'd expected continue to do moving forward?

[Raymond Quinlan:]

I would not expect to see additional nonperforming loan sales running through that line.

[Eric Beardsley:]

Okay. And then as you guys look out as an industrial loan corporation today, how you think about the potential to do a chartered change and what the incremental costs for compliance might be to do that?

[Raymond Quinlan:]

As we look at our business model and match it up to our legal vehicle, which is the ILC. Right now there is nothing that would be inconsistent in our goals for the business that would somehow be restricted by the ILC. So we have at this juncture no plans to change the ILC. Changing to a different charter given the compliance and restrictions that we currently have would probably be a relatively small change. And, in fact that TIC, obviously, yeah, we did change from an ILC to a state chartered non-member bank and the transition was quite smooth and did not incur any additional incremental expenses of any significance.

[Eric Beardsley:]

Okay. In terms of dealing with the fed and the OCC that’s not more onerous in terms of staffing or anything you need from a head count perspective?

[Steven McGarry:]

Well, first, let me reinforce that, we are (inaudible) today and we are not envisioning changing. Second is, when we look at that, we will look at the trade-off associated with that. Thirdly, the expectation would be that there would be no large increment in expenses.

[Eric Beardsley:]

Okay. And then just on your plans to diversify your funding, can you just update us on that, potential outlook for ABS issuance?

[Steven McGarry:]

Sure. So that was a very key component of getting our ABS program up and running, establishing our ability to service the loans on our own. We have taken care of that in the current quarter. We'll give the servicing platform a couple of months to season for lack of a better turn, we will then have interested parties come in and view the servicing center and platform you are comfortable with it by those, I mean, interrupted stakeholders such as the rating agencies. And once that process is completed, we would expect that we would be in the market issuing asset-backed securities probably late in the first or early in the second quarter.

[Eric Beardsley:]

Okay.

[Steven McGarry:]

As we sit here today, there is not urgent need to hit that market, but it is a key component of our long-term strategy to term out a considerable amount on the balance sheet. But yes, so late in first quarter or early second quarter, we expect to see the shortcoming to the market.

[Eric Beardsley:]

Got it. And can you just remind us in terms of what percent of your funding you would ideally like to have being ABS and how it might take to reach that?

[Steven McGarry:]

There are no hard and fast targets. The market can certainly bear $2.5 billion to $4 billion a year, and I think that that’s kind of the phase we'll probably target at $2.5 billion issuing for year one and maybe ramp that up as the program develops.

[Eric Beardsley:]

All right. Great. Thank you.

[Operator:]

There seem to be no further questions at this time. I would like to turn the conference back over to Mr. Quinlan for any closing remarks.

[Raymond Quinlan:]

All right. Thank you for joining today. This will conclude the call. Thank you.

[Operator:]

Thank you for your participation. This does conclude today's conference call. You may now disconnect.