Sallie Mae Corporation (SLM) Q4 2017 Earnings Conference Call Transcript

SLM Corporation. (SLM 1.61%)
Q4 2017 Earnings Conference Call
January 18, 2018, 8:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

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

I would now like to turn the call over to our host, Mr. Brian Cronin, Vice President of Investor Relations. Sir, you may begin your conference.

Brian Cronin -- Vice President, Investor Relations

Thank you, April. Good morning and welcome to Sallie Mae's fourth quarter 2017 earnings call. With me today is Ray Quinlan, our CEO and Steve McGarry, our CFO. After the prepared remarks, we will open up the call for questions.

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

During this conference 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 earnings supplement for the quarter ended December 31, 2017. 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.

Ray Quinlan -- Chief Executive Officer

Good morning, all, and thank you, Brian. Today, I'll run through some of the performance indicators for the year, talk a little bit about the outcome, and then focus on some of the trade-offs that we've made as we look at 2018, especially in regard to investments.

As we start the income statement, we always think about volume first. Our volume came in at $4.8 billion of newly disbursed private student loans, on target to our guidance, which had been adjusted after the end of the third quarter. We did gain market share. Our acceptance rate by customers has remained steady. If we approve them, they take our product at about the 81% level. We look at that as an indicator for both our pricing efficiency in regard to pricing elasticity as well as a competitive indicator.

Particularly gratifying is, as we have moved through the years, and thought about moving from one product to multiple products, the first step we took was a year and a half ago, when we introduced Parent Loans. Parent Loans got off to a reasonable start, with not a particularly high volume last year, about $31 million of disbursement. This year, it more than doubled to $77 million of disbursement. The delta increase of $46 million, which was fully one-third of our total increase in a market that did not have good growth characteristics this year.

We're gratified that we are able to introduce new product, get it into the hands of the right people, good coordination between sales and marketing, and the over 100% increase shows that maturation has occurred and is still in progress. This gives us come confidence as we look to the next busy season and the introduction of the six graduate products that we've talked about. We're thinking there's an opportunity in white space on all of these. The question is, can we get those into the right hands and handle the distribution in a world where we think that our product is more than competitive with the current government offerings.

As we look to next year, as you know, we expect total disbursements to go up from the $4.8 billion to $5 billion, about a 4% increase. Second, we look at credit quality, which remains high. 747 average FICO -- our approval rates remain in the mid-40s. We are turning down more people than we are accepting. We are not looking for that last piece of volume, and we have kept a high quality front end as well as portfolio, which we'll talk about through the morning. Our take rate here remains at 80%. Always in credit, one looks to see whether or not you're getting anti-select. We certainly are not.

Next, is our NIM. The pricing and yield of the portfolio for both our customers and our shareholders, at 6%, is extremely attractive. A very high level. The balance sheet is more efficient. We have multiple funding sources. We have a rich source of funding from a portfolio standpoint. We have improved cost to funds. And, as Steve will discuss, that 6% looks to us like a fairly sustainable level.

Then, when we try to measure the overall efficiency of the company as it's growing, think about one-third in terms of EPS each year, we use the operating efficiency ratio as a guide to make sure that we are within the guardrails and not being misled by growth. As you know, our efficiency ratio has a very attractive track record, going back to '14 and through '18. We had a 51% efficiency ratio is '14, 47% in '15, 40% in '16, 38.4% in '17, and we're guiding to a 37-38% number in '18.

So, over the course of five years, we've made continuous improvement on this particular measure, which we think is a key one for us. In 2017 in particular, operating expenses were up 16.3%, a big increase in expenses. Revenues, however, were up 20.2%. Obviously, the math of a fraction allows us to have an improved efficiency ratio despite a 16% growth in opex, which is clearly warranted given the growth of the portfolio.

In regard to credit performance, we have steady performance. As you know, the delinquency improved from 2.6% at the end of the third quarter, which we discussed at that time, talking about operation issues we had over the summer as well as weather disasters that occurred in several areas of the country, but especially Texas and Florida. So, the ratio has gone down, as we thought it would. Of course, it is lifted by the fact that the portfolio continues to mature, and $2.5 billion of receivables entered full P&I this year.

So, the maturation continues. And, as people get into that, we will see the delinquency move along with it. But, the delinquency is right on our models. In regard to both the efficiency ratio, the delinquency, as well as the growth in the balance sheet, from '15 to '17 -- just a matter of perspective -- the balance sheet grew from $15.1 billion to $21.6 billion, an absolute increase of $6.5 billion.

The private student loan portion, as a subset of that, grew from $10.6 billion to $17.5 billion, or increase over two years of $6.9 billion. So, the growth in the private student loan was 106% of our balance sheet growth, which continues to show the efficiency that we have over a period of time on a balance sheet which is also growing from when we spun about $10 billion, to ending this year very close to $22 billion.

All of this comes out through the strainer of EPS. Our EPS story is similar to our efficiency ratio story, a very good and consistent one over time with excellent results, so that over the period from '15 to '16, EPS on an ongoing basis was up 36% from $0.39 a share to $0.53 a share. From '16 to '17, the next year, EPS went from $0.53 to $0.72, another 36% increase. While our guidance is a range, were we to hit the high 90s even, let's say 98, that also would be a third 36% increase compounding over 100% over three years. Consistent good levels, and we expect to realize them going forward.

ROE, as we've told you, is consistently in the teens. We had another good year with this. The increase in efficiency in the balance sheet will allow us to maintain that high level of ROE, even while the company is growing and diversifying.

In regard to regulatory relations, our chief regulators are the FDIC, the Utah Department of Financial Institutions, and the CFPP. I'm happy to say we have very good relationships with all, and we have shared our forecast for the bank with a horizon over the next three years with our key regulators, both the FDIC and the UDFI. We're 100% transparent with them. They have been good partners. On the regulatory front, we regard that partnership as a positive for us, despite the fact that there is lots of carping in the industry.

In a market frame, which includes the customer, the competition, and evolution, I'm happy to say we're doing quite well. Our customer service continues to improve at dramatic levels, so that the customer calls per service to count, are down 30% in per account terms, from '15 to '17. The calls that are required in order to bring an application to fruition have dropped more dramatically, down 40% per application, while our customer satisfaction is going up. We will do 20 million customer transactions in 2017, 92% of them will have no human intervention. We are a highly automated, Internet driven, fintech in that sense.

As we look to the outlook, we will continue our storyline over the last four years -- 1.) separation, 2.) establishment of the company, 3.) refinement of that operating piece, 4.) growth, 5.) expansion, and now 6.) diversification. We end this year with a strong market position. We have an extremely valuable customer segment. We have a very strong balance sheet, which has allowed us to venture into the purchase of personal loans from other originators. We have proven delivery capabilities. We have proven delivery capabilities. We have had controlled growth, as the balance sheet has gone from $10 billion to the end of '18 (sic), approximately $25 billion, with excellent margins and profitability. We have great customer service, and improving. We will be building on these years of success to realize a promising future.

As you know, the guidance is for EPS to increase from $0.97-1.01, for the private student loan originations to go to $5 billion, and for the efficiency ratio to continue its downward trajectory, dropping from the 37% to 38% range for next year.

In regard to this, a major change since the last call, has been the tax change. Tax change has hit us very positively and is a 14% reduction. It has allowed us to look at the growth in earnings, as well as the ROE, that are consistent with that more efficient income statement, and to evaluate a series of investments within the firm.

We've chosen to focus on three. First, is approximately $10 million in bringing our operating IT infrastructure to be more geared to the cloud. This is an ongoing migration. It's a new technology, as you all know. We're working closely with both vendors and our regulators to do this in a controlled way. The $10 million looks as though it has a payback to us of approximately $5 million going forward in perpetuity. So, it will pay back in two years. And, after that, if you look at the ROE over a long period of time, you would see that the ROE on it is measured in triple digits.

Second, $10 million to continue to expand the personal loan. Our personal loan is an important feature for our customers. When we meet the customers, when they are 18 to 19 years old, 0% of the population has a personal loan. But, five years later, 30% of them have a personal loan. People use this. We are basically in the personal loan business, because private student loans are personal loans. It is particularly geared to a particular environment and a particular audience.

Having said that, we have accelerated our thinking on the personal loan, by using our balance sheet to invest in others' originations of personal loans. This has given us one year of experience this year. We'll have a second-year next year and, by the time we're doing any serious volume in regard to personal loans, we'll have had three years of market intelligence by virtue of using our balance sheet to give us a lens into the current market.

So, as we look at that, we will have good returns over time. We will invest money this year. As you all know, what happens in any of these consumer businesses that have built on the credit side of the ledger, is when you have a customer segment P&L. In the first year, the acquisition costs cause you to be negative. In the second year, credit losses and maturation cause the products to be negative. In the third year, we typically break even. By the fourth year, we're getting good returns and those returns usually last for several years thereafter. So, these investments are being held to the same level of ROE scrutiny as our other activities.

The third $10 million is in the credit card business. We are not in the credit card business, so when we look at the personal loan business, we have an infrastructure and a customer service and a credit origination engine that can be leveraged. In regard to credit cards, it's a very different business. We'll work with a partner there, so as not to replicate fixed costs in an industry that is already over capacity. We'll work our way through that this year. The same dynamics that I just alluded to apply here as well.

All three of these investments, we think, are very good. They have been made while we maintained our commitments to the shareholders to continue to increase EPS at a very attractive rate -- 36% -- continue to originate loans and gain market share, and thirdly, to continue with a high ROE.

Having said all of that, in a moment I'll turn this over to Steve. But first, it's a sad day at Sallie Mae. Yesterday, our longtime head of sales and marketing, Charlie Rocha, passed away after a long battle with cancer. We're all stunned by his passing, grateful for his friendship and participation, and struck with both admiration and inspiration for the courageous and high-quality life that Charlie led before he was taken away from us too soon.

With that, I'll turn the floor over to Steve.

Steve McGarry -- Chief Financial Officer

Thank you very much, Ray. Good morning, everybody. I'm going to fill in a few more details around the quarter before we open it up for Q&A. We'll start with some details on net interest margin. Again, it came in very strong at 6% in the fourth quarter compared to 5.85% in Q3 and 5.55% in the prior year quarter. The net interest margin increased 45 basis points year-over-year, driven by the increase in the private education loans, the percent of private education loans in our portfolio, and we continue to manage cash reserves on the balance sheet more tightly.

The change in LIBOR rates, which increased the yield on our variable rate private education loan portfolio much more than it increased our cost of funds. These favorable drivers more than offset the five-basis point reduction in our NIM to the unsecured debt that we've issued, which of course is more than offset by a reduction in after tax preferred dividend expense at nearly 7% coupon on another line item on our income statement. NIM for the full year was 5.93% versus 5.68%. We think that the NIM can remain at or above the 6% level in 2018, which is a big positive for the company.

Looking at the other income line, we recorded a loss there of $21 million in the quarter, compared with income of $4 million in the prior quarter and $13 million in the year-ago quarter. A lot of noise goes through that line in this particular quarter. The loss is attributable to the Tax Act, as a result of the reevaluation of our indemnified tax receivables with our old buddies at Nadian. So, this mark to market was $23 million. And, unrelated to the Tax Act, we actually had a lapse of an uncertain tax position which run through that line item as well and totaled $9 million loss.

By the way, both of these items were offset in our tax expense line by a reduction in our tax expense. So, they had no impact on EPS. But, excluded this noise, other income would've been $11 million in the quarter. Despite the small size of that line, we do get quite a few questions from our analysts. So, $11 million, which is pretty consistent with our quarter in, quarter out activity.

Fourth quarter operating expenses were $119 million compared with $116 million in the prior quarter and $98 million from a year ago. FDIC fees were up $1.8 million, a 32% increase. Excluding FDIC fees, core operating expenses were up $19 million, or 20%. Roughly half of this expense increase was driven by volume. We still see big increases in repayment volume, which were up 19% in the quarter. And our portfolio is still growing rapidly at 22% year-over-year.

The balance was driven by our continued buildout of our personal loan platform, our new graduate school products, which we think are going to be an important offering as we enter 2018, and investments in our brand and consumer experience to support not only our diversification efforts, but our core business where we continue to be the dominant player in the private student loan business and we continue to gain marginal shares in the market despite the competitive nature of that particular industry. So, our market share was up to 55% as we measure in the fourth quarter.

Investments we make today are laying the groundwork for future returns from both our core student loan products and our diversification efforts.

A couple of additional points on credit. Ray mentioned that delinquencies were very consistent with our expectations, at 2.4%, down from 2.6% in the prior quarter. We also saw forbearances pick up to 3.7$from 3.2% in the prior quarter and 3.5% in the year ago quarter. Delinquency and forbearance rates are very seasonable and they're high this quarter due to the size of the November/December repay wave we see every year. This year, that repay wave was $2.2 billion.

Net charge offs are very steady at 1.07%, down from 1.08% in prior quarter and up from 0.95% in the year ago quarter due entirely to the seasoning of the portfolio, the increase. Looking at another measure in charge offs as a percentage of loans in full P&I, again very consistent there. There are 2.06% in Q4, down from 2.11% in Q3, and also down from the prior quarter, which came in at 2.08%. So, the credit story, no matter how we measure it, is very steady and performing exactly as we would expect it to.

Ending loans and full P&I are now at 7.1%, that's 41% of our total loan portfolio. So, as the balance continues to grow, our performance remains very steady and we view that favorably. Provision for private education loans was $49 million in the quarter, compared with $43 million in the year ago quarter. And again, this increase was a result of $2.5 billion of additional loans and repayment in fourth quarter of '17 versus the prior year.

Allowance for loan losses came in at 1.4% of total loans and 2% of loans in repayment. Allowance coverage ratio very solid at 1.9 times annual Q4 losses. Looking ahead to 2018, the question always comes up, where's our allowance headed. We think it'll increase slightly to 1.5% over the course of the year, as the portfolio of loans and sold P&I continues to grow.

I'll talk a little bit about our personal loan portfolio. We are purchasing personal loans. As you can see by the balance sheet, we are targeting roughly $100 million a month. At the end of Q4, we had $394 million net of loans on the balance sheet. These are high quality loans. Average FICO score of 722. And, the debt to income level, including mortgages, under 20%. So, very solid stuff.

Difficult to measure charge offs and delinquencies because the portfolio is very young, but I'll give you an indicator, taking a look at delinquencies and charge offs on the loans that we owned as of June 30th. So, holding that portfolio steady, what was the delinquency rate at the end of Q4? It came in at 1.5%. Cumulative charge offs on that portfolio were 1%. So, it is performing very well and doing exactly what we expect it to do.

We got a few questions last night on the increase in the allowance for that portfolio. The story there is pretty straightforward. We thought it was a prudent thing to do to increase our loss emergency period from eight months to 12 months. That accounted for the vast majority of the increase in the loan loss reserve there.

Let's talk a little bit about consolidation activity. That picked up in the quarter to $209 million from roughly $150 million in the third quarter. Again, this is as expected as loans go into full P&I. That is when people are incented to consolidate and that is what we saw happen in 2016, repeated again at 2017. The delta is declining, which is a positive, so we continue to watch that. Again, the rate of increase is very consistent with our prepayments forecast. We're observing that the vast majority of prepayment activity occurs in the first four quarters of P&I and then declines substantially after that.

Looking ahead to 2018, I'm forecasting that probably about $900 million of our portfolio will consolidate in 2018. I will go out on a limb and suggest that that number could be lower if interest rates continue on their current path. We will watch that very carefully.

Turning to capital, the bank remains very well capitalized with a total risk-based capital ratio of 13.3% and a common equity tier one to risk related asset level of 12% at the fourth quarter. The ratios significantly exceed the requirements to be considered well capitalized, both now and after Basel III has fully phased in at the end of 2019. In addition, the parent company has excess capital available to the bank, which is an additional source of strength. That's not reflected in these numbers.

While we're on capital, let's talk briefly about CECL, a favorite topic in finance circles these days. A long story short here is, we project that, after the implementation of CECL, which requires us to build a life of loan allowance, our capital ratios, particularly common equity tier one to risk wave, which I think will become a more important measure as the amount of loan loss allowance you can include in capital -- so, that ratio we project to be significantly above the fully phased in Basel III capital ratios that banks are required to hold. So, very good outcome there.

Wrapping up, Ray mentioned core ROA and ROE came in at 1.7% and 16.3% in 2017. Solid numbers that are heading higher as we benefit from the Tax Act.

...

That completes our prepared remarks, and we are more than happy to take questions now.

Questions and Answers:

Operator

[Operator instructions] Your first question is from Sanjay Sakhrani with KBW.

Sanjay Sakhrani -- Keefe, Bruyette & Woods -- Analyst

Good morning. My first question is on the roughly $20 million you guys are spending on the incremental loan products. Could you talk about maybe the specific returns you expect to realize over the next several years and how much growth we should expect in those asset classes?

Ray Quinlan -- Chief Executive Officer

Sure. The two are different. The personal loan is much closer to what we're doing now. The incremental cluster is relatively low. We actually have the capability and are piloting loan offers and applications and balance growth while we are talking, in a very limited sense. We expect that the returns on the personal loans business over time will be consistent with our other ROE efforts, that is mid-teens or thereabouts.

The question as to how they will pay back over time is going to be somewhat determined in '18. It's not the ROE of a particular cohort that matters. The question is how large do you want this effort to be. As you add on additional vintages, which have high acquisition costs in the first year and losses in their second year, the weighted average of the entire portfolio will be dependent on the expansion path as well as determinants point.

Suffice it to say, though, that on an account-by-account basis, we expect the returns to be positive by year three and to be consistent with our other ROE that is mid-teens over a period of time. The growth I don't want to get ahead of ourselves on. We are appropriately testing and we will bound by cost benefit associated with that. We have $400 million of personal loans on the books already, so we have a very good lens into the current pricing elasticity and the current credit market for those, so that we won't be quite as naïve in going forward in personal loans, as we would have been had we not had that exercise, which is actually accelerating our learning about the industry by two years.

Sanjay Sakhrani -- Keefe, Bruyette & Woods -- Analyst

Got it. Maybe a question on the consolidation activity. Steve, thank you for all of the color you provided in terms of your expectations for this year. What is happening still is that the rate of consolidation seems to be increasing, even when you look at the ratio of loans that are in repayment. At what point does that ratio level off? It seems like you guys have talked about how there's diminishing returns for your competitors, but it's still happening at quite a brisk pace. Your guidance suggests that -- this tax benefit that could also help the economic equation for your competitors. Could you just talk about that a little bit? Thanks.

Steve McGarry -- Chief Financial Officer

Sure, Sanjay. Obviously, we have a lot of information on what's going on in the world of consolidations. But, in terms of the rate of change, we just had our biggest ever principle and interest repay wave go through. In the fourth quarter, 60% of our consolidations came from that repay wave and roughly 10% came from the 2015 wave. Our future repay waves are going to be pretty big, relative to our total P&I portfolio. But, I do think we're at the point where it is going to start to tip over and level off.

Now, the interesting thing is, consolidation is very much an interest rate play. People undercut current market based interest rates, consolidate the loans, and fund them in the wholesale markets and move on. So, we have seen a continued increase in base market rates. I think they're up another 20 or 30 basis points since the middle of December, so it is going to start biting our competitors who have not raised their rates yet.

Now, I will share with you that there are probably half a dozen people that consolidate our loans. They go from fintechies to real, publicly traded companies that have return requirements and so on and so forth. We are seeing the pace of consolidation from publicly traded companies that have to answer to shareholders and produce returns is leveling off and declining, as I would expect it to given the funding markets. The fintechies are still charging forward. We'll see where it all plays out.

As the portfolio matures, even if the fintechs continue to consolidate, they are after a very particular segment of our portfolio and the activity curtails very quickly. So, we should see the impact decline over time, even if they continue at their current pace.

Sanjay Sakhrani -- Keefe, Bruyette & Woods -- Analyst

Okay. Final question on origination, when we think about the 4% growth that you guys are estimating, how much of it is worth in the market versus market share gain?

Ray Quinlan -- Chief Executive Officer

It's about evenly split. The market should grow 1-2% and we should pick up a market share of 1-2%.

Sanjay Sakhrani -- Keefe, Bruyette & Woods -- Analyst

Okay. Great. Thank you very much.

Operator

Your next question is from John Hecht with Jefferies.

John Hecht -- Jefferies -- Analyst

Good morning. Just a little bit of clarification from one of Sanjay's questions -- for the $20 million of investments in new products, but $10 million of incremental expenses in technology -- for this $30 million in incremental expenses this year, do I look at this as a one-time project that will go away the following year and you'll start reaping the benefits of these in the following year? Are there other projects in the following year that replace these? I'm asking in the context of trying to figure out how we think about the efficiency ratio through 2019.

Ray Quinlan -- Chief Executive Officer

Sure. We had the opportunity here -- we've often thought that we have an opportunity with our customer base to do more business with them. And, they certainly do buy lots of products. For instance, in the credit card business, when we meet our customers at the age of 18, 18% of them have credit cards at that time, usually a named signer on a household card. By the time they're 27, over 90% of them have credit cards, and we're with them during that period. We think there's a very attractive change in their lives that we are present for and that we have not taken advantage of.

Having said that, in regards to your question about the $30 million, when we looked at the tax change, we said, "Here's an opportunity for us to accelerate our diversification while still having a 36% EPS growth for the third year in a row and maintaining high ROEs while lowering the efficiency ratio. There is no doubt that the tax change allowed us to move more investments into 2018 that we had previously thought about.

So, when we looked at those, we took a full inventory of investments around the company, as to which ones would qualify from an ROE standpoint, and ended up with these three. The nature of the infrastructure in the cloud is an ongoing efficient operating platform, which we'll continue. The nature of the other two investments is to get started with new opportunities that we think we have every right and legitimacy with our customers to offer them additional products based upon what we think is good customer service and a good product offering to begin with.

Having said that, these are not to be followed in queue by three or four other investments the following year, in '19. In answer to you question, there's not a line outside the door of which we did a cutoff at $30 million and we have another $30 million in line for something new and interesting in '19. This is the beginning, middle, and end of this type of $10 million investment, we believe. It was accelerated into 2018 by virtue of the tax change. We believe it allowed us to keep a consistent record with the company and shareholders while at the same time accelerating diversification, which we think will accelerate the benefit associated with that.

In regard to the other two investments, credit card and personal loans, there are very small revenue dollars associated with them in '18 and naturally, as those portfolios mature, there will be higher revenue and the cost will move along with it as we go to a three-year cycle on moving from acquisition to profitability with customers.

John Hecht -- Jefferies -- Analyst

That's very helpful. I appreciate the color. A second question -- your deposits to earning assets have been fairly stable in the 90-91% range. Should we think about funding this year with a consistent deposit base? Can you guys give us an update on how you see the deposit data as we stretch through the year?

Steve McGarry -- Chief Financial Officer

Look, our approach to funding is not going to change. We'll continue to grow our deposit base and we will continue to access the asset backed market as a means of extending the duration of our liability portfolio. You can think about it as sort of an 80% deposit, 20% ABS, funding model. We'll be more opportunistic when opportunities do present themselves. In terms of our deposit data, we like very much what we're seeing in the money market deposit products. We're actually funding at LIBOR less 10 as opposed to LIBOR plus 30-50, which we do on some of our other products. In terms of the beta, it has turned out to be better than we expected. We penciled in something along the lines of an 80% beta, and I think it has a 40 handle on it --

Ray Quinlan -- Chief Executive Officer

We started at one and we dropped to 80 and now we're down to 40.

Steve McGarry -- Chief Financial Officer

So, the retail deposit market, also known as the Internet deposit market, is preforming very well. It's where people with deposits go to shop and we're able to access deposits very efficiently without spending a whole lot of money on marketing, etc. We like what we see there.

John Hecht -- Jefferies -- Analyst

Thanks for answering the questions, guys.

Operator

Your next question is from Steve Moss with B. Riley FBR.

Steven Moss -- B. Riley FBR -- Analyst

Good morning. Could you just give some color around what your expectations are for fixed versus floating rate originations this year? And, what are you thinking the potential pricing for fixed rate loans is?

Steve McGarry -- Chief Financial Officer

We saw in the peak season, I think, 45% of our borrowers took fixed rate loans. That was up from the high-teens, call it a year ago, and that was a pretty consistent level. We will price our fixed rate loan products in the spring. I have no reason to believe at this point in time that, based on what I see in terms of cost of funds and spreads, that the price is going to increase significantly. We're probably looking at maybe a 30- to 40-basis point increase as we sit here today. I think the average yield on our fixed rate product is 9.5% today. If you compare that to our average spread to LIBOR on a variable product is around 7.25%. One-month LIBOR at 1.5%. So, they're roughly similarly priced products today. They weren't a year ago. So, the yield curve flattening has incented a lot of people to go into the fixed rates. We'll continue to watch that carefully.

Steven Moss -- B. Riley FBR -- Analyst

Okay. With regard to the personal loans that you're originating and purchasing, what is the term here? Is it typically three to four years or is it longer than five?

Steve McGarry -- Chief Financial Officer

It's about 60% three years, 40% five years. I could take it to 65/35. The three-year product is a lot more popular than the five-year product. We look at it as a weighted average life of under two years -- 1.8 years. So, it's as short-life product.

Steven Moss -- B. Riley FBR -- Analyst

Okay. My last question -- with regard to the $5 billion in originations you expect for 2018, does that include graduate loan originations?

Ray Quinlan -- Chief Executive Officer

Yes, it does. We think graduate could give you flavor for the passing on that. We do some business with graduate loans today, but it's relatively minor. We developed six tailored products for graduate -- a couple in medical and health, along with MBAs, legal, and other. As we look at these, we think that the current state of play in that market is heavily dominated by the federal government's Grad PLUS loan, which has a 4.1% origination fee associated with it and a 7.1% APR.

So, we believe that that is way off market and we can actually price a lower total cost per loan to this target audience. Having said that, the graduate schools are many -- many small ones -- and the uptake rate on this requires a reasonable amount of education in a financial office in the graduate space, and is not identical at most schools to the undergraduate space. So, we want to be conservative in our pathing to maturation. We think this has great long-term prospects and we just don't know exactly what the take rate will be in the opening season.

As I said, when we introduced the Parent Loan, work of mouth got around relatively slowly and, in the second year, we doubled the volume associated with Parent Loan. We expect to have a similar slow uptake rate and then ongoing high rates of compounded growth for the Grad products.

Steven Moss -- B. Riley FBR -- Analyst

Thank you very much.

Operator

Your next question is from Arren Cyganovich with Citi.

Arren Cyganovich -- Citigroup -- Analyst

Thanks. The question of the $30 million and how much of that is going to be recurring after this year, I'm still not quite clear on the ongoing spend of that $30 million going forward.

Ray Quinlan -- Chief Executive Officer

Okay. There are two questions inside of this. The previous question was after these three efforts of 10/10/10, is there a queue after that of another five efforts that are all $10 million as well. The answer to that was no as we sit.

A separate question is within in the areas that we're talking about, is the $10 million associated with each one of the three investments a repeatable number or will it grow over time. The answer is it varies. So, the first 10, which is related to the infrastructure and IT will not be repeated in '19. The other two may well have an increase in expense base, but they will be offset by the revenue, which is zero in '18 for all practical purposes. So, we may spend more money on personal loans in '19, but the net contribution of the activity will be muted by the fact that we expect to end 2018 with a portfolio of approximately $300 million.

Arren Cyganovich -- Citigroup -- Analyst

Okay. That's helpful. Thank you. Thinking about the diversification efforts, you had talked in the past about taking a very measured approach to this. Now, we're talking about accelerating the investment here. Can you talk about balancing those two? Obviously, people get a little bit more scared off by new personal loan products and credit card products with respect to the loss expectation of your student loan business.

Ray Quinlan -- Chief Executive Officer

Sure. Let's take the IT and put it on the side and now we'll talk about the personal loans and credit cards. Personal loan is very different from the credit card for us because, as you know and we stated earlier, we are in the personal loan business. We have a portfolio that is a personal loan. It is unsecured. It has a 6- to 7-year actuarial life and we are in this business to the tune of about $18 billion.

We take the specifics associated with the student loan and we turn them into different parameters for the non-student personal loan. So, it makes it easier for us to have a lower infrastructure cost in delivery of this. It also fits quite nicely with some of the credit models that we already have.

Having said that, we are cautious about this, which is why Steve initiated the purchase program of personal loans in the first quarter of '17. As he said, we had a reasonable portfolio as of 6/30/17 that will be two years old by the time we're talking about adding any volume. We will work our models both internally as well as in parallel to that external experience in order to mitigate the risk that you're addressing.

So, it'll be on a cost benefit basis. 2018 will be a year of experimentation. As we go into '19, we will refine from both a marketing acquisition cost standpoint as well as a credit loss expectation standpoint what we're doing in personal loans.

Credit card is following more slowly. That project is not quite where the personal loan business is. The ability to deliver the personal loan that we're talking about to the general market is extent as we speak, and we are originating loans. We are doing our first mail drop at 300,000 pieces within the next 10 days and we'll start learning about the credit cards. We are in the process of working through our relationships with a couple of partners. We will not build an infrastructure in regard to that.

We will probably have our first credit card offer in the field in the first quarter of '19. So then, we'll take in '19 a year of experimentation and then build that portfolio against the same ROE guidelines that we have for everything else we do as we go forward.

Arren Cyganovich -- Citigroup -- Analyst

Thanks. Lastly, the PROSPER Act -- maybe some thoughts on how that might progress through the year and the potential for it to get done. I know that's always a dangerous thing to talk about. And then, the thing that was surprising to a lot of folks was the discussion of increasing loan limits on the undergraduate side. If you could just touch on the PROSPER Act.

Steve McGarry -- Chief Financial Officer

Just for clarity, the PROSPER Act was the Virginia Foxx proposed legislation to reauthorize AGA. So, we do not believe that as congress sits here today the PROSPER Act has a lot of chance of being -- has a high probability of being picked up in the senate as well and passed. However, in the PROSPER Act we do like what we see. It curtails Parent PLUS and eliminates Grad PLUS. It does increase undergraduate and graduate staggered loans, but as we measured it, it would expand our addressable market by 30-50%, so $3-5 billion. It would be a big positive should it be enacted.

Ray Quinlan -- Chief Executive Officer

The only thing I would add to that is forecasting in regard to what goes on in DC is obviously a fool's errand. We don't have anything associated with this opportunity baked into any of our numbers. Having said that, when an act occurs, were it to happen all of a sudden -- as the Tax Act occurred in the fourth quarter of this year -- we don't want then to start to take advantage of what we think are likely outcomes. So, as you may recall, in 2017, we spent an additional $7 million on a project we referred to as Nike, that anticipates the growth that Steve talked about in such a way that our capacity, while we're sitting here, can accommodate that 30-50% increase in volume.

We did spend the $7 million. It's done. And we have the benefit of having a stronger platform that is leverageable in the anticipation of that act. So, we believe that we have the expense covered, in some sense, and the opportunities in front of us. We'll see what happens with that.

Arren Cyganovich -- Citigroup -- Analyst

Thank you.

Operator

Your next question is from Moshe Orenbuch with Credit Suisse.

Moshe Orenbuch -- Credit Suisse -- Analyst

Thanks. To put that $30 million in perspective, it looks like just over a third of the tax savings, maybe. How should we think about that use of the tax savings longer term after that $30 million has been invested.

Ray Quinlan -- Chief Executive Officer

I think we should think about the tax as part of the woodwork at this juncture. You're right. If we were to just do the simple algebra on what had been, I think, in everybody's model as a previous select for 2018 for our EPS -- we'll call that some number like $0.85 -- and then you just laid on the 14% delta in the taxes, you would come -- one, two, three, here we are. $1.05. Delta between those is about $85 million profits pre-tax, so it is the case that we invested about $30 million of the $85 million, so your number is approximately correct.

Going forward, we will take the Tax Act as given and we will keep ourselves within the same parameters that we have consistently promised the shareholders and delivered upon over these last four years, which include healthy EPS growth, and 36/36/36 the last three years has been very impressive. We expect that to moderate, but still expect to be way over others so far as their pathing on EPS.

We have ROEs that are consistent with what our ROEs have been the last couple of years, which was 16%. We expect that to be at or higher than that as we go forward. To continue to improve our efficiency ratio so the shareholders can gain some comfort -- while we're expanding our operating base, we're doing it consummate -- in fact, better -- than the growth in our revenue. As I said last year, the revenues grew by 20% and expenses grow by 16%. 16 is a big number, but 20 is its guiding light.

Moshe Orenbuch -- Credit Suisse -- Analyst

Great. You expected tax rate for this year of 26% -- are there things going on in '18, or uncertainties, that would make that a touch higher than we might have thought it would come out based upon your state and local tax burdens before? Are there any other things in that number that would change in future years?

Ray Quinlan -- Chief Executive Officer

There are some. Steve, why don't you walk through a couple of those.

Steve McGarry -- Chief Financial Officer

We're at 21% federal and our state has been running between 4-5%. So, 26% seems like a good place to start. Could it come in at 25%? Absolutely, positively. We just began our efforts to build, for example, a low-income tax credit portfolio and make other investments that will ultimately bring our tax rates down to the enviable level of -- J.P. Morgan talks about an 18-19% tax rate. That is an aspiration. We certainly want to head in that direction, but it will take quite awhile for us to complete the trajectory.

Moshe Orenbuch -- Credit Suisse -- Analyst

Understood. The last question for me -- reacting to your $900 million comment, more asking about how you think about that level. Is it at the level where you think that you don't need to do anything from a defensive standpoint? Is that something you're planning to put in place in 2018 or '19?

Steve McGarry -- Chief Financial Officer

Thank you for bringing that up. We are basically building the infrastructure and altering our systems to put us in the position in the second quarter to start to offer consolidation opportunities to our borrowers as they call in and talk about such things and we do get a heads up through our very effective and efficient call centers. On the drawing board right now, as we speak, was to offer a product that extends term and leaves the borrower with the same coupon payment. Given the results of the Tax Act and things that are going on in the market, if we're able to sweeten that by lowering the interest rate --

Ray Quinlan -- Chief Executive Officer

Depending who the borrower is.

Steve McGarry -- Chief Financial Officer

Obviously, depending on the circumstances of the borrower -- and maintaining a healthy ROE, we will bring that as well. But, we will be in a position in the second quarter to start to be much more defensive and proactive on that front.

Moshe Orenbuch -- Credit Suisse -- Analyst

Great. Thanks very much.

Ray Quinlan -- Chief Executive Officer

One thing we ought to mention is that our customer service has been upgraded, not only in the service that it provides, but in the MIS around it. We have a facility which is called CallMiner that allows us to search every conversation that has happened in our call center. We're in the midst of modeling anyone who calls and mentions interest rate change, consolidation, getting a different loan -- and it's an interesting analytic piece, which will allow us to target individual at-risk customers from a standpoint of consolidation in such a way that we don't put our NIM for the entire portfolio at risk by responding with a meat cleaver when a scalpel is called for.

So, that's a work in process. During the second quarter, we expect to execute both on the targeting associated with it as well as on the counter offer in a product sense.

Steve McGarry -- Chief Financial Officer

Just one final point. No level of consolidation is acceptable, but obviously we have to balance the ROEs on maintaining versus retaining.

Moshe Orenbuch -- Credit Suisse -- Analyst

Clearly. Thanks guys.

Operator

[Operator Instructions] Your next question is from Mark DeVries with Barclays.

Mark DeVries -- Barclays Capital -- Analyst

Hi. Thanks. In the past, you've talked about efficiency ratio targeting the mid-30s longer term. But, if we take the guidance today of 37-38 and then back out that $30 million of incremental investment, it would appear you'd actually be there in '18 ahead of schedule. Is that a fair statement? If so, can you just talk about what's driving the better than expected operating leverage? Is it the upside to the NIM that you experienced, better expense management, or something else?

Ray Quinlan -- Chief Executive Officer

It is true that we're continuing on a landing path that has mid-30s in mind. It's also true that, without the $30 million investment, we would be at approximately 35% in '18. It is true that, as we think about the net value associated with the franchise, the investments are in one sense optional -- that is, they're introductory products -- another sense they're defensive. As the portfolio naturally liquidates -- forget about consolidations for a moment -- we are paying a high acquisition cost for these customers and we are bereft of the ability to offer them additional products, which we know they will buy from someone else.

So, in order to both capitalize on the portfolio that we have and the position we have with younger people, as well as to mitigate any loss in balances and therefore revenue associated with things, we view the $30 million -- and especially the two twenties for the product increment -- as part of the maintenance of the franchise. So, there will be ongoing investment in any business, but you're absolutely right that the pure -- less an investment of a significant amount in this business in 2018, the efficiency ratio would have been 35%.

We're capable of delivering that, but we don't think it's in the interest of the shareholders to deliver that because we think it too much compromises the future and one day may force us to be acting in a reactive mode, which would put too much at risk. We'd much prefer to be able to invest in a leisurely way in the sense of gathering intelligent information before we bet any significant dollars. We think is both the warranted path from a defensive standpoint, an optimal path from an opportunity standpoint, and a prudent path from a trajectory standpoint.

Mark DeVries -- Barclays Capital -- Analyst

Okay, thanks. Steve, I was hoping you could give us some of the assumptions behind your NIM guidance in terms of rate increases and deposit betas and the upside to that guidance, if in fact your betas tend to be lower than what you've been assuming.

Steve McGarry -- Chief Financial Officer

In terms of rate increases, we basically pretty much follow the allowable curve and we have two additional rate increases baked into 2018. Our beta -- our expectations on the cost of our $3.5 billion of retail money market deposits is that they will be north of LIBOR as opposed to south of LIBOR. So, there is some upside there.

The other moving pieces are pretty steady. We will see some improvements in ABS cost of funding if the market remains where it is right now, although we don't plan on issuing until early spring and then again in the fall. The growth of the deposit market has been pretty steady. So, if there's an upside, it comes from the components of our funding and from the retail deposit market.

Mark DeVries -- Barclays Capital -- Analyst

Okay, good. Thank you.

Operator

Your next question is from Henry Coffey with Wedbush.

Henry Coffey, Jr. -- Wedbush Equity Research -- Analyst

Good morning and thanks for taking my call. The shift from an eight-month to a 12-month loss emergence. Can you just explain that to me?

Steve McGarry -- Chief Financial Officer

Sure. A key component of your loan loss allowance is how many months of losses are you reserving for. In our private student loans, we maintain a loan loss reserve for one year of expected losses. In our personal loan, as we started acquiring and thought about introducing them, it's a shorter life product and typically losses do emerge much quicker in that product. So, we initially went with an eight-month loss emergency period. So, we were reserving for eight months as opposed to 12. As we assessed our accounting and credit policies, we thought that it would be prudent to extend the eight months to 12 months. It does not change whatsoever our outlook on losses for that product. If anything, it frontloads the credit expense. And, once you get through the peak loss period, you basically are earning more as opposed to less on the product itself.

Henry Coffey, Jr. -- Wedbush Equity Research -- Analyst

Thank you. On the consolidation loan, a lot of other people are looking at it as a total customer value. I'm going to make up some numbers here. If a customer has $8 million worth of loans with Sallie Mae, maybe they have $20 million of total student loans and the refinance rate's not what you want, but you theoretically could double the size of your business with that particular customer, is that how you're thinking about it? Or, is it just purely defense, defense, defense?

Ray Quinlan -- Chief Executive Officer

I think there's an opportunity both ways. One is increasing the balances of the current customers and the other is protecting those balances from their being stolen away. We have been pretty much a one-note sort of disbursed to the college. That's the only way we're doing things. And recall that, while we're in the personal loan business, and the unsecured personal loan business, our product is quite unique as they say. So, it is for undergraduates. For the most part, it is dispersed to the school. 100% of our balance is originated that way.

And, as we think about the next several quarters, we're looking at changing terms with a focus on cash flow for consolidation defensive purposes -- clearly introducing the personal loan, which is unfettered from the schools, will give us much more flexibility in being both defensive and offensive. And yes, we do look at the total relationship with the customers, which is how we reached personal loans and credit cards as our two areas of diversification.

Henry Coffey, Jr. -- Wedbush Equity Research -- Analyst

Finally, I know you don't want to predict on the political front. But, if the PROSPER Act is not the final form, is there something compelling congress to do something this year? Or, is it just they'll do it if they want?

Steve McGarry -- Chief Financial Officer

HEA reauthorizations have been kicked down the road five and six times in the past, and I don't see any reason why this year could be any different. There is nothing urgent in the HEA that needs reauthorization at this point in time, so that could continue to roll.

Ray Quinlan -- Chief Executive Officer

I think that's true, but the obvious poor performance of the federal portfolio with 40% delinquency rates, and tragic losses that are involved in that, which absolutely can ruin students' lives, will over a period of time cause people to look at that program and therefore make some changes to it, both in its original underwriting as well as in the limits that have been mentioned -- as well as in whether or not the federal government should be subsidizing Parent PLUS and Grad PLUS, which is a position many people disagree with.

But, I do think it's the constant drumbeat associated with the $1.4 trillion portfolio that will drive them to act. But, it will not be a "Gee, we have to do it by midnight on Saturday," type of act. It'll happen over time and it'll gain momentum.

Henry Coffey, Jr. -- Wedbush Equity Research -- Analyst

Great. Thank you very much.

Steve McGarry -- Chief Financial Officer

I'll add one more thing to that. If there is in fact a budget reconciliation bill at some point in time in 2018, the HEA reauthorization could actually be passed through given the current composition of the senate.

Ray Quinlan -- Chief Executive Officer

And it has a positive impact on the deficit, so it's helpful from that standpoint.

Operator

Your next question is from Michael Tarkan with Compass Bank.

Michael Tarkan -- Compass Bank -- Analyst

Thank you. On graduate loans, can you remind us what percentage of the overall graduate market you think fits your credit box? And then, I know it's going to start off slowly, but big picture -- if Grad PLUS is a $10 billion program per year, is there any reason to think the private market couldn't originate 30-40% on an annual basis once you're fully up and running?

Ray Quinlan -- Chief Executive Officer

No.

Michael Tarkan -- Compass Bank -- Analyst

Okay. In terms of the percentage of under writable loans, in that 40-50% range?

Ray Quinlan -- Chief Executive Officer

Yeah, I think so. We've looked at this not in the amount of detail that would be required to have a credit model, but we have looked at the overall piece. We think 30-40%, consistent with our current approval rate, would be appropriate. The backdrop of your question is, do we think it's a big opportunity? Yes, we do think it's a big opportunity.

Michael Tarkan -- Compass Bank -- Analyst

Thanks. Competitively, you talked about picking up a couple more points of share. I know Wells is in contraction mode, but how sustainable is that? Are you seeing any recent entrants heating up a bit more and getting more aggressive in the in-school channel? Thank you.

Ray Quinlan -- Chief Executive Officer

As we've looked at that, and we have a full listing of who the competitors are, the market is still somewhat oligopolistically structured with our sales in Wells and Discover. Those shares, even though Wells is in contraction mode, it has such a great distribution that their portfolio hasn't suffered as much as it would for the long-distance provider, such as ourselves and Discover. So, there's more inertial in the nature of their business.

Having said that, as we look at the tail, the amount of originations that are done by the last ten or so competitors remains very much a small percentage. We don't see anyone gaining market share with anything that would be measurable above 0.2%. So, I think the industry right now is relatively stable.

Michael Tarkan -- Compass Bank -- Analyst

Thank you.

Operator

Your next question is from Melissa Wedel [01:08:22] with J.P. Morgan.

Melissa Wedel -- J.P. Morgan -- Analyst

Hi. Melissa for Rick. The pace of the $30 million investments in 2018 -- do you expect much of that to be frontend loaded or fairly evenly distributed throughout the year?

Ray Quinlan -- Chief Executive Officer

We think the $30 million has three different dynamics to it. A rough approximation would say about balanced through the quarters.

Melissa Wedel -- J.P. Morgan -- Analyst

Got it. Thank you.

Operator

Your next question is from Ann Maysek with Rose Grove Capital.

Ann Maysek -- Rose Grove Capital -- Analyst

Good morning. Can you quantify what a continued rise in one-month LIBOR might mean for your earnings? It went from 125 to 155 in Q4. Can you just give me a sense for what the impact might be for Sallie Mae earnings if it reached 2% in 2018, which is a pretty conservative market estimate at the moment?

Ray Quinlan -- Chief Executive Officer

Sure. Steve?

Steve McGarry -- Chief Financial Officer

Yeah, I think in our interest rate sensitivity disclosures we show that our earnings will increase roughly 2% for a 100-basis point shock in interest rates. So, it basically is not a material increase, especially the way it's mapped out to happen.

Ray Quinlan -- Chief Executive Officer

But, Ann, we had this bracketed. So, at one end of the bracket was the 100-basis point instantaneous shock, which Steve references and the other is the increases that Steve mentioned earlier, which are more gradual -- and, as you heard him say, we're at a 6% NIM and we expect that level to continue through '18. So, the gradual piece is answered in that comment at the 6% NIM. And the shock piece is positive, as Steve says. But, I think that brackets the questions.

Ann Maysek -- Rose Grove Capital -- Analyst

Perfect. I know I've asked this before and I'll ask it again, whether or not you have any plans to instate a common dividend.

Ray Quinlan -- Chief Executive Officer

You can keep asking and we will continue to have the same response, which would be appropriate. We think at this juncture, based upon what we see in the business today, and for the foreseeable future -- and we have forecasted out seven years when we look at this -- we believe that our shareholders are better served by our reinvesting all of our profit into the company as we have done the last five years.

Ann Maysek -- Rose Grove Capital -- Analyst

Perfect. Thanks so much.

Operator

And here are no further questions at this time. I would like to turn the call back over to Ray Quinlan for closing remarks.

Ray Quinlan -- Chief Executive Officer

Okay, thank you very much. Thanks for all the questions. They've all been helpful in teeing up more precise responses to particular areas. As we end, I want to thank everyone for their attention and obvious work that has been done to know the business so well. Just to remind, this is a wonderful franchise with a strong market position, a highly valued customer segment, and our strong balance sheet continues to have unanticipated benefits for us, of which the personal asset purchases are just one piece of that.

We do have proven delivery capabilities at this juncture, having doubled the size of the business in four years while maintaining good control and having good relationships with the regulators. Our controlled growth from $10 billion to $25 billion over that period, as far as our balance sheet is concerned, is a very impressive compounded growth rate.

We continue to have excellent margins, profitability, and good returns. We continue to improve our customer service, and we expect that over the next three to five years, we will be building on these last four to five years of success to realize a promising future.

So, thank you all for your attention and we look forward to 2018.

Brian Cronin -- Vice President, Investor Relations

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

Operator

Thank you for joining today's conference call. You may now disconnect.

...

Duration: 73 minutes

Call participants:

Brian Cronin -- Vice President, Investor Relations

Ray Quinlan -- Chief Executive Officer

Steve McGarry -- Chief Financial Officer

Sanjay Sakhrani -- Keefe, Bruyette & Woods -- Analyst

Arren Cyganovich -- Citigroup -- Analyst

Steven Moss -- B. Riley FBR -- Analyst

Mark DeVries -- Barclays Capital -- Analyst

Moshe Orenbuch -- Credit Suisse -- Analyst

Henry Coffey, Jr. -- Wedbush Equity Research -- Analyst

John Hecht -- Jefferies -- Analyst

Michael Tarkan -- Compass Bank -- Analyst

Ann Maysek -- Rose Grove Capital -- Analyst

Melissa Wedel -- J.P. Morgan -- Analyst

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