SLM Corporation (SLM) Earnings Call Transcript & Summary

Good afternoon. Thank you for joining us today. I'm Barclays' consumer finance analyst, Mark DeVries, and I'm pleased to be joined by Sallie Mae's CEO, Jonathan Witter. Jonathan has some prepared comments to deliver, which will be followed, time permitting, by some polling the audience and some Q&A. [Operator Instructions] Or you can try to e-mail it directly to me, and we'll do our best to address your questions in the time we have today. Before we start off with the prepared remarks, I'd like to lead off with a question for the audience. To participate, please click-through to the polls on the left side of your screen. After you respond, you should be able to toggle back to the video of the discussion. First question for the audience, what do you view as the biggest catalyst for SLM over the next year? Increasing private student loan market share, lower third-party consolidation activity, better-than-expected private student loan credit, improving NIM or buybacks from loan sales? With that out of the way, I'm going to hand it off to Jonathan for his comments. Jonathan, take it away.

Mark, thank you, and thank you to Barclays for putting this on. That was a pretty compelling list. I'd like, I think, to answer E, all of the above. It's wonderful to be here to have a chance to speak with all of you. It's great to have a chance to have a full day of investor meetings and thanks to the whole group who's been involved with that. Also thanks to everyone on the line for your interest in Sallie Mae. Let me start by saying that I hope everyone on the line has remained healthy and well as we continue to navigate a really challenging time for our country and for the world. Between the pandemic, the important discussions about social justice and systemic racism in this country, hurricanes, fires, the challenges for us as individuals have never been greater. And I think I speak for probably everyone here, the challenge for companies to perform has also likely never been greater. I also want to just take a moment and thank the really dedicated team at Sallie Mae, who are working incredibly hard to care for our students, our communities and each other as we go through this just really difficult period. As you may or may not know, I joined Sallie Mae about 5 months ago. And while I had deep experience in financial services, both Sallie Mae and the student lending space were new to me. And during those 5 months, I've gained great insight into the business. And based on that insight, the team, the Sallie Mae Board and I have continued to evolve and enhance our strategy. And if I had to boil it all down, that entire 5-month process could really be summed up in a few key insights. The first is Sallie Mae, I believe, really has an outstanding franchise. Secondly, our business model's resiliency has been proven without a doubt while navigating the challenges from COVID-19. We believe we have an incredibly simple but powerful investment thesis. And I think you'll all be glad to know we are in the process of implementing a very clear strategy to create value based on that investment thesis. So if I turn to Page 4, for those of you who have not studied this sector extensively, the private student lending market is a small but critical part of the overall student lending landscape. We focus largely on what we call gap financing, and this is filling in the holes between families of resources, federal grants and loans, school support and other funding vehicles. And to put it in context, the private market represents about $12 billion of annual originations. And that's relatively small when you compare it to the $93 billion of federal loans and approximately $458 billion spent on higher education annually from all sources. While that's a small part of the overall higher education marketplace, Sallie Mae is a big player in that space. We have, I think, unquestionably the top brand. We are the best-known brand in the industry. And that's not just about hubris. We know that, that brand translates directly into financial advantage. Just as one small proof point, our leading competitor typically sends 4 to 5x the direct mail volume that we do, but typically originates about half the volume in a given year. So top brand is really important. We also have, we think, the deepest relationships with the schools and the largest sales force. We cover about 2,400 schools nationally. And I think even more important than the number, we appear or are tops on the preferred lending list in about 98% of those cases. So either on the list or in many cases at the top of the list. In addition to deep relationships in a brand, we also, after many years, have built an incredibly rigorous and disciplined credit and underwriting capability. Just to give you a sense of it, 87% of our loans have a cosigner. The average FICO at origination is about 746, and we have about a 1.2% annual charge-off rate over the cycle. While all of that is out in front, behind the scenes, we've got some pretty special things going on as well. We have a modern and at-scale set of technologies, cloud-based technologies and a wonderful stack that are operating today at scale. And we have an incredibly strong balance sheet, again, highlighted during this incredible time, strong capital and strong liquidity positions. If I move on to Page 5, any company can talk a good game when the sun is shining. And while the economic situation such as the Great Recession and the recent pandemic are incredibly painful, they do serve as a really important set of proof points for the resiliency and strength of our franchise. And let me caveat this by saying, I'm always a little nervous to talk about performance until the environment has fully stabilized. But I do feel that Sallie Mae is performing well during this pandemic, showing great resiliency and demonstrating the strength of franchise I just discussed. Let me go into a couple of different areas, and let me start with credit. We, like other student lenders and consumer credit companies, liberally granted forbearance to customers at the outset of the pandemic. And we did this recognizing the incredible shock to the economy and the desire to care for our customers, many of whom were going through unprecedented periods of stress. During that initial period, a large number of our customers in repayment requested such forbearance assistance. And in fact, we announced on our last earnings call that, that was in the mid- to upper teens as a percent of loans and repayment. We are really pleased with our progress on disaster forbearance since that time. Our forbearance rate is down to 5.72% at the end of August. And to put that into a little bit of contrast, a normal forbearance rate in this industry might be around 4%. So very much closing the gap. To dig a little deeper, for people who received disaster forbearance benefits earlier in the year, 86% of them have returned to a non-disaster forbearance status. We are actively managing that remaining group. We have conversations every month with those customers who were receiving disaster forbearance. And we use those conversations to gain insight on their financial status and to find ways to help them manage their current situation. Our specific charge-off and delinquency numbers will be somewhat skewed in 2020 and 2021, due in large part to the timing of customers entering delinquency because of this liberal granting of forbearance. Said simply, customers who likely would have gone into delinquency and potentially charged-off in 2020 will get pushed out later into 2020 and '21 because they likely requested forbearance during this initial time. The other big impact of COVID is on schools and originations. We have heard from almost all the schools that we do business with at this point. And despite the headlines, only about 15% of colleges and universities are completely online. The remaining 85% are on-campus in one form or another, many in a type of hybrid model. This demonstrates to me the incredible dedication of universities to fulfill their educational mission. And frankly, their financial need to continue operations. Like many other enterprises, universities are getting creative and figuring out ways to operate even during these difficult times. Based on these trends, originations are trending toward the lower or better end of the range we talked about during our second quarter earnings call. The peak season was delayed for most schools as they dedicated the best -- they decided the best way to return to school in the fall. At this point, originations are trending to about $5.3 billion, which is 6% lower than in 2019, and that decline is slightly overweighted toward the latter part of the year. Even during these difficult times, we have demonstrated the earnings power of the franchise. While we suspended guidance at the beginning of the pandemic, we have earned a net income of $277 million in the first half of 2020, despite taking an additional $243 million in COVID-related loss reserves in Q2 2020. At the time, we indicated that we believe this provision fully reflected the realities of the economic scenario. If I turn you on to Page 6. As I step back, I believe we have a simple but incredibly powerful investment thesis. We have a core business with an attractive earnings profile. The market is growing and will likely to do so given the importance of higher education and the need for a variety of financing mechanisms to meet the unique needs of customers. We have a scale position that will allow us to turn good top line growth into better bottom line growth. Second, the 2 main risks in the business are manageable. We have a proven ability to manage credit risk as evidenced through the pandemic. And while political risk is real, we believe that we are well positioned to perform well. And third, we allocate our capital to higher-return loans and are building a strong reputation and rigorously allocating capital and returning it to shareholders. If I turn you on to Page 7. As the management team, Board and I refined our strategy, we have embraced this investment thesis and built strategic imperatives specifically focused on driving valuation and shareholder return. And we're going to focus on 4 key imperatives going forward. First, to maximize the profitability and growth of our core business; secondly, to optimize the value of our brand and attractive client base; third, maintain a predictable capital allocation and return program to create shareholder value; and fourth, to change the narrative around private student lending to address both real and perceived political risk. Let me discuss each in turn. If I turn you to Page 8, we believe that the private student lending market will continue to grow originations at 6% or greater for the foreseeable future. But we believe we can do better than 6% earnings growth. First, while we are a 52% market share leader, we do believe we have opportunities to enhance top line revenue and to some extent, market share. And to do so, we're going to focus on a number of key areas. First, we think we can deepen penetration at lower penetrated schools. Second, we think we can increase the size of our average loan by displacing other higher cost lending options, such as credit cards. Third, we think we can enhance our risk-adjusted pricing and underwriting through expanded data and better analytics to make credit and pricing decisions. And fourth, we think we can continue investment in high ROE direct-to-consumer marketing capabilities. In addition, operating leverage and cost discipline can help translate good top line growth into better bottom line results. 60% of our operating expenses are fixed costs. And about half of our spend is to third-party vendors. We will drive even greater efficiency in our variable costs, will obsess over any fixed cost increases and candidly, expect our vendors to likewise pursue efficiency opportunities and pass those savings on to us. If I transition now to Page 9, we will also seek to maximize the value of our brand and our customer base. We have a privileged connection to new college grads, which I hope all of you recognize as one of the most hotly contested customer segments in financial services. Sallie Mae is often a person's first real banking experience. And as a result, we know our customers better than anyone. We will seek to offer new products and services that provide great value to customers but also provide value to Sallie Mae shareholders. These products will directly leverage our customer base and brand affiliation. It's also important to note that I plan to heavily leverage partnerships and other affiliations when building these products and services, really safeguarding our precious capital and expense capacity. If I turn you on to Page 10. Our third imperative will be to maintain a rigorous and predictable capital allocation and return program. And to do so, we're going to focus on a couple of things. First, we want to focus private education loans and hold a very high ROE bar for other products that we led on our balance sheet. Second, we're going to use a hybrid hold-and-sell loan model to optimize capital consumption while maintaining a stable or modestly growing balance sheet. We have been impressed by the robustness of the whole loan market even during the worst of the pandemic and believe that they will continue to heal and provide healthy gain-on-sale options. Third, we expect to continue a strong capital return program, very much focused on share buybacks, and this is important, especially while there is such a large difference in valuation between loan sale premiums and our stock price. And of course, we expect to continue to pay a dividend subject to our Board's approval. If I transition now to Page 11, our final imperative is changing the narrative around student lending with an eye toward influencing both real and perceived political risk in the business. There are obviously hundreds of federal legislators and thousands at the state level, not to mention countless pundits, advocates and other influencers, some of whom will promote extreme views as a way of building up local brand. In addition, the press certainly has an interest in covering those more extreme positions. As we cut through it though, we believe that there are 3 broad proposals, which seem to have the most support. And as we assess each and how they might be realistically be implemented, we remain confident in the strength of our business. The first of those proposals is free college. And on the surface, that may sound like a scary proposal for a company like Sallie Mae, but let me dig in a little bit deeper. This was actually a proposal that was first brought to the mainstream by both senators Sanders and Clinton during the 2016 election. And it's very much a hallmark of Vice President Biden's program, along with free community college and job training. What's important to note is that free college doesn't mean free college for everybody and up to any limit. It really focuses typically on a means test and for a state level of tuition assistance. What you also may not know is that 19 states have something similar to what Senator Sanders and Clinton and Vice President, Biden, have proposed. And in fact, the New York Excelsior program is the most developed. And that provides state college -- free state college for those with a family income under $125,000, who maintain and make certain residency commitments. What's interesting to know is that in the first year that, that program, the Excelsior program was introduced, the impact to Sallie Mae was minimal. It had less than a 3% impact on originations on a like-for-like basis. So free college, again, is a proposal out there, lots of attention, but we think it fits well in with our business. The second proposal that seems to get a fair amount of attention is debt forgiveness. And let me start by saying it's hard to believe that the federal government will move to forgive all student debt. That would come with a price tag of approximately $1.5 trillion, which in this environment doesn't seem to be the top priority. However, there does seem to be some real support for a needs-based approach, which makes it both more affordable and politically palatable. And it's important to note that those need-based approaches really have less of an impact on our business. Most of our customers are performing well. And the impact of loan forgiveness for customers, who are not performing well, is minimal because there are customers who may otherwise already be in financial distress, and we may have already taken reserves against losses on that position. The third proposal that seems to get a fair amount of attention is bankruptcy reform, which is really just another form of targeted assistance. And you may or may not know, Sallie Mae has a long position of supporting prospective discharging of student debt with a proper post-graduate payment and seasoning period. Said differently, we don't want to create an incentive for people to default on their loans and declare bankruptcy just to wipe out a student debt. And this is really another form of targeted assistance. And like debt forgiveness, the impact is likely small if it's proactive and with the type of seasoning that I talked about. So again, political risk is something that I know tends to be on lots of people's minds when they think about Sallie Mae. But as we continue to do our homework and dissect and analyze the different positions, we believe we can continue to perform well even if some of those proposals become reality in the years ahead. Finally, if I move you to Page 12, we hope you all agree that Sallie Mae has a simple, clear but powerful investment thesis. In addition, I hope I've given you a little bit of a sense of how these 4 strategic imperatives will further enhance this investment thesis. Said simply, if we can drive growth, if we can reduce risk and minimize capital deployed, in my experience, that's a fairly sure-footed strategy for creating shareholder value. So with that, thank you for your time and happy to open it up to any questions. Mark?

Yes. Great. Thank you. Before we go to the questions, I had one more question, at least for now of the audience. So if you could register response to this question. What is the biggest risk to the shares here? Increasing third-party consolidation, worse than expected credit, political headline risk, lower gain on sale margin on loan sales or additional reserve builds? And thank you for participating in these. Moving to the Q&A portion, Jonathan, how is the in-school origination market shaping up this quarter relative to your expectations? And will it be a challenge origination environment into next year as well.

Mark, it's a great question, and I touched on some of these numbers earlier. This fall, the origination market is definitely down some. And certainly, with 15% of schools going online, not having the room and board component of those borrowing needs. And I think, candidly, just some number of students deciding to take the year off, be it a gap year or just a transition year. There's no doubt that originations are down somewhat. I will say they are down sort of at the lower end, the better end of our range of expectations. It is certainly possible to imagine a far worse scenario for return to school this fall than what we are going through today. So I think at the end of the day, our view is this fall is going to feel a little bumpy. It's going to feel a little bit like 3 steps forward, 1 step back. I think we're already starting to experience that. But this is where I think the dedication and the focus of universities really comes to play because I think the vast majority of them are really just saying, we have to figure out a way to make this work, and they're getting really creative to do it. So down but slightly better than sort of the lower end of our reasonable expectations. For the spring, I think a lot of that really depends on where we are, pandemic-wise, where we are vaccine-wise, and sort of what strategies are proven by the schools to be effective. My -- if I had to guess today, I would guess the spring will look a lot like the fall in terms of relative performance. But it's also easy to imagine a scenario where schools have really figured out what works and what doesn't work from a social distancing perspective. Students are taking greater accountability, and we're that much closer to therapeutics and vaccines, which gives everyone the confidence to move on. By the way, I would be remiss if I didn't say, one could also imagine a worse scenario, right? You could imagine a full bloom sort of second wave and sort of a subsequent shutdown, which obviously has negative impacts, not just for universities and Sallie Mae, but for the economy as a whole. But if I had to sort of guess today, my guess based on all we know is it looks a lot like the fall on a relative basis. I do think the one bonus sort of answer I would give you as well is the one thing I've learned in past recessions is, bounce backs can tend to be pretty strong. And whether that's in the spring or the following summer, we know people are pulling back competitively from this industry. We know students very much want to get back to school. We know universities very much want people back in school. And so at whatever point we start to get some sense of an all clear signal. My guess is we are going to see a period of time of really accelerated and outpaced originations, whether that's in the spring, the summer, I think the science will have to tell us.

Okay. Do you see any risk that your fall disbursements might actually -- you may have to reset them lower. If you've got schools like my alma mater, University of North Carolina, which opened up and then decided to shut down and presumably may feel like they need to offer some levels of tuition refunds. Could you see money get return that you would dispersed at some point this quarter?

It is always possible that there are refunds, in which case, that disbursement number would, in fact, effectively go down as a result of it. Clearly, the later we get into the fall and the more of the year that has gone by, the lower the risk that, that becomes.

Okay. Got it. Turning back to the audience response questions. I mean the next question is, see, what is the -- I'll ask this one. I guess it's just the last one. Over the next year, would you expect your position in Sallie Mae to increase, decrease or remain the same?

And position Mark, meaning originations, market share, what's the position?

No. Sorry, Jonathan. That was for the audience. So in other words, whether they're going to continue to hold the stock somewhat...

I see.

So turning back to the questions for you. A number of competitors have announced they're retrenching while at least one has entered the market. So what is the level of competition been like for in-school loans this season that you've seen?

Yes. Mark, it's a great question, and I wish we were a month or 2 ahead in terms of the dust settling out because as you can appreciate in the marketplace between the volume impacts of COVID and the competitive changes. There's a lot of moving pieces, and I'm not sure we have good estimates right now of sort of how much the competitive tailwinds have benefited us. But look, I think a couple of points. One, along the lines I just made, during economic downturns, I think lenders tend to do 2 things pretty predictably. They get out of hobby businesses and they narrow their credit spectrum, if they're not full credit spectrum lenders, do the things that they're most comfortable with. And we've clearly seen both of those things happen. And I think what then also was a pretty clear lesson. Certainly, we saw it during the Great Recession, is when the economy turns, there's really great business to be done in those sectors, and competition does not come back in right away and credit lenses do not expand right away. So a little bit back to your earlier question, it's sort of hard for me to predict exactly when, but it's impossible for me to imagine that competitors pulling back, and this is, I'm sure, happening under the covers, competitors narrowing their credit spectrum that those things won't have a positive impact on our business as a leading full credit spectrum lender in this space. And again, it's hard to know exactly when and how that will materialize. But we've seen this too many times before in consumer finance. And at -- and on some basis, it's just supply and demand.

Got it. So has your approach to in-school originations changed in any way through this pandemic?

It has changed in a number of ways and not just the sort of in-school originations thing. But I think, first and foremost, and it's important to say it. The #1 question we got from schools, when the whole pandemic started was, are you going to be here for us and for our students. And so back to the leading relationship that we have with schools and the depth of that relationship, I was proud, even in my early days as CEO to be able to say without question to those schools. Yes, of course. This is a market we're committed to. This is a product that we're committed to. We are going to be here for you. And I think that, that built us sort of incredibly strong stead with the schools. We have done some things on the margin recognizing sort of the changing risk landscape that the pandemic and economic downturn have suggested, we have done some things to tighten certain credit boxes. We've done some things to really make sure that we're underwriting with special care for certain types of schools. Think about aviation colleges. Those can be great educations, but there's obviously a different risk factor right now for newly minted pilots than for others. We wanted to be really thoughtful about how we took on that risk. So we've done a lot of very tailored things in how we're engaging and working with each school. But I think our general program is very much the same. We are an absolutely committed student lender. This is our core business. It's not a hobby for us. We think we're really pretty good at it, especially during times of stress in the system. It's when our underwriting really comes out. And so we did some things on the margin, but we've largely been there for our schools in much the same way we've always been.