SLM Corporation (SLM) Earnings Call Transcript & Summary

Hello. I'm Mark DeVries, Barclays Consumer Finance Analyst. I'm very pleased to be joined by SLM Corporation, Sallie Mae CFO, Steve McGarry. Thank you all for joining us. We're going to be doing a fireside chat today. I have a number of questions for Steve. For those of you who have any questions while we're doing this slide, my e-mail should be displayed on your screen, so you can send me an email at [email protected] with any questions or alternatively, you could also try to message me on Bloomberg. So with that, I want to kick it off, Steve, thanks for joining.

I wanted to start off with college enrollments for this year. What are you seeing or hearing right now from colleges as we head towards the fall semester?

Sure. So great question. Mark, what we're hearing from colleges and universities is basically that we are going to be returning to normalcy, most colleges, the vast majority are going to be opening up on campus. So that we're looking forward to a full return of students. As you've read in the headlines, many colleges and universities are going to require students to get vaccinated. So we think we're going to be pretty close to normal by the time the fall semester runs around -- rolls around in September.

Okay. Great. So what does that translate into, in terms of originations, for the back half of the year? They were down 10% in 1Q, but you kept the guidance of 6% to 7% growth for the full year, which implies some pretty strong growth in the back half. Does this still look achievable to you?

Yes. We definitely think that, that is achievable. The number that we're looking at for originations for the full year is $5.7 billion. So you are correct. The second half of the year is going to be very strong. I think we'll see growth in the low double digits for the fall semester, the peak season. So we'll get additional information when summer school opens up, and we'll be watching applications very carefully over the course of May, June and July, but we do think we're going to have a very robust origination year in 2021.

Okay. Great. Can you comment on the competitive environment? And what you're seeing currently? Your market share has picked up as some competitors have exited? Is there any room for additional share gains here?

So look, we are currently right around a 60% market share. We had a good fall of 2020 relative to our peers. We had a solid first quarter of originations. We continue to block and tackle and invest in all of the different components of our origination engine. As you know, we have the leading sales force in the industry, most experienced and largest. They continue to keep us very engaged with colleges and universities. We have relationships with over 2,400 schools. We're very well represented on lender list that exists in the industry. And we continue to invest in our digital marketing capabilities. So we are ramping up our game there. So we definitely believe that we can continue to take market share, and we're doing that 0.5 percentage point at a time. When you have a 60% market share, it is difficult to continue to grow that, but we think we have the best and most consumer-friendly lending platform. And we continue to price our product appropriately, not only to be attractive to students and their families but also to generate very strong ROEs on our product.

Okay. That's helpful. Now switching course a little bit. Can you touch on the environment for loan sales currently? The margins have been really strong on the last sale, and you've guided to another $1 billion of sales later this year. Can those margins hold up? And is there enough demand to sell more than $1 billion?

So, look, we sold $3 billion, as you know, in the first quarter. We generated a very strong $400 million gain on sale. The market has not changed dramatically since that time. There has been a slight backup in base interest rates, swap yields have increased, but a lot of that has been offset by a compression in credit spreads. We just recently did a securitization. I think we closed it last week. And based on what we saw there and demand for the various bonds, we think that the loan sale premium market is pretty rock solid. I think people are becoming more and more familiar with our products. We have a very vast trove of data for potential buyers to look at, both in terms of credit quality and prepay speeds. Investors very much like our servicing platform. So we think that the market for premiums should remain very strong. We have just $1 billion penciled in for the remainder of the year. We will probably sell that towards the end of the third quarter, perhaps beginning of the fourth quarter. And we're pretty confident that we're going to have very strong demand for that product. What we did back in the first quarter is, we ran a process internally. We invited a number of bidders to participate. People are now educated on our product and very familiar with the performance. We will do the same thing when we sell the next $1 billion of loans, and I'm sure it will be met with a very strong demand.

Okay. Great. Can you talk a little bit more about kind of the whole strategy around loan sales and capital returns? You have purchased over 1/4 of your share since the beginning of 2020. What's the outlook for sales and capital returns as we look into -- through the end of this year and into 2022? Kind of how are you thinking about that strategy longer term?

Sure. So look, Mark, we think creating shareholder value is very, very important part of our business and what we're doing here at Sallie Mae. And the fact of the matter is that we have opportunity to take advantage of a wonderful arbitrage where we can sell student loans at a premium that in the current market exceeds the expected net present value of what we would earn on the loans if we held them on the balance sheet and then we can turn around and use the gain on sale and the capital that's freed up to repurchase our stock at what we think is very much a discount to where we think it should be trading. So to put that into perspective, when we look at our cost of capital and we look at the growth rates that we think that we can put up here over the next 5-plus years, we think that we should be trading at a multiple, certainly, in the low double digits, perhaps the low teens. So we will continue to sell loans to raise capital to return to shareholders. And then it's important that I point out that we are about to enter the period where we're phasing in the impact of CECL to our capital ratios. And this is something that a lot of investors don't probably think about or put into perspective on a day-to-day basis. But we will be phasing in the CECL impact over the period of '22 through '25. And while we generate very high ROEs on our loan product, which in normal times, would generate enough capital to not only fund growth but generate enough capital to return to shareholders, the CECL phase-in dampens that capital generation. So while we're going through that period, I think you should expect us to continue to sell loans to generate capital to return to shareholders through both share repurchases and dividends and take advantage of the arbitrage, which we think exists. And we also think that when we look at our earnings capabilities over the next several years, we think our earnings will grow naturally. So we will be chasing a rising stock price as we take advantage of that arbitrage.

Okay. That's really helpful. You just alluded to the impact that the phasing of CECL is going to have on your capital generation, but as I'm sure you appreciate, CECL also has the effect of just increasing capital intensity, in general, on holding the assets. How is that affecting kind of the appeal of -- the longer-term appeal of selling versus retaining loans?

So the CECL demand -- so clearly, because of CECL, we do need to hold more capital on our loan portfolio than we would absent CECL. But the fact of the matter is the life of the student loan portfolio is fairly long, and it generates enough capital to basically offset that impact without having a major impact on the ROE of the portfolio. But look, it is true that the impact of CECL has motivated a number of our competitors and peers to also sell a portion of the portfolio. And it is a fact that they are -- the loans are -- probably have slightly better returns to those that don't have to abide by the CECL loan loss allowance process than those that do. But there is plenty of return in the portfolio with or without CECL.

Okay. So we should expect much more longer-term retention of originations, at least once you're able to kind of close this arbitrage and get a valuation that more fully reflects where you think...?

Look, I think that's right. So we'll originate $5.7 billion of loans this year. We do operate in a growing marketplace. And we think that, that loan origination number will continue to rise as we look out over the medium-term horizon. And I think I mentioned on our most recent earnings call that we will step down loan sales to $3 billion in 2022, and obviously, 2023 and '24 are long ways away. But we will probably keep a steady level of loan sales, which will enable our portfolio to start growing again in '22, '23 and beyond. So not only will we be generating earnings from the loan sales but we'll also have a benefit of a growing portfolio in future years.

Okay. Just turning next to capital targets. You've indicated you target a risk-based capital level of about 12%. You're at 13.8% last quarter. And you indicated that the company could actually end the year higher. How should investors think about the time frame to get down to the target of -- longer-term target of 12%?

Sure. That's a great question, Mark. The fact of the matter is there has been so much volatility in our numbers as a result of the CECL reserve and the pandemic environment that we were in. We want to take a slightly conservative approach to that for at least the next several quarters. And then we certainly can take our -- begin to take our capital levels down in '22, '23 and beyond. And don't forget, we also publish a ratio of GAAP equity plus loan loss allowance, which we think is also a true measure of our true capital and that number is north of 15% as well and will stay up there. But we do want to see the volatility decline before we take the next step down in lowering our capital. And look, it's going to be interesting. I saw yesterday the Moody's forecast for the month of May, which are a key component to our loan loss reserve. And in the first quarter, they were down 100 -- the unemployment forecast were down 100 basis points quarter-over-quarter. Already 2 months into the second quarter, it looks like the Moody's forecast are down another 50 basis points. So the environment is definitely a positive one for loan loss reserving.

Okay. Great. Moving on to credit. Can you just give an update on credit and talk about what's driving the really strong performance so far this year?

Sure. So look, our portfolio is performing better than we anticipated. We did maintain our guidance for charge-offs of $260 million to $280 million for the full year, despite the fact that losses and delinquencies came in significantly lower in the first quarter compared to the fourth quarter. We think the second quarter will also show some favorable delinquency and credit trends, but we will be dialing back some of the pandemic loss mitigation tools that we've used particularly disaster forbearance in the latter half of the year, and we do think that, that will result in a tick up in delinquencies and charge-offs. However, we are very, very well reserved for what we anticipate ensuing over the remainder of the year. And we have a couple of -- so obviously, the fiscal and monetary stimulus that is in the economy has been unprecedented. And as we're all aware, for example, the federal loan program has a payment holiday in place, that frees up an abundant amount of cash flow for individuals with student loans. And that's before you even take a look at stimulus checks, rent and mortgage moratoriums et cetera. So there is definitely an awful lot of wind in our back that is supporting the performance of the portfolio today. But look, our portfolio typically performs very well. It performed very well in the prior recession. And at the end of the day, we have a very high credit quality in the portfolio. And we're also -- it's a unique product where people are taking advantage of the value proposition of higher education. I think the stat is somewhere around 90% of our students complete their degree program, and that generally means that they go on to take advantage of the higher incomes and the lower unemployment rates that college degree is associated with.

Okay. Moving on to reserves. You brought the coverage ratio down to 5.4% last quarter from 6.5%. And that's still based on some pretty conservative macro assumptions. How about those forecasts kind of trended since quarter end?

Yes. So we would expect there to be another step down in the reserving at this point in time, barring any very major improvements in the economic outlook. And the 100 basis points of economic improvement in the first quarter, I think, was associated with $40 million of reserve improvement. So if we stay at that $50 million level, I don't think that we will see a substantial -- I'm sorry, 50 basis point level, I don't think we will see a substantial improvement in our loan loss reserve going forward. I think that 5.25%, 5.5% of the portfolio is probably a pretty good number at this point in time.

And I guess the next question is, longer term, does that also feel like economic stress aside like the right level is kind of a little bit below your kind of CECL day 1 reserve? But obviously, as you've alluded to, there's still -- you still have wind at your back. So where do you eventually see that kind of migrating back to in a more normalized environment?

It's difficult to say. It's going to be very important to see how the economy performs once the coronavirus pandemic stimulus is withdrawn, particularly things like the federal student loan holiday, but 5.5% to 6% is probably a pretty reasonable level for that reserve.

Got it. Now turning to the NIM. Can you just touch on the trajectory there? Has it been lower than expectations last quarter due to a cash drag? You're still expecting 4.75% for the year. So how are you tracking relative to that right now?

Sure. So we're 1 month in -- one complete month into the second quarter. The NIM is ticking up. I happen to review April results yesterday. We think we're very much on target for 4.75% for the full year. And what that means is we will tick back up towards and slightly above 5% by the end of the year. And I think that the NIM for the company could very easily stay in that 4.75% to 5% level for '21, '22 and beyond barring any major changes in our liquidity program. But we did manage to spend a big chunk of the cash, buying back our common stock, and we are managing that liquidity level lower, and that will very much support the NIM going forward. I mean what we're seeing in the student loan marketplace is that pricing remains pretty much unchanged, and we're very confident that we're going to be able to originate loans at a very healthy and stable NIM and ROE going forward.

Okay. Great. And so pricing unchanged, no real pressure being created by some of the consolidation players or any other kind of newer entrants on the fintech side?

No. We're not seeing any new pressures being introduced from consolidation players or the fintech players. Basically, look, the core competitors that we focus our time on are all the names that you're going to be familiar with: the Discovers, the Citizens, et cetera. Look, there's always been a stream of new entrants coming into and out of the student loan marketplace. It has very attractive returns. It also is viewed as sort of a gateway to building relationships with a very positive customer base, as I alluded to earlier. If you achieve a college degree, you're going to go on to earn a very attractive income and become a consumer of other financial services and products and people view it as a good way to try and build relationships with that type of consumer. But look, share of wallet is very difficult to build and breaking into the student loan market is very difficult. We think that based on our excellent brand name, our very strong servicing and lending platform that we will be able to hold our own in the marketplace going forward.

Okay. You just mentioned the opportunity to really leverage, more broadly, the relationship with the customers that you form by making those student loans. Could you just talk a little bit more about kind of the broader initiatives at Sallie Mae that -- to broaden product and broaden those relationships?

Yes, absolutely. So look, we are focused on a number of things here at the company, and we refer to them internally and publicly as our 4 imperatives. And we're focused on being the best in our core student loan business, that's our imperative number one. We're focused on continuing to improve what is already a very favorable brand. That's imperative number 2. Imperative #3 is to sort of rightsize the narrative around student lending and explaining to both policymakers and investors what our real positive role is in the marketplace. In terms of policymakers -- and I'll get back to the brand topic in a second. In terms of policymakers, many still already -- many already think that we're still involved in the federal loan program. And when people talk about a student loan issue, they're really talking about the federal loan program. The private student lending portfolio has defaults that are a fraction of the federal student loan program. And we serve a vital role for those that want to achieve higher college degree. So we're currently working to help policymakers understand our role in the industry. And actually, this gives me an opportunity to mention a website that we've developed, which is called "salliemakessense." I recommend that people go, take a look at that. It's our attempt to rightsize the narrative around student lending and you can find links to it on our website. And then our fourth imperative is appropriate capital allocation. But let's go back to what we're doing with the brand and what we're doing with our customers. So our focus now is to build out a host of resources that we have on our website that help customers understand how to pay for college, but also resources that help them figure out what college is right for them. So we have a number of products that essentially -- we give away for free and more to that in a second. We have products that help people research paying for and attending college. We have products that help people figure out how to fill out the FAFSA form. You would think it would be relatively easy, but it's actually pretty challenging. And then we have a suite of services that help high school guidance counselors help their students how to figure out his higher education challenge. And what we see is we have many millions of people that come to our website but don't end up as customers in our private student loan product. We think building out this suite of services and giving them away for free will help us generate leads, lower our cost to acquire our student loan program but also, at the end of the day, provide us with a trove of additional data that we can use one way or another to potentially, down the road, possibly partner with providers of other financial services that might want to partner with us to take advantage of the people that are coming to our website. But I want to emphasize that this is all built around our current student lending platform. We are not interested at this point in time in diversifying into other financial services products. We are really just trying to build out and become the best at student lending and generate the high ROEs that we can from that product. So I know I rambled around a lot there, Mark. I hopefully answered your question.

Yes. That's really helpful. Could you talk a little bit more about some of these, these partnerships that you're contemplating about entering into the -- to leverage those relationships?

So at this point in time, we are in the extremely early stages. What we're doing now is we're partnering with people that help us provide things like FAFSA resources. And help people figure out how to pay, plan and save for college, things of that nature. So there is nothing on the drawing board today that might be a partnership with, for example, a credit card company or something along those lines. We're in the very early stages. And we want to focus on the core business first, get that absolutely right, and then potentially down the road, we could look at other services or partnerships.

Okay. Makes sense. Turning to operating expenses. You put out guidance of $525 million to $535 million for the year. Can you remind us what the fixed versus variable breakdown is? And how much additional room to gain some efficiencies?

So look, the fixed variable is right around 65-35, 62-38, somewhere in that vicinity. That number has actually been stable over the last 3 to 5 years as we built the excellent servicing platform that we have today. So we've invested in online servicing. We've invested in mobile capabilities, and we've invested in our digital marketing platform. We now think that we are at the stage where we can start to dial back on investments in our fixed costs. And as we mentioned on the most recent conference call, we think we are at the stage where we can start to drive down our unit cost to service, and ultimately, down the road, our unit cost to acquire. So we think we're well positioned as we speak today to start to reap the benefits of the investments that we've made in our servicing and origination platform. So our goal would be, for example, to drive unit costs down 5% a year over the next several years. And we gave a unit cost range on the earnings conference call, but that is going to happen slowly and steadily. So I think we made the comment that we'll update on unit cost probably once a year because there's seasonality in there, and it's going to be something that moves slowly and steadily lower. But look, we did the big restructuring in the third quarter of 2020. And under Jon Witter's leadership -- Jon joined us just, I guess, about 13 months ago. We are very, very focused on making sure our investments have a positive return, and we are very focused on making sure that we become not only best but the most efficient student lender in the marketplace.

Great. Are there are any updates you can provide us on what you're seeing in consolidation activity? There are some people who believe that when forbearance ends later this year, consolidation activity will pick up. So making sure I'm getting your thoughts on that?

That is possible. Consolidation as a percent of the overall portfolio has been steady to down the first quarter. Look, the amount of consolidation was probably within our expectations that trended a little bit lower in April, but obviously, it's a month-by-month situation. I don't know if the Forbe -- if the student loan payment holiday will -- when that ends, if there's going to be more or less activity. The activity that has taken place while it's underway has been about as we would expect. The thing that would really dampen consolidation activity would be if base rates increased a little bit. The margins that the consolidators earn is razor thin on a good day. So something we continue to watch. And obviously, we would love to retain those loans. What we see in the portfolio is as repay cohorts season, consolidation activity declines. If that was not the case, I would be more concerned than I am today. And the fact of the matter is that many of these loans that consolidate are from very high earners coming out of college. And I think one way or another, they would either consolidate or prepay very quickly, regardless. I mean, we do earn a pretty decent return on those loans prior to consolidating. We will continue to look for a silver bullet to prevent the consolidation activity from happening, but it's very, very difficult to prevent consolidations and not cannibalize your own portfolio.

Okay. Got it. And could you elaborate a little bit more on the point you made about the impact on base rates and these consolidators are already having thin margins. Is there a level of -- for the yield curve, which it becomes uneconomic and you would expect consolidation activity to really fall off in a more meaningful way?

I mean, look, we almost got to it pre pandemic, and then interest rates plummeted. If you're originating loans at 4.25%, 5-year swap rates are at 100 basis points, you had a credit spread on top of that. It doesn't take a whole lot of movement in rates to either force consolidators to reprice higher, which would naturally have an impact of declining volume for not being able to make a reasonable return on that product. So call it 50 basis points higher and I think activity would probably start to decline.

Okay. One of the more visible consolidators is going public this year. Have you seen any kind of change in their behavior or competition from companies either in their position going public or looking to go public? And -- or have you seen them kind of get distracted as they look to further diversify their businesses? What's the dynamic been around some of these competitors?

Probably inappropriate for me to comment on what we're seeing in their activity. But I will leave it at we are not seeing any material ramping up or down as they -- I think they've already gone public, right? We haven't seen any material change in their activity.

Okay. Fair enough. So any updates you can provide us on the political front? It seems a lot of the concern or talk around legislative proposals have died down. Is there anything worth keeping on the radar for investors right now?

So look, the landscape is pretty much unchanged. And again, this is very important to us, all part of changing the narrative around the student lending industry. When we look at the landscape, we come away thinking that it is relatively benign. So let's look at the 3 topics that seem to be getting all of the attention in the political landscape these days. We can start with free college. Originally, we thought that the proposal might be free college for individuals with incomes of $125,000 or lower. And we thought that, that would be free 4-year college. So there are many programs in the states that are focused on providing free college for individuals with incomes of $125,000 or less. The number one is the Excelsior program in New York state. So that's been around now for probably approaching 5 years. And we have seen a no material impact on our business from that program. Principally because at the end of the day, we are lending to more affluent families and students, and they don't require the assistance that is provided by those programs. We are supportive of a program like that. We think it probably makes good public policy sense. It basically improves both social mobility and helps underserved and diverse communities. But that program has been diluted down to free community college, it looks like, at this stage of the game. And we don't really -- the community college is already inexpensive enough that we typically are not lending at those programs. So that was the number one topic. Number two is loan forgiveness. And loan forgiveness has received an awful lot of press. And most of those articles have pointed out how regressive loan forgiveness ends up being. And at the end of the day, it's bad public policy because you're assisting people that don't really need the benefits. So we're talking about helping people that have graduate degrees are already making substantial incomes and don't really need the public support. So the big ticket loan forgiveness recommendations have been watered down. And we're now looking at potentially loan forgiveness for people with $10,000 of student debt. And under all of these proposals, the proposals were only focused on forgiving federal debt, which I think is important for people to understand, but it doesn't appear that those programs are gaining much traction. And then the third topic that is being discussed is potentially changing the bankruptcy laws. So as you know, today, student debt is nondischargeable, and bankruptcy except under very severe hardship cases. We at Sallie Mae, we're probably the better part of a decade. I've always supported bankruptcy law changes, particularly if it was done in a way that would require, what I would call, a cooling off period, which means you can't just graduate college, immediately discharge your loans and basically abuse the bankruptcy laws in those -- in that case. What -- when we've done the work, we have concluded that because of the nature of our portfolio, and I'm talking about 90% co-signage. We don't think that changing the bankruptcy laws would have a material impact on us, and we think that it makes sense in true hardship cases for allowing some bankruptcy leniency. But at the end of the day, the legislative landscape appears to be very benign for Sallie Mae and other private lenders. And when you look at the economics and the policies, we think that, that makes a lot of sense. So we feel good about what we're seeing today.

Got it. And then just one last question for you. The ESG has become a topic that's been getting increasing amounts of focus. Can you just talk about Sallie Mae's approach to ESG?

Sure. So look, ESG is actually becoming more important and we believe that, that makes a lot of sense. At the end of the day, Sallie Mae is very much an ESG company, and I'll make a couple of points here. I mean our product by definition, helps improve the social condition of our nation. It's indisputable that higher education provides a host of benefits. We've spent a lot of time already today talking about the value proposition of higher education, which means higher income and lower unemployment. But college degree basically improves the health and well-being of many of the recipients of it. And the college board has done a lot of research and published a lot of statistics on the overall wellness of individuals that have a college degree. But then looking more internally at the company, we're very much committed to having an ethical and a diverse workplace. We just 2 weeks ago hired a Chief Diversity Officer to work towards that goal. Our Board members are very diverse. And I'll point out that our philanthropic efforts are very much focused on helping minority students and underserved communities. And as a matter of fact, I'm pretty proud of the work that we're doing here in that regard.

Okay. Excellent. Well, I think we're about out of time. I'd like to thank all of you in the audience for joining us. And thank you, Steve, very much for your time and your insights. We really appreciate it.

Thank you. Great to present here, once again, Mark, a big fan of this conference.

All right. Thanks, Steve.

Take care.

All right.