SLM Corporation (SLM) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for joining us for this fireside chat with SLM Corp.'s CEO, Jon Witter. We have a number of prepared questions we'll be going through. [Operator Instructions] We also prepared a number of audience polling questions that we would encourage you to answer during the presentation and we'll be publishing the results in our report summarizing the takeaways from the conference. With that out of the way, let's get to the discussion. Jon, thank you very much for joining us.

Wanted to start off with originations. How is the in-school origination market been shaping up during peak season this year? And how does it compare to your expectations?

Yes, Mark, first of all, thank you for having us here today. It's great to be with you. Good luck with your conference here over the next couple of days. Peak season for our fall semester is really still underway. And as I think we've talked about on some of the past earnings calls, because of how schools and financial aid offices are responding to COVID and to the pandemic, what we've seen is that peak seasons tend to start later, they go longer. They are, for lack of a better term, lumpier and candidly just more unpredictable. And again, that's not just this peak season this fall, there's certainly no exception, but that's been the case for the last couple of seasons that we've seen. And in fact, you may or may not remember from our last earnings call during the Q&A, Steve actually mentioned that peak season was off to a slow start this year. We are very confident, we're confident that our originations will see meaningful growth in 2021 versus 2020. But there are some observed headwinds in the market related to our original expectations. It is probably too early to really translate how those headwinds turn into sort of an impact on our guidance, if any. We'll certainly know more when we get to our third quarter earnings announcement a little bit later in October and look forward to providing sort of more detail at that point.

Okay. This may be one of the headwinds you're alluding to, but has the recent surge in delta variant change anything?

I would say simply, it hasn't in the grand scheme of things, it probably has on the margin. If you watched any of the college football games this last weekend, I think what you saw in TV is exactly what we're hearing from our in-school teams, which is all of these schools are doing everything in their power to get back to normal. Certainly getting back to a residential model and really wherever possible getting back to be fully normal on-campus experience. And you saw it in the stands. I think you see it in the classrooms. I think you see it sort of across the board. So the vast majority of our schools are reporting either a full return to normal or some kind of a continued hybrid residential sort of model that we saw last year. There's a couple of schools that have delayed the start of in-person classes because of delta, but I think even those are sort of relatively few in number. With that said, I think delta is certainly having a little bit of a psychological impact. And I think we have seen a little bit of softness in some of the leading indicators around enrollment. For example, FAFSA applications are down a little bit. My guess is some of that is due to the fact that this is not as far in the rearview mirror as maybe we would have hoped at this point. But I think practically, we're not seeing a huge impact on campus from delta.

Okay. That's helpful. Is there anything you're seeing that is kind of notably different around demand, competition or credit quality of loans compared to past years?

The honest answer is not really. On the credit quality side, if you look at the metrics that are sort of easiest to identify, things like FICO score at origination, cosigner rates and so forth. We have been really very pleasantly surprised, not just this peak season, but throughout the pandemic about how just robust and sort of persistent and resilient those measures have been. We've seen very little change from what we would have seen during normal times. I think what is unquestionably true, and I mentioned this a little bit on the last earnings call, I think with a major competitor leaving the marketplace, we are absolutely seeing what I would call some modest enhanced competition for those now jump all customers. We see this playing out in a little bit more active and engaged direct-to-consumer marketing type spend and programs. We see it, a little bit on the margin on pricing, although not dramatically. And I would put it all into the category of still pretty rational competitive behavior. So I think all of that has played out pretty much how we would have thought it.

Okay. Yes, your market share was around 56% last quarter. Is there any room for additional gains? I know you don't want to be 100% of the market, but where does that market share realistically settle at?

Yes, Mark, in some news off the press from our last earnings call, we now have our second quarter market share data. We came in for the second quarter at 69.3% versus 63.7% in the year ago quarter. You have to remember, before anyone gets too excited about that, there's always a bit of quarter-to-quarter seasonality in those numbers, really depending on sort of the nature of your disbursements. But if I take a step back, one, I would not read too much into any 1 quarter. With that said though, if you look at our last 3 quarters that we've announced, we've seen nice year-over-year improvement in each of those quarters to the tune of 300 basis points or more in each of those quarters. So it's not quite the long-term trend in market share that we're looking to continue here. But we do feel like we are making some market share gains, and we do feel like we are competing effectively for some of those new jump all customers that I mentioned before. With that said, my guess is over the course of the quarters ahead, those market shares will settle back down into a new normal, post the competitive change, post -- sort of hopefully, the impacts of the pandemic settling out. And my guess is we will be up sort of modestly over where we were before. My personal view though is I care about growth, but I care about profitability and returns a lot more. So I'd love to see modest market share gain with enhanced or stable profit. But if we have to choose, we will always choose to give up market share growth to sustain profitability. So we really like the discipline we've got around our marketing programs. We like the discipline we have around our pricing. We think that's really important. For anyone who's followed financial services, you can always find examples of companies that have given up on profitability or credit to drive growth, we're not going to do that. But we're optimistic. We've seen some nice trends. We're certainly hopeful that those continue. And more importantly, we like the discipline we've had around pricing and cost of acquisition along the way.

Okay. Can we step back and just maybe provide an update on the overall size of the in-school market and remind investors what the drivers of growth are longer term?

Yes, happy to. So the private student lending market is about a $13 billion market. Prior to the pandemic, it was growing in the sort of mid-to-upper single digits. So depending on how you tracked it, it might look like sort of 8% or 9% growth, but we always think about this as a mid-to-upper single-digit growth marketplace. And at the end of the day, I think the real drivers of this is sort of directly correlated to the cost of higher education. As a GAAP financer, we are those last marginal dollars of loans that enable a family of student to actually achieve the dream of higher education. And so when school tuition goes up and school fees go up a little faster, then obviously, that tends to drive some growth in the marketplace, as well as increases in enrollment, which we're also seeing. If I take both of these, I think the enrollment trends have been steadily ticking up over the course of the last couple of years. Quite frankly, even as -- there's some evidence that the number of college age students is likely to decline in the years ahead, we're seeing that offset in part or large part by enrollment trends. But what we're also really seeing is, for lack of a better term, a real competition among schools around selectivity and the desire to attract customers, attract students. And if you think about putting yourself in the position of a school president, a university chancellor, how do you increase selectivity? How do you do a better job of increasing the prestige of your university? You add more programs, you add better amenities, you add better dorms. All of those things come with cost. And so long term, we think the overall sort of level of participation in higher education is likely to increase as a percent because candidly, the value of higher education is just so high. And we think that, that competition, that's driven an increase in tuition and fees is likely also to continue for the near future, if not beyond.

Okay. That was very helpful. Are there any other drivers though of the size of that market that you're keeping an eye on, whether it's maybe a reauthorization of HEA and a change in the percentage of loans that can be financed with direct loans or whether it's just personal savings rates by parents and their ability to finance with cash as opposed to loans. Can you talk about some of those factors and what the implications are for the market size?

Yes, clearly. And this relates to one of the headwinds that I mentioned before. Clearly, things like excess liquidity in the marketplace from government stimulus, clearly things like higher education, Emergency Relief Act Funding, those things have an impact on people's needs to borrow. I think what's important about each of those is they are relatively temporary. So yes, the excess liquidity from stimulus is going to start to wane. Yes, the emergency Higher Education Relief Act funds are certainly going to wane over the course of the next 6-plus months. So we see those as sort of temporary sort of headwinds to the business. I think the far bigger driver in addition to the structural things I just talked about, though, is really what is the role of the federal government in all of that. And clearly, clearly, the federal government plays a heavy role in the financing of higher education. The federal lending book annually is probably 9x as large as the private lending book. And so certainly, if there were a curtailing or a limiting or a capping of what the federal government did, that potentially increases the size of the contestable market for the private players. It's worth noting that it's not a one for one. There's certainly business that the federal government does, loans that they make that the private sector would not feel comfortable making. So you can't just look -- at a sort of a cap and assume that all of that benefit would come sort of directly to the private sector, but there would certainly be some upside potential there in the future. Now with all that said, before anyone gets too excited, I think we are not terribly optimistic that there will be huge changes to the federal loan program anytime soon. Certainly, if you look at the state of things in D.C. today, that's just not where the attention is focused.

Okay. So is that more of an issue of attention? Or is it also an issue of priorities with this administration. I haven't really heard them articulate too much about what they want to do with the Grad and the PLUS programs.

Yes. The Grad and PLUS programs, I think, are not a huge part of what the Biden administration has been talking about when it relates to higher education. What they've really been talking about are things like expansion of Pell Grants, free community college. He hasn't spoken about it as much recently, but maybe some free public university for families below a certain income cap. And obviously then, also some aid to historically black and minority universities and colleges is sort of also a part of what is getting a lot of attention today. So that seems to be the real focus of it. I do think it's worth just noting, though, how dramatically that political environment has changed. I think if you had said to me a year ago that democrats were going to have the White House in both houses of Congress, and they would have proposed depending on how you count it, $5 trillion to $6 trillion of new domestic programs, including COVID relief. And what I just described was going to be the full extent of their focus on higher education, I think very few people would have taken that bet. But I think that's exactly where we are. And I think it just really emphasizes that there are other bigger issues that are facing us as a society, be that health care, be that the pandemic and COVID, be that early childhood education, et cetera. There's just a lot of things that this administration and the government are dealing with right now.

Got it. So there have been a number of new entrants into the school market. Can you talk broadly about how they fared and also talk about the competitive advantage that SLM has over these companies?

Yes, happy to. And look, I think this is a marketplace that really does continue to be dominated by the big 3, us and 2 of our more traditional banking competitors. With that said, there have been a number of entrants. I think none of them have catapulted themselves kind of into that top 3 league table. Although 1 or 2 have seen some nice growth, albeit off of a small base. I think at the end of the day though, we really like our competitive position against both those incumbents and against the smaller players. This is still very much a business where relationships with the universities matter. And matters -- and yes, universities care about staying power, they care about commitment and they care about how easy can you make life on them, as they certify loans and distribute funds. We think we have a great advantage in terms of our ability to be a better partner for universities and colleges. And while they will never steer volume to one player versus another, we know that, that ease of doing business really matters. Second, I think we really like our brand and our name recognition. I think we have lots of evidence where customers know and very much sort of relates Sallie Mae to student lending and we know that's a powerful tool for us. And we also love, quite frankly, the efficiency of our operations and our scale platform. We're about a 60% fixed-cost business. That allows us to really drive growth in a very profitable way and achieve meaningful, meaningful operating leverage. That gives us a lot of flexibility, be it through investments in new products and services, eventually potentially competing on price if the market should push us there without necessarily eroding returns. So that's strong fixed cost base, that efficient operations, that operating leverage, we also think gives us a lot of optionality going forward.

Got it. Can you comment on the consolidation players and the trends we're seeing? What's -- what do you view as the outlook from that part of the market?

Yes, it's a great question. And we are not a big consolidation player. So we obviously track it from the impact it has on our business, but take my comments in that context or perspective. Yes, well on the overall level of consolidation activity, I think we would describe as being pretty stable and sort of a modest watch item for us. It has certainly not grown to the point where it's a significant concern, but we never like people competing for our customers and obviously take it really, really seriously. I think our view, as we look at the reporting and the disclosures that consolidators do, is that it really is a very different business from an economic value creation perspective. I think people generally talk about in-school business being a 20%-plus ROE type business. I think we see the refi business being materially lower that, probably closer to 1/3 or half than where that is. It did not decline as much as we had predicted, and we talked about this during our earnings call during the pandemic. Certainly, during the last recession, the financial crisis, we saw it decline more. We think the low interest rates have probably sort of helped buoy a little bit of that activity. But I think we believe it's going to be a permanent part of what we see, probably challenged a little bit more as rates increase. And it's something that we continue to take really, really seriously. But at this point, it is a relatively stable part of our business, and something that we are thinking about in that context.

Okay. Can you remind us kind of what your strategy is to defending your business. I know years back, you guys were thinking about kind of proactively refinancing like some of your own. Is that just proven to be too difficult to execute?

Yes, it's less a question of difficulty of executing, Mark. It really does come back to something I've talked about on past calls of the sort of capitalization math. And if you think about the difference in ROEs of those loans, we would have to be able to very precisely target those with a likelihood of refinancing to make that math work out. Namely if we sort of refinance even just a few loans that wouldn't have otherwise, it's hard for us to make the math work out there. So from a purely economic perspective, it really comes down to that. So our strategy is not to focus as much on consolidation, but really to focus on what we think is the bigger underlying issue, which is customers want to feel smart, customers want to feel like they have a plan and customers want to make sure that they are managing their student loans well and getting on with the rest of their sort of financial and real life. And so our focus is a lot about how do we build deep loyalty. But how do we also give people the tools and the capabilities and the insights to have a plan to feel smart, to get their finances under control. And by the way, if that involves consolidation, so be it. We think for many customers, consolidation may not be the right answer. And for those customers, it's helping them find out the other ways that they can really manage their finances well. So that's our focus is to really sort of exclusively focus on what we think is the bigger underlying customer need. But we will continue to look at the consolidation piece. And I think if we feel like we can get to a point in the future where we can manage that cannibalization math better, then obviously that strategy will continue to evolve and unfold from there.

Okay. Got it. It's a good segue to a discussion around your credit card products. Could you just talk about that and the strategy there? And also update us on the progress you've made.

Yes, happy to. So I think our credit card progress absolutely was delayed during the pandemic. I make no apologies about it. When the pandemic started, we virtually stopped all credit card marketing. Being a new product for us, that just didn't feel like the right thing to do in the face of a changing and uncertain credit environment. And I think we looked around and decided it did not make sense to be at risk of being adversely affected for loans if we, in fact, didn't get that distribution right. We have started to turn that marketing back on here over the last several months. And our real focus for this year, Mark, is all about learning how to really effectively cross-sell credit cards to our core customers. How to do that in a really high-class way relative to our private student lending application process and also how to do that sort of through our servicing channels over time. We have learned a lot about what to do. We've learned a few examples of what not to do and really sort of maximizing the value of that cross-sell potential. And I think in that context, we are continuing to look to sort of optimize our strategy. So 2021 is really a year of turning the product back on and sort of optimizing and learning around marketing and cross-sell. And I think as we head into 2022, we'll be more explicit about plans and any refinement to strategy at that point.

Okay. Are there any other products that you're looking at that could also be a strategic fit?

Yes. It's less in the traditional banking sense, Mark, but it really goes along to what I talked about before. When we talk to our customers, students and parents, what we really find is that there is, what we term internally, a huge confidence gap that exists before, during and immediately after college. And that confidence gap, Mark, might take the form before college of questions like, how do I think about what programs are financially better for me? Or what schools are financially better for me than others? It might take the form of how do I find the money and make getting that money easy. Be it federal loans, be it scholarships, be it private loans. During school, it might be, what are the things that I can do to really maximize my financial success after school by what I do during school. And after school, it's all around how do I adult into my new life? How do I put my student years behind me financially? And how do I get off on a really strong foot? And I think what customers have told us is a couple of important things, which is; number one, these are really big, important moments; two, no one is really providing the degree of sort of service and insight in those moments that our customers would like. It's funny. Lots of people will tell you how to get into school, how to find a job, but how you manage and translate during those financial times is a little bit more uncertain; and third, what customers will tell us is that Sallie Mae is hugely credible in filling that space. So right now, today, we are really focused on how do we begin to fill in those confidence gap moments. So as an example, we've always had a scholarship tool to help students find and apply for scholarships. The tool that we have a year from now will be dramatically better and more marketed and we think more prevalent and adopted than the one we've had in the past. We've always had tools to help people financially evaluate programs. The same goes for those and right on down the line. My guess is more of those programs will start in a sort of freemium type space where candidly, if all they do is accrued benefit to our market share, our cost of acquisition and our loyalty rates among our core business, that will be a great outcome for us. But we also think some of those businesses will give us really interesting data and potentially really interesting revenue streams in the future. It will take a number of years to get to that point. But we think the benefits that we start to see in the core business should begin to accrue really pretty quickly. So we're going to stay true to our stripes of being an education solutions company and we're going to stay true to our stripes of the student loan really being at the core of what we do. But we think that there are some ways for us to extend that, enhance our brand along the way and probably generate some new revenue streams and data streams over time.

Okay. Makes sense. Turning to credit, it continues to be a highlight for you. Is there any color you can provide on early 3Q credit trends?

Yes. We have not updated 3Q credit guidance and won't until our next earnings call. But I think just to reiterate where we've been, we have seen really persistent credit improvement since really the sort of depths of the pandemic a year ago. And we've seen that play through in both our CECL reserves where we've obviously had a pretty steady sort of pattern of improved economic scenarios. But we've also seen it in our most recent charge-off guidance. And I think you know that in the last call, we updated our charge-off guidance to $215 million to $225 million. And that was down from $260 million to $280 million. And what we really credit this for is, one, the incredible strength of the college educated portion of the economy. This K-shaped recovery is real. This resilience of college-educated jobs is real. You see it in the employment rates, the college unemployment rates. Roughly half, a little bit more than what the national unemployment rate is. So the core customer and the core value that our loans provide is really, really solid. And I would also give full credit to our friends in Washington, D.C. I think the combination of fiscal and monetary policy has undoubtedly had a positive impact on the economy as a whole and economic achievement. So I am willing to bet that there will continue to be some slight and elevated levels of credit performance. I think you still see that in our numbers. But if you kind of compare that to where we were a year ago, it's hard to really fathom just how positive of a credit experience this has been over that period of time, especially relative to what I think we all feared and worried about as we headed into the depths of the pandemic.

Okay. With some of those forms of assistance potentially getting extended and you've got student loan forbearance extended until January and potential for mortgage forbearance to continue to get pushed out. What's the outlook into 2022 for credit?

Yes. We've not updated our specific guidance for 2022, but I think just to state the obvious, I think early those programs, both have an impact on the real economy and the real performance of those borrowers. More of them find jobs, more of them get back into the workplace, more of them build a little bit of liquidity and rebuild their personal balance sheet if it was impacted during the pandemic. And it also has a timing impact as well. So I would expect the impact of those policy changes to be real for us going out into 2022. At some point, the government support will wane. My guess is when it does so, we will see some modest impact to our projections. But I think candidly, the further this gets pushed out, the more real -- healing happens and I think the better off, not just for us as a lender, but more importantly for our customers as they recover from this period of economic disruption.

Got it. Yes, you've indicated that you'll sell another $1 billion of loans. Can you just talk about how the market for loan sales is shaping up right now on both timing and demand?

Yes. We will start that in earnest. In the fourth quarter, we expect to execute that fully in the fourth quarter. And look, we've not been in the market since the first quarter when we did the $3 billion loan sale. But I think all the indicators suggest that the market is still quite healthy, despite all the talk of tapering and raising rate expectations and so on and so forth. As just a data point, we finished recently securitization where the pricing came in actually a handful of basis points, I think 6 or 7 basis points, that or maybe it was 9 basis points than a similar securitization earlier in the year. And given that most of our loan sales end up in securitizations in one way, shape or form, we think that is a pretty good proxy. We think it's also, I think worth noting, that we have had effectively 8x over subscription to our $3 billion loan sale in the first quarter. So that was sort of $24 billion of interest. Clearly, $1 billion loan sale in the fourth quarter is meaningful, but it is probably far more bite-sized for the market. So again, I can't predict what an absolute option will return, but there's nothing that leads us to believe that the markets won't continue to be healthy and attractive for us on the loan sales side.

Okay. And how optimistic are you that, that strength will hold up into next year if you look to sell more loans in 2022?

Yes. Again, you're asking me to really look into a crystal ball, and I'm not sure I have the ability to do that. I think we believe that in addition to the interest rate environment though, there are some structural things that have really changed about this marketplace, which I think bode well for future loan sales. Number one, there's just a lot more buyers in this marketplace than there were a few years ago. I think Wells Fargo getting out of the business, selling their portfolio, I think taught a lot of people about this business. They sharpened their pencils, they built their models. And they're now really, I think, very supportive and understanding of just what a great asset class this is. They're not going to go away anytime soon. Secondly, I think the things that are driving the underlying demographic demands for fixed income products, the aging of the population, the relatively short supply of fixed income product versus asset generation, I think that bodes really, really well. And look, third, we now have a pretty long track record of selling representative slices of our portfolio. And I think people have seen those portfolios perform really well. And so, they not only like private student lending and they not only like the product, but I think they like Sallie Mae and our performance and what we do from a servicing and a loss mitigation perspective on top of that. So even if the interest rate and credit spread environment changes a little bit, I think those structural factors will hopefully be true for a long, long time. So again, can't predict the outcome of any auction. But I think we think there's reasons to be optimistic going forward.

Okay. And how should we think about the amount you might sell next year? Kind of what could cause to sell more or less?

Yes. Look, let me answer that in sort of 2 ways. I think if you think about our overall capital return strategy, there's really 2 things that we're trying to do. Number one, we're trying to take advantage of this incredible arbitrage that we think exists between whole loan sale premiums and our current multiple in valuation. And there, I think the governor is not how much we can sell, but how quickly can we buy back in those shares, how quickly can we deploy that capital without materially distorting the underlying price of the equity. I always tell my team, half of being a good capital allocator is knowing when to sell, but also half of it is knowing when to buy and at what price. And so we don't want to sort of overheat the market and end up spending more to buy back our stock than we need to. if patience over a few more months would have led to a better outcome. So to me, that's sort of factor number one. The other reason that we're selling loans is to maintain what I think we've referred to as sort of a flattish balance sheet. And if you think about where we are with the CECL phase-in perspective, the CECL phase-in is absolutely drawing on some of our capital. And we feel like if we were both growing the balance sheet and fully phasing in CECL simultaneously, we wouldn't have as much a commitment to capital return as we like. And so we sort of hate selling these loans. They're all great loans. But maintaining a flattish balance sheet for the next couple of years allows us to be healthy in the capital return perspective and phase-in CECL. The really exciting part though is the question you didn't ask, which is what happens on the other side of that? And while still a number of years out, we believe post-CECL, the ability to grow the balance sheet and organically generate capital is really the ultimate sort of capital return story for Sallie Mae. And we're excited to do a better job of telling that story and proving that out over the years ahead.

Okay. Got it. The stock has done relatively well this year it's certainly less cheap than it was going into 2021. How attractive do you view that arbitrage is being right now? And if we were to describe kind of where we are in the innings of this arbitrage, where you think we are?

Yes. Look, I think we're probably in the earlier innings of the arbitrage. And you're right, we've certainly made progress. But look, I would suggest if you believe that this is a market that's going to grow, as I said earlier, at sort of mid- to upper single digits. And if you believe we can get the operating leverage associated with a 60% fixed cost base. And if you believe that, that can translate into low to mid-double-digit earnings growth. And if you believe that will generate the kind of capital that we're looking for. And that candidly, credit risk and political risk, as we've talked about, are pretty darn manageable, especially relative to where we've been, but I would even argue on an absolute basis. It's sort of hard to put those sets of financial sort of inputs into a model and come up with a model where trading at 7x or 8x forward-looking consensus PE makes sense. And so we're not going to come out with an estimate of what we think that valuation should be. Obviously, our investors have to make that call, but it feels like it should be materially higher than where we are. We know to get there, we've got to deliver on our strategy. We've got to show the earnings growth. We've got to manage the risk. we've got to demonstrate the capital return and we need to show the power of this franchise, especially post-CECL. And so when you think about what my team and I are doing, that is what we are laser-focused on. And my guess is, over the coming years, we'll hopefully see not just growth in E and not just growth in EPS through the capital return strategies, but I hope what we'll also see during that time is a meaningful improvement in multiple as well.

Okay. Makes sense. Well, we're out of time. So I'll conclude it there. Let me just thank you, Jon, for all of your time and insights today. We really appreciate it.

Yes, Mark. Thank you, appreciate it, and again, good luck with the conference and thanks to everyone who listened for their interest in Sallie Mae.