SLM Corporation (SLM) Earnings Call Transcript & Summary

All right, good morning, everyone. Thanks for joining us. I'm Moshe Orenbuch, Specialty Finance Analyst here at Credit Suisse. I'm very pleased to have with us the management of Sallie Mae. Sallie Mae is the dominant player in private student lending has continued to increase its market share even as new entrants have entered the business, company has taken some steps recently, which we'll talk about to improve its servicing and collections. And we're very pleased to have Steve McGarry, the CFO of Sallie with us. I noted that Steve has been with Sallie Mae since 1997, that's longer than I've been with Credit Suisse, which not so easy to do. But -- we'll do a fireside chat and kind of we look forward to his commentary.

Maybe Steve, to kick it off. You did post some slides in advance of this, and there were a couple of new slides that talked about the performance and your kind of expectation from a credit perspective. Can you kind of walk us through that and we'll take it from there.

Happy to, Moshe. And thank you for having us here at the conference once again, always a very key part of our investor outreach. So yes, to provide a little bit of clarity to investors. We thought that it would be a good idea to publish some specific life-of-loan default expectations for the last 5 years of our originations. So they are the default expectations that we had at originations. We also provided some information around the expected ROEs on these cohorts of loans. And then finally, we provided some information on where we are at this point in time in the evolution of those cumulative default rates. So starting at the top, we show that between 2018 and 2022, we increased our life of loan default rate assumption from 9.4% to 10.5%. Before I get into what drove this, I would like to point out that we build our custom credit score with the help of Experian, we are on, I think, our fourth version of that model. And the model uses basically credit bureau data to predict the ability and willingness of our borrowers and core to perform. So we use custom credit score. We don't use FICO, but we refer to FICO quite often in our disclosures because it is a statistic that everybody is familiar with. So what occurred between 2018 and 2020 is we expanded our credit box minimally. We found pockets of loans that had higher default rates, but we thought that they would contribute to our targeted high ROE, which you can see has bounced around between the low teens -- I'm sorry, the high teens and basically the low 20% vicinity. And then in 2020, we increased our default expectations for 2 reasons -- actually 3 reasons. One was the pandemic. We anticipated that borrowers coming out of the 2020 and 2021, origination cohorts might have some employment challenges back then when we were underwriting these cohorts, there was still an abundance of uncertainty about the performance of the economy. Also in 2020, we extended the term of our loans. We used to offer a term anywhere from 5 to 10 years, and we thought it was more appropriate for this asset type to offer borrowers a 10- to 15-year term. And basically, in consumer credit, the longer the cash flows are out there, the higher the default expectations are. However, all well within very high expected ROEs. And then finally, in response to, and we've talked very much about the fact that we've changed our credit administration practices, namely we started to limit the amount of forbearance borrowers could receive. We started that process in 2019. So that also helped increase the expected life of loan defaults on our portfolio but all very much within the anticipation that we were going to earn low 20% ROEs, which I think is a very substantial return given our cost of capital and the returns on this type of consumer asset class. I will make one other point. We also provided what we report quarterly, a view of where our cumulative default curves stand now, and they are actually repay default curves. That is what we have been publishing for many, many years, and we'll continue to do so. And I think they're very informative. I want to make several points about those -- the performance of those charts. You will see a little bit of steepening in the 2021 cohort curve. That is primarily driven by the recent credit performance. But if you exclude what we've talked about again at some of tremendous volume, our GAAP year issue that took place during the pandemic. That curve bends down a little bit more than 10%. It would be actually 2.5% cumulatively if we excluded those loans, which we have talked about and have determined that it was absolutely a onetime nonrecurring issue stemming back to the pandemic and allowing people to remain in school. I might as well just continue Moshe or...

Well, let me ask one question related to that because on that slide, you did mention that the performance -- and I think it is an important point, the performance of even of that most recent vintage is still within that kind of tracking towards that 10.5% or so.

That is absolutely correct, and thank you for that question. We have run our expected life of loan reserve through our probability of default and cash flow model. And we are very confident that we will continue to meet the expected life of loan default rates that we had at underwriting for that cohort and for the cohorts that preceded it. And to a very large extent, the earlier cohorts have been outperforming default expectations and despite 2022's performance, we still think that we are very much on track to meet that performance in the long term.

Got it. Could you discuss the significance of that low 20s ROE? Obviously, the loans that you retain on your books will earn that ROE. Can you talk about how buyers -- potential buyers of the loans will look at that?

Sure, absolutely. So what Moshe is referring to is that we have been selling roughly $3 billion of loans each year in order to raise capital to buy back our stock, which we think it trades at a discount and to provide capital return to investors. We are required to do that right now, and I just want to point this out because we are still phasing in the impact of CECL to our regulatory capital ratios. That concludes on January 1, 2025. And we believe once we get beyond that, given the high ROEs on our loan portfolio, we will start to generate capital organically and will not have to continue to sell loans in a major fashion in order to buy back stock, pay a dividend to shareholders. I diverged a little bit from the main point of Moshe's question, we believe that our loan buyers very much understand the long-term performance of our portfolios and are very in tune with the cash flows that our portfolio generates, and we believe that they understand that we will meet the objectives or the assumptions that we had on this portfolio at underwriting. And in addition to credit. There have been some positives in the marketplace regarding loan sales. We have seen ABS spreads come in, in a pretty meaningful way since our last transaction. And we have also seen prepayments slow, which extends the life of the loans and creates additional cash flows, which increases the value of our loan portfolio as well.

Great. So what you discussed on the fourth quarter earnings call, still on track for that loan sale and the basic metrics are kind of at least as good as what we've seen.

Yes. And we have no reason to believe otherwise. I would like to make one other point about the slides that we provided last night. They do report out on our ABS trust performance, which I know investors are watching very closely after our credit underperformance in the fourth quarter. The good news here is, and we called this out, our trusts are starting to experience a decline in defaults in '19 out of 25 in the trust outstanding decline. And if you calculate a default rate on the entire securitized portfolio of loans the default rate dropped nearly 100 basis points. In addition to that, we mentioned in our earnings call that we were seeing improvement in collections, but we didn't really elaborate on that point. What we are seeing is, in January, again, our roll to default rate was the best in a year, and our roll into delinquency was the best in 9 months. And it's important to call that out because we have also commented on operational collection issues that we have had over the course of 2022. Now I will be the first to admit that 1 month does not make a trend. But in this period of time where we're watching credit performance very closely. I think it's important to call that out. And of course, we will report out on February and March as the year evolves.

Maybe just on that, what's the -- how do we think about the time frame for how long does it take to make a trend? I mean, obviously, some of these trends we'd see in 3 months and some in 6 months. But you'll have a much better insight because of the kind of those changes in the collections practices that you're talking about, stuff that we won't be able to see from the outside. So maybe amplify on that a little bit.

Sure. So I do think we're definitely in the show me state, and we're going to have to put up positive performance over the next, I think, probably 2 quarters to get investors comfortable about how our portfolio is going to perform over time. We have made a number of very important changes in our collection state. We are no longer understaffed. We have parted ways with the Head of Collections. We also elevated our Chief Risk Officer into the role of President and Chief Operating Officer. Kerri Palmer came to us from Capital One, where she was involved in the operations on the auto lending side and has experience in collections. We have brought on board a consultant, and we are making a number of changes in the collection space to increase our performance and get back on track to the strong credit performance that we have seen in the past.

As we look at your EPS guidance or your -- the entire kind of range of guidance items that you kind of put out there, obviously, you've included a relatively high level of credit loss and you've built a reserve that contemplates that. So just can you talk a little bit about what could -- what things would have to happen for it to be worse than that and what things would happen that would make it better than that? And how would that evolve during '23?

Sure. So we provided some specificity on the call. Let me repeat that and maybe elaborate on that a little bit. So we gave charge-off guidance that was only modestly better for '23 than what we saw in '22. We expect just 10% better performance in '23. And going into '24, we expect our performance to improve again marginally by another 20%. And then I think by '25, we will be on the road to recovery and getting back towards the kind of performance that we have seen in the past. Under CECL, we are required to build a life of loan loss reserve, and that reserve after underperforming over the course of 2022, I think, is really built to expect a very little improvement going forward. I will call out a couple of factors. So in 2022, we had defaults of $386 million, included in that was $59 million of GAAP year loans that charged off, which we don't expect to reoccur. We also charged off $13 million of loans that were not yet at their 120-day past due point, but they had used an abundance of forbearance in the past. We changed that practice. So if you eliminate that $72 million, we're already down to a default rate of somewhere around the lines of 2.1%, but we are reserved for a default rate of 2.4% to 2.5% in 2023. So in order to meet our guidance for 2023, we expect no improvement. So if we do see improvement in credit we should see stronger earnings as we dial back some of that CECL loan loss allowance.

Okay. We'll move on from the credit side of things, I would say, as we look at the competitive environment in your business, there always seem to be some number of new entrants. You talked about what's out there. Certainly, your former other half is curly, its third year of kind of being in the business. Talk a little bit about the competitive environment for private student lending and related to your origination growth guidance.

Sure. So as a reminder, we are talking about very high return asset class ROEs in the 20% and better. We are talking about a very attractive borrower base. Companies want to engage with young potential college graduates early on in their career so that they can sell them additional products as they grow their relationships with financial institutions. So high-quality asset class, very attractive client base. So there are a number of new entrants that come and go year after year. I certainly don't want to name any of them buy names, but we all know who they are. You mentioned our better half their on-campus loan originations, I think, haven't really sort of hit a significant growth rate just yet. Rather than talk about others, I'll talk about our own performance. We grew our market share by 2%, which is pretty impressive in 2022. We continue to block and tackle in terms of the quality of our brand, how we market and how we engage with potential borrowers, both on-campus through our sales force and through our digital marketing techniques as well.