SLM Corporation (SLM) Earnings Call Transcript & Summary

Good afternoon, everyone. Cruising and at the end of the day. And I want to thank Steve McGarry from Sallie Mae for being here today and hanging with us to the end. I know you've had some meetings today and talk through a lot of the issues and questions. But let's just do this. I think people generally know what Sallie Mae is. But just for those of you that may not and I still get questions on what exactly your role is when you get into understanding the industry and forgiveness and things like that. Just give us a quick overview of what Sallie Mae is all about.

Sure. Happy to, Jon. And first of all, thanks for having us at your conference. We have had a lot of productive meetings and expect to have a few more today before we wrap the day up. But Sallie Mae is the largest private student lender in the industry. We first started making private student loans back in the late 1990s. We, of course, spun out of OldCo in April 2014. We are primarily a bank, Sallie Mae Bank is an ILC chartered in the state of Utah. But back to our main mission. Our mission is to help students and their families pay for a college degree. Private student loans comprise a very minor component of the total spend on higher education, which does total in the $450 billion vicinity to put total private loan originations into perspective. There's probably about $14 billion of private student loans originated year in and year out, and they are a very important component of the GAP funding. We boast a market share in the mid-50% vicinity. We've had a pretty stable market share year in and year out. At that level, it's difficult to grow it in a meaningful fashion, but we're very happy with the success that we have. We have the largest sales force in the industry that basically covers financial aid offices that we think contributes about 2/3 of our volume of our annual origination volume. And in addition to our sales force, we, of course, are out there doing digital marketing, paid search, social media, et cetera, and that is where our competitors and new entrants into the marketplace attempt to make their inroads. And it is at 1/3 of our production, obviously, a very core component of our operation as well. Long and the short of it is, we are 80% deposit funded. We rely on the asset-backed securitization market for the remaining 20% of our funding. We are in the market right now, marketing and pricing, a funding securitization. And I think in a nutshell, Jon, that's pretty much Sallie Mae 101. So, I forgot to mention anything while I am here.

I think it's good. I mean, there's plenty of other stuff to talk about, but you mentioned the securitization. Talk about the decision on that and how that's generally going.

Sure. So, look, we have a relatively long-term asset with a weighted average life in the 5-year vicinity. The deposit market is very strong out to 2 and 3 years, but we like to fund our portfolio conservatively, and issuing asset-backed funding allows us to really extend the duration of our funding by issuing essentially life-of-loan funding. In addition to that, it is a very good source of long-term fixed rate funding for the fixed rate loan portfolio, which is becoming more and more popular with borrowers, obviously, in this interest rate environment. So, the asset-backed funding market has been very favorable to us and helps us lock in the type of net interest margin that we have on the portfolio. To put a point on that then in 2022 was 5.3%, rising interest rate environment, we were able to increase our NIM by 50 basis points from the prior year. We expect it to remain in the low 5 percentage area going forward.

Okay. Good. My Sallie Mae loan, when I was a youngster a young man, the duration was about 3 years, and the coupon book, and I would carry it out and mail it in right on top of what you're saying.

Very good. Thank you for paying that loan.

You are welcome. People come in still a long time ago. So, you touched on the margin. Let's just big picture go over what you're expecting for the year and then you filed a recent update in terms of some expectations. Talk a little bit about that, if you would.

Sure. So, I think what you're referring to is we provided an update in a slide that we filed this morning on our credit performance. Our credit performance has been a very hot topic for all of the obvious reasons. I think it's fair to say that we disappointed investors in the fourth quarter with our credit performance. There have been several what I like to consider to be transitory impacts to our credit performance and to put a point on it in the fourth quarter, our default rate came in at 3.15% versus 2.55% for the full year. We have been working very diligently in order to improve the performance of our portfolio, namely by focusing on our collection techniques and operations. And I was very pleased to report a month ago that the January performance was really the best in a year in terms of default roll rates from the last delinquency bucket to default. We beat our expectations pretty significantly. One month does not a trend make. I think we can all agree. We followed that up with a performance in the month of February that exceeded the expectations that we have built into our guidance for the year. The annualized default rate for the months of January and February came in at 2.17%. That is a fully 100 basis points improvement over where we were in the fourth quarter. And obviously, the room for improvement is the biggest room in the world I heard once upon a time, so, we are very happy to continue to see improvement. And I think the good news is that we are set up very well to have a good month in the month of March. So, the first quarter should turn out to be favorable relatively to the underperformance that we put up in the fourth quarter. And what we saw in the February collection activity is that rolls, we had a pretty strong resolution in the midterm buckets. So, we are set up well for collections and default prevention in the third month of the quarter. So, we're very pleased about that.

Anything you'd attribute the aberrations to? We've talked about it a little bit. But as you look back, anything you would attribute it to?

So, look, it's -- I discussed this at great length with investors. We only have 21 minutes left. So, I'll try and do a quick job of this. But what happened long story, hopefully, short is in 2020 and 2021, as we all recall, consumer assets were performing very well. What we see in our collection centers is, there's a very high turnover. So, as collects left in '20 and '21, we did not replace them. As we now all know, the beginning of 2022 brought with it a much different world from a macroeconomic standpoint. So, we saw interest rates start to rise. We also saw inflationary pressures start to impact borrowers. At the same time, we had a change in forbearance practices that we introduced in the first -- in the beginning of December of 2021. And we also had a population of loans that we kept in a grace period when they dropped out of school during the pandemic because we were just choking people to forget about the pandemic, it seems like a long time ago. But what we were seeing were high dropout rates. And we thought it was in the best interest of our borrowers to keep them in a great status, assuming they were going to return to school. When they did not, we put them into full principal and interest repayment, again, in the beginning of December of 2021. So now, we have a change in collection practices and a portfolio that is about to roll into the delinquency buckets. And we found ourselves unfortunately in an understaffed position. It took us the better part of 2022 to not only recruit and staff our collection centers, but also to get them trained up to use the new tools that they had at their disposal to help borrowers that were having a challenging time making their payments. It all kind of peaked in the fourth quarter, and we feel very good now and we have evidence that is showing that we have, I think, gotten our operation back on the right track.

Okay. And recent results indicate that.

Recent results certainly support that assertion, yes.

Okay. How do you feel about CECL and the conservatism? And do you feel like you've built in a worsening scenario and how comfortable are you with the current levels of your reserves?

So, CECL has been very impacted to Sallie Mae. We have a long-term asset class that has a life of loan loss expectations in the 10% decent and in fact, we put a chart out showing the expected life of loan default rates by origination cohorts a month ago. So, please take a look at that if you want to see the magnitude of what we're talking about. The long story short is, we were required to move $1 billion from our equity account up to our loan loss reserve account, where we do not get any regulatory credit for a significant amount of loan loss allowance in our regulatory capital ratios. So, it's been very impactful to our capital accounts and obviously, building and documenting a CECL reserve requires exhaustive documentation and is a very requiring practice. We now have, believe it or not, a 6.3% allowance for loan loss that covers all of our private student loan exposure. And at the end of the year, we built allowance for loan loss reserve that expected very little improvement in our default performance in '23, moderate improvement in '24, and then a little bit more meaningful improvement in '25 and beyond. So, to put numbers on it, we expected 10% improvement in '23, another 20% improvement in '24, and then an additional 30% improvement in '25 and beyond. So, we now have a loan loss reserve that is built to expect very little improvement in our default performance. And so far at the beginning of the year, we are starting to see some meaningful improvement.

Okay. Great. I think I mentioned this before, but I have 3 kids in college and things were very abnormal. And it feels like we're slowly moving back toward normal for you. Is that fair?

I think that's right. So, again, we made a decision to keep students that dropped out during the pandemic in Grace. We have now put those borrowers back into full P&I, that cohort of loans after and we disclosed that there were $59 million of defaults in 2022 associated with that portfolio. That portfolio is now performing very much like any other dropout performance the cohort that came before it. So, we feel like that incident is certainly in our rearview mirror. In terms of enrollment and loan originations, we think very many students are back on campus. They are back seeking higher education. You may recall that we saw an actual decline in originations in 2020, small improvement in 2021. We had very strong loan originations in 2022, with 10% loan growth. We had our strongest January, which is a very key period for the spring semester. Our loan originations in January were the strongest ever, and that's a very important month for our loan origination process, which is very seasonal. And we think kids are back. They realize the value of higher education despite the significant amount of media that you see that suggests otherwise. And we think our business is back on track very much so.

And you've stuck with this 5% to 6% origination growth for '23. You still feel good about that.

Yes. We very much feel good about the guidance that we provided.

Okay. Forgiveness is a topic, federal loan forgiveness plus or minus any real impact in your mind if we get some forgiveness or we don't get forgiveness, how does that impact you?

Sure. So, let's talk about that. I don't have a view on what the Supreme Court may or may not decide to do with loan forgiveness. Obviously, to the extent that our borrowers, we encourage our borrowers to take free money first, federal money second for all the obvious reasons, the subsidized interest rate is very attractive and the programs that come with federal loans are very beneficial to borrowers, and we recommend that they take a private student loan as their last option. So, most of our borrowers have federal loans in front of our private student loan. The exposure varies depending upon whether the borrowers are dependent or independent student, but we think all are very manageable to the extent that a loan for goodness to the magnitude of $20,000 occurs that would be favorable to our borrowers, certainly. But what we do think is going to happen is the student loan payment moratorium will end as scheduled, I think, June 30 of this year. But what we think is also going to occur is that the income-based repayment programs are going to be liberalized further. So, if you're not familiar with the income-based repayment programs, they are offered by the federal government and 2 key proposals to consider is, one is a recommendation that if a borrower has 200 income that is equal to 225% of the poverty level, their proposed payment on the federal loan program is 0. And then the second proposal is to take the percentage of any borrower's disposable income down to 5% of their calculated disposable income. So, to a certain extent, these proposals are very liberal and I think take a lot of sting out of the fact that the student loan moratorium payment is going to come to an end and loan forgiveness might not be enacted. When we look at our portfolio, we conclude that there will certainly be a marginal impact on it from the end of the student loan moratorium. We do not think it is going to be meaningful, and we base that on history. So, our borrowers have always had federal student loans and have been able to manage the payments on all of their loan exposures. But we also think that during the pandemic, the higher-income earners, which by large, meets the definition of our borrowers and cosigners have actually repaired their balance sheet and still have excess savings. I know that lower-income individuals, which typically are not our borrowers have started to use consumer debt at a pre-pandemic clip and have worked through a lot of their excess savings, but that does not typically represent the borrowers that we have underwritten. So, we feel pretty good about how things will turn out in the event of the restarting of the ending of the payment holiday and no loan for goodness or loan forgiveness.

Yes. Obviously, you've thought through this in terms of your reserve building.

Absolutely. Yes.

Okay. Balance sheet optimization in 9 minutes and 11 seconds. How much is that?

So look, we -- our own record as having $3 billion of loan sales in our guidance. We are doing a securitization right now as we speak, which is going to show tightening in spreads. I had the good fortune to go out to Las Vegas to the secured finance conference a week ago, and I met with both ordinary asset-backed buyers as well as whole loan buyers and residual buyers. And I can tell you that the demand for our product is probably better than it's ever been. I remain confident that we are going to be able to execute a loan sale along the premium lines that we factored into our EPS guidance. And I would remind investors that in addition to the premium that we earn on the sale, we are also releasing this oversized CECL reserve through our income statement and freeing up somewhere along the lines of 14% capital to use to do share repurchases and the whole purpose of selling loans is to generate capital to return to our shareholders, principally in the form of a share buyback. And our stock price is obviously continuing to trade at what we believe to be a discounted value. So, the share repurchase stock buyback arbitrage is very much alive and well in our mindset. So, we'll complete our funding securitization and then we plan on running a process to execute a loan sale. And my goal would be able to be in a position to not necessarily close that loan sale by the time we release earnings, but certainly to share with investors, a, whether or not we completed that loan sale; and b, at a high level the ZIP code of the premium that we earned on that loan sales. So, a lot of wood to chop between now and late April, but that is certainly the plan.

But the message is from your securitization visits, there's still a high level of demand for your product.

Definitely, is a high level of demand for the student loan asset class, and lots and lots of portfolios out there that are interested in acquiring consumer assets, 100%.

Okay. Post balance sheet optimization strategy and who knows when this will run out because you've talked about as long as the calculus works, you'll still do it. But what does the company look like? What is the financial model in your mind?

So Jon, that's a great question, and I'm glad that you asked it. So, I mentioned earlier that CECL took $1 billion out of the equity line, put it up into the loan loss reserve line. And through January of '25, we are making down payments on the way we calculate our regulatory capital levels to bring that into line. Post CECL phasing, the company could grow its balance sheet at a very nice clip and generate organic earnings growth without needing to sell loans that given the high ROE on our product would enable us to generate capital to return to shareholders organically. So, I think the company post CECL phasing has very attractive EPS growth prospects. And at some point, hopefully, in 2023, we will conduct an Investor Day and share directly with investors what we think those growth prospects might look like.

That would be great. I think that would be welcome. Yes. Absolutely. You've obviously been around the company for a while. Today, what is the most misunderstood piece of the story in your view?

I mean it's a very good question. I think that shareholders love the loan sale, and buyback arbitrage. We then have assigned a lower multiple to the low-quality earnings that we generate from the loan sales. Net-net, we have bought back 44% of the common stock that was outstanding just 2 years ago, was probably not understood is what we were just talking about, and that is the power of the earnings growth that this company can generate when we are -- when we have the CECL phase in behind us and we can start to grow our balance sheet organically.

Okay. Any last questions for Steve? Well, Steve, I was a little nervous about if I didn't perform on this venue, you wouldn't come back next year, but you're retiring at the end of February. So, I don't have to worry about it. So, I wanted to say congratulations on your retirement. You've been most helpful to us. Thank you for everything.

You won't get rid of me just yet. I think I'm very much going to be part of the mix for the next 6 or 7 months anyway.

Okay. Good. Thank you, Steve. I appreciate it.