SLM Corporation (SLM) Earnings Call Transcript & Summary

All right. We're going to get things going here. Very happy to welcome Jon Witter, CEO of Sallie Mae to our conference. Thanks for joining us, Jon. Before we get started, I just want to read across some important disclosures. For important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. The taking of photographs and use of recording devices is also not allowed. If you have any questions, please reach out your Morgan Stanley sales representative. Jon, welcome to the conference.

Jeff, great to be here. Thank you.

Yes. Thanks for coming. And why don't we just get things kicked off right away? You put up some slides last week. Maybe we could just dive right in. Anything to update us on the quarter? I know you talked a little bit about the credit, consolidation activity, anything you're seeing in originations either.

Sure. And obviously, it's a little bit of a tweener period not yet at the end of the quarter. But I think as we put out on Friday evening, we continue to be, I think, hopeful regarding and optimistic regarding credit trends. We obviously had a very nice first quarter. I think April and May are tracking modestly ahead of our expectations, recognizing that credit in April is always elevated just given the normal seasonality of the business. We also put out some data on consolidations. And I think we've seen through sort of our vantage point and in our portfolio, a pretty dramatic change in the consolidation environment. If memory serves me right, consolidations are down, roughly 72%, 74% versus a similar period last year. And obviously, that's an attractive tailwind for us in terms of asset staying on the balance sheet longer. And as we announced during the first quarter, very strong start to the origination season. And while our peak season doesn't really start until the early part of July, I think we continue to be optimistic and encouraged by what we're seeing sort of in the trends to date. So in a time where there's a lot of tailwinds in the industry at large, I think we feel pretty good about some of the tailwinds that we're feeling in our business right now.

And what do you think is driving that lower consolidation activity? And what do you think the outlook is from here? Is there potentially a rebound to come of consolidation away or...?

Yes. And let me preface this, as I always do when I get this question, consolidations is not our core business. Obviously, we see it through the vantage point of our portfolio, but I'm sure there's others who have deeper and different views than I do. But I think our analysis suggests that the primary driver of the change in consolidations is really predominantly rate related. And so we've seen that play out here over a number of quarters. And as we've done our reverse engineering of the likely or anticipated margins on different consolidation deals out there, it feels like the margins are getting squeezed pretty dramatically. I think on top of that, most of the consolidation activity that we see is what I would describe as federal loan first led. That's where the big balances typically sit for most of our customers and the private student loans sort of come along as a part of the deal. And I do think customers are probably recognizing that there are inherent advantages to the student loan -- or the federal student loan program, whether that's the potential for loan forgiveness and I'm sure we can talk about that more, whether it is sort of the payment pause holiday during the pandemic or whether it's the promise of even better going forward income-driven repayment or income-based repayment programs. Those are real benefits that I'm sure a lot of customers feel and might lead them to think differently about refinancing those or consolidating those loans.

Definitely, I want to get into the moratorium, but let's put that off for a little bit later. Just to follow up on the credit performance. I think you talked about the 2.38% year-to-date for the first 5 months of the year tracking better than or in line or better, I think, with your expectations. So I think this implies something more like the 2.7% to 2.8% for this quarter so far. Can you just remind us why that's going on right now. I think you talked about the grace period impact.

Yes. So the biggest thing that we see is there's obviously a level of charge-offs that are uniform and sort of consistent throughout the year. And they're really the results of just the normal things that happen in people's lives, which, of course, are kind of evenly distributed if you want to think about it in those terms. But what we also know is one of the very largest single cohorts of defaults is what we think of as sort of the zero payment sort of default cohort. And in every consumer credit business that I've been a part of, there's always a group of customers, no matter how well you underwrite, who once they have the credit, literally never make a payment and flow straight through to default. And if you think about our P&I wave, our biggest P&I wave really happens in the November time frame. And therefore, April just tends to be a seasonally high month for us, all things being equal in terms of charge-offs. So there's always that degree of seasonality. There's other factors as well. Things like the timing of loan sales can have a small impact. There's some other features and functions as well. But I think it's always a little bit difficult to annualize a single month or even a couple of months of performance. Quarterly is sort of the least I would want to do. And I think it's really more important to look at those through the guidance for the entire year.

Got it. And so it sounds like maybe we should see some of that unwind in the coming quarters beyond 2Q?

Yes. I think the thing I would feel comfortable saying is every quarter will be a little bit different going forward for idiosyncratic reasons. And we'll do our best during upcoming earnings calls of giving folks a good sense of where we see the world going and what they could expect to be different on a quarter-by-quarter basis.

And you talked about some of the credit issues you had last year. I think there were a myriad of items going on there that impacted you. I think one of the things that I wanted to ask you about though was the collection staffing and training. I think that was one key area you highlighted as you were maybe understaffed and undertrained for a bit of a period there. How is that going? Do you feel like you're at the place you need to be? Are they performing above your expectations, et cetera?

Yes, great question. And just as a reminder, for anyone who's never run sort of a big gearing ratio-oriented operation shop, seemingly small differences in expected volume can actually have a pretty big impact in overall performance. And that's just the math, if I can take so many calls in an hour, and I have so many people and -- so even 5% and 10% variances can obviously have a big impact there. Since last year, we've done 3 or 4 things, and I'm pleased with sort of the operational performance that we've made. Number one, we've really gone very hard to make sure that we are at and remain at sort of full staffing and maybe even slightly rich staffing relative to expected volumes. We feel like that's the right place to be. Secondly, we've made real changes to how we are training and onboarding this new staff. I think when you've had the luxury of sort of a large installed base of staff for a long period of time, sometimes you don't recognize all the opportunities around training. So we've made changes there from -- everything from how we train our staff to where we train them, bringing many more back in the office for longer periods of time, and we've seen real performance differences in terms of how quickly people are coming up to speed. We've made technology changes to how our staff are accessing customers and whether it's sort of how we text and sort of how calls are identified and how we're doing the outreach or how we're helping to support our agents as they work through some of the very difficult conversations and complex conversations they need to have around needs identification and sort of program matching we put in place, much better workflow tools to be able to help with all of that. And then I think the final piece is we've started thinking even more expansively about the programs that we have to offer our customers. And our previous credit administration programs were very broad. They were very flexible. We've changed those for some important reasons. And I think we did a good job of anticipating kind of a first set of programs that would help fill some of those gaps. But over the last 6 to 9 months, we've also identified some places where some newer optimized programs will be really, really helpful and beneficial to our customers as well. So across all those dimensions, I think we've made great operational progress and I think still more to come.

I'm curious, are there any examples of programs you're finding you're doing more now? Or anything you could tangibly highlight on how you're actually helping your borrowers today?

To give you a broad sense because not everyone will have sort of studied our [ loss ] programs and our credit administration programs thoroughly. We do a whole host of different things. We do graduated repayment programs. So when you're just coming out of school and maybe you haven't fully grown into your new payment sort of stepped up programs to help you sort of wage your way into your full responsibilities. We do principal reduction, we do term extension, we do rate reduction, like all of those programs are out there, and they're all part of our arsenal. I think what we're really focused on, and this is where technology comes into play is how do you balance complexity, efficiency and effectiveness. And at the extreme, you'd love to give every customer their own unique individualized plan. You'd blow the place up in terms of complexity. You could never administer that number of programs. By the very same token, if you gave everyone one plan, it'd be really simple. It wouldn't be terribly effective, and it wouldn't be terribly efficient. You'd be giving people a lot more benefit in some cases than they really needed. And so rather than a new program, I think what you should expect is greater optimization to really not come up with dozens and dozens, but the right number of those programs to really balance efficiency, effectiveness and complexity. I do think the one place that I'm especially excited is we are adding some additional programs, in particular, in the graduated repayment space. This is a place where we know most of the customers that we have who experience financial difficulty do so within the first 1 to 3 years of entering P&I. By the way, this makes sense. If you think about what it was like to be 22 or 23 years old, you probably weren't making as much as you wanted. You probably had a lot of other financial obligations. And I don't know maybe like me, you weren't quite as prudent in managing your [ affairs ] as you would be later in life. And so I think graduated repayment for those new to repayment borrowers is the one that I'm most excited about, but I think you should expect to see optimization across all those different programs.

Yes. And I think a lot of these 21 to 22, 23-year-olds today are also realizing, maybe not realizing that the moratorium is about to come to an end pretty soon. I'm just curious, have you assessed what kind of impact that's going to have in your business, maybe your borrowers' cash flow. You mentioned the newer technology you're kind of deploying in your collections department. Have they been able to start getting a sense for how borrowers are thinking about that coming up?

Yes. We've started that, and I'll give a couple of facts in details, but I think there will be more work to be done as the sort of federal programs are fully defined and rolled out. And I think that's just starting now, but we don't have full information. But maybe just as background, about 86% of all of our customers, all of our borrowers have a federal loan. So it's certainly the majority. To put that in context, the average federal loan amount is about $40,000, the median is about $25,000. So that's a healthy balance, but it's not some of the levels that some have suggested before sort of knowing the facts. And while we don't have this specific data on a per borrower basis, if you go back and you look at the program as a whole, federal program as a whole, between, call it, 2011 and 2021 or '22, like the prevailing interest rate, fixed rate tended to be somewhere between 3.4% and 5%. I think the number was actually [ 5.05% ]. The standard term in the federal loan is 10 years. But in practice, most people term that out significantly longer. It's not uncommon to see loans termed out to 20 years through the use of different programs. And as of the second quarter of '21, somewhere between 30% and 35% of all federal loan borrowers were already in an income-driven or income-based repayment program. And we actually expect that number to go up with the rulemaking that the Biden administration is proposing around the new IDR sort of programs out there today. So you can do, or one can do whatever sensitivities you want on that. I think what's important to note is when you sort of term out like what's that payment. That payment ends up for most borrowers being measured in the hundreds of dollars a month, which is meaningful and important. But it's not the sort of eye-popping number that I think some people sort of instinctively fear. Now of course, you can have those averages and you can have people who are in more extreme positions. So the real question is not does this pose sort of a broad risk, but what are the sort of pockets of exposure where there is really kind of a greater need. And I think our view is a couple fold on this. One, this is where the traditional income-based or income-driven repayment programs are so important. And I think the new federal rulemaking is so important because the very same customers that would likely be more impacted are the very same ones who are likely to qualify for some of these new programs or better benefits under these newer programs. So that's, I think, thought number one. Secondly, we're giving a lot of thought to this. So we are actively assessing and analyzing the outstanding balances of our customers in adopting outreach and sort of proactive strategies to help those customers understand the implications, understand their options. By the way, beyond just what Sallie Mae does. So that's something that we will start to kick off here this fall, especially as the rulemaking and the specific timing and patterns come more into focus. Obviously, with the debt bill last week, we got a lot more interest or a lot more information on when precisely the loan moratorium, the payment moratorium would end, so we can begin to plan appropriately for that. But I think at the end of the day, our view has always been and continues to be that this has been a modest benefit to our customers. We suspect the impact will be sort of a modest headwind to some customers, but probably largely offset by some of the enhanced income-based repayment options that are out there. So it's something we're watching, we're monitoring. But at the end of the day, we think it is a manageable risk for us going forward.

So is there anything we should be looking out for? I think you just mentioned some of the outreach you're going to be doing. Is there anything we should be thinking about in terms of impacts or benefits to the business or...?

I think we will have a lot more to say about that when we get into sort of the end of the second quarter and early third quarter. And again, I'm not trying to sidestep the issue, but the truth is we don't even know exactly what the new income-based repayment program is going to be. There's a lot of talk right now from the administration around [ phase ] and sort of various programs to help mute the impact of the start of repayment. Those haven't been fully defined yet. And so I think we look forward to greater information coming out of the administration on the exact nature of these impacts. And I think from there, it will be easier for us to set up some specific operational and outcomes-based milestones.

Yes. I mean there's still a lot of complexity to the issue, right? We still have to see whether the Supreme Court [indiscernible] forgiveness. We have to see whether the proposal comes out. You have all these borrowers who haven't reset their [indiscernible] IDRs yet. So still a lot to be looking out for there.

Yes. And I think, Jeff, the other thing I would add is it also gets to your best safeguard during times like this is a well underwritten loan in the first place. And we continue to have a lot of confidence in our underwriting standards. We continue to have a lot of confidence in the prevalence of cosigner rates among our borrowers. We continue to have a lot of confidence in the programs we've developed and we'll continue to develop. And I think lastly, we continue to have a lot of confidence in the payment hierarchy that we've created with our customers. So -- it was not an accident that our payments -- our customers have been back in full payment since effectively August of '20 approximately. And we think reestablishing that payment hierarchy early is also another thing that will bode well for us going forward.

So we spent a lot of time on credit. Maybe we'll switch it up a little bit here, competition. Can you talk a little bit about what you're seeing out there from your peers? You obviously have a pretty dominant share of the market right now, 58%. I think there's been a few other companies out there that are starting to make inroads. Just talk a little bit about what you're seeing on that front.

Yes, sure. So look, I think overall, I would describe the sort of competitive nature of the private student lending space as kind of appropriately and modestly competitive. There are really good competitors out there, and we have a lot of respect for the likes of Discover and Citizens and College Ave and others. They've had great in-school businesses and built great in-school businesses for a lot of years. There's a lot we can learn from a number of the start-ups out there that are employing new tactics and new strategies. And interestingly, we consider the aggregators to be both a partner but also to a certain extent, a competitor in this space. And at the end of the day, we work closely with them. We bought one of them recently, and we expect we will continue to have to use an overused expression, a little bit of sort of a frenemy relationship with many of them as our interests are aligned, but not perfectly aligned. I think in that overall context, we would expect the competitive intensity to probably stay about where it is. It's a hard business to get into for smaller scale players. If you think about it, it's a long number of years where people are not making full P&I payments because they're in-school. It's, therefore, a long time to really prove the validity of your underwriting models and sort of the strength of the assets that you're generating. That creates, I think, real funding and sort of growth challenges for new entrants. I think for our existing incumbent competitors, the likes of Citizens and Discover, they continue to do a great job. I think we love the fact that we're a monoline and we wake up every day thinking about nothing but how do we take great care of our customers and earn profits for our investors in the student lending space. I sense from time to time that, that gives us -- that focus gives us a little bit of an advantage. And I think at the end of the day, we sort of expect that intensity to continue. But we run our business every day as if it's going to be more competitive next year than it is this year. We do that through a focus on unit costs and continuing to build incredibly strong relationships with schools and take great care of our customers.

One of the things that's unique about your model as an in-school originator as you've also got the hybrid gain-on-sale model. Can you talk a little bit about the $2 billion you did recently. Some color on that other than what you've already said and what we should be thinking about as you look to finish off that $3 billion guide for the year?

Yes. And maybe I'll even take a half a step even further back. Since I became CEO 3 years ago, we've been very enthusiastic about sort of this hybrid model. But we've always described it as sort of a medium-term model. And I think what we realized a long time ago was for us to grow our balance sheet, fully fund our CECL obligations and return capital to shareholders, we couldn't do as much of all 3 of those things as we wanted. And we didn't have a choice but to fund CECL and I made the choice that we didn't have a choice but to return capital aggressively to shareholders. So the whole idea of every year selling a representative sample of our loans, maintaining a flattish balance sheet, I think, is the technical term we've used over the last few years. And really taking advantage of this arbitrage program like that has been a great strategy for us. If you haven't done it already, what I would encourage you to do is to actually start to model out what Sallie Mae looks like post January of 2025 because that's the point where we make our last CECL catch-up payment. And if you start to even assume sort of just a continuation of historic norms, the patterns of what the business can do from a balance sheet growth and/or probably both a capital return perspective is pretty interesting and at least for me, pretty exciting. So I would put that all into context and I would sort of say our commitment to strong capital allocation and capital return is going to be a forever thing. While I'm the CEO of this company, I can't commit multiyears out on exactly how we'll do that, but it's a key part of what we think makes us a really interesting place. Now in that context, we were thrilled to sell $2 billion already this year of loans. That was a well subscribed auction. I closed, I think, May 1 or May 2. And as I think we've previously announced, it was at prices that was highly consistent with what we had put into our guidance. So we felt great about that. Our plan is to sell another $1 billion in the third quarter of this year. And as we continue to look at the sort of market conditions, there are some that are a smidge better. There are some that are a smidge worse. But we haven't seen anything that would lead us to believe that the market conditions aren't sort of comparably receptive to doing another $1 billion in the third quarter. And I think we were delighted with the quality of the auction we saw in really knowledgeable and thoughtful and rigorous market participants who came in to be a part of that and I hope to see many of those same faces and more come the third quarter.

It sounds like everything is on track at this point. And...

Yes. Again, I'll never try to predict the outcome of an auction. I think my General Counsel would come up here on stage and drag me off if I did. But certainly, when we look at the things that tend to drive results, what's going on with rates, what's going on with macro credit spreads, what's going on with sort of Sallie Mae specific factors, things like our credit performance or consolidation performance. And then just what's the overall demand for fixed-income type product in the marketplace. I think certainly, as you go down the list there, there's no reason to believe that collectively, those things aren't as healthy or healthier than they were a month ago when we did the last deal.

So we have less than 10 minutes left. Just want to make sure the audience has an opportunity to ask any questions. So do you have any questions, feel free to ask. If not, I will continue on. In terms of the buybacks that you're also talking about this year, has the shift in your share price of late, I know it's been pretty volatile. Has that shifted your preference or still on the plan?

Yes, great question. So just as a background, and I think we've covered this in a couple of forms, but we tend to sort of look at the decision to buy back or not buy back through a couple of lenses. First of all, we look in almost a grid kind of way at the relationship between equity price and really sort of growth multiple, EPS multiple and prevailing loan premium. And we make sort of through that grid analytics, a determination of does the arbitrage exists, right? Do we believe that the debt buyers, the loan buyers are valuing the assets more than the equity buyers? So that's sort of kind of consideration, number one. And we have literally on that grid, green, yellow and red zones. And what Steve and I have said a couple of times is every deal that we've done has been well within that green zone, including the most recent one. We also -- every sale look at the premium, and we compare it to our own internal cash flow models for the loans that we're selling because the external arbitrage may exist, but we would think twice if we felt like we were selling a loan at an inherent discount to our estimate of economic value. And I will tell you, every loan sale that we've done has been at a premium that is north of sort of our internal estimates of that as well. And so that's the way that we will continue to look at that. And again, could there be a case where stock price got so high that it no longer made sense. Absolutely, that's a spot on the grid. We were not close to that with the last loan sale. And if we did get to that point, just understand, we would think creatively about other ways to return capital in that moment because return of capital is a core part of our strategy even if the exact form and mechanism by which we do it would change.

Got it. And then just switching to NIM. So NIM has been very robust recently. How are you positioning yourself for the rate outlook from here? What happens if rates stay higher for longer or the Fed actually comes through and cuts more aggressively?

Yes. This is a really easy question for me, and it's probably a boring answer for all of you, which is we work hard to be as match-funded and as balanced as we can at originations. And we do a full sort of equity discussion in our various disclosures. I think we walked through sort of our asset liability sensitivity positions. And I think what we've shown really consistently for all the quarters that I've been here is there may be periods where we're slightly asset sensitive. There may be periods where we're slightly liability sensitive, but it's always within a very, very, very narrow band. And especially when you add on top of it expected future loan sales, which we can't commit to, but I think are a reasonable part of our strategy, that tends to bring it even more back into sort of straight down the middle alignment. And so with an asset that has a 6-year average life, we actually can match-fund pretty well, both through securitizations, but also through the retail deposit in other markets, and we work hard for that. At the end of the day, my view is our core competency is originating and booking and servicing really high ROE loans that help our students, our customers fulfill the dream of higher education. Our core competency is not taking a proprietary position on interest rate movements and sort of adjusting our balance sheet or funding strategy as a result. So we would expect to continue to be match-funded. And as a result, I think you should expect NIM to be on an annualized basis pretty consistent. There is sort of, what I'll call, quarter-to-quarter, month-to-month volatility in our NIM, but it's not typically driven by investment decision. It's typically driven by us building liquidity for a big disbursement period and/or the immediate aftereffects of a loan sale where we haven't fully deployed that capital. So it's not so much on the rate as it is on the sort of quantity of dollars that we're managing.

And related to the NIM, can you give us an update on your funding? Anything you've been seeing on deposit flows? I know you guys were able to grow and you had some stable deposits in April. Just maybe a quick update there.

Yes. Look, we've, again, really enjoyed being boring over the course of the last 2 or 3 months. I think when we started this little sort of many financial crisis, we were 3% uninsured deposits. We're now 2% uninsured deposits. So we've had a little bit of runoff on the uninsured side, as you would expect, people are optimizing and rightsizing their titling and sort of disbursements of funds. But actually, as you said, during that time, we actually modestly grew our deposit book as more dollars came in than went out through that kind of reoptimization. Over the last couple of months, we've seen a small decline in our deposit base, all very much tied to loan sale and an expected runoff of some maturing brokered CDs and a new securitization deal. So like all of that was a part of that liquidity plan. But I would describe our overall deposit position as really quite stable.

And how should we be thinking about your private education loan yield trajectory from here? Is there any kind of natural cap we should be thinking about before you start to see maybe some impact to your origination demand or the credit quality of that underlying consumer over time?

Yes. And you're talking about originations here?

Yes, the yield on your originations.

The yield on originations. Look, this comes back to, first of all, I think, sort of the competitive marketplace. So we do not set price. We're part of a reasonably competitive set. Every day, we've got to think about what our competitors are doing. And if we're dramatically outside the market pricing-wise, we will absolutely see within bounds, volume move away from us. So while we have really nice share, there's enough really strong competitors out there that, that sort of pricing competition is a real part of what we do. With that said, I think there's a whole bunch of different ways that we seek to stretch margin and profitability. We are a 60% to 70% fixed-cost business. So obviously, there's the potential for huge operating leverage, especially during noninflationary times to drive outsized margin growth and earnings growth with something that's less than that in terms of originations growth. Anything that we can do to enhance our overall credit performance is a net positive. And then on the margin, anything that we can do to drive broader efficiency. So I'm not sure it would come from the pricing side, but I think as a scale player, there's always the opportunity, but I would not expect margins to blow out from here. But I would certainly hope we can, at the very least, maintain and maybe slightly on the margin enhanced -- margins just through greater efficiency going forward.

And not to put you on the spot with about a minute left, but anything you're -- you feel like maybe you're missing from the Sallie Mae offering today? I know you recently exited credit card, but any opportunities or more small bolt-on opportunities?

Yes, less from the Sallie Mae offering, but like -- if you think about what we've said of our strategy, we want to really innovate to drive the performance of our core business. We did a small acquisition last year with Nitro College. That was really successful in terms of giving us a bunch of new sort of marketing capabilities in our arsenal. By the way, it also dramatically increased the number of customers that we had a relationship with. So we're up to now 50% or so of all college-bound families, have a customer-initiated relationship with the combined franchise. So that's a great thing. I think we would look for other opportunities for us to do that kind of very small scale acquisition that's highly accretive to our core business. And if it gives us greater customer connection that we might be able to monetize at some point down the road through other means, great. But people should really expect for the near term, we're focused on driving every bit of profitability at the core as we can.

All right. That's all the time we have. Thanks, Jon.

Thank you. Appreciate it, Jeff.

Thank you.