SLM Corporation (SLM) Earnings Call Transcript & Summary

Let's get started. So good morning, everybody, and welcome. Thank you for joining us. My name is Terry Ma, I'm the new consumer finance analyst at Barclays. I'm very pleased to have the CEO of Sallie Mae with us, Jonathan Witter. So welcome.

Thanks, Terry. Great to be here.

Yes. Great to have you. So let's just get right into it. Can we maybe start with an update on how originations are shaping up for peak season? Notable that you had to call out.

Yes, Terry, I am proud to be able to report today that I think we are on track to deliver probably the best originations year that we have had since the split of the company 10 years ago. So I think on our last earnings call, we had indicated that we thought we would be at the upper end of our range or slightly better. And I think barring something really unexpected happening, I think we would expect to be at this point, notably slightly over the upper end of our range. What I think is interesting, I'm obviously proud and the team is proud of the amount of originations, that's great. We're also really pleased with the quality of the originations. I think if you look at sort of the underlying sort of risk cohorts that we've originated, if you look at things like the FICO score, the cosigner rate, I think all of those things bode really, really well for these being strong performing loans going forward. I'm also really proud of how we've originated that growth. And over the last couple of years, we've made some key investments. We've made investments in marketing technology that, quite frankly, allowed us to sort of catch up to where lots of good marketers were already playing. We've also done what we think are a couple of really important -- small but important acquisitions, which have put us in a very different place with regard to customer interaction and first-party data. And I think we've created something in terms of a marketing engine and an origination engine, which is really distinctive, really hard to replicate, and I think will bode quite well for the future. And when you look at that in a market that is sort of growing nicely, and, quite frankly, at a time where I think the competitive intensity is quite manageable for us. We think this year's originations are positive, but also bode quite well for the future.

Great. Great. So turning to credit. The net charge-off rate was 2.69% in the second quarter. It was seasonally higher, but in average, about 2.4% for the first half and still better than your full year expectations. So how is credit trending in the third quarter? And what's the outlook the remainder of the year?

Yes. In August, we put up credit numbers that were slightly better than our expectations for the month. And so I think the general trend of stabilized credit and slightly better than expectations holds. This is an environment where I think any good manager of credit is going to be a little bit nervous certainly with the uncertainty around the broader macroeconomic conditions. But we feel really good about the steps that we've taken to stabilize credit this year. And we've made important changes to our collections programs. We've made important changes to our collections operations. We've made important underwriting changes and I think sort of legal changes around sort of how we collect delinquent and past due accounts. When you put all of that together, we think that bodes well. Our target is still very much for net charge-offs to be in sort of the high 1 percentage or low 2 percentage range. So we have a little bit of work to do to get back to that level, but we're optimistic about the steps we've taken and feel good about the trajectory that we're on.

Got it. So you just touched on this. I think the high 1s, the low 2s is what you would call normalize. Maybe can you just dig in and talk a little bit more about the drivers that get you there and how long it may take?

Yes. I think we, in the last quarter earnings call set out that we thought it was probably a kind of a couple, 2, 3-year path we're reserved appropriately for that. If you go back and you look at our K from 2022, I think we lay out pretty clearly the reserve methodology along the lines. And I think that sort of defines kind of how quickly we get there. Clearly, the credit administration changes we made last year, and I think just the broader macroeconomic conditions that we were dealing with were meaningful. I don't think there's going to be the one silver bullet. But as I said before, we've [Technical Difficulty] programs to help customers be more successful who were facing financial difficulty. We, as we do every year, have implemented sort of on the margin underwriting tightening. We go through a process where we look at past performance and make decisions about where we may want to do slightly less, and I think you made some important underwriting [indiscernible] in the last year. Those were, of course, [indiscernible] play out. We've really rethought the operations of our collection shop from the leader of that area [indiscernible], touching almost every part of -- that part of our business. Systems, processes, incentive alike. And we're also thinking a lot about how we do post charge-off recovery, which doesn't have a gross impact, but it has a net impact and implementing different strategies around how we decide which loans to retain, how we work those loans, sort of how we make use of the different legal remedies that we have to work those loans. So all of those things, I think, go into sort of the mix. No one of those is going to be the answer. But I think in totality, those things together will give us hopefully pretty strong performance here over a couple of years ahead.

Okay. So helpful color. So forbearance on federal loans sets to expire soon. It's a topic you've addressed in the past. Maybe for investors that aren't quite as familiar, can you maybe just talk about the implications for Sallie Mae and give some color on how you're thinking about the impact of the 12-month on-ramp and the new IDR plans?

Yes, happy to. And for those who don't follow us as closely, Sallie Mae is not involved in the federal loan program. But a large percentage, well into the 80s of our customers who have our private student loans also hold federal loans. So things that happen in the federal loan program are obviously of interest to us and we tend to study them pretty closely and want to work effectively with our borrowers. I think our position to date is, while this is an item we're watching and paying attention to, it is not one that at this point, we believe, is -- or presents a material risk to credit performance. And in fact, maybe over the medium and long term, provide some real tailwinds and benefits to us going forward. So let me unpack that a little. As you mentioned, there are sort of 2 important things that I think really will help federal loan borrowers successfully reenter payment. One is this 12-month on-ramp program. So effectively, for the first 12 months, as a federal borrower, you miss a payment or elect not to make a payment, as we understand it, you're not going to age, you're not going to incur penalties. You will incur interest, but there's an awful lot of flexibility built into that. I think that's important for a couple of reasons. Operationally, that helps federal servicers get their feet back underneath them. But I also think for customers who maybe are experiencing a little bit of adjustment and getting back on the habit of making payments, it just gives them a bit more time. I think far more importantly is the new income based or income-driven repayment options. And this is a program that I think is really substantially underappreciated in terms of the size, generosity, scope and potential impact of the business. There's a great fact sheet on the White House website. It's the IDR fact sheet. You can Google it and look it up. It gives some great statistics in there about just the level of generosity of the program. But for example, if you subscribe to their analysis, the new program will yield about a 40% reduction in all sort of payments per dollar of loans outstanding across the board. And if you are in the sort of lower expected lifetime earnings group, that could be as much as 87%. If you're a new school teacher with a 4-year degree, and you can also take advantage of some of the service-based features of the program, your annual payments might drop by as much as 2/3. So these are really generous benefits. That has a huge impact in the short term with payments starting again. It has a bigger impact, though, on the broader creditworthiness of these customers. And remember, we underwrite our loans, assuming a level of federal indebtedness that's similar to what we see on the books today. So things that have this big an impact on federal borrowers' ability to repay those obligations, likely have positive effect on their creditworthiness with us over time. So we're excited about that. I think the other thing that is worth noting is all of this discussion, I think, has completely changed the [ political narrative ] and the perceived sense of political risk in this business. And when I joined the company [indiscernible] years ago, all people wanted to talk about in the political space was the government going to forget private loans, was the government going to make all college free. I think where you see the political debate moving to today is a pretty bipartisan view that the federal system is in need of real and practical reform. And I think a lot of the ideas that are being discussed are not -- only not risk to Sallie Mae or the double [indiscernible]. But I think actually our potential benefit is increasing the size of our potential...

Got it. That's helpful. Maybe you addressed some of this. Are there any other longer-term implications for higher education from these plans, like whether it's just overall demand for loans or how people think about education...

Yes. I mean listen, I think the biggest thing that is of worry in federal program today as it relates to these programs, it's just the very clear effect that the federal program has on inflation rates within higher education overall. And so when you look at the political discussion, there's a lot of concern about -- out there about overextended borrowers. There's also, I think, a lot of concern about just the rate of tuition increase. And I think there's a number of [indiscernible] by the New York Fed a number of years ago that really do connect the sort of the generosity of the federal programs with the rate of inflation going on in the market. And so my guess is that will be one of the key drivers of thoughtful reform should it happen.

Got it. Okay. So maybe switching gears a little bit. What's your outlook for refi activity on your portfolio? There's a least one refi lender that expects a major pickup in refi volumes after forbearance ends.

Yes. And let me be clear that we're not in the refi business, but we pay attention to it because most people make the decision to refi their loan based on their federal exposure and then they tend to refi their private student loans at the same time as sort of a package of activity. So it's something that we care a lot about. I think the headline is we have continued to see real [ material ] year-over-year reductions in the level of refi activity in that portfolio. So refi activity year-to-date compared to last year was down some 58%, 60%. So really material reduction. And I think it's our view, but I want to caveat this by saying, again, this is not my business, and I'm not an expert on it. So perhaps I'm missing something here. But I think it's our view that we don't see that picking up sort of immediately, and we don't see it picking up overnight. And I think as we look at the world, there's -- in our view, 2 kinds of borrowers who want to refinance the loan. There's a borrower out there that has the financial means and they're looking to refinance their loan to drive down their interest rate to really pay back their loans and move kind of to the next phase of their financial life as quickly as possible. In this rate environment and when you look at where federal loans, private loans, if we look for the last decade, there is no opportunity for, I would guess, any borrower or certainly the majority of borrowers to meaningfully reduce the interest -- so that group of borrowers, we don't see being major players in the refi space. Likewise, if you are a borrower who's looking to refi to lower payment, and maybe you're willing to accept a higher rate and extend term. That's great. But as we just talked about, with the new income-driven repayment options, the very best way you're going to reduce rate as a federal borrower is by qualifying for one of those our IDR programs. Not only does it reduce your payment, but the other part of IDR is your total lifetime payments are capped at some number of months as low as about 10 years, it goes up a little bit from there. So if you're looking for payment relief, there's also a good bet that refi is not your best option. So I am sure refi will have a day. And again, this is not my core business. And I have a lot of respect for our refi competitors in the marketplace, and they may know something that I don't know. But I think as we look at it, we think refi activity is down and likely to stay muted at least some period of time.

Got it. Okay, helpful. Switching gears [Technical Difficulty] indicated another $1 billion plan later this year. Is that still [ impact ]?

Yes. In the second quarter, we talked about our timing for that. And I think what we said at that point was that we were going to go to market just after the Labor Day weekend, the world opened back up again, that is, in fact, still very much our plan [Technical Difficulty] are in the early stages now with that process going. I think our early kind of feedback from the markets is, there have been some positives there have been some negatives versus kind of our expectations over the summer. Clearly, rates have been volatile and are slightly elevated from where they've been. But what we've also seen is credit spreads tightening and what seems like a pickup in demand for these kinds of transactions in general. So just as a case in point, we did a securitization transaction back in August. We saw spreads tighten versus where we had seen them historically, and we saw the demand multiple of what we wanted to do in that transaction, and we've got all of that bodes very well for our expectations. So we think we're on track. We think we will be able to execute that transaction. We believe we'll be able to execute that transaction at pricing that is consistent with our current EPS guidance. But as I say, every time I get this question on loan sales, of course, that's the result of an auction. And we'll only know those things for certain once we get to the auction, which we expect to happen toward the end of the month here.

Got it. So I guess when you put all of that together, any color you can give on directionally where gain on sale margins should be for that sale relative to less sale?

Yes. We don't talk about gain on sale margins in public forums because it is a competitive process. And I think the last thing that we would want to do is something that kind of tips our hand toward what we're hearing from various bidders in what we may or may not be willing to accept. So as a matter of practice, we just don't talk about premiums. But look, I think at the end of the day, the inputs to the equation are pretty straightforward. It's rates, it spreads, it's overall market sort of demand not just for Sallie Mae, but more broadly in the fixed income space. And I think if you track those things over time, you can get a pretty good sense of has the environment improved or deteriorated into what degree since the last sale. So anyone who wants to think about it and model it, I would encourage them to sort of think about it [indiscernible] various spaces.

Fair enough. That's helpful. So Sallie has been selling about $3 billion of loans annually and keeping the portfolio flattish during the CECL phase-in. Can you maybe just talk through what Sallie Mae looks like post the phase-in?

Yes, happy to. And maybe let me start by rewinding the tape a little bit because I know not everyone follows us as closely, and maybe not everyone has followed us over the last 3 years. We put in place the loan sale share buyback program, about 3.5 years ago, right, the time that I joined the company. And there were 2 real reasons why we thought that was a winning strategy at that time. Number one, we saw just a massive disconnect between the premiums that we could get from selling loans in the open market and their implied premium as evidenced through sort of our equity valuation. That gap was just really, really wide. And we thought that was a wonderful thing to try to take advantage of. The second thing, quite frankly, was also one of sort of capital management and capital discipline. During that very same period of time, we were implementing our CECL phase-in. As a student lender, CECL is a relatively sort of big lift for us. And what we knew pretty early on was the ability for us to grow the balance sheet, make our CECL contributions and return significant shareholder -- significant capital to shareholder, you just couldn't do all 3 of those things. And so the program was really put in place to manage that need and to take advantage of that opportunity. And I think we believe internally, and I think I hear it from many of our investors, that, that program has been wildly successful. We have bought back over the last 3.5 years, approximately half the company. We have generated 3-year absolute and relative TSRs that we think are off the charts. And even if you look at the most recent year, which I think has been challenging for us and for many, our relative TSR performance versus key indices and competitors is also quite positive during that period of time. So we love that strategy. But as your question would suggest we always knew there would -- where that strategy would need to evolve in it. And that time seems like a long time ago, 3.5 years ago, it's a lot closer today. And what's I think really exciting about this business. And I think the headline I would give you is we believe the best EPS and the best capital generation times are ahead of us, not behind us. Because what's really exciting about this business is when you start to model out, and I've said this in the last couple of earning calls and encouraged investors and analysts to do this. But when you really start to model out what happens to EPS growth and what happens to organic capital generation as you start to sort of wind down or taper down loan sales and begin to let the balance sheet grow again. It is a really, really exciting story. And what you see is a relatively short dip on both EPS and capital available for shareholders, as you would expect, you're taking away a source of earnings and capital release by beginning to taper loan sales. But then when you see after that is really exciting EPS, organic EPS growth and really exciting capital return capability and potential for the company. And the hero of that story is really the profitability of the underlying loans. When you have assets that are 20%, 25% ROE loans, you get a fairly quick snapback during that pivot time. And so what we've talked about and what we've sort of encouraged folks to do is to really begin to model that and understand that. And you can model that assuming the pivot happens a little sooner, you can model that assuming the pivot happens a little later. By the way, back to some of your earlier questions, you can model that assuming credit costs stay roughly where they are today or improvement in the conversion to credit, like it almost doesn't matter. The EPS and the organic capital generation capability of the business really [indiscernible]. So we have not made a decision as a company as to exactly when we will execute that pivot. I suspect that, that is a decision that we will make in your future. But for something that's like a long ways away, 3, 3.5 years ago, we think it's a lot closer today. And we think it provides us really a wonderful opportunity to drive organic capital generation and do it in a way that hopefully commands a higher multiple because it's perceived being lower risk, then the focus we've put on gain on sale during that period of time.

Got it. That's helpful. Maybe talk a little bit more about, I guess, how hard the pivot would be? Just retaining the full $3 billion? Like how do you think about how much you will sell or not sell?

Yes. Look, A little bit of this is art and reading the market conditions. A little bit of this is science. The science part is easier to get your head around. The thing we will continue to have to manage through January of '25, where we make our last CECL contribution, is what is the sort of quarterly -- and we even pay just sort of the monthly capital levels given just the seasonality of our business. There's seasonality around when we make the CECL contributions. They're all January of -- last one will be January of '25. And for folks who are good students of our business, capital consumption in our business is not -- throughout you. We have peak seasons, we have to fund for originations and disbursements, but we also have to fund unfunded commitments as well under CECL. So all of that gets worked into. And my guess is we will look at a combination of sort of expected premiums and market conditions, and we will look at capital [Technical Difficulty] in light of the consolidation and origination trend -- a very positive consolidation and origination trends that we talked about before. And I think that will both determine when we start and how quickly we take down the level of loan sales. And look, it's a pretty easy math. The more you start to take down loan sales and the sooner, the quicker you get the rebound; the more you delay that, the more the rebound is sort of put off for another day. So those are the things that we'll continue to pay attention to. And again, we've made no decision on that. But [indiscernible] years ago, this was barely worth mentioning because '25 -- January of '25 was such a long time. January of '25 is a lot closer sort of the constraints that CECL puts on the business are a lot less today than they were, again, when I came through the doors for the first time.

Helpful color. Switching gears. You've made some small-scale acquisitions over the past few years with Nitro College and [indiscernible]. Can you maybe just talk about Sallie Mae as an education solutions provider?

Yes. So I am in my heart of hearts a real kind of guardian of the capital of the company. I hope if we've earned a reputation for anything, it's we really -- we value capital. We try to allocate it very, very closely. And I'm not in sort of [ broad ] speculative acquisitions as a way of driving most corporate strategies. I'm sure there's an exception out there. What we really like about these strategies is they are surefooted for us, and surefooted has a very specific meaning. Number one, they are highly accretive to our core business. So what Nitro gave us literally overnight was access to over 50% of all students [Technical Difficulty] more interested in pursuing higher education, right? That was a massive change from a marketing and branding and originator perspective. So these are businesses that are highly, highly, highly accretive to the core business. And in fact, we make all of our decisions on premium ability to pay IRR of the deals, not on speculative views of what the businesses could be, and I'll talk about that in a second, but really on the very tangible benefits that they're going to convey to the core business. And I will tell you, I think a big part of the origination success that I talked about earlier is because of the first-party data and the capabilities that came to us with Nitro, and we expect that to continue. So element number one of your [indiscernible] is, businesses to the core. Yes. Number two is they have to be relatively small in price. And at the end of the day, that's just a risk element. So if it's accretive to the core and not that -- that's a pretty easy thing [indiscernible]. But I think third and really related to your question around an [indiscernible] education services company, also all have some pretty interesting growth options embedded in that. So for example, within Sallie, they have a great little advertising business. They have a great little business posting scholarships. There's a whole host of other low growth options embedded in these businesses, which we can invest in, and again, a way that's highly accretive to the core business, but also opens up some opportunities down the road. And so for us, the vision of becoming an education services company is we want to stay true to our knitting. We want to be really disciplined around capital. But we really want to be there as students go on their journey to immediately [ after ] college, we want to understand our ability to have a deeper engagement with them during that time. Again, that helps with originations. It helps with serialization. It helps with collections and credit performance and the immediately after higher education space and it provides us some interest in places to dip our [indiscernible] in a low cost, low risk way and hopefully find some additional opportunities for us to drive growth, and again, a way that we believe is pretty smart.

Got it. Okay. Helpful. I'm going to pause right here and just queue the one audience response question that I have. So operator, can you put that up? And the question is, over the next year, would you expect your position in Sallie Mae to one, increase, two decrease or stay the same? All right. So 58% increase, 42% stay the same.

I just want to get these results to my board, they'll be so happy.

Okay. So I'll open the -- open it up to Q&A right now from the audience. Any questions? Just one up here.

Just -- I know we've talked about credit quality sort of stabilizing or coming better. And I know there's a lot of initiatives that you're doing. But what are you following that might make the credit actually worse? Is there anything in particular that you are worried about?

Yes. I mean, look, I think at this point, we had our material changes to our strategy and operations hit us over the last couple of years. So I think it's well documented. You made a number of [indiscernible] a variety of reasons to our front end administration part is, I think we saw some unique characteristics of our customers as they [indiscernible] from COVID, which I think really led to the some of the operational challenges that we faced last year. We don't anticipate making broad front end administration changes sort of not to that magnitude. I'm sure we will always [indiscernible] a little bit going forward. And I really hope we're never confronted with at least not in the work in life time, the kind of post pandemic sort of stress that we have seen. So I think the sort of unique things that really drove our credit performance last year, we don't see as likely to reoccur. I think as someone who's been in the consumer and consumer credit and banking space for a long time, I think the obvious answer is just broadly what's going on from a macroeconomic perspective. And where do we expect to be? And is it a hard landing? Is it -- is it something much, much worse. At the end of the day, we've got a lot of protections built into our business. The [ co-sign ] model is protected and built into our business. The idea that [indiscernible] has to be certified against full cost attendant to real protection going into our business [indiscernible] fact that we're predominantly lending to college graduates. We do have a [Technical Difficulty]. Most of these folks are going to enjoy the earnings is a real protection in our business. And by the way, the high ROEs below is a real protection of our business. While we don't want the ROEs to erode, there is more loss absorption capability there. Should the bottom really fall out of the economy in an unexpected way. So I think we have a ton of protections built into our business. And so we feel pretty good about our outlook. But I think to answer your question, the thing that I would be worried about is something that feels more macroeconomic and broad as opposed to something at this point is Sallie specific, at least as far as we can see.

Great. Any other questions? One back there.

Just a question on the loan sales that are happening this month. Would you be open to selling more than the $1 billion? And without tipping your -- showing your cards on pricing, around how much does every $1 billion of sales free up in terms of capital and ability to buy that [ stock ]?

Yes. So I've gotten this question a number of times before, I'll give hopefully the same answer. We are always open to exploring the edges of the action volume and appetite. So I think it's safe to say every auction done, nearly every -- I think it's every auction. We have solicited bids for our target amount and for greater amounts. And so we do that as a matter of course, and we will always consider doing more. By the way, don't forget, at the beginning of this year, we actually talked about $3 billion of loan sales but the volumes being flipped with $1 billion earlier in the year and $2 billion later in the year. We like the pricing, we saw at the beginning of the year when we look at the macroeconomic conditions, we thought there was a wonderful opportunity to derisk sort of performance. I'm glad in hindsight we did. And that was because we looked at it. We asked for bids of greater amounts. So great bid came in for the $2 billion, and we took it. So that was super. So yes, we will always do that. And I think our management team and our Board are always open to sort of going off script if we think that sales, share buyback arbitrage exists and if we can make good use of it. So again, I can't sort of predict what we will do in this case and I can't predict where the bids are. But that's a natural part of what we do in every cycle and this time would be no different. The math on the proceeds is really pretty simple. We release capital, so you can go and look at our sort of held capital positions that would get released. We release the loan loss reserve. So you can go and look at that. That will be [indiscernible] or something like that, tax adjust or tax effect that because that comes back through in that regard. And we then take the premium and that's tax adjusted to. And if you add those 3 together, that gives you what effectively is the new capital that would be made available through the month's sale.

Any more questions? I think we'll wrap up with that.

Yes. Listen, Terry, appreciate the time, great to be here, and thanks for everyone's interest. And I would just say if we didn't get to your question or you didn't want to ask it. We've got a great staff and would love to get your question and be helpful any way we can. So thank you all for your interest.

Thank you.