SLM Corporation (SLM) Earnings Call Transcript & Summary

Good morning, everybody. Before we get started, I'm just going to read some disclosures real quickly. 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 not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. So with that, happy to welcome Pete Graham, CFO of Sallie Mae to our conference, second year in a row here.

Yes, good morning. Good to be here.

Thanks for coming. Maybe, Pete, we could just kick off with the evolution of Sallie Mae here before we get into the nitty-gritty. Talk to us about the Sallie Mae story, how it's evolved in recent years. Anything you think that's unappreciated about your story?

Yes, great. Thanks for having us here. Good to be here again this year. I think a good starting point really for talking about where we are in our evolution is the Investor Forum that we did in December of 2023. And there, we laid out kind of a hybrid growth and capital return strategy that called for us to begin to grow the balance sheet modestly after we got past the CECL phase-in, which the final piece of that was the first part of this year. We would continue to use loan sales to moderate the rate of growth of the balance sheet, continue to optimize the business and drive operating leverage into the business. And really, the idea is modest, but accelerating growth of organic earnings, call it, mid to high single digits coupled with operating leverage that should lead to double-digit earnings per share growth over time, all the while generating meaningful capital for return to shareholders. And it's a really balanced profile. That modest rate of growth allows us to grow the balance sheet, doesn't create extra stress on funding of the bank's balance sheet. So we've been really pleased with our performance under that framework. So 2024 was the first full year. We took advantage of the exit of a big competitor and we're able to take a good amount of market share upon that exit. And so grew in exceeding our expectations for the year. Grew 10% year-over-year growth in originations, that enabled us to grow the balance sheet a little bit faster than what we had in that initial framework. So the initial framework called for us to grow 2%. We actually grew about 3%. But if you peel that back, we exited a legacy FFELP portfolio, kind of low-yielding legacy noncore business. And our actual PSL balance growth was more in the 5% range. So really kind of jumped a year ahead in the overall strategy. We are really happy with that and it's been well received by investors.

Okay. Great. And maybe as we think about the next step in your evolution, there's been a lot of discussion over student loan reform recently. We have the federal student loan program potentially moving to the private market in a few years, in particular, with the PLUS programs, depending on what makes it through the Senate at this juncture. Can you talk about how meaningful some of those proposed changes from the House are and how meaningful that can be for the private industry in Sallie Mae?

Yes. I think this whole Congressional process is one that sometimes it's a little puzzling when you're sitting on the outside looking in. The reconciliation process itself, we know that the House has put forth a bill that does have some elements of federal student loan reform as part of that proposal from the House Republicans. We also know that, that's only half the story and that the Senate still has to act. As of today, they have not completed their process, but we do expect for there to be some common elements of reform in the federal program that will ultimately come out of this process. It's too early to kind of put a pin in the opportunity just given the actual elements of the final bill will matter. But I think the really great news is that we're kind of weeks, months away from something that we've been advocating for, for many years, which is reform in the federal programs. It's long been our belief, and I think there's bipartisan consensus that the federal program does too much for too many and not enough for the ones who truly need it. And the way that the federal programs are run with sort of unlimited ability to borrow under certain programs, the fact that they're not underwritten, it's really created the situation where students and their families are truly borrowing too much and beyond their capacity to repay. So we're optimistic that in the coming months, there'll be some meaningful reform and we're preparing ourselves to be ready for that.

And you touched on some of the common elements that might come out, still early here, obviously, but maybe touch on what you think comes out or what's more likely to get pulled back. Is it some of the more complex elements perhaps?

Yes, there were some features in the House bill that I think like average cost of program and things like that, that would be pretty difficult to sort of operationalize in terms of running an overall program. So I would expect that perhaps some things like that might get modified or simplified. But again, it's too early to kind of really give a report card on exactly what's going to happen until we see that final bill.

Okay. Great. And if we think about the potential competition in this market that opens up down the line here, Sallie Mae has had a distribution advantage over the competition. In today's world, you've got more than 2,000 college relationships across the U.S. Do you think that advantage is going to carry over to the graduate side as well? And maybe just comment on the structural setup there. I mean, I think there's been some speculation that the graduate borrower maybe is a little bit savvier. Can they get a loan outside of the preferred list or not?

Yes. I think one thing that is important to understand is that both with regard to undergrad as well as graduate loans, they still have to go through kind of a certification process with the school. And so we do believe that the relationships that we have built over many decades, and we've got the largest relationship management and sales force in the industry. We've got the, as you said, relationships with over 2,000 schools. We do think that's going to still continue to be a differentiator for us. To your point on our graduate students different or savvier, I guess what I would say, the typical graduate student has generally got their undergrad, gone and worked for a period of time before making the decision to go back to grad school. And so they're different in a number of ways from our typical undergrads, right? They've got an actual credit history. Our undergrad borrowers generally are sort of high school grads. They might have had part-time work. They are very thin file credit profiles, if they have a file at all. And so that's heavily dependent on the cosigner, typically a parent and the credit rating that comes with that. The graduate borrowers, in large part, tend to have their own credit profile. They've got a work history, they've got a payment history. And so there is a bit of a different sort of credit dynamic to that. We still do have the option for co-signing in the grad space, but they will likely have ability to qualify for underwritten loans outside of the federal program in a way that maybe undergrad borrowers would not be able to. So again, we're evaluating the potential for reform, and grad lending reform is a big piece of that. On your savviness point also, I would say, it's our hope whether they're grad students or whether they're undergrads that they are doing their sort of due diligence around the loan terms and making sure that there's a good return on the investment for them in terms of how much they're borrowing versus their ultimate sort of earnings potential after graduation.

And one thing -- one question we've gotten is, there is a small in-school graduate market today and less than 10% of your volumes last year, I believe, were graduate-based. So can you just comment on why that market exists today and how that might structurally compared for -- to what comes out?

Yes. I think it's, without a doubt, the primary competitor we have currently in the grad space is the PLUS program. It's an unlimited borrowing un-underwritten program. So it's very hard to compete with a responsible lending product against that type of competition. So that's probably indicative of why the size of our grad program is what it is. And so I think -- look, I think that the potential for reform here will drive good public policy, but it will also create some opportunity for the private market to step in and fill a responsible role, and we're looking forward to being ready to do that.

Okay. And you touched on the graduates having history and potentially having worked already. So how should we think about the credit quality of that potential new borrower or that new market as it compares to maybe where your 2% or so loss rates is today and your 3% delinquency rate sits?

Yes, again, we follow a risk-based pricing methodology. We'll continue to do that even as we expand in the grad space. As I said, they have a slightly different credit profile, a more developed credit profile than the typical undergrad borrower. But we'll keep the same sort of underwriting and pricing discipline that we currently employ as we move forward and look to take advantage of that change in the market. At this juncture, I don't think that changes in any way our view of our long-term sort of credit trajectory and getting to that kind of high 1s, low 2% annualized net charge-off rate.

Okay. Maybe switching gears a bit. Also on the student policy side, there's maybe been maybe not policy, but just relevant news is there's been some concern over international students, maybe not coming to the U.S. as much anymore, how large of a base is that for Sallie Mae today? And how impactful might some of the recent actions we've seen out there affect you?

Yes. Our programs that we have in place require that either the borrower or the cosigner be a citizen or a legal U.S. resident. And so as a result of that, we have a very low exposure to that sort of international student base. You can debate the merits of the policies around that, but I don't think it's really going to have any material impact on our business.

And just if we also switch gears, again, focus more on the capital market side. You did a $2 billion loan sale this year. You saw a really strong execution of nearly 10%. Talk to us about what we should be expecting over the remainder of the year? How do market conditions look today? And what does the demand look like in comparison to the prior sale?

Yes, I think, this loan sale strategy that we've had in place has been really critical for us in terms of managing the overall size of the balance sheet. We've executed on that strategy now for a number of years through different sort of both interest rate as well as sort of market dynamics and that's proved to be a continuing source of capacity for us. The other dynamic that's happened in the market is the exit of now 2 major bank competitors from this space over the last few years. And as those processes have been run, there have been large portfolios for bid. At one time, a lot of investors doing work around those portfolios, getting smarter on the asset class. And obviously, in a process like those, only 1 group wins the bid. And so the backdrop of that, though, has created a much more -- a much broader sort of investor base that understands the asset class, that has done the work and is interested in the profile of the assets. I mean it's kind of a unique consumer credit type. It has got duration. It's got high credit quality, low losses. And so it is very attractive in the context of the broader sort of trends around private credit. We have seen strong interest from private credit and being involved not so much directly with us, but in the background as investors in the takeout securitizations that the buyers ultimately tend to do. In the context of current year, really the expectation you should have around additional loan sales, it will be just like it was last year, which is the growth of our balance sheet is really going to be the governor of the amount of loan sale and timing will be somewhat dependent on when we think there is an optimal window for us to do another loan sale this year. The environment has changed fairly dramatically since February when we closed that first loan sale. April ushered in a period of a lot more uncertainty in the capital markets. But I would say that over the course of the last few years, as we've executed on this strategy, we've had good transactions done in a variety of different markets. So we're confident that there is still broad demand for the asset class and TBD on when and where we do another loan sale this year.

Okay. Understood. And as we kind of touch upon the strategic vision you laid out at the Investor Forum. Once again, you touched on how you've been able to execute on this plan so far, but as it relates to the potential of a new and private market opening, could you talk us through how your strategic priorities might shift if that comes through? Does it change your views on balance sheet growth, how much you want to hold? And then I think you've alluded to potential new avenues to the whole loan sales strategy or alternatives. Could you touch upon that a little bit and what that looks like?

Yes. I think maybe it would be an opportune time to sort of rewind the tape a little bit on the strategy. When Jon took over as the CEO in 2020, he realized 3 things very quickly. And that was that you couldn't grow the balance sheet in a meaningful way, phase-in the CECL requirements and return capital to shareholders. Big believers in capital return to shareholders, didn't really have an option on implementing CECL. So the first phase of the strategy was hold the balance sheet flat while we did the CECL phase-in and continue to return meaningful capital to shareholders from the loan sale proceeds. That was a huge success over the course of that time period, depending on when you cut the tape, $14 billion, $15 billion of loan sales and repurchased over half the outstanding flow to the company. The second phase of that strategy really started in 2023, as I kind of highlighted some of the points on that previously. Really focused on modest growth of the balance sheet, continue to do loan sales to moderate the rate of growth, focused on growing earnings per share at kind of a double-digit level through both organic growth and driving operating leverage into the business. And that -- again, we feel like we're off to a good start on that. We're in year 2 of a 5-year framework. So as we sit here today, I think about kind of 4 key priorities for the business in order of priority. And first and foremost is for us to continue to execute on our core strategy as we outlined in 2023, continue to invest and optimize the core business. And continue to deliver the value that, that sort of framework provides, committed to hitting our guidance for this year. And continuing to strive to meet or exceed the 5-year framework. With the guidance this year, it's interesting. We're about a year ahead of where we thought we would be in that 5-year framework. So that feels good. The second priority for us is really being ready for that potential for meaningful federal reform from both an operating perspective, product perspective. We don't know the exact form that it will take, but we do know it's imminent. And so we want to make sure that our organization is really ready to help the schools, the students and their families deal with whatever the impacts are that come from reform in the federal program. So that's really the second area of focus. The third is getting to your question, which is sort of funding. And we have been thinking for some time about alternatives to our loan sale process, particularly in the context of creating something that isn't as dependent on sort of specific transactions in capital markets that can be very dependent on market conditions as and on the day. And trying to think about ways that we can build more durable and resilient alternatives to both our bank funding as well as the existing loan sale programs. And that's something that we've got a big focus on. I think that will be important from a perspective of creating a different earnings profile and one that might be valued more positively by investors versus a series of capital markets transactions. But I think it will also create a more resilient source of capital for expanding originations in the business. So as we think about that in the context of volume that could come from potential reform in the federal system, I think that will be a big benefit there. But over time, it could also be a way for us to maximize on our originations capabilities and expand originations beyond what we would want to put into our bank funding model. So that's item #3. And then the fourth is really to achieve our sort of aspirations around education services. We bought a couple of small companies in the last few years, Nitro and Scholly. Those have formed the base of an organic content-based customer engagement engine that's really had a dramatic impact on our core business in terms of pull-through into the front of the customer relationship and creating a lower overall marketing costs for the business. But I think there's more potential there, and we're exploring creation of additional products and services that will further engage our customers, fulfill our mission and create additional capital-light sources of fee-based revenue over time. So those are the 4 areas of focus. Again, first and foremost is meeting our expectations on guidance for this year and continuing to execute on the Forum framework. But we have some other exciting things in the hopper as well for the future.

And if I just double-click on number 3 there for a minute. Any sort of early thoughts on what you'd be looking at? And when should investors be on the lookout for what that could be or timing of that?

Yes. I think putting an exact time line on it, probably not ready to do that at this point. I think it's something that is strategic in nature, and so we'll take the appropriate amount of time. We've been thinking about it for some period of time now, but if you put an endpoint on it, and we'd like for that to be an additional source of capital that will enable us to be ready for federal student loan reform, that kind of gives you an endpoint of when we'd like to be ready.

And assuming student loan reform comes through, does that shift the way you think about operating leverage as you laid it out? Or do you -- is there a potential for more to fall to the bottom line? Or do you think you'd want to kind of stick with the 60%?

Yes. I think the 60% that we laid out in the framework, I think, was a good starting point. I think aspirationally, we'd like to continue to optimize our core business. We continue to make investments in technology that improve the customer journey, but at the same time, they also give us the additional capacity of digitizing and turning the business into more of a fixed cost base by making those technology investments. And so I don't think the reform opportunity really changes our mindset around that per se. I do believe that the business that we've created does have the capacity to scale to whatever the opportunity is and scale in a way that probably doesn't have a step change in terms of the cost of that. And I would point to kind of the example of 2024, when we were able to have outsized growth versus our expectations, take market share that came as a result of the exit of a competitor, increase marketing costs and the like and still came in below the midpoint of our expense guidance, original expense guidance for the year. So I think there's still that type of capacity for us as we move into next year and think about the potential for additional volume coming from the federal programs.

Okay. Great. Great. And as we sort of think about the last 10 minutes of the conversation here, I wanted to talk about credit. Your credit losses have migrated higher versus pre-COVID, can we just maybe rewind a little bit and talk about why that is? How much of that has to do with a bit of a tougher backdrop for today's students that are graduating versus maybe some regulatory shifts and some changes in your underwriting and loss-mitigation programs?

Sure. I think the thing to keep in mind when you compare sort of pre-COVID to now is that pre-COVID, we were still in a portfolio build phase. So we really started building our balance sheet at spin in 2014. And so the portfolio then was not seasoned as it is now in terms of full vintages in P&I repayment. And so that's the main driver for sort of lower losses in that time period compared to the guidance that we're giving for where we think our loss rates are going to settle in, is that seasoning element in the portfolio. The other thing to keep in mind is pre-2021, we had broad use of judgmental forbearance as our main tool for managing borrower stress in the portfolio. And when we ceased that practice that caused a spike in delinquencies and charge-offs because we didn't have a complete tool set to help borrowers. We've rolled out these new modification programs and borrower assistance programs. And in fourth quarter of 2023, and we feel like they're performing well. The success metrics within the programs that people that get into the programs are where we would expect them to be. We did tighten enrollment eligibility in the third quarter of last year. As we again learned from the programs, continue to refine them. We felt like we might be giving mods to people that could survive on their own and so move the eligibility period later in the delinquency cycle. All those things really are going into kind of a stabilization period here. And in the programs, the enrollments are down off their peaks as we go through the months this year. We will have a graduation sort of wave, if you will, from the programs later in the fourth quarter and first quarter of next year, and we'll be looking to release more information as the success metrics and the like become more evident to us there. But we feel good about the program design. We think that it's helping borrowers be successful. We like the fact that these programs require payment of some sort versus our old tool, which did not require any payment. So on balance, we think it's good for managing our credit losses. It's good for helping the borrowers get on solid footing and establishing good payment habits. And we're optimistic about the continued evolution of the programs.

And once you start hitting that graduation wave, you've talked about the strong success rate so far. How do you think about the credit characteristics or repayment, likely to repay ability of those consumers as they roll out going forward once those payment -- those terms reset back to normal?

Yes, again, our expectation is -- and the thing to keep in mind is the peak stress in our portfolio is the sort of new to payment grads and that first kind of 12 to 18 to 24 months of being out on their own, starting to collect the paycheck in a meaningful way for the first time, starting to make their own on bill payments. And so that's sort of what these programs are designed to help with. Obviously, not 100% of the people in the programs are going to be successful in their exit, but we expect that we will -- just as we've had good success levels of borrowers in the programs making their payments, we expect that there will be good success levels of people stepping back into their contractual terms and setting themselves up for success over the longer term.

And could you also maybe just comment on what you're seeing in the near term? Maybe quarter-to-date, if you have any sort of color on the credit so far?

We've continued to see positive trends in terms of the overall credit performance we're committed to the guidance that we've given for the year and don't see anything in the second quarter results that would cause us concern about hitting guidance for the full year.

Okay. And one thing we didn't quite touch on there was you did make some underwriting changes too in previous years. When do you think those benefits will start to accrue? Is it may be starting in '26, '27, once you get to that repay wave?

Yes. I think that, again, we did, over the last few years, as you mentioned, sort of at the margins tighten our underwriting box. And that tends to have a lag effect, right? If it's a freshman, it's going to be 4 years. On average, it will be a couple of years before those changes start to manifest themselves. So we expect that it will start to be a little bit of a credit tailwind as we go into next year, and it will continue to build as those underwritten cohorts come into full P&I. Again, it's not going to be a huge step change, but it's another element that gives us confidence in our overall long-term guide around net charge-off rates.

And then just one last for me on credit. As you kind of look at slower enrollment and the prospect of AI, maybe damaging job growth for new graduates from here, do you view this as an opportunity or a challenge, maybe as younger folks go after nontraditional fields?

Yes. I think the market continues to evolve. We have seen the reports around demographics and high school grads and the like. I think that's one that is imminently manageable. It's sort of a modest decline over a multiyear period. I think that the overall core market this year, we've seen increased levels of application on FAFSA year-over-year. So that sets us up for a good, I think, peak season this year, but the market does continue to evolve. Over the last few years, we've continued to expand our for-profit sort of originations and the thing to think about there is, in the for-profit space, we tend to focus on sort of high-profile things like pilot training programs, nursing programs and sort of nontraditional, but still very meaningful certification type programs that will generate good returns for the borrowers. The other thing, I would say is, as we engage on these alternative type programs, we do a full underwriting of the programs and the schools themselves. We want to make sure that there's a good ROI for the investment for the borrower, and that's going to lead to good credit outcomes for us. And so it's been exciting to see some of the growth in those opportunities for us, and we continue the evaluation of different sort of nontraditional education options. I think that's going to be a continuing evolution of the overall marketplace for higher education.

Okay. Great. And just to wrap up, I mean, you touched on your priorities before, but are there any other strategic priorities you wanted to highlight there? Or did we already cover those?

No, I think those are the 4. Again, fully committed to guidance for this year and continuing to try and exceed the 5-year framework. We're getting ready for the potential for reform, and believe that to be more imminent now than it has been at any time in the past. We're ready from a funding capacity and operating capacity to take advantage of that. We continue to explore alternative funding capabilities that will be a complement to our bank funding capabilities and our existing loan sale processes. And we'll look to optimize our ed services business and create capital-light fee streams over time. So really excited about the future, and we feel like those are the right things for us to be focused on as a company.

All right. Sounds great. Well, I think we're out of time. So thanks for joining us today.

Yes, thanks for having us.

Thanks, as always.

Yes, pleasure.

Take care.