SLM Corporation (SLM) Earnings Call Transcript & Summary

So thank you, everyone, for joining. My name is Terry Ma, I cover consumer finance at Barclays. I'm pleased to have on stage Pete Graham, CEO of Sallie Mae. So welcome, Pete.

Good to be here. Thanks, Terry.

Yes. So I think we'll jump right into it. I wanted to start off with an update on peak origination season. How is it shaping up so far? You guys obviously put out an update this morning. So maybe just talk about that and what you're seeing in the origination environment.

Sure, sure. I think it's important to sort of reiterate our focus on originations is really around quality of originations, not just overall growth. Over the last couple of years, we've talked about the fact that we've continued to make sort of cuts at the margin to our credit underwriting to improve the overall quality of the book. By our estimate, over the last few years, that sort of, call it, 8 to 10 points of originations volume that we've taken out while still managing to grow at pretty substantial rates over the last few years. As we came into this year, we made some additional sort of cuts at the margins and had in place ideas around different strategies we were going to use to kind of close the gap, if you will, to hit our original originations guidance of 6% to 8%. As we come through the year, we did see some softness in the second quarter that we talked about on our call, but the strategy is while effective, weren't as strong as what we had hoped for. And so we thought at this point, it's prudent for us to adjust our guidance down to the 5% to 6%. We still feel really good about 5% to 6% growth, that's strong growth. And important thing is it's high quality of originations that we put on the book.

Got it. And I guess the lower origination guide that you guys put out this morning, do you attribute that to the softer demand that you saw in the second quarter kind of just pulling through? Or is it more just kind of credit actions that you've done earlier this year?

It's kind of an all of the above. Certainly, the credit actions that we came into this year with create a little bit of a headwind because it's taking out volume that we would have done in the previous year. We did see some softness in the second quarter that we attributed to sort of things that we thought would be isolated to the second quarter. We've seen some of that trickle over into the overall peak season, some program caps and things like that in California. I think probably the biggest thing that I would highlight. But nothing overall dramatic. It's more just the different strategies that we employed weren't as successful as what we thought they were going to be in terms of closing that gap.

Got it. Okay. And then, I guess, if we think about the big picture, how are you thinking about the potential upside from the legislative driven market expansion?

Yes, that's a good next point to focus on. I think the important thing there, again, focused on sort of traditional underwriting. We didn't size that based on kind of a top-down. There's this much volume in the federal space, and we're going to get x share. We really were more programmatic about it. We went and got data from the bureaus on federal borrowers and our team spent a good amount of time doing a sort of a bottoms-up underwriting analysis so that gives us comfort in that sort of 4.5 to 5 opportunity that we've sized is something that's attainable for us and within our sort of credit profile.

Got it. And how should investors think about the phase-in period for the additional volume of kind of Grad PLUS and Parent PLUS that you called out? When should the additional volume be kind of fully realized?

Yes. Again, just kind of recapping the legislation really creates a framework of new borrowers in the next academic year is when those changes start to take effect. So for undergrad borrowing, that's really going to be kind of beginning with new freshmen that come in next academic year and will phase in kind of ratably over a 4-year period. For the grad borrowers, that's going to be a little more nuanced depending on the type of programs. Some programs are shorter, kind of 1- and 2-year programs, think like accounting master's programs versus 3- and 4-year programs for business school and much longer programs for med school. So again, we view '26 as being kind of like the first start of that volume opportunity, probably the smallest year of growth opportunity. But then that will begin to build and scale as you go into the subsequent years and kind of fully phase in over a 3- to 4-year period.

Got it. You guys obviously quantified Parent PLUS as an opportunity. Maybe can you briefly touch on the desirability of Parent PLUS to investors?

Yes. Again, I think we approached this from a perspective of underwriting an opportunity for both undergraduate funding and grad funding. We will go through a process as a company of evaluating and doing sort of product analysis to determine whether we need a parent-only product or whether our existing sort of co-signed Smart Option product for undergrads is the appropriate one. Too early to say on that, but we're doing the work on that in advance of next year's peak season.

Okay. And what about Grad PLUS? How do you think about Grad PLUS fitting into SLM's portfolio? Is that a product that we can think of as having lower credit risk that may be higher consolidation risk?

Yes. I think the overall product itself fits very well. Up until now, our primary competitor for grad lending has been the federal government. And that's why it's such a small portion of our book currently. We were encouraged as we did the bottoms-up sort of credit analysis, that the profile of borrowers there was consistent with our underwriting box. So we feel like that's going to be a good fit in terms of going after that market with products that we either already have or can make slight modifications to. In terms of your question around credit risk and duration, I think in general, grad borrowers are a different credit profile. Obviously, they've typically -- well, they all have undergrads, but they've gone out and they've worked for some period of time before going -- just making the decision to go to grad schools. So they typically will have their own sort of credit profile credit score. So more an individual underwrite versus a cosign underwrite. And in terms of the duration of the sort of product, that's going to be more nuanced by the product type itself. If you think about kind of business school grads, they're going to be a fairly quick payback because they get the income opportunity fairly quickly from the degree that they've attained. And doctors tend to have a kind of a higher overall balance and take a longer period of time to pay back. So it really is sort of nuanced depending on the mix of the book. We've got experience with the variety of different product types, although on a much smaller scale. So we feel like we've got a good idea about how we're going to approach that. We'll get more data, obviously, as we start to do more volumes but we feel well positioned at this point.

Got it. And then you also indicated you're actively exploring funding partnerships in the private credit space. Can you just update us on where you stand in that process? And ultimately, what are you looking for in a partner?

Yes. We've talked about that over a number of quarters now. I would say that the process is ongoing. We'll have something to announce when we have something to announce. But in terms of what we're looking for in a partner, we're looking for obviously, a partner that has the capability. We're looking for a partner that's value aligned with us in terms of fulfilling our sort of mission to enable higher education. And we're looking for a partner that wants to build kind of a durable long-term committed relationship that will allow us to maximize originations in the space, but also sort of manage balance sheet capacity and create a more sort of capital-light fee-based revenue stream over time.

Can you maybe just expand and talk about how this new funding plan differs from your balance sheet and loan sales strategy today?

Yes. I think it's really highly complementary to that. It addresses or has the potential to address some of the things that are slight weak spots in a very successful strategy that we have now. We -- ideally, we'll be able to create an origination capability that isn't reliant on the bank's balance sheet. So therefore, has a different capital and CECL reserving requirement and also one that will remove some of the sort of episodic nature of the existing loan sale process that we have. It's been very successful for us. We've gotten good returns over time from that, but it does pose some amount of sort of capital markets risk for execution as and when the transactions happened. And our desire is to sort of create an additional leg of funding capabilities that will be supplemental to what we already have with the bank and with the loan sales strategy.

Got it. Maybe we just switch gears and talk about credit. There's more noise than normal in trust data, particularly last month. Can you just remind us what the drivers of the difference between your trust credit results and your consolidated credit results are?

Sure. Yes. We put a couple of additional slides into the materials that were posted this morning to try and help sort of highlight those differences. I think it's important to remember that the trusts are sort of static loan pools created when we do one of these loan sales. So they are a snapshot in time, selection of loans that are in the book at that point in time that then we'll have whatever the credit performance of that selection of loans is. And the main difference there from our overall book is overall book is dynamic and continues to sort of be refreshed with new originations that are coming into the book, in particular, with regard to the last few years originations, again, reminding that we've continued to sort of tighten our credit aperture and believe that those originations that have come in, in the last few years are higher credit quality than what on the margin we had originated in the past. And so you've got this sort of static versus dynamic element. I think also because of the nature of the pools and when they're selected, the static pools have a much higher percentage of borrowers that are in repayment and a higher percentage of borrowers who are in early-stage repayment. And so that will drive a different sort of credit profile versus the overall book.

Okay. And can you provide some color as to why the early-stage delinquencies ticked up in July, kind of what normal seasonal trends should look like or could look like?

Yes. I think month-to-month, you can certainly see a lot of variability in the data that tends to normalize out when you look at it on a quarterly basis. I think with regard to the July uptick in delinquencies, that's really just kind of a natural byproduct of the end of grace period for December grads and also for borrowers that were spring grads last year that took advantage of extended grace programs, they will be coming into repayment at a similar time frame as well. So sort of an elevated input into that early repayment stage. Largely, these folks in our experience will self-cure because it's really just kind of like the friction around getting their first payments on the loan set up. So again, nothing that we view as particularly alarming in the monthly data.

Got it. That's helpful. And can you remind us all the different borrower assistance programs you have out there? How are they differentiated? And ultimately, what are you seeking to accomplish by kind of having those?

Yes. At the heart of the loan mod programs really is the process that we go through to interact with the individual borrowers, assess their financial condition and their ability to pay. And then the different flavors of loan modification program are really an output of the Q&A process that has gone through with the individual borrowers. So we're trying to sort of meet them where they need to be met to provide an appropriate level of assistance. But sort of tailor that so that we're not giving too much away, but also giving them enough so that they can be successful over time. And we continue to sort of monitor that both in terms of performance of the borrowers in those programs and make tweaks at the margins to the eligibility for those programs over time. We feel good about performance of the programs. We've got a high success rate of successful payments for folks that have been in these mod programs for now over a year. And so we feel good about the design as well as the performance of the programs.

Got it. And maybe just following up. Why did you decide to change the requirements for qualifications for mod from 30 days delinquent to 60-plus?

Yes. We did that in the fourth quarter of last year. Back to the point I was making around the uptick in 30-day delinquencies, we saw as we were sort of monitoring performance that many of the 30-day delinquency borrowers self-cure. And so we wanted to sort of acknowledge that in terms of when we were offering the loan modification programs because that's more kind of like a permanent -- more permanent sort of solution for them. And that was the primary driver for sort of changing the entry point to the programs in the fourth quarter of last year.

Got it. That's helpful. Maybe just taking a step back, there has been a rising level of concern on the employment rates of recent college graduates. What are you seeing in your data so far for the class of '23 and '24? And do you have any early indications for '25 graduates? Can you maybe just expand?

Sure. Yes. We do a lot of interaction with our borrowers, surveys and the like. The information we've gleaned from our surveys of the 2023 and 2024 graduating classes, they still have a relatively confident outlook and nothing that would give us concern that they're in any different place than prior sort of graduating cohorts. So that's promising. I'd say with regards to the '25 grads, that there's been so much press about in terms of employment prospects. I think it's too early for us to really draw any conclusions there. They won't go into sort of repayment until the fourth quarter of this year. And to the extent they're still struggling to find jobs, they'll likely avail themselves to extend grace. And so it will be some period of time before we get a fuller picture on the '25 graduations. But at this point, nothing that tells us we should be concerned.

Okay. And I guess, the question I get a lot is the resumption of federal student loan payments. Have you seen any additional noise on your portfolio from that impacting your borrowers?

We continue to sort of monitor our borrowers with and without federal loans and haven't seen any deviation in terms of performance there. I think at the margin when the reporting restart happened, and I think there was some degradation of FICO reported for borrowers as a result of that. It's largely sort of self-cured as that reporting restart happened and people reacted to finding that their credit ratings were being impacted by actions they had taken. So as of now, I haven't seen any major impact in our book.

Got it. So when we put everything together, do you still view your long-term net charge-off range of high 1s to low 2s, as the right target? And any color on kind of the time line to get back there?

Yes. Again, we still feel like that's the right long-term target for us to have supported even further by the underwriting changes that we've made over the last several years that will really start to sort of kick in as we move into the next few years, we'll begin to, we believe, see the benefits of that. In terms of an overall time frame for attaining that, I wouldn't want to give a specific date, but that's the overall goal for where we're moving towards, and we feel confident we'll be able to attain that.

Okay. Got it. Maybe we'll switch gears a little bit. What are the competitive advantages for Sallie Mae that has allowed you to kind of grow your share and maintain your position as the largest private student loan lender in the market?

Yes. Again, I think there's a number of factors that distinguish our company. I'd say the sales force that we have, the school relationship team is the largest one in the industry, decades of experience and long-term relationships with the financial aid offices at the schools that they touch. I think that will be a hard one for anyone to replicate. I think there's also just the longevity that we've had in this business and the amount of data that we've got that we can use to inform our decision-making around how to operate the business, around how to underwrite and how to manage credit. Those are kind of unique things that I think will be hard for a new entrant to replicate.

And we think about potential expansion in the market, how do you think that changes the competitive landscape? And do you think there is a risk that other competitors will be drawn into the space just given it's a larger market?

Yes. I think if you got to put in context of the overall size of the market, private student lending being roughly $14 billion, even if it doubled, which isn't kind of our base case, that's still going to be a relatively small market compared to credit card or auto or other consumer finance verticals. And it's a unique product that takes some real operating knowledge to operate successfully in, and that's part of the reason that some of the competitors have exited over the last few years. So it's something that we watch and we monitor, but it's not something that we think is a real issue that gives us concern at this point in time.

Okay. Got it. And you mentioned doubling the market isn't your base case. But I think if we look at the $4.5 billion to $5 billion run rate that you kind of guided to like where is the area for kind of upside from that? Like how conservative is that?

I think the point that I would make there is that $4.5 billion to $5 billion is us doing a bottoms-up analysis of federal borrower data that's reported to the bureaus and analyzing that based on our existing credit appetite for the bank. I think as we explore different funding alternatives and partnerships, there's a potential that we could expand that credit box in a meaningful way if we find the right partner and the right funding mechanism for that.

Got it. That's helpful. And we think about the areas for expansion within that, like how do we kind of think about the Grad PLUS versus the Parent PLUS? Like how much like where can the expansion kind of come from either of those?

I don't know that it's tied directly to the specific programs of federal reform. It's really just around the adjacent sort of credit profile of borrowers that need to fund higher education. If you kind of take the cuts that we've made to our credit box to optimize for our bank balance sheet over the last few years, that's, call it 10% of originations that we would have done. That's just a starting point for the volume opportunity that we think could responsibly be taken in an environment where we had a different funding mechanism.

Okay. That's helpful. Then you laid out plans a few years ago to kind of slowly build up to this high single-digit receivables growth and also double-digit EPS growth eventually. Is that still the right growth algorithm today as you're under precipice of potential market expansion?

Yes. I think that the framework that we laid out in '23 is really still the right framework for us to evaluate how we optimize the business going forward. We purposefully selected sort of a single-digit rate of growth for the bank's balance sheet for a variety of reasons, regulatory focus, funding -- the need to obtain deposit funding and not wanting to stress deposit-taking capabilities. So I think that's still the way that we view the business. Now in the onset of this larger volume opportunity, might we tend towards the highest of single-digit sort of rates of growth of the balance sheet? Yes, sure. But I think our view is we will still have loan sales as sort of safety valve in managing that growth. And ideally, we'll also have an additional sort of private credit partnership type funding model that will be in place before then as well.

Got it. You mentioned that you agreed on pricing for $1.8 billion of loan sale in the third quarter. Maybe just talk about what the market for loan sales look like currently. You obviously did a sale earlier this year at almost 10% gain on sale margins. So maybe like how should investors think about the gain on sale medium term? And kind of what are some of the factors that we should be mindful of?

Yes. I think the demand for the asset class is there. We've seen that over the, call it, last 5 years, it kind of continues to build each year. As these large competitor exits have happened and the sale processes have gone for those portfolios that's brought in more investors that have gotten comfortable with the asset class and now you want to put money to work in this asset class. So we continue to see good demand for the loan sales. With regard to pricing, like there's variables there that differ from transaction to transaction. Obviously, these are largely sort of benchmarked against pricing in the ABS space. And there was a little bit of market volatility after April. I think we all experienced. So like that's a factor of the pricing on this transaction versus the one in the first quarter. But as we said on the earnings call, it was in line with our overall expectations for the year.

Got it. We'll shift to NIM. So you guided to low to mid-5% NIM is the right way to think about it long term with your NIM right in that range at about 5.3%. How do you expect that could be affected by potential rate cuts going forward?

We run a pretty balanced book. I'd say on the margin right now, we're slightly more liability sensitive. So as and when sort of short-term rates start to go down, that will impact the liabilities quicker than it will the overall asset book. At the margins, though, that's reflected in the longer-term guidance that we've given for NIM. So the rate cuts will be supportive, but it doesn't really change our view on the overall sort of target range that we're looking at.

Got it. And is there any reason to expect NIM could be impacted by market expansion and the new loans that you may be underwriting?

Again, that's part of the reason for sort of keeping to the balance sheet growth strategy that we've had. Having that modest rate of growth in the balance sheet helps manage all the different parts of the equation. So it doesn't change our view on the guide in terms of our longer term where we're intending to operate from a NIM perspective.

Got it. How do you think about the mix of the retained portfolio kind of going forward as you on the verge of this new opportunity. You're doing, call it, $7 billion plus of in-school undergrad, potentially up to $5 billion annually of kind of grad. How do you kind of like weigh the risk or the different kind of characteristics of each of those?

Yes. Again, I think the fact that our bottoms-up analysis said that the PLUS opportunity is largely in line with our credit box and what we have been underwriting historically. We feel good about taking -- again, that $4.5 billion to $5 billion was things that fit within our current credit profile. And so mixing that volume into the strategy that we currently have of a portion being originated on the bank's balance sheet, portion of that bank origination being available for loan sale in the spot markets. And then ideally, before next peak season, we will have another sort of funding mechanism through private credit partnership that will give us kind of early origination, maybe staying on the bank's balance sheet for a very short period of time and going into a different funding structure that gives us another avenue for taking down originations without significantly changing the overall size and profile of our bank.

Got it. And just to be clear, you expect the Grad PLUS credit performance to be consistent with the high 1s to low 2s?

Yes.

Got it. So we have a little less than 10 minutes left. I'll pause here and see if there's any questions from the audience. We have one question here. There's a mic coming.

Can you talk about capital return priorities?

Yes. I think our capital return philosophy is consistent with what we laid out in the investor forum in 2023. We kind of create pockets of capital from the different activities that we've got up until now, that's been sort of spread-based growth of the balance sheet and focus on raising the dividend as appropriately supported by that. And we've used the proceeds from the loan sales to sort of fuel our share buyback programs as we get into kind of a third leg of capabilities that would be more of a consistent over time, capital-light fee-based revenue stream at the margins, that would probably be more supportive of dividend growth versus additional share buybacks on top of what we've already been doing.

Looking out 3 to 5 years, how do you weigh the regulatory risks about expanding the credit box and the ability to repay?

I think that any expansion of credit box we would do would be done in a very responsible manner, like there's some portion of loans that are happening in the federal programs currently that, quite frankly, shouldn't be happening. And if they were properly underwritten, probably wouldn't be extended by a private lender. So when we talk about credit box expansion, we're not talking about irresponsible lending. We're just talking about at the margins, a slightly lower credit profile than what we've been currently originating and putting in our bank. Well, I'd say as a starting point, the changes we've made over the last couple of years is roughly 10% of our originations this year. So that would be just the start.

Any more questions from the audience? Maybe one more just on credit. You mentioned you made some tightening earlier this year and also last year. Maybe just remind us like what you see to kind of drive or make you kind of tighten the credit box?

Yes. We are consistently monitoring performance in the portfolio. And each year as we go into sort of setting our credit box for the year, we'll sort of look at performance and we'll make cuts at the corners and corners of the corners of our kind of credit profile. That's one aspect of the cuts that we've made over the last few years. The other element is we do an ongoing assessment of the schools that we're providing funding into and performance of those schools in terms of delivering outcomes for the students and delivering successful outcomes for the students. So we will -- in those cuts that we've made, there's some combination of just sort of performance-related credit cuts in the underwriting box, and there's also some on looking at different programs and just saying we're not going to lend to that school anymore because we don't think it's providing value to the student that's borrowing.

Okay. Got it. Any more questions from the audience? Okay. I think we will wrap it up on that.

Good to be here. Thanks for having us.

Thank you for coming.