Good morning, everybody. My name is Jeff Adelson. I'm the consumer finance analyst here at Morgan Stanley. Before we get started, I'm just going to quickly read some disclosures here. For important disclosures, please see Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. The taking of photographs and the use of recording devices is also not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. Very happy to welcome to our conference today, first time, Pete Graham, CFO of Sallie Mae. Thanks for joining us, Pete.
Yeah, good to be here, .
Maybe before we get into the meat of our conversation, let's start with a brief rundown of how the second quarter is shaping up in your view.
Yeah. So, you know, we had a good first quarter. Originations grew 6% year-over-year. And so that gives us a good trend line going into the latter part of this year. For originations, we're not really gonna see any real movement until we get into peak. That's when it matters. But we feel good coming into peak. Competitive dynamic is pretty balanced. Even with the exit of Discover, we've got, you know, some strong competitors that are private equity-backed. But it's a rational marketplace, and we feel good about going into peak. Credit performance, you know, we had good credit trends in the first quarter, and that's continued to trend into the second quarter, so feel good about that.
Broadly, we reaffirmed guidance at the end of the first quarter, and so all the metrics that matter, we feel pretty good about.
I think the trust data we look at, while it's not perfect, seems to suggest, you know, more of a better quarter this time around versus, I think, what people were expecting. Any sort of early thoughts there?
Yeah. Again, we've put in place a number of new programs to help borrowers that are in need. It's early in those programs' life cycle. We're seeing the first of the borrowers you know complete their three monthly payments and cure and go back into performing status, so that's promising. We want to see a few more months of data on the you know sort of complete picture and start to normalize that. We want to see the performance of those borrowers that have gone back into performing status, that they stay performing. But in general, we feel like the programs are performing well.
Stay tuned for that in maybe the next couple of quarters, I think so.
Yeah, I think, look, in general, when we look at the repayment waves that happen in our business, second quarter and fourth quarter, and we look at the data around the usage of programs and the delinquency levels, when you look at that sort of altogether, the trends on the newer vintages are very similar to pre-COVID vintages. So that kind of tells us that we're dialing in appropriately on these new programs. But we'll have more to share after the second quarter.
And maybe we'll touch on the new programs in a bit, but wanted to start with the recent loan sale. You announced last week $1.5 billion, so you're already tracking above $3 billion for this year. You're on track, executing on that $3 billion-plus path you laid out in the five-year framework. Seems like a validation of what you're doing, strong demand for your product. Any way to maybe compare this deal versus the February one you did, maybe in terms of characteristics of the loans? It does seem like from the outside looking in on the demand side, that ABS spreads have continued to tighten, so the market seems like there's strong demand out there for your-
Yeah. Yeah. The most recent transaction itself, we're going to be in market with sort of the takeout securitization, so I wouldn't want to talk pricing or anything specific to that deal. We were very happy with the pricing on the first transaction we closed in February. We've completed an ABS on-book funding in the early part of this quarter. That deal was three times oversubscribed, which is kind of an indication of the demand. We were able to, you know, tighten pricing and upsize the deal from launch. So it's a good indication of what the market's like and the demand for the asset class. We feel like the market's very supportive of our strategy and, you know, feel good to have those two transactions done and behind us.
It sounded like you were open to another sale later this year, depending on the market. You know, what would dictate this at this point? And what does it take for you to actually execute on another one this year?
Yeah. So when we laid out the framework back in December, you know, we indicated that we were gonna still be relatively flat on the balance sheet this year, just given the final CECL transition happens in January. Our guidance for the year is 2%-3% balance sheet growth, and that's gonna be kind of our guiding principle.
Mm.
You know, we sized our loan sale transactions in anticipation of what we think is gonna happen during peak. As we get into and through peak, if things turn out better than what we had anticipated, then we'll have a decision to make as to whether we carry a little bit more balance sheet growth through the year-end, or if markets are favorable, we might do another loan sale.
You know, obviously, the repurchase story follows that loan sale model. Can you just talk about the near-term path for repurchases here, the cadence over 2024, and is 90-100 a quarter or something that, you know, is the right way to think about it? I know you talked about how you think you're going to do half of the repurchase authorization this year and the next, but maybe just some insight into what you're thinking there.
Yeah. So, what we said we were going to do for this year, with regard to share repurchase was funded incrementally as we completed loan sales. So, that's been the approach we've been following. And then also, we indicated we're gonna be more programmatic as well. So when we completed the February loan sale, we were in market very, very quickly after that and put in place a, you know, a program that has us in the market every day. And generally, if prices are trending above trend line, we'll buy a little bit less, and if they're trending below trend line, we'll buy a little bit more. But aiming to be in market every day. And we will follow that same approach with the capital generated from this most recent loan sale.
Okay. And taking it back to the, you know, new programs you have out there with your borrowers, I think one perception that's out there is that when a lender starts doing more of this modification forbearance, it's a response to growing financial repayment difficulty from borrowers, but that's not what you're seeing, right? It's more about the credit administration practice change in late 2021, which cut down on some of the flexibility back then. So is there any way to maybe frame what the mix of your assistance programs looks like today versus back then? You know, were the borrowers you were giving more forbearance to back then similar in that, you know, extended grace period, recent graduate cohort?
Yeah. So one thing we do know about our business is that the first 12 to 24 months, you know, upon entering the workforce after graduation, exiting their grace periods, that period is the period of most stress for our borrowers. And if we can help them get through that phase, get their feet under them, and establish good, you know, financial habits, they will generally, you know, perform very well once they get through that phase. And prior to 2021, we managed that phase with the generous, sort of, more flexible use of forbearance. When we ceased that, in late 2021, we knew that we would need to develop some new programs to help bridge that gap. And the programs we rolled out in the fourth quarter of last year really intended to do that.
As I said before, they're early days, but early indications are that those are performing as we anticipated. When we look at various payment vintages over time, the trends do bear that out, that the, you know, sort of peak stress in the portfolio payment vintages is in that first 12 to 24 months. When we look at the mix of the borrowers that are either in 30-plus delinquency or in some sort of a modification program, the totality of that currently is pretty similar to what we saw in pre-COVID vintages. So that gives us another indication of, you know, we feel like we've sized it appropriately and it's behaving as intended. And we'll, you know, we'll have more fulsome information to share after the second quarter earnings.
One other way that I looked at it was, if you look, you know, before you made those changes, forbearance, which obviously includes some hardship in there as well, was about 4% of your loans. Is that maybe a potential way to think about the use of the extended grace as well going forward or?
Yeah, it, you know, it falls into that same bucket. If you look at year-over-year trends in the headline forbearance percentage, the hardship forbearance is, you know, pretty consistent at about 1%, and that growth in that, you know, disclosure is really all around the usage of that expanded grace period. Again, that's an additional six months of grace that's targeted and only available to new-to-repayment borrowers, and it tacks on to the six months that's built into the loan programs.
Mm-hmm. And is there any way to think about the magnitude of that increase in loss rates you saw in 2022? I think it was up 100-- about 120 basis points that year. Any way to think about how much of that was attributable to that policy change, by any chance?
I think it's largely that. There were some other things that were going on in that time frame that were largely transitory. The bulk of that spike in loss rates was related to the ceasing of that flexible forbearance, and it just sort of, you know, accelerated losses into that period. We went for a period of time where we didn't have additional programs, and we've been on a continued improvement trend. Last year was a good step in the right direction. Our guidance around this year is for continued improvement, and we feel like we're on a good trajectory to get back to that sort of high ones, low 2 % net charge-off rate that we've said we aspire to get to.
Is there anything else that you're seeing today or in the environment that, you know, other than those policy changes, makes you more confident in that, you know, that glide path down to the low 2s - high 1s?
Yeah, I think it's just the performance trends that I talked about before, the sizing of the overall usage of programs. Like, it feels like we're getting to a point where we should be normalizing as we move through the latter part of this year. And we'll share more as we learn more going through time.
Okay. One thing that's been pretty topical of late is just competitive intensity in the industry. You obviously had another large player exit, and you're starting to hear a little bit more news flow and or launches out there from smaller entrants in the space. Can you maybe compare what you think the level of competitive intensity in the space is versus maybe a year ago or even pre-COVID?
... Yeah, I think what we're experiencing in this space is not dissimilar from other areas of banking, whereas big banks decide they don't want to be in a particular part of the industry, private equity-backed, you know, players will step into the void. When Wells exited, you know, College Ave stepped in and took some good market share there. There's been recent press around others entering the space and launching new programs in anticipation of peak. So you know, I feel like although Discover has pulled out of the market, there have been others that are gonna be stepping in. But I think it's a very rational marketplace. We're the market leader, and so we expect to compete and take our fair share of the volume.
I think it's a little, a very rational pricing environment. Nobody's doing anything that would upset a pretty balanced market.
You know, what are some of the behaviors that you've seen in the past, or maybe you're starting to see today, that would, you know, you would flag as irrational? I mean, are you seeing anything like that at all?
Have not seen any indications. You know, we monitor that, you know, as we go through and into peak. No signs yet of anything that would be cause for concern. You know, obviously, folks are ramping up their marketing and getting ready for peak, as we are as well. But we expect it's gonna be a rational marketplace as we move through the peak this year.
Just wanna remind folks that if you have any questions, feel free to raise your hand, and we'll get to you. Also, if you're listening on the webcast, my email is jeff.adelson@morganstanley.com. Try to get to your questions if you send them in. Maybe taking it to NIM, with the rate environment here, you know, you're slightly asset sensitive at the front end. However, I think more of that fixed rate demand you're talking about more recently has made you maybe less asset sensitive than you otherwise would have been, as we look out there in the rate picture. So more of a natural buffer, I think, embedded in the model to eventual rate cuts. Is that the right way to think about it?
Yeah, I think the, you know, the important thing to understand, the thing that drives our asset sensitivity on the front end is really the securities portfolio that we hold for liquidity and capital purposes. And then once we get beyond sort of the front part of the curve, as you indicated, our overall loan portfolio is skewed heavily towards fixed rate, which makes us more liability sensitive. So, you know, in the context of a slower path of rate cuts this year, I think that's mildly positive, just given the repricing that happens in the securities portfolio. But over time, as we get into a declining rate environment, we'll be mildly benefit from that in terms of repricing of funding at a lower rate.
We run a fairly balanced book, so we're not talking huge swings one way or the other. And for us, sort of the trajectory of rates is really the important thing to think about.
You've, you know, you've put out the guide for the year, low- to mid-5 for NIM. I think that included 5 rate cuts at the time. Market looks like it's pricing in 1 at this point. So I feel like what I'm hearing now is we've got a case for NIM staying close to where it is right now in that sort of mid-5 range. Is that right? Or what would make that come in a little bit weaker?
Yeah. Again, I think, our guidance was low-to-mid 5. And in a higher-for-longer type time frame, we won't have as much pressure on compression of NIM as we might otherwise. So I think that's still the right ballpark-
Mm-hmm
... for NIM, and I feel maybe we'll be at the midpoint or higher of that guidance, but we'll see as the year progresses.
You know, you laid out the five-year framework for balance sheet growth, and you're maintaining that flexibility to do loan sales. Is there anything else out there that would, you know, perhaps, you know, other than just more originations demand for your product, cause you to maybe keep that balance sheet growth more moderate than the upper single digit you've talked about?
Sure. The framework that we laid out in December, in our view, was a really balanced way to sort of shift the growth. And, given the strong originations profile that we have, if we ceased loan sales altogether, we would be growing double digits. And I think that puts a lot of pressure on funding. That brings additional regulatory scrutiny.
Mm-hmm.
And so we made a conscious decision to focus on the rate of growth of the balance sheet and use the sizing of the loan sales as sort of a balancing factor. So, you know, again, we're focused on sort of mid to upper single digit growth. As we go through time, the framework's very flexible. If we see, you know, really strong loan pricing, we can be at the low end of that range. If we, if we feel like we're getting rewarded, for, for growth on the balance sheet, we can hold a little more on the balance sheet-
Right.
But we won't go to one extreme or the other.
Mm-hmm.
You know, I don't see a scenario where we're growing the balance sheet double digits each year.
Mm-hmm.
And nor do I see a scenario where we're not doing any loan sales in a given year.
Related to that, you know, you talked about operating leverage, roughly 60% expense growth at the rate of revenues are about 2-to-1 operating leverage. You know, that's a big factor in your double-digit EPS growth within that framework. So, you know, what are the easiest expense levers you have to pull at this point? And does that trajectory of expenses change at all if you decide to, you know, lean in or pull back on that balance sheet growth story?
Yeah. So, the key thing in that framework on operating leverage is it's about the rate of growth, right? And so, obviously, we need to have some growth of earnings by growing the balance sheet in order to make that equation work. If you think about the recent path, while we've been holding our balance sheet relatively flat, we've been making pretty significant investments in our risk management capabilities in the credit space, building out the Ed services, you know, framework, with the acquisitions of Nitro and Scholly. So those things are sort of behind us and won't be part of the growth rate going forward.
At the same time, those investments that we have made, particularly in the Nitro, you know, acquisition and build-out of that framework, is gonna help continue to drive lower cost of acquisition. And the investments that we've made in the credit and operations space, moving towards more digital interaction with our consumers, providing more opportunity for self-service, will give us an ability to scale there as well. And the other important thing to think about in our sort of operating framework is all of the loan sales that we're doing, we're continuing to service those loans. So as we build that base of loan service, that also gives us additional scale for what's turning to be more of a fixed rate of investment in servicing capabilities. It gives us more scale to spread that cost.
Does, you know, are you noticing any sort of, you know, type of increased scrutiny on the servicing side or the regulator side? You know, there's been a focus from that competitor that exited there. Anything to highlight there?
Yeah, again, we've made investments and built capabilities to try and stay ahead of regulatory expectations. That's one of the key principles we operate by. So we feel like we've got a fairly buttoned-up, you know, operation in terms of meeting the regulators' expectations in advance of them coming in. So, feel good about that. And again, I think as we start to grow the balance sheet, as we continue to do loan sales and build scale, that gives us-
Mm-hmm
... you know, more assets to spread those costs across.
And certainly not an easy product to service over time and collect on, so it seems like that's a pretty high barrier to entry for-
It-
you know, the competition.
Yeah, we do one thing, but we do it very well.
Right.
So.
Right. Maybe just taking it back to the moratorium, I mean, the credit story here. One question that's kind of come in here is from an investor over email: why do you think you're not seeing any meaningful impact from the payment restart? Do you think it's because the Biden administration has done enough on, you know, the grace period, the on-ramp, consumers still in good shape? Or do you think it's more just the support you put in place for your borrowers?
That's a hard one to tease apart.
Mm-hmm
... 'cause we only know what we know. So when we're underwriting, you know, our loans, we know what the total sort of borrowing package that the individual borrowers have. We know whether they are also taking out federal loans. But as we move through time, we don't really get updated information as to whether they're in any kind of repayment program or the like in the federal space. We do know that we put our borrowers back into repayment in the fall of 2020, and you know that's been a pretty consistent indication to them that their obligations to us are different than their obligations to the federal government.
As the federal program continued to evolve and, you know, borrowers were put back into repayment, we've been monitoring performance of those with and those without loans. The majority of our borrowers also have federal loans, and we haven't seen any, you know, real difference in performance between those two. I think some of that could be just, you know, where they are in the credit spectrum, the high cosigner rate and the like in our portfolio compared to the federal programs. But it also is down to, you know, them establishing those good financial habits because we've been requiring repayment since 2020.
Mm-hmm. And, you know, the Biden administration has been trying to, you know, launch another forgiveness initiative after the last one was blocked. Any sort of views on that program, how that might benefit or even, you know, reduce demand for your product down the line?
Look, I, I don't think there's a whole lot that's gonna get done in an election year. And what I would say is, the amount of focus that all of these sort of forgiveness initiatives has created, there's really starting to be, I think, some bipartisan focus on the need to reform the federal system. There's been proposals floated on both sides of the aisle that have elements of what we think could be, you know, really meaningful reform, things like expansion of Pell Grants targeted aid at HBCUs, and really trying to target the federal dollars at the areas of most need. But at the same time, in order to balance that out, you know, there would need to be reform in the lending programs as well.
I think on balance, those will be mildly positive. Again, we support most of the proposals that have been made. I think they're responsible proposals and ones that you know, we think would be good for the overall economy.
As we turn to capital here again, how are you thinking about the dividend? I mean, I think a lot of investors are asking me when you're gonna increase the payout here. I know you talked about the possibility of a special dividend at the investor forum. I guess why not just lean into the recurring dividend instead of the special?
Yeah. So part of our framework that we laid out was, as we start to grow the balance sheet and create growth in the sort of organic earnings, that would feed a growing dividend. And then the continued loan sales and the capital generated from that would fund our share buyback efforts. So over time, that's the delineation we would have between the two programs. At some point, we get to a theoretical point of diminishing returns around share buyback and amount of float in the stock outstanding. If we get to that point, we could do special dividends.
I think we would continue to keep separate the regular dividend and the growth of that, fed by a growing balance sheet and organic growth in the business, separate from sort of the one-off capital generated from the capital markets transactions.
Is, you know, the last CECL phase-in on the capital, is that maybe a key benchmark or goalpost to be looking at to pass here before you take any sort of action here on the capital or the dividend?
Yeah, we, you know, we've obviously got that in our sights. That's the reason that we targeted the lower 2%-3% growth in the balance sheet for this year. Once we get past that, I think that gives us a greater degree of flexibility around allocation of capital to balance sheet growth, as well as, as we begin to grow organic earnings to begin to increase the dividend.
Any sort of update on, you know, just taking it back to NIM, jumping around a little bit here, but any sort of update on deposit funding and what you're seeing this quarter on the flows? Obviously, the sale helps you out a little bit there.
Yeah. In general, particularly this year, because we're holding the balance sheet relatively flat, but even as we move into next year, where we've got a modest rate of growth, part of the reason for adopting that approach was to reduce the pressure on funding. And so, you know, we're a rate-based gatherer competing with other, you know, sort of rate-based gatherers. We look at what our competitors are doing in terms of pricing, and follow suit. We're not going to be the highest rate on the page, nor will we be the lowest, and we tend to sort of track kind of the middle of the pack.
If there are particular tenors that we need deposits in from a, you know, interest rate risk management perspective, we can adjust pricing at the margins to attract deposits at particular tenors. But the overall demand for deposits has been pretty strong, and the market's pretty rational.
I think you're targeting a little bit of a longer duration in that product right now, at this point, given your loan book. Is that correct, or are you-
Yeah, we, I mean, we obviously will have a high portion of sort of demand deposits. We have CD products, we have brokered products that target different tenors.
Mm-hmm.
So again, we're attempting to run a matched book, either through the tenors where we're gathering deposits through the ABS programs, or, you know, we also have derivative strategies we can employ to sort of balance out the-
And-
-the profile.
Oh, sorry. And also just last quarter, the prepay assumptions did, you know, come down, helped your NIM. So I think some of that less consolidation activity, that is that continuing? Or, really dependent on the rate outlook, I would imagine as well.
Yeah. I think that change was really kind of a roll forward of the historic look back we do around around prepayments. And, you know, we've dropped off, you know, periods where we had a much different interest rate environment and much higher level of consolidation activity. The trends around that have been pretty muted and continue to be so. Yeah, I've heard you know, folks in that space talk about the need for at least 100 basis points of rate reduction from here in order to get any meaningful uptick. So that's a good benchmark to keep an eye on. I think the other thing, too, is the optionality that's now there in the federal programs, in terms of the potential sort of safety valves for borrowers if they get into distress.
Could change the calculus, 'cause it won't be just a rate-based decision. They'll be giving up something else. So that'll be interesting to see how that plays out over time.
Is there anything that Sallie can do, you know, to maybe retain that customer as rates go down? I mean, I know it's a bit of a tricky process there.
I think it's something we think about, it's something we evaluate, but you kind of have that dynamic of, are you gonna cannibalize your own portfolio-
Right
... in that effort? It's something we continually think about and look at, but, you know, we've got some time to evaluate before that, that's gonna be an issue we need to deal with.
Okay. And maybe just before we wrap up here, is there anything that, you know, you want to message to investors, or anything you think is a bit misunderstood in the story at this point? You got me.
I think, I think we've hit all the hot topics that, you know, that are on investors' minds. You know, I'll just reiterate, you know, we had a great start to the year with the first quarter. We reiterated our guidance for the year. Things are trending positively in the second quarter, credit and otherwise. And, you know, we'll look forward to talking with folks after the second quarter earnings.
All right. I think we'll end it there, unless there's any questions from the audience. Thanks for your time, Pete.
Okay. Thank you.
Appreciate you joining us.
Good to see you.
... in the conference.
Yep.