Good morning, everyone. Thanks for joining us. I'm Moshe Orenbuch, specialty finance analyst here at Credit Suisse. I'm very pleased to have with us the management of Sallie Mae. Sallie Mae is the dominant player in private student lending. It's continued to increase its market share even as new entrants have entered the business. Company has taken some steps recently, which we'll talk about, to improve its servicing and collections. We're very pleased to have Steve McGarry, the CFO of Sallie with us. I noted that Steve has been with Sallie Mae since 1997. That's longer than I've been with Credit Suisse, which not so easy to do. We'll do a fireside chat and, you know, kinda we look forward to his commentary.
Maybe Steve, to kick it off, you did post some slides in advance of this. There were a couple of new slides that talked about the performance and your kind of expectation, you know, from a, from a credit perspective. Can you kind of walk us through that and we'll, you know, take it from there?
Happy to, Moshe. Thank you for having us here at the conference once again. Always a very key part of our investor outreach. Yes, to provide a little bit of clarity to investors, we thought that it would be a good idea to publish some specific life of loan default expectations for the last five years of our originations. They are the default expectations that we had at originations. We also provided some information around the expected ROEs on these cohorts of loans. Then finally, we provided some information on where we are at this point in time in the evolution of those cumulative default rates.
Starting at the top, we show that between 2018 and 2022, we increased our life of loan default rate assumption from 9.4%- 10.5%. Before I get into what drove this, I would like to point out that we build our custom credit score with the help of Experian. We are on, I think, our fourth version of that model, and the model uses basically credit bureau data to predict the ability and willingness of our borrowers and co-borrowers to perform. We use custom credit score. We don't use FICO, but we refer to FICO quite often in our disclosures because it is a statistic that everybody is familiar with. What occurred between 2018 and 2020 is we expanded our credit box minimally.
We found pockets of loans that had higher default rates, but we thought that they would contribute to our targeted high ROE, which you can see has bounced around between the low teens. I'm sorry, the high teens and basically the low 20% vicinity. In 2020, we increased our default expectations for two reasons. Actually three reasons. One was the pandemic. We anticipated that borrowers coming out of the 2020 and 2021 origination cohorts might have some employment challenges. Back then, when we were underwriting these cohorts, there was still an abundance of uncertainty about the performance of the economy. Also in 2020, we extended the term of our loans.
We used to offer a term anywhere from five to 10 years, and we thought it was more appropriate for this asset type to offer borrowers a 10 to 15-year term. Basically, in consumer credit, the longer the cash flows are out there, the higher the default expectations are. However, all well within very high expected ROEs. Finally, we've talked very much about the fact that we changed our credit administration practices, namely, we started to limit the amount of forbearance borrowers could receive. We started that process in 2019, that also helped increase the expected life of loan defaults on our portfolio.
All very much within the anticipation that we were gonna earn low 20% ROEs, which I think is a very substantial return given our cost of capital and the returns on this type of consumer asset class. I will make one other point. We also provided what we report quarterly, a view of where our cumulative default curves stand now, and they are actually repay default curves. That is what we have been publishing for many years and will continue to do so. I think they're very informative. I wanna make several points about the performance of those charts. You will see a little bit of steepening in the 2021 cohort curve. That is primarily driven by the recent credit performance.
If you exclude what we've talked about, again, at some of tremendous volume, our gap year issue that took place during the pandemic, that curve bends down a little bit more than 10%. It would be actually 2.5% cumulatively, if we excluded those loans, which we have talked about and have determined that it is absolutely a one-time non-recurring issue stemming back to the pandemic and allowing people to remain in school. I might as well just continue, Moshe, or.
Well, let me ask one question related to that, because on that slide, you did mention that the performance, and I think this is an important point, the performance of even that most recent vintage is still within that, you know, kinda tracking towards that 10.5%, so.
That is absolutely correct, and thank you for that question. We have run our expected life of loan reserve through our probability of default and cash flow model. We are very confident that we will continue to meet the expected life of loan default rates that we had at underwriting for that cohort and for the cohorts that preceded it. To a very large extent, the earlier cohorts have been outperforming default expectations. Despite 2022's performance, we still think that we are very much on track to meet that performance in the long term.
Got it. Could you discuss the significance of that low 20s ROE? Obviously, the loans that you retain on your books will earn that ROE. Can you talk about how buyers, you know, potential buyers of the loans will look at that?
Sure. Absolutely. What Moshe is referring to is that we have been selling roughly $3 billion of loans each year in order to raise capital to buy back our stock, which we think it trades at a discount, and to provide capital return to investors. We are required to do that right now, and I just wanna point this out, because we are still phasing in the impact of CECL to our regulatory capital ratios. That concludes on January 1st of 2025, and we believe once we get beyond that, given the high ROEs on our loan portfolio, we will start to generate capital organically and will not have to continue to sell loans in a major fashion in order to buy back stock, pay a dividend to shareholders. I diverged a little bit from the main point of Moshe's question.
We believe that our loan buyers very much understand the long-term performance of our portfolios and are very in tune with the cash flows that our portfolio generates. We believe that they understand that we will meet the objectives or the assumptions that we had on this portfolio at underwriting. In addition to credit, there have been some positives in the marketplace regarding loan sales. We have seen ABS spreads come in in a pretty meaningful way since our last transaction, and we have also seen prepayments slow, which extends the life of the loans and creates additional cash flows, which increases the value of our loan portfolio as well.
Great. What you discussed on the fourth quarter earnings call, still on track for that loan sale, and the basic metrics are kind of at least as good as what we've seen before.
Yeah. We have no reason to believe otherwise. I would like to make one other point about the slides that we provided last night. They do report out on our ABS trust performance, which I know investors are watching very closely after our credit underperformance in the fourth quarter. The good news here is, we called this out, our trusts are starting to experience a decline in defaults. Defaults in 19 out of 25 of the trusts outstanding declined. If you calculate a default rate on the entire securitized portfolio of loans, the default rate dropped nearly 100 basis points. In addition to that, we mentioned in our earnings call that we were seeing improvement in collections, we didn't really elaborate on that point.
What we are seeing is, in January, again, our roll to default rate was the best in a year, and our roll into delinquency was the best in nine months. It's important to call that out because we have also commented on, operational collection issues that we have had over the course of 2022. I will be the first to admit that, One month does not make a trend, but in this period of time where we're watching, credit performance very closely, I think it's important to call that out. Of course, we will report out on Februaries and Marches as the year evolves.
Maybe just on that, you know, How do we think about the timeframe for how long, you know, how long does it take to make a trend? I mean, obviously, some of these trends we'd see in three months, some in six months. You know, you'll have a much better insight because of the you know, kind of those changes in the collections practices that you're talking about, stuff that we won't be able to see from the outside. Maybe amplifying that a little bit.
Sure. I do think we're definitely in the show-me state, and we're gonna have to put up positive performance over the next, I think, probably two quarters, to get investors comfortable about how our portfolio is going to perform over time. We have made a number of very important changes in our collection state. We are no longer understaffed. We have parted ways with the head of collections. We also elevated our Chief Risk Officer into the role of President and Chief Operating Officer. Kerri Palmer came to us from Capital One, where she was involved in the operations on the auto lending side and has experience in collections.
We have brought on board a consultant, and we are making a number of changes in the collection space to increase our performance and get back on track to the strong credit performance that we have seen in the past.
You know, as we look at your EPS guidance or your, the entire, you know, kind of range of guidance, items that you kind of put out there, obviously, you've included a relatively high level of credit loss, and you've built a reserve that contemplates that. Just, can you talk a little bit about what could, you know, what things would have to happen for it to be, you know, worse than that, and what things would happen that would make it, you know, better than that, and how would that evolve during 2023?
Sure. We provided some specificity on the call. Let me repeat that and maybe elaborate on that a little bit. We gave charge-off guidance that was only modestly better for 2023 than what we saw in 2022. We expect just 10% better performance in 2023. Going into 2024, we expect our performance to improve again marginally by another 20%. I think by 2025, we will be on the road to recovery and getting back towards the kind of performance that we have seen in the past. Under CECL, we are required to build a life of loan loss reserve. That reserve, after underperforming over the course of 2022, I think is really built to expect very little improvement going forward. I will call out a couple of factors.
In 2022, we had defaults of $386 million. Included in that was $59 million of gap year loans that charged off, which we don't expect to reoccur. We also charged off $13 million of loans that were not yet at their 120-day past due point, but they had used an abundance of forbearance in the past. We changed that practice. If you eliminate that $72 million, we're already down to a default rate of somewhere around the lines of 2.1%, but we are reserved for a default rate of 2.4%-2.5% in 2023. In order to meet our guidance for 2023, we expect no improvement.
If we do see improvement in credit, we should see stronger earnings as we dial back some of that CECL loan loss allowance.
Okay. We'll move on from the credit side of things. I would say, you know, as we look at the competitive environment in your business, there always seem to be some number of new entrants. You talk about what's out there, you know, certainly, you know, your former other half is currently in its third year of kind of being in the business. Talk a little bit about the competitive environment, you know, for private student lending, and relate it to, you know, your, you know, your origination growth guidance.
Sure. As a reminder, we are talking about a very high return asset class, ROEs in the 20% and better. We are talking about a very attractive borrower base. Companies want to engage with young potential college graduates early on in their career so that they can sell them additional products as they grow their relationships with financial institutions. High quality asset class, very attractive client base, there are a number of new entrants that come and go year after year. I certainly don't wanna name any of them by names, but we all know who they are. You mentioned our better half, their on-campus loan originations, I think haven't really sort of hit a significant growth rate just yet. Rather than talk about others, I'll talk about our own performance.
We grew our market share by 2%, which is pretty impressive, in 2022. We continue to block and tackle in terms of the quality of our brand, how we market, and how we engage with potential borrowers, both on campus through our sales force and through our digital marketing techniques as well.
Yeah, you did make an acquisition, something in the neighborhood of a year ago, right? Just probably just over a year ago for the Nitro-
Yep.
acquisition. Maybe talk for a minute about what that's done for your origination engine.
Sure. In early 2022, we acquired a company that was called Nitro College. They operated a student loan marketplace. They are experts at digital marketing that built a portal that attracted students to learn how to apply and pay for college. Their biggest product was a scholarship offering. We acquired Nitro in early 2022, and we have now integrated them very deeply into our digital marketing operation. What they have brought to us is the ability to sharp shoot not only our paid search expenses, but they have also brought to us the ability to generate first-party names that we can monetize through the student loan acquisition process, and aspirationally, in the future, potentially do more with that first-party data that we have achieved, obtained through the Nitro acquisition.
The one fun stat that we like to talk about is their aspiration is to have the identities of 50% of high school graduates and their parents by the end of 2023. We think that they are well on their way to achieving that goal. More broadly, they've basically helped us refine our cost to acquire by spending more appropriately in the paid search and other digital operations. They've actually helped us learn how to take more advantage of paying for potential serial borrowers. Long story short, if you engage with a potential borrower when they are a freshman or a sophomore, 90% probability that the junior and senior loans are gonna come to you at very, very little cost, and that helps energize ROE on the product as well.
It's been a very successful acquisition to date.
A lot's gone on from a, you know, public policy standpoint in the student lending industry. Substantially all of it focused on the Federal Loan Programs. There's definitely kinda trickle-down effects in the, you know, in the private student loan market. You know, a little bit of an open-ended question, given what's gone on, I mean, obviously, the Supreme Court is going to be ruling sometime in the not-too-distant future on the loan forgiveness program. The Department of Education has also proposed some other kinda repayment modifications that would reduce borrower burdens on the federal side. You know, maybe if you could kinda just give us your thoughts and implications for Sallie Mae and its portfolio.
Sure. Absolutely. Yes, it is a fact that the Federal Student Loan Program has been on a payment holiday since the beginning of the pandemic. That is scheduled to end on June 30th of this year. It is a fact that in our marketing approach, we always encourage borrowers to take free money, such as scholarships and grants first, then avail themselves of the Federal Loan Program, which traditionally has been cost-effective and has many friendly borrower benefit programs, such as forbearance and things I'll talk about in a second. It is a fact that most of our borrowers also have federal student loans along with the private student loans. If you may recall that you can only borrow, I think it's $7,500 as a dependent student from the Federal Loan Program as a senior.
Obviously, the cost of college is far higher than that in the public and the private sector, our borrowers do need to avail themselves of gap funding. We have a long history of servicing students that have both Federal and private student loans. They traditionally have always been able to service both. We believe that once the Federal holiday is over, our borrowers should certainly be able to support both their private and Federal obligations. Now, with that being said, is there gonna be a marginal impact to credit? There certainly will be. Very important to point out that what Moshe was referring to is, on the one hand, Federal holiday is going to end, and loan forgiveness hangs in the balance.
Even if loan forgiveness is not enacted as a policy, the Department of Education is very actively refining their income-driven repayment programs, which are actually very lenient. Today, a federal loan borrower only needs to make a payment that's equal to 10% of their disposable income. The proposal on the table is to reduce that to 5% of their disposable income, and there is a clause in the proposal that says if the student is at 225% of the poverty level, which equates to a salary of $80,000 a year, my 25-year-old daughter makes that much working in the ad industry, their required payment is $0 a year. On the one hand, students might have to start making payments.
On the other hand, the proposals that are making their way through the policy process would really take the edge off of that.
Right.
We remain confident that the termination of the student loan payment holiday will not have a material impact on our borrowers. There is also, by the way, a student can avail themselves of years of forbearance if they want-
Federal loan.
...to stay in the Federal Loan Program.
Sure.
Of course, the cosigner does not figure into any of these programs because the Federal loan is simply between the borrower, the student, and the Federal government.
Got it. Okay. One of the things that surprised me a little bit about this cycle, not specific to Sallie Mae, but including it is, you know, given how, I guess, you know, you've seen strong loan growth in your, in your portfolio and many others across, deposit pricing competition's probably been a little hotter, you know, during 2022 and early 2023, than one might have thought, and certainly, a lot more significant than at branch-based banks. Just talk a little bit about where you see deposit pricing at this point. We've noticed a little bit of slowdown in the rate of increase, you know, relative to increases in market rates and, you know, what the, what that means for your net interest margin.
Sure. We have been positioned for the last couple of years in an asset-sensitive way, so we have been in a position where we would benefit from rising interest rates. We remain positioned that way in a very moderate way. When we publish our 10-K, I think the disclosure is going to say that 100 basis points increase in interest rates will provide a very minor, positive benefit into our net interest income. We have roughly $6 billion of our $28 billion of liabilities are in the form of retail deposits. When we say retail deposits, we mean, internet deposits. We have been very pleased with the performance of our deposit base. As we were talking last night, it continues to be very sticky. We study each co-origination cohort of our retail deposits, and they remain...
have remained on our books through many economic and interest rate cycles. We track our deposit growth back to around about 2010, and the depositors have been very, very steady customers. The beta on our money market retail deposits has been right around 70% for the past year, and that serves as very attractive funding for our variable rate portfolio, which is now about 45% of our overall portfolio. Our retail deposit growth aspirations for 2023 are very, very minor, and I think we've almost pretty much achieved them through the first month of the year. The internet deposit market has been very, very favorable to us.
As we reported, we increased our net interest margin 50 basis points in 2022 from 2021, which I think was very positive in a challenging rising rate environment and the first rising rate environment that we have seen in many, many years. I think that was a big positive. As you recall from our discussion in our earnings conference call, we expect our net interest margin to stay right around that 5.3% level that we achieved in 2022. I think we're positioned very well for 2023 and beyond.
Before we move on, I've got some more questions, but if there are any in the room, we're happy to take them. Just raise a hand, they'll bring you a microphone. I don't see any at this point, so we'll continue. One of the themes, and you alluded to this a little bit when you talked a little bit about the life of the loan getting longer. One of the challenges that you had over the last several years is the loan consolidation, you know, where, certain players have made a business out of, you know, consolidating loans, both grad loans, which you're not a big participant in, as well as, you know, undergrad loans. Just talk a little bit about how that's, how that's been impacted and the, and the various factors.
Sure. To Moshe's point, we were seeing approaching $2 billion a year of our portfolio consolidated away by the loan consolidators. The way it works is they target high balance federal loans. They're not specifically targeting our customers, but if those borrowers have a private loan, ours ends up in the net and going away with them. This consolidation business was targeting very high-end borrowers by offering them extremely low rate loans. The average coupon on a consolidation trust, I think, actually dipped below 3% in 2022 before rates started to rise. Losing our loans to consolidators is a big negative. Obviously, we spend money to acquire those assets, and we hate to see them just walk away.
it has had the impact of speeding up our CPRs and shortening the average life of our assets. With the rise in rates, five-year swap rates are somewhere around 4% today. Before you start to even add a credit spread and an additional spread for profitability, the consolidators have been priced out of the market. What this means for us is we'll see a little bit of an uptick in our portfolio growth. Potentially more important, and I think I mentioned this earlier, it increases the life of loan of the assets, which makes it more attractive to potential loan buyers. Obviously, we don't have to write off the cost to acquire the loans that leave our balance sheet.
Gotcha.
So...
You mentioned before, you know, selling roughly $3 billion a year through that CECL phase-in process. Are there any circumstances that would make you think about selling more if the disparity between, you know, the value of the loans and the stock price, you know, is very wide?
We definitely have a. We have charted out basically the implied value of the stock and the net present value of these portfolios. Should premiums rebound in a meaningful way and the stock price not follow it, we would certainly consider ramping up the loan sale process in order to buy back additional shares if they remain undervalued. We have repurchased 44% of our stock since the beginning of 2020. We have been very active acquirers of our common stock, and we expect to continue to do that through the course of 2023 and beyond. I noted this earlier, but it's probably worth repeating.
Once the phase-in of the CECL hit capital into regulatory, bank ratios, capital ratios, is over, which happens in early 2025, and once we start to grow the portfolio organically, we will be able to generate, capital to return to shareholders without significant loan sales, which would put us in the position of, growing, our organic earnings and the balance sheet along with it, which I think would be a big positive.
Got it. Okay. Maybe just, you talk a little bit about operating expenses. You gave operating expense guidance. You've got some, you know, work cut out in terms of revamping your servicing collections. Talk to us about the OpEx in 2023 and, you know, how you think about that as part of, you know, selling these earnings.
Sure. It's a challenging environment. We have seen the need to increase rank and file salaries. We call it merit pay. We budget for 5% or more to recruit new employees and to retain the good employees that we have on the books. The cost of health benefits, which is a very important retention tool, has also been growing at a significant pace. You know, in 2023, we will originate 6% new loans. We're gonna continue to see volume increasing as well. We continue to manage expenses in a way that we expect to see our cost to service continue to decline and cost to acquire continue to decline.
The increase in expenditures for bolstering our collection efforts is not a major chunk of the growth in 2023 from 2022. I think all in, we indicate that OpEx is going to increase around 9%. When you factor in the inflationary costs and what we're doing to support the business, I think that's a reasonable amount to invest in the company.
Great. Well, please join me in thanking Steve and Sallie Mae for their time today. Thanks. We appreciate it.
Thank you, Moshe.
Very good.