SLM Corp (SLM) 2015 Q2 法說會逐字稿

Good morning. My name is Chris and I will be your conference operator today. At this time, I would like to welcome everyone to the 2015 Q2 Sallie Mae earnings call.

(Operator Instructions)

Brian Cronin, Senior Director of Investor Relations, you may begin your conference.

Thank you, Chris. Good morning and welcome to Sallie Mae's second quarter 2015 earnings call. With me today is Ray Quinlan, our CEO, and Steve McGarry, our CFO. After the prepared remarks, we will open up the call for questions.

Before we begin, keep in mind our discussions will contain predictions, expectations, and forward-looking statements. Actual results in the future may be materially different from those discussed here. This could be due to a variety of factors.

Listeners should refer to the discussion of those factors on the Company's Form 10-Q and other filings with SEC. During this call, we will refer to non-GAAP measures we call our core earnings. A description of core earnings, a full reconciliation to GAAP measures, and our GAAP results can be found in the Form 10-Q for the quarter ended June 30, 2015. This is posted, along with the earnings press release, on investors' page at salliemae.com.

Thank you and I'll now turn the call over to Ray.

Thank you, Brian. Thank you, Chris. Thank you all for your attention this morning.

In reporting on the second quarter and indeed, on the year-to-date results for Sallie Mae, we are in the middle of a very good year for ourselves and I'd like to touch on several topics, as we have done in prior calls. First, of course, is that this is the end of the second quarter of 2015. It is our first overlap quarter. So it's the first time we're having a second, second quarter.

The Company having been launched May 1, 2014 and as you will all recall, during the first 12 months, one of the major tasks for the Management was to separate ourselves from the preexisting Company and we have kept you abreast of those steps in progress. At this particular point, we are virtually done.

The last major system to be utilized by the bank, which will give us independence from Navient, is the ATLAS fulfillment system and as we have this call, the ATLAS fulfillment system is handling over 90% of our volume. We expect full separation to continue as that moves to 100% over the next 40 days or so.

Second point was putting our team in place. It was last year at this time that we completed the last major senior hire in Jeff Dale as Chief Risk Officer. We have all been together now for a year. There have been no changes in senior management and no changes in organization.

You will start to see some of these steps to efficiency in very small ways. Jonathan Boyles and his team have once again filed the 10-Q and the earnings release simultaneously, which allows this call to be better informed.

In regard to our customer, we have and continue to be grateful for a very strong franchise. Our year-to-date disbursements are over 8% higher than last year. The quality of the through the door population, as judged by our credit evaluation, is very strong and continues to improve. Credit trends, as a result, are all favorable in the portfolio.

In regard to servicing those customers, we've taken several steps to improve the quality of our delivery, including onshoring of all previously offshore (inaudible) that is the standard student loan servicing. We've introduced Saturday service. We have improved our metrics and as of June, we now have online servicing in a mobile app.

In addition to that and in keeping with our status within the industry as the industry leader, we've recently released the latest version of How America Pays for College 2015. We see, in that research document, the continuing trends that Americans have a very high value on the value of college at 97% favorable, that families continue to support students as they move along to improve their-selves in college, and that the parent contribution has, in fact, increased, while at the same time, the price of a college education has also gone up.

In regard to our financials, we've had a good quarter and our results are on our financial model. We are on track for our full year goals.

As mentioned before, our credit is performing well. Our charge-off rate at 0.8% is right where we want it to be at this particular point as vintages mature. We have ample funding and it is in place.

Our risk-based capital ratio overall at 16% is extremely healthy and we're able to maintain that ratio, which, of course, is very important for ourselves and regulators, while at the same time posting admirable results in regard to return on assets of $2.82 in the quarter and $2.13 year-to-date and returns on equity that are in excess of 25% in the quarter and 19% year-to-date. Our NIM at 5.49% continues to be in the top tier of the industry.

As a backdrop, while we are selling some assets, as you all know, it's important for us to keep track of the size of our servicing portfolio because it reflects our interaction with our customers. The servicing portfolio has doubled from May of 2013 until today. So in two years, it is up from $5 billion to $10 billion.

In regard to our operating expenses, our efficiency ratio, as we calculated in prior calls, from the fourth quarter of 2014 and that run rate, because, as you recall, due to the conversion, the quarters leading up to the fourth quarter of last year were somewhat highly variable, so we used the fourth quarter as jumping off.

Our efficiency ratio in that quarter annualized at 48%. Our efficiency ratio is 2015 is at 42%. The marginal efficiency ratio, which we have discussed on previous calls, stands at, what I would say is, an industry-leading 21%.

In regard to the regulators, the FDIC, the UDFI, and the CFPB, we continue to experience very good relationships with all of them and we're grateful for that. As we turn to the future, and as Steve will discuss in more detail, we are reinforcing our guidance in regard to originations, OpEx, loan loss reserves, and EPS.

As we look forward to continued enhancements in our service platform, over the course of the fourth quarter, we will bring online applications to a mobile base, which will bring us current so far as technology is concerned, after playing catch up for quite a while. We will have a new desktop that will be utilized by our collectors and our customer service area, both of which will experience quite an upgrade from the current system. Over a period of time, you will see us continue on our financial model, including diversification.

With those remarks, I'd like to turn the microphone over to Steve. Thank you.

Thank you, Ray. Good morning, everyone. I'll be referencing the earnings call presentation, available on our website, during my prepared remarks, beginning with our key financial results on slide 4.

Outstanding private education loans at June 30, 2015 were $9.3 billion, up 24% from the prior year. Our owned and serviced portfolio, which includes loans sold (technical difficulty) retained was $10 billion, up 34% from the year ago quarter.

Net interest income for the quarter was $168 million, which was $3 million or 2% lower than Q1 2015 and $24 million or 16% higher than the prior year quarter. The decline from Q1 is due to lower average assets as a result of the loan sale that we did. The increase from the prior year is the result of a 13% increase in average assets. The average yield on our private education loan portfolio in the second quarter was 7.96% compared to 8.07% in the prior quarter and 8.22% a year ago.

We expect our private student loan yield to stabilize here in the 7.90%s. Our cost of funds was 1.17%, unchanged from the prior quarter and up from 94 basis points in the year-ago quarter. The higher cost of funds in Q2 compared to the year ago quarter is primarily the result of fixed pay interest rate swaps, we entered into to hedge our fixed rate loan portfolio, that were not in the cost of funds calculation in the year ago quarter because they weren't effective hedges.

The fixed rate swap costs are recorded in the other operating income until they receive effective hedge accounting treatment in Q3. The bank's net interest margin on interest earning assets was 5.49% in the second quarter compared to 5.6% in the prior quarter and 5.32% in the prior year quarter. The change from the prior quarter was driven primarily by the lower yield on our private student loan portfolio. The increase from the prior year is due to the increase in private student loans as a percent of the total portfolio.

We expect that our net interest margin will remain above 5% as private student loans increase as a percent of total assets. Non-interest income in the quarter totaled $89 million compared to $11 million in the prior quarter and $8 million in the year-ago quarter. The increase this quarter was principally due to the result of a loan sale premium of $77 million that we earned. The $5 million decline in other income was the result of one-time gains of $6 million in Q2 2014 and this was offset in the current quarter by $1 million of servicing revenue that we earned.

Second quarter operating expenses, excluding restructuring costs, were $90 million compared with $80 million in the prior quarter and $60 million in the year-ago quarter. The main drivers of the increase in the prior quarter were the seasonal increase in our direct to consumer spend and the ramping up of our sales call center for the peak selling season. In regards to the year-ago quarter, you may recall that it consisted of one month as pre-split carved out financials and two months of actual stand-alone operations.

In addition, Q2 2014 expenses (technical difficulty) by the reversal of an $8 million litigation reserve. So the increase from the prior year is due to the build-out of our own servicing platform, our corporate infrastructure, and the significant increase in loan volume. Restructuring costs in the quarter were $1 million compared to $5 million in the prior quarter and $14 million in the year-ago quarter. We still do expect to spend $1 million in restructuring costs in the second half of the year.

The origination platform, as Ray mentioned, was last major system to be converted post-spend. We implemented the final phase of the new loan origination platform in June and are currently processing nearly all of our new loan originations through this platform.

In the second quarter, the tax rate was 40% compared to 42% a year ago. The tax rate in the year-ago quarter was higher because we were establishing a reserve for uncertain tax positions. We expect full year tax rate to remain around [40%].

The bank remains well-capitalized, as Ray mentioned, with a risk-based capital ratio of 16% at the end of the quarter, significantly exceeding the 10% risk-based capital ratio required to be considered well-capitalized. In addition to this, the parent Company has excess capital available to the bank as an additional source of strength. We will continue to maintain high levels of capital to support the projected growth of (technical difficulty) and we don't anticipate returning capital to shareholders as we reinvest in our high growth business.

Turning to slide 5, you will see a summary of our origination loans. We originated $384 million in loans in the quarter, up 2% from the prior year, and loan originations are up 8% year-to-date. The loans we originated in the quarter have average FICO score of 747 and 90% of the loans had a co-signer, very consistent with our typical originations.

Keep in mind that the second quarter was an off peak period for originations. We are currently in our peak season for applications and disbursements, as students prepare for the fall semester.

However, it's too early to get a read on how we're doing in the peak season and we'll update you on that in our third quarter earnings. We're maintaining our guidance of $4.3 billion of originations for the full year, which is a [5%] growth rate.

Turning to page 6, we report on our performance statistics. We've been talking over the last few quarters about a [portfolio] of loans that entered full principal and interest repayment in the fourth quarter of 2014 of just under $1 billion. As discussed, this has resulted in increased delinquencies in the first quarter, followed by defaults in the second quarter.

This seasonality is evidenced in the graphs on slide 7 of monthly delinquencies and charge offs as a percentage of loans and principal and interest repayment. As you can see, delinquencies peaked in January through March in the various delinquency stage buckets and defaults peaked in May. This repay cohort is performing well within our expectations.

Turning to the full repayment portfolio, loans delinquent 30-plus days were 1.7%, unchanged from Q1 and up from 0.7% in the year-ago quarter. Loans in forbearance have increased to 5.7% from 2.8% in Q1 and 0.9% in the year-ago quarter.

As mentioned in the press release [in June], this is the result of a letter published by the FDIC which encouraged lenders to work constructively with borrowers impacted by the floods in Texas this spring. Accordingly, we granted a two month disaster forbearance to residents of the affected area. This doubled our forbearance rate. But it's important to point out that substantially all the borrowers were current when the forbearance was granted and half of these borrowers continued to make payments, although none were required.

Without the disaster, forbearance rate in the second quarter would have been unchanged at 2.8%. Looking at performance for July, we can report that forbearance is already declined to 3.6% with no impact on our delinquency rates as this two month disaster forbearance expires.

Net charge-offs in the quarter were 0.8%. Charge-offs increased from Q1 to Q2 due to the seasonality of repayments that we just discussed. We are very pleased with the performance of our portfolio and the continued strong results of our default aversion efforts under our 120-day collection policy.

We ended the quarter with 30% of our total loans in full P&I, up from, I think it was, 28% in the prior quarter. As a result of our strong credit performance, our provision for the private education loans is $15 million in the quarter. We ended the quarter with an allowance for loan losses of 94 basis points of total loans and 1.54% of loans in repayment. We're not changing our provision guidance, as portfolio growth and aging, as well as growth in our TDR portfolio warrants increased provisioning in the second half of the year.

On page 8, we report our earnings metrics. SLM core (technical difficulty) call core earnings. The only difference between core earnings and GAAP net income is that core earnings excludes the mark-to-market on unrealized gains and losses on ineffective derivatives from earnings.

We use derivatives, as you know, predominantly interest rate swaps, to manage interest rates (technical difficulty) portfolio. We believe all these hedges are sound economic hedges, whether they are effective or not from an accounting standpoint.

Core earnings for the quarter were $91 million, $0.20 diluted earnings per share compared with $48 million or $0.10 diluted earnings per share in the year-ago quarter. Core ROA for the quarter was 2.8% compared to 1.5% in Q1 and 1.7% in the year-ago quarter and core return on common equity was 25.2% compared to 13.2% in Q1 and 15.5% in the year-ago quarter. Much of the favorability in the quarter was due to the loan sales that we booked and as Ray mentioned, year-to-date ROA and ROE was very strong at 2.13% and 19.4%.

As many of you know, we were in the market this week to raise term funding in the ABS market. This wasn't a proficuous time to enter the market as spreads in general and for student loan debt in particular have widened substantially. FFELP spreads have widened significantly due to an issue that many of you are aware of regarding legal final dates on FFELP trusts and this had a spill over impact on private credit spreads. But the fact that we're able to issue without significantly widening our spreads, we think, demonstrates the high quality of our private credit collateral.

We're very pleased with the results of the transaction, which will be officially priced this morning after our call and we expect that those prices will be consistent with our long-term funding plan. I know many of you are interested in when we will do our next private credit loan sale. We have that on the calendar for September and we look forward to reporting results of that transaction to you.

As we've mentioned, our guidance for 2015 remains unchanged. We still expect to originate $4.3 billion of our high quality, smart option loans. We expect our provision to be $95 million and our gain on sales is expected to total approximately $155 million for the full year. Operating expenses should come in at $347 million and finally, our EPS range remains $0.57 to $0.59 for the full year.

Thank you very much. We will now open up the call for questions.

(Operator Instructions)

The next question comes from the like of Michael Tarkan of Compass Point.

Thank you. Just on the operating expenses, with that pick up ahead of peak lending season this quarter, should we expect that to trend down in the back half of the year? And is that second half run rate of around $85 million a quarter, is that a good way to think about a run rate to grow off of as we think about 2016? Thanks.

Mike, I think what you'll probably see is a slight increase as we continue our peak season spend on traditional marketing and servicing in Q3 and then a drop off substantially into Q4.

And then is that second half run rate, is that a fair sort of assumption to start thinking about 2016?

Yes. I think if you factor seasonality into it, that should definitely work for 2016 OpEx.

Okay. On the student loan yields this quarter, you mentioned we should stabilize in the 7.9%s. Can you just talk about what drove yields down this quarter? Is that a mix issue? Are you seeing pricing come down a little bit in the industry? Any color there.

So we actually implemented, we tweaked our pricing over a year ago for the last peak season. We tweaked our pricing in the pricing bands and we also introduced a graduate pricing tier to compete more effectively with the [bus] loan and this has slowly bled into the portfolio. But we fully expect it to stabilize, as I mentioned in my prepared remarks, in the [790s] on a go forward basis. That, of course, will depend upon the mix of fixed and variable.

Our variable rate loans we expect to come in rough numbers around LIBOR plus 7.5% and our fixed rate portfolio typically yields in the 9%s, low 9%s. So depending upon the mix, the mix of fixed rate origination does seem to stabilize in the low 20s, but we'll see what the peak season brings.

Thanks and just a follow up on that. Competitively, are you seeing just a rational sort of environment at this point? Have you seen any kind of changes from your two largest competitors?

No, we haven't seen any pricing changes, Michael. They continue to be fairly stable and as you know from our market share gains, our pricing strategy has continued to work.

Thank you very much.

Your next question comes from the line of Sameer Gokhale of Janney Montgomery Scott.

Thank you. Good morning.

A big part of the story here for Sallie Mae, there are several moving parts, but the idea is you can scale the business up. You've taken origination in-house, servicing in-house, and generating pretty healthy gains on sales.

You talked a little bit about operating expenses in the second half of this year and the trajectory, but this year included separation costs, I think, from the legacy Sallie Mae, bringing some of these functions in-house. So as you think incrementally into 2016, are there any additional areas of investment where you think that you will need to allocate more resources there? Or should we think of it as now all the expenses are in the numbers and everything else is only going to be very marginal as we look ahead into 2016?

So Sameer, as you know, as we've discussed, we've made several investments to improve our customer service and build our franchise. We've invested in onshoring our sales call center. We've invested in mobile apps. I mentioned that we did some additional brand spend to support the brand now that we're a separate Company and we have a lot less hits on our website. So we have made some significant investments.

As we look forward, I think that most of the investments in infrastructure and the servicing platform are, for the most part, done. So I think we can begin to realize the efficiencies that you would expect from a stabilized and established servicing platform on a go-forward basis.

Okay. Then I know call or two ago we had touched on this, but, again, I wanted to just get your perspective on forward flow arrangements. You're generating pretty healthy gains on sale with your loan portfolios. It seems like, in the current environment, given you have those gain on sale margins, have you had discussions with any of your buyers about maybe locking in certain pricing for next year's expected loan production and would you consider doing something like that?

So we have been approached by several of our residual buyers who would like to lock up [a share of it] or lock up a forward flow agreement, but you know how financial markets work. The very first thing that is mentioned to develop a forward price is a discount from the spot price. So we could enter into arrangements of that nature, but look, we're very confident in the collateral, the private credit loans that we are selling here.

You know this past couple weeks has been a perfect example of the kinds of volatilities that you can face in the marketplace, so there is a trade off between price and certainty of sale. But we think that the markets will be stable enough and that this is an attractive enough asset that we would prefer not to enter into forward sale arrangements at this point in time.

Thank you. My last question was around or tied to the loss provisioning. Later this year, I think we're expected to get new accounting rules, which would require life of loan loss provisioning. Maybe it's a little bit early, because as I understand it, the rules won't become effective until 2019, so that's a ways out. As you think about those rules and possible implementation and impact on capital ratios, have you, at this point, had a chance to contemplate that impact? I'd love to get your perspective on that.

One is, we have reviewed that and we reviewed it both in-house, as well as with the KPMG guys who are giving us lots of forewarning on it. Two is, I agree with you that the 2019 is just about 15 minutes beyond our current planning horizon and so when it gets implemented, we'll have lots more information. Many things are preliminary. We are, as you know, extremely well-capitalized as an institution, certainly better than the industry.

Since this would be a industry-wide directive when it occurs, we think that, from a competitive position, in regard to capital, that we'll be well-situated. Having said that, it's 2015. 2019 is a long way off and there's lots of uncertainty between now and implementation on that particular point.

All right. Thank you.

Your next question comes from the line of Mark DeVries from Barclays.

Thank you. Steve, I believe you alluded to some widening that you've seen in private credit spreads in the last few weeks, but you're still maintaining 10.5% on margin guidance. Does that assume that margins or spreads are going to have to tighten from here or are they still at levels that would support that level of gain on sale?

I think that they're at levels that would still support that type of a gain on sale. I mean, it certainly would help if they tightened and we do think that they probably will tighten. The other thing that I would point out is that in this particular sale, the bonds that were the most well bid were the higher yielding, lower rated bonds.

So in talking with some of the guys that invest in our paper and residuals, it seems that the equity tranches remain particularly well bid. But we'll have to monitor the volatility in the marketplace as we move forward to the sale in September.

Got it. That's helpful. Next question, is it fair to assume that the NPV of selling at a 10.5% gain on sale and then retaining servicing is actually higher for you right now than retaining loans? And if that's the case, are you thinking about maybe selling even more loans than you currently have been planning to?

There are several ways to look at it. We do several different types of analysis on this. A 10.5% premium, where you're basically essentially reaping up front four years or five years of guaranteed ROA is very attractive. You can go at breakeven analysis a number of different ways and come to different conclusions based on the assumptions that you use on discount rates and capital and so on and so forth.

But it's also true that if you hold the loans on the portfolio, it doesn't take too long to build up significant additional earnings per share in future quarters and years. So we are still tending -- we're still using the loan sales to manage our 20% growth rate cap and our proclivity is to hold onto more loans than sell them at this point in time.

Is there a level of gain on sale in which it just gets to the point where pricing is so stupid that you would sell more and retain less?

We're pretty close to that. A percentage point or two would definitely compel us to sell additional assets into the marketplace.

Okay. Fair enough. Thanks, Steve.

Your next question comes from the line of Moshe Orenbuch of Credit Suisse.

Thanks. Just following up on that question, is that 20% calendar year calendar or can it be some sort of rolling 20%?

FDIC thinks of this in a fairly rigid way as calendar year.

Okay, got it. You mention market share gains. Maybe talk a little bit about what you're seeing, if you're seeing anything different from your competitors or things that they're not doing that are allowing you to continue those market share gains.

As said earlier, the competitive frame [with Wells and Discover] and ourselves being dominant three players in the current student lending business has been fairly consistent. They are worthwhile competitors. They have obviously changed their tactics over time. We monitor them very closely. We are in the midst of a season that has quite a bit of advertising going on, direct response both in mail, as well as internet.

It's hard to know what the opposition is doing, but I would have to say that we don't see anything that is categorically different. We see more of some items, less of others, but the basic competition is taking place on familiar battle grounds.

Last question for me is on credit quality. You've shown some slides in your regular handout that look at the vintage performance of the loans that have entered repayment 2011, 2012, and 2013 and they seem to be seasoning well below your target ranges and getting better. Could you just talk through that and how you think about that relative to the high 7%s cume loss that you've got in there?

So there's a couple things to point out about those charts. As you noted, with each cohort, the starting point for charge-offs is lower. That's because in the older charge offs -- I'm sorry, the older cohorts, the loan mix is slightly different. For example, in the 2011 loan cohort, that was when we first started originating smart option loans.

So there is a higher percentage in those cohorts of drop-outs which are, of course, our worst performing type of borrower. As you notice, the starting point lowers with each successive year. That being said, I think it is reasonable to say that the cohorts are running somewhat under our 7 point expected cumulative life of loan charge-offs.

If you look at the current cohort in Q2, the annualized charge-off rate for loans in principal and interest repayment was 1.99% and that compares to 2%-plus in the life of loan charts that we put out several quarters ago. So while it is fair to say that the portfolio does appear to be performing better than our expectations, we are certainly not going to get complacent and we're going to continue to maintain a pretty conservative approach to reserving for and managing this portfolio.

Got it. Thanks, Steve.

You're welcome.

(Operator Instructions)

Your next question comes from Eric Beardsley of Goldman Sachs.

Hi. Thank you. I was wondering if you could give us a projection of the dollar amounts of loans entering full P&I repayment over the next couple of years?

I can tell you that the next big repay wave, which was a November to December repay wave, is $1.55 billion. I don't have the next cohort handy, but I can tell you that the percentage of loans in P&I of our total portfolio pan out like this: Q3 2015, 31%, Q4 2015 33%, Q1 2016 33%, and then it jumps to like 39% in the second quarter of 2016. Is that enough info for you?

Yes. That's helpful. Thanks, Steve. Then secondly, on the FDIC cap on growth, I know it's early since you're only a year post spin off now, but are you having any discussions with them of lifting that cap?

As you pointed out, we're one year into it. That's early days. We do have our DFAST stress test coming up in -- well we have to post results in July of 2016 and I would suggest that any conversations that we have with our regulators related to growth or capital levels would certainly take place subsequent to filing those results and passing them with flying colors.

Great. Thanks. That's all for me.

Thank you.

Your next question comes from the line of David Hochstim of Buckingham Research.

Thanks. Steve, could you just talk about cadence of provisioning in the second half? Should we think about the second half as a good starting point for 2016 or is something odd going on?

The cadence, our expectations what's going to happen in Q3 and Q4 in terms of size and seasonality would not be much different to what happened in 2014. But I think it's a little early to start talking about 2016's loan loss provision. It's obviously going to grow as the portfolio grows and ages. I'm sorry that I can't give you anymore detail than that, really, at this point in time.

Okay. But Q3 and Q4 should be similar in size?

The size of the provision, but grossing up for the full $95 million.

Right, okay. Could you just clarify what you said about servicing income? Did you say $1 million?

Yes, we had $1 million of servicing income in the quarter. I think that trust settled on April 30 of this year so it was just two months of servicing revenue.

So, it would just would be a part of the quarter. Okay. Then is there any update on the effectiveness of those new sales people that you hired? Is it too early? Are they producing for peak season now already?

They're certainly out there in the field working with their school clients, but that is a strategy that we would think would take a little bit more than one season to pan out. They've got develop their relationships with the schools and prove their value before they start to generate any outsize gains and loan originations.

We're happy with the addition so far.

Okay. Then just turning back to the theoretical discussion about holding loans versus selling them. If you had some kind of absurd premium available, is there a limit to how much you'd be willing to sell?

That is purely a theoretical conversation. You also have to remember that you need the demand for loan sales. So every $750 million in loan sales becomes a little bit more difficult because the investor appetite is not infinite. So that's a tough question to answer, really.

Okay. All right. Thanks a lot.

There are no further questions at this time. I return the call to Brian Cronin for final comments.

Thank you for your time and your questions today. A replay of this call and the presentation will be available through August 6 on our Investor Relations website at salliemae.com/investors. If you have any further questions, feel free to contact me directly. This concludes today's call.

This concludes today's conference call. You may now disconnect.