SLM Corp (SLM) 2016 Q1 法說會逐字稿

Good morning, my name is Erica and I will be your conference operator today. At this time I would like to welcome everyone to the Sallie Mae first quarter 2016 earnings conference call.

(Operator Instructions)

Thank you. At this time I would like to turn the conference over to our host, Brian Cronin, Senior Director of Investor Relations. Mr. Cronin, you may begin your conference.

Thank you, Erica. Good morning and welcome to Sallie Mae's first-quarter 2016 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 discussion will contain predictions, expectations and forward-looking statements. Actual results in the future may be materially different than those discussed here. This could be due to a variety of factors. Listeners should refer to the discussion of those factors in the Company's Form 10-Q and other filings with the SEC.

During this conference call, we will refer to non-GAAP measure 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 March 31, 2016. This is posted along with the earnings press release on the Investors page at salliemae.com. Thank you. I will now turn the call over to Ray.

Thank you, Brian, and welcome to the call, everyone else. I will cover certain highlights of our financial and other parameters and then turn the call over to Steve.

So in summary, the first quarter was a very good quarter. We are essentially on track to a little bit better, and as we go down the major parameters I think that will be obvious. Starting with new loans. New loans are up 8% year-on-year. As you know, that's a little bit faster than both our goal for the year as well as market growth, so we find that to be a good indicator, early days in the year so far.

This is reflected in our major earning asset on our balance sheet, which is the private student loan balances which are up year-to-year from roughly $9.8 billion to $12.1 billion, a 24% increase. It is also the case that between when the bank was originally launched at 12/31/13, right before the spin, until the end of this year, 97% of the increase in our balance sheet will be directly attributable to the private student loan receivables. The balance sheet will become more productive as we move along.

Through-the-door credit quality is gratifyingly consistent and high quality. And so the average FICA for new loans granted in the quarter was 748, approximately equal to the 749 of the prior-year. The co-signs rate is actually 100% flat at 90%. And so through-the-door credit quality is consistent with both our models as well as with our prior performance.

NIM, a reflection of course of the pricing associated with that as well as our efficiency in cost of funds, was 577 for the quarter, a little bit over where we anticipated. But it is the nature of the business that the NIM tends to be a little elevated in the first half of the year until a little bit in the second half. Last year, however, with the same seasonality was 560. So the NIM has gone up from 560 to 577, and we think that is very good.

As you know in prior calls we have talked about, gee well, will the NIM drop off significantly over time due to the competitive pressures or something else, and we had said there would be a number of at least 550 through the end of 2016. Obviously we are north of that. Our portfolio yield is flat, 807 last year, 803 this year. Through-the-door is very consistent with that, and so the NIM is a number on which we can rely.

Our OpEx, which we've given guidance on in relationship to its -- relationship to revenue was -- the efficiency ratio is 42.2% this quarter, down from 44.4% last year. As you know our guidance is to improve from the 2015 number of 47% down 8% to 10%. We are on track to go do that.

Credit performance also very consistent. Our loan loss reserves have been roughly flat from 103 at the end of the year, 2015, to 101 at the end of the first quarter. As a percent of loans in repayment, the number is also flat, moving from 157 to 156.

Earnings per share in the quarter were affected by a one time accounting estimate change associated with Upromise of $9.9 million. That is a revaluation of liability, a distributive balance sheet item, it's a one-time deal. So we are just putting that on the side here. If we were to take that out and look at the EPS for the quarter, it is $0.13. Last year at this time the EPS was $0.10. The increase in EPS year-on-year normalized is approximately 30%.

As you know our outlook numbers have not changed and we feel very confident in regard to that, just put the 30% in the context of those the $0.49 to $0.51 guidance on EPS, in the median, mean there, that would be $0.50, and last year if we removed the asset sales from the EPS actual, the number was $0.39.

So the $0.50 is looked at in relationship to the $0.39, the increase in EPS underlying organic growth in the franchise is 28.2%. And so the 30% is quite consistent. ROEs remain gratifyingly high and at a good level. After removing the Upromise estimate change, we are at 14.3% in the quarter, up from 13.2% last year and our outlook on that remains consistent.

And so in addition to all of these items, we also on Monday the 18th launched a new product, the Parent Loan, it is in soft launch now, and we have so far seen that it is a successful soft launch, the software seems to be working and we will be ready for the busy season with the additional armament of the Parent Loan.

Our funding remains robust in an industry where funding has been a challenge for the last six months or so. We remain consistent with the January call that we had at investors. We will be able to originate, fund and hold all of our assets for the foreseeable future. And our funding is more than adequate to cover any growth we anticipate which as you saw is significant.

It's also the case we will have our DFAST review with the FDIC for the first time with our filing to them due on 7/31 of this year. We are in very good shape in regards to that. And so that will be a major milestone for us as well. With that point, I'm going to turn the floor over to Steve and look forward to your questions.

Thank you, Ray. Good morning everybody. Ray certainly covered the highlights of the quarter. I'm going to drill down and just give you a little bit more detail on a couple of the numbers before we open the call up for Q&A.

Turning to our cost of funds, Ray covered the return on assets in the NIM. Our cost of funds was 126 basis points, up eight basis points from the prior-year quarter and up nine basis points from a year ago quarter. The increase was primarily due to the increase in LIBOR that happened back in December. $7.8 billion of our funds is directly indexed to LIBOR, and another $2.5 billion are money market deposits that are correlated to LIBOR, but then repriced with the December rate increase.

Finally $2.8 billion of our funding is fixed rate, and this funding breakdown actually excludes our equity component. Fixed rate funding in our portfolio along with lags and resets to the index dampened the rate impact on our spread. Our funding strategy is to remain neutral to interest rate movements and maintain a steady manage with margin to the greatest extent possible. In fact in our Q we typically publish our earnings at risk and economic value equity table where we show the impact of a 100 and 300 basis point interest rate shock.

And as you can see from that we are typically pretty neutral. One of the key assumptions in that model is that our money market deposits will reprice with increases in interest rates at an 85% correlation. And of course this time around they did not, so we benefited from that in this current quarter.

Net interest income totaled $21 million in the quarter compared with $72 million in the prior quarter and $11 million in the year ago quarter. The decrease was primarily driven by the $58 million of loan sale gains in the quarter. As a reminder loan sales are no longer a component of our business plan. And also as Ray commented, in the quarter there was a one time $10 million gain resulting from a change in the reserve estimate related to our Upromise business.

Take a little bit of a closer look at OpEx, first quarter operating expenses were $93 million compared with $85 million the prior quarter and $86 million including $5 million in restructuring in the year ago quarter. The expenses in the first quarter are typically higher than the fourth due predominantly to staff-related expenses associated with the beginning of the calendar year, such as the resumption of payroll taxes and various benefit accruals. This accounts for most of the increase sequentially in expenses.

The change from the prior year is driven by a 31% increase in customer accounts and a 40% increase in accounts in repayment, as well as investments that we have made to improve the customer experience, which we've talked about in all of our recent quarterly results. And these are things such as onshoring our call center and investing in mobile capabilities.

Ray talked about our efficiency ratio and this I think just demonstrates the kind of operating leverage that we have in our model to handle those kinds of volume increases without any significant changes in OpEx. In the first quarter the tax rate was 37% compared with 40% a year ago. We received a couple of questions about this. Our expectations is that the tax rate will approach 39% over the remainder of the year.

The bank remains very well capitalized with a risk-based capital ratio of -- total risk-based ratio of 14.4% at the end of the quarter, significantly exceeding the 10% obviously required to be considered well-capitalized. As we've mentioned in the past we expect our total risk-based capital ratio, which is the main ratio that we focus on, to approach 13.5% as our portfolio grows over the course of the year. This excludes a significant amount of excess capital available for the bank that we have off at the holding company.

Moving along to credit performance loans delinquent 30-plus days were 2.1% compared to 2.2% in Q4 and 1.7% in the year ago quarter. We focus on the sequential quarter because a year ago the portfolio was really just beginning to season. Loans in forbearance were 3% compared with 3.4% in Q4 and 2.8% in the year ago quarter.

We think that the sequential decline in delinquency is in Forbes, is a positive for the portfolio considering that we have $1.5 billion of loans that just entered repayment in November and December and are currently meandering their way through the various delinquency process. We think our portfolio is performing very well here. And that is also displayed in our net charge-off rate. The net charge-off for loans and repayment were 0.95% in Q1 down from 1.08% in quarter four.

Gross charge-offs for loans in full P&I repayment came in at 2.1% in Q1. That is also down from a 2.4% in the fourth quarter. We now have $3.9 billion of loans in full P&I. That's up from 50% a year ago. We ended the quarter with 32% of our loans in full principal and interest repayment, and we expect another $2.9 billion to enter full P&I over the course of 2016.

Provision for private education loan losses was $34 million in the quarter compared with $16 million in the year ago quarter, and Ray mentioned already that we ended the quarter with an allowance for loan losses of 1.01% of total loans and 1.56% of loans and repayment. Our allowance coverage ratio is a solid 1.7%. Again our portfolio is performing very well within our expectations. We would expect the allowance for loan losses to lower slightly over the course of the year as we cover expected losses on those new loans that enter full P&I in 2016.

So that I think pretty much covers the quarter. So we would like now to open it up for questions.

(Operator Instructions)

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

Great, thanks. I liked the fact that you compared the earnings pulling out the gains on sale. But interestingly enough since you actually don't have the loans that were sold in the last nine months of 2015 in your numbers, it actually subtracts from your growth. I'm trying to think about how we should think about the development over the next year or two in the various metrics, and maybe you could talk a little bit about in terms of loan growth and efficiency, because all of the costs of originating those loans and servicing them have been in your numbers and should be in the face and in the expectations, but you're layering on the revenue. If you could kind of talk about that I would like to discuss that.

Sure. Thanks for the question, and it is the case of course that we settle loans, they don't appear on the balance sheet, so the basis that we would be comparing to in 2014 and 2015 have to be adjusted for that if we're looking at a loans serviced, let's say, as opposed to loans owned.

And so it is the case though that we are where we are in relationship to the balance sheet, and as we have talked about on prior calls the loans that we were putting on have an actuarial life of about seven years and knowing the base we are starting from, which is this quarter's ending balance sheet, and knowing that our acquisitions of new loans are targeted to $4.6 billion, I think that the numbers associated with the PSL receivable are pretty straightforward.

In addition to that, as you know we do have both fixed and variable costs and so while the acquisition cost is [the sum] cost, it is the case that the operating costs associated with the loan are relatively low early days because they are not in repayment while the student is in college, and then after graduation and a six-month grace period, then traditional servicing -- especially associated with collections and payment management -- come to pass.

So it will not be the case that all the [costs respond] -- but I think if we were to use the current balance sheet as a basis for growth, if we were to use the guidelines for new volumes or if we take the actuarial fees into account, looking at the yield of the receivable and looking at our efficiency ratio which we have already targeted, I think you would pretty much have that [P&L boxed].

Okay, and just the comments that you made about successful soft launch of the parent loan. Any thoughts? Is it still on track for the $100 million in originations for this year that you had said before, and any thoughts about what that could contribute over time?

Well, one is we did launch on time, which is gratifying, and that was last Monday. We are in soft launch and trying to ensure that all of our thoughts and preparations for going to a larger audience are ready, and so that is coming along as expected. It is a product that has been received warmly by our professionals in the financial aid offices at schools.

We think that our estimate is a fair one. We of course would like to exceeded it. The quality of these credits will be almost identical to the credits in the base product, and so we are optimistic but we think that the estimate that we have is a prudent one for a first-time launch and obviously we have no history with this.

Right, great, and there were some comments in the Q about sales force expansion and targeting more schools. Could you just maybe discuss that? Thanks.

Yes, as mentioned we did expand our sales force last year and this is a relationship business and part of the strength of our franchise is that we have relationships with schools, with particular individuals in our Company that sometimes go longer than a decade. So it is not a rapidly moving business from that standpoint, which if you are the market leader is a position that is fortunate. The sales force expansion has been successful from our [light].

One indicator we look at are the number of -- if you were to look at all the schools in the country, and then say, gee how many of those have a preferred lender list and what percent of those preferred lender lists have us on it. The answer is over 97%, and we have been able to increase our presence in regard to that preferred lender list directly attributable to the expansion in our sales force.

Thanks so much.

Your next question comes from the line of Sanjay Sakhrani of KBW.

Thank you, good morning. First question was just secondary market conditions. I was just wondering if anything has changed quarter over quarter and whether or not you'd consider selling loans in the future given that you have the ability to keep them on the balance sheet now?

Sure, Sanjay. Conditions in the secondary market are, in the regular asset-backed markets, so for the senior bonds, it seems to be recovering pretty nicely in the last couple weeks. There have been transactions getting done across the quarter, but spreads now do seem to be tightening.

The residual end of that market or the more esoteric component of the security is I think recovering at a much lower space. If we wanted to sell loans today, which we certainly do not, I think we know the model is to originate, fund and hold. Our best guesstimate is we could probably garner a premium somewhere in the vicinity of 5%. But our interest is to hold these assets for the long haul.

We think shareholders are better served as we grow our asset base. We have talked in the past about our breakeven point being in the vicinity of 8%. I think it would take a substantial increase above that level to compel us to want to shed some of our assets.

And then when we think about regulatory capital, you guys feel pretty comfortable where you're operating with that growth going forward? And then what should we think as a baseline for capital assuming the growth you guys are anticipating?

A couple of things. When we look at our portfolio under extreme stress conditions -- so that's like a 99.9% confidence level -- and then loading up capital to cover potential operating issues. We think the smart option in student loan should require maximum of 10% in a severely stressed environment.

As Ray mentioned at the top of the call, we have just internally completed our DFAST exercise and now have to walk the Board through it, and then we will ultimately submit it in July of this year. I think that will give us an opportunity to have further dialogue with our regulators about the appropriate level of capital for the smart option student loan. With that being said we are currently at a level of 13%.

I honestly though wouldn't suspect that we're going to be moving from that level in the near-term. I think that everybody is going to want to see a little bit more of experience with how the credit actually performs before we take the next step in the downward direction.

Final question, just on competition. Obviously we've heard a lot about these peer-to-peer guys but even the government programs, are you seeing anything noticeable in terms of the change in the competitive environment or is it pretty steady?

Fortunately the competitive environment in the traditional four-year not-for-profit originations is very consistent. It is the case that we still have major competitors that are daunting, Wells Fargo and Discover. It is the case that we track them school-by-school very carefully and of course I am sure they do us.

It is the case also that we hear quite a bit about the peer-to-peers or Fintex. We look for them constantly. We don't see them in the origination of new loans. They have primarily been in the personal loan space and in the consolidation loan space. As we've looked at that versus our liquidations and a receivable, we don't see any changes there at all. And I am sure you have read the same stories I have that many of them have scaled back actually on their originations, giving the credit market conditions that Steve alluded to. So the frame for a competitive environment is consistent.

Okay. Thank you.

Your next question comes from the line of Michael Tarkan of Compass Point.

Thanks for taking my questions. Just on the guidance real quick, I guess I was a little surprised you didn't increase it after the quarter given that the -- any specific reason for the conservatism?

So Mike, we have now completed the first three months of a 12 month year. The quarter was very, very strong, but we do have a three-point range in our EPS guidance, $0.49 to $0.51. I can be constructive and say that the beat certainly moves us towards the higher end of that range, but I think it is a little premature to alter our guidance.

We are very positive on our outlook for the year and we don't see any hidden trapdoors or pitfalls. But we think the prudent thing to do is to remain our guidance -- maintain our guidance for at least another quarter as we watch our performance here.

That make sense. In terms of the NIM, I know it bounces around, but you had talked about 550, obviously we're higher than that this quarter. Are you still thinking about that 550 level, and then how sticky do you view your cost of funds at this point?

So actually what we anticipate happening is for the NIM to remain pretty steady through the second quarter and in the third quarter as we start to build cash to position for our peak season and Jan 17 disbursements, we would expect a little bit of a drag on the NIM as we hold higher cash balances earning a negative carry. But to answer your question for the average for the year we expect to certainly be 560 or slightly above that.

And to the point that Steve was making, if you look at our cash balances from the fourth quarter to first quarter they dropped off over $1.5 billion.

Make sense. And then I have one more random one. On the servicing side, I know you have the non-compete with [Navi] regarding direct loan servicing and collections into 2019. Are you technically able to bid on this new single servicer RFP that went out a couple weeks ago given that it's kind of a new contract?

Mike, to be totally honest with you we don't really focus on the loan servicing opportunities that exist out there. It's not really the business that we are in. It's not something that we've looked at. It is not something that we've considered. My guess is that under the non-compete at this point in time we would not be able to participate in that if we wanted to.

But to Steve's point, it is our concentration to originate and service in good form our customers, and we are in a consumer franchise business. And as you know with the receivables growing 24% maintaining quality there is in any sort of growth scenario, is always a challenge and that will be our focus.

Thank you.

(Operator Instructions)

Next question comes from the line of Arren Cyganovich with D.A. Davidson.

Thanks. The origination growth is a little bit higher than your full-year estimate and a little higher than we were expecting. Do you feel that's more of a market share gain or is actually an expanding marketplace of originations that you're seeing for the year?

There's at least three parts that we could talk about in regard to that. The main piece that we should have in our thinking here is that a large part of the first quarter disbursements are actually related to the prior year's contract and sign-offs, and so a typical scenario would be, you know, student gets accepted by school, they go to freshman year in September and they have a second disbursement in the Spring.

As so as we look at the first quarter, it'd be the first four months of disbursements, there's a significant portion of that is related to what we refer to in the industry as serialization of the pre-existing customer and the pre-existing contract. And so that makes it a little bit cloudy not knowing others' dynamics in regards to that to estimate the size of the market period, but also any changes in the market. It is the case of course that we are up 8% and prior models would indicate that for the full year the market will be up some number, 5% or so.

So we think we are in a good range but in the first quarter this mix of prior-year, current year and then sort of life changes as things move along, and so I think it is a little bit hard to estimate the share growth, but I would rather be at 8% than 4%.

That is helpful. Thanks. And then in terms of the loans that are going to be entering full P&I can you help me understand the timing of that throughout the year and how that affects your provisioning and your credit metrics on a seasonality basis?

Sure. So the $2.9 billion goes into repayment in two separate chunks. There is a May/June repay wave of roughly $700 million, and then in November/December there is a $1.5 billion repay wave and then the [cats and dogs] come into repayment across that period.

So we are always provisioning for losses for the next year and of course the life of loan allowance for our TDR portfolio. So the timing will give you an idea as to when to expect the provision to cover those loans entering repayment. Over the course of 2016 we expect our provision to remain pretty stable throughout the course of the year with the peaks being in the third quarter of 2016.

Thanks. And then just lastly on the new parent loan product, I believe that the Federal Loan Plus product is slightly lower yield than your existing book. Adding that to the mix, do you expect that there should be some sort of drag on your yield as you roll out that product later this year?

No. As we are looking into product, and we had previewed it with many of our partners at the schools, we think that the pricing is extremely competitive and we think that the servicing associated with it is both better and simpler. And so in regard to the design of a product we have taken the relative competition into account, and we think we're in a good position. That is the yields we think we are projecting, we think are very competitive as well as very good for our shareholders.

Thank you.

Your next question comes from the line of Eric Beardsley with Goldman Sachs.

Hello, thank you. Just wanted to go back to the margin. The thought that it could be north of 5.6% for the year, does that contemplate another rate hike? And I guess what would you expect to happen with the next Fed funds increase? Would we see similar asset sensitivity to what we saw this quarter in terms of loan yield and the funding cost?

So, Eric, the 560 number that I threw out there, upside from that is basis points, in the single basis points, when we do look at, when we do model, we do model with the yield curve factored in there. And we would expect that if the Fed does raise rates again, and my personal view is that they probably won't, but we would model in that -- the cost of our money market deposits would increase by 85% of whatever the increase in Fed funds was. And I think it is reasonable.

Nobody was really surprised that sector of the bank deposit market did not react to the first Fed funds rate hike in whatever it was,10 years. But I would suspect that if there is another there probably would be some pressure on that component of the bank deposit market.

Got it. And just on the funding mix over the course the year, how should we think of that evolving between the brokered, retail and any wholesale borrowings you do?

Sure, so we will hold steady to a 60% brokered 40% retail ratio. We and our regulators are very comfortable with that approach.

We do have in our 2016 plan that we will tap the ABS market. The ABS market does, as I mentioned earlier, look like it is tightening in. However, if it doesn't get inside of our hurdle rate we will forgo the ABS market and grow our retail and brokered deposit mix, which we are very confident that we would be able to do in the absence of wholesale funding availability.

Got it. And what is that hurdle rate in terms of your all-in cost on ABS?

I don't want to tip my hand to the ABS market.

Is it significantly south of 3%?

I'm sorry?

Is it somewhere significantly south of 3%?

Well we're talking about points to LIBOR, so it would be way south of 3%.

Okay. Got it. Thank you.

Your next question comes from the line of Rick Shane with JPMorgan.

Guys, thanks for taking my question. Steve, you've really touched on it a little bit. But as we're still learning the Company, I would like to think about the timing of things in terms of the left side of the balance sheet and the right side.

You have this strange characteristic, obviously the business is very seasonal, but Q1, I assume the disbursements are very early in the quarter and that is why you build the deposits in the fourth quarter, and in Q3 the disbursements are later in the quarter. So I am assuming we won't see a big surge in deposits in the second quarter in the way that we did in December.

That's right. We'll start growing our deposit balance in the third quarter and the cash balances will remain fairly lofty through the January disbursements.

Go ahead, sorry, I didn't mean to interrupt.

I was going to ask you, were you curious about the reset characteristics of the assets and liabilities on the balance sheet?

No, what I was really curious about is what is the timeframe to build the deposit base? Again given your unique demand for capital in very compressed windows, how do you manage that, and again, is it a one-month ramp to build those deposits or does it take a couple months? How should we be thinking about that?

The third quarter disbursements happen for the most part in August and September. So we will be starting to tap the various deposit markets in late June, July, August, September, October and so on and so forth. So there is not that lengthy of a ramp.

Got it. And is it a matter of negotiating with the markets basically saying we need X-billion dollars of incremental deposits, where is the mark to get that?

No, not really. I mean the brokered deposit market is pretty price sensitive. We know where the market is and we place orders and basically they get filled. Depending upon the name and the timing and the term, we have some leeway in terms of being 5 or10 basis points under or over the market.

But we typically target longer-term funding, [call it] one, two, three, five year CDs and not a lot of guys are out there in those sectors. But we will also fill in the holes around the three and the six month deposit market as well. There is a little bit more of a ramp time in the retail deposit market because we will have to start posting our rates in there. We typically raise money in the MMDA arena and one and three-year CDs.

But the dynamic is pricing and demand elasticity, it's not quantity purchased.

Okay, great. That's helpful. Again, just as we're thinking about things in new ways, that is very helpful.

At this time there are no further questions, and I will turn the call over to Ray Quinlan for final remarks.

Thank you all for your attention. It has been a pleasure to report on what we believe is a very strong quarter. We are off to a good start on all major parameters for 2016. We believe that the numbers are starting to illustrate more graphically the strength of the franchise. Spreads are good, we have steady income, our credit is where we want it to be. We think there's a very viable base on which to grow the franchise.

As you saw, our major revenue-generating asset is growing at 24% versus last year. We expect that rate to continue, and so it is a real pleasure to be able to report back on these results which of course are the reflection of all the efforts of our entire team. So thank you for your attention.

Great, thanks Ray. Thank you for your time and your questions today. A replay of this call and the presentation will be available on the investor page at salliemae.com. If you have further questions please contact me directly. This concludes today's call.

Thank you for participating. You may disconnect at this time.