Q3 2019 Earnings Call

October 24, 2019

Your conference operator today.

This time I would like to welcome everyone to 2019, Q3, Sallie Mae earnings Conference call.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question and answer session.

I'd like to ask a question. During this time simply press Star then the number one on your telephone keypad.

If you with my withdraw your question press the pound key. Thank you I would now like to turn the call over to Mr. Cronin BP.

Investor Relations.

Great. Thanks, Lisa Good morning, and welcome to Sallie Mae's third quarter 2019 earnings call with me today is Ray Quinlan, our CEO and Steve Mcgarry, our CFO . After the prepared remarks, we will open up at cost for question.

Before we keep before we began keep in mind or discussions 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.

He see.

During this conference call, we will refer to non-GAAP measures, we call our core earnings and adjusted core earnings descriptions of these measures a full reconciliation to GAAP measures and our GAAP results can be found in the Form 10-Q or for the quarter ended September Thirtyth 2019.

This is posted along with the earnings press release on the investors page at Sallie Mae Dot Com. Thank you I'll now turn the call over to right. Okay. Thanks, Brian and thank you off your attention. This morning, it's a pleasure to talk to you about the results for border and about our franchise more generally and I want to take couple of minutes upfront to to level set on.

Things associated with the franchise.

Especially the backdrop of how successful investment college is for most Americans and outage and a lifelong learning have continued to expand in our country and to create opportunity people have greater mobility, they have reader chances for economic and even personal success, including health.

Those were the bachelor's degree earned 65% more than those with a high school diploma and that Delta has increased significantly over the last 25 years, we do an independent research on overall borrowing for our overall attendance and borrowing propelled students in our annually published how America pays for college.

And families continue to value College, and higher education, more generally with 90% seeing it as a good investment in student future, 84% believed that theyre student in their family will earn more money and 77% are willing to give up other items and their financial plan in order to devote it's money to the investment in the new.

Next generation.

And despite all these benefits it's still we should remember that only about one third of the next generation Americans are on track to have a bachelor's degree and so we're seeing in our franchise alternative mechanisms that people are using to increase the human capital and at this point, 20% of our originations are different.

From the traditional undergraduate student loan neither pairing graduate international for profit or distance learning Sallie Mae continues to be a supporter of American families. As we helped build human capital for the next generation and at the moment, we're serving over 2 million coat students and co centers.

We are the.

Number one choice for families over all other private student lenders combined.

And so that's the case that this is due impart to our full court press franchise, including our relationship managers, who are nationwide in content constant contact with over 2400 higher education institutions, where a 98% of the preferred vendor list, we have a eight plus rating and a better business Bureau.

We're proud to announce that just recently, we acquired a JD powers certificate of outperformance for customer service operations. This is driven by vast improvements in our customer service operation over the last four years, where customers contacting us to clarify something or to fix the problem with.

Your account has dropped by 60% over the last four years from 2015 to 2019 and at the same time, we're adjusting our interface with customers to conduct ourselves in a way that inline with their preference and so this year, we'll do over 500000 chats and chat, but within approval rating.

And customer satisfaction rating over 90% of customers, who use that facility.

So it is the case that all of what I'm talking about is not the end, but is the means to an end as they say in college commencement and we follow our customers as they go past college and move onto the next successes successive chapters in their lives.

In addition to that we believe that Sallie Mae has a role in helping students more generally understand the financial backdrop for their activities and we post both tools for analytics as well as scholarship availability on our website happy to say that last year, the Sallie Mae scholarships search.

Which is branded as a free service to any when looking at our website.

It was able to help 20000 students and with $61 million scholarship funds that were distributed to them. The on the scholarship providers, but through the access on our Internet site.

So as we move forward.

We are in an environment, where the federal program dominates the outstanding amounts for student lending and there has been quite a bit of bait back and forth in regard to that and we are participant in that debate and we believe that the federal government and other government bodies have a role to play in helping economically challenged households.

To obtain the needed resources to advance their lives as they see fit but the federal program.

Is.

Certainly candidate for improvement and I'll just note in passing net of the description of it is frequently sort of lumped together some sort of average out some undergraduate profiles.

But 65% of these students there have balances under 25000. This the case that 40% of the graduates than last year had no debt at all and so we start to see that some of these distortions that are in the public press of people having.

Over $100000 in debt don't represent the average customer at average student within that portfolio and only 5% to the federal programs have balances over 100000.

9% of the federal program, 9% to students in Federal program will have a balance over 80000, they make up fully 43% of the debt. So you might think that 10% of the students have 50% of the debt outstanding and 90% students at the other 50, so it's a very skewed distribution.

And I think as people start to enhance the program. We should look at those individual segments as opposed to on average which dominates most of the conversation on the other end to the spectrum is 9% tip over 80000 more than half of all the loan defaults have balances under 10000.

So we have very fat tail Sundays, one fat tail as people one fed tail is.

His dollars and so I think this program could be greatly enhanced with some parameter changes and we are participating conversations to advanced that agenda.

Returning to us our practices, where our customers are successful, 91% and complete the course of study, which they've been rolled 91% of those become employed 88% read that worked gives them a feeling a personal accomplishment, 86% agree that the college education opened opportunities they wouldn't have had without it and 98% successfully managed.

Their loans without write off rate running under 2% per annum, the underwriting limit and loan limits are important to managing both our portfolio for financial results as well as for the student's success.

And so as we look at things.

We go forward with this quarter continuing our franchise build we've had a very successful third quarter.

And we'll go on to report about it in a moment, but it will say that backdrops to many conversations we have what people are gee, what about the political debate that his extensive United States as people buy to become candidates for the presidency and it is in this case at who ever gets elected we will still be there we will prosper we will be satisfied.

In the needs of Middle Class Americans as they seek to improve the lives of the next generation of Americans in regard to this particular quarter. We've had a good quarter coordinate incomes $122 million.29, a share 26% increase over the prior year, we originated 2.25 below.

A million dollars of.

$2.245 billion education loans in the quarter up 6% from a year ago and year to date, we're at 4.9 billion originated up 7.1% from the prior year our efficiency ratio.

Has dropped to 36.6% in the quarter normalized quarter for last year, which had some.

Financial into and out would have been about 39% are dropping from 39% about 36%.

The 30 day delinquencies or 2.8% up from 2.7 in the quarter before the second quarter and up from 2.3% a year ago, our charge offs come in at 120, 727 basis points compared to 88 basis points prior year.

And year to date charge offs are 115, compared to one 101 or 101 basis points in the prior year charge offs in delinquencies are essentially where they actually are right on our plan, we expect delinquencies to stay at the 2.8% level for the remainder of the year and at the full year charge offs will be about one point.

2%, which is on the expectation we set for charge offs over 12 months ago.

The delinquency buckets, and what we see the pipeline and Stratifying the portfolio by segments and risk cohorts. We expect that the performance that we have will continue and through the remainder of 2019 and persist through 2020.

And so the increases that we see our the continuing but mitigating maturation of the portfolio that we have been discussing with investors and other interested parties for the last three years.

Our net interest margin was 5.55% in the quarter compared to 58, 5.88% prior quarter, 6%. The prior year as you know we have been increasing our liquidity ratio and we ended that at 12.4% of total assets versus 7.2% in the prior year and as we've discussed in prior calls.

We expect the NIM to continue to drift on down, but as a pass through largely with no EPS impact as we increase liquidity on the balance sheet to be more in line with some industry norms.

In the 10-Q, there is a discussion of modifying some of our servicing collection practices as bank has grown we've continued to review the practices that we experienced we look to see what other people are doing we take feedback.

From our both our regulators as well as from our customers and we have an evolutionary approach to the collections treatment in particular.

So as we've looked at that there's a tradeoff in collections between forbearance, where no payment is made and loan modifications or interest only payments were smaller amount is paid but you're in more contact with the customer during those periods when less than contractual payments are being made and so we are changing a few things here we are.

Testing, our way through 2020 and in general I say from a philosophical standpoint, what you'll see is we're moving from periods no payment to periods of low payment and so as we look at that we will see whether or not that effect on the customers is the results in the advantage, which we believe it will have and we will keep everybody posted on.

That as we go through 2020.

And so we continue to have very good performance and this is just an enhancement of an ongoing nature.

To our portfolios and so our experience shows us that most of the customers, who use forbearance or loan modifications performed very well and its right to say that our lending happens in a venue that is extremely unusual for consumer finance types, and especially banks because most lending is based on a continuity of.

Current picture when the loan is granted.

A couple buys the house, we look and see who is working we look at the cash flow associated with that we as an lenders will say, we hope that continues and everything works out fine and we make the mortgage pay or make the mortgage.

I'd like to our customers there at the other end of spectrum, when we lend to them. They are entering a period of high volatility in their lives. They will graduate they will move they will get his job. They may get married that me by a house and over those seven years with just a normal length of loan for our customers. We have the highest volatility in their lives that's being the case.

The lives of relatively successful in regard to economics, and so the challenge for US is to move along with our customers as their cash flows increase in decrease.

That's what we're trying to do as we continue to evolve our collection practices as we look at this we think it'll affect about 4% of our customers, who wind up being some stages of delinquency worked our way through that.

It's a little bit hard to figure out whether or not these impacts of these will be neutral or not we had some estimates that said Gee. If this continues the way it had been going and we don't change our collection practices or we don't change the efficacy of those.

There might be an increase over the life loan of 4% to 14%.

In losses, we don't think that.

We will of course experienced that but that is what numbers would pull out of the current.

Extrapolations and so we will do everything we can to make sure that it doesn't occur we'll do it we're going to get to mitigate that.

And so as we go forward we will have.

Constant reports each quarter on how these changes are going which ones, we adopt which ones we don't.

For purposes of forecasting for 2020 2021, the impact on the portfolio will be negligible for those.

Returning to the quarterly results the average yield on the private student loans were 9.3%.

Nine basis points out in the prior quarter up 14 basis points from the year before cost of funds was at 275 down from 284 in the prior quarter up from 259, a year ago. These changes of course, all driven by light or and the forward curve.

In regard to guidance, we are increasing our fully diluted core earnings per share guidance.

We are holding constant on originations and our operating efficiency for the guidance will be EPS of $1.23 to $1.24 originations of 5.7 billion and operating efficiency rate of 35% to 36%.

As we leave this portion of the call.

The backdrop that we have is as.

Long term players with US know is we're going through several chapters and so the split and launch was 14 and 15, we had extraordinary growth as our receivable filled up on our balance sheet and 16 17 18 in 2019, we transitioned to a more normal company.

Growth rate mitigated somewhat as you so we authorized $200 million in stock purchases initiated dividend.

And so as we enter 2021, we will continue to do that we expect the industry revenue pull to grow by about 5%. We expect that we will continue to grow slightly faster than that we expect that we will have leverage in regard to that.

But we will start to.

Follow that growth rate.

With that growth rate compounded by the leverage that we have in our operating base. So we'll be at five 6% in revenue and.

We will track that going forward, we expect that to continue audit regular basis, so with those remarks.

I want to thank you one for your patience interest and to open up the call for Q and aid, which as Stephen I will attempt to answer.

At this time I would like to remind everyone. If you would like to ask a question. Please press Star then the number one on your telephone keypad.

We'll pause for just a moment to compile the Q and a roster.

Your first question comes from the line of Michael Kaye with Wells Fargo.

Im now that peak season is over just hoping you could provide some further commentary on what your experience been a broader pricing environment, specifically, how do you have expected our we use compared this peak season versus the past seasons.

But.

Sure Michael So we did lower prices.

During the peak season part of that was in response to a lower cost of funding.

And the ROI on this origination cohort is going to be very similar to cohorts passed and be in the very high teens.

Okay great.

And just touching on on credits.

The additional color was helpful but.

Just on on this topic on credit to refinancing players do you view them as taking off some of your better credit quality customers. It is that starting to have some impact on your credit metrics.

So look the consolidation has been going on for many years grows along with the portfolio. It's been very stable for the last three quarters. They do tend to consolidate the higher FICO score bar.

Thanks.

Im sorry.

For both of customer service group as well as for collection group, but to answer your question that for the co incident performance of the portfolio are there is no impact of these changes, which we will introduce.

As we said gradually over the next five quarters, we'll keep you posted on that but there is no impact in our current portfolio or our current write offs.

Okay got it so.

The impact the decrease in charge offs.

Take so.

It should come on gradually over time rather than.

Seeing a big impact.

Yes, and the gradually over time is actually really effective starting in 2021 right as we sort of goes through 2020.

We will conduct our tests are obviously not going to do anything which is going to be deleterious to the portfolio and so we'll keep people posted but we thought it was a good idea to announce to people that we're doing a series of test and we will take a look at those.

The interest, though transparency less then.

What we would say is the motivation is not to change the financial outlook of the company, but just to keep our in interested investors in.

Informed about practices that we are undertaking.

Okay. That's helpful and then.

Separately, just when you think about.

NIM and your asset yields.

What's in your guidance for the full year, I guess, maybe complain to fourth quarter. What do you have in terms of rate cuts and how any update that we should think about.

In terms of your sensitivity going forward.

Yes.

So we have reduced our sensitivity to.

Declining interest rates dramatically over the course of the last several quarters.

We are pretty well matched so as rates decline, we don't expect any impact on our net interest margin the net interest margin impact.

Scene is purely due to the.

Increase liquidity that we put on the books over the last.

Several quarters.

Okay got it thank you.

Once again, if you would like to ask a question. Please press Star then the number one on your telephone keypad.

Your next question comes from the line of John Hecht with Jefferies.

Thanks, very much guys for taking my.

Questions.

First of all.

Touching again on the servicing changes really I think you cited afford a 14% change in the lifetime losses tied to that but I assume thats just for the cohort of borrowers that are that have an impact from the change in servicing or how do I think about that 4% to 14%.

Sure first thing is you should think about it as life of loan. So we're talking out 567 years.

Second is the practices that we engage and we'll be.

Represented in all the vintages and driven by the individual customer behavior not by the cohorts. So if people are in moderate delinquency and they're having trouble with their cash flow.

It will be our endeavoring to do two things one is to be responsive to that such away that we worked as I said through these major changes in our customers' lives.

The way that's more accommodating to the fluctuations in their cash flow, but importantly at the same time, we're looking to maximize our contact with these customers. So as you know in our student loan portfolio, we give people an option when the loan is granted to make either interest only payments, while they're in college or too.

For a 25 dollar a month payment and we find that practices associated with that are very good from standpoint of our one staying in contact with customers and to as represented by their performance.

Better information through 2020 as to whether those numbers it will move at all and B, what they will move to it in fact they do.

Also as we go through next five quarters.

Okay. Thanks, very much and then with respect to.

I know there was.

Requirement should influence NIM or is that fully baked in at this point.

So we are still very much a variable rate loan portfolio I think we're running around 60% variable, 40% fix so declining rates. If we're approaching the funding of our fixed rate portfolio in a balanced manner shouldn't really.

Second quarter and the build will continue through the fourth quarter. So as that liquidity position is on the books for the full year of 2020 that is going to have a larger impact than it did in 2019, we have not guided for 2020 yet.

Ill speak will start to stabilize.

So we've got about $9 billion from full Pmnine and we're originating you know close to $6 billion every year. So it's a little bit of a treadmill one step forward two steps back so it will take a while for our portfolio to reach equilibrium.

Let's say three years from now, but what we're seeing in our portfolio is very steady performance very steady cure rates in the collection departments and we're very comfortable with how we see the portfolio performing at this point.

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

EPS guidance.

Purposes for purposes of 2020.

As I said the impact is negligible. So I think we can disregard that and say that what's in challenger versus test, it's more important to understand how the test get resolved.

Okay. Thank you and is the idea here that if you can prove this out on that ultimately it might allow you to change or Cecil reserve assumptions as well.

Yes, whatever whatever impact we have as we would model. It and then do life of loan forecasting will be not only will impact seasonal it will be cecil.

And so as I said, we just do a straightforward extrapolation this summer number in there.

Undergoing these tests and.

Said earlier, we don't expect any impact really for 2020 or 2021.

Last question.

As you ramp up your buyback and head into 2020.

Obviously there.

You sort of contemplate capital returns in 2020.

Curious, where you see the gating issue.

We're attempting to be as prudent as possible in regard to that in such a way that we take our let's wait until it gets implement implement did end up so as we look at it we haven't given any guidance for 2020 in regard to either a capital levels or buybacks or anything else.

And so did the case that will this a big implementation I agree with you it doesn't change the underlying cash flow economics at all.

And so thats. The first objective after that we will look at available cash available capital and see how regulatory responses go to capital image and other things as we approach the distribution of capital.

So to premature now to either talked about that in a serious way or to give specific guidance in regard to it.

Very helpful right. Thank you so much.

I have been listening discussion around the change in collection practices that simple outcome is if the planned words works as expected.

Your view is that lifetime losses will be lower is that an oversimplification of it or.

I would really wonderful I think what we're hoping for his lifetime losses will be neutral.

And then here that we're trying to be conservative at this we have new practices going in we have as we said challenger in test.

Or is that reflect an update in your analysis.

So look we did estimate as potential range afford a 14%.

On our GAAP numbers and that is why we think that makes a lot of sense to.

Can you give us an update on the progress there.

A graduate school lending.

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

Could you talk just a little bit more of that the competition in school I think you you had.

Cancel amount of new players was it just increased intensity from it from existing players because.

We haven't seen that many kind of new players and.

As Jay Pal Didnt get the memo.

And he reduce the interest rates in the country on July 26, which was inconveniently for the competitors right in the middle of our busy season.

And of course once that was in the forward curves that was sort of built into everybody projection of their cost of funds people reacted to that we reacted to it as well.

As Steve commented earlier the margin during the peak season has not changed and so what happens essentially is the entire industry followed the cost of funds down now with reflected any individual pricing as well as any aggregate pricing, which I'm happy to say across the industry remains rational.

Got it.

Just a follow up and it does you've answered a lot of questions about the servicing changes person.

They have lower losses than you would've had I guess what was the original impetus for that the started that process.

I think it was a combination of three items. One is fit review our collection practices on ongoing basis, which we do too is the idea of forbearance, which essentially is a period during which a customer doesn't make payments on alone.

Always makes us a little bit on easy we prefer to have more contact with our customers. We prefer to have a minimum payment would probably be in touch with everyday and we also would like to serve as a counselor to them as they go through these changes in their lives and so I think what we had was it's always good to have any practices to his forbearance as we.

Useight, we monitor carefully but its of situation that always causes us to worry because we don't have a payment from a customer for a longer period of time.

Thirdly, as we looked horizontally across the industry.

Noted that.

Thanks very much.

Our no further questions at this time.

Okay, well, thank you won't be a retention and I'd say, it's a pleasure talking to us Ajay August growth.

And.

I do want it just outlook as far as Patrice we had an excellent quarter, we grew faster than the market.

With that I just want to thank you all for your attention and look forward to talking to you in future.

Thank you for your time and your questions today, a replay of this call and the presentation will be available on investors page at Sallie Mae Dot Com. If you have any further questions feel free to contact me directly this concludes todays call.

Thank you. This concludes today's conference you may now disconnect.

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