SLM Corporation (NASDAQ:SLM) Q4 2022 Earnings Call Transcript

SLM Corporation (NASDAQ:SLM) Q4 2022 Earnings Call Transcript February 2, 2023

Operator: Good day, and welcome to the 2022 Fourth Quarter Sallie Mae Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session and instructions will be given at that time. As a reminder, this call is being recorded. I would now like to turn the call over to Melissa Bronaugh, Vice President, Investor Relations. You may begin.

Melissa Bronaugh: Thank you, Michelle. Good morning and welcome to Sallie Mae’s fourth quarter 2022 earnings call. It is my pleasure to be here today with Jon Whitter, 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 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 the SEC. For Sallie Mae, these factors include, among others, the potential impacts of the COVID-19 pandemic on our business, results of operation, financial conditions and/or cash flows.

During this conference 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 earnings supplement for the quarter ended December 31, 2022. This is posted along with the earnings press release on the Investors page at salliemae.com. Thank you. And now, I’ll turn the call over to Jon.

Jonathan Witter: Thank you, Melissa and Michelle. Good morning, everyone. Thank you for joining us today to discuss Sallie Mae’s fourth quarter and full year 2022 results and our outlook for 2023. I hope you’ll take away two key messages today. First, on most dimensions Sallie Mae had a strong 2022. Second, we now believe that the level of charge offs we experienced in 2022 will likely improve, but remain at an elevated level for a period of time. As such, we have taken tough financial and operational medicine to start to put that impact behind us. And third, and as a result, we believe we have strong momentum entering 2023 and are well positioned for future success. As we released last night, Sallie Mae experienced a loss of $0.33 a share in Q4 and diluted earnings of $1.76 a share for the year.

This quarterly loss was due to both an increase in our provision for credit losses, as well as the write-down of the value of an investment in non-marketable equity securities. As Steve and I will discuss, we believe both charges help position Sallie Mae for strong performance in 2023 and beyond. Absent these charges, our financial results for the quarter were in line with our guidance expectations. Let’s get into the details that drove our performance in the quarter and the year. Private education loan originations for the fourth quarter of 2022 were $819 million, which is up 11% over the fourth quarter of 2021. Consistent with guidance on our last call, our full year originations ended at approximately $6 billion, which is up 10% over 2021.

This momentum has carried into 2023 as we have just experienced the strongest January originations month in our company’s history. We also saw a notable market share growth in 2022. Sallie Mae’s share of the core student loan lending market increased 200 bps year-over-year according to the most recent industry report, reflective of our 2022 peak season success. We also observed important changes in the mix of our originations. Specifically, we saw a 15% increase in underclass disbursements compared to last year. Underclass originations have higher lifetime value to us due to greater serialization opportunity, which bodes well for future peak seasons. This performance was driven by a number of factors, including realized benefits from our acquisition of Nitro College, improvement in our marketing effectiveness enabled by past MarTech investments and the strength of our partnership and school relationships.

Credit quality of originations was consistent with past years. Our cosigner rate for fourth quarter 2022 was 82% versus 83% in the fourth quarter of 2021. Average FICO score for the fourth quarter of 2022 was 747 versus 749 in the fourth quarter of 2021. For the full year, our originations were 86% cosigned and had an average FICO score of 747. Year in and year out, our quality loan portfolio generates net interest income, significant net interest income. For the full year of 2022 we earned $1.5 billion of net interest income, higher than full year of 2021 despite having slightly lower loan balances. In this rising rate environment, our treasury team has effectively managed interest rate risk and grown our net interest margin from 4.81% in 2021 to 5.31% in 2022.

We have also managed expenses rigorously in this highly inflationary period coming in on the lower end of our guidance at $559 million. This is despite an increase in volumes and in costs such as wages, benefits and other expenses. Despite this pressure, we continue to ruthlessly prioritize and invest in our most important operational and strategic initiatives. In the fourth quarter of 2022, we continued our capital return strategy, repurchasing 10 million shares at an average price of $16.25. We have reduced the shares outstanding since January 1 of 2022 by 14% at an average price per share of $17.58. We have reduced the shares outstanding since January 1 of 2020 by 44% at an average price of $15.44. While we are excited about this performance, charge off results in the year were worse than our original expectations.

Specifically, as discussed on page 15 and 16 of our earnings press release, our net private education loan charge offs for the year were $386 million, above the revised range we set at the end of the second quarter. You will remember at that time we expected charge offs to remain elevated in Q3 and begin to abate in Q4. While we have seen improving performance in many of the transient factors we previously discussed, some factors remain elevated. In addition, while we don’t see evidence of stress across the portfolio as a whole, we began to see elevated levels of delinquency and charge offs in pockets of our portfolio toward the end of the year. As we assess industry and competitor data, we believe this is a trend similar to those seen in other areas of consumer lending.

These combined factors have led us to conclude that while we expect charge offs to be lower in 2023 than in 2022, the charge off rate will likely remain elevated. In fact, we saw this play out in January where results improved relative to our expectations. We have reflected this view in our charge off estimate in results and allowance calculations. Specifically, we expect charge offs in 2023 will be between $345 million and $385 million. As a result, we added $181 million to our reserves in Q4. In addition to this charge off outlook, this provision build incorporates portfolio and commitment growth, modeling changes and a true up of modeled and actual results. Roughly 70% of this allowance build is related to elevated charge off expectations over 2023 and into 2024 that I described a moment ago.

The remaining 30% comes from a prudent assumption that while we are optimistic that credit will eventually normalize, we are not willing to assume an immediate improvement where we and others are continuing to see economic stress. In addition to this financial charge, we have also made significant changes to our people, processes and programs to improve loss performance. We will continue to evaluate performance and the effectiveness of these changes and make further enhancements to our operations as results dictate. The other main factor of our financials in Q4 involve the valuation of our investment in non-marketable equity securities. In the third quarter, we made the decision to exit the credit card business and divest the portfolio. However, as you may recall, we made a strategic investment in a service partner when we entered the credit card business in 2018.

In 2021, we marked this investment up by $35 million. However, based on prevailing market sentiment in the fourth quarter of 2022, we were required to write the asset down and have done so by $60 million. The remaining investment on our balance sheet is immaterial. The increase in our provision and the write down of our equity investment were the primary drivers of EPS coming in approximately $0.74 lower than our expectations. About two-thirds of this impact was driven by the provision build I just described and the remainder was due to the write down of a strategic investment in a business line we are exiting. Steve will now take you through some additional financial highlights of the quarter. Steve?

Steve McGarry: Thank you, Jon. Good morning, everyone. Let’s continue with a deeper dive into our loan loss allowance and provision. Our total provision for credit losses on our income statement was $297 million in the quarter, driven by an allowance build of $181 million and net private education loan charge offs of $116 million. This Q4 provision represents an increase of $90 million from the prior quarter and $313 million from the year ago quarter. At a more detailed level, the increase in allowance during the fourth quarter brings our private education loan reserve to $1.48 billion or 6.3% of our total student loan exposure, which under CECL includes the on balance sheet portfolio, plus the accrued interest receivable of $1.2 billion and unfunded loan commitments of another $2 billion.

As Jon mentioned, there are a few factors that influence this increase in allowance, the largest being our charge off expectations over 2023 and into 2024 due to the persistence of operational issues, credit administration practice changes and the potential for increased pressure on our borrowers from the current economic environment. We also built allowance in the quarter for slower than expected prepayments. Let’s now discuss our credit metrics. Private education loans delinquent 30 plus days were 3.8% of loans and repayment, a slight uptick from 3.7% in Q3 and up from 3.3% in the year ago quarter. It is worth reminding everyone that a natural result of reducing forbearance is an uptick in delinquencies. In fact, since we implemented our forbearance policy changes, the increase in our 30 plus delinquency rate is equal to the decline in forbearance usage.

We now expect 30 plus day delinquencies to remain at recently experienced levels through 2023. Private education loans and forbearance were 1.8% at the end of the quarter, an increase from 1.4% at the end of Q3, and lower than 1.9% from the year ago quarter. As May graduates exit their grace period in November and December, it is typical to see seasonal pressures push up forbearance usage. Net charge offs for the portfolio were 3.1% in the fourth quarter compared to 2.7% in Q3 and 1.6% in the year ago quarter. Full year charge offs were 2.55% in 2022 compared to 1.33% in 2021. We expect the private education loan charge offs for the full year of 2023 to total 2.4% to 2.5%. As Jon mentioned earlier, we are appropriately reserved for this outlook.

Let me provide some further context around our projections and implications for lifetime loss. Today’s discussion has highlighted the fact that we continue to believe 2022 charge offs do not reflect our long term run rate. This belief is reflected in our provision, whereas Jon mentioned earlier, 70% of the increase was driven by expectations of elevated charge offs over the next two years. With that said, we also believe that our 2021 charge off rate of 1.33% does not reflect our long term expectations either. We believe that our long term through the cycle loss rate should be closer to 1.9% to be consistent with our expected life of loan default rates at underwriting. In recent years, we have seen loss rates well beneath that. 2022 was a catch up year for a lot of reasons that Jon and I have already discussed.

However, when we look at vintage curves and the expected remaining credit performance of our assets over time, we think that life of loan losses will be within the estimated range, anticipated at underwriting and will continue to drive attractive returns and profitability going forward, generating life of loan return on equities in the 20% range despite recent credit performance. Jon has already reported on our solid NIM performance. I would like to add to that discussion that we remain marginally asset sensitive and should benefit from a continuation of rising rates. We continue to expect our NIM to exceed 5% throughout 2023. Income tax expense for the year was $162 million. This represents an effective tax rate of 24.9%, which is a reasonable run rate for our company.

Fourth quarter operating expenses were $138 million compared to $150 million in the prior quarter and $125 million in the year ago quarter. Expenses were down from the prior quarter which was our peak lending season. Full year operating expenses in our core student loan business increased just 7.8% from the prior year despite significant inflationary pressures and dispersed volume being up 10.2%. We will continue to focus on driving both servicing and acquisition costs lower on a unit basis. Finally, our liquidity and capital positions remained strong. We ended the quarter with liquidity of 23.5% of total assets. At the end of the fourth quarter, total risk based capital was 14.2% and common equity Tier 1 capital was 12.9%. GAAP equity plus loan loss reserves over risk weighted assets are an important metric and the CECIL environment was in a very strong 15.9%.

We believe we are well positioned to continue to grow our business and return capital to shareholders going forward. I’ll now turn the call back to Jon.

Jonathan Witter: Thanks, Steve. As I said previously, I believe Sallie Mae is well positioned for the future. While we expect the private student lending market to return to a more normalized growth rate in 2023 compared to the post COVID bounce back year of 2022, our originations engine is strong and prepayment speeds continue to slow, both of which bode well for balance sheet growth or continued loan sales. Our NIM is resilient and we have demonstrated strong expense management. While charge offs are elevated, we have taken measures by increasing reserves and making operational changes that we expect should help insulate future performance from these effects. On top of these factors, we are also seeing positive signs in the fixed income markets.

Rates are now at the levels where we executed our 2022 loan sales. Credit spreads are normalizing and prepayment speeds slowing. All of this helps support future loan sale plans. As such, subject to market conditions, we plan to sell $3 billion of loans in 2023 in keeping with our past loan sale and share buyback arbitrage program. These sales are likely to take place in Q2 and Q3. In addition, under our 2022 share repurchase program, we still have the authority to purchase $581 million worth of shares this year. We do not anticipate having to seek additional board approval for repurchases this year. Beyond 2023, we remain committed to our capital return strategy. It is in this context, I’d like to provide our guidance for 2023. Specifically, we expect full year diluted non GAAP core earnings per share between $2.50 and $2.70.

Full year private education loan origination growth of 5% to 6%. We expect our non-interest expenses for the full year of 2023 to be between $610 million and $620 million. And as stated earlier, we expect our loan portfolio net charge offs will be between $345 million and $385 million. With that, Steve, let’s open the call up for questions.

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Q&A Session

Operator: Our first question comes from Moshe Orenbuch with Credit Suisse. Your line is open.

Moshe Orenbuch: Great. Thanks. Maybe just to think about, given the strength in originations in 2022, Jon, the deceleration that you’re seeing is — that you talked about or that you’re expecting, is it an element of conservatism or what do you think about — how do you think about that guide in the context of what’s happened now? We can see this morning a report that the freshman class at least has started to grow again. I know there has been some declines in college enrollment over the last couple of years. So can you put the 5% to 6% in context for us?

Jonathan Witter: Yes, sure. Happy to, Moshe, and good morning. Thanks for your question. I think the biggest thing to remember is, in 2021 we were still dealing with the impacts of the federal government HEERF program as a result of COVID. And that had, as you’ll remember, a pretty material impact on borrowing requirements for students as colleges had just a lot of money directly geared more toward direct aid in assistance to college. We are — we absolutely expected in our numbers last year to see a rebound of that program went away by statute. And I think we believe that the market this year will look more like a normal market. And I think our view is sort of long term this is a market that is growing in the sort of mid to upper single digits.

And that’s sort of the expectation that we have brought in. We have been, I think, excited by the performance we put out in 2022, both in terms of sort of the growth of the market and our market share gains. As I mentioned before, I think we saw a very strong, in fact a record setting start in our January originations. And so, I think we are optimistic about our originations outlook, but it’s really the loss of the HEERF program that led to a view of just a different market wise growth rate from 2022 to 2023.

Moshe Orenbuch: Okay. Got it. Thanks. And just as a follow-up, very good to hear your comments about the interest rate environment, we can see things with this spread environment is getting a little bit better. Can you talk a little bit about whether the improving margin slowing, kind of slowing prepays, but somewhat higher credit losses, how to think about that in the context of how we should be thinking about the value of those loans, the gain on sale that you can achieve?

Steve McGarry: Sure, Moshe. I’ll take a stab at answering that question. So the fixed income market has been extremely volatile and we saw our interest rates go up and come back down over 100 basis points from where we last executed. I think it’s pretty widely known that we last executed in the high single digits. And since that points in time, I think, (ph) spreads, which many of our loan buyers go to the ABS market to fund their purchases have actually tightened a little bit since then. The market is wide open and deals are getting done very actively. So that’s very, very encouraging. The fact that prepayments have slowed significantly, I think we saw consolidations down something like 50% year-over-year extends the life of these loans and generates additional residual cash flows, that is a very big positive.

So look — and as I discussed, I think in some detail, while we did have charge offs that exceed our expectations in 2022 and probably going to persist into 2023 and a little bit into 2024. We don’t think that that has had a major impact on our life of loan expectations, which is certainly what investors will factor into their pricing on the product. In our guidance, we were a little bit conservative in terms of the premiums that we expect to receive. And I don’t want to start negotiating against myself here. So maybe I shouldn’t even brought that up, but we are very optimistic that we will be able to execute some very strong loan sales. And finally, I will point out that there are many, many interested buyers continues to grow as we steadily sell $3 plus billion of loans each year.

So we are very encouraged and looking to get the process rolling now that we have released earnings.

Moshe Orenbuch: Great. Thanks. And I’ll get back in the queue.

Operator: Thank you. Our next question comes from Mark DeVries with Barclays. Your line is open.

Mark DeVries: Yes, just one follow-up on those comments, Steve, on the gain on sale margin assumed in guidance. Is it kind of consistent with the last sale or when you say conservative, potentially lower than that? Or how should we think about that?

Steve McGarry: I prefer not to give any further specificity on that front Mark.

Mark DeVries: Okay, fair enough. Next question is just on cosigner rates. Well, I think you alluded to it being kind of consistent. I think it’s been steadily migrating down over the last several years. Can you just talk about what’s driving that? And also what share of kind of the charge offs and delinquencies are coming from the population of loans where you don’t have a cosigner?

Jonathan Witter: Mark, let me take the first part of that question. We have not seen material changes in our cosigner rate on what I would describe as sort of a mix adjust basis. So when you look at sort of the various types of schools and you look at the population of those schools, we have not seen a change there. I think the biggest change that we have seen is a growth in a sort of a different set of programs, which tend to attract oftentimes older and more established credit risks customers who don’t in fact need a cosigner to support the underwriting decision. So, a great example of this is, think about the 20, 26 year old individual recently got out of the (ph) services has decided to go back and get their degree, that’s a pretty good indicator of the kind of person that would not have a cosigner.

And so, I think the sort of steady drift down that you’re referring to, we have not noticed patterns of that as we normalize for the underlying segments of customers. I do not have — Mark, let me ask Steve, if you do views on sort of the specific cosigner, non-cosigner default rates. We can certainly follow-up on that Steve if you don’t have that.

Steve McGarry: Look, we obviously pour over the full stats every quarter and there has been no meaningful move in the percentage of defaults that come from cosigned versus non- cosigned. And in reality, I think we went from 87% to 86% over the last couple of years. So it hasn’t been really a big mix shift in that either.

Mark DeVries: Okay, got it. Thank you.

Operator: Thank you. Our next question comes from Michael Kaye with Wells Fargo. Your line is open.

Michael Kaye: Hi, good morning. I think I heard Steve mention lifetime loss estimates now up 1.9%. I thought I heard Jon previously say 1.75%. So that’s an increase in that estimate. Correct? And also, I wanted to ask how can you have confidence of estimating these lifetime losses when you’re having trouble forecasting even current quarter credit metrics, which happened in Q4?

Steve McGarry: Thank you for that question, Michael. So look, I went back and I took a look at what Jon said at the Barclays conference and I would call his comment 10.5 divided by six is really being illustrative to try and put life of loan default rater into perspective. What I’ve done with the 1.9% is, I have taken a look at basically the disclosures that we’ve included since CECL was implemented where we basically provide information on what origination cohorts our defaults come from quarter in and quarter out. And basically what I’ve done is, applied charge off rates informed by the charge off rates that we disclosed occur in the principal and interest repayment cohorts and I essentially normalized the current charge offs that we are seeing excluding things like our best estimates of the defaults from the continuous enrollment program that was the gap year population that we talked about and also normalizing for the issues that we’ve seen in our collection centers, as well as the issues that we have seen with the forbearance changes trying to estimate what was acceleration and what was a continuation of an increase in life of loan default rates.

And I would just add Michael that, look, we’re confronted with administrative changes and operational issues that are quite candidly difficult to forecast. The model doesn’t do that and we need to rely on management judgment to calculate what we think are the appropriate and meaningful overlays. Jon, anything you’d like to add to that.

Jonathan Witter: Yes, Steve, I think that was all right. And Michael, first of all, let me say, thank you for your question and I appreciate and understand the frustration you feel in sort of the charge off performance we showed last year. And let me just assure you, there is no one who takes it more seriously and there is no one who is more sort of disappointed in the fact that we were behind on forecasting those losses then Steve and I. It is something that has and continues to have our utmost attention. As I look forward, first of all, let me say, we’re in a pretty uncertain economic environment. So everything we’re about to say is in that context, obviously, if things change dramatically on a broad macroeconomic perspective, then obviously our outlook and our views can change.

But I think, Michael, there’s three things that give me confidence in sort of our ability to better predict going forward than we have in the last year. First, we’re now a full year into the seasoning of the last of the credit administration practice changes that Steve referenced. I think the last changes went in early last January if memory serves me right. Getting that kind of ability to look and start to understand on a year-over-year basis is really, really useful for us in disentangling sort of the credit administration impacts versus seasonality, and quite frankly just the normalization of life you have post COVID, where I think everyone saw a delinquency and sort of charge off performance sort of behave differently than historic norms.

So I think seasoning is the first thing that I would look at. Secondly, you will not be surprised at all. We have ripped apart and reconstructed our analytics around loss forecasting. And I think in particular, has started to build new and different models that specifically look for and track the kind of unique patterns, the unique subpopulations that really seemed to drive the outsized loss performance in 2022. So we now feel like we have analytics that specifically take that into account. And again, we couldn’t previously, because those were populations that behave differently in 2022 than we had seen before that. And I think the good news is, we have validated those models again our historic models and actually think we have a good understanding of the similarities and the differences between them.

So I think our level of analytical understanding has really grown in this post credit administration world. And look, the third thing is, I am incredibly impressed with our company’s ability to swarm to an opportunity when we understand an opportunity is out there. And it’s a little bit of a tangent, but I would look at originations as a great example. I think if you go back two years, what you will see is, I think we had a pretty good marketing and origination engine. We saw that as a huge opportunity and we made leadership and talent changes, we made technology changes, we made analytic changes, we made process changes. And I am biased, but I would say we are on the verge of that being a real source of distinction for us in the financial services space.

After lots of years of good performance, I don’t think we recognize coming out of 2022 that we had the opportunity to improve our collections and loss mitigation programs to that degree. Believe me, we understand that now. And we talked really hard about the tough medicine we’ve taken. And I think we have done many things over the last six months to put that change into effect. I think some of those things are already starting to gain traction. And we will continue. As I said in my talking points to work that hard to make sure that we get actual losses to their appropriate and lowest level. And that we can quite frankly, Michael, regain your trust in our ability to call our shot. We will really look forward to a day where you say we’ve kind of gotten back on the right footing there.

So appreciate your question. But Steve, maybe that’s what I would add to it.

Michael Kaye: Thank you for that. My follow-up question is also on credit. Besides the impact of the forbearance policy changes and a whole staffing operational issues that are going to impact 2023, what’s kind of the underlying financial health of your borrowers? I think you mentioned something about seeing some pockets of weakness in the opening statements. Could you just elaborate on that like what’s going on?

Jonathan Witter: Yes, Michael, happy to. First of all, I want to say and I said this in my statements, we continue to look, I continue to ask as recently as yesterday, we do not see sort of evidence of broad stress across the portfolio. What I think we started to see partway through the third quarter, but really into the fourth quarter of last year was growing stress on what I would call sort of smaller kind of layered risk segments of the portfolio. So I’ll give you an example. If you look at our performance of charge offs by payment, you don’t see sort of much of a difference between high and low payment, but if you start to layer in payments and years in repayment. So like high payment amount, say, over several hundred dollars first year in repayment, you start to see very different levels of performance than what we would have seen for a similar cohort in the past.

And so, as we’ve really done the analytical work that I talked about earlier, we’ve gotten very deep into understanding these kind of layered risk pockets. I think we understand now where that risk is coming from. By the way, as I mentioned earlier, those are the kinds of populations that we have tried to build explicitly into our loss forecasting methodologies going forward. So we know that these are things that maybe in the past we didn’t have to pay as much attention to, but we need to now. And we’re developing specific programs, policies, procedures, products to go after those types of customers. So — again, it is not broad, but it is the sort of two and three dimension layered risks where we are starting to see sort of pockets of outsized performance difference.

And I think that really is driving a meaningful part of our forward-looking credit outlook.

Michael Kaye: So I just want to make sure I understand that you’re saying the pockets of weakness of these borrowers that have higher relative payments and that they’re earlier in the life cycle of their repayment. Is that right? Why is that? What’s happening? Like why are you seeing that weakness there?

Jonathan Witter: Yes. I think, Michael, it makes a lot of sense. If you’re a brand new out of college and maybe you haven’t fully grown income-wise into your full payment and inflation is going up 7% or 8% a year. So, again, when you think about that person’s individual income statement and balance sheet, it’s a thinner income statement and balance sheet. On top of that, maybe they have some other variable rate loans, you can all of a sudden see very clearly why that small sub-segment of customers might be very different than someone who has the exact same payment but three years later in their post-graduate journey. And so I do think we see a pretty direct correlation between the sort of layered risk segments and the broader economic environment.

And the way that I would sort of describe it to you, I don’t think we believe that there is a broad recessionary environment out there today. Again, that’s why we don’t see the stress in the portfolio as a whole. But I do think we have places where there are, for lack of a better analogy, sort of some scattered showers where this economic environment is hitting certain borrowers harder. And I think that’s really what we’re tracking and trying to manage with those borrowers to help them return to financial health.

Michael Kaye: Okay. Thank you so much.

Jonathan Witter: Yes. Thank you, Michael.

Operator: Our next question comes from Sanjay Sakhrani with KBW. Your line is open.

Sanjay Sakhrani: Thank you. Good morning. I wanted to follow up on some of the previous questions. Jon, can you maybe just talk about what specifically went wrong with the process element of it and what’s been done over the fourth quarter to remediate that? Maybe we could just do a little bit of a case study there?

Jonathan Witter: Yes. I mean — great question, Sanjay, and sort of thank you for that. And we would probably need an hour to do justice on all the diagnostics and analysis that we’ve done. I think at the end of the day, the simplest thing that I would say is, I think it all starts with our historical modeling of the portfolio. And I think at the end of the day, these types of layered risk segments that I talked about before are exhibiting in this economic environment, very different patterns than we have seen them exhibit in the past. And I think we needed to see some of that experience to sort of retrain our analytics and to retrain our approaches. I think the most important question is like what are we actually doing about it and what are we changing?

And again, I can’t be, Sanjay, comprehensive with you in a short period of time. But let me give you a couple of examples to maybe give you a flavor of it. First, we’ve looked really hard at sort of leadership talent and the skills of the people that we have on these teams and the way that they are organized and we’ve made meaningful changes in that space. We are working hard at developing specific programs for these sort of layered risk populations to make sure that we’re being as effective as we can. So one that I’m particularly excited about is recognizing that new-to-repayment seems to be a subpopulation that’s feeling real stress right now. We implemented a pre-delinquency loss mitigation program this year that was heads and shoulders above what we’ve done historically.

So, even before someone gets into trouble, establishing communication with borrower, cosigner, beginning to sort of help them understand the options should they be feeling financial stress, reinforcing and recommunicating the programs that exist for them like our existing Graduated Repayment Program, GRP. And by the way, even just some simple things like making sure we have right-party contacts, text and e-mail information again, borrower, cosigner, so that we — if we do get into a situation where they’re delinquent, it’s just a lot easier to make that first contact. We have implemented over the last quarter or two pretty major technology improvements in the collection space. So we are doing an awful lot of work right now to give them the workflows and the tools to make it easier for them to navigate with these customers and more cost effectively and efficiently get them into the right programs in a shorter period of time.

That’s a great way for us to sort of manage that. We’re looking a lot at our training programs. We are fully staffed today. That’s different from where we were mid-year. We are not seeing our new collectors despite a really high-quality set of classes we brought in, reach proficiency and effectiveness in all the areas as quickly as we would have expected. So we’re doing a lot of work. For example, looking at what’s the right way to train them in person versus remote, how do we make sure we’ve got sort of the right actual tools and experiences for them and the like. So, probably can’t go into all of it, but I mentioned before the way we swarmed the opportunity that we saw in originations, you can rest assured we are swarming the opportunity that we see in loss mitigation in exactly the same way.

Sanjay Sakhrani: Okay. Great. And then just maybe a follow-up question for Steve. I’m just trying to reconcile that 1.9%. I seem to recall, like in the past, that number was closer to 1%, right? And when I look at some of the peers like Discover, I understanding they have a smaller portfolio. I mean they’re kind of in that 1% range still in terms of their annualized loss rate. Is there something different about sort of your portfolio versus there? I’m just trying to reconcile that. Thanks.

Steve McGarry: So look, the credit card lenders have talked about the seasoning of recent borrowers, what we see in our portfolio. So if you go back and take a look at our disclosure on where losses emerged from — in 2019, you will see that basically 75% to 80% of losses basically come from origination cohorts that are three plus years and older. Half of it from origination cohorts that are five plus years and older, which makes perfectly good sense because with people borrowing while they’re in school and not starting to make full P&I payments until six months after graduation. That is exactly where you would expect our defaults to come from. So if you look at the 2019 cohort, which totaled 1.3% of loans, there wasn’t a high volume of loans in repayment at that point in time.

If you take a look at the 2022 cohorts, obviously, we had some challenges in the organization, total default rates were 2.55%. Obviously, the default on the older cohorts was much higher than our run rate sort of P&I default rates. So if you apply a more normalized P&I rate — default rate to those cohorts across time, you basically could triangulate back to that 1.9% default rate. And I’d be more than happy to offline walk you through those disclosures and show you how I arrived at that number, which I believe is perfectly reasonable. If you look at P&I default rates over time from cohort to cohort, they sort of peaked at 4% and then drop back down into the 3% level. Ours are running much hotter now. Obviously, you can see that in all of our Reg AB disclosures.

What I did was applied the default rates that are stressed compared to what we’ve seen over time to accommodate for the potential for higher default rates from, for example, our forbearance administrative changes. Difficult to describe a spreadsheet verbally on a conference call, but did that kind of make sense for you, Sanjay?

Sanjay Sakhrani: Yes. I guess I’m just trying to think about you guys relative to others in that — in the same space, right, in private student loan.

Steve McGarry: So it’s very important to point out, we have a much higher volume of loans now that are actually in repayment than we did in 2019, in 2018 and 2017. So to try to expect our default rates year in and year out to run at a 1.1% or 1.3% or even a 1.5% rate doesn’t add up with Jon’s illustrative math or what you see in our disclosures when we publish full P&I default rates. So it really is very similar to the seasoning issue that I think half one described on their call where they said, “Hey, we grew the book 18 months ago, and now those defaults are starting to emerge.” Our origination cohorts went from $3 billion and $4 billion — $5 billion to now $6 billion and higher over time. So it really is an issue of seasoning with a little bit of an increase in life of loan charge-offs from both our operational charges that changes that Jon was just talking about and the well telegraphed forbearance changes that we’ve been talking about since 2019.

Jonathan Witter: And Sanjay, it’s Jon. I think the only thing I would add to Steve’s discussion. It’s hard to compare loss rates across companies. There’s different customer strategies, there’s different underwriting strategies, there’s different pricing strategies. And so I’m not sure I’m the right one to sort of try to do the sort of specific crosswalk. I think what is important to me, though, is not the charge-off rate in isolation, but the charge-off rate in the context of the overall ROE on those loans over time. And obviously, there’s a level of charge-off rate that we would be uncomfortable with from a reputational risk perspective and just the impact it has on customers, no matter how much we could price for that loan.

But I think within those guardrails, the process that we employ is really a pretty rigorous process. We look at every kind of credit sale. We look at sort of expected lifetime loss for that unique credit sale. We look at the cost to acquire within those credit sales. And we look at the pricing of those credit sales. And we very routinely will sort of ex small cells off if we feel like losses at a place again where it’s not in the customer or our reputations kind of best interest to do that business. But what we really focus on for the majority of it is, are we earning that attractive ROE that Steve talked about previously? And that’s why, quite frankly, we really focus so much on what is our expected lifetime loss versus what we assume at underwriting, because we know if we can stay within that and we use our vintage curves to sort of manage that, then we know we’re generating those high-quality returns, which our investors should really appreciate.

Sanjay Sakhrani: Okay. Thank you very much.

Operator: Thank you. Our next question comes from John Hecht with Jefferies. Your line is open.

John Hecht: Good morning, guys. Thank very much. Most of my questions have been asked. I guess, one question is maybe just a refresher. The yields moved up pretty big from Q3 to Q4. I know there are some kind of resets during the year. Maybe can you just, I guess, refresh us about the repricing mechanisms in the portfolio?

Steve McGarry: Sure, John. So pretty straightforward. Basically, half of our portfolio is tied to one month LIBOR as for portfolio is fixed rate. Borrowers have been choosing fixed rate at a much higher rate in the last two or three years of originations for all the obvious reasons. So that mix is changing slowly, but surely. The bottom line is that, we were positioned marginally asset sensitive over the last year or two, and we have benefited to a certain degree from the rise in LIBOR, which is up obviously four plus percent over the last year. So we have benefited from that somewhat. But we try and run a pretty balanced book. So we’re not really getting out over our SKUs in terms of taking interest rate risk. Our real goal is to book a nice solid NIM year in and year out. And I think we’re pretty much in that sweet spot right now.

John Hecht: Okay. Thanks. And then in terms of just thinking about capital allocation, I mean, it seems like you’re targeting a similar amount of sales in 2023 versus 2022. How do we think what that means in terms of like comparable buyback cadence in 2023 versus 2022 or other kind of facets of your capital return program?

Steve McGarry: Sure. So we’re trying to be balanced here. We want to maintain a steady program at that $3 billion mark. We do want to see slight growth in the balance sheet over time as CECL gets phased in, it is a little bit more challenging to maintain the size of the buyback program that we have in the past and we did $1.5 billion, then we did $700 plus million. Last year, Jon in his prepared remarks indicated that we have $581 million of authorization left from our Board-approved buyback. We do not expect to go back to the Board this year to acquire additional share repurchase authorization. So I think that gives you an indication of the size of the program that we’re contemplating this year, it’s probably a little bit under the $581 million.

We did just make our second down payment on CECL phase-in with two left to go, and we don’t talk a lot about the medium term, but we have indicated in the past that as we fully phase-in the CECL charge on equity, we will get to a point where we can generate capital to return to shareholders without a significant loan sale. And I think that’s very important to keep in mind because that means we can start to grow our balance sheet, grow our earnings and return capital to shareholders without a major charge on our balance sheet. And obviously, it’s probably always worth reminding people that in the loan sale process, not only do we earn the premium, but we release a big hefty CECL loan loss reserve and then a nice chunk of capital that’s applied to the balance sheet to return to shareholders.

Jon, anything you would like to add to that?

Jonathan Witter: I think you covered it well, Steve.

John Hecht: Very helpful. Thanks guys.

Steve McGarry: You’re welcome.

Operator: Thank you. Our next question comes from Jeff Adelson with Morgan Stanley. Your line is open.

Jeffrey Adelson: Hi. Thanks for taking my questions. Jon, I appreciate all the color you’ve given so far on the actions you’re taking to remediate some of the issues you’re seeing. But that’s my question, it sounds like that’s more on the P&I side, on the repay side. I guess I’m wondering, is there anything you’re also doing on the front end of the book as you underwrite? I know that takes a little bit longer to play out in terms of impact to credit down the line. But just wondering if there’s anything you’re taking away from your new modeling and analytics to apply it to your underwriting today?

Jonathan Witter: Yes, Jeff, great question. And you can imagine that’s getting a lot of our thought and it goes through effectively the same process that I just described a few minutes ago. So every year, and we’ll do this again as we sort of head into peak season, we will go back, we will look at all of the losses by all these layered risk segments that I’ve talked about. And we will look at the returns, we will look at sort of the pricing, and we will look at sort of the ROEs that result from that. I think at this point, I am sure there will be some adjustments on the margin. Any time you have greater insight about sort of potential losses, you have to incorporate that into that process. I don’t think we have reason to believe at this point that that will be a major redefinition.

And of course, remember, we’re underwriting today for loans that will come into P&I a year, two, three, four years from now. And so we also want to make sure that what we’re picking up on is a true lifetime loss change versus just a blip because of environmental factors. So we will think through all of that as a part of this. So yes, we absolutely think through that, by the way, not just during times like this where we see a little more strain, we do that during the good times too where we see less strain, and we feel like we’re always trying to optimize those underwriting conditions.

Jeffrey Adelson: Got it. And then just to maybe follow-up on the other questions with the loan sales this year. Can you may be shed some light on what your potential buyers are thinking about as they see these losses start to tick up a little bit? I know you mentioned you don’t think that this is changing your lifetime loan assumption, but are the buyers willing to maybe accept a little bit of that because of the higher interest rate they’re getting today? Or maybe what’s the thought process you’re handing from them?

Steve McGarry: So buyers always stress their default expectations when they’re pricing up a loan portfolio, I think it is the case that an increase in life of loan losses of 1% or 2% does not have a meaningful issue on the IRR on that portfolio and our loan buyers are very serious students of the historical performance of our assets, and I’m pretty confident that they will be able to assess the issues that we’re having with the portfolio at this point in time and draw the appropriate conclusions. Are they going to try and challenge us and get a better premium? No doubt whatsoever, but I think that the long-term performance of this portfolio will carry the day. Jon mentioned in his prepared remarks that we are starting to see some improvement in default rates. And I think that, that will manifest itself in the stats as they emerge, for example, in the next monthly ABS servicing report, et cetera. So hopefully, that answers your question.

Jeffrey Adelson: Great. Thanks for taking my question.

Operator: Thank you. Our next question comes from Arren Cyganovich with Citi. Your line is open.

Arren Cyganovich : Yeah. I just wanted to follow-up on the net interest margin. You guided above 5%. Can you give us an idea of that much about 5%? And what kind of cadence, I think cash usually kind of swings around your net interest margin quarter-to-quarter?

Steve McGarry: Sure. So I mean, I’ll try and answer the question with as much candor as possible. I think that you can be pretty confident that our net interest margin should be relatively close to what you saw in 2022. Give or take a handful of basis points. It is the case that our funding is pretty steady and pretty long term. So in any given year, we’re replacing, I don’t know, 20% to 30% of our funding and our portfolio performance is pretty predictable. And I think we actually have done a very good job of estimating our net interest margin year in and year out. So I feel pretty confident in making the statement that I just did. And you are correct. So for example, we ended the year with 23.5% of total liquidity on the books and that was positioned to fund the big loan disbursements that we made in the first quarter of this year.

So there is cyclicality in the NIM, but it’s not as meaningful as it was back in the days when we carried a lot less liquidity than we do today.

Arren Cyganovich : Great. That’s helpful. And then just last question is with the higher loss expectations kind of booked into the provision this quarter, does that essentially kind of reduce the need for additional provision builds well above the, I guess, the charge-off rate. I know it’s kind of different because it’s more geared towards the originations? And then the last — other part of that is what kind of unemployment rate are you assuming this year in your net charge-off guide?

Steve McGarry: Sure. So, the one benefit of CECL, and I can’t think of many more, is that, at any given point in time you are reserved for all expected losses in the future. And I think we were pretty thorough in our reserve build this quarter. So unless there are major changes in the performance of our portfolio or the outlook for the economy, the only reserve building we should be doing in 2023 is for new loan originations. So I think that’s the situation there. In terms of economic assumptions and unemployment rates, we are a user of Moody’s forecast. We blend the base, the S1, which is a slight improvement in the economy and the S3, which is a meaningful economic downturn. And when we compare expected unemployment rates at both the college graduate level, and the household unemployment level prediction for the economy is large.

We’re seeing pretty steady unemployment rate. So no major changes, for example, from Q3 to Q4. Although that being said, as a result of the probability of default model and the economic outlook, there was a component of the reserve build that was attributable to — in change in the — negative change in the economic outlook.

Arren Cyganovich: Thank you.

Operator: Thank you. Our next question comes from Giuliano Bologna with Compass Point. Your line is open.

Giuliano Bologna : God morning. I realize a lot of these — the questions around the subjects have been asked. One thing I’m curious about, when you think about your reserve forecasting and your expectation around sales. You were highlighting that a higher contribution from kind of less seasoned or early in the life cycle borrowers with higher payments being a larger source of weakness at the moment. I’m curious how you think about student loan forbearance. I realize that it’s never ending . It’s been the way it’s been playing out. But I’m curious how you think about the restart of a payment on federal loans because that obviously had an additional payment on top of a lot of those borrowers we are seeing weakness with higher payments.

Jonathan Witter: Yes. Giuliano, it’s Jon. Happy to take that question. First of all, again, just to make sure there’s no misunderstanding, the example I gave you is a true and indicative example. There are other small pockets as well, but I think that’s one that’s pretty easy for folks to get their head around. But to your specific question of forbearance, I think our analysis and our perspective for a while has been that student loans — federal student loan forbearance when it is no longer an active when it’s — when payments come back will be a slight negative to our sort of kind of a loss forecast. And I think we believe should it happen that debt forgiveness is probably a small positive to that forecast. So you can pick from column A or column B of various federal proposals and it’s probably a marginal benefit, a marginal cost or maybe even just sort of neutral down the middle of both happen.

I think the thing that’s really important to note on this is, our customers, we rarely very actively move back into repayment and Steve remind me of August or so of 2020, September of 2020. So we really feel like keeping people in good financial habit is the most important thing that we can do. And so, I think part of why we believe the impact is probably more muted is, if you’re in the habit of making your regular payments to Sallie Mae, you’re probably going to continue to do that. And by the way, if you do feel stressed because of your federal programs, I think what we see pretty clearly is, there’s a lot of options for federal borrowers to get forbearance and other forms of income-based repayment and the like. And so my guess is, for the ones that are really in trouble and really sort of struggling with that added federal payment, they will have other options that are available to them through the federal program.

So you sort of put all of that in the proverbial mix master. And I think we believe it’s sort of probably a small negative, but nothing that I think we believe will kind of meaningfully move our results. So hopefully, that gives you some perspective.

Giuliano Bologna: That’s very helpful and I appreciate it. I will jump back in the queue.

Operator: Thank you. There are no further questions. I’d like to turn the call back over to Jon Witter for closing remarks.

Jonathan Witter: Great. Well, thank you. And let me just say thanks to everyone. I thought the questions were great. Hopefully, they provided you really good information that you can use to make sense of what I know is a little bit of a challenging quarter here with lots of moving pieces and parts. So really I do appreciate everyone’s thoughtful engagement and I would just sort of continue to offer if any of us in our IR group and Melissa can be helpful as you sort of continue to do your assessment of the quarter, please reach out, happy to engage. I think with that, Melissa, I’m turning the call back over to you.

Melissa Bronaugh: Thank you for your time and questions today. A replay of this call and the presentation will be available on the Investors page at salliemae.com. If you have any further questions, as Jon mentioned, feel free to contact me directly. This concludes today’s call.

Operator: This concludes the program. You may now disconnect. Everyone, have a great day.