Good day and welcome to the 2022 Third 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. 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 Brian Cronin, Vice President, Investor Relations. You may begin.

Thank you, Michelle. Good morning, and welcome to Sallie Mae’s third quarter 2022 earnings call. It is my pleasure to be here today with Jon Witter, 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 Form 10-Q for the quarter ended September 30, 2022. This is posted along with the earnings press release on the Investors page at salliemae.com. Thank you. I’ll now turn the call over to Jon.

Thank you, Brian and Michelle. Good morning, everyone. Thank you for joining us to discuss Sallie Mae's third quarter results. I hope you'll take away three key messages today. First, we had a successful peak season, highlighted by increased demand from underclassmen. Second, in a challenging environment, we delivered strong results for the third quarter and the first three quarters of the year. And third, our credit performance is in line with the expectations we laid out on the second quarter earnings call and we continue to believe that the factors we previously identified as elevating charge offs will be largely isolated to 2022. Let's begin with the quarter's results. GAAP diluted EPS in the third quarter of 2022 was $0.29 compared to $0.24 in the year ago quarter. In the quarter, we closed a $1 billion loan sale and booked a gain on sale of $75 million. This sale also released over $50 million of reserves through our income statement and freed up meaningful capital that can be returned to shareholders. In this market environment, we are pleased that we were able to execute our planned $3 billion of loan sales for the year at an average premium of just under 10%. Our loan sale share buyback arbitrage strategy has continued to work in a challenging environment. Since January 01 of 2022, we have repurchased $553 million of shares and reduced shares outstanding by nearly $34 million or 11%. Since January of 2020, we have reduced shares outstanding by 42% at an average price of $15.40. We expect to continue to repurchase shares daily for the remainder of 2022. Our financial results are not just about gain on sale. Year in and year out, our quality loan portfolio generates significant net interest income. Through the first nine months of…

Thank you, John. Good morning, everyone. Let's start where we usually do with the discussion of our loan loss allowance and provisions. The private education loan reserve was $1.3 billion or 5.5% of our total student loan exposure, which under CECIL includes not only beyond balance sheet portfolio, but also the accrued interest receivable of $1.2 billion and unfunded commitments of another $2.2 billion. Our reserve rate is up slightly from 5.4% in the second quarter of this year and 5.2% in a year ago quarter. Let's look at the major variables used to calculate our allowance for credit losses under CECIL. We continue to use movies base S1 and S3 forecasts, which are weighted 40%, 30% and 30% respectively. We expect to use this mix going forward except during extraordinary periods of economic uncertainty. Despite concerns about the health of the economy, forecasts provided by movies are remarkably stable. As an example, the weighted average forecast for college graduate unemployment is essentially unchanged from a prior quarter at 2.56% and down 31 basis points from the year ago quarter. As John discussed, prepayment speeds were slower than expected this quarter due to the increasing rate environment and our prepay speed model expects this slowdown to persist. This change caused an increase to our reserve of approximately $57 million compared to both the prior quarter and the year ago quarter. However, it is worth repeating what John has already pointed out, that this is a positive as the assets that we have paid to acquire will remain on our books and generate interest income for a longer period of time. New commitments are also an important variable in the calculation. Q3 is our peak lending season and we added $3.1 billion to unfunded commitments, which required a provision of $163…

Thanks, Steve. The results we posted this quarter demonstrate that we are continuing to execute the business plan we have outlined for our investors. We are focusing on strengthening our core business and maximizing the value of our brand. This is evidence by our strong origination growth, well-managed operating expenses, and the continued optimization of capital allocation. Our acquisition of Nitro College improved our capabilities and direct-to-consumer marketing, particularly in content and relationship based marketing. Nitro has contact with 5.5 million higher education bound high school seniors and their parents. This acquisition will broaden the amount of data we collect, increase our originations, and lower our costs to acquire. We benefited in our peak season originations as a result of this acquisition. In the quarter, we also made the decision to dramatically change our approach to the credit card business and has become clear to us that the expense required to conduct this business and the scale necessary to succeed is significant and our past strategy would not have generated shareholder value. As such, we have made the decision to stop originating cards on our books and have reached a preliminary agreement on indicative terms to divest the $29 million portfolio. We expect the cost of exiting the business to be minimal and it will free up management to focus on other opportunities. We do believe that marketing cards to our attractive customer base is both a source of incremental value to Sally Mae and useful to our customers. Our focus will now shift from managing a card business to finding a suitable referral and marketing partner or partners. The macroeconomic environment is volatile. Like other banks that have reported, we are not seeing a weakening of our core portfolio. As Steve noted earlier, the economic forecast we use to…

[Operator instructions] Our first question comes from Sanjay Sakhrani with KBW. Your line is open.

Thanks. Good morning and congratulations to Brian and Michelle. Just a question on the incremental loan growth this quarter, it's really positive that you guys have absorbed the growth inside the EPS targets you guys mentioned. I'm just curious how we should think about that loan growth into the future? Obviously the gain on sale was still pretty good. Do you think that, that level of gain on sales continues? Thanks.

Sanjay, I'm sorry you cut out at the very end there. Can you please repeat the last part of your question?

Yeah, the gain on sale on loan sales was still pretty good. Do you think that level continues into the back part of this here and to next?

Yeah, Sanjay look, first of all, let me say, I think it's impossible for us to predict market conditions, going out into next year. And as we've said all along, the strength of the auction is obviously a big determinant of the premiums that we get and we've worked hard to sort of strengthen that. I think what I would say is the following. Number one, we remain very committed to a strategy of returning capital to shareholders. We remain very committed to the arbitrage strategy that we have laid out. I think while we saw a lower premium in the last loan sale than the several before it, that was offset by a lower share price as well to buy back shares, with the proceeds of that loan sale. And as I think we've described in the past, we continue to use a very rigorous sort of grid, if you will to look at that relationship between loan sales and share buybacks. And we certainly expect, although can't guarantee, we certainly expect there to be a continued positive relationship for the foreseeable future between likely loan premiums and sort of the multiple at which we would buy back those shares. I think we were encouraged that even during a period of pretty unprecedented market volatility and interest rate increases that we were able to execute the last loan sale at a -- what we think is a very respectable premium and one that creates real shareholder value. And I think it is certainly our belief that through the course of 2023, markets will normalize and there will be a great environment for us to continue that loan sale strategy. And so, it's again, hard for us to make predictions about exact premium, but I think based on what we're seeing here, you should expect that general strategy to continue.

I appreciate that. I know it's pretty volatile out there. Follow up question is on kids coming back to school, I'm just curious if you're seeing any difference in the behavior of those. Obviously the prepayment speed slowed some, maybe you could just give us a little bit more color on that as well. Thanks.

Yeah, I think in terms of the behavior of kids coming back to school, I think all the industry data that we are getting is that the pandemic did not influence every school and every region equally, and that schools and students are not recovering equally and so if you look at it, I think there's certain geographies that have a little bit slower to come back to norm. I think there have been certain schools that have been a little bit slower in coming back to Norm. If you've read any of the Wall Street Journal or other articles recently, for example, it points out smaller liberal arts schools in the Midwest tend to be a little bit slower and coming back than potentially some others. And so I think the impacts in the impacts out of the pandemic have been a little bit uneven in that regard. This is obviously where our having a relationship with the vast majority of colleges and universities out there is really an advantage. And we obviously have relationships with schools who are doing exceedingly well this year and I think you see that in our numbers. In terms of, Sanjay, your question on prepay speeds look, we really view the slowdown in prepay speeds as an incredibly welcome and we think positive thing for our business. We work hard to attract customers. We work hard and spend money to book loans on our balance sheet. We think a primary investment thesis of this company is we originate and hold lots of high quality assets and slower prepayment speeds, we think make that investment thesis even stronger, even stronger. We have certainly incorporated current trends in prepayment speeds into our outlook and model, but I think it's certainly possible that you will see and even further deceleration. I think Steve mentioned this in his points in prepayment speeds going forward. The economics of loan consolidations, I think really support that in higher rate environments. It's just more economically challenging for competitors to engage in that part of the business. I think if that happened, we would be delighted. So we love the incremental $600 million of loan balances that I referenced in my talking points. But I think again, we're going to continue to watch this and it's certainly a possibility going forward.

Our next question comes from Rick Shane with JPMorgan. Your line is open.

Thanks for taking my questions and Brian thank you for all the help over the years. We really do appreciate it. A comment and then a question, the decision to back away from the card space I think that that reflects a culture of constantly reassessing your business. And I think that's really healthy. I hope, frankly, that we do that as investors. And I think that's a good development in terms of or good signal in terms of the way you guys assess things. I am curious, obviously a lot of conversation this morning about the slowdown and consolidation. One of the concerns has always been that the loans that consolidated -- that are consolidated away basically cause your portfolio to incur modest degree of adverse selection. Are you seeing any sort of positive mix shift or would you expect a positive mix shift is your best loan stay on longer?

Rick, first of all, thank you for your comments about Brian and thanks for your question. I think I would step back from the premise, and Steve you should jump in if you disagree. That consolidations have never been an outsized part of our business. I think there was concern about this sort of three, four, five years ago. I think, as I've said on a past call, what we've really interpreted is it's been sort of a modest and perpetual cost of business, doing business for us. So, the honest truth is I don't think we yet have enough experience to know whether there will be a material mix shift in terms of credit quality. But I think, the reality is the volumes that we're talking about relative to the balance sheet overall, I would not expect that you would see material changes in credit mix, even if there was the positive selection that you referenced just because of the weighted average math of the whole thing. So I think it's a positive in terms of overall balances, I'm not sure I would build in or assume a material change in credit metrics as a result.

Got it. And then just one last question. You talked in terms of the loan sales about the auction process and obviously we sit here basically with two metrics, volume and margin. Can you give us a little bit of insight? Obviously I realize there's discretion about who the potential buyers are, but what that process looks like, the number of participants, and just help us understand that a little bit more.

Sure. Rick, this is Steve, happy to answer the question. So look, with each additional loan sale we have tended to attract additional interested buyers. It is a very attractive asset class, high quality loans good returns to the buyer. And the more the continued auctions attract more people that do the work, understand the asset, and are ready to participate in the auctions. To put a number on it, there's probably at least a dozen interested buyers at this point in time. And in a typical process, they're working with a banker that helps them securitize the loan and parcel out the different segments to the appropriate portfolios within a purchaser's organization. So, there are a number of buyers that range from insurance companies to fixed income money managers to hedge funds, etcetera. There is a pretty deep buyer base for these assets at this point in time.

Terrific. Steve is always, I appreciate your willingness to put a number

Our next question comes from Jeff Adelson with Morgan Stanley. Your line is open.

Hey, good morning. Thanks for taking my questions. Appreciate the color on being back in the market on the daily buybacks. Just curious, you previously mentioned before that you were looking to do about half of that one and a quarter buyback billing buyback plan this year and next year. Just wondering if that still holds and then just given the slower prepayments and impacts to the loan balances, and then you've got another leg of CECIL phase in coming in 1Q wondering if there's any consideration for that in the buyback claim as well.

I'm sorry, I missed the second part of that question, but the jobs…

The CECIL phase in the next leg.

Yeah. look, I think that at the beginning of the year, we indicated that we were going to spend about $700 million in calendar year '22 on the buyback. And that very much continues to be the plan for the year, and I think we've spent somewhere along lines of $580 million at this point in time. So there is a considerable amount left to be spent in a short number of trading days left in the year.

And Jeff, to your question on the next CECIL payment and sort of whether it's factored into the Share Buyback program, the simple answer is, yes. We do pretty comprehensive capital plans and obviously the CECIL contributions are a key part of that. As a reminder for everyone on the call, part of why we really like and think the Share Buyback Loan sale program is so accretive is while post CECIL phase and we have great confidence in the organic capital generation capability this business. During CECIL phase in, there's obviously an additional draw on capital to make those incremental payments. And so what the Share Buyback program allows us to do the Loan Sale Share Buyback program, is it allows us to one, take advantage of the arbitrage. That's the single biggest reason. But it also allows us to ensure that we are consistently every year returning capital to shareholders, at a time where we would have less capital to return, had we not done that again because of the CECIL phase in. So make no mistake, we view the share -- the loan sale buyback program as a medium term strategy. We absolutely believe that post CECIL phase in there will be much more organically generated capital. But the CECIL phase in is one of the reasons why we implemented this strategy and why we like it so much.

Got it. Thank you. And then I noticed that your deposit group ticked up a little bit this quarter. It looks like you're maybe leading into CDs a little bit. Can you just remind us of your funding strategy and what your plans are for the funding there?

Our funding strategy has pretty consistently been to use deposits for 80% of our funding and the asset back market for the balance of 20% of our funding. We really like the asset back market as a means to extend the duration of our liabilities where we can basically get life of loan funding. But of course, we are a bank and the bank deposit market is deep and very liquid. So we do take advantage of that. Our plans for balance sheet growth as we execute the loan sale buyback strategy are very modest. So the balance sheet's going to grow, in the low single digits over the next couple of years. So we anticipate that our deposit base will be growing accordingly and we will grow both our activity in the retail slash internet-based deposit market as well as in what we view as very favorable funding market broker deposit market, where we can also raise long-term funding to match the long-term assets that we have on our books.

[Operator instructions] Our next question comes from Moshe Orenbuch with Credit Suisse. Your line is open.

Great. Thanks John and Steve and Brian of best of luck. What I was hoping without kind of beating a dead horse completely on the gain on sale, I guess if you think about the three components, one is obviously the interest rate or margin on your loans, the other is the, underlying credit performance, and third is the loan life. It just seems to me like each of those three move to the positive. And while we don't know exactly what the interest rate environment will be, when you're doing these loan sales in 2023. I guess one would hope there's a little more stability and so I guess, is there anything wrong with the logic that each of those three components is better? And you've probably got a 3% larger book to think about, like can you kind of critique those statements?

No. Look Moshe, I think you're absolutely correct, and in Jon's prepared remarks, he did indicate that the extending weighted average life is a net positive as the cash flows are greater and longer. And look, I think, the credit despite the last two quarters has been very consistent. Investors have done the work to understand the asset class and how to model it. And the last thing that I would point out is we are still a 50% variable and 50% fixed rate portfolio that we still representative samples of. So the reality is that really only half of it is exposed to rising interest rates. So yes, we continue to feel very good about the market for loan sales. And the last thing that I would add, and we have some curable background noise, is that when we look at the premium, we also consider the reserve release to be part of the profitability of the loan sale. So you can think about adding 5% of loan sale reserve release to whatever premium is that we earn on the portfolio. So, it's still a very viable and important strategy for the company.

Got it. And maybe as a follow up, given the commentary on the credit card sale, Jon, are there any other sort of areas that you're thinking about in terms of ways to kind of expand marketing to your customers, either directly or through partners?

Yeah, Moshe. The real first step I think in this strategy was to enhance our direct-to-consumer marketing capabilities, and as I said in my prepared remarks, really in the area of content based and solutions-based marketing. We think that the Nitro acquisition has really done that for us, and what we have added through that acquisition is a capability that now one, allows us to have a customer initiated conversation with I think the number ended up being this year about 37% of all college interested high school seniors and families. We think that will grow, and we said this last year when we did the deal, we think that will grow to upwards of 50% over the next year or two. So, we get to have those conversations and we get to have those conversations in a much broader way than simply talking about loans. We are engaging with them on a wider range of topics than what Sally Mae has historically engaged with those customers on. Our focus for that acquisition through the first six or seven months has been integration and delivery of peak season. And we very purposefully asked that team and the rest of our commercial organization, to not worry about the future, but to deliver the present. And I think the 13% numbers that we laid out earlier indicate that the team was nicely successful in doing that. The real focus now is going to be figuring out how do we expand, what that can look like. And by the way, I think that will come through, direct product referrals for banking type products, but I think it will also come for us looking for other ways to monetize, the rich first party data that we think we will have from these customers now and going forward in the future. So credit card will be, I think, the first step there, by the way, continuing to market to those customers. Our existing deposit products I think will be one of the very first steps out of the gate. We've got some great savings brands out there for example, our Smarty Pig brand that we think fits very, very nicely with this overall population. But I think you should expect, in the next couple of quarters for us to lay out a bit more of a roadmap on what some of those other opportunities could be because again, while we feel like there's real earnings growth potential in our core business, and you'll remember the little diddy, I always talk about, high single digit origination growth, 60% fixed cost business, real operating leverage, we like the organic growth capability of our core business. We think the real future growth is going to be through these kinds of things. So I would focus on the shifting card strategy and deposits as the first set of things, but I think you should also expect to hear, more in the months and quarters ahead.

There are no further questions. I'd like to turn the call back over to Jon Witter for any closing remarks.

Great. Well, I will be brief. Brian, thank you again for all of your service over the last nine years. Melissa, welcome. Look forward to working with you. And thanks to everyone on the call for your interest in Sally May. We are excited about the performance of this quarter and look forward to what we know will be continued strong performance into 2023 and beyond. With that, Michelle, Melissa, Brian, thank you. Thank you everybody. Hope you have a great rest of your week.

Thank you, Jon. Thank you for your time and your questions today. And thank you for the last nine years. The call [audio gap] will be available on the investor's page @sallymae.com. If you have any further questions, feel free to contact me directly. This concludes today's call.

Ladies and gentlemen, thank you for your participation. You may now disconnect. Everyone, have a great day.