SLM Corp Q1 FY2021 Earnings Call

Good day, and thank you for standing by. Welcome to Sallie Mae's First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Brian Cronin, Vice President of Investor Relations. Please go ahead.

Thank you, Regina. Good morning, and welcome to Sallie Mae's first quarter 2021 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 impact of the COVID-19 pandemic on our business, results of operations, financial conditions, and/or cash flows. During this conference call, we will refer to non-GAAP measures, which we call our core earnings. A description of core earnings, a full reconciliation to GAAP measures, and our GAAP results can be found in the Form 10-Q for the quarter ended March 31, 2021. This is posted along with the earnings press release on the Investors page at salliemae.com. Thank you. I will now turn the call over to Jon.

Brian, Regina, thank you. Good morning everybody. Thank you for joining us today for a discussion of Sallie Mae's first quarter results. It has been one year this week since I joined the company, and I am incredibly proud of the hard work of the Sallie Mae team and what we've accomplished during what can only be described as difficult times. We're off to a fast start in 2021, executing our strategy and delivering strong results. We are encouraged by the trends toward normalcy, driven by vaccine distribution, and we're particularly encouraged by what this implies for colleges and universities in the fall. I hope you walk away today with three key messages. First, we've delivered strong results in the quarter. Second, we're executing our 2021 capital return program as expected. And third, I believe we are well positioned to continue our performance trend this year by executing against our core strategies. GAAP EPS in the first quarter was $1.75 compared to $0.87 in the year ago quarter. Our results for the first quarter were driven by a combination of strong business performance, improvements in the economic outlook, and gains from the sale of loans. Let me start with the discussion of our business performance. Private education loan originations for the first quarter were $2.1 billion, while down 10% year-over-year as a result of the pandemic's impact on the overall market. We believe this is a strong start to the year and positions us well to achieve on our full year goals. Remember, the first quarter of 2020 originations were not meaningfully impacted by the pandemic. Our market share results for the first quarter will be available in the next few weeks, however, we are coming off a very strong 61% market share in the fourth quarter of 2020. Originations quality was consistent with past years. Our cosigner rate was 89% compared to 88% in the Q1 2020 quarter. Average FICO scores were 751 versus 746 in the year ago quarter. We executed a $3.16 billion loan sale in the first quarter of 2021 and recorded a gain on sale of $399 million. This is just under a 13% gain on sale for these loans, which represents a new high watermark for our loan sale program. Our credit continues to be a highlight as we emerge from the pandemic. Private education loan annualized net charge-offs for the first quarter were 1.29% compared to 1.52% in the fourth quarter of 2020. Delinquencies are especially important in the first quarter of the year, and that number reflects the initial performance of the new graduate vintage of loans that entered P&I in the fourth quarter of the previous year. I'm happy to report this performance is in line with past cohorts, despite all of the challenges of the last year on the economy as a whole. During the first quarter, the economic outlook and assumed prepayment speeds in our CECL loss estimates impacted our reserves. As we have discussed on past calls, these aspects of CECL are difficult to forecast because of the change in assumptions around the macroeconomic environment. While Steve will discuss both changes in more detail, the impact of these forecast-related charges was a negative provision of $226 million in the first quarter, bringing our loan loss reserve down to $1.193 billion, which includes the reserve for unfunded commitments. In the first quarter, we made tremendous progress against our capital return strategy, some of which we have discussed during our January earnings call. On January 28th, we completed the $525 million accelerated share repurchase program and received 13 million additional shares of common stock over what had been returned in 2020. This was an extremely successful program where the company repurchased 58 million shares of common stock in total, at an average price per share of $9.01. On February 2nd, the company announced the commencement of a modified Dutch Auction tender offer to purchase up to $1 billion of the company's common stock. On March 16th, the company purchased 28.5 million shares of its common stock at a purchase price of $16.50 per share for a total purchase price of approximately $472 million. Although not fully subscribed, we were pleased with the outcome of the tender offer for two reasons. First, we were able to repurchase a significant number of shares in a short period of time at an attractive price. Second, we believe the subsequent share price movement and the 47% participation rate demonstrate that investors believe in the fundamental value of the franchise. Soon after the tender closed, we began aggressively buying shares using a 10b5-1 program. Through April 20th, we spent $370 million to buy back 20 million shares at an average price of $18.51 through this program. I think it's important to keep our regular and persistent capital return program in perspective. In 2021, we have repurchased 16.5% of the shares outstanding at the beginning of the year. Since January 1 of 2020, we have repurchased 26% of the shares outstanding at that time. Said again, in a little over a year, we have repurchased a little bit over a quarter of the shares outstanding since we began our strategic capital return program. As of April 20, 2021, we have $485 million in authority left under the original $1.25 billion authority granted under our 2021 share repurchase program. Although we have made considerable progress in our stock price, we remain committed to our strategy of selling loans and using the proceeds to repurchase stock while the price is undervalued and we are facing in CECL. Before I turn the call over to Steve to discuss the quarter's financial results in more detail, I'd like to take just a moment to reflect on the progress we have made over the last year. On a Q1 to Q1 year-over-year basis, we have increased GAAP net income by 77%, reduced our operating expense by 15%, reduced our common shares outstanding 26%, and that's again, since the beginning of 2020, and increased our GAAP EPS by 101%. Although the macroeconomic environment has added volatility to the results over this last year. I hope you'd agree, we are making progress against our strategic imperatives. Steve will now take you through the financial highlights of the quarter.

Thank you, Jon. Good morning, everyone. I will continue this morning's discussion with a detailed look at the drivers of our loan loss allowance, the key components of our income statement, and our strong liquidity and capital position. The private education loan reserve, including the reserve for unfunded commitments, was $1.2 billion or 5.4% of our total student loan exposure. Under CECL, this includes the beyond balance sheet portfolio, plus the accrued interest receivable and unfunded loan commitments of $457 million. Our reserve at 5.4% of the portfolio has decreased significantly from 6.5% in the previous quarter. As you know, we incorporate several inputs that change from quarter to quarter when preparing our allowance for loan losses. These inputs include CECL model factors and overlays deemed necessary by management. The most impactful CECL model inputs include economic forecasts, forecast weightings, prepayment speeds, new volume, and loan sales. I will now discuss each of these impacts. Under CECL, the economic forecasts we employ drive quarter-to-quarter movement in the allowance. As previously discussed, we utilized Moody's base S1 and S3 forecast, weighted 40%, 30%, and 30% respectively. These forecasts and their weightings remained unchanged from the prior quarter. The state of the economy and its outlook continue to improve as you are all aware. The unemployment forecast for college graduates has decreased by an average of 1%, representing a nearly 25% reduction in projected unemployment. This reduction has contributed to the need for a smaller reserve. Regarding prepay speeds, this has been an area of monitoring since the pandemic began. Our CPR forecast, as modeled, was not aligning with the current observations and trends. Consequently, we implemented a new CPR model this quarter. The new model and the improving economy contributed to a notable increase in prepay speeds. The faster prepay speeds we modeled this quarter also reduced our reserve needs. We believe our probability of default and cash flow models are in good shape and will not add any significant volatility throughout the year. Moving to volume, it is a critical driver of our allowance supports. While the first quarter typically sees a large disbursement for the spring semester, many of these loans were reserved at the time of commitment in the fall of 2020. New loan commitments this quarter amounted to $843 million, leading us to increase our reserve requirement by $40 million. The reserve for the majority of loans sold this quarter was released in the previous quarter. Therefore, loan sales did not significantly impact the reserve this quarter. The factors mentioned, along with other elements, including overlays and the natural accretion of our discounted reserve, resulted in a $222 million provision for credit losses in our private student loan portfolio. For the next few minutes, I will discuss our credit metrics, available on Page 8 of our investor presentation. For our held-for-investment portfolio, which this quarter is the entire portfolio, private education loans in forbearance were 3.7%. This is down from 4.3% in Q4 of 2020 and 6.2% in the same quarter last year, as we anticipated due to the economic improvement we have observed and expect to continue. In terms of delinquencies, private education loans that were 30 or more days delinquent stood at 2.1%, down from 2.8% in Q4 and 3.2% a year ago. While these results are encouraging, we anticipate that 30-plus day delinquencies may rise to around 3% in mid-2021, followed by a decrease for the rest of the year. Regarding charge-offs, the percentage of average loans in repayment was 1.29%, up from 1.05% a year ago, but down from the 1.52% Jon mentioned in the prior quarter. We still expect charge-offs for 2021 to increase to about 1.8% for the full year based on our current forecasts, but we are well reserved for these anticipated outcomes. Now, let’s discuss net interest margin, which you can find on Page 6 of the deck. NIM on our interest-earning assets was 4.4% in Q1, reflecting a decrease from both the previous quarter and the year-ago quarter. This decline was slightly influenced by our high cash balances, stemming from the stickiness of deposits in the current liquid environment and the proceeds from the January loan sale remaining on our books longer than expected. However, we are rapidly deploying this cash and capital, and we still expect NIM for the full year of 2021 to be around the 4.75% range we discussed in January. Regarding operating expenses, they totaled $125 million this quarter, compared to $122 million in the previous quarter, but down from $147 million in the same quarter last year. Operating expenses in our core student loan business dropped 15% year-over-year, despite a 3% increase in loan servicing costs. This has been primarily driven by the significant cost reductions from our Q3 2020 restructuring. While we are on the subject of operating expenses, we've also talked about providing unit cost information. For 2021, our target cost to service a loan will average roughly $5.75 a month. Breaking this down, servicing a current loan costs about $4.25, while servicing a delinquent loan costs approximately $27.50. These numbers will naturally exhibit some seasonality and include our planned efficiencies. Our goal is to optimize our cost structure and technology to reduce unit costs without compromising customer experience, recovery efforts, or our effective servicing practices. Throughout the fluctuations from quarter to quarter, we plan to report our annual progress on this front. Lastly, our liquidity and capital positions are notably strong. We concluded the quarter with liquidity at 25% of total assets. By the end of Q1, our total risk-based capital was 13.8%, and our common equity tier 1 to risk-weighted assets was 13.5%. These are very strong ratios, indicating we are well-capitalized. Additionally, in the post-CECL environment, we view GAAP equity plus loan loss reserves as a measure of our capitalization, which was a robust 15% at the end of the quarter. Our balance sheet remains solid in liquidity, capital, and loan loss reserves, positioning us well for business growth and returning capital to shareholders. Thank you. Back to you, Jon.

Thanks, Steve. I hope you all agree that we performed well in the first quarter and that you share my belief that we are well positioned to maintain that momentum throughout 2021. This belief hinges on our expectation of an improving external environment. Encouragingly, there continues to be positive developments regarding COVID vaccines. It's hard to believe that students will soon be starting the spring semester in the coming weeks and quickly planning for the fall. Our initial guidance for originations in 2021 was based on the expectation that the first part of the year would resemble the fall of 2020, with the second half benefiting from more normal school operations. Early feedback from schools about their fall 2021 plans confirms this, with most indicating they will offer a fully on-campus experience. We think this return to normalcy is exactly what students and their families want, leading to a strong rebound in attendance. Unemployment rates, particularly for college graduates, are also trending positively. The average unemployment rate for college graduates in the first quarter of 2021 was 3.8%, down from 4.1% in the fourth quarter of 2020, and remains significantly lower than the current national rate of 6.0%. The federal government continues to provide additional stimulus to taxpayers and relief for federal student loan borrowers through at least September 30, 2021, which should enhance our borrowers' ability to repay their loans. On the political front, we are starting to see higher education priorities from the new administration being discussed. We believe that any proposals aimed at helping lower-income students and families achieve higher education or targeted debt assistance are crucial and align well with our business. We consistently seek ways to inform and assist lawmakers in developing policies that improve outcomes for students and families. Additionally, I want to mention our recently released Corporate Social Responsibility Report. One key takeaway from the past year is the importance of taking responsibility for one another, our communities, and the planet. This duty applies to individuals, governments, and companies like ours that serve customers and communities. We take this responsibility very seriously at Sallie Mae. This year's report showcases our efforts to fulfill our mission of supporting students on their journeys and contributing to a healthier, more inclusive, just, and equitable world. I am optimistic about the progress we have made and enthusiastic about the work ahead. Let me briefly discuss our 2021 guidance. We remain focused on our core business performance and see opportunities to enhance both top and bottom-line results, further supported by share repurchases. Therefore, we are updating and reaffirming our 2021 guidance. We are increasing our GAAP diluted earnings per share range to $2.95 to $3.15, up from our previous range of $2.20 to $2.40. This upward adjustment is primarily due to two factors. First, changes in our CECL reserve, which should be viewed as a non-recurring item in the future, contributing approximately $0.55 to the guidance increase. The additional increase of around $0.20 is a result of strong performance in our core business and expectations for our loan sale program. As a reminder, this guidance includes an additional $1 billion of loan sales in the fourth quarter of 2021 that we mentioned in our last earnings call. We are also affirming our previously announced guidance for private education loan origination growth of 6% to 7% year-over-year. Consistent with our outlook for the spring and fall semesters, we anticipate loan originations will be lower in the first half of the year but increase significantly during the fall semester. We expect our non-interest expenses to end 2021 between $525 million and $535 million, reflecting our emphasis on efficiency and operational leverage. Additionally, we anticipate our total loan portfolio net charge-offs will range from $260 million to $280 million. With that, Brian, let’s open the call for questions. Thank you.

Our first question will come from the line of Michael Kaye with Wells Fargo.

Hi. Good morning. I wanted to talk a little bit about that NCO guidance which was unchanged that seems to me like the trends are a little bit better. You know, correct me if I'm wrong, but I recall last quarter you were thinking delinquencies will rise to the high 3% by mid-2021, but now I thought Steve said to about 3%. So can you just explain that?

Our guidance on delinquencies and charge-offs remains largely the same. In the fourth quarter, I mentioned that delinquencies are expected to rise above 3%, possibly reaching the mid-3s, before decreasing again. We are maintaining our charge-off guidance of $260 million to $280 million. In 2020, the folds were significantly lower than what we anticipated for the first quarter of 2021. We do have a backlog of defaults that we have set aside reserves for. As we progress through 2021, we will be using much less COVID-related forbearance, which we previously referred to as disaster forbearance. While we've continued to use it, the rate has significantly decreased to address defaults and delinquencies. We will be reducing this further in the coming months and quarters. It remains prudent to keep reserves for the potential default of the backlog of loans in our pipeline.

Okay. Thank you. Could you talk a little bit about any changes in how you're approaching the market for the 2021 peak season with one of the larger players in the sector having exited? I was just wondering if perhaps could you spend more on marketing or hiring more salespeople as more market share stands up for grabs now?

Sure, Michael. It's Jon. I’ll address that. We’ve discussed this in recent calls, and there have been significant shifts in market competition, particularly with the exit of a prominent competitor. I want to emphasize our commitment to the profitability of our loans and their return on equity. It’s crucial that we maintain strong discipline regarding our servicing and acquisition costs, as these significantly impact the long-term return on investment for those loans. There are limits to how much we are willing to invest in chasing volume, and we strive to be very disciplined in this regard. That said, we see this as a valuable opportunity to reinforce our presence in the marketplace. Together with our marketing and sales teams, we’ve closely evaluated not only our sales resource levels but also how we’re positioning ourselves to seize opportunities in educational institutions, utilizing proven sales management strategies. As mentioned in previous discussions, we continue to effectively invest in our direct-to-consumer marketing efforts, as well as in our partnership channels, which provide us with a meaningful source of high-quality loan origination. We believe we are taking the right steps to foster growth. However, we recognize that the pandemic has impacted enrollment unevenly across various channels, and not every student or family will pursue their higher education goals simultaneously. It may take a peak season or two for us to return to normalcy. Nevertheless, we are encouraged by the fourth-quarter results we’ve previously mentioned, and we will keep focusing on this as a significant opportunity in the future.

Okay. Thank you very much.

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

Thank you, Steve. I have a question for both you and Jon. When you mentioned where you believed the stock was fairly valued earlier this year, you referred to a number in the 20s, and it's good to see the stock approaching that level. Could you discuss your thoughts on the trade-off between completing the program and the decision between the loan sale and stock buyback?

Thank you for the question, Moshe. We have discussed this extensively internally. To answer, I'll break it down into a few parts. First, for anyone who hasn't heard our previous calls, we are firmly committed to strong capital allocation and return, which is a key part of our strategy. This commitment will remain a fundamental aspect of our approach as long as I am CEO. Over time, the ways we generate and deploy excess capital will change. As we've mentioned before, we expect that with the implementation of CECL, our reliance will shift from loan sales to more organic capital generation. While we will likely continue to sell some loans to enhance asset value and maintain an open channel, the overall balance will likely change. The focus of our capital deployment will also evolve from primarily share buybacks to a more balanced approach that considers various methods of capital return. The key question is when we make that shift, which will be guided by the known timeline of the CECL implementation. Steve and I frequently discuss our valuation multiples and where we should be positioned. We consider numerous factors in our analysis, including cost of capital and growth assumptions, critical to any robust evaluation. Our views on the ideal multiple may change over time, but we are not going to commit to a specific multiple that triggers a strategic shift, as that could also change. However, it is reasonable to say that we still believe we are several turns away from our desired valuation multiple. Thus, our current strategy is expected to continue for a while, but we want to emphasize that capital allocation and return will evolve. I hope to communicate progress on this topic in each quarterly update moving forward.

Great. Thanks. And I think your commitment to that capital allocation is pretty clear. Just a quick follow-up. Jon, you mentioned that $0.20 of that guidance increase was not related to the change in CECL and related to better operating trends. Without asking for specific guidance for years past 2021, but is it reasonable to assume that those amounts should kind of persist?

Absolutely. One thing investors often overlook is that we will continue to steadily increase our earnings over the next several years. There may be fluctuations, such as selling $4 billion in loans this year that could drop to $3 billion next year, but our earnings trajectory is definitely upward. Additionally, we've just started to leverage our internal capabilities to enhance efficiencies and capture a larger market share. Overall, we have a very positive outlook for our earnings potential.

Great. Thanks, Steve, and Jon.

Your next question will come from the line of Sanjay Sakhrani with KBW.

Hi. This is actually Steven Kwok filling in for Sanjay. Thanks for taking my questions. Just the first one, just around the $1 billion of loan sales that is expected in the fourth quarter. Within the guidance, what type of gain on sale is being assumed there and is there the potential to, if the environment remains strong, to do more than the $1 billion? Thanks.

So Steven, our guidance includes a premium that is slightly lower than what we just reported, but not by a significant amount. As for selling additional loans, we believe that's largely off the table regardless of where premiums may go. We have generated a substantial amount of capital that we haven't yet deployed this year, and we prefer to maintain a steady pace as we move forward. Therefore, you shouldn't expect us to alter our loan sales in 2021.

Yeah, Steven, it's Jon. I think the only thing I would add to what Steve said is that it's important to mention. We really believe that loan sales are a great way to take advantage of the current arbitrage between the whole loan markets and the value of our equity in the market. That's why we're being so aggressive in this area. As Steve indicated, the limit on that is how effectively we can deploy that capital. I want to remind everyone that our real goal, which we've started to discuss in past calls, is to generate stable, predictable, high-quality, high-profit, and growing earnings streams. We like these loans as they are very attractive, and we want to keep as many of them on our balance sheet for their full life as possible. We believe this will drive consistent earnings flow going forward. If we can combine this with a focus on top line growth and market share, while managing risk effectively, we see a winning combination. The reason we're not just focused on loan premium is that we care about earnings and growth today, but we are also very interested in establishing a long runway of predictable and attractive earnings growth in the future, which is the balancing act that Steve, our Board, and I will continue to navigate.

Got it. That's very helpful. And then just a follow-up question around the political front. Is there anything that you're seeing that they are monitoring from the new administration? Thanks.

I think on the political front, we are encouraged by the thoughtfulness of the debate and discussion happening currently, particularly with the proposals being put forward not just by the Biden administration but also by Biden's leadership in Congress. We've mentioned several times on this call initiatives like free community college and free public university education for families earning below certain income levels, which is currently around $125,000 a year. These proposals are gaining a lot of attention and traction, and we fully support them as they promote access to education. Access to education is crucial for economic mobility, social justice, and achieving the American dream, which is deeply rooted in our society. We are also optimistic about the ongoing discussions surrounding loan forgiveness. It's becoming clear how regressive and costly large-scale loan forgiveness can be. I believe that if loan forgiveness proposals arise, they will likely be more targeted towards individuals with demonstrable need rather than a broad approach. Additionally, proposals like expanding Pell Grants are significant, providing both social benefits and aligning well with our business model. I would caution against assuming that the current political landscape will remain unchanged, as it can shift, but we are optimistic and supportive of the ongoing discussions.

Got it. Thanks for taking my questions.

Our next question will come from the line of Rick Shane with JP Morgan.

Good morning guys. It's Melissa on for Rick today. I wanted to understand your thinking around the reserve rate level. Currently, it's 5.4% this past quarter, but we've seen that drop a little bit. Can you talk about how you think about that in your framework and how the interplay between the reserve rate level and the modeling you do on the macro side?

Sure. Unfortunately, with CECL, we must rely on the models and economic forecasts that influence the CECL reserve over the life of the loan. CECL was introduced at a particularly challenging time, and our reserve has fluctuated from 6% at the beginning to a peak of 8.5%, and now it has decreased to 5.4%. We believe, given the current conditions, that this reserve level is likely appropriate as a life of loan loss reserve. As you may know from following us, we originate loans with an expected lifetime loss rate of around 9.5%. We have several cohorts that have already experienced a considerable number of defaults. When considering this and the fact that we use a discounted cash flow model to compute our CECL reserve, 5.4% seems to be a reasonable figure. However, the college unemployment rate, which is a key factor in our model, was in the low to mid 2% range before the pandemic, and we are currently seeing rates in the high 3% and low 4% range during our reasonable and supportable period. Therefore, the reserve could potentially decrease as we move towards a more normal environment. I hope that addresses your question, but that is our perspective on the CECL reserve at the company.

Yeah, that's incredibly helpful. Thank you. As a follow-up question, I'm just curious on what you're hearing from your university partners in terms of sort of the college applications fund this year coming out of COVID with the expectation of being on-campus next year. Curious what you're hearing from them if anything around how this compares to a pre-COVID environment? Thank you.

Yeah, Melissa. Thank you. I think at this point, most of what we're hearing from universities falls more into the sort of anecdotal space than it does into the specific data space. So take everything that I'm about to say in that context. But I think what we are absolutely hearing from the vast majority of our college partners is that they expect the fall to be, you know if not a full return to sort of normalcy, largely a return to normalcy. I am sure that there will be exceptions to that, but I think that is their expectation coming in. I think the only color I would add on top of that is, you really have to imagine the pandemic through the lens of an individual student or an individual family. And there are a group of students and families who have just powered through their education and have said, hey look, regardless of the hybrid model and the economic uncertainty, we're going to keep moving forward. And by the way, I think that speaks to the resilience we've seen in our originations last season and this season. I think there is a second group of people who said, gosh, maybe I will take a year off even though my other opportunities aren't as rich, aren't as attractive, because I just don't believe in the hybrid model and I really want to sort of wait till things return to normal. And we expect many of those people to come right back into the system next year. And these are all the people who have taken gap years, I think, is sort of the most, you know sort of classic label of that. But I also think it's really important to recognize that there are certainly students and families out there who have delayed college because of the very real economic damage that has been done by this pandemic and resulting recession. And as I point out, whenever I get the chance, my guess is, some of those students will come flooding back in right away, some of those students will come back in over the course of the next semester or two or three. And my guess is, some of those students will not ever come back unfortunately. They will have missed the window for them to get to their higher education and will be sort of permanently part of a mini lost generation of folks who otherwise probably would have gone to college. I think the problem is, we've never gone through anything like this before. So it's really hard for us to quantify what that looks like and what those numbers are. As we said, we're very, I think, supportive of the guidance we've given around originations for the remainder of this year, but a little bit like what I referred to earlier. I think it's going to take a year or two to really see all the trends normalize and to understand how those different cohorts of students sort of come back into the system and sort of where and how they engage in the higher education marketplace.

Our next question will come from the line of Arren Cyganovich with Citi. Please go ahead.

Thanks. Maybe you could just talk a little bit about the consolidations to third parties, they came down a little bit quarter-over-quarter, year-over-year. What's the outlook there and expectations?

Sure, Arren. Consolidations are a normal part of our business, and we monitor the trends closely. Since our portfolio began to age in 2019, we haven't noticed a significant increase in the percentage of loans being consolidated. We track where these consolidations are coming from and whether they are increasing or decreasing, and we find a steady state. Loans that go into grace tend to consolidate quickly, but then the pace slows down. I recently reviewed a chart, and that trend persists. This quarter's consolidations mainly consisted of the last two repayment cohorts, while contributions from previous cohorts have dropped significantly. If that trend were to change, we would be concerned, but it has not. We are actively searching for ways to reduce the number of loans that are consolidated away from our balance sheet, as Jon mentioned earlier, because we value these high-quality loans that yield strong returns. The consolidation business, on the other hand, offers very low returns, and we believe it is not suitable for us at this time. I've pointed out before that the loans that are being consolidated often come from high-income, high-credit-quality individuals, and they are likely to consolidate regardless. The average terms of those loans are relatively short. To sum it up, we continue to keep an eye on the trends and are on the lookout for solutions. While we haven't found a perfect answer yet, we believe our business operates effectively, generating strong returns and earnings growth despite ongoing consolidation activity.

Thanks. And maybe we could just touch a little bit on the net interest margin. You mentioned it dipped a little bit in the first quarter. I believe, there's typically some seasonality with your cash balances easily. How much was that? And the other was on the broker deposits. It didn't really come down much from a rate perspective quarter-over-quarter with the outlook on that decline there?

So look, we were very, very cash rich this quarter. We had more liquidity than we would have liked to. The deposit market is extremely, extremely sticky. I think we're probably not the only bank that is seeing deposits stay on the balance sheet when we're priced to have a lower balance. I'm speaking specifically about our retail/Internet deposit base. But we did also expect to spend $1 billion sooner than we did with the tender offer, which unfortunately was only participated at a rate of 47%. That impacted the NIM as well. But look at the end of the day, I think the important thing is that the liquidity will run off. We will spend the capital. And for the full year, we will hit a NIM of 4.75% and I think that that's going to be a sustainable level which is pretty attractive in the banking industry for the medium term as well.

And just on the broker deposits, do you expect that rate to continue to decline?

So our broker deposit, we typically take long-term brokered deposits, and we have not been very active in that marketplace. What we do is we swap them to fund our variable rate portfolio. We've had some runoff in broker deposits. We don't expect to refill that bucket of funding until later in the year when we make our peak season disbursements. So, yeah, that could decline a little bit before it increases.

Thank you.

Our next question will come from the line of Vincent Caintic with Stephens.

Good morning. I have a few quick questions. First, regarding capital return, you mentioned that you have $485 million remaining, and there are upcoming sales. I'm curious about your CET ratio, which is quite high at 13.5%. I'm wondering what you consider to be the appropriate level for your CET1 ratio and how quickly you expect to reach that level.

So we tend to focus on our total risk-based capital ratio, which we need to maintain a good margin above the well capitalized level. Most of our capital is CET1 anyway. So our target for total risk based capital is, let's call it, 12%. We ended the quarter with 13.8%. On our current trajectory of capital return, that ratio should decline a little bit, but if we stick with our current capital return strategy, we will actually end the year higher as opposed to lower than where we ended the current quarter.

Okay. I understand. It's somewhat like that.

So look, what we really want to do is, there has been an incredible volatility in our CECL reserve and clearly that impacts our capital account significantly. So we will stay on our current course of capital return until we see some stability in our CECL reserve.

I understand, that's helpful. Regarding the net interest margin, I appreciate the insights on the excess liquidity you mentioned. If you didn't have that excess liquidity, would you still be at 4.75% now? And since you've used that liquidity in the second quarter, should we expect it to ramp up quickly so that for the full year, you're at 4.75%?

That is a very good question. Yes, we should glide back up towards that 4.75% area.

Okay, helpful. And then, this is the last one for me. The CECL reserves were influenced by prepayment speeds, and you've implemented a new model for those speeds. I'm curious about how much prepayments were impacted by customers having strong cash positions. It seems that stimulus and similar factors have led to loan balances being paid off in the consumer lending sector. I'm wondering if this is a significant factor for prepayment speeds. When you determine your prepayment speeds, do you anticipate that this will persist for a while, or do you think that as consumer cash balances decrease, prepayment speeds might extend again? Thank you.

That's a very good question and an accurate observation. Our prepay model relies on ten years of data. The elevated prepay speeds we've seen in recent quarters are likely due to factors like stimulus checks and the federal student loan holiday. These influences are expected to last through September 30 because the student loan holiday is ongoing. It would likely take several quarters of significant declines in prepayment speeds to have a meaningful impact on the CECL reserve, as our models are based on long-term data and require time for short-term observations to affect them. Currently, the 10-year average prepay speeds for our portfolio are around 9%, which is foundational to our model. In summary, a substantial decline in prepay speeds would be necessary to alter our outlook.

Great. That's very helpful. Thanks much.

You're welcome.

Our final question will come from the line of Jordan Hymowitz with Philadelphia Financial.

Thanks for taking my questions guys. When I look at your company, I mean, you have no branches and you're basically all digital so to speak or in person. Why are you guys a neobank, so to speak, and if you thought about comparing yourselves more to a neobank, especially one that actually makes money with a very high return on assets. Or said in a different way, 'if a neobank might be interested in merging with you for the assets that you have'?

Hey, Jordan. It's Jon. Thanks for your question. It's challenging, and I might not be the best person to comment on the current valuation of neobanks. What we're really focused on is delivering on our core investment thesis, which we believe is highly attractive. I would emphasize that we stack up well against anyone else in this space, and I can break it down into three key points. First, we offer significant earnings growth. Consider the natural growth rate in the private student lending market and our 60% fixed cost base, which allows us to achieve even more appealing earnings growth through operating leverage. We have a strong brand, meaningful customer connections, and solid relationships with schools. We're very pleased with our earnings growth trajectory. Additionally, we are satisfied with our capital return trajectory, both before and after the CECL adjustments. We're not in a phase where we need to reinvest all this capital for growth. We’ve been deliberate in sharing the benefits of our highly profitable loans with our investors, ensuring they are compensated consistently. Moreover, we're increasingly demonstrating the strong risk management capabilities of our business, including both credit and political risks. The experiences during the great recession and the pandemic have shown the resilience of our loans, highlighting the value of a college education and the cosigner model. The discussions we've had and the political environment suggest that private student lending remains a vital and positive component of making college more affordable and accessible. We strongly believe in our investment thesis and feel it compares favorably against others. We're not stock analysts, and it's not our role to evaluate who is more or less valuable. That's up to others to determine. However, we believe we are competitive in that area. While we don’t comment on potential acquisitions or mergers, I hope it's clear that our Board is dedicated to creating shareholder value in a concrete manner, which is something we take very seriously.

Okay. And if I could just follow-up on that. We talk about profitability, I mean, you've really guided, but if you take out the gains on sale, your returns on equity are around 30% on a core basis, I mean, it's dramatically more profitable than almost any other financial institution and growing much faster, I mean, I just think that's part of the story is well known as it should be?

Jordan, Brian Cronin right now was sweating bullets that we're going to get rid of him and hire you as our Head of Investor Relations. But look, I mean, we very much like the profitability of our loans and you heard me say it earlier when we were talking about marketing growth. I would rather be incredibly profitable and only modestly growing than rapidly growing and not profitable. I mean, it is one of the superpowers of this business is to have incredibly high ROE loans. By the way, that is what in a post-CECL world allows us to organically generate capital while we are growing our balance sheet, right. And when you really understand that a new model is out, it is a very, very, very powerful thing. So thank you for the plug. Yes, we agree, and as long as I'm here, we will do everything in our power to safeguard the profitability in the ROEs of our loans. We think they are incredibly attractive.

Okay. And you know, a long time ago, when we all had a little more hair, JP Morgan and JC Flowers almost spot you guys at 20 times earnings with more regulatory clarity and more scarcity value, maybe someone else will see that opportunity again?

We don't comment on those types of discussions, but we are committed to returning value to our shareholders.

With that, I will turn the conference back over to management for any closing remarks.

Thank you everybody. Listen, we know it's a busy morning. There's a lot going on, and we know that your time is valuable, especially during these key earnings weeks. Appreciate your interest in Sallie Mae. And really please let us know if there's any additional thoughts or perspectives that we can provide to clarify the information. So with that, Brian, I think I'm handing the call back over to you.

Thanks, Jon. And thank you for your time and your questions today. A replay of this call and the presentation are available on the Investors page at salliemae.com. If you have any further questions, feel free to contact me directly. This concludes today's call. Thanks.

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