Navient Corporation (NAVI) Earnings Call Transcript & Summary

Yes. Thanks for joining us today. This is the last session for us for the day today of the first day of the conference. And very happy to host Navient. Navient's been at this conference for many, many years. And I'm always -- I always retell the story that the original creation of Navient and the separation of the Sallie Mae into the two entities was first announced at this conference, I think, 7 years ago. Navient has been, in the past, a consolidator of FFELP portfolios across the industry, has been moving into loan consolidation and is working towards entering the in-school market as well. The company has had an increased focus on being able to generate efficiencies as well as driving higher returns on its new businesses. And we'll kind of go through some of those things with Jack Remondi, the CEO of Navient.

So I guess, maybe the first thing to kind of talk about is, as you've positioned the refinance business, can you talk a little bit about how -- about that market, and how big you think it is and how big you'd like Navient to be in that market?

So the refi marketplace is an area where we help customers who have existing student loans, refinance them at a lower interest rate in order to assist them and helping them pay off, save money and pay off their loans faster. One of the things that's interesting here on the student loan space, loans and the in-school arena are made based on the prospective ability to repay the loans. And by the time we get to a customer in the refi space, that customer has now earned that credit rating. They have work experience. They have payment experience. They have the income and the free cash flow to support that. So we're really targeted and focused on those customers that have basically generated the benefit from the education that they hope to get. That marketplace has been growing rapidly, and it's been -- I think part of it is being assisted certainly by the low rate environment that we're in, but I also think it's based on a growing awareness of consumers of the product. And I think if you think about this, loan consolidation in the federal loan space was primarily a product that allowed customers to -- who had payment problems to spread out their payments over longer periods of time. And the refi product, I think, got kind of framed a lot in that same way in what -- but it's not that product, right? This product is really designed to help students, graduates benefit from the credit that they have earned, reduce the interest rates, save thousands of dollars a year in interest expense and pay off their loans faster. We originated $5 billion, nearly $5 billion worth of loans last year. We thought the program demand for that product was going to begin to stabilize in 2020. We're actually seeing demand for that product accelerate in 2020. And so we are very optimistic about our ability to continue to grow that at much faster rates than we had anticipated at the beginning of the year.

And when you say that you're seeing better demand, I mean, the amount of loans that are out there, obviously, hasn't -- doesn't really change in the short run. Is it the interest rate environment that makes it that? Is it the economic environment? Is -- are there other factors?

I think it's the interest rate environment and the awareness of the increased awareness of the product. One of the things that's also -- I mean, I said, demand is substantially higher. Things that haven't changed is the credit profile of the application pool. We're continuing to see that actually improve slightly in terms of free cash flow. But credit ratings, so FICO scores, gross income and free cash flow, have been very, very stable. You're seeing that turn up in the credit performance of the portfolio as well, extremely strong performance on that side of the equation, and we expect those kinds of trends to continue as well.

One of the things we're talking with all of the companies about is the current environment. Obviously, you just said that the underlying performance of your borrowers hasn't really changed. There's concern about the economy because of the effects that could come down from the coronavirus. Are there -- and obviously, the yield curve and other signals are kind of pointing towards lower interest rates. Can you talk about each of those factors and how they would affect Navient?

Yes. So we actually see in today's environment, with falling interest rates, tightening credit spreads, driving higher demand for our products. We actually look at where we sit today at the end of February, and we feel that we're in a much better position than we were, say, at the end of December when we set forth our financial forecast. So we're pretty excited about what we see and the opportunity that we think we can take advantage of in this space. So right now, when you look at credit performance, and I don't care whether we look at FFELP -- historical FFELP loans or new Department of Education repayment trends or our refi business, we're seeing stronger credit performance across the board in terms of lower delinquency rates, higher success, obviously, in terms of payments, et cetera. We're seeing more demand, as I said, for the refi loan product. And in our business because of the way the interest rate cycle works on our -- some of our legacy loan programs, falling interest rates is actually a positive for us as well. When you couple that with improving credit spread trends in -- across both structured and high yield, we've got a bunch of factors that are combining together to be much more positive than we had anticipated.

When you think about the kind of the legacy FFELP portfolio that's in rundown, how does this environment affect the speed at which that's paying down?

Well, that is more a function of the strength of the economy and consumers' ability to have enough disposable income to continue on their payment patterns. So we're seeing continued strong performance in that area. Delinquency rates in the federal student loan -- our federal student loan portfolio are at all-time lows or historical lows in that area. And we're seeing similar kinds of performance in the Department of Ed book as well.

Okay. One of the things that was part of your target for 2020 was an efficiency ratio of 50%. On balance, you're still seeing -- the legacy book is paying down. Talk a little bit, with essentially likely lower revenues in 2020, how do you manage to that 50%? And is that the right number? How do you think about efficiency on a long-term basis?

Yes. So I think our efficiency is, if we really manage it across the different business units and functions that we perform, and each year, this has been part of our core DNA for a long time of constantly looking for ways to improve our operating efficiency, our funding advantages, our funding efficiency. And it's really been driven -- if you think about the FFELP business, if you follow the FFELP history over time, we've had nothing but kind of margin declines in that space. And so the only way you could improve your profitability was to improve your efficiency. We focus on efficiency in 2 places. Interest expense is clearly our largest expense within the company. We spend a lot of time trying to find ways to lower our overall interest costs. And I think somewhat unique to our business model is we have a wide variance in the cost structure of different types of borrowings. So clearly, structured finance transactions against our FFELP portfolio are our lowest cost of funds, high yield that are most expensive. We've done a number of things over the last couple of years that had we not done them, we estimated that 2019 interest expense would have been about $90 million higher than it was, so obviously being able to drive a significant savings in that area and bring that to the bottom line. We take the same approach in the operating efficiency side. We look at transactional activities and how do we lower the unit cost of those components. The big opportunities for us over the last couple of years have been converting customers to electronic communications versus mail. That has saved us tens of millions of dollars a year in postage. Increasing the ability for customers and making it easier for customers to self-serve, so finding ways that eliminate the need. And frankly, the burden of having to call someone to get something done and be able to do it online, and then to simplify and automate the different processes that we do. So whether that's direct with the consumer or in the back-office. One of our biggest innovations in the last couple of years has been remaking the income-driven repayment application flow process that's available to federal student loan borrowers. The Department of Education designed this program to say, you have to leave the student loan servicer and go to studentloans.gov, complete a 12-page, easy government application with lots of jargons and acronyms, et cetera. And what we found is that customers had a really difficult time persisting through that process. Only about 27% of our customers who were qualified for a lower rate through IDR were successfully completing the application in a 60-day window. We automated that process, took the information for the customer, effectively took a manual process and made it automated by delivering a completed form ready for e-signature. And that brought our completion rate from 27% in 60 days to 72% in 10 days. That's an enormous cost-saver for us. In the old world, we would have been handling that account multiple times through the process. Now we handle it far less, obviously.

When you think about the business of -- the servicing business that you're in, a couple of different questions there. I mean, the -- I guess, one of the issues can be that we're in -- I don't know if it's the third year I've been talking about redoing the contract or even...

I'm looking right now.

Right. So it's been many, many years, and it's been extended each time, but I mean, how do you think about the potential outcomes when whomever it is that's in charge will actually decide what it is they would like to do?

So it has been a complicated process and one where the rules of the design of the program have changed materially from where they started to where we are today. We still believe, given our servicing operational expertise in both efficiency, performance and our ability to be innovative in this approach and use data and analytics to drive innovation that we can add value to that space. Without knowing what the terms and conditions of that would be, we don't know, right? We want to continue to play a role in servicing Department of Education loans, but the role has to be one that makes economic sense for us. We've tried to position the company to be able to manage multiple outcomes here. So last year or a little more than a year ago, we sold our platform, and that allowed us to convert our business from one that was heavily dependent on a fixed cost structure that required scale to be efficient to one that is now a variable-rate cost structure. So if the Department of Ed contract expands, we can expand with it. If it contracts, we can contract our operating expense with it as well. So we feel like we're in a good position on this side of the equation. We continue to try to work with the department and with others to demonstrate the value that we add. And we look forward to be able to continuing to do that, but it has to be on terms and conditions that make sense.

And what scenario would cause you to say that's not sufficient, we need to actually exit that business and fully outsource it?

Well, certainly, economics would be the major one, right? If the requirements or the expectations of service levels were inconsistent with what the payment rates would be, that could be a challenge for us. I don't expect that, but that could be a challenge.

Good. So we talked about the refi product. You're in the process of starting in -- restarting in school lending business that predecessor company, obviously, has been in for a very, very long time. Can you talk a little bit about the challenge that you face on what you're going to be doing for the upcoming school year?

Yes. So we launched an MVP, minimally viable product, the last academic season. And the design of the program was really -- the approach was really to help us gather insight and information, iterate the product and make the program better. One particular design, one in particular approach we took is that we were relying on the state lending licenses that we have for our refi business to originate the in-school loans as well. Many states or a number of states in the state licensing space do not allow interest to be capitalized by state license lenders. And so that obviously limits the ability to offer uniform terms and repayment options to customers across the country. And it's not driven by where the school is. So if you said -- if it was driven by the school, it'd be relatively easy. We could pay the students in Pennsylvania. These are the terms and conditions of the loan products from us. It's instead based on the residency of the borrower and the cosigner. And it defaults to the lowest common dominator. That limited our ability to offer uniform terms and conditions, and it made it just that much harder to explain what we could offer to a customer, particularly if we didn't know who the cosigner was when the original student borrower came to the table. We have solved for that. For this upcoming academic season, we will work with a bank partner. That bank will be the originator of the loans. And we will be able to, under federal law, export the terms and conditions of those loans across the country uniformly. And so we expect to see a significant lift as a result of that. We've also learned quite a bit in terms of working on ways to improve the user experience, to make information aspects that they deemed important to the application process more readily available or made available sooner in the process. And we'll also include the ability for the cosigner to launch or begin the student loan application rather than the student having to start it. Those are some examples.

Understood. And can you talk a little bit about the goals you have for that business?

So we continue to -- our focus in the in-school marketplace, our focus is on customers who are borrowing a private student loan for the first time. So we're not -- we expect that customers, who are returning to the marketplace, to continue to borrow from their existing lenders, keeping all their loans in one location, making it easier for them to manage. And so we have expectations of -- or desires to target somewhere in the high single digits as a market share for first-time borrowers this year.

One of the things that's been a hallmark of the company from the time of the separation has been the return of capital. And obviously, there's been varying degrees of the pace of the shrinkage of your kind of debt footprint and your capital ratios. Talk to us a little bit about where your leverage is right now, how you think it can be managed and what that means for returning capital?

So we were in -- I think we have a very strong balance sheet and a very clear vision of how much capital is going to be generated by the company in terms of earnings. And we lease as the legacy portfolio amortizes. And that gives us tremendous visibility to be able to share with investors how much we can expect to return on the capital front. For the last several years, you're right, that number has changed as kind of market conditions have evolved. Opportunities to buy portfolios came and were executed on. We acquired, for example, over $30 billion worth of loan since we've separated. That, obviously, particularly when you buy a private portfolio, slows down your capital return. When you are not buying loans, you can accelerate capital returns. So that has been pretty stable. We're now at a more stable level over the last couple of years. And that's happening despite the fact that CECL's being implemented, which is, I view it as a capital tax, right? I mean, it has effectively increased the amount of capital, consumer lending, financial institutions hold on balance sheet. It impacts us a little bit less than other financial players and other players in the student loan space, in part because we were more highly reserved already for our legacy private loan book. And our refi loan, which is the growing piece, has loss expectations that are well below 1% today on a life-of-loan basis.

Some of the companies that -- to whom we've spoken that are not banks have said that the rating agencies has been pretty willing to consider that part of the core capital base of the company. I mean, what's been your experience?

So each of the rating agencies have a different approach. The risk-adjusted capital model is probably the one that is the standard that probably is the -- drives most nonbank financial institutions and what we kind of adjust or hold ourselves to. I wouldn't call it -- I would still call it a capital tax. I do think, though, in the in-school loan side of things, net-net, across our business, we have a capital advantage compared to banks, right? We don't have regulatory capital requirements. We can -- the way we fund ourselves in the structured finance marketplace is -- has a different level of capital requirement than the regulatory framework. I would estimate that capital advantage against the bank on an in-school loan product to be about 400 basis points. So it's a pretty meaningful opportunity, we think, in this space for us.

There's been, obviously, a lot of, what do you call them, plans advanced by various candidates in terms of the outlook for both college costs, college finance and existing loans. I mean, can you talk about how you frame the relevant -- the various proposals as to their relevance for your business?

Well, without getting into the politics too much, I think I would actually take a step back and say, "What works in the student loan program and what doesn't? Where are the challenges?" People focus all the attention on student debt, which is the symptom and not the cause, right? College costs are extremely high. They have risen over the last several decades. They have twice the rate of inflation and higher than healthcare costs, which people complain about nonstop. And the other piece that has changed quite a bit is the pace or the level of graduation rates, completion rates. The 2 biggest reasons students default -- our borrowers default on student debt is they don't graduate or the debt they've accumulated in the process outpaces the value of the education. And why did that happen? It happens -- mostly that last point happens mostly because the student took much longer than 4 years to graduate. Because during that time frame, interest continues to accrue and capitalize to it. So if we don't address those fronts, I don't care whether you forgive all the loans today or not, you're going to end up with the same problem down the road, right? People borrowing money that was not necessarily appropriately matched. We've made -- put forth a number of suggestions on this front. We think students and families need more help upfront to understand not how much is it -- how am I going to pay for this semester, but how am I going to pay for the full cost of the degree, what that looks like in relationship to my income? Department has published a great new database that allows you to go in by school and major and see income levels in the first few years of graduation. That's a huge resource to help students and families figure out how much debt they could actually afford to take on. On the loan forgiveness side of the equation, there are 45 million Americans with student debt outstanding. And so there are certainly borrowers who are struggling, right, and struggling because they didn't graduate or took on too much debt or took advantage of deferment options that allowed the balances -- to postpone the inevitable. And we do need to do some -- there need to be some solutions on that. I think there are better ways to run income-driven repayment, so that interest is not capitalizing behind the scenes and only forgiven if you -- your income remains low for the full 20 years of an income-driven repayment plan. But I also think loan forgiveness broadly is ironically a bit regressive, right? It benefits wealthy people than it does poor people. And those are just some of the challenges that I would see in this space. Not to mention, obviously, $1.5 trillion is kind of a big number.

Right. I mean, you made an interesting point, not particularly relevant to Navient, but the idea that prospective students really haven't thought about this idea of am I going to be creating economic value from my education? On balance, it's generally been that way, but perhaps that's diverging.

Well, actually, a number of people have said, "So why don't you do that?" And we say, "Well, our customers in the Department of Ed process don't come to us until after the loan's in aid, right?" And so the money's been lent and spent. I mean, we can't intervene at that pace of the game. It's too late. But this statistic is shocking one to folks. And even when I repeat it, as oftentimes as I have on the Hill to members of Congress, 2/3 of all the defaults in the federal loan program come from students who borrow less than $10,000. Only 4% of defaults come from borrowers who borrow more than $40,000. The media...

This is the numbers...

Of defaults, yes. This is -- the perception in the marketplace is the exact opposite. People think that high-balance borrowers are the ones that are driving defaults, but the high-balance borrowers are students who graduated from the business degrees, professional business degrees, law degrees, medical degrees. Certainly, you have people who are on the 8-year plan on that side of the equation. I mentioned completion rates. The completion rate in this country for a 4-year college degree is only 60% of the people who start a 4-year degree earn it within 6 years. For community colleges, 2-year degree programs, only 35% complete their -- earn their degree after 6 years. A 2-year degree, only 35% complete or earn it in 6 years. Those are the numbers that need to change.

One of the things that's been a little bit of an overhang on the stock has been this -- your ongoing lawsuit with CFPB. And in the past, in some of the conference calls, you've talked about that. Can you just give us an update as to where that is and what we should be looking for?

So this has been a long drawn-out process. And there are many things that are frustrating, and like this is probably one of the most frustrating things I've dealt with in my life, including personal or professional. It has -- is taking forever. This lawsuit was filed just before -- after President Trump was elected, we got a call from the CFPB that said "Settle by inauguration day or we're going to sue you." and we said "On what?" And the reason we said that is they had not done any analysis or research yet. They hadn't listened to any customer phone calls. They hadn't examined our books and records. They had asked for a lot of information, but they hadn't started that process in theory. They filed a lawsuit. The director at the time stood up and said, "We found Navient was steering hundreds of thousands of borrowers into forbearance inappropriately." Again, that statement was made before listening to a single borrower phone call. They then searched for evidence to support that claim. After multiple delays and requests for numerous extensions that were granted by the judge in this process, they finally came up with 15 witnesses that they claimed supported their case. In depositions, all 15 of those witnesses acknowledged that Navient did, in fact, inform them of income-driven repayment. Several of them were enrolled in income-driven repayment, but just didn't like the payment that was established in that. A couple of customers were committing fraud against the federal government. But this is their customer. This is their entire witness list. They cannot add any new witnesses at this stage in the game. That fact discovery is now closed. We're now in expert witness discovery. So this is where experts review the flows and the formats, make opinions and extrapolations. That process, we expect to be wrapped up in the next several months here, hopefully sometime this spring. The judge in this case has said at the beginning of the case that he would not entertain any motions for summary judgment until we had completed these 2 phases of the trial. When those wrap up, we'll now be in a position to file for summary judgment. And since the CFPB has been unable to present any witnesses to support its case, my facts and logic approach would say we feel really good about where we stand in this case.

So we'll stay tuned. Given all these changes that we've talked about, obviously, kind of the big run-off of the portfolio now kind of working on the -- both the refi and potentially the in-school business and your fee-based businesses, can you talk a little bit about how management targets have been changed to reflect this? And what are the benchmarks that you and your team are kind of being held to?

So in terms of our incentive compensation, it's really about earnings, growing the earnings of the company and maximizing what we can generate from the existing business. That model and that financial targets are built off of the different components. So there's a legacy piece of our business, which is our amortizing federal and private loan books. Those numbers are going to go to 0 as those portfolios amortize. And our job is to maximize the earnings and efficiency of those units. That's really where the $90 million of lower interest expense came from as we were able to borrow more efficiently off of that book of business and improve margins in both of those portfolios last year. We have some businesses where we think we can grow, that's the refi and the in-school space, and also in our business processing area. And our goals are to not just grow for revenue sake, but to grow in a way that add meaningful value. So we target internally things like margins or operating efficiency and ROE are the big targets that we look at there.

Talk a little bit about the areas within business processing that are growing. Some of those businesses have been growing nicely. Some of them have had challenges that are maybe kind of outside of the student loan servicing. Can you talk about the other areas and which of them...

So when we separated the company into two, we really looked at the business as being much more -- and the value we were generating was coming off of our processing business, right? We drive and generate value off up of our FFELP portfolio by improving the performance of the loans, keeping the borrowers successfully in repayment and paying off their debt balances. We took those skill sets and thought we could apply them to other asset classes. And we looked at 2 areas where not only we saw opportunity, but kind of an ability to enter the marketplace, fragmented markets, not well served and/or are evolving into something new. That was in the municipal space and health care. Today, the health care space is growing much more rapidly than the municipal side of the equation, and this is really driven by economic need. Hospitals, for the most part, manage their revenue cycle internally. And this is getting claims submitted to the insurance companies and getting them paid appropriately and quickly, and then being able to explain to the patient their portion of what's left and giving them confidence that, that is truly the amount that's due, that the insurance company has paid everything that they were supposed to. They don't have the same level of scale that we can bring to the equation. They tend to operate. The biggest hospitals are in higher-cost cities and locations. We can consolidate that activity, run it more efficiently on a scale basis and do so in lower cost arenas. We're also able to, when we invest in technology and data analytics, apply that across hundreds of hospitals instead of just 1 or 2. So we see that marketplace as having the ability to grow organically at a double digit rate for an extended period of time here, and you're seeing that in our actual performance. On the municipal side, I think there's -- the opportunities are similar, but the procurement process is much more extended. It has a dissimilar kind of approach to the Department of Ed if it starts and stops, and then they had the opportunity for bid protests and challenges that extend that time frame. In a couple of instances over the last couple of years, one in particular, we lost a contract on price, which is something we were not willing to match because it didn't make economic sense. And so the contract went away. The other big contract that we lost was a program we ran for the state of Texas, where the program was eliminated. Not because we did a bad job, they just decided to pursue revenue from a different approach. So when you have large contracts like that, and you lose them, it obviously creates a higher burden. And because of the elongated procurement process, it's harder to replace those as rapid magnitude. I will say that despite those losses, our EBITDA, income and margins, EBITDA income grew last year, but we were able to apply significant operating leverage and improvements to drive better margins in that space constantly.

All right. We're coming -- time is winding down. There's probably time for one question from the floor, if there is one. Yes? No? Okay.

I know it's a difficult position between

Right, in cocktail...

Cocktail hour. So I appreciate you all being here and hanging in for that part,.

Well, please join me in thanking Jack for his time today. Thank you.