Navient Corporation (NAVI) Earnings Call Transcript & Summary

Good morning, everyone. Thanks for joining us. I'm Moshe Orenbuch with Crédit Suisse, and I'm proud to have with us -- or pleased and proud to have Navient with us. Navient has been with us at this conference for many years, and I'm always proud to say that the creation of Navient was something that was announced at this conference, I think, 8 years ago. In -- Navient has been a leader in ownership of student loans and in the last couple of years, has moved towards loan consolidation and entering the in-school market. So with us today is Jack Remondi, the CEO of Navient, and we'll go and conduct a fireside chat. And Jack, happy to have you here.

Great. Pleased to be here as well. So...

Thanks.

Next year in person, right?

Next year in person, exactly.

So I guess maybe to kick it off, could you talk a little bit about the 2 different pieces within Navient? A chunk of it is still in runoff. A chunk of it is poised to grow. Kind of how you see those 2 sites evolving over the next several years and how that influences your decisions about capital deployment?

Sure. I think when we did announce this spin-off and creation of Navient at this conference, I guess it was 8 years ago. It really was -- one of the things we focused on was this tremendous value that we saw in the legacy assets, right, this portfolio of student loans that was then over $200 billion in size that was going to generate a significant amount of cash flow and value for investors over time. And as I've always shared internally and externally with folks that, that was almost like a luxury, right, to have a portfolio of loans where you could see such a high degree of consistency and predictability of cash flows and earnings over such an extended period of time. And that portfolio has really performed. Not only did it perform as it -- did we meet our expectations? It's actually dramatically exceeded our expectations. So if you look at our cash flows that we thought we would generate from our legacy portfolios and loans that we acquired over time, since 2017, those cash flows have been $4 billion higher than what we projected back in 2017. And in total, we still have -- we're still projecting nearly $17 billion of cash flow remaining. And when you look at the cumulative amounts that we've collected -- actually collected minus our unsecured debt balances, as we sit here in February, cash flows have actually exceeded the entire amount that we were projecting to generate over the life of the portfolio, still with nearly $17 billion left to come. So very, very strong performance in that area. And I think what we've been able to demonstrate to investors is our management skills with that asset class in terms of credit performance, helping borrowers successfully repay their loans in terms of funding strategies that lowered the interest expense that we incur on that debt, very creative funding mechanisms, so as like unsecured debt became very expensive, finding different ways to finance the portfolio at significantly lower cost. And then on the operating expense side of the equation, continuing to drive down the unit cost of servicing a student loan and simultaneously improving the customer experience by finding and using technology tools that help make it easier for borrowers to navigate the complexities of the programs and service the loans the way they want. On the other side, as you point out, we see -- we recognize that Navient had some very strong skills and inherent assets that may not have been recorded on the balance sheet but were nonetheless very real. That is origination capability to generate high-quality assets at very low costs. We targeted first the refi student loan marketplace or the consolidation loan marketplace, as you pointed out. We saw a tremendous opportunity to leverage our insights as to what borrowers represent in terms of credit risk performance as they age and move through the repayment cycle to be able to offer them ways to save on their interest expense and repay their loans faster. That's been a very fast-growing segment of our business and will continue to be so. And then on the in-school side of the equation, we looked at the marketplace as our noncompete expired and really saw an opportunity to bring a differentiated product that help students and families finance their education but do it in a way that might not be as expensive. So one of our primary objectives is helping students and families understand the value of paying interest while the loan is in the in-school period and keep that balance from negatively amortizing. And then lastly, utilizing our operational infrastructure in other areas other than student loan servicing. And probably, we've been building that up over the years, but we probably have demonstrated the value of that franchise most clearly in 2020 when we were able to pivot and demonstrate the agility of the platform and the agility of our people and operational areas to respond to pretty important but also immediate needs of states and helping with things like unemployment insurance processing and COVID-related activity. So I'm pretty proud of what we've been able to do. And we've grown earnings now for the last 3 years at a compound annual rate. That is probably a bit of a surprise to most people who were thinking that this was more of a runoff business.

Got you. Just to get back to 1 number that you mentioned, that $4 billion of better cash flows and I think you alluded to some of the drivers. Obviously, the interest rate environment has helped some of the payment environment, some of the things that you've done on funding. Could you just talk about the biggest factors in terms of achieving that and how you think about that as we move forward?

Yes. So by far, the biggest benefit has been on the funding cost side of the equation. Interest expense is the largest expense within -- on the company's income statement. And we've been able to dramatically, I think, improve our funding efficiency and bring that to the bottom line. So that's a big part of it. Certainly, the -- keeping loans and repayment would be second on that list, right? So an earning asset is generating cash flow. A non-earning asset doesn't. And so we've been able to help borrowers find repayment solutions, keep their delinquency and default rates down and as a result of that, that contributes as well. And then last year, as you pointed out, the interest rate environment was a very favorable headwind -- tailwind for us. It generated income in some areas of our portfolio that we don't traditionally see, and that was clearly beneficial. But we don't expect that to repeat, so that was kind of more of a onetime benefit for us.

So if you look out over kind of 3 years -- and this is not guidance, this is just kind of like a directional look because it is unusual you've got those 2 different pieces of the business kind of moving at different speeds and in potentially different directions. Do you think that the EPS power of the company is higher or lower? And how do you get to that conclusion?

Yes. Well, certainly, we're driven to drive the EPS higher, right? That is our goal. And when we started and spun this business off in -- over 5 years ago, it was a big challenge because the portfolio was so huge. The percentage -- the decline that happened each year was very, very difficult to out run and growing other aspects of the business. As the portfolio is amortized, those now become in -- come within reach. You can see our net interest income, in part driven by some of the positive factors you mentioned in 2020, was higher than it was in 2019. And our goal and objective is to continue to drive earnings to the bottom line so that EPS continues to increase.

Got it. So one of the bigger areas of growth that you had mentioned was the refi or consolidation loan market. Can you talk a little bit about that business, the competitive dynamic as to how you see it? And then we'll talk a little bit about the capital side of that. So...

Yes. So this is a marketplace where I think our -- what I would say is our on us data, right? All the information we have about how borrowers perform through different cycles and where they are in their own economic cycles and where they are in their repayment cycles, has allowed us to identify customers that are highly attractive from a credit perspective. And we also see that these same borrowers, because they are such a high credit quality borrower, are paying significantly higher interest rates on their original loans than what their credit profile would indicate they should pay. And so there was an opportunity to refinance these loans, help them save money and more importantly, really drive a focus to repaying their loan balance. So as you know, traditionally, in the student loan space, loans -- student loans are very long-duration assets. In the refi space, they're much, much shorter. So our typical borrower refi loan has an average life of just over -- just under 3.5 years as we are helping borrowers kind of manage their interest expense and pay down their loans successfully. Where we see we have that real competitive advantage is in kind of multiple components. It's on the origination model that we built. It is super easy and friendly for investors. We were able to -- borrowers, borrowers link their transaction accounts with us. We're able to scrape that data and populate a cash flow model without them having to provide reams of data and other information to support their application. We're able to do all of that in a very mobile-friendly application format and decision alone extremely rapidly. Our marketing activities are also digitally focused. So a lot of players in the space are very focused on direct mail. And that's a component of our business, but we're mostly focused on digital marketing channels. And then on the credit side of the equation or servicing operations, we're able to bring that scale and efficiency and insight to help our borrowers drive better results. So what do we see? We think our cost to acquire a loan in this space runs about half the average in the marketplace. And when we look at our credit performance, these are -- in terms of ABS structures, our loans are -- the credit losses that our securitization trusts are incurring on a similar cohort basis run about half others in this space as well. So those are just significant advantages that we think accrue to our investors, right, through higher yields, higher returns.

Some of the players in that business are using the information that you cited that those people are putting into their applications and marketing other products to them. Some would even argue that they're kind of becoming closer to a full-service bank. Any thoughts about that and whether that presents any opportunities for Navient?

So the Net Promoter Scores that we get from our customers in this space run in the high 70s, low 80s on a pretty consistent basis. That would tell you that there is a significant opportunity to perhaps do other types of -- provide other types of services and products to this customer base. They're extremely attractive from other -- for other products, right? These are high-income, high-credit performing borrowers. And so I do think there's some opportunities in that space. I think most of what we would look at to do, if we were to do something, would be more through partnerships rather than through direct sponsorships. I'm -- having lived in this industry for so many years, I see the value of focus and what it means from both the customer experience and execution levels. And so for years, we competed in the federal student loan marketplace, for example, and even private loans against the largest financial institutions in the world, biggest banks in the country, and we were successful because I think our focus on that one product kept us very keen on delivering the best service levels and experience to our borrowers. So I think there's an opportunity to partner with like-minded providers but not necessarily things we would do ourselves.

Got you. Makes a lot of sense. And you had mentioned the better loss characteristics than peers and certainly a lot better than legacy student loans, yet some of the rating agencies still kind of assess a large capital charge consistent with the legacy student loan portfolio. Is there any chance that, that gets lightened up? Like how do you think about the capital charge that they're putting you with?

So that's really more on the leverage that you're able to obtain in a securitization trust or advance rates on the AAAs. And we do believe that as the rating agencies are able to see performance through various economic cycles and size that, that will be an area where we can improve. We actually had a similar product before the financial crisis that we made available to customers in the private lending arena in the Sallie Mae days, and we saw a very strong credit performance in the Great Financial Depression or crisis that we just had a couple of -- 10 years ago. We've been able to use that information, obviously, as we design our underwriting programs and criteria. So that's what drives our better performance for sure. And we think as we have more years of experience that the rating agencies will definitely reflect that.

Got it. And you mentioned the in-school opportunity. You've been at this, I guess, a couple of years. Talk about what you've learned and how you think about that as a contributor over the next couple of years.

So we see this as a great opportunity for us. Obviously, last academic year was a challenging one due to COVID and who was in school, who was not and the differences that you saw nationally. Demand for student loan products declined by double digits, right? We do expect that to rebound in the next -- in the upcoming academic year. As a parent of a college freshman, I can tell you they are -- he and his friends or eager for what a college experience might be. He's on campus, but I would say he really doesn't know what a college experience is yet. And I do think parents are eager for that as well. So we think that marketplace will continue to be strong, and the demand for that will be there. We are planning on focusing our efforts starting from 0 effectively. We have the luxury of focusing our efforts on a perhaps tighter target customer base than the market as a whole. And so we're very much focused on students and parents attending high-quality institutions where the education relative to the cost produces a return and helping students and families understand the value of paying interest while the student's in school, so keeping the loan from negatively amortizing and really making sure that, that partnership between the co-borrower and the student is more than just lending someone's credit profile or they're actually lending financial support as well.

When you think about the other opportunities, whether it's kind of other lending opportunities and Earnest, the company you had bought, had done a little bit of other lending in other areas or are there fee income opportunities to kind of expand? Like how do you think about where those might be?

So when we did acquire Earnest, they had both a personal loan product and we're exploring opportunities in the home lending arena. We decided that -- again, going back to that focus point, that would be far better off remaining -- directing all of our attention to the refi loan product and adding more programs that were more connected in a tangential way to what school lending was. So that's that -- the growth, the launch of the in-school loan product. That doesn't mean that our customers don't want or need other financing products. But I'd go back to my earlier answer that, in the future, we'd be more likely to do this through partnerships rather than try and do it directly ourselves.

And you mentioned in 2020, on the fee income side, you had added just kind of state services, I guess, to call it. Are there other kind of areas that are kind of -- that can kind of radiate out from what you're doing that you could add?

Yes. So we basically -- our fee-based business is basically an outsourcing solution for our clients. So we take work that they were doing internally and bring scale, data-driven solutions and efficiency and technology to the equation. So in a lot of states, for example, when they don't have the sophisticated call centers, not just in terms of the ability to handle volume but the information and technology to be able to digest the data and do something with it, we were able to bring solutions to states as demand was overwhelming their capabilities. We've -- we were able to stand up these call centers virtually. I mean, as all the folks are working remotely, hire thousands of them -- people to help staff, train them all virtually and get them into places where they were highly productive. So we have states that would say we couldn't have done this without you. We have states who are telling us that our programs are 25%, 35% more productive than the other vendors that they have used. And it's really, I think, a demonstration of both the agility of our technology-enabled solutions and operational skills but also the depth of information that we bring and the approach we've had as a consumer of these services ourselves to be able to know what our clients really want and can help them more effectively deliver those solutions. So I see an opportunity here for us to leverage that experience and develop less -- more long-term relationships with some of these clients versus just project work that is important but is project work.

Got it. A big part of the story has always been the returning of capital that was freed up from the legacy portfolios, and you did announce an authorization for 2021 that was above -- certainly above what we were expecting and I think above what most others were. You talk about that process given that some of the other businesses are now larger. And how do we think about that? And what's the outlook on a multiple year basis?

Yes. So our focus has always been on the legacy cash flow related side of the equation. As those cash flows came in, clearly, they pay off the structured financing activities first, right? We have to allocate the portion -- the appropriate portion that is associated with our unsecured debt. We've been driving those outstanding balances lower over time. And then the balance is basically a return of capital to the company, which we, in turn, then return to our investors. We've been fortunate in that the businesses that we are trying to grow are fee-based businesses, are very capital light for us and I think, arguably, almost becoming more capital light as some of the infrastructure that you would typically have at facilities and are maybe less important going forward. And then on the lending side of the equation, the refi loan product has a lower capital requirement than the private loans that are amortizing off. So that balance has been relatively flat, so it hasn't consumed new capital to date. I mean, obviously, I'd love to be in a position where we had greater demands on capital that were producing high teens ROEs. I think our investors would find that particularly attractive as those are few and far between in the financial services space, and our goal is to try and deliver those. But if those are not available, that capital gets returned to our investors.

Sure. So let's -- can we talk a little bit about the trend now that people are looking for debt forgiveness of student loans. You obviously both own and service them. The President has said -- has rejected from his standpoint the $50,000 a borrower approach and seems to be in favor of a more limited approach. Can you talk about the impacts to both of those businesses for Navient in a debt forgiveness situation?

Yes. So I think, obviously, is a large portion -- a large number of people who have student debt and the balances associated with those loans has been growing over the last decade. And I think there are pockets, right, to say that all borrowers are struggling wouldn't be accurate or that the value of the education that was financed wouldn't -- is not a good math, would not be accurate. We see -- and I think one of the things that we get the benefit of from our front row seat is we see where those pockets of real challenge are and we see where borrowers are super successful that they got value from their education. We know that the largest segment of the population that borrowers that struggle are borrowers with relatively low federal student loan balances. These are students who started school but for 1 reason or another didn't complete and typically owe less than $10,000 as a start. But they -- since they got no benefit from the degree, they struggle to pay it back or they're frustrated about it. And so I sympathize with that, and I can see why targeted loan forgiveness in some areas would be a good approach. Broad-based loan forgiveness may have appeal to some, but I think one of the things that we would argue is it's a solution that doesn't solve the -- what's causing the problem, right? Student cost of going to college is very expensive. And if you forgive balances today, what are we going to do for students coming into the in-school programs tomorrow? And you're just going to repeat what -- rebuild what you're trying to end. So we think there needs to be a stronger focus on the front end side of the equation. How do we make college more affordable? How do we help students and families understand what the total cost is of earning a degree? How do we increase completion rates so that there's actually value gained from an investment in human capital? And those would be where we would argue the best solutions are. I think we're heartened in that this -- the administration has asked for input about where do you see some of the biggest challenges; if you were to target payment relief or loan forgiveness, where would you do that, not how, but where. And I think those are important points. And as you know, we've made a big point of this for years that we have tremendous data and insight, and we use it to drive better performance, help borrowers be successful. But I'll make one more point here on one of the federal loan programs that people love, which is income-driven repayment plans. If you enroll in an income-driven repayment plan, until your loan balance is forgiven, if you're paying less than the stated loan payment amount, your loan is negatively amortizing. And so if you're a borrower and you're 5 years into your income-driven repayment plan and you've been diligently making your monthly payments and you get your monthly loan statement and it shows your balance increasing, it's pretty disheartening, right? And I think there's a better way to run that program through "forgiveness as you go" type solutions instead that would help people see the path to success instead of something that looks like it's a burden that's never going away.

This is kind of a tough question to ask, but Navient and the CFPB have kind of been back and forth for some time. And how do you see that evolving? You've got a court case, which you've talked about many times. And then the CFPB or at least the administration has talked about a nominee that has previously been involved in the student lending industry. So just thoughts on the regulatory environment over the next several years.

Yes. I actually think this started from the growing awareness that borrowers were increasingly struggling to navigate the whole -- the complexity of the repayment process. And over the last 20 years, the number of repayment options that have been added to the federal loan programs has increased dramatically. There are almost 60 different repayment options today. They're complex. The income-driven repayment plan that I just mentioned has a 10-page application. You can't enroll on that program directly through your service or you have to fill out a form and send it to the Department of Ed or studentloans.gov and then send it back. So there's all these handoffs and terminology and acronyms that don't help the process. And I think regulators looked at the struggles that borrowers were having and said we don't understand why, and it's probably because of servicing. And so that drove that framework and then as a result, I think some of the actions that you saw. We've now been involved in -- the CFPB filed their lawsuit over 4 years ago. It's been 6 years of the back and forth investigations. As we've said a number of times, despite massive discovery of reviewing tens of millions of pages of documentation, hundreds of thousands of borrower records, they don't -- they have yet to find the evidence to support their original claim. And our argument has all along been that it's better to work to try and find solutions to make the programs work better, understand those causes. And we're eager to work with the CFPB, the administration, Congress, state regulators to do that. And I think that we've demonstrated our actions. So perhaps one of the best things that our data-driven approach has done is we created an e-sign IDR application for them. So we found a way to work around the government rules that say you have to go to studentloans.gov. We complete the application with the borrower on the phone because they can't complete a paper one, send it to them for e-signature. And the result was that we took a -- what was a low mid-20s kind of completion -- successful completion rate and drove it all the way up into the 70s, pretty, pretty successful use of technology and innovation and support all coming from our data-driven insights, right?

We're kind of running close to the end here. I wanted to talk a little bit about you had mentioned about driving expenses down, and you do continue to drive expenses lower, but the expectation that you've put out there for 2021 is a higher efficiency ratio than in 2020. So can you talk about like how you think about expense efficiency and the ability to kind of generate the returns and kind of bring back enough of those cash flows with the expense burden that you're talking about?

Right. So most of the -- the big driver of the change in the efficiency ratio for 2021 is really a mix -- change in mix of revenues, right? So our fee-based businesses don't have the same heft of -- relative to the expense side. And so as that mix grows, the efficiency ratio moves in the other way. So we really target our operating expense efficiencies at the activity level. So if we're doing an action of X, how are we driving that unit cost down? And then how can we drive or create different solutions for our customers and clients to be able to do some of that work themselves. And that's not pushing the burden off of us to the customer. Most of our customers would prefer to do self-service, right? Most of us would prefer to go online and complete something and not be able -- not have to call a call center to get help in that area. So examples are, this year, we rolled out an AI-driven tool on the website called CORA. That allows our customers and clients to ask questions and get answers. And it's a learning process. So it's a pretty sophisticated way of providing direct response to questions that they may have and try to -- instead of trying to sort through all of the complexities of the federal programs. But our unit activity is -- will continue to improve in 2021. So our cost of servicing a student loan will continue to decline. We also think we're able to do less of the costly activities and drive performance there. Good example of that is electronic communications instead of paper mail. We're now -- over 85% of our customers have signed up for electronic communications. That has a tremendous savings for us on postage expense and delivers a better customer experience at the same time.

The mail volume -- mail speed of delivery has not increased of late. So with that, we actually are out of time. I want to thank Jack for his thoughts and insights, and we hope to see you in person in a year from now and talk in the interim. So thank you, Jack, and thanks, everyone, for joining.

Right. Thanks for hosting us and stay healthy.