Navient Corporation (NAVI) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for joining us for this fireside chat with Navient CEO, Jack Remondi. We have a number of prepared questions we'll be going through. But if anyone in the audience would like to ask a question, click on the Ask-A-Question button in the upper right-hand corner of your screen and follow the prompts to submit your questions, and we'll do our best to address it in the time we have today. We also have prepared a number of audience polling questions that we would encourage you to answer during the presentation, and we'll be publishing the results in our report summarizing the takeaways from the conference.

With that out of the way, let's get to the discussion. Jack, thank you very much for joining us. Let's start with an update on the overall origination environment. You guided to a $5.5 billion total origination number this year. How is 3Q tracking so far relative to that number?

Morning, Mark, and thanks for having us here and for the participants who are listening in this morning. Yes. So we -- our guidance is for $5.5 billion of originations. We confirmed that during our second quarter earnings call. And there's really nothing that we see that would alter that outlook or have any concerns. We certainly encountered a couple of headwinds this year with the extension of the 0% interest rate on the direct loan portfolio that certainly decreased demand for some of our refi-related customers. But our volume continues to be strong enough and it's coming from borrowers with more concentration to private student loans. In fact, during the second quarter, Navient became the largest originator of refi loans in the country. So off to a strong start, and we expect continued kind of performance in the balance of this year as well.

Okay, great. What does the competitive environment look like for refi right now? And what is pricing and credit quality look like for the loans you're originating?

Credit quality has remained really exceptional. It's -- these are customers who have benefited from their degree in the education that they received. They've been in the workplace for a number of years, have high levels of both income and more importantly, disposable income and so you see this in our credit loss metrics, right, and the securitizations that we've issued over the last several years, credit losses have just have been extremely strong, positive even through disruptions created by the pandemic. On the competition side of the equation, that marketplace also has some ebbs and flows associated with it. But in the long run, these are assets that are ultimately financed in the ABS market for the most part. And that really does drive pricing to be more consistent than irrational, right? In the market, because some of those wouldn't be able to get deals done. So we like this business. We think we can earn mid-teens ROEs in this space. And when you think about that on a risk-adjusted basis given exceptional credit quality, we see this as a very attractive business for us.

Okay, makes sense. Can you help us think about what origination numbers could look like into 2022 and beyond? What could cause originations to be higher or lower than the run rate you're kind of setting for this year?

Well, I think the biggest positive that we've seen in 2022 will be the return to repayment of the direct loan portfolio. That is scheduled to happen in February. We have been told that that's the last extension that was coming and that the only -- the reason for the most recent extension was for time to have everybody prepare more of consistent messages, higher appropriate levels of staffing on the servicing side of the equation to respond to customer calls and needs, et cetera. So we think as that -- as those loans return to repayment and interest rates -- the interest begins to accrue again that we'll see increased demand from customers who are ready to refinance those loans and lower their interest rates through the products and services that we offer. And that's probably the biggest tailwind that we will see. In terms of headwinds, I think the only thing that we would see that would be a bit disruptive would be a significant rise in rates, which I think at this stage in the game, is not -- doesn't look like it's in the cards for -- certainly not for early 2020.

Okay. Turning to the in-school product. How are originations shaping up this year? What are some of the positive takeaways? And what are the challenges you've encountered so far?

So we've -- this product is one that we are marketing primarily to parents and their students in the higher -- in the high-quality, full-year college and graduate school marketplace. We're seeing good demand from customers on that side of the equation, and we expect our originations to meet our original goals and targets for the year. This market is a slower growing market than refi. It is about making connections with customers through the school channels, through some of the direct marketing channels. And our focus has been, and most lenders focused this way, has been focused on first-time borrowers in the space. So if you have already borrowed a private student loan, it probably makes more sense for you to continue with that lender, so that your loans are in one spot. We could certainly offer them a refi loan down the road, but -- so we're targeting a 25% of the marketplace in our -- really our first significant year of origination. I think some of the other items here that have been interesting over the last 2 academic years has just been the whole COVID-related environment. Last year, the disruption was virtual school versus in person, more significant levels of students deferring classes. A lot more discounting going on in schools as the experience wasn't the traditional college experience for many. This year, we saw more of a return to normal. Still, I wouldn't say it's at 100%. But I think the students and families were more focused on getting the financing side of the equation that they needed accomplished earlier in the academic season. And we will see some of the -- that demand continue at lower levels probably through the balance of the year. I think the other thing that we're seeing, which is a big positive, is students and families are being very disciplined about understanding the financial obligations that they're taking on and the balance of that relative to the education degree. I think there's more awareness today that going to college is certainly important from an [ incline ] in growth for the career prospects, but it has to be done right. It doesn't mean you can just do it without concern about the quality of the school you're attending, the degree that you're earning and how much debt you're going to take on to earn that, to make sure it's in balance with your income potential coming out of school.

Okay. And can you talk more about what the outlook is for this product going forward?

So we believe this is a product that fits nicely in with the other lending activities and the balance sheet aspects of the company overall. We think we can earn high-teens ROEs in this space, but certainly, we allocate more capital to this product, but we also expect higher returns just given it's a -- it has a different risk distribution than the refi side of the equation has. So -- but we like it, we like it a lot, and we think our commitment and again, what we've demonstrated over the years in terms of how we meet the needs of students, help them make good financial decisions relative to their program and degree and then offer them responsible lending products so that they don't trip over and become -- over again in relative to the degree that they are earning.

Got it. So switching gears and talking about credit, which has been extremely strong to date. The federal payment holiday has been extended into January. Can you talk about how that will impact overall credit performance this year and into 2022 as forbearance eventually expires?

So our -- the Department of Education loan products are not loans that we own. So we don't -- we service those on behalf of the taxpayers and the Department of Education. And we work closely with the department to make sure that students understand -- that borrowers understand their options, their obligations and who can find the right path to successfully repay their loans. I think one of the things that we've done consistently as both a lender and servicer in the Federal Student Loan Programs has been helping borrowers avoid the devastating consequences of default. We see that in our cohort default rate statistics. We are consistently 30-plus percent better than the rest of the industry in terms of cohort default rates. This last 18 months of the pandemic has certainly been an interesting one. I think when it started, everyone was expecting some very significant dire consequences for the consumer. That turned out to be different. The federal government's response, the stimulus helped quite a bit. And borrowers are -- I think took this opportunity over the last 18 months to get their balance sheets in better strength, reduce their spending, increase their savings. And you're seeing it in our delinquency -- all statistics across our portfolio. So our FFELP portfolio has -- is experiencing delinquency default rates that are at or near historic lows. In our legacy private loan portfolio, we have 2 buckets. We have our traditional loans that have been performing exceptionally well with very low default rates over the last 18 months. And then our TDR portfolio, which is a portfolio we've always had some difficulty in the past, and even there, we're seeing delinquency and default rates at much, much lower levels than we've seen historically. In both our FFELP and private legacy portfolios, we have returned those loans, the majority of those borrowed, back to repayment, way ahead of the Department of Ed side of the equation. In part because interest is accruing on those loans and negative amortization is not a good thing if we can afford to make payments. And so we've been encouraging borrowers to make those payments. When the Department of Ed loans do come back into repayment, it will put some additional pressure on cash flows for consumers. But when we look at what the transition that took place for our commercial FFELP portfolio, we saw a very, very strong transition back into repayment from the forbearance levels that were being granted and a very high success rate of customers making payments and staying out of delinquency. So we're hopeful we'll see similar kinds of results with the Ed portfolio in February.

Okay. Now it sounds like you don't expect another extension of the forbearance, but is that something that could happen? And if it does, would it create challenges for either Navient and/or just the trusts that are out there?

We don't expect it, but it's also not loans that we've ever securitized. So -- because we don't own them. The Department of Ed and the Treasury owns those assets. So no, we don't expect it to have any implications on trust securitizations of the commercial portfolio.

Okay. Turning -- or sticking with credit, could you dive a little deeper and talk about credit in each of the different loan products? I think you spent some time on this, but a little more on FFELP refi? Nuances between them? It's helpful for investors to understand.

Yes. I think this is a -- student debt has obviously received a -- have been the subject of a lot of news and media coverage, and there are problems with the student loan program and the way it's structured and the way it operates. There's no questions about it. And we've offered, over the years, a number of suggestions that -- ways to improve the program. Probably one of the most significant changes that we would recommend is -- has to do with loan forgiveness programs. Today, when a borrower is in an income-driven repayment plan, if they are making payments below the amount of interest that is accruing on that loan, that loan continues to accrue that interest. And as long as the -- if the borrower's income stays low, it will ultimately be forgiven. But like most people who graduate college, their income gradually or sometimes significantly increases and sometimes that accrued interest actually ends up having to be repaid. And so that loan negatively amortizes and increases the overall cost of the debt to the borrower. What we try to do is -- our suggestion in that front is to have a forgive as you go concept. So that interest does not negatively amortize on the account. And we think that would be helpful. The piece that I was getting to on the media side of the equation is while we do see a number of borrowers struggling either through they didn't get a good quality education, they borrowed more than the degree was worth, or they -- even worse, dropped out of school before earning a degree. What we do see, though, is that the vast majority of students and families who do borrow in the marketplace gain a benefit from this. They earn their degree. The degree produces a job or helps them get -- land a job that is -- generates a return on their investment, on their education. And that's where we really try to work and help, and where you see that translate into credit is strong performance. And so in our FFELP portfolio, credit performance, as I said, is at -- delinquencies and defaults are at historic lows. Our legacy private portfolio is operating at similar kind of historic low percentages, particularly in the non-TDR side of the equation. And in refi, we're looking at life-on-loan losses that will be under 1%. So very, very strong credit quality overall.

Okay, excellent. Can you talk about how the overall blended credit performance should evolve as the mix in your portfolio changes?

So we would expect, as our legacy portfolio continues to amortize as we would expect and is replaced with a higher percentage of refi loans or an increasing mix of newly originated in-school loans, we would expect our credit performance to improve. But I think if you look at our portfolio and you look at the delinquency in the bulk statistics of say, the non-TDR legacy portfolio, I think that's -- those are the kinds of trends and the refi statistics that you can expect to see based on the blended mix of our loans going forward which are, as I've said, exceptionally strong in this economic environment.

Okay. And -- but then -- will there also -- as you grow kind of the in-school product, will that start creating some upward pressure on charge-offs or just...

Well, we expect the LIFO loan losses in the in-school product to be higher than the refi side of the equation, and this is really driven by just the characteristics of the loans, right? When you look at student lending, the 2 biggest risks are, will you graduate? Will the borrower graduate? And does that degree generate a job or lead to a job that generates enough income to service the debt? In the refi side of the world, we know both of those answers, right? We know that the borrower is graduating and we know what their cash flows are. And in-school, you're taking those risks, and so the loans are priced differently. As I said, we hold more capital to them. And in most instances, we're looking for the parent to be a cosigner on that account. Now one of the features that we emphasize in our in-store originations is that the cosigner here is not just a name on the paper. We are really looking for that cosigner to be an active participant in the repayment of the loan. And we help them understand the different ways that they can repay that loan, particularly during the in-school period so that they can minimize the total finance charges on the account. So we offer significant -- first of all, we share a significant amount of information about those cost differences and then we offer a lower interest rate to families who choose to make payments while in school, and we are seeing a significant portion of our application pool choose to make a payment during the in-school period, primarily so that that account balance does not grow while the student's in class. And the student, when they do [ enter ] repayment -- and graduate and enter repayment fully, are starting off in a better position than they might otherwise by having deferred interest payments.

Got it. Shifting to reserves. Could you talk about your reserves and remind us what type of loss rates and economic assumptions are contemplated?

So our -- we continue to maintain obviously a significant amount of coverage for potential loan losses. And our reserves are a function of, under CECL, an estimate of the full, remaining life-of-loan losses. These take into consideration varying economic environments, different interest rate environments and changes in regulations. So one of the things that we are focused on right now looking at is there are new call limit types of rules coming out of the CFPB that impact primarily third-party debt collections, but we're seeing more of that being applied at the first-party side of the equation. This is one of the things that I think we've done -- we do an exceptional job at, is reaching out to customers to make sure that we make contact with them. When I noted earlier, the superior performance we deliver on [indiscernible], it's all about right party contract, so getting the borrower on the phone so that we can explain the different repayment options that are available to them and help them choose one that makes sense. So our statistics here are historically consistent. 9 times out of 10, if we can connect with a delinquent borrower, we can find a repayment plan that keeps them successfully out of default and 90% of the borrowers that end up in default do so with 0 contact with us. So they -- we were unsuccessful at reaching them to have a conversation. But those are the things that we would -- that we look at. And right now, as we stand at June 30, we think our reserves are adequate to cover expected losses and the variabilities that I just mentioned in terms of economic performance, interest rates and regulatory changes.

Got it. That's helpful. So the BPS segment continues to outperform revenue expectations. Can you talk more about what's driving that, and how long it should persist for? And then kind of what is the run rate of BPS as some of these pandemic contracts start to roll off?

So we've been extremely successful at responding to the needs of some of our clients as the pandemic unfolded. And one of the things -- when we first started doing some of this work, we were helping the states and processing the flood of increased unemployment applications. We've done some work with contact tracing, vaccine awareness. One of the states we work with, for example, we do a lot of outreach to residents of the state to help them understand how to go about signing up for -- to get the vaccine, where they can go to get it. And that's been -- they've actually led much of the country in terms of vaccination rates as a result of them. It was -- when we first started doing this work, we certainly expected this to be shorter term than it has been in duration. But I think as we have seen the pandemic kind of extend, many of our clients have asked us to continue to stay on and do some of this additional work. And we're bringing to them some skills and technology and -- that they might not otherwise have themselves. Certainly, at the beginning, it was about labor. How can we provide the labor that they need? But more and more, it's about some of our telephonic capabilities, our data analytics in terms of predicting call volume. How to triage different calls that are coming in to kind of help those who need it. And a lot of things like IVR technology to address simpler questions that don't need to be answered by a live human. With all that said, I think our -- certainly, our revenue on that side of the equation has extended longer than we expected. We still expect it to materially decline through the balance of 2021. And -- but I think one of the things that we are very focused on and I think the work that we've done for our clients over the last 18 months has positioned us well for it, is to do other types of project work or longer-term assignments for these clients over time. They see what we've been able to, they see the quality of our work. I'll just -- I'll give you one anecdote here, one of our state clients has consistently told us that they had multiple vendors doing a similar type of work and that our team was outperforming or productivity was 30% better than everybody else. That's all because we're bringing some of that technology and data analytics to the process. So we're pretty excited about what it means for the long term. We do expect it to have a little -- to decline on the project-related revenue first before it's -- we can start to build it back up with longer-term assignments down the road.

Okay. And how do you think about the longer-term revenue growth potential in that segment once some of the more pandemic-related projects have run off? And what are the opportunities for growth? Are you actually -- you just mentioned this client who noted your higher productivity. Are you seeing signs that they're now willing to throw you new business and that you don't currently have with them?

Yes. I mean I think in that one instance, we picked up a special -- another special project work contract that they did, that they ran or are still running today. So then that was a competitive bid product. It was not an emergency procurement type of thing. We were able to win that contract and perform exceptionally well for the state. I think the -- when we look at our business, overall in BPS, we do have different segments that we target. In the health care side of the equation, we continue to see that, that's an opportunity for solid double-digit growth. It has been somewhat counter-intuitive, but COVID has actually decreased the revenue cycle at many hospitals across the country as they focused on the pandemic-related services and less on outpatient and more elective surgery types of work. So we have been helping them manage some of that cash flow-related activity, but it has definitely slowed down during the last 18 months compared to what we had originally expected. And I think it -- winning new contracts has also been slower as hospitals have been focused on more emergency work versus rightsizing their operations and managing their cash flows differently. We do expect that to reverse trend and do -- as I said, we expect double-digit revenue growth opportunities in that space. In the government municipal side of the equation, it's more about an outsourcing-related services. It's about kind of mirroring or matching call center-related services with back-office operational flows. As I talked about earlier, the data analytics and analysis that we've been bringing to the table, to help meet the residents' needs faster or cheaper than, say, the state might have been able to do on its own. So -- and COVID again here, I think, while it created demand -- excessive demand in some areas, what we're now seeing is many of these state clients are saying, we can actually do more of this in an automated remote type of process instead of fixed buildings, where residents would come in to transact. And they're looking for parties like Navient who could help them solve those problems and bring solutions that make it easier for the residents to do things like, hey, I don't have to go to the DMV anymore. That's -- most of us view that as a positive. Right?

Absolutely. Turning to earnings now. You're one of the few companies to actually provide earnings guidance. And I think every year, you've addressed -- every quarter, you've been raising it. Adjusted earnings of $4.20 million to $4.30 million. Is this still the current guide? Is it -- and it's more than 33% higher than the original. Does this range still feel right to you currently?

Yes. We continue to feel positive about this. It's certainly a combination of multiple factors, some of which we just discussed, with all the project work in BPS. Certainly, credit has been exceptionally strong. But we're also benefiting from a very favorable interest rate environment, both in terms of absolute levels of rates and as well as the credit spreads and the debt securities that we offer in the marketplace. So altogether, this has been -- has come together to create a very, very strong year for us. And I think our team across the platform within Navient has responded to the challenges of the pandemic really in a exceptional way. And when we continue to deliver high-quality services to our customers and clients, and we're able to take advantage of the opportunities that present themselves to deliver the strong earnings growth that we've seen this year and visibility, which is the driver been able to give that guidance.

Yes. Could you talk a little bit more about the uncertainties around that guidance? What could kind of push it, earnings, ultimately higher or lower than the current guide?

Yes. Well, I think at this point, through the 6 months reported already, there's obviously less variability in the earnings outlook than you might say at the beginning of the year. But probably the biggest variable here would be if there's any meaningful extension of some of the BPS project work that we've done. And we've certainly seen each month that that has been stronger than originally expected. I think we -- during the year, we kept saying this was going to drop off faster than it has. I think we're feeling still that it ultimately comes to an end in 2021. But the path down was much, much slower than we originally expected, which has obviously been a positive.

Yes. Is it -- has it been the Delta variant and kind of the extension of the pandemic been a big driver there and kept a lot of these projects running longer than you might have thought?

I think not necessarily, because I think there's been a little bit of pickup there for some contact-tracing-related stuff, but not a huge increase. And I would call it more of a slow -- a slower slowdown than expected versus an actual increase in opportunity. I think what we have seen, though, is that in some places where we were one of many providing those services to the states, that we became now one of one. And so where we had expected most of the vendors to see a similar kind of decline, the states -- in part because of say the productivity statistic I mentioned -- had actually retained us and others have dropped away. So that has been more of the -- I would say, more of the driver versus an overall increase in revenue from the clients.

Okay. Makes sense.

But that's a positive statement about the work that we do as well, right? That it's -- that we're being retained and others are having their contracts [indiscernible].

Yes, yes, absolutely. This year, obviously, earnings have benefited from a number of things that aren't necessarily recurring. How should we think about what normalized earnings power looks like as we go into 2022 and beyond?

Well, I think we'll -- certainly, as we get into the balance of this year and the next earnings call, we expect to have a little bit more guidance and direction on that front. But when we look at the drivers of earnings growth this year, and this is really our fourth year where we will have reported both growth in net income and growth in EPS from the prior years that there are things that are contributing to that that are permanent, right, but certainly, our student loan portfolio is performing at better spreads, better margins. Credit losses, we think, will continue to be strong into 2022 as well. So those are items that are more tailwinds to the structure. And some of the things -- the interest rate environment that created some onetime benefits, partilcularly more last year than this year, but a little bit of carryover for sure into '21 have been a very nice tailwind, but it was one that is evaporating, right? And not going to repeat. Some of the project work as well. But I would still say both myself and my team are very optimistic that over time, we'll be able to convert the experiences that we've been able to provide to these state clients, in particular, as it relates to these pandemic-related projects into more permanent-related opportunities for us to perform for them and their residents.

Got it. Turning to capital allocation and how to think about that going forward. Where do buybacks fit into that policy? A year ago, shares were at $9 and buybacks looked much more compelling. Now the shares are above $20. Do you still like that as a way to deploy capital?

So our capital return strategy is perhaps a little bit different than most. And it is really being driven by the fact that we have this large legacy portfolio that requires a certain amount of capital in order to manage it. It also generates a significant amount of capital over time. But both of those items are in excess of what we need to replace for our future growth. Now in an ideal world, we would need all that capital, right, that our growth opportunities and our lending business would be so strong that we would want to retain most of that. That would be a better use and a better return for our investors. But to the extent that we don't need that capital to support future growth in the business, we believe it should be returned to investors. And I think the combination of an attractive dividend that we've been paying out for years now along with returning that capital through share buybacks continues to make sense even at these stock price levels. I would still say we trade at a significant discount to others -- to the market in general. And that's both in terms of P/E ratio or price to book kinds of metrics. So we would continue to see share buybacks being a meaningful part. But certainly, as the portfolio declines and as you've seen over the last couple of years, the amount allocated or spent on share buybacks has been declining each year.

Got it. So what's the latest on the Department of Education servicing contract? And I guess PHEAA announced they will quit the program. What are NAVI's intentions? And how is their decision impacted?

So right now, the contract is scheduled to expire in December of this year. The department is looking for -- to provide an extension of those contracts as it evaluates different options going forward. Now the department has been working for a number of years now at trying to, what they call the -- replace the existing contracts with what they call the next-gen servicing arrangement. They have been out of the back office and call center-related work associated with that. We were offered an opportunity to accept but we declined it, simply because we didn't think the terms were sufficient to cover the costs associated with providing those services, particularly the service levels that the department was kind of looking for and I think the public kind of demands from that side. And we would have -- we think that it just wasn't sufficient. So we have some work to do with the department. We're committed to helping the borrowers that we serve make this transition from forbearance into repayment in an orderly, constructive way. I think we have shared with the department the experiences that we have had in terms of how to successfully communicate with borrowers when transitions take place and we have a lot of experience in that. And I think those patterns and communication materials, both the case cadence and content are kind of critical in that space. So we'll be working with the department closely over the next couple of months to make that transition as smooth, as I said, and as constructive as possible.

Got it. Can you provide us an update on the CFPB and state AG suits?

Not much to update. These -- and I think I said when these lawsuits were originally filed, I had to relearn my civic lessons that the right to a speedy trial doesn't apply here. And you can see this. I mean we're now, what, 5 years -- 5 plus years into some of these lawsuits. And they just -- it's a slow kind of grind to move through all of the different steps that are part of that process. We continue to feel very strongly about our defense. I think if you look at the one case where they have published, where there's data out there on what came through out of discovery and the responses, we feel very strong that our customers have been handled appropriately. They've been communicated with about the different repayment options that they exist. We've had a number of data points come out of placements, national statistics from the Department of Ed, for example, that show that Navient borrowers don't use forbearance any more than anybody else. And actually, the duration of forbearances used at Navient is less than the other services. So pretty hard to argue that there's an active steering process here. And the last point I would just say is we have a higher percentage of the borrowers are in repayment plans outside of the programs we don't run, like teacher loan forgiveness for example, than any other service. So I think we're doing a good job for a program that is incredibly complex and difficult for consumers to navigate. I think we're still doing an excellent job [indiscernible] the consumers we serve.

Okay. Where do you currently stand with the CFPB case? Is that -- have you had an opportunity yet to file a motion for summary judgment?

So it is -- there have been a number of motions filed during the process. There are some motions outstanding right now with the judge in Pennsylvania. As I said, COVID has also impacted the legal system just in terms of the volume of activity that they hear. But unfortunately, we don't control timing. And so you can file motions and it can take -- your expectations could be 90 days. It could be 9 months before motions are ruled on, so a lot of variability, unfortunately, in the United States. And we've been -- even right from the beginning to have our day in court, to be able to prove our case, and we look forward to resolving these through that process as quickly as we can.

Okay. Great. Well, I think we're out of time. Thank you very much for all the comments, Jack. I really appreciate it.

Thank you. Thank you, everyone, for participating today.