Navient Corporation (NAVI) Earnings Call Transcript & Summary

So good morning, everyone, and welcome to our 23rd Annual Financial Services Conference here at Credit Suisse, and we're thrilled to be back in person. I'm Moshe Orenbuch. I cover the specialty finance sector here. And very pleased to have with us the management of Navient. I've said this each of the last 7 years or so, but I'm very proud to say that the creation of Navient, the separation of Navient and Sallie Mae from the old Sallie Mae was first announced at this conference and I feel like we've been a part of that. Navient has been a leader in student loan consolidation, has reentered the student loan market. It recently -- always had a focus on returning capital to shareholders, has recently increased that focus and has been leveraging its expertise in its fee-based servicing businesses as well. Jack Remondi is with us. He is the CEO of Navient. He was the CFO of the predecessor company, Sallie Mae, then became COO and CEO of the old Sallie Mae and has been the CEO of Navient since the separation. So we're very pleased to have him with us. He's got a few opening comments, then we'll go into a fireside chat.

Thanks, Moshe, and welcome, everybody. I think what I just wanted to mention in the opening comments is really what our key strategies and focus areas will be as we enter 2022 and beyond. Our business has been a combination of a legacy piece of the business and some growing aspects of it. And our focus in 2022 is to maximize the cash flows that we are generating from our legacy student loan portfolios. This is something I think we've done really an outstanding job of over really since separation. And our total cash flows from that business have been coming in well in excess of what our forecasts had been. So -- and that's something we continue to focus on by maximizing the performance of the portfolio and our funding efficiency issues. We're focused on growing our loan origination business. This is a combination of both consolidation or refi-related opportunities and new loans to students and parents, who are enrolled in college. This is a business that we think we can continue to grow at a pretty rapid rate. We are the largest originator of student loans in the country on a combined basis. The #1 originator of refi loans and we hope to be a top 5 originator in the in-school marketplace. As Moshe indicated, we're also leveraging our operational expertise and that is really taking advantage of the expertise we've developed in student loan servicing and applying it into other industries and other aspects. And if you think about student loan servicing, it's really a large processing entity, back-office operation that is managing a high volume of complex transactions and we've been able to leverage those skills and apply them into other businesses. We had a very successful 2021, demonstrating the agility of both our platforms and our people to adapt to new business opportunities or really more business needs that were created as a result of the pandemic. And then lastly, when we combine all of these things together, we're still a large generator of capital and our plan will be to continue to return excess capital to investors through dividends and share repurchases. Clearly, our first interest and priority would be to reinvest it in growing the businesses, but we believe the scale and size of our capital generation allows us to be able to do both.

Great. So as we think about the portfolios that you talked about and maximizing the cash flows from them, maybe if you could just talk a little bit about a little more detail in terms of how you've been able to do that and what that means for the cash flows both from the government piece of the -- as well as the private.

So it starts with helping our customers be able to successfully manage their payment requirements. And that is educating them about the different options that are available to them and helping them find a repayment plan that fits their particular budget. I think we hear in the media more about the struggling borrowers and those are certainly real individuals with real difficulties. But the vast majority of our customer base are borrowers, who are paying successfully and they're just looking for a payment plan that better fits their particular budget. It may be that they're trying to pay the loan off faster or it may mean that they're trying to organize their payments for different life events, like purchasing a new home or expanding their families. And that's a big part of it. And as a result of our efforts and the outreach that we were able to do in using our long history of data related to borrowers. We're able to help those customers. And you can see it in our default rates. Our default rates in the federal program, for example, historically run or consistently run 35% lower than the national average. The other big opportunity for us has been on the funding side of the equation. And people on my team probably are tired of hearing me say this, but I always tell them interest expense is our biggest expense and we have to be focused on maximizing our funding efficiency. And we've been able to do that by finding innovative ways to reduce the amount of unsecured debt that we need to finance our portfolios. A big part of that has been capturing the equity that is built up in our securitization trust and leveraging that in a different way than with unsecured debt or equity. We've also been very active at refinancing liabilities when we can. So in our ABS transactions, there are cleanup calls that we're able to take advantage of and refinance those at lower rates, same on the unsecured debt side of the equation. So those have been the 2 biggest catalysts that we have deployed to increase cash flows beyond expectations.

And you did a fair amount of that in each of the last couple of years. Just can you talk about the opportunities that you see here. I mean does the rate environment impact that in any way? I mean just give us a little bit of a sense as to how it might look in '22.

Yes. So most of our legacy loans are variable rate. So the opportunities continue to exist, just whether rates are high or low to capture that. Certainly, some of the biggest movers were finding ways to finance at significantly lower cost the equity that was building up in the securitization trust. But we continue to call ABS transactions and maybe one easy way to think about this is at the end of the life of an ABS deal, you're paying the highest rates on what you issued when you issued it originally. And so if you can refinance that and push more of those cash flows into shorter duration bonds, you typically pay a lower rate.

Okay. Just talking a little bit about the guidance that you gave recently for 2022. Just can you talk through in as much detail as you're willing to in terms of the 3 big portions of your portfolio, the FFELP portfolio, the legacy private and the refi, how to think about the outlook for those -- for the margins on those businesses?

So we gave guidance for the different components of the portfolio, both in margin and then obviously for EPS and they reflect a rising rate environment. They reflect our expectations on portfolio performance as we have moved borrowers back into repayment out of the pandemic-related pauses and an expectation that the direct loan portfolio, which is not on our books, but does impact borrower cash flows will come back into repayment later in 2022. So all of those things combined probably the piece that I think was -- is a little bit different than investors saw in terms of its impact is the amount of impact to the net interest margin that is created when private student loans become delinquent. Under CECL accounting, and this is when a loan becomes more than 90 days past due, you have to reserve for the interest accruals that have happened there. And during '20 -- 2020 and 2021 because of the pandemic forbearance pause-related programs, we had a much smaller base of loans in those 90-day plus delinquency statuses. And as borrowers now return to repayment, those numbers are increasing. And so you go from almost a 0 number to a bigger impact and you saw that in our forecast for 2022. Other than that, we expect a lot more stability in our spreads. Certainly, on the FFELP side, you'll see some pressure from the reduction of floor income as rates rise, but most of that floor income is hedged and so the impact is not as sizable as it would be from a rising rate environment in total.

You had mentioned the leader in student loan consolidations, can you just talk about the competitive dynamic in that market? Obviously, one of your competitors went public in the past year. You've also had all of the issues around the moratorium, making it a little more difficult, less attractive for consumers. Like where does that sit right now? And how do you see that evolving over the course of 2022?

Yes. So we have -- if you've been a listener to these types of events or heard us on earnings calls, you've heard me say any number of times that the risk of student lending space is graduation and job, right? In the refi marketplace, you know the answer to both of those questions. The borrowers graduated and they've been working and their income is well in excess of their cash flow requirements, cash outflow requirements. And that's where we see the great -- we see a significant opportunity in that space. And I think the advantages that we have -- and there are a number of competitors, there are banks, there are fintech entities in this arena, is that we have 40 years of ONS data, right? And that data tells us about -- gives us the ability to model and predict with a higher degree of accuracy, precision through all types of interest rate economic environments, about the prospects of borrowers in the future based on where they are today. And we've been able to use that information to, I think, be more expert in our underwriting activity and it shows in our loss rates. Typically in our refi portfolio, you see losses run about half the rate they do in other lenders in this space. The other big thing is we really looked at this as an opportunity and it's the same kind of concept of understanding where borrowers are in their life cycle and have used more digital marketing strategies to target potential customers in the space and make them aware of their options in these programs. Part of that is valuable because that's where those customers live. They live in the digital world, not in the direct mail world, but it's also significantly lower cost of marketing activity compared to direct mail. And there again, we think we run about half of our competitors' average business. Where you see this where I think we saw and demonstrated the value of this type of approach is last year, right? When the pause happened, the traditional customer who is refinancing is someone who went to graduate school, has Grad plus loans, relatively high interest rates. They have now earned a lower rate, right, through their credit profile, but they weren't refinancing because the government had set their rate at 0 for -- during the pandemic. And so we changed our marketing activities and really we're focused on people, who had loans that were not subject to the pause, these would be private student loans, older FFELP loans and we were able to continue to grow our refi originations in 2021 where the rest of the industry saw a decline. And that's really that combination of insight, the ability to pivot that agility and then use our data to drive results that are beneficial to the customer. I've had someone say, why you take -- a particular senator asked me why we were taking borrowers out of the federal program where they had all these safety valves. And I was like, well, these customers don't need those safety valves and we're actually saving them money by lowering their interest rates. And that's been a valuable product, whether rates are high, low, there's a pause or no pause depending on your loan type.

And if you think out to the next few months as -- well, first, I guess, maybe I would ask you, do you think that pause gets extended? And if it does not, how does that reflect both in terms of volumes and potentially competition.

Well, politics are hard to predict. And there was right up until the pause was extended. This administration was adamant that it was not extending the pause. So hard to say where it would go. I will say that if you look to the FFELP program and you look to the private student loan program, though, the economic rationale for the pause has long expired, right? We have successfully returned both FFELP and private student loan borrowers to repayment. Those customers are making payments at higher rates than they did pre-pandemic. So delinquency rates and default rates and forbearance usage are all lower than where they were pre-pandemic. And our indications and forecast based on the patterns of behaviors that we're seeing would say that, that's a pace that's going to continue. Just look at the job market today, I'm sure all of us are feeling the same kinds of pressures of hiring people, retaining people and the rising cost of that. That just does not seem to be where the need is greatest.

Okay. Earnest had made a small acquisition. Maybe talk to us a little bit about that, what extra capabilities that gets them and how that fits in.

Yes. So we acquired a small company called -- Going Merry. And Going Merry is a company that provides high school students with information about financial aid, the financial aid process and helps them and their guidance counselors at high schools staying on track for completing the necessary forms as they seek to apply for college and find ways to pay for college. And some of those tools, for example, help students and families complete the FAFSA. And the FAFSA is a government form and so that's probably all I need to say. I mean it's a complex form. It's difficult for families to understand the jargon, particularly when they fill it out once or per child over their college experience. And it's been an issue where many parents and students have not completed the form because of that complexity. So we're helping them do that through a simple Q&A kind of tutorial type thing where we ask simple questions, get the answers, populate the forms and do that work for them. This is all done. It's free to the borrower. We also pair that financial aid application processing activity with a scholarship search program. And you might say there are a lot of scholarship search programs out there, but one of the unique attributes of Going Merry is that it is not just a national database, it's a local database of scholarships and that's what's most important to high school students. The vast majority of scholarships come at the local level. This is your -- be it your rotary clubs, et cetera, that provide these scholarships. And the fact that these are bundled together and able to be applied for through one application process, it makes it very easy for the high school administrators. So why did Earnest buy this company? Well, we think the tools that they are offering, the FAFSA completion and scholarship search are very much highly related to student loan origination at the in-school level. And so can we pair those features together to help our in-school borrowers better understand the whole financial paying for college process and how to minimize, how much they have to borrow to pay for college and it's also a lead source for us. It provides us with a list of the potential college students, who are highly motivated and are going through the process. So it's really that combination of activity that we think can make both our products and our -- more attractive, but also help us with our prospects.

It's kind of a good segue to talk a little bit about the in-school market you had mentioned in your opening comments. You like to be in the top 5. It's a concentrated market. The top 2 players have a lot of market share. The #3 player has been around for a while. And there isn't kind of a -- I don't believe there's really a strong kind of leadership in the market after that. So maybe just talk a little bit about the start that you've had in that market and what -- how do you think it shakes out in the next [ years ].

It's certainly it is one of the most unique consumer lending marketplaces and -- for a variety of reasons. It's highly seasonal, right, which means your marketing activity is taking place in a concentrated period of time. And if your products and your features are not quite ready yet, you miss an entire year in that space. It is highly serial, which means that once a customer starts in a process, even though they might borrow 3, 4 times over their lifetime, they're likely to stay with the existing lender for ease of repayment purposes. And so when you're coming -- and the third piece is that your marketing activities are sometimes heavily influenced by schools, right? So not that they're promoting one product over another, but they're offering a generic list of lenders. And if you're not on that list, how do you break into that marketplace? So it's -- unlike refi where you can come in and make a big splash quickly, the in-school marketplace is a marketplace that grows much more slowly, but we think there's long-term value in that space. And so we believe that we can see, for example, we generated a little over $200 million worth of originations last year that we can more than double that as we take advantage of some of the serialization opportunities, but then continue to develop a reputation of being a value-added provider, not just a me-too or a commodity type loan product. I think the Going Merry programs are a big part and can be a big part of that growth feature. But I would also say one of the big things that we try to do is help students and families better understand what they're signing up for. I think the whole financial aid process when applying for school gets a little complicated because you're so focused on I got in I need to pay the bill. And I'm not -- the thought process is not how am I going to repay that bill 4 years from now or 4.5 years from now. And if we can do a better job at helping students and parents understand that process of what they're signing up for and relate it to their potential income based on their field of study, we're going to have a better product. It's going to have -- it's going to perform better and customer satisfaction, obviously, will be that much higher.

Got you. The -- maybe shift a little bit to your business processing area and you talked again about it a little bit in the introductory comments. But maybe give us a little bit more detail about the types of opportunities that you see, what programs are ending, what are the areas in which you think there's a potential for new business contracts.

Yes. So when we got into this business processing solutions, it was really about helping many states and municipalities or kind of governmental authorities with revenue management. So they were sending invoices out and getting payment back and so it was just managing that particular flow for them. Part of it also included an education process, but it was -- these were relatively small ticket items, so it was more about operating efficiency. And what we discovered as we were moving through this is that, that was a valuable service to entities, but the real value was taking on more complex related activities. And so we got into the health care space and we worked with hospitals to do what they call revenue cycle management, which is really helping patients understand when they get their bills that it's been fully adjudicated between the insurance, the discounts, and this is now the amount they owe. Most of the work there is just explaining that process to them. We help hospitals make sure that the claims that they are submitting to insurance companies get paid. So that's about making sure the coding is done correctly. This is all using technology to verify the accuracy of the submission and doing the edit checks in advance before it's submitted, so that it speeds up the cash flows for the hospitals and results in higher payment rates. And all of that is really just using the operational -- the platform expertise that we've developed and then the people training-related activities. When the pandemic hit, there was a huge need for new types of services that were overwhelming states, in particular. This was processing unemployment insurance, doing outreach on COVID, protocols, vaccination sign-up, information flows, et cetera. And again, we were able to take our technology platforms, adapt them. We retrained and hired -- we hired over 10,000 people during the pandemic to field -- to do this particular work. And we were able to train them all remotely. They all worked from their homes and set them up and be very responsive to the states. In some instances, states would say, "I need 300 people answering phones on Monday," and this would be Thursday and we were able to respond to that. I think that says a lot about the agility of the platforms and the people training skills that we've developed over the years.

And if you think out 2022 and perhaps beyond, like -- you mentioned some of the programs are ending. But what's the size of the business that you see then and what kind of growth rates do you see?

We think -- so clearly, there's a reduction in revenue in 2022 from '21 as these pandemic-related programs are ending. We do think it gives us a tremendous entry point with states to find programs and be able to do work for them in new contracts that are more permanent in nature, everyday kinds of business activities. Our performance from the -- the feedback we got from the states has been incredibly positive. And several states reported that we were far more efficient than anyone else. In many instances, we were one of multiple vendors, but the last to be ended as their volume declined. And we're having conversations with folks about what other opportunities exist in those spaces. But barring that process, we still expect -- if you take our BPS revenue minus the pandemic-related revenue of last year, we expect that revenue will grow double digits. And we expect that growth rate to be able to persist for a long time in that space.

Are there any differences in the margin structure of the new business? I mean it sounds like some of those things were actually fairly people-intensive or some of the new businesses more or less so. And how does that impact the margins?

Yes. And any time we can use the platform, the technology services and analytics help us drive operating performance. But I will say, even though they were heavy, labor-intensive customer representative focused, the work we were doing was still based on analytics. So we were helping identify how to process unemployment insurance claims faster, capture the information to complete that process so that the unemployed person could get paid. In the COVID outreach side of the equation, it was designing strategies so that we were targeting -- helping states, target people who had lower vaccination rates in other segments of the population and help them become aware of what their options were, how to get it, where to get it. And that was all technology driven, right, in terms of identifying and the outreach strategies we deployed there.

Interesting. You also mentioned in your opening comments the idea of capital return and still large amounts of the legacy loan portfolios paying down. Can you dimensionalize for us what that's going to look like in 2022? And how you think about the difference between buybacks and dividends given where the company is and where the stock is?

Yes. So we have -- different portfolios generate different amounts of cash and free up different levels of capital. In the FFELP space, the amortization of the portfolio is more about a capital generation opportunity versus a release, right? Because as we hold on our FFELP portfolio 50 basis points of capital, a paydown of a loan doesn't free up a lot of share repurchase opportunity. In the legacy private side of the equation, the portfolios in many cases had higher -- have much higher levels, 8%, 10% capital assigned to them, but they're also generating capital as well. So the combination is really where we get the vast majority of our capital source. Last year, in '21, we also sold some private student loan portfolios, which generated additional gains and released capital as well. So while the private origination business was growing, the portfolio stayed relatively flat and didn't consume a whole lot more additional capital. In 2022, we expect our origination activities to consume more of that capital and we expect our private loan portfolio to grow rather than stay flat. And so that puts some downward pressure on the amount of capital return that we have overall. But it's still a sizable amount as you point out. And we expect that kind of pace to be able to continue over the near term. It's not one that would drop off. I will say though, if we could be doing 3, 4x the amount of private loan originations that we're doing today and invest that capital in the business, that would be our primary -- that would be a better outcome for investors. The mix issue, I think between dividends and share repurchases, our dividend yield is already relatively high. I think our job there is certainly for it to be -- we've always perceived it as being valuable to be steady versus to be one that's fluctuating up and down based on capital generation. And the variable component for us is through share repurchases. I think at today's -- even at today's stock price level, certainly when we were trading in the single digits, low double digits, it was a an easier analysis, but we still see this company as being undervalued. Our P/E ratio is well below our peers. It's well below other financial institutions. And we still see that opportunity to buy back shares as being highly attractive to our -- to those investors who choose to remain.

Yes. One of the things that has always been a critical element, because a significant portion of the company's cash flows earnings have come from portfolios that were in runoff and also as you mentioned some of the business processing opportunities that had limited life, has always been the idea of managing the company's operating expense base. Can you talk to us a little bit about where you see that and both -- kind of within the businesses and at the corporate level, how you're thinking about the expense outlook?

Yes. I would actually say running and maintaining operating efficiency in a business that is shrinking as it amortizes is probably one of the more difficult tasks, right? And so we've been thinking about this. And the beauty, I guess, of the FFELP business is that the visibility of that amortization process was very clear and very long, right? And so you had lots of lead time to figure out how -- what you needed to do and when the turning points might come. I think some of our early decisions on this space were to sell our servicing platform to take a fixed -- something that had more of a fixed cost structure associated with it and make it variable, was a big opportunity. But then the other pieces are really about finding ways to use our data, use our analytics and use our technology both existing and new to find ways to be more operationally efficient. So some easy things that we looked at was how do you get customers to use e-mail and electronic communications versus postage, right? Postage -- putting the letter -- a hard letter in the mail with a stamp on it does nothing to make student loan servicing operation better. So if we can convert that to a digital format, that has huge savings for the company, where over 80% or close to 90% of our customers are communicating with us electronically. Huge opportunity that we took advantage of. A lot of the call technology strategies are the same thing. So what's the right time to call, how to use that technology so that you're connecting a representative with a borrower when the phone is being answered versus while it's ringing. All of those things shrink times and make productivity rates significantly higher. So it's really been a combination of those activities. And I think if you look at our operating costs, particularly in our businesses in the FFELP segment where it's declining, you can see we've done a really good job of maintaining operating efficiency ratios there.

Yes. The -- yes, we -- I asked you already about the extension of the moratorium. But maybe we could broaden that question to the regulatory outlook for student lending in your business. You've settled the State AG lawsuits and put that behind the company. But just talk about the where student lending sits and Navient sits in that kind of governmental arena today?

Yes. We didn't talk about this yet, but one of the big things that I think we've accomplished over the last couple of years is simplifying and derisking the business model. And this goes to this question, right, which is regulatory related risk. Student lending is -- particularly the federal student loan programs is a highly political -- politicized line of business. And I think many times, Navient or student loan services, but particularly Navient got caught in the crosshairs of that political debate. And the issue is really about whether -- well, whether the student loan program should exist or not, right? That's where it is today, should the loans be forgiven or not. And if you can somehow create an image of problems does it help on that side of the equation to help the arguments for loan forgiveness. We made the decision to exit that business. We think we did an excellent job in that space. And I'm super proud of the way we actually exited the arena. We found a partner to take our business, take that business on, make sure that they were qualified and capable. Made sure that they were also of a size that had -- could ensure that the department had capacity for loan servicing. And then probably the most important piece for me was making sure that our employees, who had done a good job in this space weren't the victims of us exiting the space. And so we were able to transfer almost 800 folks over. So no one lost their job as a result of that. And interestingly, we got some queries about -- from Washington about how we were going to complete the transfer and what assurances could we give that this process would be smooth for borrowers and our response was it's already happened, right? so that's particularly nice.

They got a ramp to it.

But yes, so the regulatory world is a challenging one. And I think our operations in this space are designed to be programs that are very helpful. This construct that somehow someone wants to lend money to someone, who they know is going to default and that's a profitable business, I'd love to see that business model work some -- where that works somewhere because it certainly has never worked at Navient or Sallie Mae. I think the issues with the state attorney generals were they were very complicated. They were very time-consuming, expensive. They lasted forever. I mean I still look at this and say -- sometimes folks will say, we are pleased to have settled it. I'm not pleased to have settled this, right, because we shouldn't had to have settled this at all because none of the allegations have ever been proven and this is despite massive amounts of data in inquiry and discovery. But terms still get thrown out in that space as if somehow because someone said it, it must be true. Well, you still need to back that -- those statements up with actual examples. Putting it behind us, however, does significantly simplify our story for investors. It derisked the company. It allows us to focus on those opportunities that -- where we have growth and not be distracted by things like this. And unfortunately, that's the same issue with the Department of Ed Servicing. It was not a business that we -- it wasn't because we didn't like the business. We liked it, it just created more distractions, more disruptions. It didn't allow us to run our business the way we wanted to.

Okay. Well, I think we're almost out of time. I think maybe we could just kind of sum this up and if you've got any kind of closing thoughts in terms of -- because I think the -- we probably should have discussed that business simplification for Navient at the front end. But since we're here, like what do you think is the most significant element that, now that you've put all that behind you, that Navient can take advantage of in [indiscernible].

Well, I think for -- it's primarily one that helps investors, when they evaluate a company, look at the opportunities and the risks associated with it, right? And political risk is a very, very hard item to -- for an analyst to kind of measure, assess and assign a value to. And so when you can remove those types of things from your business model, it adds -- it derisk your business in ways that is more -- let me rephrase that. It has a bigger impact on valuation than the amount of risk you probably actually got rid of because it simplifies your story. And it simplifies the way an analyst can approach and value the company. But it's a huge issue for us internally, just on the management side of the equation. I hope to never have to tour the halls of Washington again. That's a real value add to -- in my business world. So things like that can certainly improve -- increase the amount of attention that we can devote to growing our business, focusing on helping our customers, helping our clients be more productive, more -- add more value.

Very good. And we are actually out of time. So please join me in thanking Jack for his time. And thank you.

Thank you.