Navient Corporation (NAVI) Earnings Call Transcript & Summary

Good afternoon, and we're going to get started. Very pleased to be joined on the stage by Jack Remondi, the CEO of Navient. Not much has been going on with your company these days. I'm sure we'll find some of that just talking about, though, Jack. Thanks for joining us. We're going to be doing a fireside chat. And so I've got a number of prepared questions for Jack. We'll pause in the middle for some audience response questions, and then I'll open it up to you all for any questions you might have.

But let's get started with the Biden administration's recent announcement on loan forgiveness. What are your overall thoughts and the plan? Just to begin with.

We haven't been talking about this at all today within any of our one-on-one sessions. Thank you for having us here today. I appreciate being at the conference, and thank you for participating in today's session. The Biden administration proposal is probably the most challenging thing for us right now is what we don't know. There's more -- we don't know about the plan and the program than we do know about what's going to happen. It has it's created all types of confusion, call volume, for example, spike almost 8x normal level after the announcement as customers wanted to know information and we, of course, had to respond, we don't know. We're really eager for the department to publish how they plan on implementing this program so that we can measure the impacts. Today, we issued an 8-K this morning just to provide some basics for our investors. We had hoped by this point we would be able to provide some bookends of [ cares ] like the best case or the biggest impact that we might see from loan forgiveness, but the ranges are so wide in the outcomes really just unclear at this point. Probably the most important thing that we're looking for and one that we would certainly recommend if this program goes forward is to allow borrowers to receive the benefit of loan forgiveness that they are eligible for where their loans are held today so that we don't require people to consolidate and go through unnecessary steps that they wouldn't otherwise have to do.  And just to put that into some perspective, we estimate that roughly 0.5 million customers typically consolidate into -- not our customers, just FFELP borrowers in general, consolidate into the direct lending program each year. There are about 5 million outstanding FFELP loans, both in good standing and in defaults that would have to go through that process. So 10x the normal volume, that would be a pretty significant undertaking operationally. Something that's probably not well understood by policymakers and probably borrowers themselves is the consequences of consolidation. Many students or many borrowers have outstanding FFELP loans that have been in some form of deferred repayment options or subsidized or not paying their full amount due, like an income-based repayment program. What happens in those programs during periods where they're not making the full payments as accrued interest continues to be applied to the account. If you consolidate that accrued interest, which can be substantial, gets consolidated and added to principal gets capitalized in effect. You start your counters over again. So if you're halfway through qualifying for a full loan forgiveness, you would start over again. In consolidation, your interest rate is rounded up to the nearest state so that when you look at the interest rates you're paying on your remaining balance, it's higher than you would otherwise. So we certainly have advocated. It would be easier and simpler for the department, but also better for consumers if they were to allow payment to happen directly into the FFELP program. Other items that are unclear is how they're going to treat defaulted student loans, for example, and the mechanism and the instructions that they are going to provide to services and others to how to communicate with borrowers. None of that has been shared at this stage in the game. A lot of uncertainty.

Yes. Do you have a sense yet, Jack, at this point, how -- but I think understanding how they forgive DL loans is simple, they own them outright. But I'm assuming forgiveness of a FFELT where it sits, if not consolidated, involves cash outlays. Do you have a sense if they're figuring out how they can accomplish that legally within what they're currently authorized to do [ under the law ]?

Well, so if they allow consolidation -- If they require people to consolidate loans into TL in order to qualify or if they provide forgiveness directly to FFELP loans, both of those require cash outlays. One requires a significantly higher amount of cash outlays as the consolidation balances would be greater than forgiveness. But there are a number of mechanisms that exist within the FFELP structure today, the operational structure, where cash is exchanged between the department and holders of loans. There's the whole defaulted claim process and not that these would be treated as defaults, but you could certainly submit for forgiveness through that mechanism. Each quarter, holders of loans are required to file a report with the department, which provides for cash flow mechanisms of intra-subsidy, special allowance payments or negative special allowance payments that we pay back to the department. So there's plenty of mechanisms that could be put in place that would be easier to administer than forcing so many people to consolidate into the direct loan program.

I assume -- are they giving you any kind of updates as to where their thoughts are? Are they consulting services around the best way to accomplish some of these goals? Or is this...

So the guidance has changed -- or their communication has changed a bit. When the program was first launched, FFELT borrowers weren't eligible, then a couple of days later, they said, well, they could consolidate into DL and become eligible. And most recently, they said that they're exploring ways in order to make FFELP loans eligible in other ways other than direct loan consolidation, but no specifics have been provided as to how many of those component pieces would work. They are in communication regularly with the industry group, SLSA, to help understand the different options and criteria here. But I do think one of the most important things to keep in mind is that for some borrowers, it would be a negative for them to consolidate into direct lending to get forgiveness versus being able to get forgiveness where they are today. And I don't think anyone's looking to create a negative for consumers through this process.

Okay. So the big obvious questions around this or do you have a sense for what the impact is under different scenarios where, one, the only option is you have to consolidate into DL for forgiveness? And two, the other, which obviously would be a lot less bad for you because presumably, borrowers, even those who are eligible, only part of their balances would get forgiven. Can you provide some sense for people? Maybe this is a good time just to give the broad strokes about what you put out in the 8-K today.

Sure. So in order to calculate what the impact would be to us under kind of different types of scenarios, there's a fair amount of facts, borrower specific facts that we don't know. And so it's hard for us to estimate. For example, we don't know what percentage of our borrowers receive Pell grants. That's not a data field that is available to us. And they -- while it exists, for example, in the student and the student loan clearinghouse data, it's not a field that we can access when we access that database. We don't know -- we know on average what borrowers have in terms of existing direct loans in addition to the FFELP loans that we own, but we don't know it by balance by borrower in the prioritization that the department would forgive it. So some of these things are kind of prerequisites for us to be able to calculate some decent estimates here. And as a result, what you end up with, if you -- without knowing those data points as you have bookends that are basically at the extremes and in our view, don't materially inform the direction of what's likely to happen or not to happen here. So what we decided to do today and anticipate in preparation for today's session and the one-on-one sessions I've been holding this morning, is to provide some information about the impacts of cash flow for a generic 10% assumption. We have published regularly our life of loan expected cash flows that we'll receive from our FFELP portfolio. That number was $7.3 billion at the end of June 30. If 10% were to go, that would be 73 -- $730 million, and it would split $340 million would get accelerated to us and $390 million would be lost. There would be income that we would not generate on the portfolio because of prepaid sooner. That gives you some framework of at least understanding what the different component pieces would be. We also disclosed out separately some intangible assets that under GAAP are recorded, associated with the portfolio, things like loan premium, deferred financing costs that are required to be capitalized when we issue debt securities, et cetera, offset by things like loan loss reserve and some unrecognized fees that have been assessed to the account. Net-net, those total in aggregate about $420 million. If -- depending on what percentage of the portfolio were to amortize a percentage of that would likely would also be -- have to be amortized or accelerated amortization as well. And then finally, there's some goodwill on our books associated with the acquisition of a company over 20 years ago, that just goodwill never amortized as it just stays there. And so eventually, that would have to be measured for any impairment down the road.

Okay. Are there any other characteristics about your borrowers that you can share with us that we haven't discussed that might help people think about the potential impact?

Our borrower base -- If you think about what the department has issued in terms of rules, they've talked about income levels. They've talked about a waterfall, a priority of who -- which loans would get paid first and then eligibility of 10,000 to 20,000 based on whether or not one received a Pell Grant. We know, for example, that not all borrowers are going to qualify. We see the refinance activity that has taken place over the years from our FFELP portfolio into Refi loans, what income levels are on segments of the business. I think if you step back and you say, "Why do kids go to college in the first place? And why do they borrow money?" It's because they're going to get a degree. They're going to earn that squeezes going to confer and then the ability to get a job that pays a higher level of income than they would otherwise. And that program works. Frankly, loan forgiveness feels like it's saying that school doesn't work. But that program works, and it has worked extremely well. The challenge that we see in the student loan marketplace in our existing customer base as well, is that kids who don't graduate or kids who take a particularly long time to graduate. And so the compounding of interest that takes place over the fact that it took you 6, 7, 8 years to get your degree versus 4 are really where the negative challenges exist. Our FFELP book is old. I mean it has been around -- the last loan was made well over 10 years ago. These are borrowers that have been in repayment, have moved through kind of different stages of their economic life cycle and are generally paying their loans back successfully at this stage in the game. And so this is really the target audience, I think that is trying to be addressed here. So we look at our portfolio and say it's higher quality than the direct loan portfolio in total because of its seasoning. It's going to likely have higher income levels than the direct loan portfolio as a whole, again, because of the seasoning aspects. And they are also going to be less likely to have received a Pell grant because Pell grants have been expanded in eligibility over the last 10 years. Fewer people got them 10, 15 years ago than, say, today, overall. So all that combined means that if you said a $50 billion portfolio of direct loans and a $50 billion portfolio of FFELP loans, presumably the -- Our estimates would be that the $50 billion of FFELP would have a lower impact due to forgiveness than the direct loan portfolio would.

Yes. Yes. On that Pell grant question, I struggled to find any data on [ Congram ] back beyond when the FFELP program ended. And I think back, the lowest I've seen to be is almost like maybe 33% of almost every direct loan borrowers getting -- Or are you saying it's materially lower than that in kind of the pre-end of FFELP era.

The statistics that I have seen, and these are not ours, that we have no ability to verify them. The department has said 65% of the direct lending portfolio is a recipient of a Pell Grant. That seems high. But like I said, I have no way of independently verifying that. Nationally, the department reports that roughly 35% of college students today are recipients of Pell grant, but that certainly would be high compared to 15, 20 -- 10, 15, 20 years ago.

Yes. Yes, it looks like they -- based on the data, I saw like the significant ramp, at least the size of the [ Col grants ] right around the time that they ended the FFELP program.

[ Aside from the ] eligibility for it.

Yes. Okay. Turning to legal challenges. What are your expectations for whether we see any kind of meaningful legal challenge to this program?

It's a good question. And I don't know -- we don't have any direct knowledge of who would be suing or not. It's pretty clear that the precedent here requires someone to have standing in order to sue, we would clearly have standing as a holder of FFELP loans. But it's not clear whether or not some political entity that might have standing in their state because of a state agency that owns FFELP loans will or will not decide to sue. We know there's a lot of action around it and that people are inquiring. There's folks encouraging some people to sue. This is -- I think the argument here is this is a constitutional question. Is this allowed by the constitution or not? It will not be us.

Yes. Well, yes, it seems like a case of a lot of people hoping somebody else is going to sue, but it's not clear who's going to step up and fight that political battle.

Yes. I think that's right.

Okay. Let's switch gears and talk about the origination environment. Now that there's a definitive answer to loan forgiveness and a set end date of the federal payment holiday, how will that impact your refi originations. I mean clearly, this is shrinking the addressable market and rates are still somewhat unfavorable. But what's kind of your outlook over the next year or 2 for that business?

So in the last 1.5 years, we've been in more so in the last -- in calendar year '22 when the prospects of loan forgiveness became greater. We've been fighting several headwinds here. We have a 0% interest on direct loans. We have a payment pause. We have the potential for loan forgiveness and we have high rates. All of those are negatives for demand for Refi loans. We expect in January that 3 of those will be eliminated, and we'll be looking at a more normalized market, certainly smaller than what it was pre-loan forgiveness and small are also driven just by the absolute level of interest rates. We won't refinance a loan, for example, if it doesn't create a tangible benefit for the customer. And so we work hard to make sure that the consumer understands what benefits they might be giving up if they have federal student loans. Those disclosures are numerous and comprehensive, and they actually require explicit action from the borrower to acknowledge them, not just that they can kind of read over them like you do in your Apple disclosure statements. But we do expect some normalization of markets in return. Today, we are very much -- our refi demand is coming primarily from borrowers with private student loans. The vast majority of private student loans outstanding today, not new ones being originated, but older ones are variable rate. And so as rates have been rising, their rates are actually changing, and they're encouraging seeing the benefit of refinancing. And I think just as the loan forgiveness issue gets resolved, it eliminates some of the hurdles or blockages that have happened there. On the in-school side of the equation, this academic peak season is coming to a close. We haven't released our results yet, but we had a very good academic year in terms of new originations, significant increase in market share. At the end, I think you'll see originations in our in-school business be up close to 60% or more for the full year. We still have a few more months to go, but obviously, far faster than the 5% growth that you're kind of seeing overall nationally.

Okay. Sticking with the refi for a minute. I think one of the things you've indicated in the past as you thought a lot of people were sitting on the sidelines, they're waiting for announcements around forgiveness. Now that they've got a little bit more clarity on that, have you seen any uptick in activity yet? Or are they -- a lot of people waiting to figure out if they're going to have balances forgiven and then look to consolidate what they have remaining?

So people are definitely starting to think about what it means for them and trying to understand the terms and conditions of the direct loan program. And so they're certainly calling and asking questions. The pace of activity, I think, will pick up once the rules become clear, and borrowers can understand whether or not they have federal loans that will qualify for forgiveness or not. But as I said, our materials and in particular, the application materials that a consumer has to go through has several times through the application and approval process, disclosures about what they would be giving up if federal loans are included. And one of the things we do is, if we scrape through the customer's credit bureau and see that there's a federal student loan with a 0% interest rate on it, we automatically exclude it from the refi side of the equation, but the customer has to explicitly say I acknowledge that my federal loan is included in this, and then I may lose some benefits, and we try to educate them about making sure they're making the right decisions on that front.

Yes. That reminds me one other question about the existing FFELP borrowers. Do you have a sense for how many of those have -- are in some form of income-based repayment and run the risk of losing the benefit of how far they've gone down the path with that one if they were to look to consolidate the deal.

About 1/3 of our outstanding balances are in some form of income-based repayment program in the FFELP book.

Okay. Got it. Got it. And so those borrowers are at least 12 years...

Well, they could sign up for it at any many different times. And there's differences between borrowers who are still in income-based repayment. Once you sign up for income-based repayment plan, you're always in it, even if you're not necessarily getting a benefit from it. You are not on what's called a permanent financial hardship. And that would be for different reasons, your income grew, and you no longer qualify, you didn't -- you have to resubmit an annual certification in that process. And for some reason, you didn't maybe because you didn't qualify, but different things happen across different points in time there. But there are the roughly -- There is a significant amount of accrued interest on our outstanding felt book that would be at risk to being capitalized. It's about 6% of the outstanding balance of the principal balance of the loans today.

Okay. Got it. One last question on the refi market. Can you give us a sense for how much that addressable market may have been impacted by the movements in rates that we've had and kind of the reduction in the incentive to refinance.

Yes. So it is significant. We would expect that a little over 60% or 2/3 of the portfolio, 2/3 of loans are no longer able to get a financial benefit. Federal student loans. We're talking about doing a financial benefit through refi just based on the current rate environment. The thing to keep in mind with refi is while it is a cyclical kind of business based on interest rates overall, it's a little bit unique attributes of this business that each year, a new pool of loans is being originated at current market rates. And as those borrowers move through graduation into the job markets and into repayment, they are refreshing or creating a new pool of borrowers that would be -- have the ability to benefit from a refi loan somewhere down the road. I think one of the things when we look at like our in-school lending as a credit risk related product, there are 2 big risks when you are underwriting a loan to a student, and that is, will they graduate and when they graduate, will their income be sufficient to service the debt? And the refi -- and loans are priced for that risk. When you are in the refi market, you'll check this is a customer who has now graduated. You know their outstanding debt, their income, and they've generally been in repayment somewhere between 3 and 5 years. So they have a demonstrated track record of servicing that student loan. And so the interest rate that we're able to offer to that customer reflects the fact that the biggest risk factors have been resolved and answered. It no longer exists and you can see that. So our loss rates on our refi portfolio, life of loan loss rates, for example, are running well under 1% compared to, I think most people look at the in-school marketplaces running at around 6% life of loan. We would expect ours to be lower than that, but that just shows you the magnitude of the difference here. And so when you can take those risk factors off, the interest rate we need to charge on that loan product is significantly lower and there's a big financial benefit. And most of these customers are borrowers with higher loan balances because they went to graduate school. So they are typically in the $80,000 to $150,000 worth of debt, but they have income that is in the 150,000 plus type range FICO scores in the 760 plus-type range and the credit performance shows for that.  So we still think that's an addressable market. These are not customers who typically would be eligible for loan forgiveness. Clearly, since they're able to service their debt, with their income, with extensive free cash flow each month. One would argue they don't need loan forgiveness, but it is -- we see it as a really good marketplace. It fits very well with an in-school loan product for us. And we've been the largest originator of refi loans for the last 1.5 years and would expect to continue that market position.

Okay. Great. I'm going to pause here and turn to the audience response questions. For those in the audience, if you want to participate, please grab the controller in front of you and register your answers. If you could queue up the questions, please. Thank you. What do you view as the biggest catalyst for Navient over the next year? One, share gain in the new in-school origination market; two, pick up in volume of consolidation refi loans; three, clarification of the impact of student loan debt forgiveness; four, better-than-expected credit; five, resolution around CFPB; six, capital return. Okay. Not surprisingly, 68% for clarification, the impact of student loan debt forgiveness. Next question, please. What do you view as the biggest risk to shares? Worse-than-expected outcome from CFPB; worse-than-expected income -- I'm sorry, impact from debt forgiveness; three, worse-than-expected credit; four, consolidation and refi volumes do not pick back up; five, below than anticipated in-school loan originations or; six, other. All right. Consistent responses. Next question, please. Over the next year, would you expect your position in Navi to one; increase, two; decrease; three, remain the same?  Okay. So 43% decrease. At this point, I'm going to open it up to the audience for questions if there are any. We've got one upfront.

Jack, I think it's a pretty fair bet that this -- if this case gets us -- the Supreme Court would disallow this program? -- for constitutional reasons, as you said. But how would it work practically? I mean, do you expect the program to go ahead? And then once the force is out of the bar, it's going to be impossible. They may make that ruling, but you're not going to reverse all the debt that's been forgiven at that point. So -- or do you expect somebody to get standing and then get the program gets [ stayed ]. So I'm just kind of curious as to the procedure here.

Yes, I don't know what's in the thought process of those that might consider a lawsuit here, but I think you've got the mechanics down correctly, which is if you were to file a lawsuit, you would want to try and block it from happening so you'd seek some form of stay or injunction to prevent the program from being implemented until it was resolved. These types of cases when they do rise like this, they tend to move through the court system very, very quickly because of the prominence and the importance of the decision.

I mean you expect -- you guys are not going to be the one, but are you expecting somebody to go forward? I mean it seems like somebody...

So we don't -- I mean they're not consulting us obviously, in terms of what should they do or not do, and we wouldn't give them advice on that anyways. But we know there's definitely people moving around talking about it. You can see it in the state attorney-- The attorney general discussions that are happening across the diverge, the Democrat Republican side of the equation. So it's a -- but I don't know the answer to the question. I don't know what's going to happen here.

I know it's still early stages on what the size of the portfolio is going to look like in a couple of years. But are you doing anything on the funding side to get ahead of that? Any changes to the funding structure in the future?

So in our FFELP -- this is really related to the FFELP portfolio specifically. Our FFELP Portfolio is primarily financed with asset-backed securities, and they are pass-through structures. So as prepayments occur, they naturally will pay down. The cash flow waterfall will naturally pay down those securities. There's some nuances to individual deals about how low the balances get before you can do things like cleanup calls and other activity. But I think you've seen our history as it relates to our securitization management of our liability structure, particularly as it relates to securitization transactions that were very active at maximizing the cash flows that get released by either doing cleanup calls or tender offers on transactions to pull things forward, and I wouldn't expect anything different here as well. This is a -- there's some potential timing issues that could take place here that might alter some of this. But generally, this is a cash flow positive event for the company. Generally, it is a cash flow positive event for the company. The nuance would be that if the administration said, we're going to forgive all these loans on October 30, 2023, throw everyone into a forbearance, that would create some challenges, cash flow challenges, but not something we haven't seen before COVID and the payment pauses and all those things created similar kinds of activities in the past. So we think we're well prepared to manage them.

Jack, you mentioned earlier that some of the headwinds for the origination business should be abating, but you also mentioned that a substantial portion of the existing pool of loans may not be incentivized to refine a higher interest rate environment. So at the beginning of next year when forbearance ends, what do you expect to happen to your origination volume vis-a-vis what it was previously?

So this year is probably we're feeling the impact of those 4 items I mentioned, most acutely. And loan forgiveness is -- I mean several things have happened here. The 0% interest rate was supposed to be short term. And several times when it was extended, the comments were, this is it. We're not going to extend it again and then it got extended again. And so I think consumers have gradually come to the view that, hey, this is going to happen forever. And so I might as well take advantage of this as long as possible. So that has been a big factor. The increase in discussion and now, obviously, the proposal for loan forgiveness that's come out has been -- those have been the 2 biggest factors, I think, that have been suppressing demand. Logically so and appropriately so, until consumers understand what's happening here. Our marketing activities have pivoted to those who don't have loans that would be eligible for loan forgiveness. So we're targeting private student loans, primarily variable rate private student loans. And that has allowed us to continue to create some additional flow. Our existing portfolio average life is extending, so we're benefiting from that. But come January, when all loans return into repayment, we expect those headwinds to come down and overall demand to go up. Will it be $6 billion a year as it was a year ago? No, I don't think it will be that high, but we do think that over time, it will gradually rebuild back to the size that we were seeing when these factories weren't as prominent.

Okay. Moving on. One question I have is just on expectations for capital returns, but -- in addition to that, thinking about the earlier discussion around the potential consolidation away or forgiveness of debt. How much capital might get freed up from FFELP loans that are paid off early? And what could that mean for capital returns?

Yes. So one of the big benefits of the FFELP portfolio for the company is that they are capital light. We allocate internally and have for over 20 years now, 50 basis points of capital against these loans because of the high advance rates we're able to achieve in the financing market and the low credit losses. Credit losses on that book run 6, 7, 8 basis points a year, depending on economic factors. So it's really more the future earnings and the equity, if you will, that's been trapped in the securitization trust that gets released. A good portion of that $340 million of accelerated cash flow that I mentioned would certainly go to pay down unsecured debt that is associated with some of these portfolios, but there would still be a significant portion that would be available for other uses. Whether they be perhaps portfolio purchases in the open marketplace or private loan portfolio purchases. Maybe acquisitions that would create some opportunity to accelerate growth in our BPS business and capital returns.

Okay. Turning to the NIM. Could you just talk about the outlook there, just given what -- particularly the FFELP NIM, given what rates have done. And also, what impact might we see on that NIM should we see accelerated repayments related to debt forgiveness?

Well, the NIM on our -- Our FFELP portfolio is a variable rate asset for the company. It is -- and the mechanism works off of 30-day LIBOR reset daily. And so in a rapidly rising rate environment, our assets are repricing more frequently than our liabilities. Our liabilities are 30- and 90-day LIBOR but discrete settings versus daily reset. And so as rates have risen this year faster than perhaps the curve always indicated, it caused us to -- it helped us earn a higher net interest margin in our FFELP portfolio.  So it's not the absolute level of rates, the pace of change and the direction of that change that drives that number. Once you think rates stabilize and the FFELP slows down, its rate increases or pace of those increases, the NIM, we would expect the FFELP NIM to return to more normal historic levels there. Prepayments, how does that impact -- how is our NIM impacted from prepayments is really going to be a function of which loans are prepaying and whether or not they are [ full ] eligible or are not [ full ] eligible would be big components -- newer loans and new, this would be closer to 10 years old, would be our [ no-floor ] eligible older loans are. And so if you think about economics of likely income and eligibility, older loans, you would think would be less eligible for forgiveness and newer ones, but those are -- those would just be estimates of ballpark directional items.

Okay. Any updates you can provide us on the CFPB litigation?

So we're in year 6 of this process and probably -- which is frustrating by itself. But we have had motions outstanding now in front of the judge and the court that have been waiting decisions for 2 years. And we're just -- The case has been effectively frozen until those motions are ruled upon. The judge in our case this summer announced that he would be going on senior status. It's like a partial retirement. He has the option of deciding how he wants to manage his case load. He could return our case to the court for reassignment or he could retain it. A little bit like the Department of Ed, we don't know. Unfortunately, this is -- it's super frustrating. I mean these claims were made 2 -- more than 2 administrations ago. We stand very firm and the fact that in the evidence that has been submitted, all the discovery and pretrial motions have been made at this point in time. There's no new evidence that's going to be submitted. There were no customers submitted by the by the CPB to demonstrate steering as they alleged. And we just need the court to give us our day to have the hearings go to trial, if that's what it is and resolve this matter.

Okay. That's very helpful. I think we'll end on that note. Please join me in thanking Jack for all of his time.

Thank you.