Navient Corporation (NAVI) Earnings Call Transcript & Summary

Good morning, everyone. Thanks for joining us. I'm Moshe Orenbuch, specialty finance analyst here at Crédit Suisse and I'm very pleased to have with us the management of Navient. Navient has been with us at this conference every year that they've been around. And actually, I believe, announced the separation and formation of Navient at the conference a little while ago, probably 10 years ago, in fact. Navient has been a leader in loan consolidation, has, in the last several years, also entered the in-school market, continues to work to further decrease its leverage, has been buying back stock, and has a large servicing and business processing business as well. So with us, we have CEO, Jack Remondi, who has been in the Navient damage predecessors for many, many years and like I said, someone with whom we've had a long-standing relationship. So, I think, Jack, first, welcome.

Thank you. Glad to be here.

Yes. Thanks for coming. Can you please kind of talk a little bit about that evolution of Navient, how your products and services have evolved, maybe a little bit about where they are now, and what that means for your priorities this year?

Sure. So, when we separated from Sallie Mae, I think one of our -- we had a number of assets or value propositions associated with the company. And clearly, the #1 was we owned this very large portfolio of student loans that was going to have a tremendous amount of earnings, capital generation for cash flow that we could maximize and use to either deliver as returns to investors or invest in kind of new opportunities. We also had an operations business in student loans that we have clearly been able to transform into providing like services for other entities. This was probably on display in its best form during the pandemic when we were able to ramp up thousands of employees and call center agents to help states and health authorities respond either implement pandemic-related programs or respond to the needs of their constituents due to the pandemic. During that period, we hired over 15,000 people put them on our platforms. We were able to hire them virtually, train them virtually, and get them to be highly productive. In fact, one of our state clients who hired 9 different entities to do some work for them told us that we were 35% more productive than all the other entities that they had hired and that's all coming from the skill sets that we had developed as a servicer. Our ability to use our technology, our people, data, and strategies to deliver better outcomes in a more efficient way. We also had 40 years of history of student lending and so we had all this experience associated with where the risks were, how to underwrite loans, how to price them and then, of course, how to manage them once they were originated. Some of that insight was higher risk portfolios that have been originated years before that we had to manage through some very difficult economic cycles and some of it was really high quality. What we were able to do with that is identify an opportunity to say, we know these borrowers who look like this are going to be super high-quality borrowers 2, 3 years down the road. And is there a way that we can market products to them and capture that benefit in effect, help the students realize the benefit of their higher education. That has s been the real crux of our refi business, where we take existing student loans and refinance them at lower rates basically given the student benefit of their education and their income and be able to drive value there. Our success in that space, as you pointed out, we quickly rose to be the #1 originator in that space and our credit performance has continuously been better than our competitors, on the outcomes, if you look at our securitization trust data. Then most recently, we've been expanding that into the in-school marketplace for similar reasons. And I think probably the biggest one for us is that marketplace has been really static for over a decade, not a lot of change, not a lot of innovation, product designs were similar, and we really felt that we could use our insights and our tools to deliver products to students attending higher-quality schools in a way that drove value for them and drove value for our constituents.

I think what I'd like to do is kind of come back to each of those individually and kind of dig a little bit deeper. Maybe starting out with the broad government student loan market, you have a portfolio. That portfolio has some unique characteristics. But in 2022, the federal government did a couple of things. They put forth a debt forgiveness plan, that forgiveness plan doesn't include your loans. That plan is being challenged, and that will be decided one way or the other. Then they also put together a based or income-driven repayment expansion plan. Could you talk a little bit about how you see your portfolio in that environment? And both a little bit from a public policy standpoint, but pretty much how is it going to affect Navient and Navient's portfolio.

Yes. Well, I think one of the more challenging aspects is the 2 sides of the opinion on student debt. Is student debt an investment, a capital investment in yourself to get a better education and improve your economic outcome? Or is it a burden that needs to be forgiven? And I think philosophically, if you're going to make loans and forgive them then you shouldn't be making the loans, right? You should be... Call it a grant, do something different in that aspect but there is this long-standing effort by some to create some better outcomes here. I think a good example of different approaches that have been taken during the pandemic and post pandemic can be found in looking at our FFELP portfolio and looking at the department's direct loan portfolio. Like the department, we offer customers the ability to pause their payments. We didn't bring their rates to 0, but we offer them the ability to pause their payments. And as the pandemic unit started to subside from an economic perspective, meaning jobs weren't being lost, but jobs were being created. We slowly saw borrowers back into repayment and so customers had to call us and demonstrate that they had a need for further deferment extensions versus just an automatic extension. The result has been that our FFELP portfolios, delinquency and default rates have remained below pre-pandemic levels. And yet you have, on the other side, the direct loan position that all these loans are going to default. Well, I think the challenge on that portfolio today is certainly going to be 3 years of making no payments. It's going to be tough to get people back on track. So, you asked a question about the income-driven repayment. Some of these programs were designed for the direct loan customers only loan forgiveness is a good example of that. The income-based repayment proposal changes are for direct loans only as well. So, a customer, if they wanted to take advantage of those would have to move over. And then they had a bunch of onetime initiatives like public student loan forgiveness. That has been the one program that had the biggest impact on us because they waived prior requirements or gave credit for prior periods, which is something they haven't done before. And it did cause a spike in consolidation activity away from us that has -- in December and January, those numbers have now plummeted back to lower than pandemic levels.

And as you think out in terms of this income-based, income-driven repayment program, do you think that causes a higher level of consolidation at some point in the future?

I think it's a value proposition that is -- one is designed and geared for more recent graduates. And our portfolio is significant beyond that time frame. So, there have been income-driven repayment plans that have been available to our customers. The more favorable ones have always been in the direct loan program versus in FFELP for certain borrowers of a certain income. So, our view is that if customers needed to do those, they moved in that direction to begin with. And I wouldn't expect to see a significant change. Our delinquency and default rates in our FFELP portfolio are not -- first of all, they run well below national averages. So, I think that's an important point to consider as well.

In the past, you've talked about that as when you were servicing those loans yourself talked about that as a result of the servicing, I would say, I guess that it's still -- they haven't had that long, extended break the way the direct loans have had. So -- if we think about it in terms of your refinance business, there's, I guess, 2 separate challenges; one, federal moratorium will expire in all likelihood in 2023 but you also have kind of an interest rate environment that's less hospitable you talked about it on the earnings call. Maybe kind of give us a sense as to how you're thinking about that business once the moratorium ends and what it's going to take from a rate environment to get back to where you want to be.

So our price in the refi space is designed to take existing loans and refinance them at a lower interest rate. If the customer can't achieve a lower interest rate, then it's not worth it for them to do it, and we don't promote products to customers who don't get that financial benefit. The worst environment for us in that marketplace is a rapidly rising rate environment. That's what we had. That means the older loans that were originated in lower rate environments don't have that financial incentive to refinance. New loans that get originated in the current rate environment will eventually be eligible for that. And I think if you look at the program and the demographics, it is definitely cyclical. It's going to be a rate-driven related program, but it gets regenerated with new volume every year and at whatever current rates are so that we will have that opportunity to refinance at some point in the future. Today, our business and the refi side of the equation is very much focused on borrowers that still have higher coupon loans. These would be generally much older or they have variable rate private or fixed rate private loans that also have higher coupons. If you think of the student loan lending marketplace, when you make a loan to an in-school student, there were 2 big risks; will the student graduate, and will they get a job upon graduation with an income that supports their debt. In the refi marketplace, we know the answers to those questions. We run cash flows on the customers and so our credit losses, our life of loan credit losses and the refi marketplace are about 1% as an example. So super high quality, very much focused customers who are interested in paying down their debt faster. Lots of positive attributes to that. Our goal and plan are that in this rate environment is to be not chase volume for volume's sake, be disciplined in that approach. And when the markets are ready and they turn, we'll be ready the first out of the fox hole to make loans.

And when you think about the undergraduate borrower, I guess, you probably give up the co-borrower that many of the -- I mean, what percentage of them do you see as creditworthy because obviously, losses in that market are higher than 1%?

Sure. Well, so there's 2 things. The refi marketplace has historically been a single borrower only, and that's the student product. This year, we launched our 2022, we launched a cosigner option. So, this is specifically targeting parents and students who have undergraduate private student loans who will come together and gain the benefit of that. In terms of credit losses, the difference is that we are underwriting the loan after the students graduated and with their job and a payment track record, not before that. So, the credit losses on the portfolio, if you will, we're targeting the 90% of the loans that are not likely to default in the private loan marketplace, not the 10% that are likely to default.

Okay. Makes a lot of sense. All right. The in-school market business, you entered a couple of years back. I think this is your third season that you've recently completed. You mentioned that there hasn't been a lot of change. Probably one thing that you could agree with the CFPB Director about. My words not yours. And I would say that maybe, first of all, why do you think that is that there hasn't been that much competition and change in that market?

I think that probably goes back to the first point first word is that there hasn't been a lot of competition, right? It's been a pretty narrow market controlled by a handful, or dominated, I should say not controlled by a couple of lenders, and some of those lenders had been banks where this was not one of their key products or services. And so, I just don't think they have gotten the innovation associated with that. It was also a strange distribution model and the products were primarily originated through the financial aid office of the school. So, the school wasn't the buyer of the loan, but yet it was the channel in which the loan products were distributed. They had a lot of -- I think there's a lot of bias in the program is like it has to match and mirror what they do in the federal program. And when we got into this space, we tried to take a different look at that. One of the big surprises that consumers have in the student loan space is that they borrow money and then 6, 7 years later, they say, well, wait a minute, I owe more than I borrowed, right? Because they forget that negative amortization has occurred. I thought after the -- I said -- I think it was one of my quotes after the financial crisis was people may not understand negative amortization, but they know it's bad. They've forgotten again and so our products in the in-school market, one of the innovations that we've brought. And it's not just -- I wouldn't call it innovation, but more of a promotion, how we promote the product, how we help customers understand is that making payments while in school dramatically reduces the cost of the product. And over 80% of our customers choose to make a payment while the student is in school. That, to me, is like an innovation, it's hard to call that an innovative term, but it is a product design that is very important to us.

When you think about what your market share ambitions in that business, how would you think about them over the next couple of years?

Well, we would like to be a top 2 lender in this space. We clearly see the ability to be that. We saw very strong growth last year. Our originations were up 52% in a marketplace that probably grew 5% or 6% in total. We took market share. Our expectations is that our originations will double in 2023. So very strong growth. And some of the other things that we're bringing to the table is less of just like a transactional activity with a customer. I'm going to oversee a loan here and then our relationship certainly extends over the repayment period, we're not a customer during that time. We recently bought a business that helps high school that is targeted toward high school students and principally through guidance -- high school guidance counselors' offices where we as families and preparing [ Vasa ] if anyone hasn't tried to complete that form. It's very, very complicated, lots of jargon and very difficult to do. This is a TurboTax type feature. We asked a bunch of questions in an interview style. It completes the form. It gets super high reviews from folks as being easy to do. We have a scholarship search engine that is both national and local. Lots of scholarship recipients out there. Most of them are national. Most of the scholarships that are delivered each year are local. So having this together is important. Customers can complete, input their information, and then it gets [ appointed ] to scholarships that are appropriate for them. They don't have to fill out 10 applications. It's done in one step. And perhaps the most -- this is the most recent project and one that's not fully hasn't been fully utilized yet is a comparison tool. So, when you get accepted to a school, you get an offer letter with financial aid component pieces, it will tell you what the cost is, what different grant programs you're eligible for loans, et cetera, in the net family contribution. Well, those are not delivered to students and families in a uniform fashion. Each school does it their own way. Our customers can take that information, put it into the system. It puts it on an apples-to-apples comparison, imports data from places like the Department of Education that show graduation rates, starting salaries by major, things that the families can then use to evaluate the different offers and the outputs of the school, and whether or not which school is the better choice for their son or daughter.

Got it. And the nature of student loan borrowing is that there's this idea of the realization that your borrowers -- I mean so when you -- the growth rate numbers that you're talking about have a little bit of a tailwind and maybe talk about that for a second.

Yes. So, there's no question. When you start in the in-school marketplace, your target customer base is not juniors and seniors that have borrowed from someplace else before because very hard to convert that -- move that customer from one lender to another. So, we were very much focused on first-time borrowers. We also have different strategies for different market segments of the business, some who move through the financial aid office, some who are very price sensitive, others who do their own research online, they require different go-to-market strategies in that area. So that is where it is the combination of those things, the ease of the origination platform and particularly unique in the student loan space is when you're applying you have the student and the parent who need to participate in the process. I don't know as parents, how many people want to show their kids, their entire financial statement and credit worthiness, right? So, you have that kind of push and pull kinds of issues and the handoffs can be complicated. So having a sophisticated system that makes that easier, allows either party to initiate, allows information to be less visible to one party or the other can be super helpful.

So, we've now talked about the lending portions of your business, the ones that consume capital. You kind of said it in your first set of comments that, obviously, returning capital as the portfolios -- the legacy portfolios amortized, you're at a point where the dollar growth in your private loans probably is less than in prior years just because of where we are, both in the interest rate cycle and the student loan moratorium cycle. Talk a little bit about your plans for capital return this year and then kind of maybe on a longer-term basis?

Yes. So, as I said at the beginning, one of the best assets of this company has been this legacy, large legacy portfolio, both development and private loans that generated a very predictable stream of cash flows and earnings and capital, if you will. Capital generation from earnings and capital release as the portfolios amortize them. Our focus has been to share with our investors what we think is a very consistent approach to how we manage capital. And certainly, we want to make sure we're funding our dividend but it is about growing the business, investing that where we can and growing the businesses that we have. Our lending business is more capital intensive. Our servicing operations business is less so. And then to the extent after that, we obviously want to maintain a strong balance sheet, in appropriate capital ratios and those have been changing as the mix of our assets have been changing with that. And then the balance is return to investors through share repurchases. In the best case, we would be investing in all of the capital that we're generating in the growth businesses and not doing and managing a share buyback program. But our view is following capital on the balance sheet doesn't belong to us to just sit there for multiple years, it's supposed to be returned to shareholders. And we think the most efficient way for us to do that is share buybacks.

Switching over to your servicing type or BPO businesses, you mentioned that you obviously had some very unique opportunities during the pandemic. I think you've now talked about that now being kind of rightsized and working on the margin side of that business. Can you talk a little bit about the scope of the services you're currently providing? And how you think that can grow over time?

Yes. So, we are providing -- we're basically taking over back-office operations of various entities, and we've identified some target markets where we think we can be most helpful. And then generally, it is areas where there are high-volume transactions, a little bit of complication to the process or, in some cases, very complicated transactions. And there's a revenue component piece to it. So, helping our clients maximize the revenue that they are generating in that process. Our verticals are in -- where we work are in health care. Clearly, one of the more complicated pieces. There, we help hospitals run their back-office operations. They're medical providers trying to provide care. They're not super -- this is not their area of expertise. They tend to operate in high expense areas. We can centralize those activities, leverage the insights that we bring from multiple organizations use that data to drive strategies and outcomes. That's getting insurance claims processed timely and accurately. The amount of coding that has to be corrected in that is a fairly significant piece. And then to make sure that the client, the patient understands what's left over is what and what their obligation is, right? Most of us who have had a medical procedure to get the bills and like you say, well, if I wait 3 months, they'll finally figure out how much I owe, and then I'll pay the bill. So, we can help that process and move it far more efficiently. And hospitals right now are in a really tough position, right? They got a lot of revenue input coming from COVID, that has declined, and now they're running on very, very thin margins or in many instances, at losses, and so we can help on that side. In the government space, it's a similar kind of activity. It's taking over some of the back-office work and bringing some technology and tools and data analytics to that. So, when customers are calling in, we're able to triage them and direct those calls to the most appropriate spot if it can be self-served, which most of us want self-service, right? We don't actually want to have to talk to somebody. We get them to that self-service locations instead of them having to kind of hunt through the website to find where the appropriate places to go. That's where we drive efficiency. And we also use our strategies and data to understand how our customers want to be connected with or contacted. So, we have multiple channels, whether it's text or e-mails or phone, all of this, if you can drive the activity and predict which mode is most efficient for that particular individual, again, it's a way to drive operating efficiency.

Do you think that you will need to make acquisitions in that area? You've done a couple over the last few years. Is it an area where there's expertise or contracts that can be better gained that way?

So, our acquisition, our M&A philosophy in this space was partly designed to give -- to buy entities that we could then grow organically. And part of it was about credentials. One of the earlier challenges we had is Navient, aren't you a student-owned servicing company? Why are you trying to pitch me government services-related businesses. The pandemic work really elevated our profile in terms of what we can do. And in fact, one of the contracts that we just won in December, it was our largest contract with a governmental entity came directly because some of the pandemic are -- we were helped by the credentials we were able to present because of our pandemic-related work.

And how do you think about the scope of it? I mean you say government; government is obviously very large, especially when you think about federal government, each state government. So, like how do you bring that to specific winds?

So unlike some businesses, government contract opportunities are all published, right? There are databases out there where you can see which contracts are coming up for an RFP-type process. So, there's a lot more transparency on that side of the equation. There's a lot more competition as well. That was not the case during the pandemic. It was like who has the ability to put boots on the ground tomorrow and we were able to do that. It's more competitive in that space for sure but I do think it's also we come with a different approach. And internally, we talk about this as like our whole operations business was built with the technology and the analytics and the process from the perspective of an owner. We own the loans. And I think this is probably one of our challenges when we service loans with a direct loan program, we treated that portfolio as if we owned it. We're trying to drive outcomes and decisions based on how we would want those outcomes and decisions to be as an owner. But, again, that's a good learning lessons from them. But that's just how we approach the BPS space. So, it's about how do we improve outcomes for the client so that we cement our position and bring value to them because our ability to win can't be just on price. It has to be on a value proposition.

Do you have a goal, like how big that business could be in 5 years?

Yes. Right now, I think that program, our aspirations are to get it to $1 billion in revenue. We're making our way to that. We grew our organic -- our core business by 10% last year. We think we can easily do that in double digits again this year. We're more focused a little bit on our margins suffered a little bit as businesses were winding. Some of the COVID contract work was winding down, but we expect that to rebound into the high teens in 2023.

Right. I've got a few more, but if there are any questions in the room, raise your hand, and I think they'll bring you a microphone. Okay, not seeing anything. I will continue. One of the things that you've been able to do over time is use -- I don't know if you call them financial innovations or tools to improve the profitability of your legacy portfolios. Obviously, 2022 was a year -- certainly the second half of 2022, where financial markets were a little bit less favorable. Are there things as that normalizes? Are there steps or things you can do to take advantage, generate more cash from your portfolios like you did in some prior years?

Yes. This is one of our key areas of focus. And I think this is important because, oftentimes, when you have a business that is effectively winding down, people take their eye off that ball, right? They become an orphan within the company instead of being actively managed. This is such a large contributor to our earnings. It has our focus, and we're very active at trying to manage the portfolio in order to maximize both earnings and life of loan cash flows. We publish those, so you can actually see how they have been remarkably steady in many years despite the fact that the portfolio is amortizing because of that expectation. But the things we do there, it's about asset management, but it's also, to your point, about liability management. So earlier in '21 and '22, when interest rates were so low, they can -- 25 basis point LIBOR. -- they can't go any lower in that process, we began to restructure some of our liabilities to be more fixed rate in their nature so that as interest rates rose, we actually were able to -- most people think of our FFELP portfolio as negatively impacted by rising rates, and we were able to offset that by the liability side being more asset sensitive versus liability sensitive. We've been particularly innovative in coming up with different financing structures to lower our cost of debt. So, we have warehouse facilities that we use as acquisition vehicles. We have term ABS facilities, which is our primary funding vehicle and then unsecured debt. Unsecured debt is our most expensive debt. And we were able to develop a part working with some of your colleagues on the banking side, some really sophisticated financing vehicles that allowed us to capture more of the funding on the asset-back side of the equation at much lower rates, 300, 400 basis points cheaper than what we could borrow on the unsecured side of the equation, and that has been a huge benefit for us. One of the reasons that if cash flows and earnings have been much higher.

If you think about a big topic, you were always talking about is the expense footprint of the company. Obviously, it's going to be growing in your Business Processing segment, but talk about it in aggregate. You've taken some pretty strong steps recently to reduce expenses. Where does that go as you still have that legacy portfolio, which is paying down?

So one of the luxuries is this large portfolio of assets. One of the challenges is that large portfolio is getting smaller, and the cost structure needs to be appropriate. I think one of the hardest jobs in cost management is managing the cost of a business that is shrinking, right? There's lots of fixed costs that show up that you don't think quite as being fixed. But we've taken a number of steps over the years to variabilize as much as we can. We sold the loan platform to make sure that scale and variability came into play. That has proven to be a very good deal for us and a very good deal for our partner in that space. The efforts that we continue to make in this area don't stop. This is one of the strong messages my team and I have within the company, is this is not a one-and-done process where you cut and then you move on. We need to continuously find ways to be more efficient and even if we were growing at like -- the yield we get on a loan doesn't change. And so, we have to offset inflation and labor costs and increased regulatory requirements and find ways to drive either automation or self-service related tools or cost takeouts. Some of the things we've done that have been huge have been -- we have over 80% of our customers receiving statements electronically. That's a super high rate, it takes postage out of the equation. Postage does not benefit anyone in terms of outcomes. Self-service automation. So, customers who -- one of the tools that we brought into place if someone is struggling, the last thing they really want to do is talk to somebody and tell them they're struggling is provide information and website tools that allow them to complete, input data, and be able to calculate different options for themselves so that they don't have to share their unfortunate position with another. That obviously saves us money. It increases engagement and it reduces delinquency and default. So, it's like a win across multiple areas.

Got you. We only got a couple of minutes left. What I would just ask, Jack, is as you look out for 2023, just tell us what your biggest priorities are for the year? So, our goal is we have 4 big priorities for us that are our consistent areas of focus. It's to grow our growth businesses, loan originations, and our BPS revenues. We're very focused on that with dedicated teams. They are -- I spend a huge amount of my time in those areas to try and find ways that we can grow faster as well as grow profitably. It's maximizing the performance of our FFELP portfolio. This is an asset to the company. It's our job to maximize those returns and not let them slip away. Cost efficiency. We can't lose sight of what we need to do in this area. We are expecting costs to go down again in and be transparent with a disciplined capital management approach. Those are the 4 things we're focused on. I think we've been pretty consistent on that theme. I think the good part of the story here is, I think the foundation -- before 2022, there was more of, okay, this is what you're going to do and I think at the end of '22, investors felt stronger about, okay, you've actually done it in the building blocks here, and we can see the jump-off points for growth. So pretty excited about '23 and beyond and really look forward to delivering for you.

Please join me in thanking Jack and Navient.