Navient Corp Q3 FY2020 Earnings Call

Thank you, Andrea. Good morning and welcome to Navient's third quarter 2020 earnings call. With me today are Jack Remondi, our CEO; and Joe Fisher, our CFO. After their prepared remarks, we will open up the call for questions. Before we begin, keep in mind, our discussion will contain predictions, expectations, forward-looking statements and information about our business that is based on management's current expectations as of the date of this presentation. Actual results in the future may be materially different from those discussed here. This could be due to a variety of factors. Listeners should refer to the discussion of those factors on the company's Form 10-K and other filings with the SEC. For Navient, these factors include, but are not limited to, the risks and uncertainties associated with the severity, magnitude, and duration of the COVID-19 pandemic and the related economic impact. As reported previously, the work from home policies and travel restrictions that have been put in place have not negatively affected our ability to close our books and maintain our financial reporting systems, internal controls over financial reporting or disclosure controls and procedures. During this conference call, we will refer to non-GAAP financial measures including core earnings, adjusted tangible equity ratio, and various other non-GAAP financial measures derived from core earnings. A description of our non-GAAP financial measures and a full reconciliation to GAAP measures, and our GAAP results can be found in the third quarter 2020 supplemental earnings disclosure. This is posted on the Investors page at navient.com. Thank you. And I'll turn the call over to Jack.

Thank you, Nathan. Good morning, everybody. Thank you for joining us today and for your interest in Navient. Before I begin my comments on the quarter, I'd like to welcome Joe Fisher to his first earnings call as CFO. Joe brings a wealth of knowledge of our business and an outstanding commitment to help us deliver value. And to those of you who have worked with Joe in his role in Investor Relations, you know this already. I'm excited to see Joe take on this important and challenging role. And I look forward to working with him even more closely. I'm confident in his ability to succeed. Congratulations, Joe. I also want to acknowledge and thank Ted Morris, our Controller, who bridged the gap as Acting CFO. This was no small task and he did it while maintaining his responsibilities as Controller. Thanks, Ted, for stepping up and for helping out. While the pandemic continues to create significant challenges, our business model continues to deliver outstanding results. Once again, this quarter's results demonstrate the resiliency, adaptability, and commitment of our team and our business model as we continue to meet the needs of customers and clients. Throughout this pandemic, we have helped millions of borrowers address their individual economic challenges with payment relief and other assistance. We've also deployed thousands of our teammates to help residents apply for and receive unemployment benefits, and assist communities in COVID contact tracing. In doing so, we kept our team safe, employed, and even added thousands to our payroll. I'm extremely proud of how our team continues to perform in this challenging environment and in their commitment. Our results this quarter were outstanding, and they exceeded our plan. For the quarter, adjusted core earnings per share rose a substantial 58% over the year-ago quarter to $1.03, and we delivered a core earnings return on equity of 33% in the quarter. The quarter's results were driven by continued strong credit performance, increasing demand for our credit products, a favorable interest rate environment, significant demand for business processing solutions, and our active focus on improving operating efficiency. In other words, every area of the business contributed to our strong results. While Joe will provide more details on the quarter shortly, I will start with some of the highlights. Net interest income continued to benefit from a favorable interest rate environment and improving funding spreads. The increase in refi originations also contributed to the $12 million increase in net interest income over the year-ago quarter. Despite the floor reset on July 1st that eliminated $30 million in floor income this quarter, net interest income fell by only $8 million compared to the second quarter. Given the current rate environment and funding execution, we expect our full year net interest margin for both FFELP and private loans to be greater than the original guidance provided at the beginning of the year. With the onset of the pandemic, we provided significant payment relief to millions of borrowers. As the economic situation began to recover, requests for forbearances fell, and the majority of borrowers successfully returned to repayment. For example, forbearance rates decreased from a peak of 28.5% in our FFELP portfolio to 14.3% at quarter-end, and from a peak of 14.7% in our private loan portfolio to 4% at quarter-end. In both portfolios, forbearance rates are consistent with pre-COVID levels. The initial usage of forbearance did reduce delinquencies and defaults in both our FFELP and private portfolios year-to-date. As borrowers returned to repayment, private loan delinquency rates have remained very low, and our substantial loan loss reserves provide the ability to absorb significant losses if necessary. While we expect delinquencies and defaults to increase next year, our substantial reserves are set for this and are adequate to cover expected losses. In our Consumer Lending segment, we saw strong demand for our refi loan products, as we relaunched marketing in the quarter. Refi originations this quarter totaled $1.3 billion with attractive spreads and very strong credit characteristics in line with our mid-teen ROE targets. The demand for loans to fund in-school programs was higher than last year, but lower than planned, as fewer students were enrolled and many schools operated in a virtual environment. This, along with conservative underwriting, kept new loan originations at the low end of our plan. Including second disbursements, commitments in the academic year totaled $60 million, with $37 million disbursed through the third quarter. Our BPS segment saw record revenue and EBITDA in the quarter with an EBITDA margin of 25%. Revenue was driven by the continued but slow recovery of business and healthcare and transportation and our ability to assist states in providing much-needed services to their residents. This strong performance of this segment is expected to continue through year-end. Our efforts to improve our operating efficiency also contributed to our strong results. Even as we hired 2,000 teammates to meet growing demand, total operating expense fell by $20 million, and our core operating efficiency ratio improved 8% to 45% in the quarter. Operating efficiency remains a top priority for us. At the same time, we're continuing our work to improve customer experience and leveraging new technology. For example, we've launched an AI-powered online assistant and are creating video channels to make it easier for constituents to do business with our government clients. Finally, we continue to strengthen our capital ratios, while returning $96 million to shareholders in the quarter, including the repurchase of 4% of our outstanding shares during this quarter. Given our earnings outlook and strong capital position, we will continue to return excess capital to shareholders. Every area of our business contributed to this quarter's outstanding results. It is a clear demonstration of the strength of our business model, the strong credit profile of our loan portfolio, and our ability to originate high-quality attractive loans. It also reflects our ability to leverage our business processing skills to assist our clients and win new business, and our ability to deliver increasing operating efficiency in a very challenging environment. Our earnings along with the capital released from our amortizing legacy loan portfolios also provide substantial resources to support the business, maintain our dividend, and return surplus capital to investors. And all this while maintaining a position of substantial financial and operational strength. We expect this strong performance to continue supporting another increase in our core earnings forecast to between $3.25 and $3.28 for the full year. I also would like to acknowledge my teammates and their commitment to our customers and clients. Adjusting to new work arrangements and new services, while juggling the uncertain environment and increasing family needs has not been easy. Thank you. I appreciate your interest in listening in today and I look forward to your questions later in the call. I'm very pleased now to turn the call over to our new CFO, Joe, for a summary of this quarter's results. Joe?

Thank you, Jack, and thank you to everyone on today's call for your interest in Navient. During my prepared remarks, I will review the third quarter results for 2020 and provide additional color on the impact of the COVID-19 pandemic on our business. I will be referencing the earnings call presentation which can be found on the company's website in the Investors section. Starting on Slide 5, key highlights from the quarter, we delivered GAAP EPS of $1.07 and adjusted core EPS of $1.03, provided continued immediate payment relief options to borrowers impacted by COVID-19, originated $1.3 billion of private refi loans, achieved record BPS EBITDA margins of 25%, reduced operating expenses by 8%, and improved our efficiency ratio to 45%, maintained our strong liquidity position and capital position, repurchased $65 million of common shares, and increased our adjusted tangible equity ratio to 4.1% or 6.4% after excluding the cumulative negative mark-to-market losses related to derivative accounting. Let’s move to segment reporting, beginning with Federal Education Loans on Slide 6. On both our FFELP and private portfolio, we continue to grant disaster related forbearance to those in need. As borrowers begin to transition back towards payment, we've seen a decline from the peak forbearance usage rates of 28.5% that occurred during the second quarter, down to 14.3% at the end of the third quarter. While the portfolio continues to amortize, the net interest margin improved 21 basis points from the prior year, which led to overall net interest income increasing 12% to $161 million in the quarter. The increase from the year-ago quarter was largely driven by the favorable interest rate environment we are experiencing. This resulted in a significant increase in unhedged floor income compared to the prior year. In the quarter, unhedged floor income contributed 18 basis points to the segment's net interest margin of 103 basis points. The current outlook for interest rates should continue to positively impact the net interest margin on our FFELP portfolio. As a result, we are raising our full year net interest margin expectations to be in the mid to high 90 basis point range. The higher net interest margin along with lower operating expenses contributed to a $9 million increase in net income from the prior year. Now let's turn to Slide 7 and our Consumer Lending segment. Forbearance usage peaked at 14.7% or $3.4 billion during the second quarter and has declined to 4.0% or $867 million at quarter-end. On the following page, you can see the trajectory of forbearance usage of borrowers that have successfully exited forbearance and have not requested any additional payment relief options available to them. Our delinquency rate declined 50% to 2.4%, and the charge-off rate fell by 53% to 75 basis points. The early trends we're seeing as borrowers exit forbearance are encouraging. For example, 98% of our refinance education loan customers that have exited forbearance have made a payment. As borrowers continue to transition out of forbearance, we expect both charge-offs and delinquencies will increase from these historic lows beginning in the fourth quarter. Based on the performance we have seen to-date, and absent a significant deterioration in the economy from this point, we feel confident that we are adequately reserved given the well-seasoned and high credit quality of our portfolio. The provision of $10 million in the quarter primarily related to $1.3 billion of newly originated education loans in the quarter. The average FICO associated with these loans is 764. Net interest income of $189 million was driven by the stability in our net interest margin, combined with an increase of our Private Education Refinance Loan balance, offsetting the natural amortization of our legacy portfolio. The net interest margin of 324 basis points was better than expectations, largely due to a lower interest reserve related to a decline in late-stage delinquencies and lower loan modifications. Our updated full year net interest margin guidance of 315 basis points to 320 basis points assumes an interest reserve build related to increased late-stage delinquencies and loan modifications. In addition, operating expenses declined by 16% year-over-year while growing our average balances and increasing net income to $110 million. Continue to Slide 9 to review our Business Processing segment. In the third quarter, we saw the results of our ability to leverage our existing technology and infrastructure in order to respond rapidly to support states in providing unemployment benefits and contact tracing services. These new opportunities contributed to a 36% increase in total revenue from the prior year and record EBITDA margins of 25%. Turn to Slide 10, which highlights our financing activity. During the third quarter, we issued $1.6 billion of term private education refi ABS. We continue to see attractive demand for our high-quality assets as we have securitized $4.8 billion year-to-date of private education loans and $1.5 billion of FFELP loans. On October 14th, we priced our second FFELP deal of the year. The investor book was oversubscribed by nearly 2.6 times. This allowed us to take in pricing that was 15 basis points tighter than our last FFELP ABS transaction. At quarter-end, we had additional capacity in our funding facilities of $2.2 billion for private education loans and $122 million for FFELP loans to go along with $2.5 billion of primary liquidity, of which $1.8 billion is cash. As a result, we ended the quarter in a very strong liquidity position. In the quarter, we acquired 7.7 million shares or 4% of the shares outstanding for an average price of $8.42. We ended the quarter with an adjusted tangible equity ratio of 4.1%. The cumulative negative mark-to-market losses related to derivative accounting declined by 5% to $657 million in the quarter and in line with expectations. Excluding these temporary mark-to-market losses that will reverse to zero as contracts mature, our adjusted tangible equity ratio is 6.4%. Turning to GAAP results on Slide 11. We recorded third quarter GAAP net income of $207 million or $1.07 per share compared with net income of $145 million or $0.63 per share in the third quarter of 2019. In summary, the strong results this quarter benefited from a favorable interest rate environment and our ability to leverage our existing infrastructure to win new BPS contracts. Assuming that credit performance remains consistent with the early results, we feel confident that we can exceed our original core EPS guidance range of $3 to $3.10 per share and deliver core EPS between $3.25 and $3.28 per share. Before I turn the call over to questions, I would like to express my appreciation to Ted, the entire finance team and all of team Navient for supporting me in my new role and their hard work and effort in these unprecedented times. In a year that has presented many unique challenges, I'm extremely proud of how we have responded to our customers and clients with innovative solutions to help them navigate the current environment. I will now turn the call over to questions.

Your first question comes from Mark DeVries of Barclays.

Let me be the first to congratulate you, Joe, on your new role. Thank you for the guidance on the NIM for the rest of the year. Could you elaborate on the factors contributing to that strength and how we should consider that moving into 2021?

There are several points to note. In our federal portfolio, we are benefiting from the favorable interest rate environment. Although the annual reset floor income has decreased, our fixed-rate floor income remains a significant contributor to our spread. As Joe mentioned, the funding aspect and the cost of funds for new transactions have seen strong investor demand, enabling us to execute at tighter spreads than we initially planned. On the private side, we are also seeing advantages from the favorable spread between prime and LIBOR. Additionally, due to the unique characteristics of CECL accounting, with fewer loans being delinquent, we are required to set aside less coverage for accrued and unpaid interest on those delinquent accounts, which also contributes positively. Finally, on the private front, we are experiencing fewer borrowers needing interest rate relief through our loan modification programs.

Got it. And then the BPS revenue has also been quite strong, I think you highlighted. Can you just unpack the different pieces there and give us some color on what's more permanent and what's more temporary, so we get a better sense of the run rate could be going forward?

A significant amount of the work we have been doing in the third quarter, continuing into the fourth, is related to project or contract work with states. Ideally, we won't be doing that work long-term because demand for unemployment insurance and COVID contact tracing is expected to decrease. Currently, those contracts are typically rolling in on a monthly or quarterly basis. We anticipate that most of that revenue will end in the fourth quarter and not continue into next year. However, this could change depending on the demand from individual states. As it stands now, that's our expectation. At the same time, we are starting to see a return of transactional activities from our other clients, particularly in healthcare and transportation. As those businesses begin to recover and the economic situation stabilizes, we should see these sectors return to normal as well.

Your next question comes from the line of Moshe Orenbuch of Credit Suisse.

Great. And Joe, congratulations, and thanks for taking our questions. The first question I had was about capital. You made good progress, but you started repurchasing stock again. Could you talk a little bit about that? That's an improvement from what you indicated three months ago. Maybe provide us with some background about your current thinking regarding the equity ratios you are targeting and what that means for buybacks in the future?

Sure. So Moshe, I think when we think about the remainder of this year and beyond, obviously, we've given our guidance for adjusted tangible equity ratios of that 4.5% to 5%. And the way we think about it for the remainder of the year, in terms of share buybacks and other capital returns is, we're looking to meet those hurdles in terms of what we have set out for the rating agencies and our debt investors. So to the extent that we return any additional capital in the form of share repurchases this year, it's really going to come down to any excess capital levels we have above and beyond what our targeted ratios are. And as we enter into 2021, I think we're in a much stronger position in terms of as we build those ratios, specifically to the rating agencies, where you're going to be seeing more normalized levels of what we have done. Obviously, we'll look to be opportunistic when we can. But I would say that, I would think of it as more of an even pace where if there's opportunities at hand, we will take advantage of those.

Got it. As a follow-up, could you discuss any opportunities you see regarding your debt structure? Are there any chances in the current environment that would allow you to optimize the balance sheet further?

It’s a challenging process, partly because the demand for our excellent unsecured debt has been particularly high. This makes it more difficult for us to enter the market and periodically repurchase that debt to alter the mix structure as we would like. However, I believe we have made significant progress over the past couple of years in restructuring that aspect of the balance sheet. We have leveraged not only traditional ABS financing but also the equity accumulated in certain securitization trusts, borrowing against that at rates significantly lower than unsecured funding costs. As a result, we have been able to reduce our unsecured debt through maturities at a faster pace than expected. We have a considerable amount of debt maturing this quarter and into 2021, which will provide some opportunities. However, I had hoped there would be more available in the open market for us to take advantage of than we have found.

Got you. And then just last 1 for me. The efficiency ratio you showed here in the slides, that 47% year-to-date, your guidance about 50%. What's the driver? Why you don't think that's going to be sustained at that level? Is it what you were talking about with business process servicing revenues? What's the plan, I guess, on expenses? And how should we think about that?

We remain absolutely focused in terms of hitting the targets that we put out, especially on the operating efficiency ratios. And from that standpoint, obviously, as you touched on the BPS segment, that is a margin business that we're focused on hitting in the mid to high teens. So a little down from this quarter, but certainly, within our targeted range. So we feel confident that we're on a pace to achieve or exceed that target, or I should say, from a positive, obviously, be on the better end of that 50% target ratio. But as we go forward, I think you have to look at us and look across other companies. I mean, this efficiency ratio compares very well against our competitors, and that's something that we focus on and looking to maintain those levels, not exceed them as the portfolio amortizes over time.

Your next question comes from the line of Arren Cyganovich of Citi.

Congrats, Joe. And good luck in the new role. The drop in the Pell that's forecasted, I guess, for the fourth quarter based on your guidance. You mentioned the interest reserve build. I assume that that's what's driving the Pell NIM to come down there. The other comment about CECL driving this benefit because of the low delinquencies. Are you expecting delinquencies to rise in 2021? Is this going to be a bit of a headwind into next year?

Yes. When we allowed for widespread disaster forbearance, many customers who were behind on payments and might have defaulted in 2020 entered forbearance. As a result, those delinquencies and defaults have been deferred to 2021. Consequently, our loss rates and charge-off rates in the private loan portfolio this year are significantly lower than we initially anticipated. We believe those losses don't vanish; they simply shift from the year 2020 to 2021. As the delinquencies accumulate, this is where the provision for accrued interest expense comes into play. However, as customers transition out of forbearance and begin repayment, the performance of those loans is better than we had expected. We will be monitoring these trends closely. A key strength of our servicing operation is how we leverage data and various strategies to engage with borrowers, helping them establish payment plans that keep them on track and effectively reduce their loan balances. This can be seen in our Troubled Debt Restructuring portfolio statistics, where the amortization of that portfolio has been quite strong over the past year, which is something we aim for.

And Arren, regarding the reserve as well, as Ted mentioned in the last call, the standard practice for most financial institutions involves reserving for the 90-day interest through net interest margin. So it's not just about delinquencies. As loans exit forbearance, there will be some build as they transition through the 30-day and 60-day categories into the 90-day category where that build will occur. As you noted from the previous quarter, our 90-day delinquency actually declined. However, if you examine the dollar amount in the 30-day and 60-day categories, you can see how that build might transition from this quarter to the next in the 90-day delinquency category.

Just so I can try to get my head around the magnitude. What are we thinking in terms of the magnitude of the headwind into 2021?

I think if you think about the guidance that we gave for ‘20, the remainder of 2020, that 3.15 to 3.20, just backing out the math of what that would mean for an impact just from this alone for the fourth quarter. If you're at delinquency levels that are closer to historic levels, you could see as much as, I’d call it, a 20 basis point to 30 basis point impact, depending on the level of delinquencies that hit 90. So if you're assuming essentially 100% of what's in 30-days to 60-days rolls through into 90, you could see that much of an impact on the high end.

Okay. Got it. And then I'm not sure if you can provide much insight on this, but it seems we're moving towards a possible democratic sweep in the election. What do you think that will mean for NAVI over the next four years?

There has been extensive discussion surrounding student debt, particularly in the context of federal loans, and we acknowledge that focus is warranted. The primary issues are not with borrowers who have high debt amounts but with those holding relatively modest debts of $10,000 or less, typically incurred by students who start school but do not finish. Previously, I've noted that two-thirds of defaults in federal loan programs come from students who borrowed less than $10,000. We believe the federal government should intervene to provide relief in this area. Importantly, simply offering relief without addressing the underlying issues will only perpetuate the cycle. It’s crucial for students and families to better understand their financial plans before starting school, the implications of borrowing for a degree, and ensuring that the debt incurred aligns with the economic opportunities the degree offers. Over the last two years, we have engaged in productive discussions with policymakers to share our insights on these challenges and ensure that relief programs are effectively targeted to those most in need.

Your next question comes from the line of Vincent Caintic of Stephens.

Joe, congratulations on a well-deserved promotion. So first, a question on just the student loan trends and the originations. So understanding third quarter kind of hit the low end of the range as you updated your guidance. Any update to how October has been performing so far, and how you expect this to trend just because it seems like this time this year is somewhat different with the hybrid and maybe people coming on later?

We haven't discussed the in-school aspect yet. The demand for credit in that product category is very seasonal. Typically, applications are submitted in July and August, with school certifications and disbursements occurring in September, followed by another round in December and January. Similar to previous years, we are currently observing a decline in application volume because students are already enrolled and tuition has been paid. There is a possibility of increased demand for the second semester. However, as we approach the end of October, schools have not yet announced their plans for operations in January. Therefore, until these plans are finalized, we do not anticipate any changes until students and families have clearer information about the upcoming semester.

Okay, that makes sense and is helpful. I have a follow-up question regarding the yield discussion. We appreciate your guidance on net interest margin and understand there is some reserve buildup involved. Considering that benchmark rates are at their lowest and we have already gone through the annual reset, is there anything else that might affect the yield? Additionally, with regard to net interest margin, we see ongoing benefits from improved funding costs, but is there anything else you would like to highlight?

I think as Jack mentioned earlier on the call, we're in a beneficial interest rate environment. And that what we're seeing on the FFELP portfolio should continue as interest rates remain low. The other item I would just highlight that we have in the past on the private NIM is really just a mix shift as we originate more refinance loans at a lower rate than what we have on our legacy book, that will also cause additional pressure. But obviously, those are very high-quality loans, and we're targeting mid-teens ROEs.

Our next question comes from the line of Mark Giambrone of Barrow, Hanley.

Joe, congratulations. Great quarter, great progress on things you can control and improve the earnings power over time. I'm just curious, Wells Fargo announced they're coming out of the business. And I just wonder what you guys think that means generally. And then there is a large portfolio potentially sitting out there. And if you would find that attractive, or think there might be a chance that you could acquire that over time?

Thank you, Mark. We have always believed that as CECL became the accounting standard for provisioning consumer loans, financing in-school loans on a bank's balance sheet would become increasingly challenging. The recent move by Wells Fargo could be a part of that shift, though they have their own reasons to consider. Over the long term, we see this as a potential positive for the demand of our in-school loan products, given that Wells was a significant player in that sector. While they continue to originate loans this academic year, we anticipate that this will eventually benefit us. We are always eager to explore ways to engage with available loan portfolios in the marketplace, whether through servicing or loan ownership, and we will be looking for those opportunities as they arise.

Your next question comes from the line of Sanjay Sakhrani of KBW.

Congrats, Joe, well deserved. I guess I just wanted to go back on the NIM expectations as we move into next year. Just want to make sure I completely get it. For the FFELP NIM, it sounds like you guys could probably sustain the 90s, the mid-90 levels, all else equal? And then on the private student loan NIM is the expectation that you drop about 20 basis points to 30 basis points, all else equal? And if rates stay the same, that's sort of where we level out next year? I just want to make sure I get that.

Yes. Looking at our original guidance from the start of the year, we had forecasted 300 to 310 basis points. As we conclude this year, I think you'll find that we will be on the lower end of that range as we add more loans. We believe that thinking in terms of 300 basis points or slightly below that is appropriate, considering the mix shift.

And FFELP?

Yes. So I think your statements on FFELP were accurate. I mean, the current interest rate environment and what we're seeing the stability of that portfolio and the predictability, absent any, obviously, significant changes in the interest rate environment, that's where we feel comfortable of what we're seeing really today in our guidance into the fourth quarter and beyond for 2021.

Sanjay, I would like to add that there have been several positive developments in 2020, particularly on the FFELP side, more so than on the private side, mainly due to the income benefits we received from the annual reset loans. As we approach the end of the fourth quarter, we will provide guidance on our expectations for 2021 in January. We remain very optimistic about our earnings and the company's performance next year. While the interest reserve on the private side does present some challenges, it is not significant enough to materially affect our earnings outlook.

Okay. Great. And then just a follow-up to Mark's question on the Wells Fargo opportunity. Just thinking about this enrollment period, do you guys think it can have an impact on your pace of originations this specific year, given there's a big player that's exited? And then just maybe a follow-up on the regulatory side. There was a lawsuit in New Jersey. Obviously, the CFPB lawsuit still remains out there. Could you just comment on sort of where we are with all of this? And if this New Jersey lawsuit poses any threat or is it sort of just to follow-on to similar lawsuits in other states?

Yes. On the in-school side, the absence of a major player like Wells not originating loans is a benefit for us during the academic year 2021-2022. This year, there has been a decline in demand for lending in both federal and private sectors partly due to significant drops in student enrollments nationwide and a high number of students completing classes virtually, meaning they're not on campus or in dorms. There was a report recently highlighting how schools are struggling because students are not paying for room and board. We are optimistic that COVID will be behind us in the next academic year, which should lead to a more normalized lending cycle. We continue to receive very positive feedback from customers using our loan origination systems regarding ease and logical flows, resulting in a great overall customer experience. Regarding the regulatory side, New Jersey filed a lawsuit yesterday, which mirrors previous lawsuits from the CFPB and other states. There is nothing new in this case, no new evidence or allegations. It is unfortunate that a lawsuit was filed without supportive facts or circumstances. We have consistently stated our intention to defend against these lawsuits as they lack factual basis. The evidence submitted by the CFPB includes 15 witnesses who claimed we steered them into forbearance, yet all acknowledged in depositions that we informed them about repayment options, including income-driven plans. Many were enrolled in such plans, making it impossible for them to have been steered elsewhere. Some of them were committing fraud against the federal government. Therefore, we are very confident in our position regarding these lawsuits, which we believe are largely political statements stemming from similar cases in various jurisdictions.

Your next question comes from Mark Hammond of Bank of America.

Congrats to Joe and Nathan. On the adjustable tangible equity ratio, the target of 4.5% to 5%, is that with or without the impact of cumulative derivative account mark-to-market?

So that includes the impact. So excluding that of where we are today, we're at 6.4%. And in this quarter, you saw the mark declined by 5%. So that gives you a sense that we were in line with our expectations. So it gives you a sense of how to back that out going forward.

I noticed that on the cash flow slide for the FFELP side of the portfolio, there hasn't been a change in expectations from the second to the third quarter. I'm curious if there have been any changes in assumptions or expectations regarding the cash flow that could be generated by the FFELP portfolio moving forward for the rest of its life. I'm just trying to understand the situation better.

Sure. As we do each quarter, we updated our forward yield curve as of September 30. Additionally, we adjusted our CPR assumptions, particularly in the third quarter, as we usually do. Our CPR speeds increased compared to the previous quarter and last year. Specifically, the FFELP Stafford portfolio's consolidation rates rose from 4% to 5%, and Stafford rates increased from 8% to 9%. These were the significant adjustments made during the quarter.

Thanks, Joe. And my last one, for the $500 million of high-yield unsecured notes that are maturing in 5 days, are you just going to use cash on hand to retire those? Or is there some other means of financing to refinance these notes?

No, we intend to use the cash on hand.

Your next question comes from the line of Rick Shane from JPMorgan.

Joe, congratulations. I wanted to discuss the Consumer Lending segment, specifically the private student loan portfolio. We categorize it into three segments: the legacy book, the new in-school book, and the refi and consolidation book. It appears that most of the activity this quarter was on the refi side. What stands out to me is that the reserve rate for that segment is quite low, around 77 basis points. Interestingly, the reserve rate for the overall portfolio remained flat from the previous quarter.

So the net provision that we made this quarter was primarily due to new loan volume, which, as you pointed out, is principally refi loans. Our loss expectations on that portfolio are a little over 1% over the life of the loans. The net amount that you see there has to do with the amortization of the portfolio and some of the refinancing activities of existing loans that are included in the refi number. Some of the volume that we're generating is actually volume of borrowers who are refinancing existing loans with us.

Got it. Okay. That makes sense then. Okay. And over time, do you think that there will be additional granularity given the pretty different credit characteristics between in-school, private student lending and the refi business?

We analyze each of these businesses, including the portfolio segments and the three categories you mentioned. As these segments grow larger within the overall mix, we can certainly provide more detailed statistics. It's clear that the refinancing loan portfolio is of much higher quality and lower risk compared to other lending activities. In in-school lending, there are two main risks: whether the student will graduate and whether they will secure a job that provides enough income to manage their debt. However, in refinancing, those risks are eliminated because we know the student has already graduated, and we have access to four to five years of earnings data to assist with underwriting. Consequently, this results in significantly lower loss rates. In the future, we can look to provide more detailed breakdowns of these factors, including spread, credit loss expectations, and performance. Much of this information can be observed through the ABS financing transactions, and we can also enhance the quarterly disclosures to reflect this.

Your next question comes from the line of Lee Cooperman of Omega Family Office.

I have a series of questions that lead me to an observation. The first question is, as you guys sit around and look at all these pushes and pulls, what do you think in normalized recurring earnings are? You talked about 3.25, 3.28 this year. Is that indicative of what you think are recurring earnings or your recurring earnings materially lower? But what do you think your recurring earnings are? I'll get to the real question after that one.

Yes. I mean, you're kind of looking for a little bit of guidance into 2021, but I...

Not really, I'm talking long-term. You obviously have a view because you've spent billions of dollars buying back stock. So you must have a view of value and the value derives some recurring normalized earnings. So I’m just curious what you would think?

We see this as the ability to manage the impact of a large legacy loan portfolio while sustaining earnings in the very high $2 to low $3 range.

That's what I expected you to say. I used a Bloomberg terminal, and their numbers are pretty accurate. The S&P has a 25 times earnings ratio, while Navient has a 3 times earnings ratio, priced to book at 3.6 times the book value of the S&P, and Navient is at 88 times its nominal book value, indicating a slight premium to tangible book value. The dividend yield for the S&P is 1.7, and for Navient it’s 6.5; the return on equity for S&P is 24%, and for Navient, it’s 25%. You mentioned that we did 35% in the last quarter. I believe the stock price does not reflect well on the company. Over the years, I've participated in these calls for a decade, and you've chosen to return funds to shareholders through stock buybacks, which I appreciate, but it hasn't convinced anyone. The average price target from analysts covering us is $11.61. We began repurchasing shares in the high 20s because you believed they were worth in the 30s. The highest price target is 14. Has the Board considered increasing the dividend, which has remained the same for 5 years, as a way to signal to the market that we believe our recurring earnings capacity is undervalued? Honestly, I'm not sure, as I feel confused by this situation. Normally, I would say that buying back stock makes a lot of sense, but the market appears indifferent. Investors seem to want income, especially since you've been paying $0.16 quarterly for 5 years, totaling $0.64. Looking at the DuPont formula, which calculates return on equity times retention rate for sustainable growth, we're not really growing. You have the capacity to increase payouts slightly. If you raised dividends by 10%, that would generate an additional $12 million in cash, which is minimal for a company of our size. How do you view the relationship between dividends, stock repurchases, and potential changes to that program? To be honest, your statistics are very attractive, and I don't understand why you're focused on buybacks. I would repurchase more than what you're currently buying, but I'm questioning whether the consensus on the Street is correct. Many experts covering you have price targets that are not very different from the current stock price. Today your stock is down $0.50, even after what you would think was a strong quarter. It seems that nobody is paying attention to us. I apologize for the lengthy questioning, but I hope you understand the essence of my inquiry.

Thank you, Lee. I share your frustration about the stock price. When you consider our P/E ratio and price-to-book value, it's evident that our earnings have consistently performed well in both positive and challenging economic conditions. This current environment has been tough for many companies, yet our ability to outperform and raise guidance throughout this cycle demonstrates the company's strength rather than a weakness, and I would argue that it justifies a higher valuation multiple, not a lower one.

Exactly.

I believe there are several factors that people may be overemphasizing. Political risk currently seems to have a greater influence on the stock compared to its actual economic impact. However, in a few weeks, we might see a shift as people better understand where decisions are being made, allowing them to price the stock more accurately. Regarding the balance between dividends and share repurchases, if our yield were relatively low, that could potentially be more impactful. However, since our yield is significantly above that of the financial services sector and almost all companies in the market, it's hard to justify increasing it further when we can buy back stock at a price below book value. Therefore, I would prefer to repurchase shares at this time rather than raise the dividend. Ultimately, this is a decision we regularly discuss with the Board, and we will provide updates as we progress into 2021.

Yes, it's complicated. However, the reality is that stock repurchases signal something that the market has largely overlooked. Another indicator is the confidence in the consistency of your earnings and the increase in dividends. I don't believe a 10% dividend increase would amount to more than $12 million, but I understand your perspective. I have my own uncertainties as well. Good luck and congratulations to Joe.

Your next question comes from the line of John Hecht of Jefferies.

Clearly, a lot of questions have been asked and answered. So just a couple of incremental ones. One is, Joe, I think you said, your 5% decline of the mark-to-market accounting for derivatives. So should we think of that as the pace of that as 5% a quarter? Or will there be any acceleration of that change over time?

I mean the primary metrics behind that, Mark, obviously, in terms of the derivatives, the weighted average life there is about 3 years. The decline that we saw, there's obviously some other moving pieces in that. But I think for modeling purposes and your purposes, 5% is fair to think about. Obviously, if there’s an increase in interest rates, that would accelerate that return of the mark. So I would say that 5% common is more of an all else being equal in terms of the interest rate environment.

Okay. And then the second question is, I think we talked a little bit about the fact that Wells is leaving the market, what that might mean to some of the bank portfolio opportunities. What about the refi side? I mean, the markets have been somewhat more resilient than we would have anticipated. But you guys clearly have better access to capital than some of the other emerging competition in that category. Interest rates are lower. So I assume that has an impact on addressable market and set. How do you think about competition on the refi side and how that might change over the next year or two, just given overall potential market dislocations?

So we think there's a couple of things. Certainly, whether it's refi or in-school lending, obviously, your access to capital and attractive funding markets are important. In both of those areas, we think we have a competitive advantage. But I think our biggest competitive advantage remains our servicing capabilities. We know when we put loans on our books and we service those loans, they perform substantially better than they do in other lender servicer hands. If you look at our refi ABS transactions, our cumulative default rates in those portfolios outperformed the industry average. When you look at our federal loan statistics, this is an apples-to-apples kind of comparison. We consistently outperform all other servicers year-to-year anywhere in the high 20s to mid-30s percent in terms of lower cohort default rates, and that makes a difference. It makes a difference in terms of the customer experience that someone is working with them to help them find a payment plan that keeps them on track. It allows us to generate higher earnings and returns on loans we make. Those combination of factors that I think will allow us to continue to outperform in the origination side, particularly on refi. The last piece I would just add on refi is, is that we are principally a digital marketing program in this area. We believe we also have an advantage on our cost to acquire. Our CTA, our cost to acquire alone runs about half the industry average as well. Those combination of factors do allow us to be more competitive. You saw that in terms of the ability to rebound origination volume and grow it to $1.3 billion after pausing in the second quarter.

Your final question comes from the line of Henry Coffey of Wedbush.

Let me add my congratulations, Joe. It's very exciting. I have a couple of points to make. First, regarding Lee's comments, when we examine all the adjustments we've discussed in terms of earnings, capital ratios, and other factors, one area we haven't addressed is tangible book value. Is it reasonable to assume that all the reversals you've mentioned regarding capital also apply to the calculation of tangible book value? If so, could you provide some insight into whether all of that is fair value? Or are there additional cash and capital-related adjustments that need to be considered?

So that, Mark, you're right, absolutely impacts the tangible book value. You're talking about probably $650 million mark that's going to come back over time. So that's just a natural bleed through into GAAP equity that we would benefit from over the next several quarters here.

And if the accounting rules were different, which they aren't, that mark wouldn't even be there, correct?

It would not.

It would not.

On a different topic, my understanding is that Wells Fargo primarily originated most of their student loans in the branch. From your comments, it seems you are more focused on digital channels. How does that influence your marketing strategies if you're looking to capture a portion of that business? Is there any partnership you can establish with Wells beyond purchasing the portfolio that would help drive more of that business to you?

So the vast majority of in-school student loans are originated through online processes, principally with assistance through the financial aid office. So branch activity is not as big a factor as you might normally think here. We do think there is an ability to translate this into origination volume for us. We don't see other banks getting into the in-school marketplace in any meaningful way, certainly no national banks playing in this with Wells' departure. There really is no national branch bank player left originating in-school loans. So we think this is a good opportunity for us. We think we can run this business in a very appropriate, conservative way. We're targeting really just 4 year not-for-profit educational institutions and graduate school lending, where credit performance is more predictable, more stable, and demand in normal times is more predictable and more stable as well.

I mean, your greatest strength is, as you've said, is your servicing. And I would add to that, given all the data and the years of experience you've had is sort of insight into not only how traditional in-school loans perform, but how loans in the private education sector perform? Even though that's a riskier channel, is there an opportunity there that over time should be explored? Or are you just going to stick to the traditional in-school market?

I believe the traditional in-school marketplace is currently our strongest area, presenting the largest opportunity for us. We see the potential for significant penetration and the ability to generate high-quality returns. While we may consider expanding beyond this market in the future, we would approach lending cautiously, focusing on students and families who genuinely need the product rather than just pursuing attractive returns on loans.

I would now like to hand the call over to Mr. Rutledge for any closing remarks.

Thanks, Andrea. We'd like to thank everyone for joining us on today's call. Please contact me if you have any follow-up questions. This concludes today's call.

Thank you for your participation. This concludes today's call. You may now disconnect.