Navient Corp Q1 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to the Navient First Quarter 2021 Earnings Call. Please be advised today’s conference is being recorded. I would now like to hand the conference over to the speaker today, Nathan Rutledge. Please go ahead. Thanks, everyone. Good morning and welcome to Navient's first quarter 2021 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 discussions will contain predictions, expectations, forward-looking statements and other 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 disclosed here discussed here. This could be due to a variety of factors, including among other things, 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. Please refer to the discussion of those factors on the Company’s Form 10-K and other filings with the SEC. During the 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. Our GAAP results and description of our non-GAAP financial measures and with a reconciliation to GAAP can be found in the first quarter 2021 supplemental earnings disclosure. This is posted on the Investor page at navient.com. Thank you. And now I'll turn over the call to Jack.

Thank you, Nathan. Good morning everyone and thank you for joining us today, and thank you for your interest in Navient. Our results this quarter were exceptional. In fact, they were a record high for a quarter. They are the results of our continued ability to adapt to the changing economic environment and the changing needs of our customers and clients. Our operational agility has been a long-term source of strength for Navient, but never has it been more apparent than during the pandemic. As a result of our ability to adapt and respond, we were able to provide relief to student loan borrowers in need, assist others in securing lower cost loans, and respond to clients with systems and people to address their rapidly growing and changing needs. And we opportunistically captured the benefits of this low interest rate environment and strong investor appetite for quality assets. The benefits this quarter include historically low delinquency rates in both our FFELP and private loan portfolio; strong net interest margins as we continue to execute on several lower-cost funding transactions; increased BPS revenue as we met our clients’ changing needs; and two loan portfolio sales that accelerated cash flow and earnings with combined gains and related reserve release of $191 million. In total, we earned $304.5 million in core net income and delivered adjusted core earnings of $1.71 per share, an increase of 235% over the year-ago quarter. This quarter, we sold $560 million in legacy private education loans, and the residual from a $1 billion securitized refinance loan portfolio. Both sales produced gains driven by lower discount rates on expected future cash flows and expectations of strong credit performance. Both highlight the value of our legacy and refinancing loan portfolios and the benefits our servicing brings to these portfolios. Demand for longer-duration fixed-income investments led investors to increase their valuation of private loan portfolios, given the strong credit performance and steady cash flows generated by the loans. While we don't intend to be a make and sell originator, strong investor demand made this an attractive time to sell. And it clearly demonstrates the value we create when we originate new refinance loans. Even with the current interest holiday on government-owned federal loans and the cause for broad-based loan forgiveness, we saw solid demand from graduates looking to lock in today’s low interest rates, saving thousands in interest expense by refinancing their student loans. One noticeable change we see is a higher portion of the loans refinanced our private loans. We see continued opportunity to help people save thousands in interest expense and further opportunity to expand the share of private loans being refinanced. I'm also optimistic of our ability to grow our in-school lending business. As the vaccines are more widely delivered, we expect the upcoming school year to return to a more traditional experience with more typical demand for responsible and transparent education financing solutions. Combined, we are reconfirming our projections for at least $5.5 billion in new loan originations in 2021. In our BPS segment, we're pleased to be able to respond quickly and in size to our state clients' needs. We leveraged our adaptable technology platforms, so our teammates could provide much-needed support in processing unemployment claims, providing contact tracing assistance, and more recently resources to help accelerate vaccinations. While we were happy to continue to provide this critical assistance, we do hope the need for these services will decrease as the pandemic subsides. Our ability to adapt our systems and operations to hire thousands of new remote employees and contractors and respond with active assistance often within just a few days has been a great demonstration of the value we bring to a client. As the COVID project work begins to wind down, we are focused on leveraging our proven experience, capabilities, and flexibility to deliver value and innovation to longer-term solutions. In our consumer lending business, a year-ago, we, like many other lenders, increased our loan loss reserves in the face of significant economic uncertainty and rapidly rising unemployment. As the economy regained its footing, many consumers were able to manage their loans including their student loans. In fact, the challenges created by the pandemic further demonstrated the value of a college education as this segment of the population was more likely to be able to work remotely. Though credit performance to date has clearly outperformed our original expectations, with the economic outlook still uncertain, we have maintained our strong level of reserves. Our ongoing efforts to improve profitability contributed to our positive results this quarter. While traditionally this means a focus on operating expenses, at Navient, this also includes a strong focus on reducing interest expenses. We completed several new financings this quarter that achieved our lower-cost objectives. And we've continued to reduce the balances of our most expensive debt, our corporate unsecured notes. Operating expense initiatives include enhanced web tools and ongoing automation efforts that both improved the customer experience and increased operating efficiency. We're also reviewing our space needs and have recently exited a lease on one of our more expensive offices. Our efforts to improve both operating and funding efficiency will continue. The implementation of CECL and the subsequent decline in interest rates impacted our targeted capital ratios earlier this year. I'm happy to report that with our strong financial performance over several quarters and the expected reversal of some of the derivative marks, we exceeded our target adjusted tangible equity ratio at March 31. As a result, with the acceleration of earnings and release of capital from the loan sales, we will also accelerate our return of capital by increasing our planned share repurchases in 2021 by $200 million to $600 million for the full year. Finally, I remain optimistic about our outlook for the rest of 2021. Our portfolio performance remains strong. Our loan origination and fee revenue forecasts are intact. And our earnings outlook is well ahead of plan. In fact, we are well on a path to deliver our fourth year of year-over-year growth. Before I turn the call over to Joe, I want to thank my colleagues. Our results this quarter are the product of their efforts and commitment to serve our customers and clients. Thank you for listening. And I'll now turn the call over to Joe for more details on this quarter's results.

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 first quarter results for 2021. I will be referencing the earnings call presentation, which can be found on the company's website in the investor section. Our first quarter results compared to our original outlook for 2021 is provided on Slide 4. We are off to a great start to 2021 as we are currently on pace to exceed all of our original targets provided at the beginning of the year. This quarter's results reflect the continued dedication from Team Navient to meet the challenges and needs of our customers. As a result of the strong first quarter and updated outlook, we are increasing the range of our original 2021 adjusted core earnings per share guidance by over 30% to a range of $4.15 to $4.25. Our outlook excludes regulatory and restructuring costs, reflects a favorable interest rate environment, and includes a 50% increase in planned full year share repurchases in 2021 by utilizing the remaining share repurchase authority of $500 million. Key highlights from the quarter beginning on Slide 5 include GAAP EPS of $2 and adjusted core EPS of $1.71. Lower delinquencies on both FFELP and private education loans, sold $1.6 billion of private education loans that resulted in total gains on sale and release of provision of $191 million. Originated $1.7 billion of private education loans, achieved BPS EBITDA margin of 29% in the quarter, strengthened our capital position and returned $129 million to shareholders in the form of repurchases and dividends. Let's move to segment reporting beginning with federal education loans on Slide 6. The net interest margin improved to 97 basis points, which led to overall net interest income increasing by 9% to $144 million compared to the first quarter of last year, even as the average balance of loans declined by 9%. The increase from the year-ago quarter was driven by the favorable interest rate environment and ongoing improvement in funding costs. FFELP borrowers transition back to repayment. Total delinquency rates have declined 21% from the previous year to $3.8 billion. Fee income and operating expenses in this segment declined primarily as a result of the expected decreases in asset recovery volume, impact of COVID-19 on certain operational activities and improvements in operating efficiencies. Now, let's turn to Slide 7 in our Consumer Lending segment. The $180 million increase in net income was largely driven by the two loan sales that occurred in the quarter, which I will provide more color on in the following slide. The net interest margin of 299 basis points was in line with expectations as the decline from the year-ago quarter was largely driven by the increased percentage of our high-quality private refinance product within our consumer lending portfolio to nearly 40% of total loans. The delinquency rate declined 36% to 2.3% from a year-ago, and the charge-off rate fell to 68 basis points. As borrowers continue to transition out of forbearance, we feel confident that we are adequately reserved given the well-seasoned and high credit quality of our portfolio. At this time, we have not incorporated a significant change in our economic forecast as it relates to the allowance. Although the trends we're seeing remain highly encouraging, excluding the provision release related to the loan sales, the remaining provision of $15 million was primarily related to $1.7 billion of newly originated education loans in the quarter. Let's turn to Slide 8, which highlights our loan sales. In the first quarter, we sold $1.6 billion of private education loans, consisting of $560 million of non-refi loans, and $1 billion of newly originated refinance loans. The non-refi loans were all originated prior to 2014. These loans were primarily funded with unsecured debt, and we hold 8% of capital on our non-refi portfolio. The gain on sale from this portfolio totaled $46 million and resulted in the reversal of allowance for loan losses of $88 million. The second loan transaction consisted of a residual sale related to $1 billion of newly originated refinance loans. We hold 5% of capital against refinance loans, given the high credit quality and the low default rates that continue to outperform expectations. Gain on sale from this portfolio totaled $43 million and resulted in a reversal of allowance for loan losses of $14 million. The total gains associated with this transaction exceeded our last similar sale that occurred in 2019 and demonstrate the attractiveness of this asset class. The majority of the cash raised from these transactions will be used to reduce existing debt that was directly funding these loans, including unsecured debt and warehouse facilities. The gains on sale from these transactions combined with the acceleration of future cash flows and release of capital allowed us to increase our planned share repurchases for the rest of 2021 by $200 million, all while meeting our targeted capital thresholds. Our updated guidance presented today does not include any future loan sales. Let's continue to Slide 9 to review our Business Processing segment. In the first quarter, we continued to expand on opportunities that leverage our existing technology and infrastructure. This allowed us to achieve EBITDA margins of 29%, one more than doubling our total revenues to $125 million. The $68 million increase is largely due to supporting states in providing unemployment benefits, contact tracing and vaccine administration that we believe will begin to decline during the second quarter as the economy reopens, and these contracts are set to expire. The $37 million increase in expenses in the quarter associated with the growth in revenue in this segment contributed to increased total operating expenses for the company of $7 million from the year-ago quarter. We continue to focus on improving our operating efficiencies across all of our segments as our growth businesses contribute a larger proportion to our overall revenue and expense. Let's turn to our financing and capital allocation activities that are highlighted on Slide 10. During the quarter, we repurchased 8.2 million shares at an average price of $12.23. At today's share price, our planned share repurchases of $500 million for the remainder of the year would reduce our outstanding share count by nearly 20%. In addition to the loan sales, we saw tremendous execution on the issuance of $2.8 billion of term funded ABS in the quarter with $1 billion related to the residual sale. For example, our FFELP issuance that priced in February was over 30 basis points tighter than the previous transaction that priced in the fourth quarter and was our largest FFELP transaction since 2017. We continue to see increased demand for both our private and FFELP transactions. Our issuance of $500 million of unsecured debt in the quarter marked our lowest coupon ever printed for Navient's unsecured debt. On April 5, we retired $627 million of unsecured debt and have no remaining maturities for the rest of the year. These transactions demonstrate our ability to lower our cost of funds while managing our debt maturity profile to better align with the cash flow projections of our total education loan portfolio. We ended the quarter with an adjusted tangible equity ratio of 6.2%, which was in line with our updated forecast. The cumulative negative mark-to-market losses related to derivative accounting declined by 19% to $499 million in the quarter due to the increase in projected rates and the natural passage of time. Excluding these temporary mark-to-market losses, which will reverse to zero as contracts mature, our adjusted tangible equity ratio is 8.1%. Let's turn to GAAP results on Slide 11. We recorded first quarter GAAP net income of $370 million, or $2 per share, compared with a net loss of $106 million, or $0.53 per share in the first quarter of 2020. In summary, the outperformance across all of our segments highlighted by our financing activity and growth businesses position us well to exceed our original targets, strengthen capital and increase returns to shareholders. I will now open the call for questions.

Our first question comes from Sanjay Sakhrani with KBW. Your line is open.

Thanks. Good morning. I wanted to start off with the loan sale. I was just wondering what factors sort of led to your decision on the sale. And then Joe, I think I heard you say that you're not assuming any additional sales for the rest of the year. Maybe you could just talk about the thought process on future sales. Thanks.

Sure, I think there's just been an incredible demand for our asset class over the last several months and actually last several quarters. And just as a result of that demand, we took a look at our portfolio. And given the current interest rate environment and the attractiveness of this asset class, we felt it was appropriate to take advantage of this opportunity. And as we've done in the past, we've been opportunistic; I mentioned the 2019 loan sales. We've also sold loans prior to that on both the FFELP and private side. But really felt that this was a great opportunity here that presented itself to demonstrate the value not only of our legacy portfolio, but also the value of the refinancing portfolio in the new originations. And so we provided guidance today, our updated guidance, we're not forecasting any future loan sales as we do not believe that is our strategy of a make and sell model, but we will be opportunistic as we have in the past. And I would say that one thing to take into account with our updated guidance is that reflects the loss of these loans for the remaining 9 months of the year in terms of that earnings. So this really is a great quarter that we saw, and I think it's going to lead to a great year based on the early trends for the first 4 months here.

Absolutely. And then I guess, maybe, Jack, you could just talk about if there's anything on the regulatory or political front that you're watching closely. I know you testified before the Senate committee a couple of weeks ago, just maybe any thoughts from that as well? Thanks.

Yes, I think on the regulatory side of the equation, that environment has been relatively stable in terms of no new developments. We continue to be eager to bring the outstanding items to resolution that we've had now for a number of years. As we've said in the past, the facts and circumstances that have come out of the discovery process there, I think make it very clear that the work we do is in full compliance with the loan programs and consumer laws. On the political side of the equation, there’s just been a tremendous amount of discussion and talk about student debt and the challenges it presents to some borrowers. I think the proposals that we've seen have been broad-based, meaning everyone gets loan forgiveness, of some depending on the size. We've talked about that as being probably not the ideal solution for a couple of reasons. One is it doesn't address tomorrow's borrowers in any way, shape or form. And two, it really is providing a fairly significant benefit at a super high cost to taxpayers, indiscriminately. It's not targeting the relief to those who need it most and providing it to many who have received the value of their education. And you mentioned that I testified. In that testimony, I mentioned that half a million borrowers each year that we serve pay off their loans and fall. We're reporting today delinquency rates in the FFELP and private loan portfolios that are at or near historic lows. I mean, this is clearly not an asset class where the majority of borrowers are struggling. There certainly are problems here. We know where they exist. We've shared that detail and hope that we can provide some assistance to policymakers as they try to address some of the concerns here.

Okay, great. Thanks.

Our next question comes from the line of Rick Shane with JPMorgan. Your line is open.

Good morning, guys, and thanks for taking my question. Look, I'd like to delve in a little bit deeper on the Business Processing segment. You guys highlight the scalability of the model in terms of profitability. I think what's equally interesting is actually the practical scalability that you were able to increase the throughput so much, and actually be able to address that operationally. You talk about some of the tolling of some of these contracts. If you can help us sort of understand what might happen in terms of revenue pressure, both on the government services and on the RCM side, that would be really helpful. I'm curious, particularly if the RCM revenues are going to face the same downward pressure.

Sure. I think you're absolutely right. We have discussed the agility and adaptability of our people and systems over the past year. Our quick transition to a work-from-home setup was not only beneficial for health and safety but also enabled us to increase our workforce to meet the rising demands for unemployment insurance processing, COVID contact tracing, and related work. We hired thousands of employees and contractors during this time, all of whom received virtual training and are working remotely while connecting to our adapted systems to meet these unique needs. We’ve achieved impressive efficiency and performance levels for our clients; for example, one state informed us that our unemployment insurance processing team was working at a 30% higher efficiency rate compared to their other contractors. Our vaccine distribution efforts included targeted outreach to hard-to-reach population segments, leading that state to have the highest vaccination rates in the country. This work contributes to revenue in both government services and healthcare revenue cycle management, with COVID-related initiatives, such as the vaccine and contact tracing, appearing in the RCM segment and unemployment work in government services. We anticipate a revenue decline likely starting in the second quarter, estimating about a third decrease as we transition that specialty work into Q2, eventually phasing most of it out. However, we have demonstrated our service quality and capabilities to the states, leading many to discuss more permanent opportunities rather than just project-based work. Additionally, much of our traditional business process services was greatly affected by the pandemic, especially transportation and revenue cycle management at hospitals, which saw a dramatic volume decline due to reduced travel and fewer transactions. Inpatient and outpatient services also fell rapidly unless they were COVID-related. These areas are starting to recover, though none have reached 100% of pre-pandemic levels yet. As the COVID project work decreases, we expect the core processing work to begin rebuilding as well.

Thank you for your detailed response. I have a follow-up question regarding the potential changes in revenue. Can you clarify how much of the operating expenses are variable if revenues decrease by a third over time? What impact will this have on the operating expenses?

Most of the work involves a significant labor component, and many of the hundreds of thousands of people hired have been on a temporary basis. Therefore, we would be able to adjust that work and manage that cost if revenues were to decrease.

Our next question comes from the line of Arren Cyganovich with Citi. Your line is open.

Thanks. The thought process of loan sales, how do you go through that thinking about that relative to the present value of the residual cash flows associated with those loans versus the gain on sale? Are you exceeding that? I'm assuming that you're doing some sort of analysis whenever you're looking at those loan sales?

Yes, thank you for the question, Arren. When we consider the discount rates applied, particularly regarding whole loan sales, the results have been significantly better than what you and other analysts predicted based on discount rates for the private portfolio. This indicates the current environment and the appeal of these assets, which, as I mentioned, were primarily originated before 2014, with 99% originating before 2010. These assets have performed exceptionally well and are now very well seasoned. In comparing this to our own projections, we believe it was the right time to showcase the value dictated by the bids we have received, a value that we feel is not reflected in our current share price. If you review your model and as other analysts adjust with similar assumptions, this should reveal an intrinsic value considerably higher than our current trading price.

Got it. Thanks. And then on …

And I think, Arren, just to add to that, the ability to take those gains, which is essentially an acceleration of earnings that we would have generated in the future, and use them to buy back shares that are not reflecting those values today, is really what leads to the decision to sell.

Got it. That’s helpful. Thanks, Jack. Regarding the higher share repurchase amount of $500 million, which is more than what you did in the first quarter, do you need to go through some sort of accelerated program to achieve that, or do you think you can accomplish it through your regular share repurchase program?

We can achieve that through our regular share repurchase program. I would say that certainly at these levels we look to accelerate some of that into the second quarter. So for your modeling purposes, I would weight it a little heavier in the second quarter, but we can do that through normal share repurchase activity.

Our next question comes from the line of Moshe Orenbuch with Credit Suisse. Your line is open.

Great, thanks. Following up on a couple of those other questions, have you examined the rest of the portfolio to determine how many other assets could make that trade effective? Considering those types of gains and the current stock price, how much of the existing book is in a position where you would be willing to pursue that?

When considering the rest of the portfolio, I previously mentioned in our last quarter call that we were investigating various alternative financing methods, which included loan sales and different facilities we've established over the years. There are benefits from our turbo repo facilities as well as loan sales that allow us to bring future cash flows forward to capitalize on the current share price. This is not limited to a single approach; there are multiple strategies we evaluate to leverage the share price, which we have implemented over the past few years. Today, using this option was particularly appealing, so we acted swiftly to take advantage of it. Additionally, we have other options available related to our residuals and whole loans. Specifically addressing your question about our unencumbered non-refi portfolio, we hold just under $2 billion in assets of that kind.

Thanks, Jack. You mentioned that we're not planning to become a make and sale company. Can you elaborate on whether there was anything specific about that residual that made it more attractive or easier to sell? Also, what would the financial implications be if we were to consider adopting that model today?

Yes, I think, as Joe mentioned, we have an investor in our marketplace who is taking advantage of today's low interest rates to discount future cash flows. The current strong credit performance of our portfolio results in an attractive deal. This is particularly true for the refinance side, where we can showcase our origination franchise's value based on the available gains. However, we still believe that we are better off owning these loans, given our ability to finance them with a 5% capital level and the securitization rates we can achieve in the marketplace. The situation might be different if we were a bank with a different capital structure for this asset class.

Our next question comes from Eleanor Gravenhorst with Allstate. Your line is open.

Hi. Thank you for the call this morning. I'm just wondering if you could provide a little bit more detail around the projected runoff for the Department of Education contract, the asset recovery services. Correct me if I'm wrong about those supposed to end kind of at the start of 2022. And revenues have just kind of declined, I guess somewhat substantially quarter-over-quarter.

We had two contracts with the Department of Education. One was for asset recovery, which has now ended and the related revenue has also ceased. The other contract involves servicing loans for the Department of Education and this contract is still active, set to expire towards the end of this year. However, we believe the loans will need to be serviced by someone, and we are collaborating with the department, anticipating they will announce their plans for that portfolio later this year.

Okay. And then …

That contract runs about $145 million a year in total.

Okay. Thank you. And then just on the charge-off, obviously those, I guess this quarter were lower than what you've projected kind of for FY '21 in total. I mean, are you still kind of standing by your FY '21 outlook in terms of charge-offs? Or should we maybe guide towards something slightly lower levels, just given first quarter performance?

So we're not providing updated guidance, but we're certainly on pace in a trajectory to be below what the targets that we originally set out at the beginning of the year.

Okay. And then, last question for me. You guided towards a $5.5 billion, I think total originations for the year. Are you able to provide any color regarding kind of what mix of that would be from the in-school segment versus maybe the refi product?

We haven't broken that out. And I think it was important to reconfirm that just given some of the commentary I think you've seen from other consumer lenders of reduced demand for new loans. We stand by our original forecast here of $5.5 billion.

Okay. Thank you.

You’re welcome.

Thank you.

Our next question comes from the line of Peter Josse with Barclays. Your line is open.

Hey, good morning. Joe, just on the loan sales, you mentioned principal proceeds from the non-refi private loans will be used to reduce unsecured debt. It seems like there's about $560 million of cash that you've earmarked for that debt reduction. Can you give us a sense for how much of that you might use to retire the unsecured bonds versus repaying the warehouse borrowing that you mentioned?

Sure. So on April 5, we reduced all of the maturities to zero for 2021 through the repurchase of the $627 million that was due in July. I would say that in terms of the warehouse facility reduction, that's primarily related to the refinance sale, but on the whole loan transaction, there was about, call it just a little south of $200 million that was related to a turbo facility in that transaction. So you're left with roughly $400 million to address the unsecured debt.

Okay. That's helpful. Thank you.

There are no further questions at this time. Now I will turn the call back over to Nathan.

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

That concludes today's conference call. Thank you for participating. You may now disconnect.