Navient Corp Q4 FY2021 Earnings Call

Thanks, Deborah. Good morning, and welcome to Navient's Fourth 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 that our discussion will contain predictions, expectations, and 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 discussed here. This could be due to various factors. Listeners should refer to the discussion of those factors on the company's Form 10-K and other filings with the SEC. During this call, we will refer to non-GAAP financial measures, including core earnings, adjusted tangible equity ratio, and other various non-GAAP financial measures derived from core earnings. Our GAAP results reconciliation, GAAP results and description of our non-GAAP financial measures and with a full reconciliation to GAAP can be found in the fourth quarter 2021 supplemental earnings disclosure. This is posted on the Investors page at navient.com. Thank you. And now I'll turn the call over to Jack.

Thanks, Nathan. Good morning, everyone. And thank you for joining us today and for your interest in Navient. 2021 was a year that presented some significant opportunities along with a few challenges. Our company responded to both with agility, determination, and success, positioning us well for 2022 and beyond. In 2021, we delivered outstanding financial results, simplified and derisked our business, and demonstrated a continued ability to deliver attractive returns and sustainable growth. For example, in Consumer Lending, we originated $6 billion in attractive ROE student loans, a 30% increase, making Navient the largest private education lender in the country. In Federal Education Loans, we achieved a major objective to simplify and derisk the business with the constructive solution to transfer our Department of Education loan servicing contract to a third party. This provided a seamless transition for millions of borrowers, ensured ongoing servicing capacity for the department, and ongoing employment for 700 teammates. We leveraged our business processing platform to provide technology-enabled solutions to address pandemic-related needs. This included retraining existing resources, hiring 9,000 temporary customer service representatives, and providing data analytics to improve performance and efficiency for our clients. We responded to the pandemic with payment relief options across our loan programs and then assisted hundreds of thousands of customers who are ready to successfully return to repayment. Today, in both our Federal and Private Loan portfolios, delinquency and forbearance rates are below pre-COVID levels. And we continued to execute on new financings and transactions that reduced interest expense and improved our net interest margin. For example, we identified an opportunity to sell an older portfolio of loans, delivering both a significant gain and reducing our reliance on our most expensive funding source. Recognizing and capturing diverse opportunities across our business is not unique at Navient. We are deploying these same skills in 2022 to continue creating and delivering value for our shareholders, with our strategy to maximize cash flows, invest in our growth businesses, and return excess capital to investors. While Joe will provide the financial highlights for the quarter and the full year, I would describe our performance in 2021 as our most complete and successful year ever. It was a year where we exceeded all of our goals. This execution drove adjusted core earnings to $4.45 per share, 31% above 2020 results. New loan originations increased, as already mentioned, by 30% in 2021 to $6 billion, even as the Federal direct loan interest and payment pause was in place for the full year after being extended several times. We are generating this volume efficiently and profitably. We are also achieving very high customer satisfaction scores. Credit performance has also been strong. The rebound in the economy and numerous stimulus programs have helped consumers strengthen their overall financial position. In fact, private credit loan losses are well below pre-pandemic levels, as are our delinquency and forbearance rates. Our multi-channel approach to communication continues to help our customers learn about and evaluate their options and avoid the negative consequences of delinquency and default. We also made significant progress in simplifying our business and reducing our risk profile. First, we completed the transfer of our Department of Education contracts. And while we delivered strong performance for the department, this business was a small contributor to revenue, no longer growing, and presented a challenging political risk profile that was unlikely to change. The solution we developed ensured a smooth transition for millions of borrowers and ongoing employment for our teammates. In addition to simplifying our business and focus, it also materially reduces our operating risk. Following this, we announced the resolution of all of the state lawsuits and investigations. These matters began more than 8 years ago and have consumed significant resources and expense. During these years, the exhaustive examination and discovery process identified no evidence to substantiate the theories and claims made. This is the outcome we knew to be the case. Unfortunately, the legal process was and remains lengthy and costly. Our decision to resolve these cases eliminates the significant time and expense we would incur to pursue our defense to the end. Closing these cases in this manner is a net positive and it simplifies our business. While the CPB action, which is based on virtually identical claims, remains outstanding, it is much further along, and we remain committed to a vigorous defense. These two actions mark another set of milestones in our active management of our cost base and efficiency optimization. Together with the sale of the loan servicing technology platform, we have created a significantly more efficient and variable long-term cost structure for our business. Throughout 2021, we also supported our team members with flexible work locations, thousands of hours of training, and new leadership development programs and employee resource groups, yielding strong increases in employee engagement. Team Navient was active in our communities through local and national organizations, including a significant national partnership with the Boys & Girls Clubs of America. We're also proud to have received recognition for Board diversity and military support, among other awards. As we begin the New Year, we are excited to focus completely on creating value. We will maximize cash flows, grow loan originations with high-quality, high-value products, grow business processing revenue, improve operating efficiency, and still return excess capital to investors. In Consumer Lending, our goal is to originate at least $7 billion in refinance and in-school loans, an increase of 16% over 2021. Our product design, application flow, and underwriting expertise have driven significant growth in market share, with lower-than-market acquisition costs and better-than-market credit performance. We remain committed to our profitability targets for both refinance and in-school loans, and we see a significant opportunity to deploy our capital at scale at attractive ROEs. In BPS, virtually all of our COVID project work ended in 2021, with just a small carryover into the New Year. This project work totaled $265 million in revenue last year. And as our clients return to more normal operational volume, we expect to grow traditional BPS revenue by 10% in 2022. And we remain confident in our ability to continue to grow revenue at similar double-digit rates over the next several years. While the COVID projects may have been short term, the relationships we built with key states and municipal clients are not. These partnerships have accelerated BPS relevance, reputation, and growth potential. Our BPS business leverages our platform and capabilities to generate attractive margin, asset-light fee income. On capital, our first priority remains the generation and retention of sufficient capital to support our growth businesses and our dividend. The balance will be returned to shareholders through our projected $400 million in share repurchases in 2022 as part of the $1 billion authorization approved by the Board in the fourth quarter. Our capital generation supports a strong balance sheet, maintenance of our credit ratings, and the ability to support meaningful growth while returning capital to shareholders. I couldn't be more pleased with our 2021 results and would like to thank my colleagues across Team Navient for their contributions. Our 2021 results reflect our strong commitment and focus on delivering high quality, high value services to our customers and clients and an intentional effort to simplify our business model and reduce risk. Our ability to identify and capture new opportunities created and delivered clear value. And it was particularly satisfying to see investor recognition of this success in the strong share price appreciation. I'm even more excited about the opportunities ahead of us. And I'm confident in our ability to continue to maximize cash flow, grow loan originations and BPS revenue and return excess capital to investors as we deliver sustainable earnings growth year after year. I'll now turn the call over to Joe. And I look forward to your questions later in the call.

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 fourth quarter and year-end results for 2021. I will be referencing the earnings call presentation, which can be found on the company's website in the Investors section. Before I turn to the highlights for the quarter and year, I would like to acknowledge the hard work and dedication of the thousands of people who make up Team Navient. The success across all of our business lines contributed to the strong quarterly results and full year EPS that exceeded our original guidance by 40%. As a result of this effort and the demonstrated agility to leverage our current platform and capabilities, we are well positioned for 2022 and beyond. Key highlights from the quarter and full year, beginning on slide five, include fourth quarter GAAP EPS loss of $0.07 and a full year GAAP EPS of $4.18, fourth quarter adjusted core EPS of $0.78 and full year adjusted core EPS of $4.45. EPS results include debt repurchase losses of $0.21 in the quarter and $0.33 for the year as we took advantage of a favorable economic opportunity to retire unsecured debt early. We originated $1.4 billion of private education loans, bringing our total originations for the year to $6 billion; increased full year BPS net income to $99 million while exceeding our high teen EBITDA margin targets, improved our adjusted tangible equity ratio to 5.9%, while returning $707 million to shareholders through dividends and repurchases in 2021, achieving levels consistent with our target of 6%. Let's move to segment reporting, beginning with Federal Education Loans on slide six. Net interest margin decreased 7 basis points from the year-ago quarter to 99 basis points and was unchanged for the full year. We expect the net interest margin to be in the mid-90s for 2022. FFELP credit trends continued to be at or below pre-pandemic levels, with total delinquency rates of 10.6% and forbearance at 12.4%, while charge-offs remain at historically low levels. Our expectation for 2022 is that charge-offs remain below 10 basis points. Fee revenue in this segment declined $12 million from the third quarter. This was attributable to our October transfer of the Department of Education servicing contract. This transfer resulted in a decline in servicing revenue by $31 million and was offset by a $20 million increase in other income that was primarily a result of our transition services agreement, for which we will receive offsetting revenue payments for the expenses we incur for the transition. Outside of this agreement, services provided through our Federal Education Loans segment now pertain solely to FFELP loans. Now let's turn to slide seven and our Consumer Lending segment. The total portfolio grew modestly from the third quarter. It was down 4% from a year ago as a result of the $1.6 billion in loan sales that occurred earlier this year that contributed $91 million of gains and a reversal of $107 million of allowance for loan losses. In the quarter, we originated $1.4 billion of total private education loans. For the full year, we originated $6 billion of private education loans compared to $4.6 billion a year ago. The increase of 30% was accomplished even though we saw multiple extensions of the CARES Act, which continue to provide a 0% interest for borrowers through May 1st, 2022. Our $6 billion of originations included $212 million of in-school private education loans compared to $73 million a year ago. These loans were made through our banking partner, entirely to students attending not-for-profit institutions. Our total origination guidance of $7 billion for 2022 assumes that the CARES Act expires on May 1st of this year. We expect to see lower origination volumes in the first half of the year as borrowers delay refinancing decisions until after the extension ends and the rates on current loans moved from 0% to their higher original stated rate. The expiration of the moratorium should be a significant tailwind for the refinance origination backdrop even as rates rise. As a reminder, we reserve for loan losses at origination. So for every dollar of new refinance originations, we reserve approximately 1.25%, and for new in-school originations, we reserve 6%. The full year net interest margin of 292 basis points exceeded our original target of 270 to 280 basis points. This quarter's NIM of 276 basis points is lower than a year ago, primarily as a result of the increase in interest reserve for late-stage delinquencies that was expected to occur as borrowers exited forbearance. Our full-year 2022 net interest margin guidance of 255 to 265 basis points assumes a greater mix of our private refinance product compared to our legacy book. As borrowers transition back to repayment, credit trends continued to exceed our expectations, with total delinquency rates below pre-pandemic levels and charge-offs at historically low levels. While economic conditions continued to improve, our allowance reflects the uncertainty related to the potential negative impact on the portfolio from the end of various payment relief and stimulus benefits that recently occurred or are currently forecasted to end in May 2022. As borrowers continued to transition to repayment, we feel confident that we are adequately reserved for the expected life of loan losses given the well-seasoned and high credit quality of our portfolio. Let's continue to slide eight to review our Business Processing segment. In the fourth quarter, we continued to see the positive results of our ability to leverage our existing technology-enabled platform and infrastructure to support states in pandemic-related services. This agility contributed to a 19% increase in total revenue from the year-ago quarter and a 61% increase for the full year, while exceeding our targets of high-teen EBITDA margins. As discussed on prior calls, we anticipate that the expiration of pandemic-related contracts will decrease revenues in the BPS segment for 2022 as more traditional services return to normalized growth. For 2022, we are targeting revenues of at least $260 million, with high-teen EBITDA margins. Let's turn to our financing and capital allocation activity that is highlighted on slide nine. Over the last 12 months, we reduced our outstanding unsecured debt balance by 16%. While our primary source of funding remains ABS, we issued two unsecured transactions during the year totaling $1.25 billion and repurchased $2.6 billion of unsecured debt, reducing our interest expense, and resulting in $73 million of debt repurchase losses. These transactions lowered our cost of funds and reduced our needs for future issuance as we have no existing maturities for all of 2022. During the fourth quarter, we issued $1 billion of private refinanced loan ABS and $1 billion of FFELP ABS. For the full year, we issued nearly $10 billion of ABS through 10 transactions. As we manage the growth of our high-quality private education loan portfolio, we continue to see increased demand from new investors in these transactions. During the year, we reduced our share count by 17% through the repurchase of 34 million shares, returning $707 million to shareholders through share repurchases and dividends while increasing our adjusted tangible equity ratio to 5.9%. At today's price, our planned share repurchases for 2022 of $400 million will reduce our outstanding share count by 13%. Before turning to our outlook for 2022 on slide 10, I would like to highlight the efforts that we have taken to simplify and derisk the business. During the quarter, we transferred the Department of Education servicing contract to a third-party, reached agreements with various state attorneys general to resolve their previously disclosed litigation and investigations, and reduced our real estate footprint, resulting in an $18 million restructuring charge in the quarter. Our continued focus on efforts to simplify the business while improving efficiencies allowed us to achieve an overall efficiency ratio of 49% for the year compared to our original target of 52%. Our targeted efficiency ratio for 2022 of 54% is primarily a result of the growth businesses contributing a larger proportion of our overall revenue and expenses. We are providing 2022 adjusted core earnings per share guidance of $3 to $3.15, with targeted return on equity in the mid to high teens. Our outlook excludes regulatory and restructuring costs, assumes no gains from loan sales, reflects a rising interest rate environment, with the expectation of four rate hikes of 25 basis points occurring each quarter and $400 million of planned share repurchases. Turning to GAAP results on slide 11. We recorded full-year GAAP net income of $717 million or $4.18 per share compared with net income of $412 million or $2.12 per share in 2020. In summary, 2021 was a year where we exceeded all of our original financial targets, demonstrated the value of our education loan portfolio, leveraged our technology and infrastructure to grow BPS, increased returns to shareholders, strengthened capital, and took significant steps to simplify the business. I am proud of our accomplishments this year and look forward to continued success as we are well positioned for meaningful and sustainable growth. Thank you for your time. And I will now open the call for questions.

Thanks, good morning. You guys have had a good productive year. I guess first question, Joe, on the interest rate sensitivity. You mentioned you guys are factoring in four rate hikes. But as we think about the timing of those rate hikes, I know there are some differences between sort of short-term rates and long-term rates. How have you figured that into your NIM expectations?

Yeah. So I think one thing to continue to focus on is where one month LIBOR is as that determines the majority of what we're earning here on both the private and the FFELP side. And how we think about it is those four rate hikes evenly distributed over the year, so one occurring in each quarter. And how that impacts on the FFELP side of the equation is that our assets typically reset or are resetting daily, and there's a little bit of a funding lag. So you get somewhat of a benefit in terms of if there's a faster rise there that you're going to pick up on the asset side, but then you're going to lose some of that benefit, obviously, as rates rise with it impacting floor income. So overall, between where our projections are compared to last year, that's where we felt comfortable in the mid-90s range. So from a floor income standpoint, we would anticipate, based on the current curve, that we'd lose about $14 million in floor income over the course of the year, but we would benefit from some of the rate expectations here on the asset side as well as the financing decisions that we've made and activities that we've taken place. So over the last year, that will offset that. So that's why we feel comfortable with the mid-90s range given the forecasted rate hikes.

Okay. And then on the private side, we're very quick to adjust from a spread perspective. So we're - as we look at rates and rates rise, you're going to see us, and as you've seen some competitors more recently, adjust the rates upward to factor in the rising rate environment. Okay, great. And then I guess my follow-up question is a question I've been getting a lot from investors, just some of your competitors have gotten stronger, potentially now getting a bank charter, I'm curious if you feel like it affects the competitive environment or you guys feel pretty good going out of the way you're currently composed. Obviously, your guidance suggests continued strength there. So maybe you could just elaborate that on that, Jack.

Sure. So certainly, we, over our years, as Sallie Mae and Navient have been competing against institutions with bank charters, large and small, and really don't see any significant difference by a new competitor obtaining a bank charter. But I would just note, on the refi side of the equation product in particular, this is a product that we were able to leverage more efficiently than you could on a bank balance sheet, given the very low credit risk profile. And our funding efficiency has really been second to none in the securitization markets. And so we expect those positives to continue. And then the last point I would just make on those - on that product side of the equation is we are far more efficient than our competition in the space. We believe we consistently run at a - or incur a cost to acquire a new customer that runs about half the industry average. If you look at our ABS transactions, you'll see credit performance in our portfolio is also running about - credit losses running about half of the industry average. Those combinations of factors really allow us to outperform in this space. I don't think you have to look much further than the 30% growth that we generated in 2021 compared to the decrease in originations that most of our competitors saw.

Thank you.

Thanks. Jack, you mentioned that you've formed a lot of relationships with states and municipalities during your pandemic work. And maybe just talk a little bit about some of the types of conversations you might be having with additional types of work for BPS. And then I just want to clarify what the base is that you're growing the 10% off of in terms of BPS revenue in your 2023 expectation?

Sure. So I think the work we've been able to do with states here has been not just about providing resources of additional people to answer a higher volume of calls. I think one of the things where we've been able to distinguish ourselves compared to some of the other vendors that work for states is the analytics and insight that we've been able to provide that dramatically improve efficiency or outcomes. For example, in one of our larger clients, where we were working alongside a number of different vendors to respond to and submit unemployment insurance claims during the pandemic, our client repeatedly told us that we were running at about a 30% greater efficiency rate than everybody else in that space. As a result of that, as volume was declining, all the other vendors ended their contracts or their contracts were ended ahead of ours. So I think that's an example of the type of value that we're able to produce. And so as states are now looking to return to a more normalized effort, it's how can they continue to capture some of those value-added services and benefits that we bring to the table of improved insight, efficiency, and effectiveness. And those conversations are, in fact, happening, and we're pretty excited about the opportunities in that space. In terms of the growth from the BPS side of the equation, Joe.

Yes. So the numbers Jack was referencing. So of the $488 million of revenues that we had this year, roughly around $260 million of that was related to pandemic-related services. So take that out of the equation, then the growth of 10% on the more traditional businesses that have not yet fully recovered, plus a little bit of lag of some pandemic contracts that are ending here in January and February. So our assumption of that at least $260 million revenues assumes that all of those contracts and at their stated expiration dates and that there's no additional pandemic-related contracts.

Guys, thanks for taking my question. Just to be clear, so when we talk about the 10% growth on the BPO, that is really off the $260 million number? I was a little confused. I thought I had it, but then I got a little confused?

Yeah, going forward, I think that going forward into 2023, we're looking at this as long term, a business that can grow double digits. So 10%, that's appropriate as you think about the out-year. So this is '23 and beyond.

Yeah, thank you. I had a follow-up question on the FFELP NIM. Could you just talk about the sensitivity of your guidance to the number of rate hikes kind of what the upside, downside is if you get more or fewer hikes than expected?

Sure. So the way that the rate hikes are forecasted over the course of the year, if we were to have less rate hikes than expected, again, it's more on the shape of the curve and what the expectations are going in. So I would, again, focus on one month LIBOR. But ultimately, just from a hedge perspective and where we are, I think, as I quoted earlier, the $14 million of loss of floor income assumes those four rate hikes over the year. If that does not occur, then you would see relatively flat floor income if LIBOR continues to maintain at these low levels, and you don't see that, we would certainly benefit. The question is what our expectations and whether you get those asset resets. And so from that standpoint, I'd say $14 million is really your sensitivity in terms of a potential upside on putting us back in the high 90s or beyond. In summary, 2021 was a year where we exceeded all of our original financial targets, demonstrated the value of our education loan portfolio, leveraged our technology and infrastructure to grow BPS, increased returns to shareholders, strengthened capital and took significant steps to simplify the business. I am proud of our accomplishments this year and look forward to continued success as we are well positioned for meaningful and sustainable growth. Thank you for your time. And I will now open the call for questions.

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