Navient Corporation (NAVI) Q4 2014 Earnings Report, Transcript and Summary

Good morning. My name Laurel and I will be your conference operator today. At this time, I'd like to welcome everyone to the Navient Fourth Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] Thank you. I'll now turn the call over to Joe Fisher, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Laurel. Good morning and welcome to Navient 2014 fourth quarter earnings call. With me today are Jack Remondi; our CEO and Somsak Chivavibul, 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 and forward-looking statements. 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 and other filings with the SEC. During this conference call, we will refer to non-GAAP measures, we call our core earnings. A description of core earnings, a full reconciliation to GAAP measures and our GAAP results can be found in the four quarter 2014 supplemental earnings disclosure. This is posted along with earnings press release on the Investors page at www.navient.com. Thank you and now I'll turn the call over to Jack.

Thanks, Joe. Good morning and thank you for listening in today. I appreciate your interest and your support. 2014 was a busy and productive year. We started the year as one company with a very long list of tasks to complete, and we finished the year as Navient having successfully completed the legal and operational separation from Sallie Mae. While the separation project consumed most of the resources here, we retained our focus on our business delivering outstanding performance and generating strong financial results. Highlights for the year include, of course, our completion of the separation from Sallie Mae, the acquisition of $13 billion in student loans, and we reduced private credit charge-offs by 18% to $717 million for the year. Our servicing skills enabled our federal loan customers to significantly outperform the national average with the cohort default rate 48% lower than all other services. We distributed $849 million to shareholders through dividends and share repurchases, and we generated $2.10 of core earnings per share. I am very pleased with our performance in 2014 and the resulting gains for our shareholders. The separation not only proved to be a catalyst to unlock the value of our business, but is also unlocking Navient's potential to grow in businesses beyond education finance. While I'm proud of our accomplishments in 2014, I want to focus my comments on here and now our plans for 2015. Our goals for 2015 can be summed by one word, growth. We see growth opportunities in each of our operating areas. In asset management, we continue to see opportunities to purchase both federal and private loan portfolios, and while we are unlikely to repeat the volume acquired in 2014, we believe there will be substantial opportunities in 2015 as the environmental factors remain unchanged. Our competitive advantages also remain intact, but we did see what we believed to be irrational pricing on some portfolios in late 2014. We also see continued opportunities to increase the expected cash flows from our federal and private loan portfolios as credit continues to improve, and we benefit from lower financing costs and low interest rates. During 2014, we increased the undiscounted expected cash flows from our loan portfolios by $3.6 billion, including $3 billion from portfolio acquisitions. In our business services segment, while total revenues declined as a result of rehabilitation fee cuts from last year and the wind down of the transition services we provided to Sallie Mae Bank in 2014, we expect to see growth in our loan servicing business from both the department of education and third party service contracts. We also see opportunities to grow our municipal asset recovery business and believe will have the opportunity to bid on meaningful government collection contracts. Our success in opportunities in this area are driven by our strong performance. Our goal is to deliver industry leading results and to enable customer success, while doing so in a cost effective and compliant fashion. We believe our industry leading performance, cost efficiency, and control structure are significant competitive advantages. The improving economy and growth and employment for young workers are helping student loan performance. We also see borrowers making better decisions, allowing them to successfully manage their student loan payments. The fact is that nationally, delinquencies and defaults are declining. And Navient is leading the way with more customers enrolled in affordable repayment programs in dramatically lower default rates compared to the national average. With the separation complete, we’ll return our focus to improving our operational efficiency. We've a long track record of annual efficiency gains, and we are confident we can continue to produce further improvement. We are also keeping our commitments to return the value we create to investors. In December, we announced the new authorization to repurchase up to $1 billion in our common stock. This authority is based on a very strong capital foundation, and the very sizable and predictable cash flows generated by our student loan portfolio. Given the seasoned nature of our portfolio, our significant reserves and conservative funding approach, we allocate 50 basis point of capital to our FFELP portfolio and 8% to our private loan portfolio. The result is an exceptionally strong capital base, well in excess of our capital allocations. It supports out outstanding debt, our capital return plans, and the investment required to support our growth objectives. To borrow a phrase, our predictable cash flow, high percentage of duration match debt, and strong capital base truly creates a fortress balance sheet. While our outlook for growth is positive, I'd like to remind folks that 2015 will need to overcome some significant headwinds. For example, the rehabilitation fee cuts and the amortization of our FFELP portfolio will reduce net income from these businesses by an estimated $75 million in 2015. In addition, we continue to feel the number of information requests and exams from federal and state regulators and expect the level of activity in 2015 to remain similar to last year. Though these requests are time consuming and expensive, we are committed to being a responsive partner. We are confident in our ability generate core earnings per share of $2.20 in 2015, and to generate ongoing EPS growth in the years beyond. I see a company and the team of significant strengths and with the cash flows, performance, efficiency, and controls to grow and succeed, creating value for our customers, employees, and shareholders. Somsak will now provide more details of our financial results for the quarter and the full year. Thank you.

Thanks, Jack. Good morning, everyone. During my prepared remarks, I'll be referencing the earnings call presentation which is available on our website beginning with Slide 4, which provides a summary of our core earnings. Excluding expenses associated with regulatory matters, we earned $2.10 per share for the full year and $0.54 per share for the fourth quarter. And as Jack mentioned, we expect our core EPS to be $2.20 for 2015. Our fourth quarter operating expenses totaled $206 million and $804 million for the year. These expenses included a $4 million incremental cost, related to the $9.5 billion of loans acquired during the quarter. We do expect to transfer majority of these loans to our servicing platform by the third quarter of 2015. As a result, we expect to incur one time conversion expenses of approximately $25 million and ongoing incremental servicing expenses of approximately $20 million in 2015. Let's turn to Slide 5 to discuss our FFELP results. Core earnings were $82 million for the fourth quarter compared with $81 million for the fourth quarter of 2013. The FFELP student loans spread was 100 basis points in the quarter as these assets continue to generate high quality predictable returns and cash flows. For 2015, we expect our student loans spread for FFELP to be in the mid-90s. We acquired $9.5 billion of FFELP loans during the quarter bringing our year-to-date FFELP loan acquisition to $11.3 billion. Let's now turn to Slide 6 in our private education loan segment. Core earnings in this segment increased $6 million from the year ago quarter to $92 million. Profitability continues to improve as price remains consistent and losses continue to decline. Our fourth quarter student loan spread came in at 3.99%. And for 2015, we expect our student loan spread for private portfolio to be approximately 4%. Charge-offs for the fourth quarter were at 2.5% which is a significant reduction from the year ago quarter. We continue to see year-over-year improvement in both our total and 90 plus day delinquency rate. The improvement in our outlook for future charge-offs led to a decrease in our provision for loan losses which came in at $128 million for the quarter. And that's a decrease of $24 million from the year ago quarter. Slide 7 shows our asset quality trends over time and how our portfolios are dominated by high-quality loans. Our highest risk segment what we call non traditional loans is now down to only 8% of our portfolio. And as you can see on the chart on right, losses have steadily declined across all our loan segments in the past four years. This portfolio is well seasoned with 91% of our loans in repayment status having made more than 12 payments. Let's turn to Slide 8 to review our business services segment. In this segment, core earnings were $98 million for the quarter compared with $187 million from the fourth quarter of 2013. We saw decrease in our asset recovery revenue of $28 million versus the year ago quarter. The decline was driven by the Bipartisan Budget Act of 2013, which reduced the revenue earned from helping previously defaulted federal loan borrowers rehabilitate their loans. The new reduced fee structure became effective on July 1, 2014. We do expect our asset recovery revenues to be between $75 million and $80 million per quarter during 2015. The company now services 12 million borrowers with 6.2 million borrowers under the Department of Education servicing contract. Servicing revenue from this contract was $34 million for the quarter compared with $31 million in the prior year. Let's turn to Slide 9 and review the increases we've seen in our projected cash flows from our education loan portfolio. This portfolio is expected to generate significant and predictable cash flows of $36 billion over the next 20 plus years. In 2014, we received actual cash collection of $2.7 billion, but yet added $3.6 billion of future cash flows through acquisitions, refinancing, improvement in credit quality and additional floor income. During the quarter, we added more certainty to our cash flows by hedging $14 billion of loans and locking in our $660 million of future floor income. To date, we have locked in or hedged $1 billion of the $1.9 billion of projected future fore income. Do expect to enhance these cash flows in meaningful ways as we take advantage of the market price overall. We are going to move Slide 10 and highlight our loan acquisition and financing activity for the year. We acquired $13 billion of loans for 2014 and closed on the $10 billion ABCP facility that helps finance these acquisitions. We do believe that student loan purchase opportunities will continue going forward. On the financing front, our ABS transactions continue to attract strong investor demand. For the year, we issued $6.8 billion of ABS. Just last week, we priced $689 million private ABS transactions which came in tighter spreads than our previous private ABS deal. During the quarter, we repurchased 8.7 million shares for $168 million. And for the full year we repurchased 30.4 million shares for $600 million. And during the fourth quarter, the Board authorized $1 billion share repurchase program. Although this activity was undertaken while maintaining a strong capital position. On Slide 11, you will see that since 2006, we have increased our tangible equity ratio as well as our net asset ratio, while at the same time reducing our unsecured debt outstanding from nearly $50 billion to $17.5 billion today. We feel that our debt and maturities are well matched to our expected cash flows and coverage ratios are conservative. At yearend 2014, our tangible equity ratio was 2.6% compared to 2.3% in 2013. With the well seasoned portfolio and conservative funding strategy, we believe that the appropriate capital level for our private credit portfolio is 8%. In the past, when we were an originator of private loans, we had provided an additional 12% of capital against these assets. And finally turning to GAAP results n Slide 12. We record fourth quarter GAAP net income of $263 million or $0.64 per share. That's compared to net income of $270 million or $0.60 per share for the year ago quarter. The primary differences between core earnings and GAAP results are the marks related to our derivative position, expenses related to the restructuring and reorganization and the income associated with the SLM BankCo prior to the spin. Just to reiterate, our core EPS guidance of $2.20 for 2015 includes; FFELP student loan spread in the mid-90s, private student loan spread of approximately 4%, and one time conversion expenses of $25 million and ongoing incremental servicing expenses of $20 million in 2015. And asset recovery revenues between $75 million and $80 million per quarter. With that, I'd like to now open the call for questions.

[Operator Instructions] Your first question comes from the line of Sameer Gokhale with Janney Capital Markets. Your line is open.

Hi, so I just had a couple of quick questions. Just on your asset recovery revenue, it was a bit higher sequentially, and I know you kind of explained the year-over-year declines but sequential increase; it was a bit greater than I had modeled in and I was just curious what might have driven that, that sequential increase in asset recovery revenue?

So that was -- it was really driven by the fact that with ahead of the fee cut and that was effective July 1. That activity was pulled from that quarter into the second quarter, and what you see in the fourth quarter is a more normalized run rate.

Okay, that's helpful. And then as far as the $9 million or so in regulatory, I think you had some expenses related to that, can you just talk briefly about what that related to specifically?

Yes. It's professional fees associated with implementing the consent orders, and some of the exams that we are going through right now. That workflow proved to be a little bit more time consuming principally on the consent orders than anything else.

Okay. And then in terms of your floor income and locking in floor income through hedges, I think it gets cheaper for you to actually lock those in through those forward contracts as rates rise. So what's your thinking around locking in additional floor income? How much would rates need to increase before you maybe have an increased appetite for locking in that floor income?

Hey, Sameer. What we try to do is just go through, and there is no exact science in that but -- what we try to do is looking into the rate environment beyond more than just intermediate period, and the hedge that we entered into, really locked into floor income that went from 2017 and 2019, so what we are trying to do is just lock-in, yes, what I call a longer-term value of floors up to 2019 more than anything else.

Okay. And then just my last question on the share buyback authorization, for $1 billion, I mean how should we think about that? Would you plan to spend all of that this year? Is that contingent on how much you might acquire in terms of FFELP or private student loans or how do you think about that or should we assume some of it will bleed into 2016?

So the authorization, it takes into consideration our assumptions for loan acquisitions, our capital generation, the investment that will make into supporting our growth objectives. We do expect the majority, if not all of that, to be used in 2015. However, it is a function of the environment. If we see opportunities to buy portfolios greater than our projections, that could alter some of that particularly if they are private credit loans less so on the FFELP side. So that's our plan at the moment.

And what are some of your assumptions as far as acquisitions and portfolios for this year?

So we are not -- some of that needs to be data that we don't really want to -- don't want to talk about in terms of the pure details here, but it is based on what we see in terms of opportunities that are in the pipeline today as well as opportunities that we think have a strong chance of materializing during the course of the year. I just want to it leave at that.

Your next question comes from the line of Michael Tarkan with Compass Point. Please go ahead.

Hi, this is actually Andrew Eskelsen on for Mike. My question is just to clarify regarding the 2015 guidance. Does the $2.20 include assumptions for share repurchase or M&A activity?

Yes, it does. It is our assumption based on what we have in the plan today.

Okay, thank you. And then on the M&A environment out there specifically from the FFELP standpoint, are you seeing more activity now that the Wells portfolio has moved and on the private side anything to note there?

Well, the Wells portfolio was the largest portfolio held by banks, and yes, we are seeing some more activity. I think the drivers what we see is being the drivers for banks in particular to sell is the fact that loan growth is growing, so they are seeing demand for loan elsewhere in their business, which gives them an opportunity to redeploy those cash flows. The regulatory environment as it is associated with both consumer assets and the student loans base as well as their obligations to oversee third party vendors are the principal drivers there.

All right, thank you. And just one more for me. In terms of the servicing on the Wells portfolio and transferring it over to your platform, can you sort of walk us through how that process will work?

Yes. So these loans are all serviced today by third parties. The majority of the loans are eligible to be transferred. So when we acquired the portfolio, we also acquired the servicing rights associated with them. That portfolio that is eligible to be transferred will be transferred by the third quarter of next year.

Your next question comes from the line of Mark DeVries with Barclays Capital. Your line is open.

Yes, thanks. I just have a follow up question on the transfer. I think you referenced $20 million of incremental servicing expense from 2015 as a result of that. Should we assume it is more of like a $40 million annualized number given that it is not going to transfer until 3Q?

No, that's fully annualized number there, Mark.

Okay, got it, got it. And Jack, I think you referenced the opportunity for some operating efficiencies. Could you give us some color on what you have in mind there and whether that's embedded in kind of the earnings guidance for 2015?

Yes. It is in our forecast. But generally what we have been able to do year-over-year is improve the operating cost of our internal operations. And so that would be everything from what is it cost to service loan and repayment to what is our cost of collecting on a delinquent account to porting new acquisitions onto our servicing platform. What we typically do as we measure the unit activities in those areas and over the years we've been automating a number of the functions in that space, improving both our operating efficiency as well as the control structure associated with those activities. And we continue to see opportunities to do that. An example of a big item that we rolled out last year or this fall, 2014 fall, was our mobile web application for customers. And this dramatically simply their ability to make payments on a mobile device which our customers increasingly do. And it gave them the flexibility to actually make allocate those payments to specific loans and that both as a customer experience benefit but it also improved their operating expense as that function was previously more manual.

Got it. And then finally could you just give us some color on the types of FFELP loans you acquired in the quarter outside of the Wells deal? I guess there was $1 billion of other loan. What types of loans was those, and gives a sense of how the returns on those compared to your portfolio, your average portfolio returns?

So they-- it is a variety of different smaller portfolio purchases with the piece of these are, our purchases coming from guarantee agencies as borrowers are rehabilitated and the loans are return to good standing. And then smaller portfolios that we acquire, some of which were on our servicing platform, some of which were not. The returns vary pretty significantly depending upon the different features there, or characteristics of the loan. Obviously loans that are on our servicing platform have, can generate the best returns after operating expense because they -- the incremental cost is relatively low to service compared to a third party service contract as an example. But the returns I would say are consistent -- they are consistent with the spread guidance that Somsak gave for our FFELP portfolio in his remarks.

[Operator Instructions] Your next question comes from the line of Sanjay Sakhrani with KBW. Your line is open.

Hi, thanks. This is actually Steven Kwok filling in for Sanjay. Just quick question around the guidance as well. Does the guidance include any debt repurchase gains?

No. They do not.

Okay. And then in terms of when we look at it from the service side, you mentioned about the opportunities for a larger piece of the Department of Education contract and third party contracts. Can you drill down little bit more in terms of other opportunities out there? How should we think about that going forward?

Yes. So each year the department of Ed increase is really coming from two things. It is coming from the loans that were added in the last calendar year, having the full year impact on our -- on the revenue stream, more of those loans in repayment which we get paid higher fees, there is cost associated with servicing those loans. And then each year the department uses their score card mechanism to reallocate the volume and based on our scores for the last measurement period, we increased our allocation share to 24% of new placements for the upcoming year. So those are the big drivers.

Got it. Are there other opportunities outside of the Department of Education?

Yes. So we do believe that there are opportunities to continue to take on third party servicing roles for other holders of loans, we are seeing more inquiries on that space. And winning some contracts in those areas as well.

Got it, got it. And then just finally on the expense side. In terms of given the puts and takes with regards to the one time cost like how should we think about it on a normalized basis going forward?

Sure. I mean exclusive of the incremental cost, the servicing costs were-- yes, I just talked about the $4 million of cost we incurred in the fourth quarter. I think we've been running about $800 million annually and given the increased compliant cost and as well as the fact that we are going to be increasing our loan service I think outside of the incremental cost, I alluded to an $800 million run rate probably appropriate going forward.

Your next question comes from the line of Alan Straus of Schroders. Your line is open.

Hi. I am just curious what tax rate you guys assuming for the year? And second question is on the private student loan side. Do you see any chance of acquisitions? Is it something you are interested in besides from Sallie?

Hey, Alan. The tax rate we expect to have is 37% for both 2014 and 2015.

And on the private acquisition front, yes, we are definitely interested in acquiring portfolios in that area. And we do see opportunities and are pursuing them for acquisitions outside of Sallie Mae Bank. They are much smaller than the FFELP side but the returns, yes; you can see from the margin that Somsak provided in his open remarks are four times what they are in the FFELP space. So those are -- those can be very attractive opportunities. And we deliver a lot of value when we acquire them because of our servicing capabilities. We are very good at helping customers understand their payment obligations and find payment solution that they can afford. Our programs, there have been out and have really led the industry in that side and we see it in our default performance.

And just a follow up. What's the stumbling block that there have been so few acquisitions? Is it all priced or is it regulatory issues?

I think it is a bit of both, frankly.

What would you need to break through on the regulatory side? Is that just something that can't be overcome because --

No. I think it's just getting people comfortable with the process, and demonstrating what we are doing on that side of the equation and how we are helping customers. I also think that if the loans are third party serviced, the regulatory environment and ownership of the lender over that third party's performance is a growing factor that is driving the interest of banks in particular to sell. And so when you look at on the FFELP side, that's a very significant factor. I got to oversee a third party vendor as if it is my own an internal shop, for a business that I am not in any longer. I think that's a factor that's driving the desire to sell. It is true of both federal and private.

Your next question comes from Connor Pickett. Your line is open.

Hi, thank you. Could you confirm that you are reducing your equity allocation higher to the private student book to 8% from 12% and maybe provide a little more color on that shift?

Yes. So when we look at what the reserve --what the capital levels are for our portfolios, it is driven by a function of what we expect the loss rates to be and then the cap which are covered by reserves and then an estimate for the capital based on a variety of facts. This is based on what kind of funding capabilities we have on those assets. And what percentage of funding we can obtain and what kind of loss rate we might be exposed to above and beyond our expectations. As our private loan portfolio has seasoned and move through substantially move through its peak default period, and as we see a higher percentage of our portfolio covered by life of loan loss reserves and our TDR portfolio. It is moved capital from-- allowed us to basically move from providing coverage to capital through providing it through reserves. And it does allow us to pull our capital rates down in that area.

So then would you expect to reach that 8% on a capitalization basis over a certain period of time or are you going to continue to operate on the excess to that 8% allocation?

We don't like it is appropriate when we were at 12% and that was such an enormous cushion against kind of the potential credit losses that might occur in stress environments. We tended to run closer to those numbers. At 8%, we feel it is more appropriate to make sure that we have flexibility in our capital position, flexibility to acquire portfolios, flexibility to pursue growth opportunities and flexibility to change frankly some of our funding structure. So I think you see the capital that we are running at to be fairly consistent going forward.

Ladies and gentlemen, this concludes the Q&A portion of today's conference. I'll now turn the call back to the presenters for final remarks.

Thank you for joining our conference call today.