Good morning. My name is Ashley and I will be your conference operator today. At this time, I would like to welcome everyone to the Navient Second Quarter 2018 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be question-and-answer session. [Operator Instructions] Thank you. Mr. Joe Fisher, you may begin your conference.

Thank you, Ashley. Good morning and welcome to Navient’s 2018 second quarter earnings call. With me today are Jack Remondi, our CEO and Chris Lown, 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-K 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 second quarter 2018 supplemental earnings disclosure. This is posted on the Investors page at navient.com. Thank you. And now, I will turn the call over to Jack.

Thanks, Joe. Good morning, everyone, and thank you for joining us today. Before I provide my comments on this quarter’s positive results, I’d like to provide an update on the regulatory political issues. We are approaching the fifth anniversary since the CFPB served its first civil investigated demand on the company. This process has been backwards from the start. It began with the conclusion that the problems student loan borrowers were experiencing were caused by improper servicing then they looked for examples. However, the ongoing search for evidence to support this claim continues to come up empty handed. The bureau is now requesting yet another extension to continue its search. Five years and no evidence, it’s time for this case to be dismissed. These regulatory cases do not address the real issues facing federal student loan borrowers. High-cost, lack of financial planning, resources, program complexity and low graduation rates are the issues that need to be addressed. We have long advocated for changes to address these issues. And today, we published a letter that lays out the issues and advances five recommendations that would improve outcomes for borrowers. This letter is available at news.navient.com. Let’s turn to something positive, our financial results. Our results this quarter were particularly strong across the board. On a consolidated basis, we generated adjusted core earnings of $0.52. Earnings were driven by stable margins, strong refi originations, continued improvement in private credit portfolio performance and lower operating expense. In our federal loan segment, we continue to deliver stable student loan spreads, even in a rising rate environment. We also delivered greater efficiency in our funding and operating expense. This quarter’s results did include a higher provision for risk-sharing as a result of several factors, including the numerous natural disasters last year. As a result, this…

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 second quarter results for 2018. I will be referencing the earnings call presentation, which can be found on the company’s website in the Investors section. Starting on Slide 3, adjusted core EPS was $0.52 in the second quarter versus $0.44 from a year ago. This brings our year-to-date adjusted core EPS to $0.95. As a result of our solid performance during the first half of the year, we are updating our full year EPS guidance to $1.90 to $1.95, excluding restructuring and regulatory related expenses. A few key highlights from the quarter include better than expected private education performance, continued focus on cost rationalization, robust loan origination growth and business processing fee revenue growth of 23%. Let’s now move into the segment reporting, beginning with Federal Education Loans on Slide 4. Core earnings were $148 million for the second quarter versus $138 million in the second quarter of 2017. Primarily as a result of the elevated use of disaster forbearance at the end of 2017, we expect to see temporarily higher charge-offs in the next several quarters. The provision for FFELP loans in this quarter therefore increased to $40 million from $10 million in the prior and year ago quarter. This increased provision captures the expected increase in charge-offs, and we expect that FFELP provision for the second half of the year to be back in the $10 million range per quarter. In addition, on the expense side, we saw the reversal of reserve, which reduced expenses by $40 million in the quarter. The net interest margin for the second quarter was 82 basis points compared to 81 basis points in the year ago quarter. We…

[Operator Instructions] And your first question comes from Michael Tarkan with Compass Point.

Thanks for taking my question. Appreciate the commentary on the storm as it relates to FFELP versus private. But as we think about the private side, can you just talk a little bit about the trajectory there sort of delinquencies and ultimately how we should think about reserves over the next 12 to 18 months as you mix more towards Earnest? Thanks.

It’s a good question. On the private side, I think, we feel very comfortable and confident that provisions that we have to-date, and so from that perspective, there is no change from our previous guidance and how we thought about that business. Obviously, the Earnest portfolio is performing incredibly well. You can see some of those statistics in our earnings presentation, and so, again, don’t see a meaningful shift from what you’ve seen historically on the private side.

Okay. And then, I know it’s early, but in terms of CECL and new accounting rules coming on, I’m just kind of curious if you have an update there on that front?

So we’re still doing work on the impact of CECL and we will provide additional information, but we are still early days on the analysis and the work and implementation of that standard.

I’ll just point out that we do have a much longer loss forecast window than most consumer lenders at two years. And our conservative designation of accounts and a TDR status, which is a life of loan reserve mechanism is a relative high percentage of our total portfolio.

Yes, makes sense. And last one from me, on the collection side, relating to the Department of Education. And I know the situation is fairly fluid, but how should we think about potential revenues associated with that big step up in inventory that you just got and maybe as it relates to the potential for more volume given some recent court cases? Thank you.

So this has been – fluid is a good word for this. I would say, it’s been highly volatile ping-pong match, I would say, with things going back and forth through the court process. Right now as it stands, the department, we understand, has been calling back placements from other agencies, but no new placements have been made. Our revenue stream on the collections-related activity is really driven by successfully enrolling customers and a loan rehabilitation process. And we get paid at the end of that process, which is typically 10 to 12 months after a payment pattern is initiated. So there’s – any new placements that would occur in 2018 will have minimal impact in 2018’s results.

Thank you.

Your next question comes from Terry Ma with Barclays.

Hey, good morning. So you guys are on pace for over $2 billion in refi loans for the year. Can you just talk about what’s driving upside to your initial guidance? Is it more from the expansion of the total refi market annually or you’re just taking more share?

So, we don’t have a pure insight into total volume that’s occurring nationally, but we believe our strategies of how we are targeting and marketing the product, primarily through digital, the digital means and our ability to decision and fund loans relatively quickly is what’s allowing us to grow our volume faster than what we think the market is growing at. So we would say we’re taking market share. Our insights here are really a huge advantage for us in addition to the digital strategies that we deploy, is our insights into loan performance. And as Chris mentioned, the credit performance of the refi business has been exceptionally strong and much better than kind of the way we would model it live to date. So we’re very happy with what we are seeing so far.

Got it. So credit has been tracking better for refi. Are your acquisition costs also tracking in line with expectations? Can you talk a little bit more about that?

Yes. Our CTAs, cost to acquire has been also slightly better than planned. And as I said, our competition competes in the space in multiple ways. Many players are large, direct mail operations. We rely, principally on digital strategies to drive volume and that has a much lower cost associated with it. And we believe it’s much more effective.

Got it, that’s helpful. That’s it from me. Thanks.

Thank you.

Your next question comes from Sanjay Sakhrani with KBW.

Thanks. Good morning. My first question is the confidence level that disaster forbearance impact is behind us. Maybe you could explain the timing of why it happened this specific quarter? And how we should think about the impact going forward? Thanks.

Yes. So there were a number of disaster forbearances and these are disaster zones declared by the federal government in 2017. And by design of the federal loan program, any borrower who is delinquent in that status, we place into a mandatory forbearance. So these are not voluntary positions. If you become delinquent, the department requests us to put them into a mandatory forbearance. As those customers exit those forbearance statuses, we then begin to see the entry rates of accounts into delinquent statuses and then resolution rates. And so your ability to predict what will likely be higher loss rates or default rates on that portfolio really don’t show up until the customers exit those statuses. As we begin to see them, I think, we’ve taken a very conservative position as to what we expect will happen here based on entry rates and resolution rates. It all happens at once. So you see it all at the same kind of timeframe here for the most part in our two-year loss window says to us that this one-time $30 million increase in the provision is enough to cover all expected losses as a result of the disaster forb. Interestingly, we’re not saying the same kind of performance in the private loan side equation. It shouldn’t be a huge surprise. The customers are different in those segments; one’s a credit underwritten loans, the other is not. And the private loan performance continues to be year-to-date is significantly better than we projected.

And I think that Jack’s point is important to just remember back that third quarter, fourth quarter and first quarter, we had rolling natural disasters, whether it was Florida, Texas, Puerto Rico and then California, with the mudslides and the wildfires. I mean, it just was a rolling natural disaster that we were monitoring very closely and we were watching come through.

Okay. And then my second question on the capital management planning process going forward and I guess I’m more thinking about next year, one weighing items like the growth in the consolidation loans in school potentially and CECL. Could you just talk about how we should think about capital management into next year? I know you talked about the share repurchase authorization for the remainder of the year, but maybe we could think a little bit ahead. Thanks.

So I think that thinking into 2019, the guidance we have given, we still haven’t clearly formulated it but I would – it would be highly likely that you’re talking about a range still on the 1.23x to 1.25x. That range in our views taking into consideration a number of factors, which includes potential impact of CECL originations, buyback capital management. And so I think, thinking in your capital analysis of that 1.23x to 1.25x for next year is important but still a little uncertain how the regulators and also the rating agencies are going to manage the impact of CECL. And so we’re in dialogue and following that closely, but there is still – it is still not clear exactly how they’re going to treat that.

So should we see a pickup in the pace of share repurchases then?

Versus what?

Versus this year?

I think clearly, if you look at – if you do a capital analysis of what’s freed up, what our capital uses are, there clearly should be room to have a pickup. Again, we haven’t made up a determination yet, but the capital allocation analysis would suggest that.

Okay, great. Thanks.

Your next question comes from Moshe Orenbuch with Credit Suisse.

Great, thanks. Kind of following up on that question, you’ve been able to reduce the debt footprint this quarter. Is that something that can go on over the next few quarters to 2019 and 2020? Because I think that’s going to be a significant factor in terms of maintaining that TNA ratio.

So that’s a great question. We are consistently looking in the open market to repurchase debt. Obviously, we do the analysis of what’s buying that debt in the open market is versus a make-whole call versus waiting to maturity. But where there are opportunities to acquire debt in the open market in the 2019s and the 2020s, we do so and – when it’s an advantage versus a make-whole call. So there are opportunities, but I’ll tell you, the closer you get to the maturity date, the more robust in sellers are at that better value. But we do continue to monitor that and we have a very active dialogue with investment banks around what maybe in the market.

Great. And kind of on a slightly different vein, you mentioned in the opening remarks the idea of switching to a more variable cost call for servicing. I was hoping maybe you could flesh that out a little more, what are other opportunities that could give you both from the standpoint of potentially doing other things and in terms of reducing costs?

So our focus has, I think, if you look at the history of our company, we’ve always been very focused on the expense side of the equation and running a very efficient, effective organization. When we look at our cost ratios compared to our peers, it was – we clearly outperformed. One of the – you are pointing to one particular structure, which is that, when we had, we build our platform, our platform benefited tremendously from growth in the number of assets or accounts that we serviced. And so, as we look at our business today, in where we sit with our FFELP business declining where we sit with the Department of Education recompete bid and kind of what they’re trying to achieve. We really saw two things that we were trying to – two main things we were trying to pursue with this deal. One is, it was clearly a call and a demand for a neutral platform that could be shared by multiple parties and not be viewed as something that would impact a competitor in that side of the equation. They were looking for something that was very robust and efficient and scalable, clearly what our platform is capable of. And by putting it into that neutral position, we think we have positioned that platform to be more attractive for long-term solutions. The second thing we were trying to achieve is what Chris and I mentioned in our comments is converting our cost from fixed to variable. And so, our fee structure is now on a like a Software-as-a-Service type of structure, we are paying on a per unit measure. And so as our volume goes up and down, our costs are now much more variable than it would be if we were maintaining a large mainframe servicing platform for our own use.

Great, thanks.

[Operator Instructions] And your next question comes from Mark Hammond with Bank of America.

Thank you. Hi, Jack, Chris and Joe. I had a question on funding. So I’m looking at what’s coming due on the unsecured and there is 1.2 of unsecured bonds coming due in Jan 2019. And so I was thinking with that in mind, can you give the approximate capacity that’s left that you could do for that private education loan repurchase facilities for the overcollateralization? Is there any capacity left there?

In the Turbo facilities today where there isn’t capacity obviously, everyday that goes by that a capacity starts to increase, but we have for the moment, maximized that opportunity. But we obviously have numerous liquidity sources, cash on hand. We obviously have a huge unencumbered balance of both FFELP and private loans. We have other financing arrangements as well as the unsecured market, which, as I mentioned before, we tapped last month. So I think, we really feel confident about 2019 and 2020 and it’s more about optimizing the cost of that refinancing effort versus raising the liquidity.

All right.

Mark, you’re pointing out here to that I mean, this is the single largest expense within the company. And we are very focused on the different tools that we have, access points that we have available to us and not just provide liquidity, but to drive down our overall interest expense. And we’ve been successful at this year and we expect to continue to put our full focus on that for the balance of 2018 and beyond.

Understood. Thanks. And then on the reserve release this quarter and more of a bookkeeping thing, what revenue stream was that tied to for the release there?

This was a deferred revenue component that we had reserved for on a contingency basis to service – for services we no longer provide. And as a result of that, we were able to release the reserve.

Got it. And is there anything similar to this on the horizon that I should be looking for? Or is this more of just a one time and move on?

It was a one time and it just came through this quarter.

All right. Thanks for taking my questions.

Sure. Thanks.

Your next question comes from Henry Coffey with Wedbush.

Good morning, everyone. And thanks for all the detail on this. When we look at the First Data contract, should we assume – just really two questions. One, should we assume essentially they’re your sub-servicer, but you still have – like as would be the case in the mortgage business, you still have sort of the financial implications of holding onto that servicing? And secondly, looking at the Department of Ed, I know we should be hearing something soon, assuming that “you won everything and your servicing balances doubled or you lost everything and it went away,” what would be the financial implications for you of either of those outcomes, given that you have this new sort of variable cost model?

So on the First structure, we are basically using, First Data provides a technology service to us of the account record and effectively the accounting system for our loan servicing. All of the servicing work including back-office processing, customer service activity, customer outreach, default prevention are things that we continue to perform. So we’re effectively, as I said it’s like a Software-as-a-Service agreement. We’re licensing that platform to use on behalf of the accounts that we service. The Department of Education RP has been – the decisions there have been delayed due to a big protest, which we expect to be resolved sometime in September. What the timing is for a decision after that is a TBD. We don’t quite know. What the department’s RP design provides for here is they are looking to segment the different components of loan servicing. So they’re looking for a technology platform, they’re looking to have a single brand that all customer accounts would be effectively serviced by the department –or be known as the Department of Education. And then have multiple parties that would provide back-office customer service related issues. We think that brings – bring about significant cost efficiencies. We think it can address uniformity in terms of servicing and eliminate some customer confusion. We get, for example, a fair number of customers think we own the loan and therefore set the interest rate and all the policies associated with that. We even have some regulators who think that – our job is we manage the loans on behalf of the terms and conditions that Congress and the Department of Education set. So we like what we see in that RP and hopefully, we will get decisions quickly here.

So with a single brand, if I’m mad at my servicer, I’ll be throwing darts at the Department of ED, not at Navient?

It would be – so that would be correct. Your account would be owned by the department and you would know your account would be owned by the Department of ED.

And I would blame them for all my woes?

Well, service and responsibility, doing a good job for a customer would still be held to the servicer and no one would ever be relieved of that obligation. And we’re not looking to be relieved of that obligation. But when you owe money to a party, you owe it to the lender. You don’t owe it to the servicer. When the interest rate is set on the loan, the interest rate is set by the lender, not by the servicer. If you are worried about loan forgiveness opportunities or get discharged, those are terms that are set by the lender, not by the servicer. Those are the things that would be properly belong at the lender level.

So the situation with the CFPB, everything rings true to us in terms of what the mortgage industry went through and it’s the same deal that Fannie Mae is the one who determine the outcomes, but everybody would demonize the banks. But it was an identical situation. So one of the things that came out of the CFPB is when you had the stand-in Director, who’s from South Carolina. One of the first things he did was he immediately kind of backed off and all their punitive action against the small loan and payday loan industry, all of which are heavily concentrated in South Carolina. Is it some natural evolution of your case with the CFPB where it finally gets to the very top level of the organization and then the director finally rules or because there is a court case, is there something that just kind of drags on until the court sort of either rule or everybody decides to let it go?

I can’t speak to how the CFPB will manage the caseload and the issues that are in front of them. I can speak to our particular case as it relates to the court process. As I said, this has been somewhat of a backwards process. They issued their conclusion before they began their research. And since that conclusion five years ago, they’ve been in search of evidence to support what they believe to be true. They have found nothing. And there is no evidence to-date to support their case. I mean, these are in the court filings. They have not presented any customer accounts that are consistent with their claims. The big frustration for us is that in a civil legal matter like this, we do not have a right to a speedy trial. So here we are two years into the legal process and we probably won’t see the inside of a courtroom if this thing goes to trial for another two years. And so our arguments here are, you had five years to look your evidence, you found none. It’s time to move on.

Well stated. It does not seem that any of this, except with the fact that it is a very time-consuming and expensive, it hasn’t impacted your – with the Department of ED?

No. We have a very good relationship with the Department of Ed. I think the things that stand out for us is that we deliver on the service levels for them. Our customer performance leads the industry. We have the highest levels of enrollment and income-driven repayment plans. We have the lowest levels of severe delinquency and our customers, if you’re serviced by Navient, are 37% less likely to default. If every other servicer met our standard, 300,000 fewer defaults would have occurred last year.

Great. Thank you very much for your comments.

You’re welcome.

Your next question comes from Mike Del Grosso with Jefferies.

Good morning. Most of my questions have been asked and answered. I guess, higher level one though on the private student loan refi market, can you briefly comment about some of the characteristics of those originations, any noteworthy descriptors or borrower characteristics? Or would you say it’s generally a fairly broad-based cross-section of the student loan market?

No, it is not broad-based, the federal student loan marketplace and these products, the refi product is designed for customers who have completed their education, had joined – had successfully entered the workplace and had demonstrated a successful career record over a number of years. So these are borrowers who have been in repayment for a number of years and have been successful at making payments. It’s designed for customers who can manage that have substantial cash flow, to be able to manage their monthly payments, don’t need some of the flexible repayment programs that are available on the federal loan side of the equation and are looking to pay off their loans faster and save thousands, in many cases, tens of thousands of dollars of interest over the remaining life of their loans. So it is a segment of the total of $1.4 trillion of outstanding debt that would qualify for this product.

And you can get a pretty good handle on the market too. If you look at the myriad of securitization documents, will give you breakdowns of customer type, graduate, undergraduate, FICO bands, et cetera. So you actually pretty quickly determine what this universe is.

Okay, thank you.

Your next question comes from Arren Cyganovich with Citi.

Thanks. Just on the consumer lending net interest margin, I think, guidance was for 325 for the full year. It has been declining through the first half of the year. I think you said that there was couple of rate hikes that will be helping that. I haven’t really noticed that being particularly sensitive to rate hikes. Can you talk about what’s driving the expected increase there?

There are some financing costs benefits, which we expect to see come through in the second half of the year. And so again, we feel pretty comfortable with our 325 guidance. Obviously, in the first, second quarter, you did see it lower than that guidance but our expectation is to have in that area for the full year.

Okay, thank you.

Your next question comes from Ashish Nair with Citi.

Hi guys. Thank you for taking my question. I just had one quick one. In the past, you viewed yourself as a BB company. I don’t know how much you can say but I’m curious, is that the view shared by your new investors? And have you had discussions with them on how you get there in near-term in terms of debt pay down versus investment in your – on the private side, growth in the private side and the servicing business?

Well, I’d say we are a BB company today. I mean the reality is two of three rating agencies have us in that zip code and one doesn’t. Our expectation is the issues around our ratings are not related to capital liquidity that really related to the exogenous events that are currently around the company, including the CFPB lawsuit and the debt maturities in 2019 and 2020. We obviously feel very comfortable with being able to manage these maturities in 2019 and 2020. We remain hopeful that we can resolve our issues with the CFPB. And so, again, if those pressures were to ease, we clearly would be back from a rating agency perspective in the BB area because those are the primary concerns that they’ve highlighted to us.

Got it. And I know I read that you hedged – your portfolio is hedged for the next five years. How much of your portfolio is hedged? Could you remind us?

I’m sorry, say that again?

In your press release, it said that your portfolio is hedged to the next five years on the rate side.

Are you talking about our floor income or ones-threes exposure?

No, floor income.

Yes. Our floor income is hedged for the next four years 90%-plus. There is obviously still some additional value we can derive from it, but it was clearly prudent to hedge a lot of that exposure given the rising rate environment. And we do provide some disclosure of yearly floor income, but again that 90% number is what we’ve done for the next four years.

Got it. Thank you.

There are no further questions at this time. I would now turn the call back over to Joe Fisher for closing remarks.

Thank you, Ashley. I would like to thank everyone for joining us on today’s call. If you have any other follow-up questions, feel free to contact me directly. This concludes today’s call.

That concludes today’s conference. Thank you for your participation. You may now disconnect.