Navient Corporation (NAVI) Q4 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, my name is Lance, and I will be your operator for today’s conference. At this time, I would like to welcome everyone to the Navient Fourth Quarter 2018 Earnings Call. All lines have been placed on a listen-only mode to prevent any background noise. Later, there will be a question-and-answer session. [Operator Instructions] I would like to turn the call over to Joe Fisher. You may begin.

Thank you, Lance. Good morning. And welcome to Navient’s 2018 fourth 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 fourth 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, and for your interest in Navient. Our fourth quarter results capped a strong year. Our adjusted core earnings per share of $0.58 brings our full year earnings per share to $2.09. Our 2018 results demonstrate that we have the expertise, systems and data driven strategies to create value by maximizing cash flows, originating high quality loans, growing our fee revenue and improving operating efficiency. Our actions also demonstrate our commitment to manage capital appropriately by maintaining a strong balance sheet, supporting our loan origination opportunities and returning significant capital to shareholders. This commitment and focus on creating value produce meaningful contributions in 2018 from all areas of the company, including net interest margins, student loan additions, portfolio performance, fee revenue growth, operating efficiency and capital management. For example, the net interest margin in our federal and consumer loan segments benefited from our efforts to lower our overall funding costs, we executed on solutions that raise funds at lower rates, refinanced existing facilities and reduced our need to issue unsecured debt. We developed and implemented successful hedging strategies for our one-month, three-month LIBOR exposure. We improved our return on temporary cash positions and we retired or repurchased $3 billion in high cost unsecured debt. During 2018, we originated or acquired over $3.6 billion in student loans. This includes 2.8 billion in refi loans. In the last three years, we have added nearly $20 billion in student loans to our portfolio. Our ability to successfully generate new refi loans demonstrates the strength of our earnest origination platform, combined with our operational expertise and funding capabilities. Importantly, we were able to steadily improve the net interest margin of new refi loans, achieving the highest margins of the year in the fourth quarter. Credit trends in our FFELP and Private Loan portfolios continued to improve, the strong jobs market in our innovative data driven customer focused strategies had led to lower charge-offs and improving delinquency rates. For example, Private Loan charge-offs declined 16% to 1.7% rate and our FFELP portfolio of 90-day plus delinquency rates are at the lowest levels in over 10 years. In our Business Processing segment, fee revenue increased 26% to $267 million in 2018 and we delivered 20% organic growth in both our Government Services and Healthcare businesses. Total revenues also benefited from the full year contribution of our 2017 acquisition of Duncan solutions. Our EBITDA margins in this segment also improved increasing over 30% to 17% in 2018. We continue to leverage our skills and workflow processing, account resolution and data driven strategies to deliver value to our over 600 clients in these markets. We are always developing new strategies and solutions to improve operating efficiency and customer experience, 2018 was another year where we delivered on these goals. On an apples-to-apples basis, operating expenses declined 11% to $819 million. We also rolled out a new website for our student loan customers and launched a digital process for income driven repayment application. This all digital application flow greatly benefits our FFELP customers by dramatically simplifying a very complex process. It’s a prime example of how we continue to automate and innovate processes that benefit all stakeholders. Finally, our goals in 2018 included strengthening our capital ratios, while continuing to return capital to our investors. We did both. Our TNA ratio improved to 1.25 times from 1.20 a year ago. We paid dividends of $166 million and repurchased $17.4 million shares or 7% of shares outstanding. While we have taken a brief moment to celebrate 2018 results, we are now clearly focused on 2019. We expect to deliver stable margins in our student loan portfolios by focusing on both the yield and reducing funding costs. Our goal is to add over $4 billion in student loans, including a billion dollars of FFELP and at least $3 billion in refi loans. Demand for our Refi product remains strong with January shaping up to be our best month ever. We will also benefit from the end of restrictions on who we can market to. We continue to believe, we can generate double digit ROE’s from this low risk product. Later this year, we planned to launch a new in-school loan product. Our capabilities and insights give us an opportunity to develop a highly competitive offering that promotes responsible borrowing and meets an important need for many families. The in-school lending market is an attractive opportunity for us. We have the infrastructure, credit expertise and unique marketing insights that will generate assets that we believe can deliver mid-to-high teens returns on equity. Our target this year is modest. It is to disperse at least $150 in 2019. I am excited about leveraging our skills and infrastructure to generate attractive low risk assets and to deliver value from our refi and in-school lending products. We also expect to see strong credit performance in both our FFELP and consumer loan portfolios, and we are starting the year off in a strong position and expect these positive performance trends to continue. Our ongoing efforts to improve our operating efficiency will deliver results again in 2019. We continue to develop and implement new automation tools, and deliver simpler solution tools to our customers. Even with growth in our business process, servicing and new loan origination segments, our total adjusted operating expense will decline again in 2019. Finally, our strong starting capital position and cash flow generation will allow us to return nearly $600 million to shareholders through dividends and share repurchases. Though only three weeks into the year, we are off to a strong start and are excited about the ability to deliver value for our customers and our investors. I look forward to your questions later in the call. Now let me turn the call over to Chris for a more detailed review of 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 fourth quarter and full year results for 2018. I will be referencing the earnings call presentation, which can be found on the company’s website in the Investor section. Starting on slide three. Adjusted core CPS was $0.58 in the fourth quarter versus $0.43 from the year ago quarter. For the full year adjusted core EPS was $2.09. A few key highlights from the quarter include refinance loan originations of $769 million, improving credit quality and lower adjusted operating expenses. In addition, we benefited from a lower effective tax rate of 19% in that quarter and then $18 million gain from the repurchase of $1.4 billion of unsecured debt. For 2019, we are providing additional transparency on the key targets and metrics we use to measure the success for the company and its business units. These metrics and targets are highlighted on slide four. As the portfolio of federal education and legacy private education loans continues to amortize, we remain focused on managing our net interest margins across the portfolio and reducing charge-offs to maximize cash flows. With regard to our fee-based businesses, improving our EBITDA margins and generating organic growth opportunities are key measures of success. Contributions from these segments coupled with our nascent loan origination businesses, the end of our non-compete with Sallie Mae should generate attractive mid teens ROE’s for the company. In addition, we remain committed to our tangible net asset ratio range of 1.23 times to 1.25 times and ensuring that excess capital is returned to shareholders. As mentioned on the previous slide, we are laser focused on maximizing the cash flows from our education loan portfolios. As can be seen on slide five, we generated an additional 6 billion of cash flows between 2014 and 2016 versus our original projections at separation from Sallie Mae. These cash flows are generated primarily through enhanced financing activities and education loan acquisitions. Our updated cash flow projections can be found in the appendix of this presentation and do not include the benefits of future loan originations or acquisitions. Let’s move on to segment reporting beginning with the Federal Education Loans on slide six. Core earnings were $147 million for the fourth quarter and $580 million for the full year. The provision for FFELP loans declined 17% from the year ago quarter. This is consistent with our expectations, as the delinquency rates have significantly declined from a year ago. The net interest margin for the fourth quarter was 86 basis points and our full year net interest margin of 83 basis points ended the year at the high end of our guidance. This positive trend was a result of numerous proactive financing transactions we executed throughout the year. Contingency collections inventory increased by over $13 billion from the prior year. This increase contributed to the 21% growth in asset recovery revenue from the third quarter. Now let’s turn to slide seven and our Consumer Lending segment. Core earnings in this segment were $66 million for the quarter and $252 million for the full year. During the quarter, we originated $769 million of Education Refinance Loans and $2.8 billion for all of 2018. We continued to see healthy demand and strong credit performance in this product, and we have continued to increase our average coupon rate on new originations. We are excited about the additional opportunities to expand our product in 2019 and expect at least $3 billion of refi originations. The full year consumer lending net interest margin was 324 basis points, in line with our expectations. Our financing and operational initiatives have resulted in improving net interest margins on both our legacy and newly originated refinance loan products. At year end education refinance loans represented 14% or $3.2 billion of our Consumer Lending portfolio, compared to 3% or $761 million a year ago. Our NIM guidance of 3.1% to 3.2% for 2019 is a result of the shifting mix of our portfolio towards the higher quality refinance loans. Let’s continue to slide eight to review our Business Processing segment. Fee revenues on the segment grew 10% from the year ago quarter, with EBITDA margins improving by 50%. The 26% increase from the prior year, contingent collections inventory is primarily a result of increased placements from federal and local government services contracts. In 2019, we expect full year revenue of at least $270 million, with EBITDA margins in the high-teens. While we anticipate high-teens revenue growth in our Healthcare segment, the loss of the previously discussed tolling contract will mitigate overall growth in this segment in 2019. Let’s turn to slide nine to provide additional color on our continued focus on expenses. For the full year, our ongoing operating expense initiatives resulted in an 11% decline in adjusted operating expenses, exceeding the decline in the average balance of our total education loan portfolio. For 2019, we expect operating expenses, excluding regulatory restructuring costs of between $940 million and $960 million, which is a 5% year-over-year decline, when excluding the one-time non-cash impact of the contingency reserve release in the second quarter of 2018. Let’s turn to slide 10, which highlights our financing activity. During the quarter, the company repurchased $10.6 million shares for $125 million and we have $440 million of remaining authority under our share repurchase program. Importantly, we did this while increasing our tangible net asset ratio to 1.25 times. For 2019, we expect to continue to operate within a 1.23 times to 1.25 times TNA ratio range. In the fourth quarter, we actively repurchased $1.4 billion of our unsecured debt to make calls [ph] and open market transactions. As a result of these actions, we were able to reduce our 2019 maturities by $1.3 billion, while also taking advantage of the recent market dislocation to realize the core earnings gain of $18 million in the quarter. In the quarter, we issued two private education loan ABS transactions totaling $1.3 billion. For the full year, we issued $3 billion of private education loan ABS, compared to $662 million for all of 2017. Before turning to GAAP results, I’d like to recap our full year 2019 guidance on slide 11, which excludes expenses associated with regulatory costs and restructuring expenses. In 2019, we expect core earnings per share between the $1.93 and $2.03, operating expenses between $940 million and $960 million, full year FFELP net interest margin in the low to mid 80s, full year private education loan and interest margin between 310 basis points and 320 basis points, full year private education refinance loan originations of at least $3 billion and full year business processing revenue of at least $270 million, with expected EBITDA margins in the high-teens. Let’s turn to GAAP results on slide 12. We recorded fourth quarter GAAP net income of $72 million or $0.28 per share, compared with a net loss of $84 million or a loss of $0.32 per share in the fourth quarter of 2017. The primary differences between core earnings and GAAP results are the marks related to our derivative position. In summary, in 2018 we meaningfully reduced operating expenses across the company, successfully executed on our earnest business plan, developed and executed multiple financing transactions, bolstered our capital position and returned nearly $400 million in capital to shareholders. In addition, we are well-positioned to execute on our 2019 plans and look forward to another successful year. I will now open the calls for questions.

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

Thanks. Good morning. I guess, my first question is on the in-school origination channel, obviously, you guys put some targets out there. Could you just talk about what the driving factors are, whether would come in in-line weaker or more. I guess, Jack you have talked, historically, about, there might be other avenues through third-parties to actually accelerate the growth there. What kind of discussions have you had so far?

So, our -- first of all, we view this market as an attractive opportunity for us based on our expertise in this particular area and really the strong insights and data that we bring from servicing loans for so long. I also think there’s an opportunity for us to really differentiate our products in a marketplace that really hasn’t seen a whole lot of change or innovation in the last 10 years. Our focus is a direct to consumer approach through the school channels. So it is marketing the product similar to the way we do our refi products, which is a digital first approach. And $150 million represents origination volume that is just the first half of the disbursements that would typically take place in an academic year cycle. So full academic year originations booked and processed in 2019 would total about $300 million.

Okay. And do you think that there’s room to do better on that number and what might accelerate that?

Well, certainly, if you look at the market opportunities here, our focus will be on first time borrowers. So we expect that many borrower -- many students and families who have borrowed previously in the private education marketplace will return to their existing lender. But these are, as I said, I think, these are modest expectations and we would certainly work hard to beat them in any way we can.

Okay. And just one follow-up on the refi product, obviously, you guys had a very strong year this year and you are expecting more of the same. Could you just talk about where the opportunities lie going forward? Is that part -- is part of the optimism there, just as a result of the non-compete ending or is there opportunities without that even to hit those targets? Thanks.

So, I -- it’s a good question and I think the opportunities here really come from a couple of different sources. One is expect graduate school students who have been borrowing in the Grad PLUS marketplace are generally paying still or paying relatively high interest rates and there’s an opportunity for them based on the progression that they have experienced in the job market and their income levels to materially reduce the interest rate that they pay on their loans. That’s still represents an opportunity for us as more recent graduates move into that very, very strong credit quality perspective. And certainly on the private education loan side of the equation refinancing those loans is also an -- effectively an expanding opportunity for us in 2019 as the non-compete expired on January 1st, so it’s really a combination of the two markets.

Thank you.

You are welcome.

Your next question comes from the line of Michael Tarkan from Compass Point. Your line is open.

Thanks for taking my questions. Just on the credit side on -- in Private. Thanks for the color around the charge-off guidance. I am just kind of curious if you can touch on how you think about reserves as you are continuing to mix towards earnest? And maybe if you can unpack sort of how to think about reserves on the legacy portfolio versus earnest, versus what you are going to be reserving for on the in-school product?

So which -- we are seeing very strong trends in credit performance really across the Board, but particularly strong performance in the refi portfolio. Our credit losses continue to come in below the guidance levels that we have provided in the past and on our legacy portfolio you have got -- the non-TDR segment of the portfolio credit losses are continuing to push into new historic lows and that’s really a function of the -- seasoning of the portfolio and then, of course, a very strong economy. The outperformance that we continue to see is really coming though from the TDR portfolio. These are borrowers who have experienced some difficulty in the past. As you know, we are reserved for the full life of the loan, loss expectations there, but credit performance has been particularly strong really as we have been able to continue to find innovative solutions to make sure that we are able to connect with these customers and work with them to find solutions that make loan payments affordable and manageable for them. And I think that -- the biggest contrast I would put here in this portfolio compared to the Federal Loan programs is that we work to make sure that consumers are still amortizing their loan balance. So that they are seeing themselves make progress towards paying down that debt and moving forward. So those are the combination in the drivers there.

Thanks. Just as a follow-up, I mean, as it relates to your reserves as a percentage of loans and repayment. Should we continue to expect that or should we expect that to drift lower in ‘19 and ‘20 as the mix shifts more towards earnest?

Yeah. I think it should -- you should see that on two parts. One the mix shift, obviously, moving towards the higher quality portfolios, and as Jack mentioned, our refi product is performing better than our expectations, which is a great result. But in addition, as these loans are seasoned and amortized, we are seeing better performance as well. Obviously, we are heading into seasonal, not all -- that will change how we manage this on that loan basis, but for 2019 what you said to transpire.

Okay. Thanks. And then last one for me, just back to the in-school product, do you view kind of the competitive environment and where pricing is generally across your competitors. Do you think there’s an opportunity there or I am just kind of curious what the go-to-market strategy is to scale the product a little bit faster?

So we will be launching this a little bit later this year as the 2019, ‘20 academic year cycle begins and I think I’d rather reserve our marketing strategy and approach until we officially launch the product there.

Understood. Thank you.

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

Great. Just, first of all, on the guidance, could you just tell us how much buyback is in -- is kind of in your guidance for 2019?

Well, as I have mentioned, there’s $440 million of remaining authority. That’s all we have in the authority that’s what’s in the -- in our guidance.

In the guidance, great. And I guess, given that you are at your 1.25 TNA ratio, what -- not to sound greedy. But how do we think about the possibility of having more available than that, like, how do you think about that and how do you think about the trade-off between that and some of the asset growth choices that you are making?

I think, Moshe, as you well know, we are all heading into seasonal in a year, we are all trying to make sure that we manage in through that process in a way that is at least disruptive as possible for the business and to capital return and to the markets, and we are all still want to make sure that in that transition we are prepared, there’s still a lot of questions from the rating agencies and from the regulators that we are all still trying to determine. And so, historically, I have talked about the 1.23 times to 1.25 times range, I have probably talked about wanting to be at the top end of that. I think about the amount of capital return we are going to have in 2019, which as Jack mentioned, nearly $600 million plus, hopefully, being able to transition through a seasonal in a way that is least impactful. So, obviously, if there is an opportunity where we find ourselves in an excess capital position or generate excess cash then we would, as we have committed to return that excess capital to shareholders. But I think we have a pretty strong plan in place now with a lot of transparency that should give some pretty good guidance. And as you think about capital allocation that you talked about, I think, the new products versus what we are doing. Again, I think, what we are trying to do is manage that capital allocation process. We still believe that at scale the refi business and the in-school business is a low-to-mid-teens plus ROE business and when you think about that from a capital generation -- from a return perspective that’s a pretty compelling opportunity, as well as returning a significant amount of capital to shareholders. So it’s a -- but it’s a great question, that’s what we think about all the time.

Just to follow-up on, I think, Jack made a comment on the refi business is being kind of at the highest margins of the year in the fourth quarter. I guess, I wanted to square that with the securitization data, which kind of showed margins of -- over 2.2% earlier in the year and 1.6% in the December securitization, so that’s kind of down 60 basis points. And now you have got you know key buying lower road [ph]. I guess maybe can you kind of square those things with that expectation?

So margins, what we securitized in the fourth quarter would not have been Q4 originations and there’s a -- in a rising rate environment, our hedging activities effectively don’t show up in the securitization spreads. So when we are hedging those fixed rates that we are offering to consumers, when we go to securitize the benefit of those hedges don’t show up in the cost of funds reported there. But margin pressure, we definitely saw in a rising rate environment, particularly a more rapidly rising rate environment and it’s not, of course, it’s not just what the Fed does, but it’s what the markets are doing. Margins were pressured in the mid part of 2018. We made a concerted effort to focus on improving those, and as I said, we had the highest margins of the year in the fourth quarter.

I am not sure I understand that, maybe we can take it offline. But if there are benefits from hedging that are not in the securitizations, I mean, because usually…

You are locking in…

…some money, yeah.

Well, if you are locking in the rate, if you are making loans and you are offering a fixed rate to a consumer and you are locking that in through a derivative trans -- well, hedging that to a derivative transaction, but not issuing the debt until three months or four months later or two months later, that hedge accounting rules don’t allow you to transfer that hedge over into the securitization cost of funds. We can -- well, we can take it offline now if you don’t understand with more detail [ph].

Thanks.

Your next question comes from the line of Mark Giambrone from Barrow Hanley. Your line is open.

Good morning.

Hi, Mark.

Congratulations on the great quarter and the concise information of what’s going on. Most of my questions have been asked, but one question I did have is for the refinance loans, what is the life of loan there? How long you expect those to stay on the balance sheet?

So the weighted average life of those loans, obviously, terms go well classless, but the weighted average life of these loans is three and a half to four years and so as they cycle through the securitizations that’s our expectation and that’s what we have seen. The speeds have been relatively constant, this is a pretty fast paying off loan and so from a risk return perspective we do think it’s pretty attractive.

Okay. Great. Thanks very much.

Thanks, Mark.

Your next question comes from the line of Mark Hammond from Bank of America High Yields. Your line is open.

Thanks. Hi, Jack, Chris and Joe. I had two quick ones, so far in-school, in-school origination, do your existing private loan facilities except those loans as collateral, I am just trying to get a sense for how you will finance the in-school originations in the near-term as it ramps up?

So we will be structuring new warehouses their facilities today don’t contemplate an in-school loan, it’s obviously a different loan, it’s a different disbursement and different hold. But I can tell you is that there is a lot of banks who are discussing with us about warehouse opportunities. This isn’t an uncommon structure, it is attractive from a financing perspective, so if there is a significant amount of capital out there we are looking to continue to finance assets and are very attracted to this loan as well -- this loan type as well.

Okay. And then, my second loan was regarding the mention of longer dated bonds that Navient repurchased in 4Q. Would you happen to be able to share, which bonds are repurchased. I know the five-year and five-year base [ph] of 2033 are out there, but it’s not the only ones. So I was wondering if you can share?

Right. So we had the opportunity in the dislocation. We were offered a bond that was at a very attractive price and as I think about this from a capital allocation perspective, we look at the term of that bond, as you said it was in the -- it was past 2030. It was a foreign currency bond, which means there was a derivative against it and there is capital against it. And so as I looked at that it was -- we as a team look at what that discount represented from a return perspective versus what our cost to issue a new five-year or seven-year was. What the benefit was to the P&L from that perspective, those are all very attractive, so we decided to retire that foreign currency denominated bond.

Got it. Thank you. Much appreciated.

[Operator Instructions] Your next question comes from the line of Rick Shane from J.P. Morgan. Your line is open.

Hey, guys. Thanks for taking my questions this morning. I just want to go through, I think, you started to touch on it and provide some color in the last response. But from a GAAP basis you reported a $28 million gain on the retirement of the bonds, from a core perspective you reported an $18 million gain. I just want to make sure we understand the difference? And also, if you guys can sort of help us understand why we should think about that gain as a part of core income?

Yeah. The primary difference is there is a difference in accounting for the derivatives and so really it just a derivative issue what you see in our core versus GAAP numbers normally. So it’s just the unwind of that and we can take it offline, I mean, it’s just simple as that.

Got it. And in terms of how to think about this in terms of core income?

The gain.

Yeah. As opposed to, I mean, because again core income suggests recurring and I just want to when we think about the things we add and subtract from core income, want to hear your thoughts on why you’d include this in core?

I mean it falls within our definition of core and net income. I would just go back to that definition and think about it from that perspective. I understand what you are saying, but it – again, from a perspective of definition it falls within it.

We are highlighting it, so investors can see that was a benefit that is not something we expect to repeat in every single quarter. But it’s not a mark-to-market related issue that we exclude on the derivative transactions, for example, under GAAP.

Got it. Okay. That makes sense. That’s a good distinction. Thank you, guys.

There are no questions at the moment. Joe Fisher, please continue.

Thanks, Lance. We’d like to thank everyone for joining us on today’s call. If you have any other follow-up questions feel free to give me a call. This concludes today’s call.

Thank you for joining. This concludes today’s conference call. You may now disconnect.