Navient Corporation (NAVI) Q1 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. And welcome to the Navient First Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Mr. Joe Fisher. Thank you. Please go ahead.

Thank you, Lashana. Good morning, and welcome to Navient's 2020 First 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. For Navient, these factors include, among others, the risks and uncertainties associated with the severity, magnitude, and duration of the COVID-19 pandemic. But the work from home policies and travel restrictions that have been put in place did not negatively affect our ability to close our books and maintain our financial reporting systems, internal controls over financial reporting or disclosure controls and procedures. 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 first quarter 2020 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, Joe. Good morning, everyone. And thank you for joining us today. I hope you and your families are healthy and staying safe. These are challenging times. This morning, we will share the steps we've taken in response to the crisis, review our quarterly results, and discuss the estimates we have made about future financial impacts. Let me start with our response to the COVID-19 crisis. As this crisis evolved, we took early and decisive action to protect the health and safety of our teammates. We expanded our work from home capabilities and implemented best practices and safety and hygiene to protect those who needed to come to the office. We were able to quickly and successfully move 90% of our team to a work-from-home status. As a result, we have thankfully had less than a handful of positive cases among our employees. We've also focused on meeting the needs of our customers and clients. Our team rose to this challenge not only meeting the normal workflow, but rapidly implementing and deploying COVID relief information and options across our businesses. In my call listening, it is clear that the programs we have implemented are providing important relief to our customers, some of whom are on the frontlines. We've also responded to those impacted by the ongoing COVID-19 crisis by deploying hundreds of teammates to assist states in processing the surge of unemployment claims they are receiving. With just a few days to prepare, we were able to respond to incoming calls and provide support. This is a great example of how team Navient is repurposing our skills to help during the crisis. As we prepared our team and our business for the rapidly changing environment, we also thought about how we could help support our communities. Our prior business continuity planning process had included stockpiling a supply of N95 masks. Clearly, these masks met a higher need with the frontline responders in our communities. So, we donated our stockpile of nearly 10,000 masks to local hospitals and others to help protect those who are treating the sick. To me, the best news of this quarter is that we kept our team healthy, met the needs of our customers and clients, and kept everyone on our team gainfully employed. Turning to our financial results. Core earnings this quarter were $0.51 per share compared to $0.67 in the fourth quarter and $0.58 in the year-ago quarter. Earnings this quarter included a $95 million provision for loan losses or $0.36 a share. On the financial side, our company remains strong. We are carefully managing our expenses, capital expenditures and balance sheet. We believe we have ample liquidity and we are seeing steady performance and cash flow from our student loan portfolio and processing businesses. Early in the first quarter, we completed our planned unsecured financing activity for the year, raising new proceeds and extending the maturities of short-term bonds. We also completed $1.9 billion in term ABS issuance, and most recently expanded the size and extended the maturity of some of our warehouse funding facilities. Looking forward, cash flow from our loan portfolio and services contracts remain a strong source of liquidity as our very seasoned loan portfolio has experienced lower levels of stress. To be clear, we are here to assist our customers and clients who are impacted by the virus and its economic consequences. We offered numerous relief options, including immediate payment relief to those in need and we'll continue to do so. We've also seen most borrowers continue to make payments according to their payment plans. And while forbearance rates have risen, the balance of loans delinquent has not. This trend has continued into April. As a result, we expect that defaults in both our private and FFELP portfolios will be significantly lower in 2020 than expected at the start of the year. While we're paying close attention to our customers, it is too early to know the full impact of this crisis or the path and timing of the recovery. How long does this crisis last, how many more will lose work, and what the recovery will look like are all questions we can only guess at. Nonetheless, we have looked toward other significant economic crises, including the Great Recession and the more recent regional natural disasters to guide us. As a result, our provision for loan losses this quarter totaled $95 million, bringing our total reserves to $2 billion at quarter-end, which represents reserves equal to 7.1% of our private loan portfolio, and 25% of the risk sharing component of our FFELP portfolio. While our portfolio's strong credit characteristics and the historic resilience of the US economy provide hope for the best, we are prepared for things to get worse. Our student loan portfolio is very seasoned and conservatively funded. Despite the volatility in rates and basis spreads over the last few weeks, net interest income was in line with expectations. Volatility in the basis spreads of our assets and liabilities was a negative this quarter for our FFELP net interest margin, which was offset by higher levels of floor income. We expect this basis spread to improve in the second quarter. Other notable items for the quarter include new refi originations of $1.9 billion, up 92% over the year-ago quarter. Demand was very strong for our products through March. Given the uncertainty with both funding costs and the economic outlook, we materially reduced our marketing efforts and tightened credit to reduce future originations until we have a greater visibility in funding costs and economic outlook. Private loan charge-offs in the first quarter declined 30% to $68 million compared to $97 million in the fourth quarter. This decline was driven by the strength of the economy into March. We expect charge-offs during the balance of 2020 to be lower than 2019 and our original forecast for 2020, given the increased use of payment relief options. Private loans and forbearance increased to $1.6 billion or 6.9% of the portfolio at March 31. This increase is entirely driven by our COVID-19 relief options. Loans and forbearance continued to increase in April to $2.8 billion as of April 15. This quarter also saw continued improvements in operating efficiency. And while total OpEx was unchanged from the fourth quarter, this quarter includes $9 million in seasonal payroll-related expenses. At quarter-end, our adjusted tangible net equity ratio declined to 3.2%. While Chris will provide greater detail later in the call, I would like to remind folks that the portion of our derivative book hedging floor income is marked to market each period and reduces equity in falling rate environments. The offsetting value we receive in floor income, however, is not marked to market and, therefore, its value which increases in falling rate environments is not reflected in our equity. The significant decline in rates delivered a larger-than-normal negative mark this quarter. As a result, at March 31, our GAAP equity position is reduced by a cumulative $629 million for derivative valuations that will reverse to zero as hedge contracts mature. As a result, while our equity ratio is below our target range, we are comfortable with our position and our outlook. While our response to the crisis has taken center stage, we've also continued to work on other important initiatives. For example, we continue our efforts to move our remaining systems off our mainframe. And we remain focused on delivering our in-school loan products for the upcoming academic year. The COVID-19 crisis has created unprecedented challenges across all aspects of our lives. Your company entered this crisis from a position of substantial financial and operational strain to see this crisis through. Our team has responded with flexibility, resilience, and innovation to meet the needs of our clients and customers. I'm inspired by that commitment, and I'm thankful for their health and safety. I'll now turn the call over to Chris for a deeper review of this quarter's results. Chris?

Thank you, Jack. And thank you to everyone on today's call for your interest in Navient during these unprecedented times. I'd like to add my thanks to Team Navient for their incredible resilience and support, helping our customers navigate this challenging environment. During my prepared remarks, I will review the first quarter results for 2020 and provide additional insights on the portfolio and the impact of COVID-19 pandemic on our business through April 15. I'll be referencing the earnings call presentation, which can be found on the company's website in the Investors section. Starting on slide 4, key highlights from the quarter include: Delivered adjusted core EPS of $0.51 cents, provided immediate payment relief to over 200,000 Navient borrowers impacted by COVID-19 as of April 15, originated $1.9 billion in student loan refi loans compared to $984 million from a year ago, and returned $366 million to shareholders through dividends and the repurchase of 23 million shares. Let's move to segment reporting, beginning with the Federal Education Loans on slide 5. Since quarter-end, we have seen our forbearance rate increase to 19% and our delinquency rate fall slightly to 10.3% as we provide additional payment relief to those impacted by COVID-19. To add some additional context, over 50% of the FFELP borrowers who have requested repayment relief were previously in a delinquent or forbearance status. The increase in charge-offs in the quarter was primarily a result of the implementation of CECL, which requires the company to include the premium or discount related to defaulted loans in the charge-off number. Going forward, we anticipate charge-offs and delinquencies to decline through the rest of 2020 as a greater percentage of borrowers seek payment relief. The net interest margin was 81 basis points for the first quarter, within our guidance. In the quarter, we earned $35 million of unhedged floor income on $16.2 billion of loans as a result of the lower interest rate environment. The rate on $6.8 billion of these loans resets annually on July 1, and so therefore, we do not anticipate earning floor income on this portion of loans for the second half of the year. The benefit in the quarter from the unhedged floors was offset by the differences in timing between our assets that are on an average daily reset basis and are funded primarily with monthly resets. While we remain cautious, the current outlook for interest rates should positively impact the net interest margin on our FFELP portfolio during the rest of 2020. Now, let's turn to slide six and our Consumer Lending segment. Much like the FFELP portfolio, we have seen an increase in forbearance and a decrease in delinquencies from the prior quarter. Since quarter-end, we have seen our forbearance rate increase to 12% and our delinquency rate rise slightly from 3.6% to 3.9% as we provide additional payment relief to those impacted by COVID-19. During the quarter, we saw a 24% decline in the charge-off rate and expect further reductions this year as impacted borrowers seek immediate repayment relief. Year-over-year increase in net interest margin to 331 basis points was primarily driven by an improvement in the cost of funds. The increased volatility in rates that occurred in March is anticipated to negatively impact the spread on $10 billion of our primary loans that are funded with LIBOR. We anticipate this dislocation will continue and lead to a net interest margin that is at the low end of our original full-year guidance of 300 basis points to 310 basis points. Total private education portfolio grew 1% to $22.3 billion, primarily driven by the growth in refi originations. During the quarter, we originated $1.9 billion of high quality education refinance loans. Through the first 15 days of April, we have originated $80 million. We have updated pricing on new originations to reflect the increase in cost of funds in the ABS market, and anticipate managing to lower volumes until we see increased activity in the ABS market. Let's continue to slide 7 to review our Business Processing segment. Through the first 15 days of April, we are seeing significantly lower transaction-related placements in both government services and healthcare revenue cycle management compared to the first 15 days of the previous month. However, we have been able to transition hundreds of our experienced BPS colleagues to support state clients working to help their newly unemployed residents access benefits implemented in the CARES Act. These new opportunities are expected to reduce the negative impact BPS is seeing as a result of COVID-19. In the quarter, total BPS EBITDA margin fell to 7% from 21% a year ago. The decline in margin was primarily driven by contract terminations and expirations that occurred in the second half of 2019, combined with planned investments to improve long-term operating efficiencies and the impact of COVID-19. Let's turn to slide 8, which highlights our financing activity. We successfully accessed the funding markets during the first quarter, beginning with the issuance of $700 million of unsecured debt that matures in March 2027. $190 million dollars of this issuance was used to reduce 2021 maturities. In the quarter, we issued $1.9 billion of term private education ABS and refinanced $472 million of private education repurchase facilities that both extended term and reduced overall costs. On April 1, we extended a FFELP facility to 2022 and expanded the total capacity in our private education refinance facility to $2.6 billion. We ended the quarter with an adjusted tangible equity ratio of 3.2% and $1.7 billion of primary sources of liquidity, of which $1.1 billion is cash. Let's move to slide 9 to provide greater detail on the movement that occurred in our equity and allowance during the quarter. As expected, the implementation of CECL reduced our capital ratios, which we plan to rebuild over the course of 2020. The adoption of CECL reduced equity by $620 million, which was within our previously disclosed range. In addition, GAAP equity was reduced as a result of the accelerated repurchase of shares that occurred in January and as a result of the change in derivative marks that occurred on derivatives that hedge interest rates. The mark-to-market on the derivatives reduced shareholders' equity in the first quarter by $394 million, bringing the cumulative negative mark to $629 million. Importantly, these negative marks will reverse to zero as the hedge contracts mature over the next several years. Finally, let's turn to GAAP results on slide 10. We recorded a first quarter GAAP net loss of $106 million or a negative $0.53 per share compared with net income of $128 million or $0.52 per share in the first quarter of 2019. The net loss in the first quarter was the result of $236 million of pretax mark-to-market loss on derivatives and hedging activities as a result of the significant reduction in interest rates. In summary, we began 2020 with a strong start to the year, executed on a variety of financings that positioned us well for the current environment, successfully transitioned our workforce to a work from home model, and are providing solutions to our borrowers and customers to help them successfully navigate this pandemic. While we are uniquely positioned with robust liquidity and a well-seasoned and partially guaranteed loan portfolio, the difficulty of providing guidance at this time as a result of the pandemic has led us to temporarily suspend our full-year guidance. I will now open the call for questions.

[Operator Instructions]. Your first question comes from the line of Mark DeVries with Barclays.

Yeah, thank you. Good morning. Could you give us a sense of how much more forbearance activity you might anticipate? And also a little more color on kind of the trajectory of credit from here. It sounds like near-term, the forbearance is going to push charge-offs and delinquencies lower, but how should we think about it going into 2021 and beyond?

Thanks, Mark. So, the forbearance rates certainly accelerated. The demand for forbearance was accelerating as we exited March and into April, and this is why we gave the April 15 data point. Since then, the pace of demand has been declining, although it's still increasing in the tens of millions of dollars each day over the last week. Still, at this point in time, we still have about 78% of our private loan portfolio is current, meaning they're not even one day past due in their payments and over 80% of the portfolio is either current or less than 30 days past due. And so, that's obviously a very optimistic outcome here, which means that our current borrower base, with a mixture of very seasoned private student loans and our more recently originated refi loans, are kind of weathering this crisis better than most consumers. The things that we're looking at here, as we point to, is other forms of disaster forbearances that have happened in the past and what type of payment recovery happens as those crises move away, and that's going to be the big challenge here, right, is how long does this crisis last, how much deeper does it go in terms of job loss. Those are the things we're monitoring. But as we sit here today, our customer base appears to be managing this as well as can be hoped for.

Okay, great. And can you give us a sense for – what we should expect from credit performance on kind of your seasoned loans versus your newer consolidation loans, and how you're reserved against those two different groups of loans?

Yeah. So, we definitely model the outcomes differently and have expected -- cumulative future losses are very different for each of those. We use the Moody's Analytics models as part of our CECL modeling expectations and included higher weights to their severe stress scenarios for this quarter's estimate. But if you look at our portfolio overall, as I said, we have 7.1% reserves now against our total private loan portfolio. And if you look at what others have been publishing in terms of expectations on student debt and consumer debt, our coverage ratios are well within the ranges that people are publishing there. If you think about it a little bit differently and said, the weighting differences of our mix, if you assume that credit losses on the refi portfolio might move from, say, 1.5% over the remaining life to 3%, that would imply a coverage ratio of over 9% for the legacy private loan portfolio. So, certainly, economic conditions can change, and the duration of this could have a different impact, but from where we sit right now, we think we're in a very conservative position.

Okay, great. Thank you.

Your next question comes from the line of Vincent Caintic with Stephens.

Hey, thanks. Good morning. Could you remind us how you're thinking about your capital ratios in this time and also how you're thinking about capital return?

Great. So, as you remember on the last call, we had put out guidance that we would get to an adjusted tangible equity ratio of 6% or better by year-end. As we mentioned in March, we're at 3.2%. There will be a lot of capital build that'll happen naturally throughout the year. Obviously, with profitability up somewhere around 25% if interest rates stay the same of our marks on our derivative portfolio, we'll reverse out. And so, there are a number of positives that will help us build capital throughout the year trying to get back to that 6% ATE ratio. We have already completed a pretty significant portion of our buyback program for 2020. And so, we will be very flexible and opportunistic throughout the rest of the year. So, that is how we're thinking and looking about capital, but we feel very good about our capital build. We feel great about our liquidity position. So, it really is just managing that build and getting us back to the right place over the next 12 to 18 months.

Okay, great. Thank you. And next – so, I appreciate the guidance you gave on the segment NIM. Maybe if you could break that out a little bit. So, funding -- nice to see that you're able to get different funding sources. If you could describe, say, the availability of funding and the price you're getting there. And then, how should we think about sort of asset yields and then also the slower income we should expect going forward.

So, obviously, in the interest rate environment we have, floor income will continue to accrue, although I mentioned that we have -- there are annual resets that are part of our floor income portfolio that, after July 1, we expect to stop receiving floor income on. So, that inevitably is an important component. But on the financing side, we obviously got a significant amount done in the first quarter more than we were expecting, more than our plan. We accelerated some of our financing activities. So, we got the $700 million high yield done at the lowest rate this company has ever posted a high-yield coupon. And so, we actually, for the rest of year, have no real financing needs. We, obviously, would like to – the ABS markets to recover and to improve and we will watch there and we will look to execute on those when the market gets back, but we have really no real pressure for the rest of the year from a financing capacity.

Perfect. Thanks very much.

Your next question comes from line of Moshe Orenbuch with Credit Suisse.

Great, thanks. Could you talk, either Chris or Jack, a little bit about the cash flows that you're likely to see from the portfolio, the rate of change, given all of these changes? Obviously, you've got the forbearance and you've got a general probably slowdown in prepayments. How do we think about that? And anything that that means in terms of both the amount of cash you'll likely collect over the balance of this year and next and the life of your loans?

Moshe, great question. Thanks for asking. So, as you all saw, obviously, we removed the cash flow forecasts from our materials only because it is a forward-looking guidance number, and so we wanted to pull them out. What I could tell you is we have done a significant amount of stress testing on our cash flows over the last three to four weeks. Even with our own revised internal estimates, we don't expect our cash flows to be that meaningfully impaired. Obviously, there will be a slight decline in residual cash flows, but servicing cash flows are top of the waterfall. And our expectation is we're in a still pretty strong cash flow position versus what we were expecting before this crisis. I think, inevitably, we made some moves that are helpful, but there really wasn't that significant a move in our stress testing as a result of this. And obviously, that's as of today. If the economic environment gets significantly worse, there will be some deterioration. But I would just tell you that there is a significant amount of resiliency around our cash flows, given the servicing component, given the return component, and principal versus interest that really benefit the company.

I would just add to that. The way our financing structures work, if principal payments are coming down as borrowers are using forbearance, the duration of our liabilities that are funding those assets to the ABS markets are extending. And so, it's a match-off in terms of those cash flows, which is why our stress test scenarios hold up so strongly during crises like this.

Got it. Got it. And I would assume that life extension, though, does mean that there's cash flows into future periods that, if we had those tables in front of us, you'd be adding more just in later periods. Is that correct?

That's right. And the absolute value of them would be higher as well because your asset has a longer average life.

Right, right. Okay. I guess, could you maybe just give a little more detail about one of the previous answers about these annual resets on the floor income? Like, how significant is that and how much of an impact that can have in the back half?

Well, it's $6.8 billion of our 16-ish-billion dollar portfolio. But I'd also say, given the low interest rates, there's a huge benefit anyway in the FFELP [ph] portfolio. So, inevitably, it's not a wash, but it clearly isn't as impactful as that $6.8 billion versus the $16 billion sounds.

Yeah, I would just add on this. Obviously, our original guidance for the year did not have any annual reset floor income in the second half of the year anyways. And very rarely do we ever earn floor income on annual reset loans just because of the way the formula works. So, each May, when the rate is set for the July 1 through June 30 timeframe, it's set out of the money, and so rates have to fall a fairly significant amount before they come into any value, which happened obviously beginning late in the fourth quarter and into the first quarter of this year.

Yeah. So, it was a very unique year for that portfolio compared to sort of years where we did not have them.

So, effectively, a step up in Q2, a step down in Q3, but still higher than it was expected as at the beginning of the year?

Because of where rates are, yes.

Right. Okay, great. Thanks a lot.

Thank you.

Your next question comes from the line of Lee Cooperman with the Omega Family Office.

Thank you. Good morning. I'm glad to hear that the majority of the staff is in good shape and that you're functioning fine. I'm a little bit confused. And I'd like you to help me out. You use words like unprecedented times, but we're flexible and opportunistic. On the $335 million you spent in the stock repurchase, about 23 million shares, that means you pay $14.56 for stock you bought back in the first quarter. The stock currently is around $6.50, $6.60. I assume the stock is different at different prices. But if you thought we were worth $14.56 in the first quarter, have things changed enough that you're sorry you bought back the stock – obviously, you're sorry, because you basically paid too much. But does that motivate you to be more aggressive at these lower prices? Or has the environment deteriorated more rapidly than the price of the stock has deteriorated? So, what I'm really asking, one, is what is the status and intention of the buyback? And I'd like you to be as explicit as possible. What is the status and intention of the buyback? Question number one. Question number two. Do you envision any scenario where you would need government assistance? And the reason I'm asking that question is these left wingers who are recommending that you eliminate your dividend and stop buying back stock who don't understand capitalism, they have no case if you're not looking for government assistance. So, I'd like you to address those two things. The first one is quite important to my thinking. I asked you five years ago why you were buying back stock in the 20s. And your response was you thought it was worth $30. Well, if you bought back as much stock as you bought back at an average price of maybe $14 or $15, that $30 you thought you were worth is a lot more than $30, which clearly is academic. But I think it's important you come clean and just explain to people what your expectations are and when do you think this buyback philosophy of yours is going to be vindicated by the market?

Thanks for your question, Lee. So, our story has been a capital return story, principally because of the fact that we have an amortizing portfolio of legacy FFELP and private credit loans. And as those portfolios generated earnings and released capital through their amortization, our policy and practice was to return that back to shareholders through dividends and share repurchases. Typically, we repurchase shares through a normal kind of price averaging kind of concept where we're buying back shares on a regular basis through the course of the year. And that amount is set based on our financial forecasts of how much excess capital we would have available to return. This year, we expected that number to be approximately $400 million of share repurchase capital return. And unusual in this year is that we had an opportunity back in January to buy back a large share block at a single point in time. And normally, that's a difficult – we don't get those opportunities on our daily basis where we've been typically buying back about around the 10% amount of daily activity – trading activity. So, that was a unique opportunity. Obviously, if I had to play that hand again, you'd love it to have been different. I'd rather be buying back the shares today than I did at the January price. But we, obviously, can't reverse that. So, our plan was to do $400 million this year. We've done, as you point out, $336 million through the first quarter. Right now, that doesn't leave a whole lot left for the balance of this year. We also have the capital ratio targets that we're trying to hit. So, I wouldn't expect anyone to see that number rise above what we had originally forecasted for the year. In terms of government assistance, as we've laid out this morning, we think we're in a very strong financial position from both a balance sheet and cash flow perspective. And while government assistance programs may be available to our customers in the form of some payment relief on federally-owned student loans, it's possible that they may extend some of those benefits to FFELP portfolios. Those are benefits that are received by the borrowers, not by the company. And we would expect to not need any government assistance through this process. Similarly, we didn't get or use any government assistance during the last financial crisis.

I anticipated the answers you gave. The question that I just ask out loud – I ask myself –you spend billions of dollars of capital buying back stock at 2.5 times the current price. We're selling it $4 a share or so below book value. Does it seem as intelligent to you to say that we got $65 million left to buy back stock? Should we not look to accelerate some asset sales to buy something back at a fraction of what you think it's worth? Or if you changed your view about the value of the business? People want fixed income now, okay? So, we have historically low valuations of your stock, historically high valuations of your assets in terms of the government-backed fixed income, why not sell off more of those assets, release capital and buyback a dollar bill for $0.30 or $0.40. Why not be more creative in your thought process?

Yeah. We certainly evaluate and look at opportunities. Effectively, what we own when we securitize a – whether it's a federal or a private student loan is the equity component in that securitization transaction.

It's about 3% of the loan or something like that, right?

Yeah, it's the residual – whatever that residual interest is. It's wider on private and smaller on FFELP. We have sold some of those transactions in the past. We view that market as not a particularly efficient market. And unfortunately, in today's market conditions, even though the student loan portfolios on the FFELP side are government guaranteed, market pricing would indicate that those spreads have widened in the crisis, not tightened. So, we still would – there's limited opportunities, I think, in terms of buyers there. That doesn't mean we wouldn't look at things if the situations presented themselves, but at this stage in the game, I wouldn't expect that those would be realistic opportunities.

Well, the sad thing is you have $64 million left to buy something at less than half you paid for recently. This seems to be – I would be more creative, but what do I know? Thank you. Good luck.

Thanks, Lee.

Your next question comes from line of Rick Shane with J.P. Morgan.

Hey, guys. Thanks for taking my questions. You cited your Moody's models. I'm curious if you could help us understand the timing of the economic assumptions that were embedded in those models and what the key assumptions were in terms of unemployment at that time versus where they are today.

Thanks, Rick. So, if you look at our CECL process, when we were updating our CECL number for quarter, what we ran is the March 27 pandemic Moody's model and then their scenarios for March 31. So, those scenarios are all public. And you can see the inputs generally. What I would highlight – I think what you're seeing is we've looked across the financial universe as that is very much in line with what most of the banks have reported using and we relied on heavily as well. And so, I think your question is, post March 31 and post those Moody's numbers, what will the updated Moody's model show and what will be the impact. There, obviously, has been some continued deterioration since quarter-end, but it's still very much up in the air of where we're going to end up at quarter-end second quarter. But we did rely on what were the most up to date Moody's models and our primary foundation was the pandemic model.

Got it. Great. That's helpful. Second question. Look, I think there's some confusion when we think about life of loss reserves. And historically, things like forbearance and TDRs historically have had life of loss reserves and current loans and delinquent loans do not. And so, there's been this perception of a convergence between the two. But the reality is that the performance of a loan under forbearance is different than a current loan, despite the fact you might be reserving for them now using the same methodology. Should we think about as forbearance increases and you're experiencing that in the portfolio that that will continue to have an impact on your CECL reserve policies?

So, CECL, obviously, moves everything to effectively the same kind of reserve methodology as what was a TDR, life of loan loss reserve expectations. Certainly, loans in a forbearance status versus loans that are current have very different loss expectations. But I would argue, in our experience over 40 years has shown that a loan that's in forbearance in a positive economic environment is different than a loan that's in forbearance and in a crisis, like we have today. And so, what we look at is we look at who our borrower types are, where they are in their repayment cycle. As an example of that, a borrower who is just graduating or just recently out of school is going to be a different risk than someone who has successfully been in repayment for five plus years, which is the majority of our private loan portfolio. We have seen over the last several years that our charge-off rates on our private book have been coming down materially. They came down again in the first quarter. Because we do have more flexibility as a non-bank entity, we do offer more flexible repayment options during periods and relief during periods like we're in right now. And as a result of that, even though we expect unemployment rates to rise and forbearance usage to increase, we expect defaults in 2020 to decline. And so, we look forward in terms of what is the economy forecasted to look like in 2021, as borrowers might be exiting forbearance and what the delinquency and default rates would likely be. For many of our customers, particularly some of our – with professional degrees and such, we expect their jobs to recover and their income to recover and their ability to continue to make payments going forward to return. But that's, obviously, the big question mark here, is how deep is this impact and when does the recovery look like and what shape does it take. Those are obviously difficult to predict right now.

Rick, I would just add that forbearance is a component of our CECL modeling exercise, and we have a pretty long history and understanding of how forbearance plays out, given all the natural disasters we've seen and the economic declines we've seen over the last 40 years. And so, forbearance isn't a new thing. It's part of the CECL modeling process. And so, it is contemplated in our life of loan reserve and something we'll continue to watch and model out.

Terrific. That's very helpful, guys. And thank you for all the hard work you have done to manage through this. And it sounds like you've been able to do some good things for your employees and your customers. So thank you.

Thank you.

Thank you.

Your next question comes from the line of Mark Hammond with Bank of America High Yield.

Thank you. Hi, good morning. So, on the earlier comment about not thinking cash flows would be meaningfully impaired, could you just give a sense for the near term, like 2020 cash flows on the private ed and the FFELP side as well in terms of what meaningfully impaired might mean? Is it a 10% hit? So, for example, like, private ed loans at the end of the year, you thought 2020 would be about $1.4 billion of cash flows from your slide deck then. What's not meaningfully impaired mean just as far as thinking about cash flow in the near term?

In broad strokes, I think something inside of 10%. And what we saw at quarter-end is broadly in line with what we're expecting. Like I said, our cash position is not expected to be materially different by year-end. Our quiddity position is relatively similar as quarter-end. And so, inevitably, we will see some of the forbearance come into play over the next three quarters. But your sort of 10%, inside of 10% number is not far off.

Christian, that's really helpful. And same for FFELP too, I suppose?

Yeah. Actually, maybe probably even less impacted.

Got it. And then, the last one on the…

[indiscernible] because of the servicing flows, there was already a pretty high component of "forbearance" or people not in repayment. So, a slightly different animal.

Got it. Yeah, I was just going to ask, I think you answered it on. Just any nuances or differences between the two in terms of securitization cash flow between private and then the FFELP.

It really goes back to how much the servicing component is of the cash flows as sort of interest income and the amount of forbearance or non-paying that was already a part of the portfolio in that, the relative change or impact. I think one of the important things to highlight too is these trusts are incredibly resilient. There is a lot of built-in resiliency to these trusts. So, like I said, we did a significant amount of stress testing over the last three or four weeks and I just highlight that we feel very comfortable with where we are today and our position over the next year.

All right. Thanks for answering my questions. Much appreciated.

Your next question comes from line of Sanjay Sakhrani with KBW.

Thanks. Hope you guys are well. A couple of questions. One, you guys talked about the seasoned portfolio and how some of your customers might come out of this better than others. I was just wondering if there's any breakdown of the portfolio across some of the more professional occupations that you feel better about going through cycle versus others. Do we have any clarity in terms of those exposures?

So, we don't have high concentrations across the entire portfolio. But in our refi space, one of our more impacted segments of the population would be medical professionals, particularly in the dental area. Dentists, obviously, are not working right now. But that's a group that we would expect to be – once the recovery starts to happen that those practices will be back up and running. And those borrowers will recover better than the areas where jobs might disappear for a longer period of time.

We don't have a breakdown of how much is dental, medical, that kind of stuff?

No, we don't disclose that kind of detail. But I would look back and look at the portfolio statistics that I mentioned earlier, in that 80% of the total private loan portfolio is either current – the vast majority is current, meaning no days past due or less than 30 days past due. That portion of the portfolio is holding up extremely well and I think is a statement about the seasoning and strength of the customer base as a whole. Obviously, we continue to be there to help customers who need relief by offering them immediate payment relief options like forbearance or changes in their payment rates, so that they can manage to their adjusted cash flows of their households. But, again, it all depends on where you think the impacts of this economy are going to be and how long are they going to be felt, is will ultimately drive the outcomes here.

And, Sanjay, just to provide a little more detail on the medical, what we're seeing is these – a lot of our proprietary shifts – so what you've had is them having to shut their offices down for two, four, six, eight weeks. But inevitably, to us, it's a delay in cash flow as Jack said. It's not an elimination of jobs and corporations. It's people who have had to shut down practices, either medical or dental, and which will ramp back up. And so, what you saw are some forbearance usage, but our expectation is that these businesses will get up and running again and people go back to using dental and medical services the way they did before. So, for us, it's really a delay on their part, not a job elimination or an unemployment scenario.

Got it. I guess, my follow-up question is on the competitive environment and opportunities that could arise as a result of this period of weakness. You've, obviously, had a rise in these fintech companies that have sort of been biting at the ankles of some of the incumbents. I'm just curious how you guys are thinking through any opportunities that might present themselves? Or whether or not there would be opportunities presented, given there being an extended period of a downturn?

I think the real challenge with that, Sanjay, is what is the outlook look – what is the economic outlook that you're using in your estimates here. And because of the lack of visibility, it's a little hard to execute on some of those opportunities right now. As I mentioned in my comments at the beginning, we've cut back on our marketing of our refi loan products, really, because there's not a lot of clarity in terms of long-term funding costs through ABS issuance or the economic outlooks here. When those become a little bit more visible or we're more confident about them, I think there's an opportunity for us to execute and take market share where we can. I think one of the things where we've been very responsive and have been able to be reactive, less on the fintech side, is on our operational side of the equation, and that we've been able to reposition our team to respond to things like unemployment claim processing. And those have been – that tells you a little bit about the flexibility we have within our operational infrastructure, how we can reposition call center activity, including folks who are working from home to do this to be responsive and help states who need the assistance, but also create opportunities for our team. So, as I said, we've been able to keep 100% of our team gainfully employed through this crisis, which I'm very proud of that ability.

Sanjay, I'd also highlight the in-school opportunity, in that we have – we are now signed up with a bank partner. We have the technology in place to be able to originate loans for the next academic quarter. It's an early read, but I think you're going to see further bank withdraw from that market, which would increase some opportunity there as well. And so, I think as Jack said, it's tough to navigate given the uncertainty around what's going to happen. But we do see that as a real opportunity. And I believe there may be more space in that market, not less in the next academic year, regardless of what happens. And we are prepared and ready to roll it out in a more robust way.

Okay. And can you remind me who that bank partner was?

One American Bank.

Okay, cool. One final clarification. These COVID – and I know you guys talked about this earlier, but the COVID-19 relief options, you guys will provision for them after the period is done, the deferral period is done? Or are you guys making some kind of assumption inside the reserve today?

It's not just where they are today. It's where we expect the loans to be over the next several months. So, if our forecast model says unemployment is going to increase by X, and another Y% is going to need forbearance, that would be incorporated in the model.

Okay. All right, great. Thanks.

[Operator Instructions]. Your next question comes from the line of John Hecht with Jefferies.

Morning, guys. And thanks very much for the call this morning. Most of my questions have been answered and asked. I'm just wondering, though, with the change in kind of forbearance patterns, your servicing fees with the DoE, do they change at all when you have kind of higher forbearance rates?

So, on our Department of Education servicing contract, we are paid based on the status of the account. And we do expect to see some slight decrease in monthly revenue as a result of the status changes for those loans granted under the CARES Act. But during that forbearance period, some of our operating expenses change as well. Frankly, our biggest operational concern right now is planning for the exit of those borrowers back into repayment. And that is something – it's much easier to move customers in. We're going to have to manage that flow out through both communications and phone calls and things, and that's something we've been working on. I mentioned this only because I think one of the things we've done extremely well and I think the team across the company has done extremely well is plan and prepare. Our preparation for COVID began back in February when we started to see some of these issues. We bought the equipment, the licenses and the bandwidth necessary, so that we could get 90% of our team to a work from home status. We were able to implement the CARES Act provisions extremely quickly and as quick or faster than anyone else in the space. And we are preparing today for what it's going to take to return those customers back into repayment statuses and our teammates back in the office type of arrangement as conditions warrant and allow.

Okay. That's helpful color. And then, within the Business Processing segment, obviously, some of the municipalities have been disrupted. Obviously, things like fee and their toll income, obviously, gets impacted. How do you guys think about the recovery of that and are there any other kind of opportunities that present themselves in this kind of environment for special servicing for different elements of state governments?

So, there's no question in our BPS business, transactions drive our opportunity, right? And so, if we're managing parking or tolls for an authority and those volumes are down, as they are, that impacts our workflow. And our healthcare side of the equation, medical billings are down across as all types of optional services have been delayed. So, what we have been able to do, and it is reposition a good chunk of our efforts to assisting states and new issues that are arising for them and helping their residents. So, we mentioned the unemployment processing, for example. We've done work now for a number of states where they called and said, 'We need help and we need it now.' And within a day or two where our representatives are on the phone, answering questions, and providing the services that the residents of those states need to take advantage of those programs. So, those are the things that we're doing and we'll continue to look for as the market conditions change the opportunities here.

Thank you, guys, very much.

Welcome.

Your next question comes from the line of Henry Coffey with Wedbush.

Yes, good morning. And thank you for taking my question. In the idiots' guide to CECL, is it fair to assume, given your outlook in terms of delinquencies and charge-offs, that if Moody's keeps their COVID forecast where it was in March that your provision levels stay fairly light? Or is that going to also be impacted by, for example, rises in forbearance or other issues?

Well, clearly, we'll be monitoring the portfolio. But the Moody's models, if you think about it, the life of loan reserve and the CECL model is to encompass the entire future of a loan. And so, those models weigh heavily on what we think that future will be and what the impact will be. Obviously, there is some overlay components into our own portfolio and what we see as performance, et cetera. But a lot of that is really driven by the Moody's inputs and the other inputs we have. So, I would say it's kind of an 80/20 rule that you're 80%, 90% right that, if Moody's did the same, that development should relatively be what we see. But if we do see there better or more adverse reactions in our portfolio, there would be true-ups or overlays that we would apply to our number.

I know there was extensive discussion around the buyback. But the other side of return of capital is the dividend. You, obviously, have the earnings to cover it. What is the thought process in terms of when you look at stress testing and the cash flow issues, et cetera, what is your thought process on the dividend as well in here?

So, we think of capital return, as Jack mentioned, we put a capital plan in place every year, which looks at our cash flows, our capital builds or release, and then we inevitably divide that capital return between dividends and buybacks. Today, our stock is sort of a 8%, 9% yield, which is a pretty high attractive yield. We bought back $336 million of stock. We're going to maintain that plan and try to stay in line with that plan, given what happens over the next three quarters. So, we don't see any alter to our dividend payout ratio, especially given how high the dividend yield is today, but it's something we think about, we talk about, we analyze, but we feel confident in the position we're in today.

Great. Thank you very much.

Thank you.

Your final question comes from the line of Arren Cyganovich with Citi.

Thanks. Just on the floor income issue, the one-month LIBOR has been kind of out of whack, it's getting a little bit better, but it's still pretty far off of where we would expect it to be relative to the treasuries. As that kind of continues to normalize, will that further improve your floor income that you'll be earning on the portfolio?

Yeah. So, that's a great question because there's actually two parts to it. One, yes. That obviously will help that, as you said. One-month LIBOR is about – say, it was yesterday 62 basis points, right? The curves do show of getting back to like the low 20s or where it should be. There's been a lot of dislocation because of the money market funds and the intervention by the US government. So, A, yeah, should improve floor income. But, B, it also has an impact on our prime portfolio. Our prime portfolio is, obviously, the assets are benchmarked against prime and funded primarily with LIBOR, one-month LIBOR. And therefore, what you see is that – historically, that relationship has been about a 300 basis point margin. And inevitably, in dislocation, that can change meaningfully and we've seen that dislocate over the last three weeks. It's actually, as you mentioned, been improving – one-month LIBOR was sort of 99 basis points, 100 basis points three weeks ago. It's now in the low 60s. We expect it to get back. So, I talked about that dislocation in our consumer portfolio, which has primarily been impacted by our prime portfolio. But we do expect that to improve as well over the next couple of months. And that's what the curves are suggesting. But it's something we're watching closely.

So, you'll actually get a benefit on both sides of your book then from that…?

Yes. It depends on how fast it improves. Obviously, we don't have guidance out right now. But what we've seen is that one-month LIBOR, the curves are moving faster even over the last couple of weeks to getting back to that lower number. So, every kind of week, that curve has been moving lower faster than the previous week's curve suggested.

And the resets, I guess the portion of the book, the July 1 reset, did that have to be, I guess, fixed by that period for that portion of the book?

Yeah, we would not expect that that annual reset book earns floor income after July 1.

When they reset on July 1, they set out of the money. So, 50 basis points typically out of the money.

So, rates would have to fall 50 basis points.

Negative.

Okay. All right.

Sorry, that portfolio, that happening was not unusual. And so, it just was a benefit in the last year, but it's not something we've had consistently for a very long period of time.

And then, just lastly, is there any room to cut expenses in your Business Services area, now that we're going to have a bit of a slowdown there?

So, we are looking pretty aggressively at all our expenses. The positive thing on the BPS side is we were actually not only able to reallocate BPS people who may have been furloughed potentially, given what happened, but to put them into other opportunities on the state side. And in fact, we're actually looking for additional capacity or additional people, given the opportunity that we see over the next few quarters. And so, from an expense perspective, on the people side, which is the majority of the expense, we actually are probably short staffed given the opportunity we have in the short to medium term, which is a great place to be in the current environment. But there may be opportunities around office space, there may be opportunities around technology. And as you know, expenses is – we've put out an efficiency ratio target. We still want to try to hit that target, even in light of lower profitability. And so, we are continually focused on how we can get expenses down, not only in BPS, but in corporate and our Consumer Lending business. It is a primary focus that we've been digging into over the last, call it, four, six weeks.

Okay. All right. Thank you very much.

There are no additional questions. I would now like to turn the conference back over to Mr. Joe Fisher for closing remarks.

Thank you, Lashana. I'd like to thank everyone for joining us on today's call. Please contact me or my colleague, Nathan Rutledge, if you have any other follow-up questions. This concludes today's call.

Ladies and gentlemen, this does conclude today's conference. You may now all disconnect.