Navient Corp (NAVI) 2014 Q2 法說會逐字稿

Good morning, ladies and gentlemen. My name is Ryan, and I will be your conference operator today. At this time, I would like to welcome everyone to the Navient second quarter earnings call.

(Operator Instructions)

I would now like to turn our call to the Vice President of Investor Relations, Joe Fisher. Please go ahead.

Thank you, Ryan. Good morning, and welcome to Navient's 2014 second quarter earnings call. With me today are Jack Remondi, our CEO, and Somsak Chivavibul, our CFO. After their prepared remarks, we will open up the call for questions.

Before we begin, keep in mind our discussion will contain predictions, expectations, and forward-looking statements. Actual results in the future may be materially different from those discussed here. This could be due to a variety of factors. Listeners should refer to the discussion of those factors on the Company's Form 10 and other filings with the SEC.

During this conference call, we will refer to non-GAAP measures, we call our core earnings. A description of core earnings, the full reconciliation to GAAP measures and our GAAP results can be found in the second quarter 2014 supplemental earnings disclosure. This is posted along with the earnings press release on the investors page at Navient.com. Thank you, and now I will turn the call over to Somsak.

Thanks, Joe. Good morning, everyone. I will be referencing the earnings call presentation which is available on our website.

But before I get into a discussion of Navient's first earnings release as a standalone Company, let me provide an update of the definition of core earnings. Core earnings excluded unrealized mark-to-market adjustments on derivatives, as well as the amortization of goodwill and intangible assets. In order to provide transparency in comparing results to prior periods, core earnings has also been redefine to include the results of the consumer banking -- to exclude the results of the consumer banking prior to the spinoff, as well as the related restructuring and reorganization expenses.

So let's begin with slide 3. In the second quarter, we delivered solid earnings of $0.56 per share. We completed the spinoff from Navient from SLM Corporation, announced a $400 million share buyback authority, and returned $128 million to shareholders through share repurchases and dividends, saw a 90 day plus delinquency in annualized charge-off rates for private education loans drop to their lowest level since 2008. And finally, we received notification that Navient's servicing contract with the Department of Education has been extended for five years.

Slide 4 provides a summary of our core earnings. For the quarter, core earnings were $0.56 per share, an increase of $0.04 per share from the prior year. Our 2014 core earnings guidance of $2.05 excludes regulatory remediation expenses recorded in the first quarter.

Our second quarter operating expenses totaled $195 million, a decrease of $12 million versus the first quarter. Compared to the second quarter 2013, expenses increased $10 million. This increase was primarily due to higher third-party servicing and asset recovery activities that improved revenue by $38 million.

Now let's turn to slide 5 to discuss our FFELP segment results. FFELP core earnings were $72 million for the second quarter, compared with $238 million for the second quarter of 2014. The second quarter 2013 included a $257 million pre-tax gain from residual interest sales. The FFELP student loan spread was 98 basis points in the quarter. These assets continue to generate high quality, predictable returns and cash flows. We expect the FFELP student loan spread to remain in the high 90%s for the remainder of 2014.

Let's now turn to slide 6, and our Private Education Loan segment. Core earnings in this segment increased $25 million from the year ago quarter to $86 million. Profitability continued to improve, as spreads remained consistent and losses continued to decline.

Our second quarter student loan spread came in at 4.1%, leading to an increase in net interest income from the prior quarter. We do expect the private student loan spread to be between 4.0% and 4.1% for the remainder of 2014.

Second quarter charge-offs were 2.5%, which is a reduction of the previous quarter and the year ago quarter, and we also saw significant improvement in our total and 90 day plus delinquency rate. The continued improvement in our credit metrics led to a decrease in our provision for loan losses, which came in at $145 million for the quarter, a decrease of $44 million from the year ago quarter. We expect the private education loan provision for losses for the rest of 2014 to be equivalent to second quarter levels.

Slide 7 shows our asset quality trends over time, and how our portfolio is dominated by high quality loans. The dark blue bars in line at the top of both charts represents the highest quality and lowest risk loans in our portfolio. These high quality assets now account for 67% of our portfolio.

By contrast, the light blue lines and bars at the top of both charts represent the highest risk segment, what we call non-traditional loans. These loans are down to only 8% of our portfolio. And as you can see on the chart on the right, losses have steadily declined across all segments in the past four years. This portfolio is well-seasoned, with 91% of our loans having made more than 12 payments.

Let's turn to slide 8 to review our business services segment. In this segment, core earnings were $130 million for the quarter, compared with $168 million in the second quarter of 2013. The decrease is primarily related to the $38 million after-tax gain from the sale of subsidiary in the second quarter of 2013. Navient now services 5.8 million accounts under the Department's Servicing contract. Servicing revenue from this contract was $31 million in the quarter, compared with $26 million in the prior year.

In our asset recovery business, we saw an increase in revenue of 21%, or $23 million over the year ago quarter. As previously disclosed, we expect an estimated $[50] million reduction in fee revenue in the second half of the year, as a result of the bipartisan Budget Act of 2013. This Act will reduce revenue earned from helping previously defaulted loans -- defaulted FFELP loan borrowers rehabilitate their loans. The reduced fee structure will become effective on July 1.

Let's now turn to slide 9 for highlights of our financing activity for the quarter. In the second quarter, we issued $747 million of FFELP ABS, which was the first securitization issued under the Navient name. This trust was secured by both consolidation and non-consolidation loans, and was the first time since 2000 that we blended these asset classes in a single trust.

We achieved better pricing with longer weighted average lives than (inaudible) our prior issuance. The Company acquired $1.3 billion of FFELP loans in the first half of the year. We believe FFELP loan purchase opportunities will increase in 2014.

We closed on $1 billion private education loan asset-backed commercial paper facility during the quarter. This facility is available for private education loans, refinancing and new acquisitions. This week, we priced a $463 million private education loan at ABS. The loans in this securitization were primarily from a 2009 private education trust that matured earlier this year.

This financing was done at AAA spreads that were 115 basis points tighter, and an advance rate that was 20% higher than the original 2009 trust. We will pursue opportunities to refinance our existing secured debt at lower rates, in order to both improve our net interest income and cash flows.

During the quarter, the Board authorized a $400 million share buyback program. In the quarter, we repurchased 4 million shares for $65 million. In the first six months, we have repurchased 12 million shares for $265 million.

Finally, turning to GAAP results on slide 10. We recorded second quarter GAAP net income of $307 million or $0.71 per share, and that is compared to net income of $543 million or $1.20 per share in the second quarter 2013. And as I mentioned before, the primary differences between core earnings and GAAP results are the mark related to our derivative position, goodwill and intangible asset amortization, expenses related to restructuring and reorganization, and the income associated with [F1] banking. Let me now turn the call over to Jack.

Thanks, Somsak. Good morning, everyone, and welcome to the first earnings call for Navient. After a year of hard work, we are now Navient, and it feels very good to say that. With the legal separation complete, we are focused on the final steps to complete the process. This includes the transfer of bank-owned loans to their servicing platform, and the introduction of Navient as the new name in loan servicing to our 12 million customers.

We are well on our way to successfully completing this operational transition this fall, and to ensuring it is a simple and clear experience for our customers. The process to separate into two companies was significant and complex.

Despite this, we completed it on schedule, and with minimal disruption to our day-to-day businesses. I am particularly proud of the work of our team in what we accomplished, and I would like to take this moment to acknowledge this hard work by so many. Thank you.

As a newly independent Company, our attention is on creating value for our customers, our employees, and our shareholders. One of the benefits of our separation will be a tighter focus on our businesses. I have a deep appreciation of the benefit of a tight focus, and I expect this to create meaningful growth opportunities over time for Navient.

Our results for the second quarter were strong on a number of fronts. As Somsak noted, this quarter's results included core earnings of $241 million or $0.56 a share, private credit charge-offs of $166 million, a decrease of 24% over the first quarter, a six year low in federal and private loan delinquencies, and the return of $128 million to shareholders in dividends and through share repurchases. This quarter was a very good start for Navient, and I am confident of our ability to deliver strong results and growth opportunities going forward for our customers, employees and shareholders.

In our FFELP segment, we continue to see stable margins and cash flows consistent with our expectations. This area is a significant source of strength for Navient, and we will look to grow this portfolio and the earnings we generate from it through loan acquisitions.

As we expected, there will be meaningful opportunities to acquire FFELP loans from other holders, and we will be aggressive in pursuing these opportunities at appropriate returns. Our scale, our efficiency, and our industry-leading track record of helping customers successfully manage their loans, create distinct advantages for us and benefits for sellers, as we pursue opportunities in this area.

Our private loan segment continues to benefit from improving credit metrics, delinquencies and defaults continue to fall hitting six year lows, and driving down credit costs. Our loan servicing associates work closely with borrowers to find repayment solutions that not only keep borrowers out of default, but help them make real progress in repaying their debt balances. We will also look to grow our private education loan portfolio through loan acquisitions.

The results in our business services segment are driven by the same skills. We lead the industry in lower default rates in the loans we service for the Department of Education, and we also lead the industry in helping borrowers rehabilitate their default at federal loans, returning their loans to good standing. In fact, for the last reported quarter, our Department of Education serviced portfolio default rate continued to lead all four services, with the next best default rate 50% higher. That is where our -- and the fourth place finisher are 125% higher than our results.

In addition, each week we help nearly 1,200 borrowers rehabilitate their loans. Our expertise and efforts allow us to identify high-risk customers, and enroll them in repayment programs they can manage and avoid default. 9 out of 10 times when we connect with a borrower who is having difficulty repaying their loans, we provide a solution such as an income-driven repayment program that gets them back on track, and avoiding default.

With the student loan topic continuing to receive significant media and political attention, let me share an example of what our analysis is telling us, that will likely surprise you. For the 12 million federal and private loan customers we service, delinquency and default rates are improving. In fact, graduates from the class of 2013 who are now six months into repayment on their federal loans have substantially lower delinquency rates than their peers from the classes of 2009, 2010 and 2011. In fact, as much as 50% lower, and it is the lowest rate since we began tracking this metric nine years ago.

Yes, the Great Recession led to higher default rates, but the improving economy and our default prevention efforts are producing significant improvements. This quarter, the Department of Education extended our servicing contract for a second five year period. We appreciate the opportunity to continue to service loans for the Department of Education, and we will remain focused on providing our industry-leading default prevention efforts on behalf of their customers.

We are also pursuing opportunities to grow in our business services segment. For example, we have seen our business grow in asset recovery, with revenues up 21%, and inventory up 11% over the year ago quarter. We are pursuing new opportunities in this space, particularly in the federal, state, and local government area.

With the separation complete, we see opportunities to grow through portfolio acquisitions, by adding new accounts and loan servicing, and by increasing our inventory and asset recovery. Combined with continued improvements in credit, opportunities to improve our net interest margin through debt refinancing, and a focus on expense control, we see the ability to create value, and generate increasing earnings per share.

Let's now open the call for your questions. Operator? We are ready to take call questions.

(Operator Instructions)

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

Thanks for taking my questions. So I noticed you are reiterating the $2.05 guidance for 2014. It looks like that will be a little slow down in the second half, and I know we are getting the impact from the GAC cuts, but is there anything else in there that is driving some of the conservatism? Thanks.

Yes, nothing at this point. I mean, I think at this stage of the game, we expect all elements of our segments to be fairly steady for the balance of the year. And you are right about the impact of the rehab fee cuts that is running through the second half of the year, but nothing in particular at this point, Mike.

Okay. And then on the credit side, if I heard you correctly I think you were guiding to provision expenses basically flat-lining the rest of the year. Why wouldn't we continue to see that trend lower, if credit is continuing to improve?

Yes. We do expect credit to improve, but one of the things you have got to take into account, Mike, is the fact that we have got to reserve for our TDR portfolio on the life of loan basis. And so, I think that element of the portfolio has to be taken into account, as we look at our provisioning for the balance of the year.

Okay, understood. And then just one more. Can you just provide a little color on the FFELP acquisitions during the quarter? Was it a number of smaller portfolios or more concentrated? And then, as a follow-up on that, with the third largest FFELP holder putting their portfolio into held-for-sale, do you think we are finally now at the inflection point, where you are going to see some legacy holders look to get rid of these portfolios? Thanks.

So the acquisitions year-to-date are primarily from smaller holders, that is correct. In terms of acquisitions from some of the larger players, this is something we expected to see. It is driven by the fact, that it is a legacy asset, no new loans are being originated, higher capital requirements for banks, and increasing regulatory issues there. So selling to people who have demonstrated skills in those areas and can add to it, I think are -- is what we would expect to see.

Thank you very much.

Next question?

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

Yes, thanks. I understand you can't be too specific, but Jack, could you give us high level thoughts on how you are going to approach share repurchases going forward? I mean, should we expect an approach similar to what we saw at Sallie Mae, where there may be multiple authorizations in a year that you feel kind of dependent on your need for capital to fund any asset acquisitions? And if you don't do any, should we expect a total pay out in excess of 100%, given the run-off that you have in the private student loan book?

So we -- we are in the fortunate position of we are generating a substantial amount of capital through earnings each year. And how we deploy that is a function of opportunities, as you say in the space to acquire loan portfolios or build our businesses. And if those opportunities are less attractive than returning it to shareholders, then the dollars go to shareholders.

When we ask for and received authorization for the $400 million, that was an expectation of what we had available through -- for share repurchases for the 2014 calendar year. I would prefer to run that on an annual basis, rather than a quarterly, or semiannual basis going forward.

Got it. Next question is the $195 million OpEx in the quarter, is that a reasonable run rate going forward, subject to changes in level of activity of servicing and selections, or any kind of a one-time items to call out in that?

There are some seasonal aspects to our operating expense levels, particularly as new classes of borrowers enter a repayment or new accounts are added to the portfolio, but I do think this is a reasonable number. There is no where near the seasonality that existed, when we were combined with the consumer lending business as an example.

Okay, got it. And then just finally, are you seeing early signs of confusion among borrowers are the change in the name from Sallie to Navient, and any kind of concern that you could see a spike in delinquencies?

Well, until -- so our customers are continuing to be serviced under the Sallie Mae name until later this fall, when the bank is ready to take on servicing responsibility for bank-owned loans. So that that activity won't take place until later this year. We have been sending communications to customers to alert them of what is happening. We have a very detailed and comprehensive plan to guide customers through the transition and we expect this to be as seamless and unconfusing as possible for our customers.

Got it. Appreciate your comments.

Thank you.

Your next question comes from the line of Sanjay Sakhrani from KBW. Your line is open.

Thank you, good morning, and congrats on the split. I guess, I had just a follow-up question on the Wells Fargo portfolio. I mean, Jack, is there any color you could give us on Wells Fargo, like do you see -- service the portfolio, or does a third-party service the portfolio? Just any anecdotal color you might be able to provide would be helpful?

And then secondly, obviously Sallie Mae bank will be selling and possibly have sold loans. Is there any reason to believe that you wouldn't be buyers maybe in the third quarter? I know in the second quarter, they really wanted to test the market outside of you, but as we look into the third quarter, is there any reason to believe that you guys wouldn't be aggressive buyers of the loans that they are selling?

So we are clearly interested in acquiring both FFELP loan portfolios and private education loan portfolios, and we would include acquisitions, interest in buying loans from the bank as well. We think we are a strong buyer, because of our scale, our cost efficiency, what we bring to the loan performance and sell-through default prevention.

And as long -- when we can pick up portfolios, in particular if we can put them on our system for servicing, those are benefits, distinct advantages for us. And we think they bring advantages for the seller as well, because they will know that their loan portfolios are being served -- well-serviced and their customers will be more likely to avoid default than if they were serviced someplace else.

In terms of the large holders of loans, typically are not serviced on the Sallie Mae servicing platform. Different lenders have different agreements. Some of them are held -- are serviced under life of loan servicing contracts. Some of them are -- they have the ability to be transferred, and each is somewhat unique at each lender. I think that is probably the most I could say, in terms of specific lenders at this point.

Okay. I guess conversely, I mean what is the opportunity to sell residuals today? Is that just a non-opportunity today, given the pricing paradigm?

I think that it depends on the portfolio itself. I mean, we saw in a transaction that occurred in the first quarter, extremely aggressive pricing on a portfolio. We do think that was a little unusual in terms of its strength, so we do look at each opportunity, or opportunities to both buy and sell in this particular space.

Right now, given the value that we are generating from the earnings stream itself, and the amount of capital that we allocate, and so the returns on equity that we can create based on our servicing costs and servicing performance, we think we are better off being buyers than sellers. But that could change.

Okay. And I guess, a final question. Just on the contingency collection side, obviously, you will have an impact starting in the third quarter. Have you seen anything change in the market, as you might have suspected it would among the guarantors? The other income line was a little bit stronger than what we expected it to be in the quarter. Has there been anything that you are seeing on the margin that could be helpful, despite the reduction in revenues you are expecting to see?

Well, we are aggressively pursuing opportunities in an area that we have been building for the last couple of years, which I would call state, local, municipal areas. We continue to pursue opportunities in that space. And those are contracts that are certainly smaller in size than say, the department contracts would be. But it is -- we think we can build a very nice portfolio in that space, and the skill sets that we bring of low cost, performance and compliance are highly attractive in that area to the clients we manage the portfolios for.

Okay, great. Thank you.

Your next question comes from the line of Sameer Gokhale from Janney. Your line is open.

Hello, thanks. I just wanted to drill down a little bit more into the provisioning and the expectation for the rest of the year. And I think what I am a little bit confused by, is the fact that you had that $68 million incremental provision relating to recovery shortfalls. So the first question is, that if your recovery rates are trending below your previous expectations, then why not reduce that 27% estimated recovery rate to something more realistic?

And then, the second question is -- I am assuming this is kind of a catch-up that you do periodically, the $68 million. And Somsak, I know you talked about an inventory of TDRs, but given the improvement in charge-off performance, and the fact that you seem to have made the catch-up adjustment already, and all else equal, it still seems like your incremental provisioning should be driven by your charge-off performance in the portfolio, which is declining some.

So I am just a little bit confused about the dynamics between the two, so if you could just provide some more detail that would be helpful?

Sure, Sameer. Yes, you are absolutely right, that we did increase the reserve for recovery shortfalls. Just from a P&L perspective, that provisioning or that reserve that we have got at this point, really gets us to -- down from a 27% to roughly a 20% recovery rate. So we feel like we are pretty much, from a P&L perspective there on -- to the 20% rate.

That increase in the reserve was more than offset by the reserve that we take for future charge-offs. And that was taken -- just given the fact that our charge-offs had declined by $52 million from quarter to quarter, we did take a decrease in the reserve to account for that improvement performance in the charge-off portfolio. So all-in, we took an increase in our recovery rate reserve, and then that was more than offset by improvement that we saw in our charge-off performance.

Going forward, I am not sure you are going to see the same decline that -- in charge-offs that we see from first quarter to second. And as a result, I think that if you combined that with the TDR performance, I think that is why we are saying, that our provision for losses for the rest of the year will be equivalent to the second quarter levels.

Okay. That -- (Multiple Speakers).

Just to add to that, Sameer, I think the -- when you look at the recovery rates, we historically recovered at 27%. Loans that defaulted during the recession, the Great Recession are not performing at that same level. And we want to make sure before we finalize on a new number that, that we realize that -- was that a temporary phenomenon based on the economy at the time, and the longer duration it takes for those borrowers to recover, versus what we have seen in the past?

And we are seeing recovery rate on the more recent cohorts coming in higher than 20%.

I see. Okay. No, that is very helpful. Thank you for clarifying that.

The other question I had was, the last time I looked at some of the data in terms of portfolios, aside from the other large company that also has a portfolio of FFELP assets, it seems like there were maybe about $80 billion or so of loans -- of FFELP loans that were held by banks and other non-profits, and of that roughly $10 billion would be Wells Fargo. So if you look at the remaining $70 billion call it, can you give us a sense for how much of that $70 billion in loans are serviced by third-parties, versus how much you service?

And do you have a sense for how many of those have life of loan servicing versus a fixed contract period. Because I am trying to get a sense for how much of that potential inventory you could actually win, were you to bid for them? So if you could you help us size some of that, that would be helpful?

Well, we would certainly be interested acquiring loans that -- in the FFELP space from sellers regardless of whether they are capable of being moved on to our portfolio, or if they were subject to a life of loan servicing contract. What it impacts us is, what is the price that we can pay for that?

If it is serviced by a third-party, we cannot change the cost structure associated with that, or the performance of the loans themselves. So if our customers, as an example, default at a [30]% lower rate than the national average, we can't bring that skill and that performance improvement to bear on third-party service loans.

Lenders don't publicly disclose the terms of their servicing contracts, so I couldn't tell you specifically who -- I can tell you where the portfolios are, but I couldn't tell you whether it is life of loan or a portfolio that could be moved. The Department of Ed does publish the top holders list. And so, that list is very well-known. It is -- it includes the large banks, and then a bunch of entities that were consolidator's of student loans several years ago. We think there is opportunities to acquire portfolios from that whole range of institutions, including even potentially some of the not-for-profit holders as well.

Okay. So maybe let me ask the question another way. What is the size of your portfolio of third-party loans, non FFELP loans, so third-party FFELP loans that you are currently servicing?

Our third-party service portfolio is relatively small. For most of the institutions, we were competitors and did not -- the third-party service work we did were businesses that had forward purchase sale commitments to us. So they would originate, hold for a period of time, and then sell. And for the most part, we have acquired most of those loans already off of our servicing platform.

Okay. And then just my last question, you talked about municipal collections earlier. It sounds like you have already been collecting on that type of paper, those receivables. What type of receivables in particular are you collecting on, because there are a wide variety of receivables that you can collect on, when you talk about municipal collections? I mean, it could be fines for parking tickets, library fines, other types of things, taxes. So are there any specific verticals you are focused on?

Yes, so in the state and local arena, we do everything. We do work to run amnesty programs for example. We do collect on unpaid taxes, just as a regular course of business, it could include property income, excise types of taxes. We do court fines and penalties in that space. Obviously, there is a different level of activity that goes on for high ticket versus low ticket items.

But generally speaking, the business that we do in our contingency collection work is that there is an incentive for the customer to want to resolve the open account. That may mean that they can release a lien on their property. They can re-register their automobile, those types of things. So what we don't do in the collection space is really straight up collection work like say, credit card portfolios as an example.

Okay, great. Thank you very much.

You're welcome.

(Operator Instructions)

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

Just a quick question on the reserve, on private loans sitting at 6%. Where do you think that could normalize down to over the next few years as the portfolio runs off? And at the same time, I am making an assumption -- may you can correct me -- that when you buy private student loans from other entities, those would be brought in on a mark-to-mark basis, you don't put up an initial reserve at all? So could you clarify what that might look like going out 12, 24 months?

Well, certainly in terms of performance of the loan portfolio, you are correct, that as loans make payments, the incidents of default drops dramatically. That is true on both private as well as federal loans. And we do provide in the earnings presentation in the appendix, that the actual history of how the default rates or charge-off rates perform as borrowers make more payments. And typically, they drop almost close to half, as you move from the first year repayment to the second, et cetera. So that would give you a good indication of where things are headed.

I think what Jack was referring to earlier in the troubled debt restructuring accounting requirement, is as you deal with delinquent borrowers and make accommodations to get them back on track and repaying their loans, that you move from a periodic loss forecast to a life of loan loss forecast. And an increasing portion of our -- what I would call our at-risk portfolio of default is -- qualify for the TDR status and that is driving the reserve in the opposite way of improving credit trends.

When you buy a portfolio, and you look at your loss levels, it all depends on how you acquire it. If you are acquiring like a distressed portfolio, you are correct, in that your price does reflect that, and you run it through at that level. If you are buying a portfolio in the normal course of business, non-distressed, you do book the reserves, as periodically as we do the loans that are on our books today.

And I will add that today, about a third of our portfolio is reserved on to the TDR accounting model, on the life of loan basis.

Okay. And could you give -- care to give a forecast of how low this could run? Because I am making the assumption that 6% won't be necessary on a go forward basis, especially on your purchases because they will be co-signed and much higher quality?

I think you are right in the direction of where this is headed. We are just giving guidance through the balance of this year at this point.

All right. Thanks.

Your next question comes from the line of Eric Beardsley from Goldman Sachs. Your line is open.

Hello, thank you. In terms of the contingency collections, is this current level in the second quarter an appropriate run rate excluding the decline you expect? Or was there anything that made this quarter particularly high relative to what it might be otherwise?

Well, we did get a benefit from rehabilitations -- in the rehabilitation space you have to sell -- the loan has to be sold, in order for the revenue to be earned by the guarantor, and then paid to the contingency collection agency. And we did see sales accelerate in the second quarter.

But most of what you are looking at in terms of decline will be as a result of the rehabilitation fee cut that Somsak described. And we -- as I said, we are looking to grow this business through new contracts with parties in the state and local arena.

Got it. And then, just back to the reserve coverage, you talked about a large percentage of your portfolio having life of loan. But if we were to just look at it on a number of years of charge-offs, what do you targeting now for that? Three years seems like quite a bit of coverage.

It certainly is. I think our policy has not changed in this sense, we have loans that are not TDR. We reserve for a two year loss cycle, and loans that are TDR are reserved for life of loan. And as the bigger percentage of the portfolio that would be more -- the at-risk kinds of accounts -- fall into that category, you move to the higher levels. And so, that will shrink over time, but it may not shrink as much as you would expect had we -- had loans not moved back and forth -- had not moved into the TDR status. They don't move back and forth.

Got it. So you are looking at a two year forward loss for the rest of the book that is not TDR?

Right.

Right.

Okay, got it. And then as you are looking at loan acquisitions, what is your target hurdle rate?

I am smiling, because it is -- we don't disclose that. If we did, everyone would know how much to bid. (Multiple Speakers).

Yes.

Well, obviously you have different economics than everyone else. So the bidding there would take into account your servicing cost, and everything else that you could achieve in terms of bringing it on to your platform. So I don't know if that is entirely the case. You could have a required rate of return, and that would be the same as someone else, but you could arguably pay more. So just curious on any color -- whether it is high double-digits, low double-digits, or how you think about what the returns that you need are, before you buy something?

You are right in your -- we have low -- if we have better cost structure and better loan performance, we can pay more if we can bring the loans on to our platform. We look, we are buying -- I mean, the equity we are investing requires an equity-like return. And that is probably as much as I want to say on that.

Okay. Is there any color you can share? You had mentioned that the first quarter residual sale that you saw was priced aggressively. I mean, what would the return have been for you if you acquired that, do you have a sense?

We thought that portfolio had yields in the single-digits.

Okay.

Equity.

All right, great. Thank you.

Your next question comes from the line of David Hochstim from Buckingham Research. Your line is open.

Thanks. Just to go back to the loss provisions and the reserves. Just so in the quarter, the $68 million was in the provision, and the provision also reflected the $54 million improvement in charge-offs? That is the way to think about it?

Yes, over the next two year period.

Yes. And so, looking forward, your guidance for kind of flat provisions would assume then that there isn't much of a further improvement at all-in charge-offs? So if there was a further decline in charge-offs, should we expect the provision to come down?

Yes, I mean David, the quarter-over-quarter, our charge-offs went from $218 million to $166 million. That is a huge improvement. And I just don't see that same dollar amount of improvement continuing on through the rest of the year at this stage of the game. I think it will improve, but not at that rate.

Okay. But is it reasonable to think that provisions could still come in below charge-offs in most periods?

Yes. I think that's true.

Okay.

Just kind of look at $166 million versus the -- of charge-offs versus the $[145] million that we booked this quarter.

Right. Okay. But there shouldn't really be another kind of sort of one-time true-up like we had this quarter for at least those vintages? And unless there are -- ?

I mean, are you referring to -- ?(Multiple Speakers).

The $68 million.

Yes, I think that's accurate.

Okay. And then, just give us an update on the direct loan origination contract, what is the timeline, and what is kind of the next step? And do you think -- is the government going to have one originator, or maybe more than one this time?

So the contract went through an initial round of qualification, kind of RFP. We were one of four entities that cleared that hurdle. We -- the new, the final RFP has not been issued yet. We are expecting it in the next several weeks or so.

We think we are well-qualified to deliver the services that are required there, and in particular, can work with customers that help them better understand the debt that they are taking on. The incumbent has done a good job in this space, so it is going to be a -- I would expect it to be a challenging RFP. But it is something we are very interested in doing.

Okay. And then, just on the $1.3 billion of loans that you bought during the first six months, is that split pretty evenly between the two quarters? Or a -- ?

I think it was $900 million for this quarter, and then $400 million in the first quarter.

Okay. And are there small portfolios that could continue to trickle in at those kinds of rates? Or do we, have any -- ?

Yes, we believe so.

Okay, that's it. Thanks a lot.

Thank you.

Your next question comes from the line of Brad Ball from Evercore. Your line is open.

Thank you. Regarding the remaining separation items, Jack, how much of Sallie Mae's private loans are you currently servicing? What is the dollar value?

We are servicing right now 100% of the loan portfolios of the combined companies. Later this fall, the bank's loan servicing platform will be up and running, and their roughly -- was it, $8 billion or $9 billion worth of private loans will move. The [$1] billion dollars of federal loans will not -- and actually, the portfolio of the bank will not move in its entirety. Accounts that, where borrowers have a loan owned by Navient, a split account in effect, will stay on the Navient system as well, for the customer fees perspective.

And is there a financial impact from the move that you are describing this fall?

No. It is -- there is a slight revenue-related impact, but there is no -- it is a nominal earnings contributor.

Okay. And I am sorry, did you say that you will continue to service the FFELP assets owned by Sallie Mae, the [$1] billion or so will stay on your platform?

And there is -- and any loans that are serial, or whether there is a subsequent private loan that Navient owns on the Navient platform.

Okay. And would you expect that if you acquire FFELP assets, private education loan assets from Sallie newly originated, would you be acquiring the servicing as well, or would they retain the servicing?

We would -- for private education loans, we would be very focused on acquiring the servicing. It is -- most of what we see in the servicing space is on private education loans is more of a compliance-driven servicing operation. And having control over the ability to manage and work with a customer to get them in a repayment program, and keep them out of default are something that is very important to the economics of the portfolio.

Yes, okay. That's very helpful. Thank you.

You're welcome.

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

Great, thanks. Jack, could you talk a little bit about the opportunities on the private loan side? I mean, it seemed like late last year there was some discussion about that, and then it kind of cooled down. Just give us some sense there?

Yes. So we do think -- we know the bank, Sallie Mae Bank is going to be a seller of private education loans. That is part of their strategy, and we would certainly be interested in acquiring portfolios in that space.

There is also a handful of lenders that have legacy portfolios of private education loans that they are not servicing, or not originating anymore today. And not dissimilar to FFELP, these loans are -- they require a unique level of regulatory -- they have a unique set of regulatory rules and compliance associated with them, compared to other consumer assets. We are obviously well-structured to provide, and comply with those rules.

And as I said earlier, one of the things that we do better than anyone else is default prevention. And that has just an enormous benefit obviously to the economics, but obviously an enormous benefit to the customer. And we would expect those factors, much as we expect them in the FFELP's side of the equation, to encourage banks who are not in the business anymore to sell.

When you think about why they haven't sold yet, is it more of a price issue, or is it more like a rep and warrant type issue? What is -- what do you think the holdup has been? (Multiple Speakers). I am not talking about Sallie Mae bank. (Multiple Speakers).

There is a variety of factors. It depends on the institution itself. So it could be just -- they are relatively small portfolios, and they just haven't gotten to focus on this piece of the business yet. As you know, banks have been under tremendous pressure on the regulatory front on a -- in a number of different areas. And as they work through those issues, they may turn their focus to their student loan portfolios, right? And you would have to really look and talk to each institution one by one.

Right. Okay. Just the last thing, and not to beat up too much on this whole reserving thing, but given the run-off of the portfolio and the fact that the performance is improving, but there is a time lag for TDRs to go re-performing. I mean, could you talk a little bit about what that time lag is, and what that might mean for -- when you would see kind of that process kind of rollover, where the reserve requirements would be lower?

Well, we wouldn't say TDR loans -- in many instances, when we work with a customer to put them, get them engaged and enrolled in a repayment solution, the performance of the portfolio improves dramatically. So we have something I think, 75%, 80% of customers who go into what we call a rate reduction program come out of the program, and in a year after that, they are current on their accounts. But that is under GAAP accounting, that loan must be reserved for its remaining life, under a life of loan loss forecast.

But look, in a portfolio that is amortizing by definition, the reserves in the provisioning have to go to zero, and it is really that the timing differences of that. So as a higher percentage of the loans to go to TDR, your provisioning issues actually stop. So it is a more conservative approach, but we think that the direction of where we are headed here is lower provisions, lower charge-offs.

Okay. And it is fair to say, that the older loans have higher reserves on them?

Yes.

Yes.

Thanks very much.

You're welcome.

We have no further questions in the queue. I would now like to turn our call back over to the presenters.

Thank you for joining Navient's earnings call today. That concludes the call. Thank you, Ryan.

This concludes today's conference call. You may now disconnect.