Navient Corp (NAVI) 2014 Q4 法說會逐字稿

Good morning, my name is Laurel, and I will be your conference operator today. At this time, I would like to welcome everyone to the Navient fourth-quarter earnings call.

(Operator Instructions)

Thank you. I'll now turn the call over to Joe Fisher, Vice President of Investor Relations. Please go ahead, sir.

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

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

During this conference call, we will refer to non-GAAP measures we call our core earnings. A description of core earnings, a full reconciliation to GAAP measures, and our GAAP results can be found in the fourth-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'll turn the call over to Jack.

Thanks, Joe. Good morning, and thank you for listening in today. I appreciate your interest and your support.

2014 was a busy and productive year. We started the year as one Company with a very long list of tasks to complete, and we finished the year at Navient having successfully completed the legal and operational separation from Sallie Mae. While the separation project consumed most of the resources here, we retained our focus on our business, delivering outstanding performance, and generating strong financial results.

Highlights for the year include, of course, our completion of the separation from Sallie Mae, the acquisition of $13 billion in student loans, we reduced private credit charge-offs by 18% to $717 million for the year. Our servicing skills enabled our federal loan customers to significantly outperform the national average, with the cohort default rate 48% lower than all other servicers.

We distributed $849 million to shareholders through dividends and share repurchases, and we generated $2.10 of core earnings per share. I'm very pleased with our performance in 2014, and the resulting gains for our shareholders. The separation not only provide proof to be a catalyst to unlock the value of our business, but is has also unlocked Navient's potential to grow in businesses beyond education and finance.

While I'm proud of our accomplishments in 2014, I want to focus my comments on here and now, our plans for 2015. Our goals for 2015 can be summed up by one word: growth. We see growth opportunities in each of our operating areas.

In asset management, we continue to see opportunities to purchase both federal and private loan portfolios, and while we are unlikely to repeat the volume acquired in 2014, we believe there will be substantial opportunities in 2015, as the environmental factors remain unchanged. Our competitive advantages also remained intact, but we did see what we believe to be irrational pricing on some portfolios in late 2014. We also see continued opportunities to increase the expected cash flows from our federal and private loan portfolios, as credit continues to improve, and we benefit from lower financing costs and low interest rates.

During 2014, we increased the undiscounted expected cash flows from our loan portfolios by $3.6 billion, including $3 billion from portfolio acquisitions. In our Business Services segment, while total revenues will decline as a result of rehabilitation fee cuts from last year, and the wind-down of the transition services we provided to Sallie Mae Bank in 2014, we expect to see growth in our loan servicing business from both the Department of Education and third-party service contracts. We also see opportunities to grow our municipal asset recovery business, and believe we will have the opportunity to bid on meaningful government collection contracts.

Our success and opportunities in this area are driven by our strong performance. Our goals are to deliver industry-leading results, and to enable customer success, while doing so in a cost-effective and compliant fashion. We believe our industry-leading performance, cost efficiency, and control structure are significant competitive advantages.

The improving economy and growth in employment to young workers is helping student loan performance. We also see borrowers making better decisions, allowing them to successfully manage their student loan payments. The fact is that nationally, delinquencies and defaults are declining, and Navient is leading the way with more customers enrolled in affordable repayment programs, and dramatically lower default rates, compared to the national average.

With the separation complete, we'll return our focus to improving our operational efficiency. We have a long track record of annual efficiency gains, and we are confident we can continue to produce further improvement.

We are also keeping our commitments to return the value we create to investors. In December we announced new authorization to repurchase up to $1 billion in our common stock. This authority is based on a very strong capital foundation, and very sizable and predictable cash flows generated by our student loan portfolio.

Given the seasoned nature of our portfolio, our significant reserves and conservative funding approach, we allocate 50 basis points of capital to our FFELP portfolio, and 8% to our private loan portfolio. The result is an exceptionally strong capital base, well in excess of our capital allocations. It supports our outstanding debt, our capital return plans, and the investment required to support our growth objectives.

To borrow a phrase, our predictable cash flow, high percentage of duration matched debt, and strong capital base truly creates a fortress balance sheet. While our outlook for growth is positive, I'd like to remind folks that 2015 will need to overcome some significant headwinds. For example, the rehabilitation fee cuts in the amortization of our FFELP portfolio will reduce net income from these businesses by an estimated $75 million in 2015.

In addition, we continue to field a number of information request and exams from federal and state regulators, and expect the level of activity in 2015 to remain similar to last year. Though these requests are time-consuming and expensive, we are committed to being a responsive partner. We are confident in our ability to generate core earnings per share of $2.20 in 2015, and to generate ongoing EPS growth in the years beyond.

I see a Company and a team with significant strengths, and with the cash flows, performance, efficiency, and controls to grow and succeed, creating value for our customers, employees and shareholders.

Somsak will now provide more details of our financial results for the quarter and the full year. Thank you.

Thanks, Jack. Good morning, everyone. During my prepared remarks, I'll be referencing the earnings call presentation, which is available on our website beginning with slide 4, which provides a summary of our core earnings.

Excluding expenses associated with regulatory matters, we earned $2.10 per share for the full year and $0.54 per share for the fourth quarter. As Jack mentioned, we expect our core EPS to be $2.20 for 2015.

Our fourth-quarter operating expenses totaled $206 million and $804 million for the year. These expenses include a $4 million incremental cost, related to the $9.5 billion of loans acquired during the quarter.

We do expect to transfer a majority of these loans to our servicing platform by the third quarter of 2015. As a result, we expect to incur one-time conversion expenses of approximately $25 million, and ongoing incremental servicing expenses of approximately $20 million in 2015.

Let's turn to slide 5 to discuss our FFELP segment results. Core earnings were $82 million for the fourth quarter, compared with $81 million for the fourth quarter of 2013.

FFELP student loan spread was 100 basis points in the quarter, as these assets continue to generate high-quality, predictable returns and cash flows. For 2015, we expect our student loan spread for FFELP to be in the mid-90s. We acquired $9.5 billion of FFELP loans during the quarter bringing our year-to-date FFELP loan acquisitions to $11.3 billion.

Let's turn to slide 6 and our Private Education Loan segment. Core earnings in this segment increased $6 million from the year-ago quarter to $92 million. Profitability continues to improve, that spreads remain consistent, and losses continue to decline.

Our fourth-quarter student loan spread came in at 3.99%, and for 2015, we expect our student loan spread for our private portfolio to be approximately 4%. Charge-offs for the fourth quarter were at 2.5%, which is a significant reduction from the year-ago quarter.

We continue to see year-over-year improvements in both our total and 90-plus day delinquency rates. The improvement in our outlook for future charge-offs led to a decrease in our provision for loan losses, which came in at $128 million for the quarter, and that's a decrease of $24 million from the year-ago quarter.

Slide 7 shows our asset quality trends over time, and how our portfolio are dominated by high-quality loans. Our highest risk segment, what we call non-traditional loans is now down to only 8% of our portfolio.

As you can see on the chart on the right, losses have steadily declined across all our loan segments in the past four years. This portfolio is well seasoned, with 91% of our loans in repayment status having made more than 12 payments.

Let's turn to slide 8 to review our Business Services segment. In this segment, core earnings were $98 million for the quarter, compared with $187 million for the fourth quarter of 2013.

We saw a decrease in our asset recovery revenue of $28 million versus the year-ago quarter. This decline was driven by the Bipartisan Budget Act of 2013, which reduced the revenue earned from helping previously-defaulted federal loan borrowers rehabilitate their loans.

The new reduced fee structure became effective on July 1, 2014. We do expect our asset recovery revenues to be between $75 million and $80 million per quarter during 2015.

The Company now services 12 million borrowers, with 6.2 million borrowers under the Department of Education servicing contract. Servicing revenue from this contract was $34 million for the quarter, compared with $31 million in the prior year.

Let's turn to slide 9, and review the increases we have seen in our projected cash flows from our educational loan portfolio. This portfolio is expected to generate significant and predictable cash flows of $36 billion over the next 20-plus years. In 2014, we received actual cash collections of $2.7 billion, but yet added $3.6 billion of future cash flows through acquisitions, refinancings, improvement in credit quality, and additional floor income.

During the quarter, we added more certainty to our cash flows by hedging $14 billion of loans, and locking in on $660 million of future for income. To date, we have locked in or hedged $1 billion of the $1.9 billion of projected future for income. We do expect to enhance these cash flows in meaningful ways, as we take advantage of the marketplace overall.

I'm going to move to slide 10 and highlight our loan acquisition and financing activity for the year. We acquired $13 billion of loans in 2014, and closed on a $10 billion ABCP facility that helped finance these acquisitions. We do believe that student loan purchase opportunities will continue, going forward.

On the financing front, our ABS transactions continued to attract strong investor demand. For the year we issued $6.8 billion of ABS. Just last week, we priced a $689 million private ABS transactions, which came in at tighter spreads than our previous private ABS fee.

During the quarter, we repurchased 8.7 million shares for $168 million. For the full year, we repurchased 30.4 million shares for $600 million.

During the fourth quarter, the Board authorized a $1 billion share repurchase program. All of this activity was undertaken while maintaining a strong capital position.

On slide 11, you will see that since 2006, we have increased our tangible equity ratio, as well as our net asset ratio, while at the same time reducing our unsecured debt outstanding from nearly $50 billion to $17.5 billion today. We feel that our debt maturities are well-matched to our expected cash flows, and our coverage ratios are conservative.

At year-end 2014, our tangible equity ratio was 2.6%, compared to 2.3% in 2013. With a well-seasoned portfolio and conservative funding strategy, we believe that the appropriate capital level for our private credit portfolio is 8%. In the past, when we were an originator of private loans, we had provided an additional 4% of capital against these assets.

And finally, turning to GAAP results on slide 12 we recorded fourth-quarter GAAP net income of $263 million, or $0.64 per share. That's compared to net income of $270 million or $0.60 per share for the year-ago quarter. The primary differences between core earnings and GAAP results are the marks related to our derivative position, expenses related to the restructuring and reorganization, and the income associated with SLM Bank Co prior to the spin.

Just to reiterate, our core EPS guidance of $2.20 for 2015 includes FFELP student loan spread in the mid-90s, private student loan spread of approximately 4%, one-time conversion expenses of $25 million, and ongoing incremental servicing expenses of $20 million in 2015, and asset recovery revenues between $75 million and $80 million per quarter.

With that, I would like to now open the call for questions.

(Operator Instructions)

Sameer Gokhale, Janney Capital Markets.

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

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

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

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

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

Sameer, what we try to do is go through, and there's no exact science in that, but what we try to do is look into the environment beyond more than just the intermediate period, and the hedge that we entered into clearly locked into floor income that went from 2017 to 2019. So what we are trying to do is just lock in, what I will call a longer-term value of floors. Up through 2019 more than anything else.

Okay. Then just my last question, on the share buyback authorization for $1 billion. How should we think about that? Would you plan to spend all of that this year?

Is that contingent on how much you might acquire in terms of FFELP or private student loans, or how do you think about that? Should we assume some of it will bleed into 2016?

So the authorization takes into consideration our assumptions for loan acquisitions, our capital generation, the investment that we will make into supporting our growth objectives. We do expect the majority, if not all of that, to be used in 2015.

However, it is a function of the environment. If we see opportunities to buy portfolios greater than our projections, that could alter some of that, private credit loans, less so on the FFELP side. But that's our plan at the moment.

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

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

Okay. Fair enough. Thank you.

Michael Tarkan, Compass Point.

This is actually [Andrew Resselsen] on for Mike. My question is just to clarify regarding the 2015 guidance, does the $2.20 include assumptions for share repurchase or M&A activity?

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

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

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

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

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

That's it for me. Thank you.

Mark DeVries, Barclays.

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

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

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

Yes, it is in our forecast, but generally, what we have been able to do year-over-year is improve the operating cost of our internal operations. So that would be everything from what is our cost to service a loan in repayment, to what is our cost of collecting on a delinquent account, to porting new acquisitions onto our servicing platform. What we typically do, is we measure the unit activities in those areas, and over the years, we've been automating a number of the functions in that space, improving both our operating efficiency as well as the control structure associated with those activities, and we continue to see opportunities to do that.

An example of a big item that we rolled out last year, or this fall 2014 fall, was our mobile web application for customers, and this dramatically simplified their ability to make payments on a mobile device, which our customers increasingly do. It gave them the flexibility to actually make -- allocate those payments to specific loans, and that both is a customer experience benefit, but it also improved our operating expense, as that function was previously more manual.

Got it. Then finally, can you just give us some color on the types of FFELP loans you acquired in the quarter outside of the Wells deal? I guess there was $1 billion of other loans. What type of loans were those, and give a sense of how the returns on those compare to your portfolio, your average portfolio returns?

It is a variety of different smaller portfolio purchases, a good piece of these are purchases coming from guarantee agencies, as borrowers are rehabilitated and the loans are returned to good standing. Then smaller portfolios that we acquired, some of which were on our servicing platform, some of which were not.

The returns vary pretty significantly, depending upon the different features there, or characteristics of a loan. Obviously, loans that are on our servicing platform have -- can generate the best returns after operating expense, because the incremental cost is relatively low to service, compared to a third-party service contract, as an example.

Got it. Thanks.

But the returns, I would say, they are consistent with the spread guidance that Somsak gave for our FFELP portfolio in his remarks.

Okay, thanks.

(Operator Instructions)

Sanjay Sakhrani, KBW.

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

No, they do not.

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

So yes, so each year the Department of Ed increase is really coming from two things. It is coming from the loans that were added in the last calendar year, having a full-year impact on the revenue stream. More of those loans in repayment, which we get paid a higher fee, there's also a higher costs associated with servicing those loans.

Then each year, the Department uses their scorecard mechanism to reallocate the volume, and based on our scores for the last measurement period, where if we increased our allocation share to 24% of new placements for the upcoming year. Those are the big drivers.

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

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

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

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

Great. Thanks for taking my questions.

Alan Straus, Schroder's.

Just curious what tax rate are you assuming for the year? And the second question is on the private student loan side, do you see any chance of acquisitions? Is this something you're interested in, besides from Sallie?

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

On the private acquisition fronts, yes, we are definitely interested in acquiring portfolios in that area. We do see opportunities and are pursuing them for acquisitions outside of Sallie Mae Bank. They are much smaller than the FFELP side, but the returns, as you can see from the margins that Somsak provided in his opening remarks, are about 4 times what they are in the FFELP space.

Those can be very attractive opportunities. We deliver a lot of value when we acquire them, because of our servicing capabilities.

We are very good at helping customers understand their payment obligations and find payment solutions that they can afford. Our programs there have been out, and have really led the industry on that side, and we see it in our default performance.

Just a follow-up, what's the stumbling block that there have been so few acquisitions? Is it all price or is it regulatory issues?

I think it is a bit of both. Frankly.

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

No, I think it is just getting people comfortable with the process. Demonstrating what we're doing on that side of the equation, and how we're helping customers. I also think that if the loans are third-party serviced, the regulatory environment and ownership of the lender over that third party's performance is a growing factor, that is driving the interest of banks in particular to sell.

So when you look at on the FFELP side, that's a very significant factor. I've got to oversee a third-party vendor as if it is my own internal shop, for a business that I'm not in any longer. I think that's a factor that's driving the desire to sell. It's true of both federal and private.

Okay, thanks.

[Connor Pickett].

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

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

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

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

Okay. Thank you. I appreciate it.

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

Thank you for joining our conference call today.

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