Navient Corp (NAVI) 2015 Q2 法說會逐字稿

Good morning. My name is Stephanie and I will be your conference operator today. At this time, I'd like to welcome everyone to the Navient second quarter 2015 earnings conference call.

(Operator Instructions)

I would now like to turn the call over to Mr. Joe Fisher, Vice President of Investor Relations. You may begin.

Thank you, Stephanie. Good morning and welcome to Navient's 2015 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 in the Company's Form 10-K and other filings with the SEC.

During this conference call, we will refer to non-GAAP measures we call our core earnings. A description of core earnings, full reconciliation to GAAP measures, and our GAAP results can be found in the second quarter 2015 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, everybody, and welcome to our second quarter's earnings call. Thanks for listening and I appreciate your interest and support.

Even though the financial performance on many of our segments of our business were strong, a few areas were not. This quarter's results and our revised guidance for 2015, a clearly a disappointment in direction and impact. Our results and the change in guidance were really driven by three main items. First, our original forecast assumed we would be able to purchase private education loans this year. Aggressive bidding from others and delayed timing by some sellers reduced the prospects here. While we still expect to have the opportunity to bid on private loan portfolios later this year, if successful, they will likely occur too late to contribute to this year's earnings.

Also included in our forecast was the ability to refinance some of our higher cost asset-backed securities issued during the recession. The opportunities to do so have not materialized thus far, though we will continue to pursue them. Finally, we're seeing higher default rates than we projected in a narrow segment of our private loan portfolio. This segment of borrowers returned to school during the great recession and exited from their in-school deferment in 2014. The size of exits also increased to $2.5 billion in 2014, up from $1.8 billion in 2013. We expect deferment exits to decline to $1.7 billion in 2015. These 2014 exits, which do not include borrowers who are entering repayment for the first time, are experiencing significantly higher levels of delinquency and default than prior cohorts. As a result, we increased our loss forecast for 2014 by approximately $100 million. We believe we have this issue well reserved for.

While the impact on our financial results for 2015 from these items is not insignificant, they're not reflective of the larger story here. First, our expected cash flows from our student loan portfolio remain a sizable $33.2 billion and year to date, our student loan portfolio generated $1.6 billion in loan-related cash flow and we added $500 million in expected future cash flows from a combination of student loan acquisitions, net of financings, and increased forecast of Floor income.

This quarter also saw positive trends in several other areas. For example, we purchased $1 billion in student loans, we achieved a second place finish in the Department of Education loan servicing scorecard, driven by our industry-leading default prevention success. We saw another year-over-year improvement in new college graduate credit trends and generated strong growth in fee income from our asset recovery businesses and we returned over $360 million to shareholders through share repurchases and dividends.

Earlier this quarter, we announced organizational redesign and the corresponding restructuring. This effort is designed to align our business units to further improve organizational effectiveness and efficiency. We created two main business teams: an asset management and servicing group and an asset recovery and business services group. We also streamlined layers to improved speed of execution, efficiency, and enhance the lines of responsibility in these business areas.

While the primary objectives of these changed, changes which contributed to a restructuring charge of $29 million this quarter, which will improve the effectiveness and align our team into the related business groups, these changes will also improve our operating efficiency going forward. For example, we expect to see a total run rate benefit and operating expense of approximately $25 million in 2016. Growing our fee-related business lines and improving our operating margins continues to be a major area of focus for us. For example, we have been successfully growing our asset recovery revenue with a focus in areas beyond student loans. Earlier this year, we acquired Gila, a $70 million in revenue asset recovery and business service company, to add to this effort.

The integration process has proceeded very smoothly and Gila's management team has quickly demonstrated their capabilities with the successful implementation of a large and very complicated services contract and overall performance better than expectations. We continue to look for opportunities to expand our asset recovery and business services skills into new areas.

In our loan servicing operations, we also continue to deliver superior results. We excel at helping our federal student customers successfully manage their student loans with overall default rates that are 48% lower than all other servicers combined. Our efforts to help our customers understand the very complex array of repayment options available to them and select the option that helps them successfully manage their loans. While our efforts continue to produce lower delinquency and default rates, the economy is also helping borrowers as they leave school. Combined, these factors are driving significantly better loan performance.

Each spring, we track the performance of recent graduates as they enter repayment for the first time. Looking at the performance of recent graduates six months into repayment, we see that the incidence of severe delinquency has fallen each and every year from a recession high of 22% for the class of 2010 to a low of 8% for the class of 2014, the most recent graduating class to enter repayment. Our better than average delinquency and default performance is the result of our data-driven outreach efforts that help us reach borrowers and offer affordable solutions. This is why we advocate so strongly for customer contact. It works.

With the reauthorization of the federal student loan programs gearing up, we've been strong advocates for program simplicity and for tools that help students and families make better decisions about paying for college before they borrow. Today, in the federal loan programs, there are 15 repayment options, eight loan forgiveness programs, and some 35 forbearance and deferment options for federal borrowers to navigate. Not surprisingly, our customers seek our help to understand the options they're eligible for and how to choose the plan that works best for them. These federal efforts, however, are focused on helping borrowers manage payments only after the loan is made. Simplifying this complexity and helping borrowers make more informed decisions before they borrow should be top priorities.

Moody's and Fitch's ABS teams recently wrote about the impact of extended repayment options on federal student loan asset-backed securities. In their view, this may impact whether or not a bond is paid in full by the bond by the final maturity date. We actively monitor the performance of our student loan securitization trusts, including adherence to the legal final maturity date. Since 2013, we have a amended 17 trusts and exercised loan purchase rights of $428 million to address potential issues here. In order to amend the legal final maturity date, we encourage noteholders to reach out to us so we can work with the agencies to modify the terms and successfully resolve this potential issue.

As the largest issuer of student loan-backed securities, we take our leadership role seriously and we're working with the rating agencies, trustees, and investors to develop alternatives to minimize any impacts to our ABS investors. These efforts are consistent with our commitment to maintain a strong financial profile for our investors. Our capital and liquidity remain both strong and conservative given our risk profile and our reserves for loan losses cover more than two times annualized charge offs. Our capital return approach is fully consistent with these commitments.

At Navient, we have made a significant and ongoing investments in customer success, and compliance. We believe that our success is aligned with our customer's success. Since the recession, we've been engaged with several regulatory agencies and have responded to numerous data requests. While these inquiries are time and data intensive and therefore costly, our focus is to remain responsive and collaborative. We also make the effort to provide additional insight into the trends we see and the efforts we make to drive customer success. We're extremely proud of our track record in producing the highest success rates in the industry. We believe our experience, and ability to use our deep data to continue to drive customer success are the foundation of our continued ability to add value.

Finally, while I am deeply disappointed with the impact a few areas had an our financial goals, I am confident in our ability to execute on our business plan and I am committed and our team is committed to creating value for our customers, employees, bond investors, and shareholders. With that, I'll turn it over to Somsak for a more detailed view of the financial results.

Thanks, Jack. Good morning, everyone. During my prepared remarks, I'll be referencing the earnings call presentation, beginning on slide 4, which provides a summary of our (technical difficulty).

In the second quarter, we reported $0.40 per share and that's compared to $0.56 per share from a year-ago quarter. Our second quarter operating expenses totaled $225 million compared to operating expenses of $195 million from a year ago quarter. The increase in operating expenses were related to incremental costs resulting from the recent acquisition of Gila, incremental third party servicing costs related to the $8.5 billion of loans acquired in the fourth quarter 2014, higher servicing and asset recovery volumes, and increased regulatory compliance costs. We expect core EPS to be approximately $1.85 in 2015 and operating expenses of less than $900 million for 2015.

Now let's turn to slide 5 to discuss our FFELP segment results. FFELP core earnings were $93 million for the second quarter compared to $72 million in the second quarter of 2014. In the quarter, the FFELP student loan spread was 91 basis points and the associated NIM was 81 basis points. The FFELP NIM may be impacted by future loan acquisitions and future LIBOR rates, which will impact the amount of unhedged Floor income in our portfolio. We do expect the FFELP net interest margin to range between 81 and 85 basis points for the second half of 2015.

Let's now turn to slide 6 and our private education loan segment. Core earnings in the segment decreased by $64 million from the year-ago quarter to $22 million. Our second quarter student loan spread came in at 3.66% and the associated NIM was 3.55%. Compared to the prior year, the net interest margin was primarily impacted by the interest rate reserve adjustments associated with the increase to our provision for the quarter and higher cost of funds. The increase in our provision for loan losses, which came in at $191 million for the quarter, came as a result of the segment of borrowers that Jack mentioned previously. These borrowers exited deferment in 2014 and are experiencing unfavorable credit trends compared to those who exited deferment in previous years. For the second half of 2015, we do expect the private student loan net interest margin to range between 3.83% and 3.85%. We expect the provision for private education loan losses to be between $575 million and $600 million for 2015.

As a result of the recent performance and our long-term recovery rate on defaulted loans, the Company changed its recovery rate assumption on charge-off loans to 21%. In recent years, we have been charging off periodic shortfalls and expected recoveries against our allowance for private education loan losses and the related receivable for partially charged-off loans. The $330 million adjustment eliminates the allowance for estimated recovery shortfalls and reflects the Company's confidence in its long-term recovery rate assumptions.

Our second quarter charge-offs came in at 2.7% or $13 million higher than the second quarter of last year. Total delinquency was at 6.8% and that's compared to 7.1% from a year ago. The forbearance rate was 3.7% compared to 4.2% from a year ago. Slide 7 shows our asset quality trends over the last five years. Our portfolio is well-seasoned with 93% of our loans in repayment status having made more than 12 payments. And our highest risk portfolio, what we call non-traditional loans, is down to only 8% of our portfolio. We expect annualized charge-off rates for the second half of 2015 to between 2.2% and 2.4%.

Let's turn to slide 8 to review our business services segment. This segment, core earnings were $90 million in the quarter compared with $130 million in the second quarter of 2014. We saw an increase in our asset recovery revenue of $10 million versus the first quarter. This increase was primarily related to the full integration of Gila, which expands our footprint in the asset recovery and business process outsourcing space. The decline from the year ago was driven by the new reduced fee structure for guarantee agencies, which became effective on July 1, 2014. We expect asset recovery revenues to be between $360 million and $370 million for the year. The Company services loans for more than 12 million borrowers with 6.1 million borrowers under the Department of Education servicing contract. Third-party loan servicing revenue increased to $47 million in the quarter with $35 million coming from the Department of Education servicing contract.

Let's turn to slide 9 for highlights of our loan acquisition and financing activity. We acquired $1 billion in student loans in the second quarter and while we removed future private loan acquisitions from our guidance, our best opportunity for loan purchases remain with whole loans that we can convert on to our servicing platform in order to take advantage of our significant cost advantage and servicing and our ability to deliver superior performance and customer success. In the quarter, we issued $1.8 billion of asset-backed securitizations. And as Jack mentioned, we are proactively working with rating agencies and investors to develop alternatives to minimize any impact to our ABS investors.

In the quarter, we repurchased $522 million of unsecured notes. In 2015, we have reduced our unsecured debt outstanding by roughly $1.2 billion through repurchases and maturities. In the quarter, we repurchased 15.2 million shares for $300 million. We do have remaining authority of $400 million under our current share repurchase plan. All of this activity was undertaken while maintaining a strong capital position and as of June 30, 2015, our tangible net asset to unsecured debt ratio was at 1.25 times.

And finally, turning to GAAP results on slide 10, we recorded second quarter GAAP net income of $182 million or $0.47 per share. That's compared to net income of $377 million or $0.71 per share in the second quarter of 2014. Just as a reminder, the primary differences between core earnings and GAAP results are the marks related to our derivative positions, expenses related to restructuring and reorganization, and the income associated with SLM Bank Co. With that, I will now open the call for questions.

(Operator Instructions)

David Hochstim, Buckingham Research.

Good morning. Could you just talk about your thoughts regarding potential sale of some private loans? If prices are too high to buy, would that suggest that it would make sense to sell some loans? I have another question.

Sure. So we do look at this as both the purchaser and a seller of loans. I think if we look at the marketplace overall, we would say that the prices that people are willing to pay for portfolios is aggressive, but it is not what I would call particularly deep and so, we have looked at opportunities in that area. We have sold some FFELP portfolios, principally ones that were not serviced by us to reflect that and would continue to look at opportunities in both the federal and private space going forward.

And the FFELP loans that you bought, how many different sellers were there?

It was a variety of portfolios from both guarantee agencies and banks.

Okay. You or Somsak just talked about the chart on slide 7 that you update every quarter with the loss performance of low risk, moderate risk, and elevated risk loans. And just talk about how the slug of the $2.5 billion relates to these different segments.

So on the deferred exits, they really do cross all of the different components that are shown here and so they are not unique to any of these risk segments that we broke out on this chart. This is what I think makes us a little bit unusual. What we saw in this portfolio, compared to other years, is obviously a worse default performance as the loans came out of the in-school deferments. When we looked a little bit deeper at these loans, we saw that this year's cohort had a higher percentage of borrowers who were having difficulty making payments before they had returned to school than prior portfolios. And, in particular, this portfolio had multiple occurrences of in-school deferments, meaning that these customers exited school, entered repayment, returned to school, exited school, entered repayment, and then went back again and that's what's a little bit unusual.

Normally, our in-school deferments are students from the undergraduate side going back to get a graduate degree and here, I think we're seeing a little bit more of students who are working hard to get their undergraduate degree. And with the recession impact, we just, you know, they did not perform. When we look at the overall delinquencies, particularly our high level delinquencies, over 90 days, we are, at June 30, $1 low for the last year, and a low that is a rate that is $150 million less than what we were at year-end. So I think this issue is somewhat behind us. Our reserve policy, which looks at a two-year window, certainly covers future expectations at similar rates from exits going forward. But both that and the lower dollar amount, we think we've got this issue under control at this point.

Okay, thanks. Maybe one last quick question before get in the queue again, in asset recovery, are there contracts that Gila or the rest of the business is looking at that might be additive this year or is it more kind of a longer-term story?

No, so this is a business that we've seen good growth at and our focus has really been growing our business outside of the student loan arena, particularly with state and local governments. That's one of the big drivers of adding Gila to our portfolio. Those contracts, particularly at the state and local level, are more numerous. They're also smaller in size. So yes, we do see opportunities to win new business in that area this year and will contribute to this year's earnings results and going forward, as well.

Okay, good. Thank you.

Welcome.

Sameer Gokhale, Janney Montgomery Scott.

Great, thank you. Jack, could you or Somsak just talk about the inventory of those higher risk receivables? Because you've talked, I think, about the dollar amount of loans that are exiting repayment out of this higher risk category, but if you were to just look at this point in time, at the dollar amount of those loans which fall into that higher risk category, that you size that for us?

You're talking about the non-traditional loans?

Yes, because as I understand it, these loans that have contributed to the increase in the charge-offs weren't necessarily non-traditional loans, they were just high risk spread across the buckets. And I think you talked about the $2 billion-plus in 2014 that entered repayment and then those $1.8 billion in 2015 and $1.7 billion in 2015 and I was just trying to get a sense for the total inventory of the high risk loans in total if you could size that?

Sameer, I wouldn't necessarily call them high risk loans. These are just basically loans that are what we have left to go through are the remaining loans and deferment. As Jack mentioned, we've got $1.7 billion of loans that are scheduled to exit deferment. I think what Jack's talking about is a good chunk of those loans will now be, what I'll call traditional deferment exits, more of the traditional borrower that got an undergraduate degree and then got a graduate degree afterwards.

Okay. Because I'm just trying to get a sense for, there was some percentage of your loan portfolio that I think, when you initially made the announcement, you said there was some high-risk and I think it was Jack characterized it, there would be students who kind of dropped out or went back to school again, and then they just had trouble making repayments. I just want to see if you can isolate that piece of the portfolio, just so we get a sense for that slug of it relative to the rest of your portfolio, which is performing well. So is there any way for us to size it? That's what I was really getting at.

I think you need to look at the -- it's the inventory of what's entering or exiting deferment is really what I would focus on, Sameer. It's the $2.5 billion that exited in 2014, $1.7 billion that will exit in 2015, and we expect that number, and obviously new borrowers can go to school, but the projections would be for 2016 exits to be under $1 billion. So it's moving in the right direction, our portfolio is becoming more seasoned, as Somsak provided in his statistics, and the performance becomes more predictable as borrowers are seasoned. This segment of borrowers who moved in and out of school several times during the recession and finally, have exited more permanently now, saw loss rates that were 45% higher than what we saw in 2013's cohort. We certainly are reserved for that at this stage in the game, but we don't expect that kind of performance going forward.

Okay. And then on another note, I was just curious if you could share your thoughts given widening debt spreads? If you could just talk about how you think about share repurchases, capital return to shareholders versus just retiring debt. I know that you did some this quarter again versus issuing new debt and refining out maturing debt. How do you think about that at this point in time?

So, our share return policy and the practices that we follow here are driven by the fact that we generate a significant amount of capital each year from the earnings of our loan portfolio. And so the dollar amounts that we returned this year are really a reflection of those kind of strong and consistent cash flows. As principle comes down and is collected on the loans, the debt is repaid and it's the spread in the earnings that we generate that goes back to shareholders is that profit margin and in fact, we don't expect that to change in terms of our philosophy at this point. And we'll continue to be active in both share repurchases and dividends consistent with the earnings and the excess capital generate each year.

Okay, and then just a last question on your servicing revenue, it seemed to have jumped a bit to $106 million from I think $77 million or so last quarter, if I'm looking at the numbers correctly. I was just wondering what -- this was on the asset recovery revenue, I was just wondering why that might have increased so much sequentially?

Sure. Basically, during the quarter, Sameer, we made an adjustment relative to servicing revenue to reflect the day one recovery expectation for late fees that are assessed against our portfolio. Basically, that's a true up calculation as previously would have been recognized income or late fee income more or less on a cash basis.

Okay. So you just changed your estimate for your expected recoveries of those late fees? That's essentially what happened?

That's correct.

Okay, okay. Great, thank you.

Sanjay Sakhrani, KBW.

Thank you. Good morning. I just have a question on the NIM guidance and your comfort level going forward on the FFELP NIM guidance. Maybe you could just talk about your cost of fund assumptions and what the options might be to do better or worse than those assumptions? Maybe if you could just speak to the specific impacts that you might be seeing right now from the Moody's downgrades? That would be helpful, as well, thank you.

Sure. Our NIM guidance for the rest of the year is between 81 and 85 basis points. I think given that vast majority of our portfolio is now funded to term, I think that cost of funds element for the rest of the year is pretty much locked in. I think the variable going for the rest of the year is going to end up being where LIBOR rates end up, which will have an impact on, ultimately, what our unhedged Floor income and that will be a variable to the spread for the rest of the year.

And the Moody's, is there a specific impact that you're seeing?

Not for the rest of the year. It would only impact any financing activity that would occur going forward. But at this point, any of that impact really wouldn't have much impact on the spread for the rest of 2015, because those transactions would come in late in the year. I think it will be a little premature to see what the ultimate impact on the future funding costs will be until they take action and we see with the results are.

Okay.

I would just to add to that, the loans are -- this issue is a timing of payments, not a timing of earnings capabilities or generation from the portfolios that are interest accruing loans are generating the margins that we expected them to and it's actually by extending the term, you're actually increasing the amount of cash flows that you'll earn from the trust or collect from the trust over the life of the loan. We have tools available to us to kind of manage this process. We do need some -- we can work with investors on this front. I think combined, given the size of our issuance in this area and our leadership role and working with investors rating agencies and the trustees, we hope that this will -- we will be able to come up with some resolutions that will cause no disruption in this marketplace.

Okay. I mean, is it fair to assume that this could be additive for you guys if you're buying back these trusts or pieces of these trusts?

Not necessarily. All you're doing is when we buy loans back from the trust, you're recycling them into new asset-backed securities.

Okay. Got it. And I guess I have a question on the segment that you saw elevated losses in, are there any other segments like this one in other categories that might -- where there might be higher risks in the future of higher defaults or anything? Is there anything else that we should be concerned about going forward?

So, I think the things -- we pay a whole lot of attention to is the portion of the portfolio that has been making payments for extended periods of time. And once a borrower is in that mode, the incidence of delinquency and default declines progressively each and every year as the number of payments grow. The majority of our portfolio is now in that mode and so we had this small segment move in and out of repayment a couple of times, primarily I would say due to the great recession and as long as the economy kind of stays where it is, we wouldn't expect to see a disruption. In fact, we believe our portfolio performance becomes more predictable as customers mature and season through cycles here.

Okay. Great. One final question, and I want to follow up to what Sameer was asking on the share buyback. You talked about the levels of capital you operate and the fact that you're operating at higher levels of capital than what you might going forward. Is there any appetite to maybe use some of that excess capital to buy back additional shares, given where the stock is?

So I think our capital position has been consistent over this time frame in terms of both how much we expect to generate and how much we expect to return to shareholders. Generally, we like to have -- we don't want to run right down to the edge of where we set our standards. It gives us flexibility in terms of opportunities to buy loan portfolios, look at opportunities and asset recovery business, for example. Our preference right now is just kind of stay with that framework.

Okay. Thank you.

Welcome.

Eric Beardsley, Goldman Sachs.

Hi, thank you. Just a question on the targeted OpEx savings of $25 million, on an annual basis here, you have revenue declining and if you have $25 million of OpEx savings, just wondering how much incremental ability do you have to take costs out as the portfolio amortizes? Is there any incremental step up in expenses as you have some more of these loans entering repayment?

Yes. Well, Eric, one of the things that you've got to remember, also, is that within our guidance of $900 million for 2015, there are also one-time expenses that we're incurring in 2015 of about $25 million related to the $8.5 billion of loans that we are converting onto our portfolio that we expect to compete later this year. So, in terms of moving from the $900 million going to 2016, not only do you have the removal of that $25 million, you've got another $25 million that's going to come out of the expense base next year because of our structuring initiative.

Yes, I would just add to that, Eric, that the $25 million I referenced in my opening remarks was not a forecast for what our OpEx would be in 2016, it was what we would expect to save as a result of this organizational initiative only.

Got it. So combined, you have $50 million that you would expect to get out. On top of that, I'm curious, how much more could you hypothetically take out over time? How much operating leverage could you take down further?

So these are, we're not getting into a forecast of 2016 OpEx. We've listed two items. I want to be clear that's not necessarily comprehensive and I don't want to go down a laundry list here at this stage in the year. But when we look at our operating expense items here, they're driven -- a good portion of them are driven by the variable nature of our revenues. So as loans mature, they actually become less costly, they can become less costly to service if they're making payments on a regular scheduled time frame. Our big drivers of servicing expense are the number of units we're adding as we increase the number of accounts we are servicing for the Department of Education. So if you look at our business on the loan servicing side as an example, our account load has actually increased over the last three years even though our loan portfolio is amortizing down because we're adding new business and revenues associated with that.

In the asset recovery side of the equation, we have similar activity of our FFELP-related workloads are decreasing but our other workloads, particularly outside of the education lending space, have been increasing. So to some extent, operating expense is a function of the revenue drivers that we have going and my preference is, of course, to see revenues increasing.

Got it. And just on the buyback, you had initially said that it would be an annual buyback. Is there any potential to re-up it this year and accelerate the usage of it?

So we look at this on a regular basis. We have both internally and with the Board and we work with them on a combined basis to decide what's the appropriate level. I don't have much more to add to that at this point.

Okay. And just not to beat a dead horse, but just on the cohort of the 2014 loans to exit deferment, what made them different from 2012 and 2013? Where there any characteristics that were particularly different that led to the higher default rate?

I think the two biggest things are the ones I mentioned, which is that we had a higher percentage of these borrowers who had demonstrated difficulty in making payments when they were in repayment prior to returning to school than in prior cohorts. So that gives you an example of an indication that they were struggling to begin with. And the second piece is the statistic that said that more of these customers had moved in and out of school multiple times, not just two, but more than two times. Those were the primary differences.

Okay. Great. And then just lastly, you've recently filed an appeal on the collections business loss with the Department of Education, is there any timeline of when you expect to hear back on that?

Unfortunately, the courts work after their pace, so no indication at this stage in the game.

Great. Thank you.

Mark DeVries, Barclays.

Yes, thanks. I just want to discuss the issue of reserves against this problem cohort. I think, Jack, you indicated you believe it's mostly cover. Is it fair to assume that when you identified the problems in this cohort with the roll rates and these characteristics you just mentioned, given your, usually, your two-year forward look on reserves that you would then look at what's coming out of deferment the next couple of years, figure out which ones share those characteristics and then have reserved for those already?

Yes.

Okay. And I assume, given the characteristics you mentioned, that of these people who kind of went in and out, perhaps around the recession, I think you mentioned you expect only about $1 billion coming out of deferment in 2016, but that cohort is basically going away over the next year or two?

Correct. People return to school for multiple reasons, right. We have the normal trend we would see in our private loan portfolio is undergrads, which is the primary customer of which private loans are made, returning to school to get a graduate degree. Those are generally positive trends, right. You are getting an advanced degree in all of the history and data suggest that these customers coming out of graduate school have higher incomes, more stable jobs. In fact, in our private loan book, the best performing segment across the board is loans made to graduate school students.

What we saw here is a second group of return to school which is borrowers who, this isn't true for the entire $2.5 billion of course, but borrowers who did not obtain their undergraduate degree went back, took more classes, reentered repayment and went back again. So, these customers took longer to either obtain an undergraduate degree or maybe did not obtain it at all. The incidence of delinquency and default on borrowers who take more time to get an undergraduate degree is certainly higher and I think that's what we're seeing this particular cohort. Generally speaking, every year it takes someone to graduate increases their debt load by about 10%. So if you're going from four years to six years, you have -- not only has it taken you longer to get to the point of where you're going to generate higher income, but you've got more -- you have a higher debt burden as well. I would describe this pool and the losses coming more from customers who didn't complete their degree.

Got it. That's helpful. And just finally, I know you don't provide 2016 guidance, but as you think out to 2016, how much risk is there for additional NIM pressure if your unsecured funding costs don't recover? Is there kind of a need to refinance some more maturities as you look out it next year?

Certainly, that'll impact spread going forward. But I think one of the things that we're going to need to look into is alternative sources of financing outside of unsecured debt.

And then, Somsak, I think you also alluded to the issue of the potential impact of the unhedged Floor income. If the forward curve is realized over the next year or two, should we expect some pressure on FFELP NIM from that?

Certainly, there will be pressure on that, just given the fact that older loans that earn Floor income will amortize away quicker than our newer FFELP loans that will amortize slower. So that value will naturally decline over time.

Okay.

All of that is baked into the projected cash flows that we disclose in the release.

That's correct. The other thing I will add is that we have hedged in or locked in value of about $900 million of future floor income and that's locked in through about 2019.

Got it. Okay. Thank you.

(Operator Instructions)

Mark Hammond, Bank of America.

Thanks for taking my question. Following up on what you mentioned about the possible alternative sources of financing outside of unsecured, would you elaborate on that for me?

Sure. One of the things that we've got is basically a balance of about $11 billion of over collateralization built in within securitization trust and one of the things that we would look to do is figure out ways to either refinance those deals going forward or using ways to better lever the balance that are built-in within those securitization trusts.

Okay. Could I be interpreting that as shifting from unsecured to more securitized debt?

Yes.

Okay, great. My last question would be on the unsecured bond repurchase strategy, I was wondering how you determine which bonds to target? I know you have some short-dated high coupon bonds and then some longer dated bonds below par, as well.

Yes, the vast majority of the bonds that we've bought so far this year have really been targeted at the January 2016 maturity that is coming due. We had access liquidity that's been sitting on a balance sheet. So we decided it to better manage our NIM by basically buying those maturities out because they we're going to be due within the next 12 month anyways.

Thanks, Somsak. That's all.

Sure.

Moshe Orenbuch, Credit Suisse.

Great, thanks. I guess I just wanted to follow up on the share repurchase and ask how the assumption of no private student loan purchases, which I thought there was like $1 billion annually kind of purchases in the original forecast, which I would assume, if you assumed a premium and capital against that, wouldn't that have a couple of hundred million a year of extra capital?

Moshe, this is Jack. We did take out assumptions of any private loan portfolio purchases from our 2015 guidance. Although, as I've said, we certainly expect portfolios to come to market from some sellers later this year.

Those were private, though, Jack.

Private and FFELP, both, actually, but the private, in particular, I was referring to, but they'll come too late in the year to have any meaningful impact on 2015 earnings. Clearly, we think we are the best buyer for student loan assets in terms of both federal and private, given our low-cost -- particularly to move them on to our servicing platforms given our low-cost of servicing and the higher performance that we can generate out of a portfolio of student loans. So, sometimes the loan portfolios that are offered aren't servicing released. We're going to be less competitive on those deals. Sometimes they're residuals, in which case, you're basically just buying cash flows with no ability to influence the performance. And in some instances, on some smaller portfolios, particularly on the deal, the private loan deal that was sold earlier this year, was the residual tranche. It brings in, because there's no financing requirements and because the servicing is structured as part of the agreement, it brings in buyers who are not traditional buyers and they're willing to pay higher prices than we would pay. The transactions we expect later this year are likely to be whole loans that we would be able to control servicing and therefore, we think that we have better chances of success.

All right. Certainly, good luck. But I would just observe that if a whole year does go by, that couple hundred million would certainly be excess at that point.

You are correct, yes.

As a follow-up on the Moody's, my understanding is that your plan would be to buy, to the extent that you've bought a few hundred million of assets and continue, that doesn't absorb equity capital, that's just absorbing kind of liquidity and bank lines and the like, right?

Right. Correct.

Okay, good. You kind of answered a question before, I know it's far from your preferred situation, but to the extent that this does go against the industry from Moody's and these bonds are downgraded, it would actually present opportunities, just like there were for you after the crisis, to buy those tranches in at a discount, would it not?

I think it will create opportunity -- opportunities for us to buy student loans more than perhaps on some of these tranches, but the things we're looking for here are making sure that the bonds don't suffer downgrades due to timing issues and we're working with investors and the rating agencies to make sure that happens. So I think we're better served by having an orderly liquid ABS marketplace.

Got it. Thanks.

Michael Tarkan, Compass Point.

Thanks. Most my questions have been answered. Just getting back to the rating agencies, you mentioned you've amended 17 trusts since 2013. Can you just give us a sense of how many could be affected by the new actions and maybe what the dollar amount of exposure is there, any color there?

Moody's in their press release said that would cover about 50 of our securitization trusts. But keep in mind, the vast majority of that have maturity dates beyond five years, Mike, and actually, there's one in particular, I think, that has a legal final maturity date of 2043.

Okay. And is there any sense for size or dollar amount of exposure there in the 50?

Well, it's hard to try to figure out what the exposure there is. There's about $35 billion associated with that 50 trusts, but again, I think, we need to work with the rating agencies to give them a little better color on what the actual performance of those trusts are and how we've been working to mitigate the issue.

We don't know what their criteria is yet, that's part of what they're taking time to look at. We obviously have our own cash flow projections and as I said in my comments, we've been active in this area since 2013, well before this issue has been raised by the agencies on this topic. So, we'll need to see -- we certainly don't believe that all $50 billion worth of trusts have issues here, not even close to it. I'm sorry, 50 trusts not $50 billion. We'll work with the rating agencies and the investors to make sure that we can restructure the deals or exercise options that are available to us to make sure we don't have issues here.

Okay. Thanks. On the asset recovery side, I think before this quarter, you were projecting a $90 million run rate quarterly. You did $99 million this quarter. Can you just talk about where that strength came from, whether it was Gila, Ed, or guarantee agency collections and how we should think about those three buckets in the back half of the year, given that it looks like revenue will drift a little bit back down?

It was really, it did come from across the board, but we had particular strength in the rehabilitating federal student loans for both guarantors in the Department of Ed. I think that the big variable for us is what happens with the new contract from the Department of Ed on that side of equation, which has still not been -- this is separate from the question that I answered earlier on the appeal. This is -- the Department has indicated that it is going to sign new contracts with collection agencies. We've been expecting an answer on that, really, since the spring and they keep indicating that it's coming, but we don't know the exact date yet.

Okay. And then last one for me, I saw a release from Marlette last week indicating you guys are involved in their most recent capital raise. I know it's relatively small, but can you just give us a sense for how you're thinking about marketplace lending and sort of any details around that agreement, whether it's some sort of forward flow agreement? Any kind of context there would be helpful.

Sure. So we actually -- kind of what's going on space is exactly what we have done for 40 years, right, which is originate loans to consumers outside of a banking arrangement through online processes. So to some extent, I would say we were the original marketplace lender. We view this as an interesting opportunity to learn a little bit more about the space and find ways to participate in it through a variety of opportunities, through both loan ownership, servicing capabilities, et cetera.

Do you service loans for Marlette? Would this be strictly focused on the personal loan side or is there potential for this to get into some student loan refinance?

This was just strictly an equity investment. There's no other contractual arrangements here.

Okay. But just to be clear, this is focused on the personal loan side as opposed to -- Marlette is just doing personal loans at this point and there's no sort of --

I think there are opportunities across the board. I think it's both personal and student.

Okay. Thank you very much.

Alan Straus, Schroders.

Yes. A few questions, first, the Congress and Senate almost passed a bill for the tax collections for delinquent income tax. Is that something that you might be bidding on, if something goes forward there in a year?

So we'd have to see with that legislation passed -- whether it passes or not and what the implementation schedule looks like there, but it's something we have been following.

Okay. And just beating the dead horse of share repurchase, historically, when you were together with Sallie, you guys were pretty aggressive in times of stress, taking advantage of a low stock price. Is there any reason to believe why we wouldn't do it at this time?

I don't think there's any changes in direction and practices here from the past.

Okay. So the Board -- you guys used up authorizations historically pretty quick in these times and the Board hasn't changed that much. I would assume that you would be relooking at the authorization probably by the end of the third quarter?

It's a process that we go through. We reset the authority at the beginning of the year. It was based on an expectation of what kind of capital we would generate in excess of our needs for the year. I would go back to more what are the consumers of other forms of capital, loan portfolio purchases et cetera, as being the main variable in that discussion.

Okay. Thanks.

You're welcome.

Louise Pitt, Goldman Sachs.

Yes. Hi, good morning, guys. Thanks for the call. Just want to follow up comments about moving to additional secured funding from unsecured. You have a decent amount of unsecured maturities coming up. How many of those do you think you'll be able to move to the secured portion of your funding? The second follow on question is have you had discussions for the rating agencies about what impact that might have to your secondary ratings?

Yes, I think it just depends on what the availability is at this point. One of the things that we'll open up is that within our private credit deals that once -- we have certain trusts that were issued post-credit crisis which are paying down on a [turbo] basis. At some point, we'll be able to exercise our 10% call options so that we can buy all of the assets out of those deals and refinance those deals, take a good chunk of those proceeds, and use those to pay down unsecured debt over time.

So what is the strategy in the short term for refinancing the unsecured maturities in the upcoming quarters?

We'll be absolutely using our available cash to buy back debt early on as much as possible and to the extent we have ability to raise cash through other sources and we have done things like loan sales previously to be able to raise additional cash. So to the extent it's economical and makes sense, those are the vehicles we would look to.

So, that's sounding like you're not expecting to tap the unsecured markets anytime soon.

We will need to tap the unsecured markets from time to time, but one of the things, I think Jack mentioned earlier, is that the unsecured debt is going to be, will be a mix, an important funding mix going forward, but one of the things we want to do is rely less and less on that mix over time. Again, as our balance sheet amortizes down, we expect the unsecured debt to amortize down along with that.

And have the rating agencies commented on the additional plan, the plan for additional secured funding, or do think that's factored into current rating?

I think that's factored into current ratings. We have discussions and annuals reviews of our projections with them, an ongoing dialogue with them constantly.

Okay, thank you.

There are no further questions at this time. I turn the call back over to the presenters for closing remarks.

Thank you, Stephanie. We'd like to thank everyone for joining us on today's call. If you have any other follow-up questions, feel free to give me a call.

I would like to thank Joe for being here as he and his wife, Jamie, are waiting for their third child this week, I believe. Thanks, Joe.

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