Navient Corp (NAVI) 2016 Q4 法說會逐字稿

Good morning. My name is Christa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Navient fourth-quarter 2016 earnings call.

(Operator Instructions)

Thank you. Mr. Joe Fisher, Vice President of Investor Relations, you may begin your conference, sir.

Thank you, Christa. Good morning, and welcome to Navient's 2016 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 could be due to a variety of factors. Listeners should refer to the discussion of those factors on the Company's Form 10-K and other filings with the SEC.

During this conference call, we will refer to non GAAP measures we call our core earnings. A description of core earnings before reconciliation to GAAP measures, and our GAAP results can be found in the fourth quarter 2016 supplemental earnings disclosure. This is posted on the investors page at Navient.com.

Thank you. Now I'll turn the call over to Jack.

Thanks, Joe. Good morning, everyone, and thank you for joining us today. I appreciate your interest and your support.

Before I address our financial results for the year and the quarter, I would like to provide some color on the announcements to the State Attorney Generals and the CFPB from last week. After three years of engagement in our full efforts to share our servicing practices, our high performance results, the robust programs that drive enhancements and customer tools, communications and education, and our extensive list of recommendations to improve VAR outcomes, it was disappointing that regulators disregarded the facts, in order to make a political statement.

This political statement is based on a false narrative about the practices and outcomes Navient delivers for borrowers. Just because they say it, doesn't make it true. It ignores the fact that we follow the servicing rules and regulations issued by the Department of Education, the owner of the majority of the loans we service.

It attempts to create new servicing standards and apply them retroactively via lawsuits, versus the rule making process that has been the foundation for establishing servicing rules and regulations in years past. And it ignores the fact that the CFPB has had over five years to develop and implement new servicing standards through their rule making authority, yet has failed to do so.

In one accusation, the claim is that Navient steered borrowers into forbearance versus income-driven repayment plans. This accusation was made despite the fact that 49% of the balances we service for the Federal Government are enrolled in an income-driven repayment program. It was made despite the fact that borrowers serviced by Navient use forbearance at a lower rate than others.

It was made despite the fact that a forbearance is often needed to cure a delinquency, as delinquent loans are not eligible for income-driven repayment plans. It was made despite the fact that servicers are actually paid less for our accounts enrolled in forbearance, and that calls that end in forbearance are actually longer than other calls.

It's inconceivable and disappointing that these very helpful services would be portrayed as harmful. The irrefutable facts are that Navient service borrowers are more likely to be enrolled in alternative payment plans, including IDR. Navient borrowers are also less likely to be severely delinquent, and ultimately, are 31% less likely to default. This is the exact opposite of borrower harm.

Navient welcomes and will continue to support clear and well-designed guidelines that all parties can follow. This is what we work in good faith with the regulators to achieve. We cannot and will not, however admit to false accusations, allow penalties or payments for new rules applied retroactively. We have an obligation to defend ourselves, and we have faith that our courts will seek and hear the facts, and rule accordingly.

I'm also committed to keep this action from becoming a distraction to our business. Our team remains focused on executing our business plan, and capturing the significant growth opportunities we see in 2017. I will cover these in a moment, after some color on our 2016 results.

We started 2016 with our access to the debt capital markets in question. These issues were largely driven by the rating agency review, or the timing of FFELP ABS cash flows. We set out a very specific plan to close this issue with the rating agencies, and to complete a broad range of funding transactions, well in excess of our needs. I'm very happy to report we did both.

The rating agencies published their revised ratings criteria, and are nearly complete with their ratings reviews. The impacts have been better than market expectations, and we have worked with bondholders to amend terms to return the ratings to AAA on nearly $10 billion of bonds.

During the year, we completed nearly $8 billion in term financings across our full stack of liability structures, and we materially reduced near-term unsecured debt maturities. We are in an excellent liquidity position as we enter 2017, with only $700 million in unsecured debt maturities this year.

Our credit performance in 2016 was exceptional. Private credit charge-offs declined $146 million or 22% over 2015, and loans greater than 90 days past due ended the year at $801 million, $45 million lower than a year ago.

We also had more borrowers successfully making payments, and amortizing their loan balances. The strong starting point for the improving jobs market and rising pay rates combined to create a very favorable outlook for credit in 2017.

Net interest income for 2016 was $1.6 billion, and reflected the 8% and 12% amortization of our FFELP and private loan portfolios. Net interest income was also impacted by the higher cost of funds, and the negative relationship between our asset and funding indices.

To be conservative, we assume the negative relationship will continue for most of 2017, as the amount and timing of rate increases remain uncertain. Somsak will provide more details on this in his remarks.

We made excellent progress in growing our non-education fee revenues in 2016. Total non-education fee revenue for the year was $174 million, a 77% increase over 2015. We added a number of new contracts in 2016, including contracts with the IRS, tolling authorities, states, and healthcare providers.

Other highlights from the year include adjusted core earnings of $1.89, $0.02 better than the high end of the guidance we provided a year ago. We acquired 17% or $60 million of our common shares. We converted $5.7 billion in FFELP loans onto our servicing platform. We assisted over 628,000 severely delinquent customers, who are now current, in finding a solution that helped them avoid default.

We acquired $3.7 billion in student loans, and continued to improve our operating efficiency. Our team did a great job this year delivering these results, creating more than adequate liquidity, and positioning the Company for further success in 2017. And despite the politically-driven noise, they continue to hold our heads high in pride of the work they do each day.

I'm excited about the opportunities ahead of us in 2017 and beyond. I see meaningful opportunities to add value across our business. For example, in our legacy businesses, we expect to see increased opportunities to purchase both federal and private loans, expand our guarantor services, and add third-party servicing.

One aspect of our legacy business is the service we provide to federal loan guarantors. We're the largest player in this space today, with USA Funds being our largest client.

At year-end, Great Lakes Higher Education Assistance Corp assumed control of USA Funds, and as part of this transfer, they notified us of their intent to rebid the work we provide here, upon the expiration of our contract at year-end. We're excited about this opportunity, and look forward to demonstrating the value we deliver. Any new opportunities or changes here are likely to begin in 2018.

In business services, we're excited to begin work for the IRS, and see significant opportunity to increase revenue from our other non-education clients. In fact, we expect revenues here to grow by more than 20% in 2017. We also believe we are uniquely qualified to deliver on the requirements of the Department of Education servicing RFP.

Finally, we plan to increase our participation in the student loan refinance marketplace. In 2016, we purchased $225 million of refinancing loans, mostly in the last four months of the year. We see the potential to play a more meaningful role in this market in 2017.

Since our separation, we have consistently worked to increase the value of our business. In 2016, we did this through portfolio acquisitions, growing fee income, and repurchasing 60 million common shares at prices well below intrinsic value.

Our focus for 2017 is to continue to create value, by increasing the cash flow delivered through our legacy businesses, growing our business services revenue, and generating new assets through the refinance marketplace. We will also continue to return capital to shareholders, and we'll seek to maximize the shares we acquire at discounts to intrinsic value.

While the action brought by regulators is creating noise, we are determined to defend our practices and superior results, and not let these items distract us from supporting customer success and capturing the value-creating opportunities we see in front of us. Thank you for your interest and support, and I look forward to delivering again on our promises.

I'll now turn the call over to Somsak to review the quarter and year in more detail.

Thanks, Jack. Good morning, everyone. During my prepared remarks, I will review both the quarterly and year-end results for 2016 that we reported last night, as well as provide guidance for 2017.

I'll be referencing the earnings call presentation available on our Company's website, beginning with slide 4, which provides a summary of our core earnings. In the fourth quarter, we reported adjusted core EPS of $0.47, compared to $0.48 in the fourth quarter 2015. And for the full year adjusted EPS, we reported $1.89, compared to $1.82 for 2015.

The fourth-quarter adjusted operating expenses totaled $226 million versus $228 million from a year ago. During the fourth quarter, we transitioned $2.7 billion of Navient-owned FFELP loans, that were being serviced at a third party, to Navient's servicing platform. As a result of this transition, we incurred an additional $7 million of one-time operating expenses in the quarter.

For the full year, total operating expenses before regulatory related and legal contingency costs were $917 million. Excluding the expenses associated with the Gila and Xtend Healthcare acquisitions, and the one-time servicing transition costs, we reduced our operating expenses by 7%, which is better than the 6% reduction we guided to at the beginning of the year.

In the fourth quarter, the Company identified an error, which understated previously-reported FFELP loan net charge-offs, and the provision for losses in 2015 in earlier years. The impact of this error to all prior periods was immaterial, and the numbers throughout this presentation and the earnings release reflect this correction.

Let's now turn to slide 5, to discuss our FFELP segment results. In 2016, we acquired $3.5 billion of FFELP loans, and while we are optimistic about the opportunity to purchase FFELP portfolios coming to market this year, our 2017 guidance will reflect acquisitions at similar levels that we saw in 2016.

Our FFELP core earnings was $68 million for the fourth quarter of 2016, compared with $71 million in the fourth quarter of 2015. The net interest margin for the fourth quarter of 2016 came in at 89 basis points, and reflects the revised application of prepayment grades previously disclosed in the third-quarter 2016 Form 10-Q.

As a result of this change, the FFELP loan premium balance increased by $7 million, which resulted in the same increase to our net interest income. The FFELP net interest margin in the quarter was primarily higher than anticipated, due to this change. We also saw significant year-over-year improvement in the credit quality of our FFELP portfolio, as the late stage delinquency rates declined by 23%.

Let's now turn to slide 6, and our private education loan segment. Core earnings in this segment declined by $15 million from a year ago quarter to $41 million. In the quarter, our net interest margin was 308 basis points, and reflects the impact from the prepayment adjustment mentioned earlier.

The private education loan discount balance increased by $9 million, resulting in a corresponding decrease to net interest income, and a 14 basis point decrease to the private education loan NIM in the fourth quarter. The decline in the NIM from the prior years and third quarter is attributable to this adjustment, as well as higher cost of funds from our LIBOR-based debt, and the timing of when our private based earning asset reset, versus when our LIBOR base debt resets.

The outlook for private education loan losses continued to improve, as a result of the overall improvement in our charge-off trends. Charge-offs declined $146 million or 22% from the prior year. While the total delinquency rate increased slightly from the prior year, our delinquency rate declined by 19% for our non-TDR portfolio, and by 3% for our TDR portfolio.

In addition, we saw double digit declines in our forbearance rates. Our charge-offs on a dollar basis are expected to decline in the mid-teens in 2017, with provision falling at a slightly lower pace, due to the additions of newly-acquired private education loans.

Let's turn to slide 7 to review our business services segment. In this segment, core earnings were $71 million in the quarter, compared with $81 million in the fourth quarter of 2015. This decline was primarily driven by the increase in reserves for legal contingencies, and one-time costs to transfer third-party loans to our servicing system.

Our non-education fee revenues increased 77% from the prior year to $174 million, and we're excited about the growth opportunities in this space in 2017 and beyond. During the year, we grew our total federal loan servicing book by $5 billion, and recently submitted our bid for the Department of Education single servicing solution. While the contract was originally anticipated to be awarded in February, the contract is currently under bid protest by another bidder, that could potentially delay the announcement of the award. Our guidance for 2017 does not include the impact from this potential contract.

I'd like to highlight the financing activity that took place over the course of 2016 on slide 8. In 2016, we completed or renewed financing transactions in every area of our liability structure, including returning to the FFELP ABS market, where we issued $5.8 billion of FFELP ABS through seven transactions, and saw our spreads improve 17% from our 2016-2 transaction to our most recent deal.

We also issued term private ABS of $488 million. We renewed conduit facilities in both our FFELP and private education portfolios. We completed a second private credit residual financing transaction. And finally, we issued unsecured debt of $1.25 billion through two transactions.

In 2016, we reduced our total unsecured debt outstanding by $1.4 billion, and reduced through repurchases our near-term debt maturities in both 2017 and 2018 to very reasonable and manageable levels. We have reduced our 2017 debt maturities to $700 million, and will continue to work towards reducing our 2018 and 2019 debt maturities throughout the year.

During the quarter, we repurchased 12.5 million shares for $180 million, at an average price of $14.43. For the full year, we reduced our outstanding shares by 17% through the repurchase of 60 million shares, at an average price of $12.68. In total, we have returned $956 million to shareholders through both share repurchases and dividends in 2016.

On December 8, 2016, we announced a new share repurchase program for up to $600 million of the Company's outstanding common stock. All of this activity was undertaken while maintaining a strong capital position, and a tangible net asset ratio of 1.24. We have managed this ratio within our target range of 1.2 to 1.3 over the past five years.

Slide 9 provides our full-year 2017 guidance, in addition to the growth opportunities that Jack highlighted for 2017 and beyond.

In the third quarter, and in recent Company presentations, we have highlighted the widening of the three-month LIBOR rate, compared to the one month LIBOR and prime rate, and how we manage this basis risk. While we have already seen these spreads come down off its most recent highs, our guidance is based on a higher than historical one month or three-month spread for the mid 20%s for 2017, which is about where we are today.

Our guidance also includes the impact of two interest rate hikes of 25 basis points in 2017. As a result of these factors, we expect full-year FFELP net interest margin in the high 70s, and full-year private education net interest margin in the mid 320s for 2017.

Also included in our 2017 guidance are operating expenses below $900 million, excluding regulatory costs, business services revenue excluding inter-Company loan servicing to range between $630 million and $660 million. And finally, while we see potential opportunities to grow EPS from our 2016 levels, and are eager to pursue these opportunities, we expect 2017 core earnings per share to be between $1.80 and $1.84, excluding expenses associated with regulatory costs.

Finally, turning to GAAP results on slide 10. We recorded fourth-quarter GAAP net income of $145 million or $0.48 per share, compared with net income of $283 million or $0.73 per share in the fourth quarter 2015. The primary differences between core earnings and GAAP results are the marks related to our derivative positions, and expenses related to restructuring and reorganization.

I will now open the call for questions.

Your first question comes from the line of Sanjay Sakhrani with KBW.

I guess my first question is on Somsak's point on the NIM in the guidance. Could you just talk about how you factor that in as the rates rise? Do you expect the spreads to gap out more, or maybe you can give us a little bit more color on that?

Sanjay, all we're really doing at this point, because the rates and one-month and three-month LIBORs are uncertain, we are just projecting this based on what the curve is telling us today. And the futures forward curve is just plotting out the one-month three-month LIBOR is going to be somewhere around the mid 20s for 2017 at this point.

And to the extent that the rate rises don't happen, what would be the impact on the FFELP NIM?

So if the rate rise doesn't happen, it will mean that we'll probably end up picking up a little bit more in unhedged floor income, but one of the things I'll note, Sanjay, embedded in this NIM guidance, is the fact that as we went into 2017, we have hedged more of our core position, and this was something that we did at the beginning 2016, anticipating that eventually rates will rise.

Okay, great. And then Jack, on the CFPB lawsuit could you just talk about the next steps for you in terms of defending yourselves? And have you had any communication with members of the new administration, in terms of the CFPB and their motives, as you mentioned? Thanks.

So we didn't take this action lightly. You never want to be fighting with your regulator, but we really felt like we had no particular choice here, just given the facts as they exist in our portfolio, versus the accusations.

Our focus in the near term here is going to continue to communicate and demonstrate how we deliver borrower success. This means helping borrowers manage their payments, as I have mentioned a few times, in terms of some of our statistics, our customers are less likely to be delinquent, they're more likely to be enrolled in income driven repayment programs, and they are substantially less likely to default.

We believe that those measures are the complete opposite of borrower harm, and they actually create borrower success, and we do a better job at that than all of the other servicers out there. This process will take some time, and as it will move through the court systems, it moves at a slower pace than we probably all would like, but we're confident in the facts and the data that back up our position here.

Final question, just on this refi, industry entry in the fourth quarter, can you just talk about the addressable market there, and how much growth potential is there for you on an annualized basis in that market?

So we believe that the market opportunity here exists through a combination of both borrower balances in the federal and the private loan sector, and as borrowers -- as you know, firstly, every student loan is made today based on the prospective ability of the borrower to pay, that is that they will complete their education, earn their degree and gain or get a job that produces the income necessary to support that, but there's risks with that. There's risks that those things don't happen.

And so in the refi marketplace, it's an opportunity to basically reward customers who have achieved those objectives, by providing them with loans that have better terms than their existing student loan products. So we see an opportunity here to significantly increase our participation, but at this stage in the game, I'd like to leave it at that. Just that we see a significant opportunity increase.

Okay, thank you.

The next question comes from the line of Arren Cyganovich from D.A. Davidson.

In terms of the FFELP portfolio acquisition opportunities, I think in the past you said $7 billion to $10 billion. Was wondering if that still stands as what you think is potential for 2017 versus the $3.5 billion you have in your forecast, and whether or not the legal action impacts those discussions at all?

We do believe that legacy holders of FFELP loans will be more inclined to sell. I think some of the regulatory comments and questions here might actually accelerate the desire to sell. We don't believe that they create any barriers for us to be the acquirer.

Great. And then in terms of the private education loan net interest margin, I was wondering if you could talk a little bit about, obviously a very sharp decrease year-over-year, you said 14 basis points of that was due to the revised prepayment rates. Is that just a one-time issue, and that bounces back? And what else is in there besides the one-month, three-month spread? It seems like there's something else that's causing that to decline a little bit more.

Over time as you know, we've continued to issue new unsecured debt and new ABS transactions that, as they get added on, come in at a bit of a higher cost in the legacy debt that replaces, so that puts over time, puts a little bit of pressure on the NIM, so that's going to be also, I think a component that we also take into account into our private NIM guidance.

Thanks, and then just lastly, the legal reserve that was established, is that to establish expected payments out, or is that just expenses that you can anticipate having over the next 12 months? I'm just curious as to what specifically that represents.

It represents expense, it's unrelated to the CFPB stuff it's just normal legal activity in the course of business here.

Okay, got it. Thank you.

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

I was wondering if you, you made the statement that the repurchase shares have all been repurchased well below intrinsic value. I'm just curious if you could articulate your view of intrinsic value, and what you're buying back, as you buyback shares in the market? Because I guess the current authorization is about 13% of the market cap of the Company. This is a significant investment, and just curious your view of intrinsic value.

Sure. Lee, thanks for the question. We see intrinsic value in the low to mid $20s per share. The 60 million shares that we acquired last year were purchased at a little over $12 a share. So obviously, a significant benefit or significant discount to intrinsic value. And to the extent that we're able to execute at those types of levels, obviously it has an impact and increases the intrinsic value for the remaining shares outstanding.

It's probably the academic get fly question but with the Management and your team working so hard to deliver value to your customer, and the regulators being so hostile, and the intrinsic value so far above where the stock is trading, have you ever thought about just giving everybody back their money, and just going out of business and letting the government worry about this?

Well I do believe the actions taken were very political, politically-driven here, and they are not uniformly shared across members on the Hill or in Washington. We think we create value for our shareholders in these activities. Clearly, our legacy cash flows are a big part of our intrinsic value, and that is something that we believe we can add to, and continue to maximize. And as we have this year, and we believe we continue to do next year.

I think if you look at where our other growth opportunities are, in terms of the business services that we had, we're really leveraging the skills and capabilities that we've developed in our loan servicing operations. Scale, data analytics, performance-driven results that are valuable to other entities, and we see this in terms of some of the new contracts we sign, like the IRS, some of the tolling authorities, and the expansions we're seeing in healthcare.

And then on the refi side of the equation, these are real opportunities for us, and really, are a function of our data. We believe we have a better ability to look at borrowers and their credit profile and understand what their outlook looks like, based on 40 years of experience here. And to be able to use that to capture value in the form of these refinancing loans that are taking place in the marketplace. So we think at the end of the day we create more value for shareholders by running our business, than we do by not.

I appreciate your efforts for the shareholders and hopefully the new administration will appreciate your efforts, as well. Good luck.

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

Had a follow-up question on the FFELP NIM. Your new guidance of the high 70s is so material step down from the mid 80s you realized in 2016, much of the year was impacted by that three-month, one-month dislocation. Are you saying that much of that incremental step down is related to the additional hedging costs from what you did to protect floor income this quarter, or are there other forces pushing the NIM down further?

Mark, it's not related to the hedging costs at all. It's related to the fact that as rates rise, you will record less on hedge floor income over time. I'll note that our total floor income that we recorded in 2016 was around 50 basis points, and so in that guidance, reflects the fact that as rates increase, a piece of that floor income will decline, depending on where rates are. But I'll note that a vast majority of that -- while a vast majority of that floor income is at 50 today, we will capture a vast majority of that, a significant greater portion of our floor income next year will come in the form of hedge floor income.

I would just add to that, as we look at our business, we're looking at what we expect to generate in terms of cash flows from our portfolio. And the amount of floor income that we were forecasting is based on the forward curve, as Somsak said earlier. And that number is still $2 billion in terms of estimate, based on that forward curve at 12/31/16. And if you think about where it was a year ago, plus what we collected, this number has actually grown, not shrunk. So it shows up differently in terms of the spread, but it doesn't show up, its been growing in terms of value to the overall business.

Over time, yes.

Got it, thanks. Was hoping to get a little more color, Jack, around your comments around the USA Funds acquisition by Great Lakes. Does Great Lakes compete in that services business for guarantors, or are they rebidding it with a view to potentially take that away from you? Just wondering what the opportunity risk is around that.

They do not provide these services for other guarantors. They do manage their own book, and most of the work that they do in this space is outsourced, so this would be a continuation of that effort.

Okay but--

That's where we believe it will go. They obviously are the decider here.

Okay and you indicated you're excited about the opportunities. Is there an opportunity for you to pick up more of their business, as part of this rebidding?

We do, we don't provide services to them today, so as they rebid this, we would be hopeful that we would see an opportunity to bid on the entire book of business, not just the funds piece.

Okay got it, and any color on how meaningful that could be if you were successful there?

Well the opportunity in this space is like the FFELP loan business. It's an amortizing business, but the biggest opportunity we provide is helping borrowers who have previously defaulted on their federal student loans recover from that, and rehabilitate their loans.

And so our services that we provide here to USA Funds and other guarantors puts us as the top-performing entity in this particular space, and that's where we see the opportunity. If we can deliver better results, it increases the cash flows for us. It also increases the cash flows for the guarantors, and so and it obviously delivers a better result for the customer. So all across, it's a win-win-win solution for folks. But we'll have to see what the, there is no RFP outstanding, we'll have to see what that looks like, and respond when it's released.

Okay, got it. Thank you.

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

It seems Gila and Xtend and the accompanying acquisitions on that front have been quiet. Is there anything in particular driving this?

I'm not sure what you mean by the question. Quiet in terms of?

Just what they announced recently. Is it more focusing on operations internally, or just priced too high thing?

Okay, so we a couple of things, I think, in this front. Our acquisition philosophy has really always been to -- if we're looking to get into a new space, is to buy something that has enough of a foundation and solid reputation that we can grow off of that organically, and that's been our focus.

So in years past, when we moved into the asset recovery space, it's exactly what we did, and then worked extremely hard to grow those organizations at very significant levels on an organic basis. We see those opportunities in both Gila and Xtend, in both our state and municipal and tolling activities, as well as our healthcare. We think the opportunities are very significant.

We think they leverage our skills, and probably more importantly, our data analytics capabilities, all of which are designed to deliver higher returns, higher cash flows for our customers. And so the focus has been on organic growth there.

Thanks. And then timing on the single servicing solution solicitation award, at last I read, was February. Is there any better sense from your end?

So February was their original date. They did delay the response, the delivery of the responses, our submissions, by about a month. They didn't change their new date.

As Somsak mentioned, one of the three bidders did submit a bid protest on -- not against us but against the really another one of the bidders in the process, and so that has to be resolved before any award can take place. In the mix of a transition administrator change, we fully expect that there would be some delays here. And until the new Secretary of Education is in place, and starts to opine on some of this stuff, it would just be guessing.

Thanks and then my last one is more of a balance sheet question. Would you talk a bit about the restricted cash balance line items? I had modeled it just following with the portfolio, going lower by about $300 million, but it really didn't change quarter-over-quarter. What's driving this, or how can I think about their strategic cash balance going forward?

I think there it can vary from quarter-over-quarter based on seasonality and timing of when interest payments are made, and when distributions are made over time. So we've got to trust that, pay at various different months within -- over the course of the year. So year-over-year, you should see that restricted cash balance line up with the loan portfolio, but from quarter over quarter, it can have some seasonal impacts come through because of timing of interest payments.

Thanks, Somsak, thanks Jack.

(Operator Instructions)

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

Jack, one of the things that's been absent from this whole discussion about the CFPB is actually the Department of Ed. Is there any chance they are going to weigh in on their servicing rules? I assume that they've looked at your performance over time.

So I don't think there's probably any student loan servicer out there that has been audited or reviewed more than we have over the last three years, in terms of performance and compliance aspects. This is part, you're pointing to something that has been a bit of a frustration for us, is that in the student loan space, there are multiple entities who are all vying for oversight and responsibility on servicing.

You see it at the Department of Ed, who is responsible for it. You have the CFPB, who is supposed to be monitoring some of this stuff, and proposing improvements, enhancements in that area. And then you get a whole variety of state entities engaged, I think, all because of the political headlines around student debt.

The reality is, I think part of our biggest challenge in that, and why there's so many people involved is the public narrative is very different from the reality of what goes on. The struggling borrower for the most part is someone who has borrowed and has not completed their education. So the statistics here is that two-thirds of all federal loan borrowers who default each year owe less than $10,000, yet the average media story shows a borrower who owes more than $80,000.

Large balance borrowers are generally students who went to graduate schools, and they are amongst the best-performing loans in any federal loan portfolio. So that is part of the issue. And we certainly have advocated from day one, as we've been working with the regulators, that a successful and appropriate approach would be to have all parties in the room, the Department of Ed, the CFPB and the servicers, so we can work together to say, look, this practice doesn't work, and how can we make it better?

And a lot has to do with federal rules, so I would just point to IDR as one great example. The application for an income-driven repayment plan is 12 pages long, it does not reside on our website, because it's not allowed to, the borrower has to go to StudentLoans.gov, the Department of Ed website, where they complete the form, and then it gets returned to us by the Department of Ed.

And oftentimes that form is not completed accurately, or the borrower indicates they want to sign up for a plan that they aren't eligible for, and they have to move them to a different direction. It's that complexity in both program design and process that we think that have material benefits, in terms of making the process easier for borrowers, and therefore improving borrower success.

I've got two other smaller questions. Any sense as to the financial terms of entering the refinance private loan market? Like are you buying these loans at par to premium, any sense you can give us there?

So any loan that's made is -- new loans that are made are typically acquired at the equivalent of a premium, whether that's the costs that we incur to originate, or the reimbursement of those costs back out. But when we look at buying portfolios or originating portfolios, it takes into consideration those items, and the capital that we would allocate to that business, and whether or not we can earn an attractive return on equity through that investment.

As I said, I think one of the things that we have that's unique to Navient compared to all other players in this space is we have 40 years of data. So a borrower with a particular credit profile, there may be other attributes, there are other attributes that we would look at on that borrower, that would help us, help indicate whether that borrower is going to over perform or out perform or under perform what that credit profile might look like. And that's where we add value.

Same on the servicing side of the equation. Our servicing processes are all data driven, and so we typically see and can identify problems or issues ahead of time, and we will reach out to that customer for contact, and the result that we have higher rates of right party contact on struggling borrowers. That's why our delinquency and default rates are lower than everybody else's. And we could bring that to bear in the process, as well.

And then finally, our private loan portfolio, and we expect this to be less of an issue in the refinance space, but in our existing portfolio, there are borrowers who are struggling. And the solutions that we offer to those borrowers we think are not only highly effective, in terms of keeping them out of default, but also very beneficial for the borrowers.

Our programs are designed to allow borrowers to make payments and amortize their balances. So we are not putting them into programs where they are negatively amortizing, like many in the income driven repayment plans do, or just kicking the can down the road. We are working with them to create a payment amount that is affordable, and as I said, and reduces the principal balance each year.

Thanks, Jack. There's one quick follow-up on the private side. I noticed that the TDR balance continues to creep up modestly, as the entire portfolio is running down. And so if that trend were to continue, the TDR balance could be half of the total portfolio, with an 11% reserve against it. Could you talk about how that will impact provisioning at some point in the future? And when we might see that change, because you've got life alone reserves against those?

Right so once a borrower is designated TDR, they are never undesignated TDR. So if a borrower who is non-TDR today has some difficulties and requires a temporary delay in payment or a modification, to the terms it automatically moves into the TDR status, and stays there.

You're seeing delinquencies and charge-offs in that segment decline year-over-year, and the balances are amortizing. It's just that there's a transition going from non TDR to TDR. As you know, in TDR loans, we reserve for the life of the loan in that portfolio.

And so the periodic provision is less of a function of adding an incremental year of our incremental quarter of periodic expected charge-offs, as you see in the non-TDR space, and more of a function of how has the life of loan loss expectations changed from the prior period. So most of our provisioning today is a function of adding the additional, the next quarter in the two year window for non-TDR loans, and adding the life of loan provision for borrowers who are moving into TDR status, versus adding reserves for the previous TDR portfolio, that would make sense.

Okay, thanks.

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

Just a quick follow-up on USA Funds. Could you just give a sense for how meaningful that was in 2016 for you? Any color there?

Mike, revenue from the contract was a little under $170 million for 2016.

Thank you. Then as a follow-up on the refi loans, so I'm assuming the spreads are a little tighter, but credit probably a little bit better. I'm just wondering vis-a-vis your current book, how to think about the returns there, versus your existing private portfolio?

You're right on those, both those points. The spreads are, well they are certainly consistent with the higher quality loans that we have made as an originator for in-school volume years ago.

They tend to be shorter average life loans, because -- not tend, they are, because you've eliminated the in-school period, and they tend to amortize a little bit faster. So spread, growth spread of the coupon is tighter, funding costs should be lower, because of the shorter average life. Servicing costs are more about processing and less about outreach activities. So net-net, when you add those together and you look at the appropriate levels of capital, we think we can earn a return on our capital here, very consistent with what we've been earning in our private loan portfolio over the last couple of years.

Perfect, thanks. And then just a clarification. Are you servicing those refi loans as well?

Yes.

Perfect, thank you.

The next question comes from the line of John Hecht with Jefferies.

Most of my questions have been answered, but a couple. It sounds like, can you remind me what's the seasonality between the Q4 and Q1 spreads? I believe there are some inflections there.

Yes, the seasonality really exists in the FFELP loan space, where the day count on what we received and the gross floor income on our entire portfolio, versus the day count that's calculated for floor rebates that we have to pay out to the Federal Government. The formulas are different, so you will see a little bit of -- all else being equal, you would see a little bit of a dip in the first quarter FFELP NIM, from the fourth quarter to the first quarter. But as I see it based on where rates are today, I think at this point, we're sticking to the high 70s NIM over the course of 2016, pretty consistently over the course of all the quarters in 2017, at this point.

Okay, and then with respect to -- you seem like you're indicating a consistent year of acquisitions in the FFELP portfolio, like last year. Is there a seasonality with respect to purchasing opportunities, or is it just fair to pace that over the year?

For purposes of guidance, I think that it's fair to pace it over the course of the year.

Okay, and then last question more just thematic. We see both portfolio credit trends looking positive in terms of their trajectories. And I know that the servicing costs for working loans are much different than something where you have to have a little bit more hands-on. If the current pace of credit trends, is there a chance or intermediate or over a long period of time, that you can really reduce overall servicing costs over to the servicing margins, relative to total margins? Or how should we think about the opportunities there over the long term?

So no question a borrower making -- a current borrower making payments has a lower cost structure to the Company, and if we're servicing for a third party like the Department of Ed, a higher revenue stream as well. You have seen delinquency rates improve across our book of business. We track this data pretty closely.

Borrowers coming into repayment during the recession, which peaked for new graduates in 2010. We saw early 90-day plus delinquency rates early in the life of repayment cycle six months in, north of 20%. Those numbers have come down to about 7%, so they are about a third of where they were in the peak of the economic recession.

And it's not a surprise, when joblessness is increasing, new graduates have a harder time finding jobs. As the economy has improved and the job markets has improved, those numbers have improved as well. We do expect that to reduce our costs.

It's one of the things, but we always lock for ways to improve efficiency across all aspects of loan servicing. We do that through automation, through better services for customers. We just launched a new IVR for example, voice response system for our customers, that allows them to speak in natural language versus pushing buttons, for if you want this push one. That has dramatically, we think that will result in higher borrower satisfaction, but also higher ease of borrowers to find the solution that they're looking for, and also to self-serve for things that are relatively easy for them to do.

Great. Appreciate the color, thanks very much.

There are no further questions at this time. I will turn the call back over to Mr. Fisher.

Thank you, Christa. I'd like to thank everyone for joining us on today's call. If you have any other follow-up questions, feel free to reach out to me directly. This concludes today's call.

Thank you for attending Navient's fourth-quarter 2016 earnings call. You may now disconnect.