Navient Corp (NAVI) 2018 Q1 法說會逐字稿

Good morning. My name is Christy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Navient First Quarter 2018 Earnings Conference Call. (Operator Instructions)

Mr. Joe Fisher, you may begin your conference.

Thank you, Christy. Good morning, and welcome to Navient's 2018 First Quarter Earnings Call. With me today are Jack Remondi, our CEO; and Chris Lown, our CFO. After their prepared remarks, we will open up the call for questions.

Before we begin, keep in mind our discussion will contain predictions, expectations and forward-looking statements. Actual results in the future may be materially different from those discussed here. This could be due to a variety of factors. Listeners should refer to the discussion of those factors on the company's Form 10-K and other filings with the SEC. During this conference call, we will refer to non-GAAP measures we call our core earnings. A description of core earnings, a full reconciliation to GAAP measures and our GAAP results can be found in the first quarter 2018 supplemental earnings disclosure. This is posted on the Investors page at navient.com. Thank you.

And now I'll turn the call over to Jack.

Thanks, Joe. Good morning, everyone, and thank you for joining us today and for your interest in Navient. Our financial results this quarter were very strong and delivered on the potential we outlined in January. We also are presenting our financial results in new business segments this quarter that reflect how we are managing the business. This new format is designed to provide you with greater insight into the performance of our legacy and new businesses and to shine a more focused light on the potential within each of the new business segments.

Our new business segments are Federal Education Loans. Here, we combine the earnings from our FFELP portfolio in the servicing and asset recovery work we provide to federal education loan lenders, guarantors and the Department of Education; the Consumer Lending segment includes our Private Education Loan assets and servicing, including our newly launched refi origination business; the Business Processing segment includes the various management and processing services we provide to our clients in the government and health care markets; and our Other segment is where we report our centralized overhead functions and our corporate liquidity portfolio.

Starting on a consolidated basis, we're off to a very strong start in 2018 and our financial results reflect this. Our adjusted core earnings of $0.43 per share was driven by strong performance in each business area, expense management and from the lower tax rate implemented with the Tax Act. The results build off the corporate and student loan acquisitions we made in 2017 and our focused efforts to improve operating efficiency.

For example, on a comparable basis, operating expenses fell almost 8% from the year-ago quarter. Highlights this quarter include excellent growth in our refi and Business Processing business lines, continued improvement in credit quality, stable student loan margins, improving our operating efficiency and lower taxes.

In the Federal Education Loan segment, we delivered an improving student loan margin of 83 basis points and a meaningful reduction in operating expense, 17% when you exclude the new revenue recognition accounting rules.

In Consumer Lending, we delivered very strong refi origination volume, $500 million in the quarter, value from the student loan portfolios we acquired in 2017 and improving student loan margin of 3.23% and improving credit quality evidenced by the $59 million decline in charge-offs.

I'm very excited with our success in refi originations in the first quarter and continue to see a very strong ability to grow originations in this environment. Our products deliver meaningful cost savings to customers who have the ability and desire to amortize their student loan debt more rapidly. The ability to create value here can be clearly seen in an analysis of our recent refi ABS transaction completed in the first quarter. And Chris will describe the details of this in his remarks.

In Business Processing, we set out to leverage the workflow skills and high-performance results we have demonstrated in student loans and deploy those in the government and health care markets. Our strategy has been to acquire the right foundational base and combine these with our operating skills to deliver strong organic growth and attractive margins. Our results this quarter and prospects for 2018 are demonstrating the value we can create in this segment.

Results this quarter include revenue growth of $29 million or 66% with an organic revenue growth rate of 32%. And we delivered increased efficiency and scale that led to a 50% increase in the EBITDA margin to 21% overall. The government and health care markets represent a very attractive opportunity for us. Both markets are very large and they continue to move to a partnership services model to deliver lower cost and higher performance.

Our services leverage our workflow designs, use of data analytics and strong compliance systems to deliver exceptional value and higher performance. They are also not capital-intensive. Most importantly, they allow our clients to focus on the core services they provide to their constituents, patients and other customers. I see continued strong growth trends in this area, and more specifically, we expect to deliver full year organic revenue growth of 30% while continuing to improve EBITDA margins.

Credit quality in our private loan portfolio was another bright spot this quarter. The provision for loan losses declined by $18 million to $77 million for the quarter, and the charge-off rate for our Consumer Loan segment fell to 1.4%, the lowest level in more than a decade. Our outreach efforts in alternative payment programs allow us to help borrowers with loan terms they can afford and most importantly, programs that amortize their loan balances.

We also continue to support federal student loan borrower's success, and new Department of Ed data shows we continue to lead comparable services in enrollment and income-driven repayment plans and with the lowest default rates. Last week, we and our teaming partners submitted our round 1 proposal for services under the Department of Education's next-gen servicing RFP. We believe this combined comprehensive proposal is best-in-class and look forward to the opportunity to work with the department here.

By delivering on our mission to enhance the financial success of our customers, we helped millions of individuals achieve their goals for themselves and their communities. For 2018, we are focused on delivering outstanding results for our customers, clients and investors. Our goals are to maximize cash flows, create value by growing our refi and Business Processing businesses and continuing to improve our operating efficiency. This quarter's results begin to deliver on the potential and promise we talked about in January. As our strong financial results improve our capital ratios, we will return additional capital to shareholders beyond dividends to include share repurchases. Our goal is to create value that is recognized in the share price.

Thank you for your interest this morning, and I look forward to your questions later in the call. Chris?

Thanks, Jack, and thank you to everyone on today's call for your interest in Navient. During my prepared remarks, I will review the first quarter results for 2018. I'll be referencing the earnings call presentation, which can be found on the company's website in the Investors section.

Starting on Slide 3. Adjusted core EPS was $0.43 in the first quarter compared to $0.37 from a year ago. As Jack mentioned, we've changed our reporting segments to provide investors with greater visibility into Navient's underlying growth and how we manage and value the business. In conjunction with the filing of our first quarter 10-Q, we will provide 3 full years of historical financial statements as they would have been reported in these new segments beginning with 2015.

Let's now move into our new segment reporting, beginning with Federal Education Loans on Slide 4. Core earnings were $141 million for the first quarter versus $129 million in the first quarter of 2017. The increase was primarily related to reduced operating expenses and a lower tax rate, partially offset by a $23 million decrease in fee income associated with the new terms contained in a previously disclosed modified contract.

The net interest margin for the first quarter was 83 basis points compared to 78 basis points in the year-ago quarter. The recent dislocation in 1 month versus 3-month LIBOR rates has been mitigated by our new hedging strategy implemented last year. At quarter-end, 93% of this risk was hedged for the remainder of the year. We now expect the full year FFELP student loan NIM to be in the mid- to high 70s.

Now let's turn to Slide 5 and our Consumer Lending segment. Core earnings in this segment increased to $50 million from $38 million in the first quarter of 2017. In the first quarter, the Consumer Lending net interest margin was 323 basis points, in line with our expectations. We continue to expect full year NIM to be approximately 325 basis points. However, as we have discussed previously, Navient is negatively biased to a rising rate environment, and we continue to closely monitor the fed and funding rates.

On Slide 11 in the appendix, we provide additional detail to the long-term profitability of newly originated education refinanced loans. As we continue to transition loans from outstanding facilities to securitizations and build our portfolio, we expect the student loan spread on these loans to approach 2%. The economics provided on this slide are based on our most recent private ABS transaction.

We're very pleased with the continued improvement in our credit quality as private education loan losses and delinquencies continue to decline year-over-year with total delinquency rates declining by 16% from the prior year. Due to a number of significant natural disasters, over the last 3 quarters we have seen an elevated use of disaster forbearance compared to a year ago. We believe this will ultimately lead to a higher charge-off level this year compared to the current quarter.

We also expect to see slightly higher charge-offs for the rest of 2018 associated with the $3 billion portfolio that we acquired last year, but are still below our original projections. As a result, we anticipate the quarterly provision for loan losses to be in the low- to mid- $80 million range for the remainder of the year.

Let's continue to Slide 8 to review our Business Services segment. Fee revenues in this segment grew 66% from the prior year. Excluding the acquisition of Duncan Solutions, noneducation fee revenue grew 32% organically year-over-year. Our EBITDA margins also increased to 21% from 14% last year as a result of our continued focus on expenses and growing our client base. We continue to see organic growth opportunities in both government services and health care revenue cycle management and are on pace to achieve our guidance of at least 30% revenue growth year-over-year.

Let's turn to Slide 7 for additional detail on our reported first quarter total expenses of $282 million. During the quarter, we incurred $7 million of restructuring and other reorganization expenses in connection with our continued efforts to reduce cost and improve operating efficiency. This quarter's regulatory related legal expenses were $4 million, virtually all of which stem from the CFPB case and related matters. Excluding restructuring of regulatory costs, we reported operating expenses of $271 million in the first quarter compared to $234 million a year ago.

Taking a closer look at these expenses, first quarter operating cost related to Duncan Solutions and Earnest, which were acquired in the second half of 2017, totaled $29 million. We also incurred $3 million of servicing fees and a onetime expense of $9 million related to the transfer of a $3 billion third party service portfolio to Navient. This $9 million investment will be accretive to earnings going forward.

We adopted the new accounting revenue recognition standard in the first quarter, which resulted in a $14 million increase in operating expenses that primarily impacted our fee-based contracts in the Federal Education Loans segment. Further detail can be found in the full earnings release. As a result, only of the newly adopted accounting revenue recognition accounting standard, we now expect operating expenses for 2018 to be $70 million higher than our previous guidance, resulting in new guidance between $980 million and $1 billion, excluding restructuring and regulatory costs. This does not alter our $1.85 to $1.95 EPS guidance for 2018.

Let's turn to Slide 8, which highlights our financing activity. In the quarter, we acquired over $800 million of education loans with $500 million originated organically. At quarter-end, we have $2.4 billion of available capacity in our FFELP facilities and $723 million in our private facilities. We expect to further reduce the size of our FFELP facilities in 2018 to more effectively manage expenses associated with unutilized excess capacity.

In the quarter, we issued 2 FFELP ABS transactions for $2 billion. These 2 transactions were financed at re-offer spreads that were 35% tighter than our first deal of 2017. We also issued our first securitization that consisted entirely of Private Education Refinance Loans. There was significant investor interest across the capital structure that led to a reoffer spread to swaps of 56 basis points, the tightest spread of any benchmark student loan refi ABS transaction this year.

In addition, we closed on $1.4 billion of ABS repurchase facilities that included the refinancing of $478 million of existing facilities. This raised $849 million of net new cash at a weighted average cost of funds that was nearly 120 basis points lower than our previous facilities. In addition to reducing our outstanding maturities by $167 million in the quarter, we also announced a $1.2 billion make-whole call, effective April 27 for unsecured notes due in June. As a result, our next unsecured maturity isn't until January 2019.

Let's turn to GAAP results on Slide 9. We reported first quarter GAAP net income of $126 million or $0.47 per share, compared with net income of $88 million or $0.30 per share in the first quarter of 2017. The primary differences between core earnings and GAAP results are the marks related to our derivative positions. In summary, our financial results this quarter were strong across the board and were highlighted by robust growth in our refi and Business Processing business lines and continued improvement in credit quality, operating efficiencies and financing costs.

And with that, I will open the call for questions.

(Operator Instructions) Your first question comes from Mark DeVries with Barclays.

So this quarter's implied run rate on the consolidation originations of 2 billion was kind of above what you guided to, is that a good run rate going forward? Or did you kind of get off to a higher start than you expected?

We certainly got off to a great start in the first quarter, and we expect the trends here to continue to be similar to what we're seeing so far this year. Our guidance right now is we left it the same at $1.5 billion, but clearly, we're on a pace to surpass that.

Okay. Is there any kind of seasonality in that activity, which would suggest this quarter might be bigger than normal?

No.

Okay. Jack, can you give us a sense of the addressable market there? Both at the current rate of closer to 5% and how might that change if benchmarks rates risen enough that you have to kind of move the rate in your new loans to 6% IRR?

Well, the majority of the customers that are looking to refinance their education loans have been out of school for a number of years and have demonstrated very strong employment trends and earnings profiles, and these are customers that are generally looking to take advantage of the fact that their cash flows are more than sufficient to amortize their debt more rapidly than the standard terms in the federal programs, and they're taking advantage of that by selecting program terms that give them a better rate and allow them to pay their loan off faster. I think the combination of activities when you look at where the loan products are that we are refinancing, their balances that had been outstanding for a number of years, the opportunities are coming, as I said, from graduates, from those folks who primarily have attended graduate schools. And we really don't see that marketplace slowing down even though rates have been rising here over the last couple of quarters and are expected to continue to increase over the next couple of quarters. So we're optimistic about the opportunity and the ability to play a meaningful role in this space.

Okay, great. And then finally, for Chris. I heard you indicated that you're still guiding to a private NIM of 325 bps but then you qualified that by saying you're negatively biased to higher rates. Could you just give us a sense of what type of rate assumptions are embedded in that guidance? And kind of what could happen to the NIM if rates kind of move materially higher than what you're assuming?

Sure. So our original guidance in January, obviously, the move shifted pretty meaningfully after our earnings call in January, and so we're fighting that negative bias. And we had, in our plan, 2 rate increases. Obviously, the expectation now is for 3 to 4, and timing matters as well. So there is a negative bias, but there's a lot we're doing to try to stem that bias as well. So we do feel comfortable maintaining that 325 basis point NIM guidance, but it's just something we do consider and look at if the Fed raises sooner, the dates when the Fed raises matter as well, so we just continue to monitor that. Number of raises will probably have the biggest impact.

Okay, so should I take from that, that it would need to be in excess of 4 raises before we would see any kind of erosion from that 325 guidance?

No. I actually think it will be less than that, but as I mentioned, we're employing some other strategies to try to do other things to solidify that NIM. So it's just a lot of work on our side to try to assuage that rising rate environment.

Your next question comes from Sanjay Sakhrani with KBW.

I guess, first, Jack, I'm just curious, when we think about the competitive environment and the potential for M&A for portfolio acquisitions, is there anything that's meaningfully changed in the marketplace? And maybe you could just qualitatively talk about what's happening and how you're positioned.

Sure. So in the legacy arena, this would be FFELP portfolios and older private loan portfolios. The large financial institutions that own portfolios that are no longer in those businesses have for the most part sold their portfolios, and so we definitely had expected and projected, I should say, and would expect the volume opportunities to decline. The rate environment and the funding capabilities in the ABS space has certainly made that marketplace more competitive as well. And as you know, over the last 5 years or so, we've been very disciplined in terms of our -- on the pricing side of the equation when purchasing portfolios. We view these as basically buying cash flows. It's not a franchise purchasing opportunity, and so they don't generate the returns that we find attractive. We don't participate. So our view at this stage in the game is that the opportunities for purchase -- to purchase portfolios will be somewhat modest and will be impacted by competitive forces.

Okay. And we've heard about some of the larger players are actually sort of retrenching potentially from the market. Is there -- is that an avenue or window in for you as we look towards 2019? And maybe reengaging in the market?

Are you talking about for FFELP portfolios or...

Private.

In loan sales or loan originations?

Origination.

Actually I'm sorry. I was responding to loan purchase -- portfolio purchase opportunities before. I think in the origination side of the equation, the marketplace is dominated obviously by 3 large players and certainly, we're seeing one of those players be less aggressive in that space. We look at that marketplace as being an attractive opportunity for us to potentially play in the future. We have that -- a non-compete that restricts us from participating there until 2019, but it's certainly something we're looking at. And when we look at the skill sets, the infrastructure, the existing infrastructure that we have in this place, our ability to understand the performance of borrowers and the different risk profiles there, we definitely see ourselves, if we play in that space, as having a distinct competitive advantage.

Okay, great. And then Chris, just two questions for you. One, the margins in the Business Processing segment, they've done quite well year-over-year. Obviously, you expect them to sort of moderate for the remainder of 2018, but kind of what is the margin potential in that segment over time? Can we see an expansion from these levels and to what levels or what point? And then on CECL, have you given any -- or are there any updated thoughts around CECL and how it might affect you?

So on the Business Processing segment, what you're seeing in that margin expansion is, as we've acquired these businesses, we've been able to drive synergies through them as well as focus on originating new business and driving value into those franchises. But we've only owned these businesses for a couple years, so it's all starting to come together in a way that we expected, but it's obviously from our perspective, very attractive, and we look forward to the development going forward. Now the margin of 21%, we had historically guided towards mid- to high-teens EBITDA margins in this business. Is there opportunity to get through 21%? Sure, but I think we feel very good about the margins we're producing today and the opportunity. And you look at comparable margins at other BPS businesses, these are actually fairly attractive numbers from that perspective. On the CECL perspective, we obviously are monitoring what's happening very closely. You saw some announcements from the regulators recently. The rating agencies still haven't given a lot of guidance on how they think about the implementation of CECL. We are starting to do our work and our analysis around that, but we don't have anything else to opine on at this time.

Your next question comes from Michael Tarkan with Compass Point.

Just on the credit side, so I understand some higher charge-offs flowing through this year with storms, but the TDR portfolios has come down sequentially now for 3 straight quarters and reserves are flat, the provision guidance is helpful, but how do we think about reserves longer term especially as you're mixing in Earnest loans and then eventually, in-school loans? I mean, should that 5.8% of loans and repayment, should that start to trend down? And then as a follow-up, just on the CECL comments, wouldn't you be better positioned on a relative basis given that TDRs are over 40% of your portfolio and you've already reserved for life of loan losses?

So a few comments there. Your comments around the reserve and the blend-in of the refi product, clearly will have an impact. And you see the performance in the refi product. You can look at the trust, not only our trust, but other trusts, and clearly have been very strong. So we would expect the trends that you're seeing to continue. So that is our expectation and we provided the guidance for the rest of the year. With regard to -- I'm sorry, your second question was?

Just on CECL and TDR mix, yes.

So if you look at our portfolio, we have a $24 billion, $25 billion private loan portfolio, and as you mentioned, roughly $10 billion is TDR, the other 14 plus is non-TDR. Now that $14 billion portfolio is still a fairly large portfolio and so inevitably, we will be impacted by CECL in a meaningful way given the 2-year reserve window, given the size of that portfolio, but having that TDR portfolio provision for it does help, but it does not mean that we won't be impacted either.

And then just as a follow-up. With the Earnest loans, how should we think about reserving for those loans? Is that -- I know loss of confidence is really low, but you have to do the 2-year forward. Just what kind of reserves do you build for Earnest? And then where do those stabilize?

Actually if you look in the appendix, you can see sort of the way that we have projected out the trust for that information, and you could model that pretty identically going forward with additional originations and as we finance it. So we've got a lot of information on Slide 11 in the appendix to give you some numbers.

But you're right. We definitely expect credit losses to be a small fraction of what we see in our legacy private loan portfolio. The charge-off rates in this portfolio are running 10% of what our legacy portfolio is running today, and the CECL impact in the -- the TDR side of the equation is 43% of our portfolio overall. The challenge with the CECL implementation is as I -- as we discuss this internally, any number we give here, we all know is going to be wrong, right? Because it's a projection of life of loan losses, which will vary depending on economic and life impacts of our customers. So that's just something that we're trying to gauge and provide perhaps a broader range versus a narrow target.

Your next question comes from Moshe Orenbuch with Crédit Suisse.

Maybe, could you guys discuss a little bit your thoughts about capital return given the success you've had on the capital markets front, but then again, the success you've had kind of generating these refi loans? And how you think about that, particularly in the context of the core FFELP portfolio seems to be declining at least in the first quarter at what would be an annualized double-digit rate?

So as you saw in the earnings presentation, our TNA ratio rose into the level we had expected in the quarter at 1.21x. We feel even more confident in our guidance of being at 1.23, 1.25x by year-end and our expectation to return to buying back stock in the second half of the year. As you mentioned, there are a number of moving factors that may be generating a little more capital, and I think what we committed to in the last call is, if there is an opportunity where we see excess capital beyond the guidance we've given, we clearly will take advantage of that, but we do feel very confident in the guidance we gave last quarter.

Right. And I guess does the stock price itself factor into that in terms of where the stock is? Thinking about buying it back at current levels versus something that could be at a different level at a future point in time?

Yes, there's no question, stock price is a factor here and obviously, we'd prefer to be buying the -- buying back stock at lower prices versus higher ones, but we'd also prefer a higher stock price than a lower one in total. But we certainly are going to take a look at what the opportunities present themselves and how we might take advantage of today's stock price for third and fourth quarter stock repurchases.

All right. And just on a separate matter, kind of went through some of the restated financials and the regrouping of your groups and it's a little difficult because the history is not really there for most of the metrics, but I guess, could you talk a little bit about how you think about the $80 million in the quarter of kind of like central cost, which is a number that I guess is probably significantly higher than you had had in that Other segment before, and how it relates to your cost allocations to the government loan segment?

Yes, I think our -- the focus of putting centralized overhead and liquidity cost into another bucket rather than distributing them is in part to shine more focus on that and make sure we're being responsible in managing those costs down. We definitely -- we moved things around a little bit in the buckets here, but the overall expenses in that side of the equation are trending down as we look to become, continue to -- continue our focus on improving operating efficiency and that comes -- the focus here on operating efficiency is not just about OpEx. Chris talked about the efforts we're making on the interest side of the equation of what can we do to reduce the impact of the drag in earnings that is caused by maintaining a liquidity portfolio, managing our funding capacity in FFELP programs, for example, to not maintain more lines than we need, to the financing transactions that we completed during the quarter. We've got much better pricing on our term ABS fields. We refinanced some of our private credit ABS repurchase facilities to materially lower cost and -- from the prior financing transactions, but they're also substantially lower than unsecured debt costs as well, all of which are contributing to improved operating efficiency.

And I think what we really tried to do is put -- make sure that costs with the business leaders that were embedded within their segments were costs that they could control and that they could manage. What we found historically is that there was some cost there that they really couldn't control and move those costs that are uncontrollable into the overhead bucket where Jack and I can actually focus on them and spend a lot of time in trying to manage them and get them down. So it really was an alignment exercise so that we can all be held accountable and take charge of the costs that are embedded within our own business units.

Right. And I just kind of following up on that, the question of how much of those costs by each segment, particularly in the centralized segment and in the government servicing are fixed versus variable would be extremely helpful to understand as we're kind of looking at those businesses, particularly given what you showed on, what I think was, Slide 7 in terms of the performance of that business.

That's a good thought and we'll think through that, but that's a good comment.

I do want to point out that just because something appears to be a fixed cost does not mean we're not focused on ways to reduce it. And I understand your point, but it doesn't reduce our efforts there.

Your next question comes from Arren Cyganovich with Citi.

The FFELP margin guidance coming, I guess, a little bit higher than last, but still somewhat lower I think than this past quarter. What's driving that down for the remainder of the year?

Yes, so there are couple of things that resulted in the NIM on FFELP portfolio being a little better than expectations. One, slower premium amortization on the portfolio, which benefits the NIM margin on the FFELP portfolio and that is partially a result of some of the forbearance we saw in the natural disasters and so we would expect that to equalize over time although we are just seeing a little slower premium amortization than we had expected. And there also was an asset-index mismatch that [reversed] the benefit of the FFELP portfolio in a rising rate environment. So again, as that moderates and we see rates stop rising, when you look at the curve, that drives us to our mid- to high 70s guidance.

Does the hedges that you put on in place of that, does that include expectations of rising cost to hedge -- to continue hedging that over time?

So the 1s, 3s -- so we've mitigated the 1s, 3s risk for 2018 because -- as we're mostly hedged. So it really doesn't come into play given all the hedging activity we did last year to release -- neutralize that risk in the FFELP portfolio. What we've really done is eliminated that risk from an impact on the FFELP portfolio. It doesn't do much to bolster or benefit the NIM.

For the remaining life of the portfolio?

For the remaining of 2018. Obviously, we're having to keep hedge going into 2019, and we're actually -- we're hedging by going out and buying contracts that start 6, 9 months out, but inevitably in 2019, we are facing a wider 1s 3s spaces versus what we had hedged in, in 2018.

Got it. And then in terms of the combined next-gen RFP, maybe you'd just give a little bit of color on some of the nuances around that contract? And what your expectations are from a timing standpoint.

So the contract provides basically segments, the services that the department is seeking for into individual components and people can bid on the individual components or choose to bid on a comprehensive basis for all of the other components. We chose to bid on a comprehensive basis for all of the components. We believe that can drive both higher levels of success in terms of the conversions of portfolios and management of borrower outcomes and also probably most importantly, drive lower cost for the Department of Education. In terms of timing, the expectation is, is that later this summer, we will hear from the department on round 1 selections and then they will issue a time line for the submission, more details of the specifics they're looking for and a round 2 process and the time lines for that. But there's a fair amount of noise and discussion on this including some restrictions coming from Congress as to how the department can operate this contract here that have yet to fully play out.

Okay. And with ASC 606, looking at the higher expenses, there were also higher revenues booked associated with those, can you talk a little bit about, I guess, one, what specifically does that represent? I read through the disclosure, and I still don't fully quite understand the timing impacts here and what the ongoing impacts of this -- for accounting for these contracts represent in the financials.

Sure. So the majority of our 606 adjustment had to -- came through our portfolio management contract, which is a gross-up of our expenses and revenues. And if you think of that $70 million guidance, basically the majority of it is really coming from that, but is a -- what becomes a pass-through for us. So they're gross-up of revenues and expenses on the PM business. You're right in that there was a little increase. There is a little delta between the revenue and expenses as a result of the adoption of 606, and that was in particular to 1 contract where we were expecting to realize the revenue throughout 2018 and because of 606, actually accelerated that acceleration and expenses into the first quarter versus over more of 2018, that tails off and so the majority of it really ends up just becoming the adjustment as a result of the portfolio management, 606 adjustment.

I think just to add a little more color there in the PM contract. Effectively, those expenses that Chris is referring to are netted against revenue. So this is nothing more than a pass-through process that will now gross up revenues and expenses by an equal amount in that particular contract of the guideline.

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

Three questions, pretty quick. So the first one is, with the new segments, what's the allocation of unsecured debt between the Federal, Consumer and Other segments?

So the allocation -- we obviously look at the allocations from a number of perspectives. The reality is a lot of the unsecured today -- unsecured debt is allocated against the private portfolio, but there is some minor allocations also to the refi product as well as the FFELP portfolio, but the majority of that unsecured debt is aligned against the private portfolio and specifically the legacy portfolio versus the refi portfolio.

And the liquidity portfolio.

And the liquidity portfolio.

Okay. When -- that liquidity portfolio, that's in the Other segment, right?

That's right.

And that's just -- I'm trying to get a sense for what that is funding? Just assets and liabilities. I know the unsecured debt will be funding part of that, but what is it funding exactly?

The liquidity portfolio is there to meet our cash needs of maturing debt. So one of the things Chris mentioned in his comments is that we did a make-whole call for the final debt maturity we have in 2018. If we did not do that, we would be sitting on a larger balance of cash in anticipation of that debt maturity. So we're actually sitting on that in March 31, but we're -- by calling it, we're able to effectively minimize the impact of that negative drag, right, of short-term cash investments versus unsecured debt cost of funds, but the allocation, and we look at how we allocate the unsecured debt, it really is about the -- you can look at the advance rates that we get on securitization transactions and with FFELP portfolios, the advance rate is very high and so, therefore, they consume substantially lower levels of unsecured debt in the process.

I mean, inevitably, we run liquidity, and you can see it on our balance sheet, just as Jack mentioned, to manage maturities, but also to make sure that we're in compliance with buffers, et cetera -- liquidity buffers that we require to be prudent. So it's really just the management of that to ensure that we can meet obligations from the business and maintain our ratings.

Okay, great. And then moving on with the segment name change. Is there any reason why you chose the broader Consumer Lending name as opposed to being more specific, like calling it the education lending segment?

Yes, so I'll just take that. The reality of the Earnest business that we acquired -- when we acquired it, they were originating a very small amount of originate-to-sell assets in the personal unsecured loan space and on the mortgage space. So these are not balance sheet loans. These are loans that are originated to sell. We like that model. We think that model can potentially be grown, and so in order to accomplish a broader number of products, we named it Consumer Lending. I mean, you're correct, in reality today, it is primary an education/refi segment, but there is the opportunity for us on an originate-to-sell basis to grow those businesses, and we are exploring that opportunity.

Okay, great. And then last one is on, typically we hear talk about purchasing performing loan portfolios. Has Navient ever considered purchasing portfolios of delinquent or nonperforming consumer loans and then collecting on them?

We do not -- that business was something we were in many years ago, but we exited that space and have no plans to return to it.

(Operator Instructions) Your next question comes from John Hecht with Jefferies.

You may have addressed this question in certain ways, but we've got costs related to Duncan and Earnest running at about $29 million a quarter. How scalable are those costs given some of your growth prospects in each of those segments? And then second related question is, we've talked about Earnest and some of the kind of volume opportunity there and so forth. I wonder if you can give us an update on Duncan in that same regard.

So there are component -- both of these businesses have what you would effectively call volume-related cost components to them. In the Earnest side of the equation, it's the variable cost that we incur to acquire loans. It's marketing, the digital strategies and efforts that we make in that space. The leverage opportunity in that area is to drive those variable costs down as we become -- as our market -- digital marketing strategies become more efficient. That is something that has happened in Q1 versus Q4 as an example. It's also to leverage the core infrastructure costs associated with running our data analytics, the modeling and strategy build off of a larger base of origination volume. In Duncan, you have similar kinds of metrics here, although you certainly, as volume ramps up, the cost opportunities of leveraging the overhead management structures in the systems are definitely achievable, and I would add one more piece in Duncan that's different than Earnest in that the efforts that we -- the customers we serve in that space had some overlap with the work that we were doing. We do a HELOC, particularly in the toll space, and the opportunities to -- for lack of a better word, capture synergies out of that combination of business activities is pretty significant. And then the last thing I would just mention in terms of our Business Processing opportunities broadly is one of the things that we have done an excellent job at in the federal student loan -- in the student loan servicing side of the equation is using workflows and analytics to automate and materially improve operating efficiency over time, and we think there's a significant opportunity for us to do the same in the BPS space and are working aggressively on that front. That's part of why you're seeing the margin expansion in Q1 for this reporting period.

Okay, and as a follow-up, you mentioned some improvement in customer acquisition costs at Earnest. I'm sure you can't disclose those in detail, but I'm wondering, can you give us -- in order to kind of quantify the opportunity, what type of percentage decline have you seen recently? And how far can you drive that down over the next year or 2?

I think our efforts right now in the -- we've owned the company for 5 months. I think it's probably a little bit too early to say where we can drive it to, but we definitely -- they had detailed plans of how to reduce those costs over time and build more efficient, digital strategies and models there, but we're definitely looking to continue that process. Some of it is, of course, also just how you originate the loan product as well so that you become more efficient at moving volume through the underwriting pipelines in the process, but that's a -- we'll talk more about that later in the year, I think, in terms of where we're headed.

Your next question comes from Rick Shane with JPMorgan.

When we look at some of the outlook commentary, a little bit of spread compression or NIM compression in the FFELP business, higher provision expense in the Consumer Lending business. It strikes me that those businesses will probably trend flat to down slightly from the Q1 run rate. I guess, the FFELP business probably trend down slightly, the Consumer business will be offset by some growth, but implicitly, your guidance suggests that there's about $35 million of net income that's going to be picked up in the remainder of the year. Is the expectation that, that's really going to come from the new business, from the Business Processing segment, is that really where we should see that growth?

Yes. So the purpose of the new business segments were to provide greater transparency into the performance of the individual segments, but in the Federal Education Loan segment business, by itself, I mean, you're correct in that, that is a declining business, right? No new FFELP loans are being originated, and the vast majority of the revenues and earnings in that segment come from either owning FFELP loans or providing services to FFELP loan participants in that process. That, we provide the forecast of the cash flows that we expect to derive from that space out 20 years. It's -- since the portfolio is nationalized in 2010, it's -- this has been kind of what that business is. We've been able to alter it a bit by buying portfolios, but those opportunities we see as becoming smaller and smaller. And when we look at where we can drive future earnings growth, it is coming from a combination of activities. It's primarily coming from growing in the BPS and Consumer Lending segments, as you point out in refi, but also the opportunity to expand that perhaps into in-school originations. It's coming from our focus on operating efficiency, driving down our cost, improving the margins that we have in the business and minimizing or reducing interest expense in the process as well as the component of the overall spread. So those are the principal drivers that we're focused on for the balance of 2018 and really beyond.

And also capital return will have an impact as well, as you get into the second half of '18 and into '19, which will clearly benefit earnings per share as well.

And look, I want to put a little bit of a finer point on the student debt, sort of back-of-the-envelope math that I'm talking about assuming some repurchase. I understand that, obviously, the sort of wasting-asset nature of the FFELP business, but in 2000 -- in the back half of the year, it sounds like there's going to be a little bit of NIM compression. So let's assume that, that -- we saw sort of peak earnings, at least for the year, in that segment. In the Consumer Lending business, you talk about additional provision expense. Certainly there's going to be growth there. Potentially, if you move back into in-school, there is going to be expense associated with getting back on preferred lender's list. So realistically that business is going to be perhaps flat for the year from here and that's fine, but what I'm trying to understand is, does it really -- and again, can you sort of walk us through the path in terms of the revenue growth objectives on the BPS to sort of drive that incremental $35 million? And again, it's not $35 million per quarter. It's a $35 million gap between where you are today and where you would need to be at the end of the year to hit the lower end of guidance. Is that the way to think of this?

So as we -- our goal and our guidance in the BPS space is for 30% organic revenue growth in 2018. We certainly benefit from the acquisition we made in terms of total revenue of Duncan midway through 2017, but generally speaking, we're looking to drive increased profitability -- increased revenue and increased profitability from that business segment and frankly, that's one of the reasons why we've created this new business segment and highlighted it here for you, so you can see the revenue growth specifically and see the margins specifically, but everything you've said is generally correct, right? The pressures on FFELP and private are there. Those are things that we've been expecting since the portfolio, since the business was nationalized in 2010.

Got it, okay. With that in mind, I appreciate the fact that you guys are going to provide '15, '16, and '17 numbers broken out annually. Because of the way that everybody sort of looks at the numbers, quarterly numbers for '17, at least '16 would be ideal, but if you could include '17 numbers sooner, rather than later, rather than rolling them out when you report each quarter, that would be really helpful as people go back and reconstruct their models.

Noted. Thanks.

Your next question comes from Henry Coffey with Wedbush.

That's going to be a lot of work. But on that topic, the -- breaking them down -- breaking the line of businesses into new categories is obviously very helpful. I had some questions around that and this answers all of them. The consolidated numbers are modeling of sort of the revenue in the consolidated businesses, that's -- I mean, except for the fact that you'll be achieving your goals of being more effective on certain fronts, that's not really going to change that much. Is that an accurate way of thinking about it? When I look at P&L, it's not going to be radically different?

Well, I do think your -- I mean, your mix of components of business is changing, right? Because one, your largest business, our largest segment, the Federal Education segment is amortizing and it's amortizing at a pace that's pretty much in line with what we expected, sometimes it's a little faster, sometimes it's a little slower, as was this quarter, but that is declining and the other businesses are expected to replace that, not dollar per dollar, of course, but they're just pieces. They're growing. They're growing at different paces than the other businesses are declining. I think probably one of the bigger items that has been -- and we hope this and appreciate your comments on the value of the new segments that we try to provide here -- is that the amortization and profitability that's been coming on the portfolio is coming from a spread business, which is being replaced with, in many instances, revenue on a fee-based business and the dollars are smaller and profitability, although margins might be attractive, is smaller as a result of that. And so you're -- that has always been part of the challenge in the mix issue as it gets, I think, explained and disclosed to investors. Breaking it into these segments is our attempt to make some of those points more transparent and easier for investors to see results and frankly, growth opportunities. So those are the 2...

No, I agree. I'm just thinking about it from -- no, I agree completely. This was -- I had questions around all of this and then, now you've solved them. But the actual modeling job is -- the challenges are about the same. You had to know the FFELP portfolio. You had to think about student loans. So it's not -- I mean, it's a lot of work for you and then we just have to redo our models, but the intellectual task is actually simplified here.

Great. Thank you.

On a sort of unrelated topic, you opened the discussion already, but mortgage. The biggest issue facing successful student loan -- former student loan borrowers, now successful professionals is getting a mortgage because their DTI numbers tend to still look horrible, their FICOs are fantastic. I have one, so I know. I have one that's going through all this, so I know all this. But the ability to get a mortgage is going to be challenging for this demographic. Have you -- when you look at doing mortgage, is it just something that they happen to be doing because so far, you happen to be doing it? Or is this an area where you're going to invest capital and maybe even work on some product innovations and the like with other -- in the buy-sell business, you'd be working with the buyer, of course.

Yes. So a couple of points on this. I think the -- there are broad comments made about student debt and the impact of things. When we -- we have a distinct advantage in that we have 12.5 million customers and so we actually see details versus broad statistics. When we go through and survey our customers and look at actual borrower activities, students -- borrowers with student debt actually have mortgages at similar rates than they've had in prior cycles. The biggest challenge -- and this is a policy issue that we have advocated for a change here -- but the biggest challenge for customers is that when they were coming into repayment during the great recession and experienced an inability to get a job and now they have one, is they have delinquencies on their credit bureau report and the stringent mortgage underwriting criteria sees that delinquency and denies the borrower a conforming mortgage. And as you know, alternative mortgage products are relatively few and far between these days. That is the biggest challenge facing this demographic, not DTI in the product. It's that inability to qualify because of a prior delinquency event. I think in our Earnest side of the equation, this is an out -- this is very much a pilot opportunity for us, and we're just exploring what the opportunity is and how attractive it could be. It is not capital-intensive. We have no intentions of owning or service -- there's originated and servicing -- and sold servicing released, and we would expect it to be a modest related business that we think we might have potential to cross out to our customers on a wider scale down the road, but that is a to-be-determined and to-be-proven concept.

Very much as technology is with it.

Right, no, exactly. The intellectuals -- you're going to supply the intellectual and technology capital. Would you be exploring the "delinquency" side of the business, which means going down FICO a little bit even though not all FICOs are created equal? Or would you be looking at a project -- product for the high net worth side of the student loan equation?

Our customers in this space are very high -- these customers are very high FICO, very high income. So if we're talking about cross-selling products, that's where we would be focused.

And that's all the questions that we have for this time. Back to you, Joe.

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

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