Navient Corp (NAVI) 2018 Q4 法說會逐字稿

Ladies and gentlemen, my name is Lance and I will be your operator for today's conference. At this time, I would like to welcome everyone to the Navient Fourth Quarter 2018 Earnings Call. (Operator Instructions) .

I would like to turn the call over to Joe Fisher. You may begin.

Thank you, Lance. Good morning, and welcome to Navient's 2018 Fourth 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 fourth 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 fourth quarter results capped a strong year. Our adjusted core earnings per share of $0.58 brings our full year earnings per share to $2.09. Our 2018 results demonstrate that we have the expertise, systems and data-driven strategies to create value by maximizing cash flows, originating high-quality loans, growing our fee revenue and improving operating efficiency.

Our actions also demonstrate our commitment to manage capital appropriately by maintaining a strong balance sheet, supporting our loan origination opportunities and returning significant capital to shareholders. This commitment and focus on creating value produced meaningful contributions in 2018 from all areas of the company, including net interest margins, student loan additions, portfolio performance, fee revenue growth, operating efficiency and capital management.

For example, the net interest margin in our federal and consumer loan segments benefited from our efforts to lower our overall funding costs.

We executed on solutions that raise funds at lower rates, refinanced existing facilities and reduced our need to issue unsecured debt. We developed and implemented successful hedging strategies for our 1-month, 3-month LIBOR exposure. We improved our return on temporary cash positions. And we retired or repurchased $3 billion in high-cost unsecured debt.

During 2018, we originated or acquired over $3.6 billion in student loans, this includes $2.8 billion in refi loans.

In the last 3 years, we have added nearly $20 billion in student loans to our portfolio.

Our ability to successfully generate new refi loans demonstrates the strength of our Earnest origination platform, combined with our operational expertise and funding capabilities.

Importantly, we're able to steadily improve the net interest margin of new refi loans, achieving the highest margins of the year in the fourth quarter.

Credit trends in our FFELP and private loan portfolios continue to improve. A strong jobs market and our innovative data-driven, customer-focused strategies have led to lower charge-offs and improving delinquency rates. For example, private loan charge-offs declined 16% to 1.7% rate and our FFELP portfolio of 90-day plus delinquency rates are at the lowest levels in over 10 years.

In our Business Processing segment, fee revenue increased 26% to $267 million in 2018, and we delivered 20% organic growth in both our government services and healthcare businesses.

Total revenues also benefited from the full year contribution of our 2017 acquisition of Duncan Solutions. Our EBITDA margins in the segment also improved, increasing over 30% to 17% in 2018.

We continue to leverage our skills in workflow processing, account resolution and data-driven strategies to deliver value to our over 600 clients in these markets.

We are always developing new strategies and solutions to improve operating efficiency and customer experience. 2018 was another year where we delivered on these goals.

On an apples-to-apples basis, operating expenses declined 11% to $819 million. We also rolled out a new website for our student loan customers and launched a digital process for income-driven repayment application.

This all-digital application flow greatly benefits our FFELP customers by dramatically simplifying a very complex process. It's a prime example of how we continue to automate and innovative processes to benefit all stakeholders.

Finally, our goals in 2018 included strengthening our capital ratios while continuing to return capital to our investors. We did both. Our TNA ratio improved to 1.25x from 1.20 a year ago. And we paid dividends of $166 million and repurchased 17.4 million shares or 7% of shares outstanding.

While we've taken a brief moment to celebrate 2018 results, we're now clearly focused on 2019. We expect to deliver stable margins in our student loan portfolios by focusing on both the yield and reducing funding costs.

Our goal is to add over $4 billion in student loans, including $1 billion of FFELP and at least $3 billion in refi loans. Demand for our refi products remains strong with January shaping up to be our best month ever.

We will also benefit from the end of restrictions on who we can market to.

We continue to believe we can generate double-digit ROEs from this low-risk product.

Later this year, we plan to launch a new in-school loan product. Our capabilities and insights give us an opportunity to develop a highly competitive offering that promotes responsible borrowing and meets an important need for many families. The in-school lending market is an attractive opportunity for us. We have the infrastructure, credit expertise and unique marketing insights that will generate assets that we believe can deliver mid- to high teens returns on equity.

Our target this year is modest. It is to disperse at least $150 million in 2019. I'm excited about leveraging our skills and infrastructure to generate attractive low-risk assets and to deliver value from our refi and in-school lending products.

We also expect to see strong credit performance in both our FFELP and consumer loan portfolios and we are starting the year off in a strong position and expect these positive performance trends to continue.

Our ongoing efforts to improve our operating efficiency will deliver results again in 2019. We continue to develop and implement new automation tools and deliver simpler solution tools to our customers.

Even with growth in our Business Process servicing and new loan origination segments, our total adjusted operating expense will decline again in 2019.

Finally, our strong starting capital position and cash flow generation will allow us to return nearly $600 million to shareholders through dividends and share repurchases.

So only 3 weeks into the year, we're off to a strong start and are excited about the ability to deliver value for our customers and our investors.

I look forward to your questions later in the call.

Now let me turn the call over to Chris for a more detailed review of this quarter's results.

Thank you, Jack. And thank you to everyone on today's call for your interest in Navient.

During my prepared remarks, I will review the fourth quarter and full year results for 2018.

I will 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 $0.58 in the fourth quarter versus $0.43 from the year-ago quarter. For the full year, adjusted core EPS was $2.09.

A few key highlights from the quarter include refinance loan originations of $759 million, improving credit quality and lower adjusted operating expenses. In addition, we benefited from a lower effective tax rate of 19% in the quarter and an $18 million gain from the repurchase of $1.4 billion of unsecured debt.

For 2019, we are providing additional transparency on the key targets and metrics we use to measure the success for the company and its business unit. These metrics and targets are highlighted on Slide 4. As the portfolio of Federal Education and legacy Private Education Loans continues to amortize we remain focused on managing our net interest margins across the portfolio and reducing charge-offs to maximize cash flows.

With regard to our fee-based businesses, improving our EBITDA margins and generating organic growth opportunities are key measures of success. Contributions from these segments, coupled with our nascent loan origination businesses, the end of our noncompete with Sallie Mae should generate attractive mid-teens ROEs for the company.

In addition, we remain committed to our tangible net assets ratio range of 1.23 to 1.25x and ensuring that excess capital is returned to shareholders. As mentioned on the previous slide, we are laser focused on maximizing the cash flows from our education loan portfolios.

As can be seen on Slide 5, we generated an additional $6 billion of cash flows between 2014 and 2016 versus our original projections at separation from Sallie Mae. These cash flows are generated primarily through enhanced financing activities and education loan acquisitions.

Our updated cash flow projections can be found in the appendix of this presentation and do not include the benefits of future loan originations or acquisitions.

Let's move on to segment reporting, beginning with our Federal Education Loans on Slide 6. Core earnings were $147 million for the fourth quarter and $580 million for the full year. The provision per FFELP loans declined 17% from the year-ago quarter. This is consistent with our expectations as the delinquency rates have significantly declined from a year ago.

The net interest margin for the fourth quarter was 86 basis points and our full year net interest margin of 83 basis points ended the year at the high-end of our guidance. This positive trend was a result of numerous proactive financing transactions we executed throughout the year.

Contingency collections inventory increased by over $13 billion from the prior year. This increase contributed to the 21% growth in asset recovery revenue for the third -- from the third quarter.

Now let's turn to Slide 7 and our consumer lending segment. Core earnings in this segment were $66 million for the quarter and $252 million for the full year. During the quarter, we originated $769 million of education refinance loans and $2.8 billion for all of 2018.

We continue to see healthy demand and strong credit performance in this product and we have continued to increase our average coupon rate on new originations.

We're excited about the additional opportunities to expand our product in 2019 and expect at least $3 billion of refi originations.

The full year consumer lending net interest margin was 324 basis points, in line with our expectations. Our financing and operational initiatives have resulted in improving net interest margins on both our legacy and newly originated refinance loan products. At year-end, education refinance loans represented 14% or $3.2 billion of our consumer lending portfolio compared to 3% or $751 million a year ago. Our NIM guidance of 3.1% to 3.2% for 2019 is a result of the shifting mix of our portfolio towards the higher quality refinance loans.

Let's continue to Slide 8 to review our Business Processing segment. Fee revenues in this segment grew 10% from the year-ago quarter with EBITDA margins improving by 50%. The 26% increase from the prior year in contingent collections inventory is primarily a result of increased placements from federal and local government services contracts.

In 2019, we expect the full year revenue of at least $270 million with EBITDA margins in the high teens. While we anticipate high teens revenue growth in our healthcare segment, the loss of the previously discussed totaling contracts will mitigate overall growth in this segment in 2019.

Let's turn to Slide 9 to provide additional color on our continued focus on expenses. For the full year, our ongoing operating expense initiatives resulted in an 11% decline in adjusted operating expenses, exceeding the decline in the average balance of our total education loan portfolio.

For 2019, we expect operating expenses, excluding regulatory restructuring costs of between $940 million and [$960] million, which is a 5% year-over-year decline when excluding the onetime noncash impact of the contingency reserve released in the second quarter of 2018.

Let's turn to Slide 10 which highlights our financing activity. During the quarter, the company repurchased 10.6 million shares for $125 million, and we have $440 million of remaining authority under our share repurchase program. Importantly, we did this while increasing our tangible net asset ratio to 1.25x.

For 2019, we expect to continue to operate within a 1.23 to 1.25x TNA ratio range. In the fourth quarter, we actively repurchased $1.4 billion of our unsecured debt through make-whole call and open market transactions. As a result of these actions, we were able to reduce our 2019 maturities by $1.3 billion, while also taking advantage of the recent market dislocation to realize a core earnings gain of $18 million in the quarter.

In the quarter, we issued 2 Private Education Loan ABS transactions totaling $1.3 billion. For the full year, we issued $3 billion of Private Education Loan ABS compared to $662 million for all of 2017.

Before turning to GAAP results, I'd like to recap our full year 2019 guidance on Slide 11, which excludes expenses associated with the regulatory costs and restructuring expenses. In 2019, we expect core earnings per share between $1.93 and $2.03, operating expenses between $940 million and $960 million, full year FFELP net interest margin in the low- to mid-80s, full year Private Education Loans net interest margin between 310 and 320 basis points, full year Private Education Refinance Loan originations of at least $3 billion and the full year business processing revenue of at least $270 million with expected EBITDA margins in the high teens.

Let's turn to GAAP results on Slide 12. We recorded fourth quarter GAAP net income of $72 million or $0.28 per share compared with a net loss of $84 million or a loss of $0.32 per share in the fourth quarter of 2017. The primary differences between core earnings and GAAP results are the marks related to our derivative positions.

In summary, in 2018, we meaningfully reduced operating expenses across the company, successfully executed on our Earnest business plan, developed and executed multiple financing transactions, bolstered our capital position and returned nearly $400 million in capital to shareholders.

In addition, we are well positioned to execute on our 2019 plans and look forward to another successful year.

I will now open the call up for questions.

(Operator Instructions) Your first question comes from the line of Sanjay Sakhrani from KBW.

I guess my first question is on the in-school origination channel. Obviously, you guys put some targets out there. Could you just talk about what the driving factors are? Whether it would come in, in line, weaker or more? I guess, Jack, you've talked historically about there might be other avenues through third-parties to actually accelerate the growth there. What kind of discussions have you had so far?

So our -- first of all, we view this market as an attractive opportunity for us based on our expertise in this particular area and really the strong insights and data that we bring from servicing loans for so long. I also think there's an opportunity for us to really differentiate our products in a marketplace that really hasn't seen a whole lot of change or innovation in the last -- over the last 10 years. Our focus is a direct-to-consumer approach through the school channels. So it is marketing the product similar to the way we do our refi products, which is digital-first approach. And the $150 million represents origination volume that is just the first half of the disbursements that would typically take place in an academic year cycle. So full academic year originations booked and processed in 2019 were total about $300 million.

Okay. And do you think that there is room to do better on that number? And what might accelerate that?

Well, certainly, if you look at the market opportunities here, our focus will be on first-time borrowers. So we expect that many borrower -- many students and families who have borrowed previously in the private education market place will return to their existing lender. But these are -- as I said, I think these are modest expectations and we would certainly work hard to beat them in any way we can.

Okay. And just one follow up on the refi product. Obviously, you guys had a very strong year this year and you're expecting more of the same. Could you just talk about where the opportunities lie going forward? Is that part -- is part of the optimism there just as a result of the noncompete ending? Or is there opportunities without that even to hit those targets?

So I -- it's a good question. And I think the opportunities here really come from a couple of different sources. One is that graduate school students who have been borrowing in the Grad PLUS marketplace are generally paying still -- are paying relatively high interest rates. And there's an opportunity for them based on the progression that they've experienced in their -- in the job market, in their income levels to materially reduce the interest rate that they paid on their loans. That still represents an opportunity for us as more recent graduates move into that very, very strong credit quality perspective. And certainly, on the private education loan side of the equation, refinancing those loans is also, I think, effectively an expanding opportunity for us in 2019 as the noncompete expired on January 1. So it's really a combination of the 2 markets.

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

Just on the credit side on private. Thanks for the color around the charge-off guidance. I'm just kind of curious if you can touch on how you think about reserves as you're continuing to mix towards Earnest? And maybe if you can unpack sort of how to think about reserves on the legacy portfolio versus Earnest versus what you're going to be reserving for on the in-school product?

So we're seeing very strong trends and credit performance really across the board, but particularly strong performance in the refi portfolio. Our credit losses continue to come in below the guidance levels that we've provided in the past. And on our legacy portfolio, you've got -- the non-TDR segment of the portfolio, credit losses are continuing to push into new historic lows. And that's really a function of the seasoning of the portfolio and then the, of course, the very strong economy. The outperformance that we continue to see is really coming, though, from the TDR portfolio. These are borrowers who have experienced some difficulty in the past. As you know, we're reserved for the full life of the loan loss expectations there. But credit performance has been particularly strong really as we have been able to continue to find innovative solutions to make sure that we are able to connect with these customers and work with them to find solutions that make loan payments affordable and manageable for them. And I think that the biggest contrast I would put here in this portfolio compared to the federal loan programs is that we work to make sure that consumers are still amortizing their loan balance so that they're seeing themselves make progress towards paying down that debt and moving forward. So those are the combination and the drivers there.

Just as a follow up. I mean as it relates to your reserves as a percentage of loans and repayment, should we continue to expect that? Or should we expect that to drift lower in '19 and '20 as the mix shifts more towards Ernest?

Yes. I think that you should see that on two parts, one, the mix shift obviously moving towards the highest quality portfolio, as Jack mentioned, our refi product is performing better than our expectations, which is a great result. But in addition, as these loans have seasoned and amortized we are seeing better performance as well. Obviously, we are heading into CECL and that all will -- that will change how we manage this on a like -- the loan basis. But for 2019, what you said [to] transpire.

Okay. And then last one for me just back to the in-school product. Do you view kind of the competitive environment and where pricing is generally across your competitors? Do you think there's an opportunity there? Or I'm just kind of curious what the go-to-market strategy is to scale the product a little bit faster?

So we'll be launching this a little bit later this year as the 2019-'20 academic year cycle begins. I think I would rather reserve our marketing strategy and approach until we officially launch the product there.

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

First of all on the guidance, could you just tell us how much buyback is kind of in your guidance for 2019?

Well, as I've mentioned there's $440 million of remaining authority. That's all we have, $440 million. That's what's in the -- in our guidance.

In the guidance. Great. And I guess given that you're at your 1.25 TNA ratio, what -- not to sound greedy, but how do we think about the possibility of having more available than that. Like, how do you think about that and how do you think about the trade-off between that and some of the asset growth choices that you're making?

I think Moshe, as you well know, we're all heading into CECL in a year and we're all trying to make sure that we manage in through that process in a way that is as least disruptive as possible to the business and the capital will return into the markets and then we also want to make sure that in that transition we're prepared. There's still a lot of questions from the rating agencies and from the regulators that we're also trying to determine. And so historically I've talked about the 1.23 to 1.25x range. I'd probably have talked about wanting to be at the top end of that. I think about the amount of capital returns we're going to have in 2019, which Jack just mentioned, is nearly $600 million plus hopefully being able to transition through CECL in a way that is least impactable. So obviously, if there is an opportunity where we find ourselves in an excess capital position or generate excess cash then we would -- as we've committed to, return that excess capital to shareholders. But I think we have a pretty strong plan in place now with a lot of transparency just to give some pretty good guidance. And as you think about capital allocation and then you talked about, I think, of new products versus what we're doing, again, I think, what we're trying to do is manage that capital allocation process. We still believe that at scale, the refi business and the in-school business is a low to mid-teens plus ROE business. And when you think about from a capital generation -- from a return perspective, that's a pretty compelling opportunity as well as returning a significant amount of capital to shareholders. So it's a -- but it's a great question. It's one we think about all the time.

Just to follow up on the -- I think Jack made a comment on the refi business as being kind of at the highest margins of the year in the fourth quarter. I guess, I wanted to square that with the securitization data which kind of showed margins of over 2.2% earlier in the year and 1.6% in the December securitization. So that's kind of down 60 basis points. And then now you've got key buying lower road. I guess maybe can you kind of square those things with that expectation?

So margins, what we securitized in the fourth quarter would not have been Q4 originations. And there's a -- in a rising rate environment, our hedging activities, effectively, don't show up in the securitization spreads. So when we're hedging those fixed rates that we're offering to consumers, when we go to securitize, the benefit of those hedges don't show up in the cost of funds reported there. But margin pressure, we definitely saw in a rising rate environment, particularly in a more rapidly rising rate environment, and it's not -- of course, it's not just what the Fed does, but it's what the markets are doing. Margins were pressured in the mid-part of 2018. We made a concerted effort to focus on improving those. And as I said, we had the highest margins of the year in the fourth quarter.

I'm not sure I understand that. Maybe we can take it off-line. But is there a benefits from hedging that are not in the securitizations, I mean, because usually [securitization] costs some money?

Well, if you're locking in the rate. If you're making loans and you're offering a fixed rate to a consumer and you're locking that in to a derivative -- hedging that through a derivative transaction but not issuing the debt until 3 or 4 months later or 2 months later. The hedge accounting rules don't allow you to transfer that hedge over into the securitization cost of funds. Well, we can take it off-line and explain that in more detail.

Your next question comes from the line of Mark Giambrone from Barrow, Hanley.

Most of my questions have been asked, but one question that I did have is for the refinance loans what is the life of loan there? How long do you expect those to stay on the balance sheet?

So the weighted average life of those loans -- obviously, terms go world class with this, but the weighted average life of these loans is 3.5 to 4 years. And so as they cycle through the securitizations, that's our expectations. That's what we have seen. The speeds have been relatively constant. This is a pretty fast paying off loan. And so from a risk-return perspective, we do think it's pretty attractive.

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

I had 2 quick ones. So for in-school, in-school origination, do your existing private loan facilities accept those loans as collateral? I'm just trying to get a sense for how you'll finance the in-school originations in the near term as it ramps up?

So we will be structuring new warehouses. Our facilities today don't contemplate the in-school loan. It's obviously a different loan. It's a different disbursements, a different hold. But what I can tell you is that there's a lot of banks who are discussing with us about warehouse opportunities. This is an uncommon structure. It is attractive from the financing perspective. So there is a significant amount of capital out there looking to continue to finance assets and are very attractive to this loan as well, this loan type as well.

Okay. And then my second one was regarding the mention of longer-dated bonds that Navient repurchased in 4Q. Would you happen to be able to share which bonds were repurchased? I know the 5 and 5 [aces] 2033 are out there. But it's not the only ones. So I was wondering if you could share.

Right. So we have the opportunity in the dislocation. We were offered a bond of what was at a very attractive price. And as you know, as I think about this from a capital allocation perspective, we looked at -- the term of that bond as you said it was in that -- it was past 2030. It was a foreign currency bond, which means there's a derivative against it and there's a capital against it. And so as I looked at -- we as a team looked at, what that [discount] represented from a return perspective versus what our cost of issue, new 5 or a 7 year was, what the benefit was to the P&L from that perspective, it was all very attractive. So we decided to retire that foreign currency denominated bonds.

(Operator Instructions) Your next question comes from the line of Rick Shane from JPMorgan.

I just want to go through -- I think you started to touch on it, you provided some color on the last response. But from a GAAP basis you reported a $28 million gain on the retirement of the bonds. From a core perspective, you reported an $18 million gain. Just wanted to make sure we understand the difference. And also, if you guys can sort of help us understand why we should think about that gain as a part of core income?

Yes. The primary difference is there is a difference in accounting for the derivatives. And so really it's just a derivative issue which you see in our core versus GAAP numbers normally. So it's just the unwind of that. And we can take it off-line. I mean it's just as simple as that.

Got it. And in terms of -- how to think about this in terms of core income?

The gain?

Yes, as opposed to -- I mean, because, again, core income suggests recurring. And I just want to -- when we think about the things we add and subtract from core income, I want to hear your thoughts on why to include this in core?

Well, it may have fallen within our definition of core and net income. I would just go back to that definition and think about it from that perspective. I understand what you're saying. But at the -- again, from a perspective of definition that falls within we're going to --

We are highlighting it so investors can see that, that was a benefit that is not something we expect to repeat in every single quarter. But it's not a mark-to-market related issue that we exclude on the derivative transactions, for example, under GAAP.

There are no questions at the moment. Joe Fisher, please continue.

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

Thank you for joining. This concludes today's conference call. You may now disconnect.