Navient Corporation (NASDAQ:NAVI) Q1 2023 Earnings Call Transcript

Navient Corporation (NASDAQ:NAVI) Q1 2023 Earnings Call Transcript April 26, 2023

Navient Corporation beats earnings expectations. Reported EPS is $1.02, expectations were $0.83.

Operator: Good day and thank you for standing by. Welcome to the Navient First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference may be recorded. I would now like to hand the conference over to your speaker host for today, Jen Earyes, Vice President, Investor Relations. Please go ahead.

Jen Earyes: Thank you Shannon. Hello, good morning, and welcome to Navient’s earnings call for the first quarter of 2023. With me today are Jack Remondi, Navient’s CEO; and Joe Fisher, Navient’s 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, forward-looking statements, and other information about our business that is based on management’s current expectations as of the date of this presentation. 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 financial measures, including core earnings, adjusted tangible equity ratio, and various other non-GAAP financial measures that are derived from core earnings. We will also refer to adjusted core earnings, which are measurements derived from core earnings and adjusted to exclude expenses related to regulatory and restructuring costs. Our GAAP results and description of our non-GAAP financial measures can be found in the first quarter 2023 supplemental earnings disclosure, which is posted on Navient.com/investors. You will find more information about these measures beginning on Page 15 of Navient’s first quarter 2023 earnings release. There is also a full reconciliation of core earnings to GAAP results included in the disclosure.

You can view and download presentation slides, including slides you may find useful during this call. On the events and presentations section of Navient.com/investors. Thank you. And I now will turn the call over to Jack.

Jack Remondi: Thanks, Jen. Good morning, everyone, and thank you for joining us today for a review and discussion of a very good first quarter’s results. And thank you for your interest in Navient. Our first quarter’s results demonstrate the stability of our business even in varying economic environments as we execute the four pillars of our strategy, delivering on our growth potential, maximizing loan portfolio performance, continuously improving operating efficiency, and disciplined capital management. Our results this quarter include adjusted core EPS of $1.06, strong FFELP and private net interest margins, strong and improved credit performance, and continued operating efficiency gains. Combined, we delivered a core return in equity of 19% this quarter.

Turning to the business segment results, we remain very focused on delivering on our growth potential. In consumer lending, we are preparing for the coming lending season. In this quarter, we originated $168 million in private education loans. While demand for in-school loans is seasonally low in the first quarter, we remain confident in our guidance to more than double new in-school loan originations in 2023. In business processing solutions, we’re off to a strong start, with revenue from traditional services increasing 26% over the year ago quarter. Here, we continue to promote our data driven processing and customer contact capabilities, which we forecast will deliver 10% growth in revenue along with a high teens EBITDA margin for the full-year.

As Joe will discuss more fully, while this quarter’s results include expected start-up costs that reduced profitability by $0.03 per share, our full-year profit forecast remains intact. Last year, we saw accelerated prepayments in our FFELP portfolio. FFELP prepayments have now fallen well below the store level levels. The resulting slower amortization of loan premiums drove this quarter’s $10 million FFELP loan loss provision. Our effective funding programs and interest rate management helped to deliver stable net interest margins in both our FFELP and private loan portfolios even as interest rates rose again in the quarter. Importantly, our strategy of funding our loan portfolio for the life of the loan via asset backed securities, currently 85% of our funding mix really shows its value during times of liquidity challenges.

Credit performance remains an area of strength. We saw improvements in delinquencies and private loan defaults were significantly lower than expected for the quarter. Our results also include two significant items impacting the provision for loan losses this quarter. One was a $52 million benefit from an accounting rule change for modified loans. This was reflected as a reduction in the provision for loan losses. And the second was an agreement to resolve several bankruptcy related class actions resulting in an increase in provision for loan losses of $23 million. We believe this agreement provides a clear framework for the treatment of loans and bankruptcy from these legacy student loan programs. This nationwide agreement, which is subject to court approval, resolves several class proceedings related to this limited category of legacy private loans originated years before Navient was formed.

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Navient has never made any loans in these categories. Navient has long advocated for student loan bankruptcy reform along with calls for a clear and consistent treatment for loans and bankruptcy that are easily understood by borrowers and lenders. Our focus on efficiency delivered a reduction in operating expense versus the fourth quarter. First quarter operating expense includes several significant seasonal items and also includes start-up expenses associated with new business processing contracts. We will continue to pursue initiative to improve our overall operating efficiency. Now, on capital management, we repurchased 4.9 million shares to pay $21 million in dividends in the quarter. We earned a core return on equity of 19% and improved our adjusted tangible equity ratio to 8.5%.

These results demonstrate our commitment and ability to deliver strong risk adjusted returns by investing your capital and attractive opportunities, while returning excess capital to you, all while maintaining a strong capital position. Our results this quarter are a strong start for Navient that reflect our commitment and ability to generate high quality, high value products and services, and deliver solid financial results even in volatile and challenging markets. They also reflect our ongoing commitment to simplify our business model and reduce risk. More importantly, our efforts to build the foundation from which to create and deliver value. Our affirmation of our guidance for 2023 reflects our confidence and our ongoing ability to deliver on our growth potential, maximize portfolio performance, deliver better margins through operating efficiency, and deliver attractive risk adjusted returns on capital.

I want to thank my colleagues for their efforts and commitment to our success. And together, we look forward to delivering another great year of results in 2023. Joe will now provide a more detailed review of our results. Thank you for your time. And I look forward to your questions later in the call. Joe?

Joe Fisher: 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 first quarter results for 2023. I’ll be referencing the earnings call presentation, which can be found on the company’s website in the Investors section. The first quarter’s strong results position us well to meet our full-year 2023 guidance targets with key highlights from the quarter beginning on Slide 3, including first quarter adjusted core EPS of $1.06, which includes a net provision release that I will provide additional detail on later in my remarks. Achieved an ROE of 19% and an overall efficiency ratio of 53%, FFELP NIM of 112 basis points, private NIM of 312 basis points, origination of $168 million, EPS revenues of $72 million, and increased our adjusted tangible equity ratio to 8.5%, while returning $106 million to shareholders through dividends and repurchases.

Provide additional detail by segment beginning with Federal Education Loans on Slide 5. In the Federal Education Loans segment, we achieved a net interest margin of 112 basis points, compared to 104 basis points a year ago. Since November, there has been a significant decline in prepayment activity and we are seeing consolidation requests that are below historical levels. Our expectation for full-year 2023 FFELP NIM of 100 basis points to 110 basis points assumes that prepayment speeds remain at these levels for the remainder of 2023. Compared to the fourth quarter, self-delinquency rates decreased to 14.4% from 15.6%, and forbearance rates decreased to 16.9% from 18.1%. We saw charge-offs increase to 22 basis points in the quarter, and we anticipate a net charge-off rate between 10 basis points and 20 basis points for full-year 2023.

While credit trends have improved, the slowdown in prepayments that we are experiencing is expected to increase the life of the portfolio, which results in an increase to unamortized premium allocated to expected future defaults. As a result, we added $10 million in provision in the quarter for FFELP loans. Let’s turn to our Consumer Lending segment on Slide 6. Net interest income in the quarter was $153 million and resulted in a net interest margin of 312 basis points, an improvement of 32 basis points, compared to the prior year, driven largely by improved funding spreads. We continue to see a slowdown in prepayment speeds in the overall portfolio as borrowers with fixed interest rates and less of an incentive to refinance and the current rate environment, which is benefitting net interest income.

We anticipate our full-year net interest margin for 2023 to be between 280 basis points and 290 basis points. Our credit performance improved from the prior quarter as total delinquency rates declined from 5% to 4.5% with forbearance rates improving from 2.1% to 1.9%. Net charge-offs remained flat at 1.6% and $75 million compared to the fourth quarter. While credit trends are improving, the net $24 million release of provisions private education loans in the quarter was largely driven by the adoption of the new accounting guidance for modified loans. Our private education loan modification program provides borrowers with options to successfully navigate their loan process in times of financial hardship. During which we offer a lower interest rate to help the customers successfully make a lower payment that amortizes the loan.

Prior to adopting the new accounting guidance, we calculated the present value of the amount of interest forgiven for loans currently in the modification program and included it as part of the allowance for loan loss. This reserve element is no longer allowed when borrowers enter new loan modification programs. At the end of 2022, our loan loss allowance included $77 million related to this practice. We elected to adopt this new guidance prospectively, resulting in a release of this allowance over time as borrowers that had previously entered into modification program exit those programs over the next few years. This quarter, $52 million of the $77 million was released as the majority of these programs are typically short-term in nature. Of the remaining 25 million in allowance, we expect a little over half to be released this year with the remainder in 2024.

In the quarter, we reserved an additional $5 million related to new origination volume and $23 million pertaining to the bankruptcy related resolution that Jack discussed. We remain confident that we are adequately reserved for the expected life of loan losses given the well-seasoned and high credit quality of our portfolio and anticipate net charge-offs to remain in the 1.5% to 2% range for 2023. In the quarter, we originated $168 million of private education loans. This was comprised of $33 million of new in-school volume and refinanced loan origination volume of $135 million. The decline of the refi volume from the prior year is primarily driven by the higher rate environment and delay in Department of Education loans entering repayment.

We anticipate quarterly refi origination volume to remain at these lower levels throughout 2023 as we expect the expiration of the CARES Act to provide no meaningful impact in the current rate environment. Continuing to Slide 7 to review our business processing segment, revenue from our traditional DTS services increased 26% from a year ago, partially offsetting the expected wind down of revenue from pandemic related services. First quarter revenues totaled $72 million and earned a 7% EBITDA margin. The margin was impacted by start-up costs, primarily related to new government services contracts, which reduced the overall margin by 600 basis points. We expect to see continued fee revenue growth of at least 10% in our traditional services in 2023.

With full-year EBITDA margins in the high teens as we benefit from the addition of new contracts and efficiency initiatives throughout the year. Turning to our financing and capital allocation activity that is highlighted on Slide 8. The recent market turmoil emphasizes the importance of strong asset liability and capital management. We ended the quarter with 85% of our education loan portfolio funded to term and reduced our total unsecured debt outstanding by 14% or $1 billion. In addition, we reduced our share count by 3% through the repurchase of 4.9 million. In total, we returned $106 million to shareholders through share repurchases and dividends this quarter, while increasing our adjusted tangible equity ratio to 8.5% from 7% a year ago.

Our 2023 guidance includes the repurchase of $225 million for the remainder of the year. Turning to GAAP results on Slide 9, we recorded first quarter GAAP net income of $111 million or $0.86 per share, compared to $255 million or $1.67 per share from a year ago. In closing and turning to our outlook for 2023 on Slide 10, the adjusted first quarter’s results of $1.06 from the efficiency ratio of 53% and core return on equity of 19% reflect the steps we have taken to simplify the business, build capital, and provide consistency in the face of a volatile rate environment. The continued efforts to improve efficiency and success across all of our business lines contributed to the strong quarterly results. As a result of this quarter’s performance and our outlook for the remainder of 2023, we are maintaining our EPS guidance range of $3.15 to $3.30 for the full-year.

Our outlook excludes regulatory and restructuring costs and assumes no gains or losses from future loan sales or debt repurchase. It also includes the impact of provision related to the accounting change for the remainder of the year. A rate scenario that is based on the recent forward curve and assumes that we do not see an acceleration of prepayment speeds related to changes in the federal programs. Thank you for your time, and I will now open the call for questions.

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Q&A Session

Operator: Thank you. Our first question comes from the line of Mark DeVries with Barclays. Your line is now open.

Mark DeVries: Yes, thanks. You called out, I think 15 million of revenue growth from ongoing government healthcare revenues for . Can you talk one more about that and also, kind of what additional opportunities are to grow revenue in that segment?

Jack Remondi: Sure. We are continuing to see a strong pipeline for growth really leveraging some of the service – the skills that we have developed over the years and managing on servicing our internal student loan portfolios, and applying them to different businesses. So, we work with clients in government, in both government services, transportation, and healthcare. Each of them are a little bit different, but they’re really relying on the same kinds of skills, the data analytics driven approach to helping customers, their clients, and customers resolve activity. So, where we see strong growth right now are really in the government services space. We did win a large new contract in that area last in the fourth quarter, it’s being implemented in the first quarter as an example in that drag earnings this period.

But it involves in-bound and outbound telephony, customer communication, and transaction processing related work. In healthcare, we also see similar growth opportunities and there we’re working with hospitals, primarily as they manage their end-to-end patient admittance and revenue cycle management activities.

Mark DeVries: Okay, great. And are there any remaining pandemic related revenues in that segment that’s still expected to run-off?

Joe Fisher: In this quarter, there are no pandemic related services.

Mark DeVries: Okay, great. Thank you.

Operator: Thank you. Our next question comes from the line of John Hecht with Jefferies. Your line is now open.

John Hecht: Thanks guys. Just, you gave some good confirmation of the guidance that you provided earlier in the year, but I’m just – I’m wondering how do you see given all the, kind of moving – kind of the moving parts with respect to potential government policy changes and this and that and inflation and so forth. How do you see, kind of the demand trends for loans ramping up in the consumer category ramping over the year?

Jack Remondi: Yes. So, I think in the two different products in that side of the equation, and certainly in our refi loan product, this is a program that allows students who have graduated earned their degree and have demonstrated a track record of successful repayment to refinance their loans at a lower rate. Obviously, when interest rates are rising, that opportunity is smaller and we wouldn’t – one, we wouldn’t encourage borrowers to refinance if they can’t get a lower rate. Demand is definitely lower. Our preparation for 2023 is to be ready when market conditions return and to be able to meet whatever demand comes from that side. Our focus in 2023 has been primarily on the in-school side of the equation. Here, this is a market that is – demand is driven primarily by new students enrolling in school.

And those trends have been more positive. Enrollment levels were down coming out of COVID. They are now starting to rebound and that gives us the confidence to be able to say, we’re going to double loan originations in 2023. Overall, we look at that market as growing about 5% to 6% a year. So, clearly, if we’re doubling volume, we expect to be able – we’re expecting to take market share in this arena. And we’re doing so by an ease of an application process, an underwriting program that is, leverages our 40 years of experience in both originating and servicing student loans. And really working with customers to explain and help them understand the cost of attendance and how they can minimize their overall borrowing costs. One of the programs that we didn’t talk about in our prepared remarks, but that we offer is a series of options that help students and families complete the , apply for scholarships, and then compare their overall financial award letters that they get once they’re accepted.

These are the types of things that we think can help elevate our products in the in-school marketplace to higher prominence and more value to the customer overall.

John Hecht: Okay. Thanks very much for that. And then a little follow-up on Mark’s question before in the business processing segment. It seems like you’re going to have a pretty strong ramp in the EBITDA margin throughout the rest of the year. Are the new contracts consistent like from a, call it from an economic perspective relative to the – call it maybe some more of the contracts that you’ve had over the years or are, kind of terms improving where you’re going to get a better net margin over time as you scale?

Jack Remondi: Well, I think you get a little bit of both of that, but this quarter’s margin was definitely negatively impacted by the start-up costs. So, just provisioning in the expenses that come with ramping up a large contract where we hired over 350 people to meet the needs of the client. And that’s based and had to provision equipment, etcetera, to them. So, we certainly are expecting those margins to increase significantly on new contracts as we move through 2023.

John Hecht: Okay. Thanks very much.

Operator: Thank you. Our next question comes from the line of Arren Cyganovich with Citi. Your line is now open.

Arren Cyganovich: Thanks. I was wondering if you could just talk a little bit more about the government contracts that you were just referencing. What are these specifically related to and what’s the length and term of these? And is this a new area that you’re going into? It sounded, obviously you said start-up cost. I don’t know if that’s just new because it’s a new contract or if it’s, kind of a new specific area that you’re entering into?

Jack Remondi: Yes. So, it’s not a new area for us. We’ve been providing services to various government municipal and state agencies for a number of years now. And most of these contracts rely on the same types of activities. It’s telephony, it’s yielding in-bound and outbound communications with their clients. It’s processing transactional activities. So, obviously no two contracts are identical, but the services that we are providing are leveraging the same technology platforms, the same telephony platforms, the same processing activities that we have done in our business processing solutions that are really leveraging our student loan servicing piece. The start-up costs here are just related to the new contract with just the share volume of starting up something new with a client, you’re pre-positioning people, technology equipment into the field, etcetera, and revenue follows that. So, just a little bit of a timing related issue there.

Arren Cyganovich: Okay. And then in terms of – you listed a few one-time items in the prepared remarks. I don’t know if I grabbed all of them and the start-up costs, the slower amortization, maybe you could just list what those are, I didn’t see them in the release or the slide presentation?

Joe Fisher: So, just to be clear, our guidance of is based off of the quarterly reported number of $1.06. So, that is how we’re thinking about the remainder of the year. But in terms of the items that we’re impacting the quarter that some analysts had in the model, some did not, but I’ll highlight some obviously wouldn’t have known about the 52 million was included in some of our analysts and some of the street’s numbers not related to the accounting update and you had the 23 million related to the bankruptcy, potential settlements here that Jack discussed. I know a number of also did not have the 10 million of FFELP provision that I referenced, and then Jack referenced the $0.03 as it related to the start-up cost. So, those would have been, I would say, for significant items that were not either included in everyone’s models or was at least a mix. But to be clear, our guidance of 315 to 330 is based off of the $1.06 for this quarter.

Arren Cyganovich: Great. Thank you.

Operator: Thank you. Our next question comes from the line of Moshe Orenbuch with Credit Suisse. Your line is now open.