NAVI - NASDAQ

Good day and welcome to the Navient First Quarter 2024 Earnings Call. [Operator Instructions] As a reminder, this call may be recorded. I would like to turn the call over to Jen Earyes, Vice President of Investor Relations. Please go ahead.

Hello, good morning, and welcome to Navient's earnings call for the first quarter of 2024. With me today are David Yowan, Navient CEO, and Joe Fisher, Navient CFO. After their prepared remarks, we will open up the call for questions. A presentation accompanies today's discussion, which you can find on navient.com/investors. 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. Our GAAP results, description of our non-GAAP financial measures, and the reconciliation of core earnings to GAAP results can be found beginning on Page 15 of Navient's first quarter 2024 earnings release, which is posted on our website. Thank you. And I now will turn the call over to Dave.

Thanks, Jen. Good morning, everyone. Thank you for joining the call and for your interest in Navient. Let me begin by providing an update on our progress against the 3 strategic actions we announced in January. We've begun to implement these actions and have made significant progress in a short period of time to deliver on the overall expense reductions, within the timelines we described during our Q4 earnings call. As a reminder, the 3 strategic actions we're pursuing are, 1, adopting a variable cost outsourced servicing model, 2, exploring strategic options for the business processing division, including divestiture, and 3, streamlining shared services infrastructure and corporate footprint. These actions are intended to significantly reduce the expense base and simplify the company. They should increase the amount of net cash flows from our loan portfolios and increase the visibility in returns around growth initiatives. First, we've begun to implement a variable costs servicing model to an outsourcing relationship with MOHELA. We have identified and notified nearly 900 colleagues, who will be transferred to MOHELA. These include frontline servicing colleagues, as well as colleagues in shared service and corporate functions. We expect these employee transitions to begin during the current quarter and to finish up in July. We're also well underway on plans to transfer several proprietary and customized technology tools and solutions to MOHELA. These add-on systems will maintain automations and other efficiencies. Fortunately, since MOHELA uses the same third-party loan servicing platform as Navient, there's no need for a loan system conversion, which helps ensure borrowers will have a seamless servicing experience during the transition. We've prepared a multi-stage communication strategy designed to educate borrowers in advance of the transition and to help them know what to expect when the shift occurs this fall. We're on track to reach a final agreement with MOHELA during Q2. We expect there'll be several transition services agreements between MOHELA and Navient that will continue through and beyond year end. Second, I'll turn to business processing solutions. We have initiated a divestment process and are in active discussions with potential buyers. We've received broad interest in these businesses and are encouraged by the initial conversations and activity thus far. Our third strategic action is to reshape our shared services functions and corporate footprint to align with the needs of a more focused, flexible and streamlined company. We said in January that the full scope and timing of these opportunities will depend on the progress of the outsourcing and potential divestiture transactions. As outsourcing has come into sharper focus, we've taken steps that will reduce the shared service expenses in the company as a consequence of outsourcing. For example, of the approximately 900 employees we expect to transfer to MOHELA, roughly a 100 are shared service employees. Our plans for a leaner company post outsourcing and post divestment were further developed during Q1 through an intensive and focused analysis. This included a bottoms-up process by process-by-process, person-by-person assessment of our current costs of certain shared service and corporate activities. We have plans for a simple operational footprint for areas like IT and identified opportunities to consolidate like functions. We recently took steps to create a streamlined organizational structure that aligns to our future outsourced environment. In January, we stated that approximately $400 million of our full year 2023 operating expenses would have been eliminated under a scenario in which we had completed these 3 actions. As a reminder, a BPS divestment scenario would also not include corresponding BPS revenue. The progress we've made during the first quarter has increased the clarity of our plans and our confidence in our ability to execute the necessary steps to achieve these reductions within the timelines we laid out in January. This full scope and timing of these opportunities continues to depend on execution of the outsourcing and potential divestiture transactions. To summarize, we expect to finalize our plans and continue implementation on all 3 strategic actions this year. We believe substantial parts will be delivered this year with the final steps to be completed by the end of 2025. Now turning to our Earnest business. Earnest continues to efficiently generate high quality loans. Originations are off to a strong start in Q1. Joe will provide an update on our results thus far shortly. At the same time, we continue to pursue customer-centric relationships with students and college grads and explore opportunities through product extensions to deepen those relationships and deliver attractive lifetime economics. As a reminder, we're undertaking the strategic actions discussed earlier to realize increased net cash flows from our loan portfolios, increase our capacity and flexibility to invest and distribute cash to shareholders and improve the returns we can achieve from investments. We remain confident that the combination of the cash we have on hand, the accelerated cash flows from our loan portfolios, proceeds from the divestment of EPS combined should generate significant cash flows over the next few years. The FFELP loan prepayment activity that Joe will discuss within our quarterly results accelerates the return of loan principal within those cash flows. This cash will be available to distribute to shareholders. We will invest that cash only if we have clear visibility and opportunities to earn returns in excess of our cost of capital. This is the first update on our progress in implementing our strategic actions. We'll provide additional updates and call out their impacts on our 2024 reported results, as we progress throughout the year. As our visibility into these actions becomes more certain, we expect to provide a revised outlook and plans during the second half of the year. In closing, I'd like to thank my colleagues company-wide through their tireless commitment, we made substantial progress in a short period of time against 3 complex and large undertakings, our strategic actions. At the same time, our results for the quarter reflect strong performance against items within our control, such as expense discipline. I'm pleased with how the company is delivering significant change, while simultaneously serving our customers and clients. With that, let me turn it over to Joe, and I look forward to your questions later in the call.

Thank you, Dave, and everyone on today's call for your interest in Navient. During my prepared remarks, I will review the first quarter results for 2024 and provide updated guidance underlying our outlook for the remainder of the year. In the first quarter, we reported GAAP EPS of $0.64. On a core basis, we delivered first quarter EPS of $0.47. The $0.47 includes a $0.16 reduction to EPS related to significant items in the quarter. The first of these items relates to an increase in our accrual by $12 million in connection with the CFPB litigation as we continue to explore a solution that is acceptable to all stakeholders. The second of these items is associated with changes in federal student loan policy that were effective in the second half of last year, which continue to drive elevated prepayments within our FFELP portfolio. I'll provide additional detail on the Federal Education Loan segment on Slides 5 and 6. Our original guidance for net interest margin of low 70s included the higher rate environment that we experienced in corresponding decline in floor income and assumed a return to more normalized prepayment rates. As expected, the decline in floor hedges reduced FFELP NIM by 17 basis points compared to the fourth quarter. We do not anticipate earning a significant amount of floor income in the current rate environment. From a credit perspective, compared to the prior year, our greater than 90-day delinquency rates improved to 6.6% from 7.9%. The charge-off rate improved to 13 basis points from 22 basis points, and forbearances improved to 16% from 16.9%. We encourage borrowers who are experiencing or have historically experienced difficulty repaying their loans to take advantage of the recent programs and policy actions. In order to take advantage of the majority of these programs, a borrower generally needs to consolidate to the Department of Education Direct Loan Program. The quarter's NIM of 55 basis points reflects the elevated prepayment levels we experienced during the quarter and Slide 6 shows the dollar amounts of monthly FFELP prepayment activity since January 2022. The sharp increase in prepayment activity during the second half of 2022 was related to consolidation activity driven by the administration's proposals at that time to provide broad debt forgiveness to borrowers. In that instance, prepayments quickly returned to normalized levels. We believe the primary drivers of this quarter's elevated prepayment activity are a new and different set of policy actions taken by the Department of Education. These provide a broader array of payment and loan forgiveness programs, and therefore encourage borrowers to consolidate their FFELP loans into the Direct Loan Program. In the quarter, we experienced FFELP prepayments of $1.6 billion compared to $700 million a year ago. Loan prepayments reduce future net interest income, but accelerate loan principal payments within our life of loan cash flow projections. It is important to point out that the write-off of unamortized loan premium that accompanies prepayments is a non-cash expense and does not impact our life of loan cash flow projections. Looking forward, some of the policy actions that encourage consolidation provide incentives that are set to expire. The administration continues to propose and implement additional loan forgiveness and debt reduction programs. We cannot predict whether some or all of the expiring policies will be extended, nor the impact and timing of proposed or future debt forgiveness initiatives. In addition, the legality of several of these initiatives is being litigated in the courts, and we cannot predict the outcomes of those cases. If prepayments were to remain at the elevated levels in Q1 for all of 2024, we would anticipate NIM would remain in the mid-50s, and approximately $100 million of loan principal cash flows would be accelerated. Let's turn to our Consumer Lending segment on Slide 7. Net interest margin in this segment was 299 basis points in the quarter compared to 291 in the fourth quarter. Originations grew over 50% to $259 million compared to $168 million a year ago, as we remain focused on generating growth from high quality borrowers. We anticipate that the Consumer Lending NIM will be in the low 300s for 2024. This includes projected total education loan originations of $1.4 billion compared to $1 billion for all of 2023. Credit metrics in our Consumer Lending portfolio performed as expected with late-stage delinquency and forbearance rates relatively flat year-over-year at 2.1% and 1.8% respectively. The $24 million increase in charge-offs compared to a year ago was primarily related to the resolution of certain legacy loans in bankruptcy that were previously reserved for in the first quarter of 2023. This impact is reflected in our change in allowance on Slide 8. At the end of the first quarter, our allowance for loan loss for our entire education loan portfolio is $961 million. We reserved $1 million for FFELP loans during the quarter and new origination volume contributed $5 million to the allowance. Continue to Slide 9 to review our Business Processing segment. Total revenue increased $5 million to $77 million with an EBITDA margin of 11% compared to 7% a year ago. As we explore strategic options for this segment, I want to acknowledge the BPS team for remaining focused on growing revenues at attractive margins. Although, it is early in the process, we are encouraged by the interest we have seen so far from prospective buyers. Turn to our capital allocation and financing activity that is highlighted on Slide 10. We continue to maintain disciplined asset liability and capital management strategies with 83% of our education loan portfolio funded to term and an adjusted tangible equity ratio of 8.4%. In the quarter, we reduced our share count by 2% through the repurchase of 2.6 million shares. In total, we returned $61 million to shareholders through share repurchases and dividends. Let's turn to expenses on Slide 11. Total expenses for the quarter were down to $184 million. This includes $14 million of regulatory and restructuring expense, $12 million of which relates to an accrual in connection with the CFPB matter. Operating expenses declined 15% in the Federal Education segment and 12% in the Corporate/Other segment when adjusting for regulatory expenses. The strategic actions we have undertaken have allowed us to identify meaningful opportunities to reduce expenses in future periods. As you can see on Slide 12, the elevated FFELP prepayments lowered our overall Q1 EPS by $0.15 versus our internal expectations. This was partially offset by $0.08 from other operating improvements. The impact of the increased reserve for the CFPB matter is shown separately and was not included in our expectations. Based on Q1 experience, we updated our full year 2024 core earnings per share outlook of $1.55 to $1.75. It reflects the $0.47 reported EPS from the first quarter. This updated guidance contains several significant assumptions that are different than those embedded in our original guidance. The most impactful of these is our assumption for continued elevated prepayments on the FFELP portfolio for the remainder of the year, which was the primary contributor to a $0.15 EPS drag in the quarter. It also includes our current expectations for the transition to MOHELA in the second half of the year and assumes 3 rate cuts through year end. The updated guidance continues to exclude future regulatory costs and any future restructuring costs associated with rightsizing our shared service and corporate footprint. While we are encouraged by the interest shown so far in the potential divestment of BPS, we are excluding any impact from that transaction in the 2024 guidance. The amount and timing of certain shared service and corporate footprint reductions depends on the nature and timing of a BPS transaction. In summary, we made significant progress during the quarter against the strategic actions we announced in January. We continue to believe our objective of a simpler, leaner, and more focused company within the next 15 to 21 months is achievable. We are off to a good start and efficiently growing our origination volume at Earnest. The strategic actions position us to better manage the uncertainties we face around legacy loan prepayments in the future interest rate environment. Before I open the call for questions, I want to thank team Navient for their significant efforts throughout the quarter, as they work to execute the strategic actions while running the business and delivering value for clients and shareholders. Thank you for your time, and I will now open the call for any questions.

[Operator Instructions] Our first question comes from Sanjay Sakhrani with KBW.

This is actually Steven Kwok filling in for Sanjay. The first question I just had was around the updated guidance. You mentioned that the FFELP NIM was the primary driver. Can you just walk us through what the updated NIM expectations are? And how we should think about the trajectory for the remainder of the year?

So the way I think about it is we provided a updated guidance at the beginning of the year of low 70s. The primary driver of this quarter's miss is the just pre-pay -- the extended programs that we've seen and policy changes that have occurred that have led to elevated prepayments. We are expecting that to continue throughout the remainder of the year. That'll create what I would do as a 15 basis point drag. And that's where that low or that mid to low 50s comes in. And that is primarily driven from non-cash items, such as deferred financing fees, as well as the accelerated premiums. So I would just assume that that is fairly stable throughout the remainder of the year. And if there's changes in that policy, that could certainly impact different quarters, but we're assuming a straight line from this first quarter all the way to the end of the year.

That's definitely very helpful. And then just an update around the recent developments related to the CFPB matters, if you could provide some additional colors, given that the last couple of quarters you've been taking in an accrual for it.

Yes, Steven. It's David Yowan. Those that accrual this quarter, the $12 million, which approximates $0.08, just reflects the developments in the discussions that we're having with the CFPB. We've not gone any farther than that, and I'm not going to go any farther than that at this time.

[Operator Instructions] Our next question comes from Melissa Wedel with JPMorgan.

I'm Melissa on for Rick today. I wanted to better understand any potential impact on NIM. I think you covered it well on the FFELP side, the impact of the prepayment activity. Should we be thinking about the consumer lending NIM as being relatively unaffected? Because that is sort of focused on the FFELP program in particular. So should the low 300 bp NIM on consumer lending kind of hold in place versus what we talked about last quarter?

That's correct. We did not change our guidance as it related to the consumer lending NIM. And we would assume that that remains in the low 300s throughout the remainder of the year.

Okay. Thanks for confirming that. And then on the business processing side, guidance was for high teens EBITDA margin at 11% in the first quarter, that assumes a pretty steady ramp through the remainder of the year. How are you thinking about that? Is there any seasonality we should be factoring in?

There is some seasonality in the first quarter. As we saw, if you look at a year ago, we were at 7%. This quarter, we are at 11% EBITDA margins. That typically kicks up in the remainder of the year, and we would assume that occurs here as well. That's primarily driven just by compensation timing. We also saw a little bit of lag billing revenue on the health care side. And so we would anticipate that those EBITDA margins would increase throughout the year as it -- versus the first quarter.

Okay. But high teens for the full year still stands?

That is still our target, yes.

There are no further questions at this time. I'd like to turn the call back over to Jen Earyes for closing remarks.

Thanks, Michelle. For everybody on the call, if you have any follow-up questions, please just contact me. We'd like to thank everyone for joining on today's call. This concludes today's call.