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Edited Transcript of NAVI earnings conference call or presentation 23-Oct-19 12:00pm GMT

Q3 2019 Navient Corp Earnings Call

Newark Oct 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Navient Corp earnings conference call or presentation Wednesday, October 23, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christian M. Lown

Navient Corporation - CFO & Executive VP

* Joe Fisher

Navient Corporation - VP of IR & Corporate Development

* John F. Remondi

Navient Corporation - President, CEO & Director

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Conference Call Participants

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* Dominick Joseph Gabriele

Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst

* Henry Joseph Coffey

Wedbush Securities Inc., Research Division - MD of Equities Research

* John Hecht

Jefferies LLC, Research Division - Equity Analyst

* Leon G. Cooperman

Omega Advisors, Inc. - President, CEO & Chairman

* Mark C. DeVries

Barclays Bank PLC, Research Division - Director & Senior Research Analyst

* Mark William Hammond

BofA Merrill Lynch, Research Division - Associate

* Moshe Ari Orenbuch

Crédit Suisse AG, Research Division - MD and Equity Research Analyst

* Peter Vincent Troisi

Barclays Bank PLC, Research Division - Director & Senior Analyst

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* Sanjay Harkishin Sakhrani

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* William Haraway Ryan

Compass Point Research & Trading, LLC, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Thank you for standing by, and welcome to the Navient Third Quarter 2019 Earnings Conference Call. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Mr. Joe Fisher. Thank you. Please go ahead, sir.

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Joe Fisher, Navient Corporation - VP of IR & Corporate Development [2]

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Thank you, Polly. Good morning, and welcome to Navient's 2019 Third 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 third quarter 2019 supplemental earnings disclosure. This is posted on the Investors page at navient.com.

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

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John F. Remondi, Navient Corporation - President, CEO & Director [3]

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Thanks, Joe. Good morning, everyone, and thank you for joining us today and for your interest in Navient. I'm thrilled to be sharing the results of another exceptional quarter. We saw strong contributions across all business segments, delivering core earnings per share of $0.65. This quarter, we delivered better net interest margins, saw continued strength in credit, delivered a 57% increase in refi loan originations and saw an increase in our EPS -- EBITDA margin to 20%.

Through the first 9 months of the year, we are exceeding the financial targets we shared with you back in January, and we are raising full year EPS guidance for the third time this year to a range of $2.52 to $2.55. Our results this quarter continue to demonstrate our ability to deliver value for our customers, clients and investors. We are delivering high-quality earnings, maximizing cash flows, achieving operating efficiencies and producing strong growth in our new businesses, and we are leveraging our capital and our capabilities to generate very attractive risk-adjusted returns, as evidenced by an 18% return on equity this quarter.

Some highlights from the quarter include stronger net interest margins, as we continue to develop innovative lower cost options to finance our student loan portfolio. This has eliminated the need for us to access more expensive unsecured debt this year and reduce the outstanding balance by $1 billion.

Credit performance continues to show significant strength. Delinquency rates in our FFELP, Department of Education and private loan portfolios are either matching record lows are setting new ones. For example, the 90-day plus delinquency rate fell to 5.8% for our FFELP portfolio and 2.3% for private loan portfolio. The charge-off rate for our private credit portfolio this quarter was 1.6%, down 25% from a year ago.

Loan originations in the quarter totaled $1.4 billion, a robust 57% increase from a year ago, and totaled $3.25 billion year-to-date. We continue to see very strong demand for our products, which typically save clients thousands of dollars in interest expense and help them payoff their loans faster.

Credit quality and margins on this year's volume are very strong and are higher than last year. Earlier this year, we launched an in-school loan product. We used an MVP approach, which was designed to create learnings we could use for future enhancements and growth. Our focus was to target high-quality borrowers, who wanted to make in-school payments, both of which are increasingly important given refi options available in the marketplace.

Loan volume this academic season was disappointingly immaterial due primarily to the inability to offer consistent terms and eligibility nationally. We have plans to address this and to incorporate what we have learned as we prepare for the next academic season.

In our Business Processing segment, we signed several new clients in government, transportation and health care. Our continued focus on automation and data-driven solutions help support an increase in the segment EBITDA margin to 20% for the quarter. Finally, we returned $166 million to shareholders this quarter, including a $130 million to purchase 9.7 million shares.

We've been actively engaged with the Department of Education's next-generation servicing solution. Each segment of the proposed solution has now gone to bid with the major components awaiting award. Under today's contract, we provide end-to-end servicing to approximately 5.7 million borrowers, and this contract generates just under 8% of our total annual revenue.

We submitted a very competitive proposal that focuses on how we help student loan borrowers successfully manage their loans. Our history here is exceptional as we consistently lead others in default prevention and enrollment in alternative payment plans, including income-driven repayment options.

January, we will adopt the new accounting policy on loan losses. This policy known as CECL requires financial institutions to establish reserves for loan losses expected over the life of the loan. Preparing for this new rule is a major effort. And Chris will provide our estimate for the implementation of this policy in his remarks.

The requirement to estimate life of loan losses includes numerous estimates on economic environments at different stages of a loan life cycle, along with predictions of graduation rates and employment rates, et cetera. We built a robust model using our extensive data and experience to produce this life-of-loan loss estimate. This new accounting policy will alter our capital ratios and the annual GAAP profitability of newly originated or acquired loans.

In January, the implementation of this policy will result in a onetime reclassification of equity to loan loss reserves, and while this will change our capital ratios, we do not anticipate any changes to our capital return plans in the fourth quarter or in 2020.

We plan to maintain our dividend, and we plan to utilize the remaining $77 million available under our existing share repurchase authority this year. Furthermore, today, we are announcing a new $1 billion multiyear share repurchase authority. We expect to allocate approximately $400 million from this plan in addition to the $77 million remaining in the prior plan to purchases through 2020.

As this quarter's results illustrate, we are continuing to exceed our financial objectives, including maximizing cash flows, improving operating efficiency, generating growth in our new businesses and returning capital to investors. We are also well positioned to do the same in 2020.

Thanks for listening in today. And Chris will now provide a deeper review of the quarter's results. Chris?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [4]

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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 third quarter results for 2019. 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 $0.65 in the third quarter versus $0.56 from the year ago quarter. Key highlights from the quarter include a 57% year-over-year increase in refinance loan originations at attractive spreads and strong credit, further improvement in credit quality across our education loan portfolio, continued optimization of our capital structure as a result of additional securitizations and improved facility structures, core return on equity of 18% and the return of $166 million to shareholders through dividends and the repurchase of 9.7 million shares.

Let's move to segment reporting, beginning with the Federal Education Loans on Slide 4. Core earnings were $128 million for the third quarter. The net interest margin was 82 basis points in line with our guidance. Both the delinquency and charge-off rates has significantly declined from a year ago, with a charge-off rate at 6 basis points. Asset recovery revenue increased to 36% or $15 million from the prior year. This increase demonstrates our continued success rehabilitating new placements.

Now let's turn to Slide 5, and our consumer lending segment. Core earnings in this segment increased to 10% year-over-year to $79 million. Credit quality in this segment continued its strong performance as the total delinquency rate declined 24% and the forbearance rate declined 23% year-over-year. During the quarter, we originated $1.4 billion of education refinance loans at attractive spreads. The total private education portfolio declined less than 3% year-over-year. The net interest margin increased 23 basis points from the second quarter to 345 basis points.

While we continue to see the benefit of more efficient financing initiatives, this increase was primarily driven by the favorable interest rate environment, and we now expect net interest margins for the full year to be in the mid-3.20s.

Let's continue to Slide 6 to review our Business Processing segment. Total revenues in the quarter were $66 million, as both health care RCM and government services won and implemented multiple engagements. This was accomplished while growing EBITDA margins to 20% exceeding our targets and driven by continued synergies, increased automation and disciplined cost management.

Before highlighting our financing activity, let's turn to Slide 7 to discuss the estimated impact of the adoption of CECL to our balance sheet, income statement and capital allocation philosophy. The anticipated implementation of CECL is expected to result in an incremental allowance between $750 million and $850 million. This increase is primarily driven by the change in our non-TDR portfolio and FFELP portfolio from a 2-year reserve to a life-of-loan reserve. The after-tax impact is estimated to decrease equity by $590 million to $655 million. This will initially increase leverage ratios on day one of implementation.

After implementation, our ongoing profitability is expected to benefit from a significantly reduced provision expense compared to prior periods. The provision in 2020 will primarily be driven by the amount of new education loans that are originated, which will be reserved for, for the life of the loan. This change is expected to temporarily pressure our capital ratios, which will rebuild quickly as a result of the increased profitability in 2020. As a result, we do not see any change to our capital return philosophy.

As Jack mentioned, our Board approved a $1 billion multiyear share buyback program, and we expect our 2020 capital return to be broadly in line with 2019.

Let's turn to Slide 8, which highlights our financing activity. We began increasing our share repurchase activity in the second quarter as a result of the increased confidence in our financial outlook. The $130 million share repurchases that occurred in the third quarter represent a 21% increase from the first quarter's activity, while maintaining a TNA ratio of 1.27x. In the quarter, we issued $535 million of term private education ABS and $749 million of term FFELP ABS. In the quarter, we also called 2 legacy private education ABS transactions in order to optimize existing capacity in our warehouse facilities.

Earlier this week, we also issued notice for a make-whole call for $1 billion of March 2020 unsecured debt. Some of you may have seen this incorrectly reported by DTCC as a full redemption. This is in the process of being corrected. This call is expected to reduce our total unsecured debt outstanding balance to approximately $9.6 billion. We expect this to generate an accounting loss in the fourth quarter of approximately $15 million.

Moving to Slide 9. As part of the proxy settlement agreement disclosed earlier this year, we hired a third party to review our cash flow assumptions and model. The third-party has completed their analysis, and our third quarter cash flow forecast includes enhancements as a result of that review in addition to our regular quarterly updates.

Moving to Slide 10. We remain focused on the 2019 targets outlined at the beginning of the year. As a result of the exceptional performance through the first 9 months, we are raising our core earnings per share guidance to a range of $2.52 to $2.55, excluding regulatory and restructuring expense. This guidance represents a 28% increase from our original 2019 guidance and includes the estimated $15 million loss from the recently announced fourth quarter make-whole call of $1 billion.

Finally, let's turn to GAAP results on Slide 11. We recorded third quarter GAAP net income of $145 million or $0.63 per share compared with net income of $114 million or $0.43 per share in the third quarter of 2018. The differences between core earnings and GAAP results are the marks related to our derivative positions and the accounting for goodwill and intangible assets.

In summary, we continue to exceed expectations across the entire company, and we look forward to a strong finish to the fourth quarter.

I will now open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question comes from the line of Sanjay Sakhrani with KBW.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [2]

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Chris, I got 2 for you and 1 for Jack. Chris, on the EPS guidance upgrade, could you just talk about how much of that is driven by the interest rate movements and the basis impacts -- the related basis impacts? Just want to make sure I understand how that plays out over the course of the year, and how we should think about it going into next year?

And then secondly, you mentioned that the capital return isn't really impacted by CECL. I was just wondering if you've had a chance to talk to the rating agencies and what their thoughts were.

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Christian M. Lown, Navient Corporation - CFO & Executive VP [3]

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So well, I'll start with your second question first, Sanjay, and thanks for the questions. We have talked to the rating agencies. We have reviewed our preliminary results. Obviously, this is a preliminary number as of today, but they were generally in line with our views as well, which gave us comfort to announce these numbers. So we did have input and insight from them and therefore, I've shared that this quarter.

On the interest rate question, obviously, there was a benefit in the third quarter from our prime assets, which we said at the end of the last quarter versus the benefit we received during the full quarter. We are -- our projection isn't for a big benefit in the fourth quarter. We are -- our expectation is probably at this point only one more rate cut and that's at December. It clearly is -- it is unclear at this point if we're going to see a rate cut in October or December. But I'd say that most of that benefit has come through in the third quarter.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [4]

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Okay. Great. And then, Jack, could you maybe elaborate a little bit on the in-school loan growth disappointment there? Could you maybe just talk about the strategies to tackle that?

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John F. Remondi, Navient Corporation - President, CEO & Director [5]

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Sure. So one of the things that we had developed and planned to use a state licensing approach similar to what we do on the student loan refi product for our in-school loans. And one of the features or one of the items that we encountered during that process is the kind of the inability to capitalize interest for accounts that defer during the in-school period in certain states. And so that meant that we were depending on what state the borrower was in and the co-borrower was residing in, terms and conditions of our offering would differ and that just created a fairly significant obstacle for schools as they were promoting or recommending different lenders in that side of the equation.

For the customers that did move through our process, I think we saw very strong acceptance of some of the unique features that we offered, for example, how we invite a cosigner into signing the process, the quicker rate check that they can deploy. And I think one of the things that we were able to -- that I was particularly satisfied with was an acceptance and an understanding of the value of our -- that the customer saw in making payments while in-school. And as I said, both -- that high-quality customers and a willingness to make payments in-school, I think was particularly important in a marketplace that could see what -- where students and borrowers have an opportunity to refinance their loans after they -- the risk factors decrease upon graduation.

How do we address that? We will be working with a bank partner next year, which would allow us to basically have a single set of terms and conditions that we can offer nationally to our customers across the marketplace.

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Operator [6]

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

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Leon G. Cooperman, Omega Advisors, Inc. - President, CEO & Chairman [7]

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You disclosed the CECL impact on our book value, which I guess is something like a little under $3 a share. But what is the pro forma impact on our earnings because I assume, would -- should lift our earnings quite a bit? So would be question number 1. Question number 2, you earned 18% equity, would you say that we're over earning now? Or is this the number that you view as being reasonably sustainable?

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John F. Remondi, Navient Corporation - President, CEO & Director [8]

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So on the first question, CECL is a -- can only be best described as a very strange accounting policy because it's all based on estimates. And you're correct and that it adjusts book value, but really what the accounting policy is, is a movement of geography, right? It takes balances that were in equity and moves them into loan losses, estimates over the life of the loan. We would expect at the end of the cycle, the life cycle of the loan, that the earnings would be the same regardless of whether CECL existed or did not. So it's really just a temporary geographical change there.

In terms of earnings, one of the changes that happens with CECL is, of course, you're -- you would be eliminating -- if you get your estimates right on the CECL at adoption, you would not be making future provisions on the existing loan portfolio for the remaining life. So we do expect the loan loss provision expense to decline materially in 2020 and beyond. The only charges that you'll -- you should see is any adjustments to life-of-loan loss estimates, and of course, as we make loans or purchase loans, we would have to book a loan loss provision for the full life of the loans over that time frame.

And in terms of return on equity, this number is something that we think is -- it's what we're targeting, and we hope to be able to continue to achieve. Obviously, the CECL book equity will down, so ironically, ROEs will actually rise as we move into 2020.

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Leon G. Cooperman, Omega Advisors, Inc. - President, CEO & Chairman [9]

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From my knowledge of financials, companies that are in 17% and 18% on equity are generally selling probably 2x book or more. And we are selling on the pro forma book may be 1.2 or something like that. So I assume this stems from the legal overhang and the concerns of Elizabeth Warren, forgetting Elizabeth Warren for the moment because we can't forecast the future yet. The resolution of the legal overhang, any insight as to when you think that might achieve some clarity for us?

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John F. Remondi, Navient Corporation - President, CEO & Director [10]

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I do agree that the legal overhang is a -- is not an -- is a significant issue for us. This -- as I think I've mentioned in prior calls, the civil litigation process is a slow grinding process. We have completed the fact discovery process, we expect expert discovery to end early next year, and that then sets up the stage for setting a court date and process there. .

One of the things that we think is important to note here is when this lawsuit was filed, it was filed without having any kind of extensive or meaning -- really any listening to customer phone calls, so they made an allegation without actually listening to customer phone calls in the first place. And as anyone can see from the fact discovery process, which is available, it's probably disclosed at this point, the 15 witnesses that the CFPB has identified as supposedly supporting their claims of steering, in fact, all have said, "No, Navient did provide me information on income-driven repayment plans."

So it's unfortunate that this case was -- which was brought for political reasons continues to exist, but we are confident in our defense and this is the reason why we are fighting this case because the allegations are baseless.

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Leon G. Cooperman, Omega Advisors, Inc. - President, CEO & Chairman [11]

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Right. One theoretical question. No, it's not theoretical, it's probably practical. We have been consistent in keeping the dividend flat and buying back stock. What level of stock price would you suggest, would you think will be necessary for you to be looking at returning more money through the dividend rather than repurchase?

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John F. Remondi, Navient Corporation - President, CEO & Director [12]

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When we look at the enterprise value here, it's a function of the expected cash flows coming off the legacy portfolio, and then, of course, the business franchise value of the ongoing business activities. That's going to be something -- look, I'd love to have the luxury, the high-class problem of addressing that issue, but I think that's somewhere that begins with a 2 handle on the stock price.

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Operator [13]

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

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [14]

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Jack, you talked a little bit about the -- or maybe John or I mean Chris did it. You talked about the impact of rates the latter part of this year. But just thinking through next year, lower rates have a variety different influences, you talked about the basis risk, but it also influences volumes, I think the opportunity set for volumes in the refi market and so forth. So maybe can you just talk us through or remind us of all the elements we want to think about over the next several quarters when we think about a declining rate environment?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [15]

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Sure. So a couple of points there. On the lower rate environment, clearly, it has increased interest in the refi product, and we continue to see that going into the fourth quarter. We're a spread lender in that product. So as Jack mentioned, we're capturing very attractive spreads and returns of the product today even at lower rates and that should continue into 2020 as rates either decline or stay where they are.

Now one of the places where we're the biggest beneficiaries, where there's an anticipation of declining rates, but the rates don't actually decline, and so we'll be watching that through the rest of this year and into next year depending how many rate cuts we have. But there is that continued mismatch given our prime portfolio where the assets are pegged to prime and funded with LIBOR, and LIBOR rates continue to be lower than the prime reset. So that should continue, it is in our models and our forecast, but if that environment continues or there are more rate cuts than expected, there clearly could be upside as well.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [16]

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Okay. And then, obviously, very strong momentum in the private education refinance loans in the quarter. Can you -- is there any characteristics you can give? Is there any geographical trends you're seeing or type of borrower? Any light you could shine on that for us?

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John F. Remondi, Navient Corporation - President, CEO & Director [17]

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So the refi loan product is marketed primarily to students who have successfully completed their education and are out in the workplace with a demonstrated track record of making payments on their loans. The real -- the balance or the real target audience in this case is customers who typically have both undergraduate and graduate degrees, they have larger debt balances as a result of that. But when you look at the characteristics of our borrowers, loan balances tend to be in the high-double digits or 5 figures or low-6 figures. Their income is well into the 6-figure range. Their FICO scores are in the high 700s. And they typically have been in repayment, successfully making payments for somewhere between 3 or 5 years. That means credit losses on this portfolio are extremely low and that has been borne out by the actual experience to date.

As I mentioned, this year's loan volume has -- even though it's been up, it's up 60% year-to-date, is also seeing both better margins and better quality characteristics associated with that. Chris mentioned the ability, the interest rate environment and the options there, the customers that are refinancing particularly federal student loans in the space, typically have coupons in the high-5s all the way up into the 7s. And so we're able to offer terms and conditions that can save them thousands of dollars in interest expense and give them the ability to repay their loans faster. This is kind of in direct contrast with the federal programs, which really are designed to push out payments and extend term.

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Christian M. Lown, Navient Corporation - CFO & Executive VP [18]

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Yes. I think it's important to emphasize even with the increased volumes, we are seeing stable or even better credit metrics on FICO and free cash flow, et cetera. So really it's been a great year for us on the refinance side.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [19]

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Great. Well, that's great color. And if I can ask one quick question. Jack, what was the timing of phase -- that $477 million phase 1 of the buyback that we should think about?

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John F. Remondi, Navient Corporation - President, CEO & Director [20]

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So that will be the amount that we expect to return through share repurchases through the end of 2020.

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Operator [21]

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

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Mark William Hammond, BofA Merrill Lynch, Research Division - Associate [22]

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On CECL, can you give any insight as to what type of economic cycles is assumed there?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [23]

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So the CECL models actually require that you use multi-economic scenarios to drive the CECL model, and you can choose the number of options you choose. But -- so we've chosen 3 scenarios. Those scenarios are, it can be a mix of different scenarios, stable, deterioration, significant recession, et cetera. And then you weight those 3 scenarios to drive an outcome, and so it is a multivariable analysis, you're blending a number of economic scenarios. What I can tell you in general, most people I would think are assuming sort of stable to deterioration/recession and some weighting in their models, and we would be no different in that regard.

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Mark William Hammond, BofA Merrill Lynch, Research Division - Associate [24]

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And then also regarding CECL, just I quickly estimated your tangible net asset ratio remaining above 1.2x when CECL is first shown in the GAAP statements at the end of the first quarter? Is that generally the ballpark? Or what are you targeting is still to be above 1.2?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [25]

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Yes. So that is generally ballpark. What I'd also highlight is because we have been so efficient with our balance sheet over the last year and being able to optimize our capital structure and our assets and pay down unsecured debt, utilizing assets on our balance sheet. What we're clearly facing in the future is other constraints from a capital perspective, and we're paying more attention to things like risk-adjusted capital ratios and the rating agency models. And so the TNA ratio to some degree is becoming less of an influence on our capital management as we look towards risk-adjusted capital analysis to drive capital allocation plans, and we'll talk more about that in the fourth quarter.

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Mark William Hammond, BofA Merrill Lynch, Research Division - Associate [26]

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Okay. Great. And then last one for me is, of the $2.5 billion unencumbered private loans on the balance sheet, can you describe the collateral for me, just -- however, you can in terms of seasoning, whether it's some in-school loans or refi loans, however best you can represent them?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [27]

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Most of it is private credit very seasoned loans that we clearly could achieve leverage against if we needed to and is in our portfolio -- in the portfolio stats, and so it is just private credit. Unencumbered that we have the option to monetize or to create some leverage against in the future.

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Operator [28]

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(Operator Instructions) Your next question comes from the line of Mark DeVries with Barclays.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [29]

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I had a follow-up question on the private loan originations. What impact has the rallying rates we've seen this year had on the rate incentive that you can offer? And are you seeing that boost demand? And also what impact if any has it had on your abilities on the spreads you can generate as origination?

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John F. Remondi, Navient Corporation - President, CEO & Director [30]

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Sure. As Chris said, we are a spread lender, so what we are looking for is less about the absolute yield on the loan and more about the difference between the yield and our cost of funds. And in this environment, as we said, we're able to generate both -- we're seeing both higher quality, credit quality metrics on the loans we originate year-to-date as well as a higher margin on the loans. There's no question that the lower interest rate environment is -- sparks more demand. I think it's just a greater awareness of the product and opportunity in this space, but we're -- really what we see as the largest driver of demand for refi is borrowers coming out of the in-school status being in a period of repayment and having the opportunity to take a 6% or 7% interest rate loan and convert it into a somewhere in the 4% -- 3% or 4% interest rate loan today saving, as I said, thousands of dollars in interest expense. So we really don't look at it on an absolute rate basis, we look at it on a spread basis.

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Christian M. Lown, Navient Corporation - CFO & Executive VP [31]

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One I'd highlighted that probably starting in the second half of last year, the industry started becoming much more rational and that rationality has continued throughout this entire year. So there hasn't been any people looking to gain share from a pricing perspective, et cetera, that rationality has continued, which we've been very pleased with.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [32]

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Okay. And your volumes have exceeded your expectations this year. Is that due in part to the more rational environment you just alluded too? Or you getting more effective at marketing? Or are there other drivers of that?

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John F. Remondi, Navient Corporation - President, CEO & Director [33]

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I think it's all of the above. Certainly, the demand based on the rate environment is a factor, but our marketing strategies and approach here continue to evolve and get better. I would also add that our origination and underwriting process is a very easy process for consumers to participate in, and there are features of our product offering that really are designed to kind of provide a solution that is customized for each customer. They get to select the effectively the monthly payment term that they want to make, and that allows the loan balance to meet and the payment obligations to meet their budget and their pay down objectives. So it's really the combination of those factors that are driving demand and volume for us.

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Mark C. DeVries, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [34]

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Okay. Got it. And then just finally, well, what drove the strength in the asset recovery income during the quarter?

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John F. Remondi, Navient Corporation - President, CEO & Director [35]

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So in the last 1.5 years, 20 months, we received a large placement accounts from the Department of Education. We also signed some new guarantors in the old FFELP relationship side, so it was increased placement activity that is driving that. And the performance on that portfolio, our ability to demonstrate what we do best, which is connected with customers, educate them on the different options they have available to them and get them back into a payment plan that they can afford and more importantly, basically satisfy their obligations on the federal student loan side of the equation. We look at -- in the Department of Ed book as an example, 2 entities receive placements over that time frame, and we outperformed the competition by 46% in terms of recoveries.

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Operator [36]

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And your next question comes from the line of Rick Shane with JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [37]

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I just want to focus on Slide 8 on the financing component. Jack, you've used the word efficiency and that's clearly what's going on here. I'd love to understand, on a static basis, what all of these actions would do to your NIM? And then on a dynamic basis, curious with putting swaps in place or not if these actions increase your liability sensitivity in the 2020?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [38]

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So on the liability sensitivity, they actually have muted -- our hedging programs have muted our interest rate sensitivity. We have -- we published those sensitivities, you can see them, but we have been able to even mute further hedging activities and the interest rate sensitivity. And in our view, I think that's a huge benefit to the story over the last couple of years and what we've been able to generate from a return perspective.

Your question on dynamic versus static on the financing side, I think I can answer it this way. Obviously, we think about 2 things from a financing perspective, we think about rate, we think about term. We're always looking for ways to reduce rate on our financing, financing is a big cost in the company, it's something we focus a lot on, and so we can find opportunities to finance assets at a lower cost versus using unsecured debt. We aggressively pursue those opportunities. What we've been able to do over the last couple of years is do things like that or to call trust and repackage them and put them into lower cost facilities. We've had banks approach us about wanting to create on-balance sheet securitizations and really just take assets to term. The savings generally can be 200 to 250 basis points.

So it's very attractive, but you clearly don't have the term you have in the high-yield market, which is, like I said about 250 basis points more expensive. So we keep our eye on that term sensitivity, the cost perspective, but we've been very pleased with our ability to really optimize our assets and our capital structure to improve our cost to financing and just get much more efficient around it. I don't know, Jack, if you want to add anything?

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John F. Remondi, Navient Corporation - President, CEO & Director [39]

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I would just add, I mean, the innovation or the solutions that we're tapping into here are not just lowering our cost. They're not taking on additional interest rate risk or liquidity risk for the company. It's not like they're changing the profile.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [40]

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Got it. I'm just wondering if in an environment where we expect rates to go lower if these funding strategies by shifting things a little bit more floating or actually potentially going to enhance your sensitivity to that.

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Christian M. Lown, Navient Corporation - CFO & Executive VP [41]

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No. I mean sort of our asset liability mix is along that lines. What we capture is delta in financing costs and that kind of float. So it's -- I think what you really just look is to optimize the ultimate cost because we have -- our assets and liabilities float generally.

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Operator [42]

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And your next question comes from the line of Moshe Orenbuch with Crédit Suisse.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [43]

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Most of my questions have actually been asked and answered. Although I thought, Jack, could you just talk a little bit about -- a little bit more about the contract renewal? And what elements and when we're likely to hear about the various pieces?

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John F. Remondi, Navient Corporation - President, CEO & Director [44]

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Yes. So there's a couple of moving parts in this space. Clearly, the next generation component is where the department has signaled that intends to go, those contract responses have been solicited and submitted. We're now awaiting award. Our expectation is that even with an award, it's going to take time for implementation. So the current contracts that the major servicers have with the Department of Ed actually are set to expire in December of this year. They have signaled an intent to extend those, but we haven't seen the specific proposals at this stage in the game.

As I said, we service 5.7 million accounts for the Department of Ed today. And certainly, this is an important contract for us, and we think we do an outstanding job on this side of the -- for the department and more importantly, for the customers. But the entire contract represents less than 8% of our total revenue.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [45]

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Got you. Then a couple of follow-ups. Chris, you've done a really great job kind of tapping cash from various parts of the balance sheet. Have you talked about how you're going to finance the $1 billion of the call on the 2020 maturity?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [46]

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Well, what I'd say is, we don't need to use -- we don't need to issue high yields. So we found additional options to raise the cash, and we feel like we're in an incredibly strong position, not only for the $1 billion make-whole call, but for the 2020 as well.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [47]

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Got you. That's...

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Christian M. Lown, Navient Corporation - CFO & Executive VP [48]

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We'll talk about -- Moshe, we'll talk a little bit in the fourth quarter call about what we've executed.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [49]

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Got it. And then just lastly. I mean the kind of expenses in general, you've had better results kind of on the fee-based business, a little more expense because of the originations on the private loan refi side. Just talk a little bit about how you see that going forward? And maybe just about how acquisition costs are behaving in that refi market?

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John F. Remondi, Navient Corporation - President, CEO & Director [50]

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So operating expense, and particularly, operating expense efficiency is one of our top objectives within the company. Expenses this quarter were flat relative to a year ago. A lot of that has to do with some of the growth items that you mentioned. If you think about like our contingency collection work, whether we do it ourselves or we do it through agents, there are direct variable costs that come with that revenue that show up in that side of the equation. But look at the end of the day, our portfolio is amortizing, and we need to continue to find ways to more efficiently run the business and reflect the runoff or the amortization that comes on that side of the equation.

On our refi business, I think, one of the things that we have done exceptionally well on that front is, is not just about credit quality and spread metrics, but it's also our cost to acquire. We do have a process that is -- relies more heavily than the competition on digital strategies. We think this creates a CTA or cost to acquire in the refi space. That is typically about half the average that our competition is spending to originate loans.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [51]

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So you think that's persisted even as you stepped up the volume?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [52]

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Yes.

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Operator [53]

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And your next question comes from Henry Coffey with Wedbush.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [54]

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When you're looking at the -- your dialogue with the rating agencies, are they -- it seems that they're being very flexible about CECL and just kind of fluffing it off. Is that an accurate description about how they're looking at it? And they seem to have digested it very well. Is there the risk that there's an event on the horizon when they suddenly wake up and say, "Oops, we didn't mean to be so nice about all this." Because it seems like they're just looking at it from a finance point of view and just saying, "Oh, it's geography, we don't care where your reserves and capital are?" Or is that just inaccurate?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [55]

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So to be clear, I would not say they're fluffing it off. But what I would say is that they clearly are cognizant of the fact that this is a geography issue, that they understand there's a phase in element to this. I think that they have digested it well. Some of them have come out with statements and some research that actually said just what you said and that this is a geography issue, and they don't see any change. And saying that, obviously, we want to be cognizant of the potential issues that may face if they change tact. And so over the last year and 1.5 years, we've been trying to get to this point to manage this transition in a way that really was as least disruptive to this company as possible, and I think, we've navigated those waters well thus far.

And so we'll see how it transpires in 2020, but I do think to restate, they do see it as geography, they do see it as an impact, and they're going to work it in over time, but they are cognizant of the fact that you do have a lot of loss-absorbing capital on the balance sheet as a result of this. And I do not expect that they're looking for a build back to the levels that would include or that would include additional equity capital as a result.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [56]

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The bank regulators don't seem to be as flexible. Does this creating a competitive advantage for a nonbank lender like yourself? Or do you have any thoughts on that yet?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [57]

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So that's an interesting question. And I think the regulators are still -- they may be less flexible, but they're obviously giving more time and there is a phase in and 3 years is a very long time and see where things go. Inevitably, one of the benefits a diversified finance company has always had over a bank is not having a stronger regulatory requirement or capital requirements that the banks have. And so that could play out as an advantage depending on the regulatory actions. So it could clearly be a benefit. We want to get through 2020 smoothly, and then we'll see what the opportunity is, but we feel very good about where we are today.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [58]

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And then finally, sort of an unrelated question. It's very clear in listening to how you're describing both the refinance program and the in-school lending program that you're focused on the upper end of the quality spectrum. You have billions and billions of dollars of experience collecting lower credit quality loans. You've had a lot of experience in the private education market, et cetera, et cetera. Is there a prospect over time that you'll evolve a product for, in essence, lower quality, but still very durable borrowers? Or what are your thoughts on that process?

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John F. Remondi, Navient Corporation - President, CEO & Director [59]

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So there is no question, one of the huge assets of this company is our history and experience working with borrowers across -- all types of borrowers across all types of economic cycles. In the federal loan programs, they're entitlements. And so a customer is able to obtain a loan from the Department of Education regardless of what where -- what type of degree they're pursuing, how long they will take to get there if they get there at all, and whether or not that adds any value. And we see that as problematic. That doesn't mean low quality FICO Score customers are bad credits in this -- in the education space, but we do need to focus on students and borrowers here who have a high propensity to graduate are taking on reasonable amounts of debt for the type of degree that they expect to earn.

And I think, more importantly, it's a demonstration that there is an acknowledgment that they want to make payments so that they're paying down their loans. I think one of the -- philosophically, one of the challenges with the federal loan programs is this desire for all borrowers to be in income-driven repayment plans, the majority of whom are negatively amortizing, and then there's somewhat of a shock that borrower balances are not declining. Well, what did you expect, right? So we want to target a different customer base here. Customers that are using the loan products we offer to help them improve their economic outlook, graduate on time, and as importantly, make payments to amortize their loan balances as quickly as they can afford.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [60]

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Another way of thinking about the question, would your existing skill set allow you to make more loans into the for-profit business, if you felt you had a borrower that met your criteria?

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John F. Remondi, Navient Corporation - President, CEO & Director [61]

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I think our experience allows us to identify customers who are more likely to be successful across the spectrum. And so that is looking at customer persistence in terms of graduation rates, debt levels and willingness and ability to make payments. So it's really a combination of those things. There are good borrowers across all different types of schools, there are bad borrowers, credit borrowers across all different types of schools.

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Operator [62]

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And your next question comes from the line of Bill Ryan with Compass Point.

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William Haraway Ryan, Compass Point Research & Trading, LLC, Research Division - MD & Senior Research Analyst [63]

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I have a question related to the runoff analysis on Slide 9. Looking at the prior quarter, it seems like there may have been some adjustment in the expected runoff cash flows of both the FFELP and the private portfolio, and you mentioned an independent analysis that was performed. Were there any material adjustments made as a result of the independent analysis? And second, in relation to the runoff analysis does it pretty much at this point incorporate the CECL expectations you're going to be embedding in your numbers next year?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [64]

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So on the third quarter adjustment, the primary adjustments to the third quarter actually were just our annual -- our quarterly updates around interest rate curves. And as you can see, we increased some of our CPRs. So those were the primary adjustments as well as realized cash flow in the quarter. The cash flow analysis that the third-party did with us was very helpful, in that it allowed us to feel even more confident in our analysis and our projections. What I'd say is on a net basis, it ended up being relatively some puts and takes and inevitably, not a significant impact other than just verification of the process and the models that we have to -- that we put out every quarter.

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William Haraway Ryan, Compass Point Research & Trading, LLC, Research Division - MD & Senior Research Analyst [65]

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Okay. And then just in relation...

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John F. Remondi, Navient Corporation - President, CEO & Director [66]

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The number -- the loss estimates are in connection with CECL loss estimates, for sure. And we don't have 2 different models there.

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Operator [67]

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Your next question comes from the line of Peter Troisi with Barclays.

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Peter Vincent Troisi, Barclays Bank PLC, Research Division - Director & Senior Analyst [68]

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I think my question was just asked, but just a follow-up. Did you say that the figures -- the cash flow figures on Page 9, do you incorporate CECL economic assumptions?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [69]

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They do.

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Operator [70]

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Your final question comes from the line of Dominick Gabriele with Oppenheimer.

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Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [71]

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I just wanted to clarify, did you mention that you would likely not raise the dividend unless the stock was above roughly $20, did I hear that correctly?

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John F. Remondi, Navient Corporation - President, CEO & Director [72]

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We don't -- I mean that's a - as I said that would be a high-class problem for us to be addressing. I think we would take a look at where we are and what are the drivers behind our view of enterprise value at that particular point in time. But as it stands right now, our plan and approach is to return the lion's share of the capital that we are returning to investors through share repurchases.

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Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [73]

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Great. And just real quick. If we look at the core EPS number and I believe you may have said this earlier in the call, but would that include the $15 million expense in the fourth quarter for the -- when we're thinking about the kind of base level of core earnings for 2019 in your new guidance?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [74]

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That's right. So our $2.52 to $2.55 full year estimate includes that $15 million loss from the make-whole call in the fourth quarter.

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Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [75]

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Okay. Great. And then is there any chance that you could provide perhaps some of the NIM benefit between the FFELP segment and the private consumer segment? When it comes to a 25 basis point cut in rates, the kind of geography there of the split?

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Christian M. Lown, Navient Corporation - CFO & Executive VP [76]

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So it's a little more complicated than that, and maybe we can take that off-line and talk about that. You, me and Joe can get on the phone. It's interesting, it depends on the date of the rate cut because some dates are better than others and when we incorporate those changes into our assets or not. And so we can have that discussion on sort of how the FFELP and private portfolios impact from -- are impacted by a rate cut off-line.

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Operator [77]

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And this concludes the Q&A portion of the call. We will now go back to Mr. Fisher for closing remarks.

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Joe Fisher, Navient Corporation - VP of IR & Corporate Development [78]

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Thank you, Polly. I'd like to thank everyone for joining us on today's call. Please contact me or my colleague Nathan Rutledge if you have any other follow-up questions. This concludes today's call.

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Operator [79]

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And thank you. Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect.