Navient Corporation Investor update

Thank you for joining today's call. With me are Edward Bramson, Navient CEO and Chair of the Navient Board of Directors, and Steve Hauber, Navient CFO. After the presentation, we will open up the call to take your questions. During today's call, we will refer to a corporate reorganization presentation, 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. As part of the presentation, we will discuss illustrative financial models and statements related to our legacy and continuing businesses. This discussion is meant for illustrative purposes only and is not intended to be a forecast of future results. Actual results in the future may differ materially from those discussed today 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 may also refer to certain non-GAAP financial measures, including core earnings, adjusted tangible equity ratio, and various other non-GAAP financial measures derived from core earnings. Listeners can refer to Navient's second quarter earnings release, which is posted on our website for a complete reconciliation between GAAP net income and core earnings. Thank you, and I will now turn the call over to Ed.

Thank you, Roger, and thank you everybody for joining us this morning. We're going to talk about the presentation that's online about our recent corporate reorganization that we announced yesterday. To provide some context, this was another in a series of strategic moves that we've been making to enable us to increase shareholder value over time. That being the case, I'm not going to go through all of the details of what we've done, which we hope are clear from the disclosures we've made, but I will touch on a few of the strategic aspects as we plough through the presentation. If you go to page 3, about a new corporate structure, hopefully what we've done here is pretty clear.

I think the salient point, though, is that we now have our two businesses in separate legal entities, both of which are SEC-registered and will be filing separate financial statements going forward. That's the real point I want to make there. If you go to page 4, this just sizes what we are doing at the time of the reorganization. Almost all of the assets that Navient Corporation has are ending up in Navient LLC, which is effectively the successor. We are transferring to our new Earnest subsidiary basically at the moment, the intangible assets that relate directly to it. Over time, because it is doing servicing and originations, it will need some additional working capital. We are not expecting Earnest to be carrying loans for an extended period of time. It will sell those loans to the market or transfer them to Navient.

Earnest will continue to be relatively capital-light, and the capital-intensive business will reside in Navient LLC. If you go to page 5, the objectives section. We really restarted originations in a serious way late in 2024, so we did not see a result until 2025. As a result of that, we are getting an increasing divergence between the legacy business and the continuing business, which we call Earnest. We think it is to the point now where we need to get a greater differentiation between the two, and capital intensity is only part of the differentiation. As we focus more on Earnest, it is managed differently, has different growth characteristics, and we think it is a good idea to now start to differentiate how we measure business success.

For the legacy business, we are going to be using a number of metrics, but the key one is going to be the availability of cash after unsecured debt service. In Earnest, what we are doing because we are building the business over time, the success metric here will be return on attributable equity. I think the other point to make is that obviously there are arguments to be made for valuation or other purposes that these companies should be split entirely. We think there are counterarguments at the moment that argue for keeping them together. What the reorganization has done now is in the event that we did decide to make a complete separation, a lot of the work that is required to do that has already been done. If you go to page 6, it is just an overview of what the differences between the businesses are.

If you look at the Legacy business. Its portfolio at the end of June was about $40 billion. Three-quarters of that, or thereabouts, is actually comprised of loans of types that we do not make anymore. That is why we refer to those as non-strategic. It is a good loan portfolio, but by its nature, it is shrinking. When you have a shrinking portfolio, despite the fact that we are constantly reducing expenses, you have negative operating leverage. The other thing is most of the assets in the portfolio are securitized. As the securitizations age, the leverage drops, and so the return on equity also comes down. It is not that it is not a good business, but to run it for return on equity or earnings growth really is not the right way to do it.

If you look at the second bullet on the page, what this is is basically information that we disclose, I think, every quarter. So in June, you can see how much cash we had. Every quarter, we forecast the expected inflows from our portfolios, net of the trust debt that is securitized. The new information on the page is the third-party cost of servicing these portfolios over their expected life. As you may remember, back in 2024, we outsourced most of the servicing to a third party in order to variabilize that cost. So at the moment, we're estimating about a $600 million lifetime servicing expense. And I think it's worth saying that had we not outsourced, that number would be a multiple of that.

Anyway, the net of it is, I think that we expect to have coming on to $5 billion of cash after all these items have been paid, but before overhead and before taxes. Whatever those things turn out to be, I think it's reasonable to expect that there'll be several billion of discretionary cash available, and that can be used either for growth or for distribution to shareholders. But if you go to page 7, I think at present, the strategic reason for keeping the businesses together is fairly clear, that the cash flow from the legacy business is available to fund Earnest as it's really in the early stages of its growth. Looking at Earnest, obviously, it has been growing pretty quickly. You can see we're expecting originations for this year at about $3.8 billion.

If you go back to 2023, I think they were probably less than $1 billion. So you're getting a lot of growth in originations. But at the same time, when we began the new strategy, we made a strategic shift, which is to focus on higher quality underlying assets. So that is not an effort to optimize margins. It's an effort to optimize overall efficiency and return on equity. If you look at the second box, you can see that in contrast to what happens in the legacy business, the operating leverage for Earnest through its growth is actually very positive, and that's an element of efficiency. The other thing is in terms of financing efficiency. Because of the, among other things, the change in the nature of the underlying assets, we're able to get a higher proportion of AAA financing in our securitizations than we did before.

All of these things are focused on a strategy of growth, quality, and efficiency. And we think at the moment, as we said, that it's a good combination with our legacy business. What we talked about is what we've done, to some extent why we did it. There's also a question of why we could do it now. There are a lot of reasons for that. But part of the reason for the reorganization is that we're getting ahead of a potential constraint. ATE, that's adjusted tangible equity, the percentage of that is a significant component of our unsecured debt rating. And I'm going to oversimplify, but what it basically is the percentage of tangible equity to our private loans, meaning excluding the ones that are government guaranteed. 90% probably of our assets, maybe more, are securitized. So they're sold in the true sale.

We don't actually own the assets. But under GAAP, we're required to consolidate them. As our change in strategy makes our financings more efficient, they require less equity. That actually puts pressure on the ATE ratio on a consolidated basis. If you look at the range for our current rating today, it runs 8%-12%. At the end of June, we were at 9%. If you go to the next page 9, what it shows is in 2024 when we started, we had about a 10% ATE, which is right in the middle of the range. As we started growing, you can see it's been coming down. It doesn't look like we have an immediate problem in 2027, but if we keep growing like this, certainly as you get out around 2028, this could become a constraint.

The reorganization helps with that in the sense that we want LLC to be our primary holder of loans that we haven't sold. If the ATE ratio for LLC gets too close to the bottom of the range, and we want to keep a reasonable buffer, then we have the option of moving some of the securitizations to the holding company, which takes the related consolidated leverage with it. That's probably a timing issue for what we do. On page 11, there's another item which aren't strictly related to the corporate reorganization. I think the first two of them kind of speak for themselves, so I'm not going to cover them. The third one, though, I think is strategically significant because it represents a change in the philosophy of how we look at our existing loan assets.