Navient, the student loan servicing behemoth, has big ambitions in a business that has been dominated by smaller, nimbler fintech players: originating loans to refinance the debt of borrowers who have already graduated and are gainfully employed.
It agreed this month to acquire Earnest, a consumer lending startup that gained significant market share in refinance loans but had been struggling to raise money.
Navient believes that the 40 years of performance data it has acquired as a loan servicer gives it an important advantage in this market. The company had recently begun to offer its own refinance loans and saw the acquisition as a way to accelerate growth.
In a conference call Wednesday to discuss third-quarter financial results, Navient CEO Jack Remondi touted Earnest’s “exceptional” customer service and “distinctly different approach” to the market. “The combination of our respective skills will create significantly more value than either of us would alone,” he said.
Navient expects to add $1 billion in refinance loans to its balance sheet this year through the acquisition and to originate an additional $1.5 billion in 2018. “We’ll be the dominant player in this space,” Remondi predicted.
One hurdle will be convincing skeptical shareholders that it’s worth suspending a share buyback program through next year to help fund the business. Navient repurchased $18 million of shares in the first half of this year for $275 million, according to Compass Point Research & Trading. But on Oct. 5 it announced it was halting the program.
Among the detractors is billionaire hedge fund manager Leon Cooperman, who owned approximately nearly 1% of the company’s stock as of Aug. 14, according to a Securities and Exchange Commission filing.
Cooperman, who participated on the conference call, opened by saying he was “somewhat critical” of the buyback suspension, noting that Navient’s stock is now trading several dollars below its level when the buyback began three years ago.
“If we liked the stock at $15.17, shouldn’t we like it a lot more at $12.20?” he argued.
Then he really got going.
“The debate the board should be having is whether [Navient] should be liquidated and the money returned to shareholders,” and not when to resume buybacks, the hedge fund manager continued. “You’re basically impotent and can’t do anything.”
“I take your comments in a constructive way, Lee,” Remondi replied.
The CEO said that management is equally frustrated with Navient’s stock price, but it wants to allocate capital for investment in businesses that will generate high returns as the company’s legacy portfolio of federally guaranteed student loans runs off.
Navient has made other acquisitions this year, too. It also purchased $10 billion in student loan portfolios as well as Duncan Solutions, a transportation services provider.
Cooperman has been betting on Navient’s stock for some time — alternately defending management and breathing down its neck. In a 2015 interview with the Huffington Post, he argued that the company, which faces multiple investigations into its dealings with borrowers, was being unfairly targeted by federal and state regulators.
Meanwhile, there are other critics of the Earnest deal, too. Management fielded a question from Henry Coffey of Wedbush Securities, who raised concerns that Earnest’s biggest selling point may have been its $155 million price tag, which was reportedly a discount to its valuation.
Like other fintech lenders, Earnest was able to fund its student lending in the securitization market but had been struggling to raise additional capital to expand its business. Social Finance, perhaps the most successful player in this space, applied for a bank charter over the summer that would allow it to add services like deposits, checking and savings accounts to its ; SoFi withdrew the application following a scandal that resulted in the departure of CEO Mike Cagney.
“We hear a lot … from fintech companies that have a pretty high opinion of themselves, but when you dig in, they seem to be doing everything a normal financial company would do,” Coffey said.
Other analysts see value in the transaction, even though they do not expect it to be immediately accretive to earnings.
Compass Point analyst Michael Tarkan downgraded the company’s stock to “neutral” from “buy” when the suspension of the share buyback was announced. He also lowered his target for the share price to $15.50 from $16.50.
“While the strategic rationale for the deal is evident as Earnest helps Navient stem the runoff of its legacy loan portfolios … the suspension of buyback activity through 2018 should meaningfully impact [earnings per share]; and the deal is not expected to be accretive until [the second half of 2019],” Tarkan said in a research note.
“That said, the deal does position Navient well to kick-start origination growth — at scale — with refinance originations building in 2018 and in-school originations ramping up in 2019,” Tarkan wrote.
At that point, he noted, a noncompete Navient entered into when it was spun off from Sallie Mae will have expired.
Asked to describe the scope of opportunity, Navient execs put industrywide originations of refinanced student loans at $8 billion to $10 billion so far this year. While many of those who currently qualify have already refinanced, “the beauty of this market is that there are new loans to be made each year, as borrowers graduate each year,” get jobs and begin making payments, Remondi said.
Under Navient’s ownership, Earnest may continue to explore offering additional products such as unsecured loans or even mortgages, but these would likely be sold to investors as whole loans on a future flow basis, rather than held on balance sheet, Chief Financial Officer Christian Lown said on the call.