Navient Corporation: Q1 2019 Form 10-Q Summary
Business context and reporting period
Navient provides education-loan ownership, servicing and asset-recovery services, plus business-processing services for government and healthcare clients. The filing covers the unaudited three months ended March 31, 2019, compared with the three months ended March 31, 2018. Reportable segments are Federal Education Loans, Consumer Lending, Business Processing and Other.
- Education loan portfolio, net: $92.0 billion at March 31, 2019, consisting of $69.9 billion of FFELP Loans and $22.1 billion of Private Education Loans.
- Navient serviced approximately 12 million education-loan customers, including 5.9 million accounts under its Department of Education contract, and served more than 600 business-processing clients.
Financial results and key metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total interest income | $1,234 million | $1,172 million | +5% |
| Net interest income | $285 million | $329 million | -13% |
| Provision for loan losses | $76 million | $87 million | -13% |
| Net interest income after provisions | $209 million | $242 million | -14% |
| Other income | $219 million | $211 million | +4% |
| Total expenses | $264 million | $291 million | -9% |
| Net income | $128 million | $126 million | +2% |
| Diluted EPS | $0.52 | $0.47 | +11% |
| Core Earnings net income | $136 million | $107 million | +27% |
| Diluted Core Earnings per share | $0.55 | $0.40 | +38% |
- GAAP net margin, calculated as net income divided by total interest income plus other income, was approximately 8.8%, compared with approximately 9.1% in the prior-year quarter.
- Consolidated GAAP net interest margin was 1.17%, compared with 1.21%. Core Earnings segment margins were 0.80% for Federal Education Loans and 3.22% for Consumer Lending.
- Business Processing revenue was $68 million, versus $73 million; EBITDA was $14 million, versus $15 million, and the EBITDA margin remained 21%.
- Operating cash flow was $188 million, compared with $284 million. Investing cash flow was $2.408 billion, and financing cash flow was negative $3.638 billion. Ending cash, cash equivalents and restricted cash totaled $4.220 billion.
- At March 31, 2019, total borrowings were $95.645 billion, including $7.505 billion short-term and $88.140 billion long-term. Unsecured borrowings were $11.451 billion and secured borrowings were $84.459 billion.
- Unrestricted cash and liquid investments were $1.206 billion, and unencumbered FFELP Loans were $465 million, providing $1.671 billion of primary liquidity. Additional capacity was reported under FFELP and Private Education Loan facilities.
- Shareholders received $39 million of dividends, or $0.16 per share. Navient repurchased 9.4 million shares for $107 million and had $333 million of remaining repurchase authorization.
Material changes versus the prior comparable period
- Interest income increased $62 million, but interest expense increased $106 million, causing net interest income to decline $44 million. The company attributed the decline primarily to the natural paydown of the education-loan portfolio and higher funding costs.
- Ending net FFELP Loans declined from $79.4 billion to $69.9 billion, while Private Education Loans declined from $22.9 billion to $22.1 billion. The total net education-loan portfolio declined from $102.3 billion to $92.0 billion.
- Private Education Loan originations, principally refinancing loans, increased to $984 million from $500 million. Refinance loans outstanding increased to $4.0 billion from $1.2 billion.
- Loan-loss provisions declined $11 million, including a $9 million decrease in the Private Education Loan provision. However, Private Education Loan charge-offs increased to $94 million from $78 million, and the annualized charge-off rate increased to 1.7% from 1.4%.
- FFELP delinquencies greater than 30 days improved to 11.0% of loans in repayment from 13.1% a year earlier; greater-than-90-day delinquencies declined to 5.2% from 7.7%.
- Private Education Loan delinquencies greater than 30 days improved to 5.2% from 5.7%, while greater-than-90-day delinquencies increased to 2.6% from 2.4%. Forbearance declined to $575 million from $969 million.
- Operating expenses declined $19 million, reflecting efficiency gains, lower restructuring costs and the absence of certain prior-year one-time costs. Restructuring expense declined to $1 million from $7 million.
- GAAP results included a $6 million negative impact from derivative accounting, compared with a $31 million positive impact in Q1 2018. Core Earnings exclude specified derivative mark-to-market effects and goodwill and intangible-asset accounting.
- The company adopted new lease accounting prospectively, recording a $28 million right-of-use asset and liability. It also adopted revised hedge-accounting guidance, with $2 million of fair-value hedge gains recorded in interest expense in Q1 2019.
Outlook, management commentary, risks and unusual items
- Management expects the education-loan portfolios to generate significant earnings and cash flow over their remaining lives and estimates approximately $23 billion of cash flows over the next 20 years, net of secured financing obligations.
- The company expects to use operating cash flows, loan principal repayments, existing liquidity, securitization-trust distributions and financing facilities to meet obligations, including repayment of approximately $2.3 billion of senior unsecured notes maturing within the next twelve months.
- Management targets a tangible net asset ratio of 1.23x to 1.25x; the ratio was 1.25x at March 31, 2019. Three credit-rating agencies rated the company’s long-term unsecured debt below investment grade.
- The Department of Education servicing contract was scheduled to expire in June 2019. The timing and outcome of the Department’s new servicing-platform procurement remained uncertain.
- The Department of Education collections contract operated by Pioneer was scheduled to expire in April 2019. The company had not received communication regarding subsequent plans and could not predict the contract’s outcome.
- Navient and subsidiaries faced CFPB and state Attorneys General litigation and investigations alleging violations of consumer-protection and servicing laws. The company denied the allegations, had not established reserves for these matters, and stated that an adverse ruling could materially affect results, liquidity or cash flows.
- In March 2019, an administrative law judge affirmed findings in the Department of Education Special Allowance Payments audit. Navient appealed to the Secretary of Education. A reserve had been established in 2014, and management did not currently expect a material company-wide effect.
- The company identified interest-rate, funding-index, liquidity, credit, derivative-counterparty, regulatory, litigation, cybersecurity, operating-system and general economic risks. A 100-basis-point increase in interest rates was estimated to reduce annual after-tax earnings by $18 million, while a 10-basis-point increase in funding indices was estimated to reduce annual after-tax earnings by $61 million, based on the filing’s sensitivity analysis.
- Beginning January 1, 2020, the current incurred-loss model will be replaced by the expected-credit-loss standard. Management expected the change to increase loan-loss allowances but had not yet quantified the impact.
Investor verification points
- Verify the renewal, replacement or expiration status and economics of the Department of Education servicing and collections contracts.
- Assess potential exposure from CFPB, state Attorneys General, securities and other litigation, including the absence of reserves for certain matters.
- Monitor the $2.3 billion of senior unsecured debt due within twelve months, below-investment-grade ratings, refinancing access and available collateral capacity.
- Track Private Education Loan charge-offs, greater-than-90-day delinquencies, allowance coverage and the effect of changing forbearance trends.
- Reconcile GAAP earnings with Core Earnings and separately evaluate volatile derivative mark-to-market gains and losses.
- Evaluate the eventual adoption impact of the 2020 expected-credit-loss standard on allowances, retained earnings and capital ratios.
- Confirm the sustainability of share repurchases and the $0.16 quarterly dividend given portfolio runoff, liquidity requirements and debt maturities.