Navient Corporation: Q3 2015 Form 10-Q Summary
Business context and reporting period
Navient is a loan management, servicing and asset recovery company. Its principal businesses are FFELP student loans, private education loans, business services and corporate activities. The filing covers the unaudited three and nine months ended September 30, 2015, compared primarily with the corresponding 2014 periods and December 31, 2014 balances.
Navient services more than $300 billion of student loans for more than 12 million customers, including 6.3 million accounts serviced for the U.S. Department of Education. At September 30, 2015, its net student loan portfolio was $125.8 billion, consisting of $98.5 billion of FFELP Loans and $27.3 billion of Private Education Loans.
Financial performance and key metrics
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Total interest income | $1,077 million | $1,132 million | $3,238 million | $3,603 million |
| Net interest income | $553 million | $624 million | $1,685 million | $2,053 million |
| Provision for loan losses | $123 million | $140 million | $446 million | $490 million |
| Net interest income after provisions | $430 million | $484 million | $1,239 million | $1,563 million |
| Total other income | $181 million | $288 million | $631 million | $735 million |
| Operating expenses | $228 million | $195 million | $683 million | $773 million |
| Net income attributable to Navient | $237 million | $359 million | $711 million | $885 million |
| Diluted EPS | $0.63 | $0.85 | $1.83 | $2.05 |
- Q3 GAAP net income declined 34% year over year; nine-month net income declined 20%. The decreases primarily reflected lower net interest income, lower derivative gains and higher Q3 operating expenses.
- Q3 net interest margin was 1.64%, compared with 1.82% in the prior-year quarter; nine-month net interest margin was 1.65%, compared with 1.92%.
- GAAP FFELP Loan net interest margin was 1.20% in Q3 and 1.21% for nine months, versus 1.32% and 1.30%, respectively, in the prior comparable periods.
- GAAP Private Education Loan net interest margin was 3.68% in Q3 and 3.64% for nine months, versus 3.91% and 4.13%, respectively.
- Management reported non-GAAP “Core Earnings” of $174 million, or $0.47 diluted EPS, in Q3, compared with $218 million, or $0.52, in Q3 2014. Nine-month Core Earnings were $523 million, or $1.34 diluted EPS, compared with $601 million, or $1.40.
- Derivative and hedging gains were $20 million in Q3 and $73 million for nine months, compared with $108 million and $161 million in the prior-year periods. Core Earnings exclude significant derivative accounting volatility.
Balance sheet, cash flow, debt and liquidity
- Total assets were $137.7 billion at September 30, 2015, down from $146.4 billion at December 31, 2014. Total equity was $3.9 billion, compared with $4.2 billion.
- Cash and cash equivalents were $1.3 billion, compared with $1.4 billion at year-end. Total unrestricted cash and liquid investments were $1.3 billion; unencumbered FFELP Loans were $1.2 billion, producing reported primary liquidity of $2.5 billion.
- Operating activities provided $1.5 billion of cash in the first nine months, compared with $1.6 billion in the prior-year period. Investing activities provided $7.3 billion, primarily reflecting loan repayments and reductions. Financing activities used $8.9 billion.
- Total borrowings were $131.1 billion, including $2.8 billion short-term and $128.3 billion long-term, down from $139.5 billion at December 31, 2014. Secured borrowings were $114.9 billion and unsecured borrowings were $15.8 billion.
- Navient had $1.2 billion of senior unsecured notes maturing during the following twelve months. The filing states that three rating agencies rated its long-term unsecured debt below investment grade.
- Additional capacity under FFELP Loan facilities was $10.1 billion at September 30, 2015. Available capacity under the $1 billion Private Education Loan asset-backed commercial paper facility was $242 million.
- Navient issued $500 million of senior unsecured debt, $2.8 billion of FFELP asset-backed securities and $1.4 billion of Private Education Loan asset-backed securities during the first nine months. It repurchased $1.1 billion of unsecured debt.
Material changes versus prior comparable periods
- Private Education Loan interest income declined 9% in Q3 and 20% for the first nine months, driven by a smaller portfolio and lower margins. Net Private Education Loans declined to $27.3 billion from $29.8 billion at year-end 2014 and $30.5 billion at September 30, 2014.
- FFELP Loan net interest income also weakened as funding costs and premium amortization increased. The FFELP portfolio remained substantially stable year over year but declined from $104.5 billion at December 31, 2014 to $98.5 billion at September 30, 2015.
- Asset recovery revenue increased 31% in Q3, helped by higher volume and the Gila LLC acquisition, but declined 11% for nine months because of lower fees following the Bipartisan Budget Act. Gila was acquired in February 2015 for approximately $185 million.
- Operating expenses increased 17% in Q3, primarily due to Gila operating costs, higher servicing expenses, $11 million of one-time conversion costs for moving $4.9 billion of FFELP Loans to Navient’s platform and higher regulatory costs. Nine-month operating expenses declined 12%, partly because 2014 included significant regulatory settlement costs.
- Private Education Loan delinquencies improved to 7.4% of loans in repayment from 7.9% at September 30, 2014; FFELP delinquencies increased to 15.9% from 15.1%. Private Education Loan forbearance declined to 4.0% from 4.4%, while FFELP forbearance declined to 14.7% from 16.8%.
- In the second quarter, the portion of Private Education Loans charged off at default increased from 73% to 79%. This reduced the receivable for partially charged-off loans by $330 million without affecting provision expense; the remaining receivable was $892 million at September 30, 2015.
- Navient repurchased 41.9 million shares for $775 million during the first nine months and paid $0.16 per common share quarterly dividends, up from $0.15 in the prior-year period. The remaining authorization under the $1 billion 2015 repurchase program was $225 million.
Guidance, outlook, commentary and risks
- The filing does not provide a specific quantitative full-year earnings or revenue forecast. Management expects FFELP and Private Education Loan portfolios to generate substantial cash as they amortize and intends to pursue additional loan portfolio, servicing and asset recovery opportunities.
- Management stated that the post-Spin-Off restructuring initiative was expected to be substantially complete by December 31, 2015. Nine-month restructuring expense was $32 million, including $29 million recorded in Q2.
- Navient completed the acquisition of Xtend Healthcare in October 2015, after the reporting date. The business provides health care payments and account resolution services.
- Liquidity and funding risks are significant. Moody’s and Fitch placed $34 billion of affiliated FFELP asset-backed securities on credit watch in June 2015 because of concerns that trust cash flows might not repay all bonds by legal final maturity. Navient funded cleanup calls on seven FFELP trusts totaling $852 million during Q3.
- Key risks include higher funding costs, reduced access to unsecured or asset-backed markets, credit-rating downgrades, interest-rate and basis risk, derivative collateral requirements, loan prepayment variability, private-loan credit losses, servicing and collection performance, cybersecurity and systems failures, government contract losses, regulatory investigations and litigation.
- The CFPB notified Navient Solutions in August 2015 that its enforcement office was considering recommending legal action related to disclosures, late fees and other matters. Potential restitution, civil penalties and corrective action could be sought; the filing states that exposure could not yet be estimated and no additional reserve had been established for these investigations.
- Navient is also subject to state investigations, a CFPB investigation of Pioneer Credit Recovery, a New York Department of Financial Services inquiry and an Education Department audit regarding Special Allowance Payments. The filing states that the ultimate exposure cannot currently be estimated.
Most important facts for investors to verify
- Reconcile GAAP results with Core Earnings and assess the recurring versus nonrecurring effect of derivative accounting, restructuring and acquired-intangible adjustments.
- Monitor Private Education Loan credit performance, including delinquency, charge-off, recovery and troubled-debt-restructuring trends, and test the adequacy of the $1.5 billion allowance.
- Review FFELP asset-backed securities performance, rating actions, cleanup-call activity and the risk of repayment shortfalls at legal final maturity.
- Assess refinancing requirements for the $1.2 billion of unsecured notes maturing within twelve months and the effect of below-investment-grade ratings on funding costs and liquidity.
- Track CFPB, Education Department, state and New York regulatory matters, including any potential penalties, restitution, contract losses or additional reserves.
- Evaluate whether share repurchases and dividends remain appropriate given declining equity, primary liquidity of $2.5 billion and substantial secured and unsecured debt.