Navient Corporation — Q3 2014 Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and nine months ended September 30, 2014. Navient is an education-loan management, servicing and asset-recovery company with FFELP and private education loan portfolios. The April 30, 2014 separation from SLM BankCo materially affects comparability: pre-separation GAAP periods include the former consumer-banking business, while “Core Earnings” exclude it and are non-GAAP.
- At September 30, 2014, Navient serviced loans for more than 12 million customers, including 6.1 million accounts under its Department of Education contract.
- The company held $97.7 billion of FFELP Loans and $30.5 billion of Private Education Loans, or $128.2 billion of net student loans.
Key financial metrics
| Metric | Q3 2014 | Q3 2013 | Change |
|---|---|---|---|
| Total interest income | $1.132 billion | $1.340 billion | Down 16% |
| Net interest income | $624 million | $799 million | Down 22% |
| Provision for loan losses | $140 million | $207 million | Down 32% |
| Total other income | $288 million | $69 million | Up $219 million |
| Operating expenses | $195 million | $257 million | Down 24% |
| Net income attributable to Navient | $359 million | $260 million | Up 38% |
| Diluted EPS | $0.85 | $0.57 | Up $0.28 |
| Core Earnings | $218 million | $259 million | Down 16% |
| Core Earnings diluted EPS | $0.52 | $0.58 | Down $0.06 |
GAAP net income benefited materially from $226 million of derivative-accounting adjustments, compared with a $19 million unfavorable adjustment in the prior-year quarter. Core Earnings exclude such mark-to-market volatility, the pre-spin-off SLM BankCo results and goodwill or acquired-intangible amortization.
- Q3 GAAP net interest margin was 1.82%, compared with 2.05% in Q3 2013.
- Q3 Core Earnings FFELP spread was 1.02% and Private Education Loan spread was 4.06%.
- Private Education Loan provision declined to $130 million from $176 million; total Private Education Loan delinquency declined to 7.9% from 9.8%.
- FFELP delinquency declined to 15.1% from 17.1%, while the forbearance rate increased to 16.8% from 14.5%.
Balance sheet, debt and liquidity
| Balance-sheet item | September 30, 2014 | December 31, 2013 |
|---|---|---|
| Total assets | $140.3 billion | $159.5 billion |
| Cash and cash equivalents | $1.9 billion | $5.2 billion |
| Short-term borrowings | $6.0 billion | $13.8 billion |
| Long-term borrowings | $127.7 billion | $136.6 billion |
| Total borrowings, including hedge adjustments | $133.7 billion | $150.4 billion |
| Total equity | $4.2 billion | $5.6 billion |
- Unrestricted cash and liquid investments were $2.0 billion; unencumbered FFELP Loans were $1.7 billion, providing $3.6 billion of primary liquidity on a Core Earnings basis.
- Total additional capacity under FFELP facilities was approximately $11.0 billion. The Private Education Loan ABCP facility had $263 million of available capacity and matures in June 2015.
- Approximately $1.9 billion of senior unsecured notes mature in the next twelve months.
- Senior unsecured debt totaled $17.4 billion. Fitch, Moody’s and S&P rated the company’s long-term unsecured debt below investment grade following the spin-off.
Cash flow and capital allocation
- Nine-month operating cash flow was $1.6 billion, compared with $1.4 billion in the prior-year period.
- Nine-month investing cash flow was $4.9 billion, primarily reflecting student-loan repayments exceeding acquisitions and originations.
- Nine-month financing cash flow was negative $9.7 billion, driven by debt repayments, the distribution of the consumer-banking business and other financing activity.
- Cash declined by $3.2 billion during the nine months to $1.9 billion.
- Navient paid $189 million of common dividends and repurchased $432 million of common stock during the first nine months. It repurchased 9.5 million shares for $167 million in Q3 and had $168 million of remaining repurchase authority at September 30.
Material changes versus the prior comparable period
- GAAP earnings increased because of favorable derivative valuation changes, lower loan-loss provisions and lower operating expenses, despite lower net interest income and asset-recovery revenue.
- Core Earnings declined because of a $39 million reduction in asset-recovery revenue and a $48 million reduction in net interest income, partly offset by a $47 million reduction in loan-loss provisions.
- Asset-recovery revenue was reduced by the Bipartisan Budget Act, effective July 1, 2014, which lowered fees paid to guarantor agencies for rehabilitated defaulted FFELP Loans.
- Average FFELP Loans declined by approximately $9 billion year over year in Q3, while average Private Education Loans declined by approximately $7 billion.
- Nine-month GAAP results no longer include the prior-year $312 million gain from selling residual interests in FFELP securitization trusts, the $38 million after-tax gain from selling Campus Solutions and $42 million of debt-repurchase gains.
Outlook, commentary, risks and unusual items
- Management expects the FFELP and Private Education Loan portfolios to generate significant cash as they amortize and intends to pursue opportunistic loan acquisitions, servicing contracts and asset-recovery opportunities.
- Management expects restructuring and reorganization costs related to the spin-off to decline as transition activities are completed. The company completed the servicing transition and Navient brand rollout in October 2014.
- Regulatory matters remain material. Navient funded a $30 million FDIC restitution reserve and was required to fund a $60 million DOJ settlement fund plus a civil penalty. The company also estimated $42 million of additional late-fee refunds. Of a $168 million regulatory reserve, $120 million remained at September 30, 2014.
- Separate CFPB and state attorney-general investigations remained unresolved, with no reserves established because outcomes and losses could not be estimated.
- Navient remains responsible for certain pre-spin-off liabilities and indemnification obligations involving SLM BankCo.
- Key risks include refinancing and liquidity risk, below-investment-grade ratings, rising funding costs, interest-rate and basis risk, derivative valuation volatility, private-loan credit losses, regulatory actions, litigation, operational failures and risks from the recent separation.
- The company reported that disclosure controls were effective as of September 30, 2014 and that no material change occurred in internal control over financial reporting during the quarter.
Investor verification points
- Reconcile GAAP net income of $359 million with Core Earnings of $218 million and assess the sustainability of the $226 million derivative-accounting benefit.
- Review upcoming unsecured debt maturities, available secured-facility capacity and the adequacy of $3.6 billion of stated primary liquidity.
- Monitor the $120 million remaining regulatory reserve, CFPB and state investigations, indemnification obligations and the unresolved Ubaldi class-action litigation.
- Evaluate private-loan recovery assumptions, including the $1.253 billion partially charged-off loan receivable and $392 million allowance for estimated recovery shortfalls.
- Assess whether falling loan balances, reduced asset-recovery fees and below-investment-grade ratings will constrain future earnings, liquidity and capital returns.