Business Context and Reporting Period
Navient Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2014. Navient became an independent, publicly traded company following the April 30, 2014 spin-off from SLM Corporation. Its business consists primarily of FFELP and private education loan portfolios, loan servicing, and asset recovery. Historical periods before the spin-off reflect Old SLM and include the consumer banking business later distributed to SLM BankCo, limiting direct comparability.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2014 | Prior Comparable Period |
|---|---|---|
| Total interest income | $1.175 billion | $1.337 billion |
| Net interest income | $662 million | $784 million |
| Provision for loan losses | $165 million | $201 million |
| Net income attributable to Navient | $307 million | $543 million |
| Diluted EPS | $0.71 | $1.20 |
| Core Earnings, non-GAAP | $241 million; $0.56 diluted EPS | $447 million; $1.00 diluted EPS |
| GAAP net interest margin | 1.87% | 1.94% |
| GAAP return on assets | 0.87% | 1.35% |
For the six months ended June 30, 2014, net income attributable to Navient was $526 million, or $1.20 diluted EPS, compared with $889 million, or $1.94 diluted EPS, in the prior-year period. Core Earnings were $383 million, or $0.89 diluted EPS, compared with $709 million, or $1.56 diluted EPS.
Balance Sheet, Debt and Liquidity
- Total assets were $143.0 billion at June 30, 2014, down from $159.5 billion at December 31, 2013.
- Net FFELP Loans were $99.7 billion and net private education loans were $30.3 billion, for a total net student loan portfolio of $130.1 billion.
- Total borrowings, including hedge accounting adjustments, were $136.2 billion, consisting of $4.3 billion short-term and $131.9 billion long-term borrowings. Senior unsecured debt totaled $17.5 billion.
- Total equity was $4.0 billion, compared with $5.6 billion at year-end 2013. The decline primarily reflects the $1.75 billion deemed distribution of SLM BankCo’s consumer banking net assets in connection with the spin-off.
- Unrestricted cash and liquid investments were $1.6 billion, and total primary liquidity under the company’s Core Earnings presentation was $3.4 billion, including $1.8 billion of unencumbered FFELP Loans.
- Navient reported $13.5 billion of total unencumbered assets, including $7.9 billion of unencumbered student loans. Additional capacity under FFELP facilities was $10.7 billion, and a new $1.0 billion private education loan asset-backed commercial paper facility was available through June 2015.
- Cash and cash equivalents declined from $5.2 billion at December 31, 2013 to $1.6 billion at June 30, 2014. Six-month operating cash flow was $1.1 billion, investing cash flow was $3.2 billion, and financing activities used $7.9 billion.
Material Changes Versus Prior Comparable Period
- Second-quarter GAAP net income declined $236 million, or 43%, primarily because the prior-year quarter included a $257 million gain from selling residual interests in FFELP securitization trusts and a $38 million after-tax gain from selling the Campus Solutions business.
- Net interest income fell $122 million in the quarter and $150 million for the first six months, mainly because average FFELP loan balances declined by approximately $13 billion in the quarter and $16 billion for the six months.
- Loan-loss provisions decreased $36 million in the quarter and $92 million year to date, reflecting improved private education loan credit quality, delinquency and charge-off trends.
- Servicing and asset recovery revenue increased $27 million in the quarter and $32 million year to date. Asset recovery revenue rose 21% in the quarter to $132 million.
- Operating expenses decreased $33 million in the quarter but increased $97 million year to date, primarily because of a $103 million regulatory reserve recorded in the first quarter.
- Restructuring and reorganization expenses increased to $61 million in the quarter and $87 million year to date, mainly due to spin-off-related costs.
- Private education loan delinquency declined to 7.1% of loans in repayment from 8.4% in the prior-year quarter; charge-offs declined to 2.5% from 3.0%. FFELP loan delinquency declined to 14.8% from 15.7%.
- The company repurchased 3.9 million shares for $65 million during the quarter and had $335 million remaining under its $400 million repurchase authorization at June 30, 2014. The quarterly common dividend was $0.15 per share.
Outlook, Risks, Contingencies and Unusual Items
- The filing does not provide specific formal earnings guidance. Management expects the amortizing FFELP and private education loan portfolios to generate significant cash flow and intends to pursue loan portfolio acquisitions, third-party servicing and asset recovery opportunities.
- Navient’s long-term unsecured debt ratings were lowered to below investment grade by Fitch, Moody’s and S&P following the spin-off. Management identified refinancing risk, higher funding costs and reduced access to capital markets as key liquidity concerns. Approximately $1.2 billion of senior unsecured notes were due within the next twelve months.
- Regulatory matters include FDIC and DOJ consent orders involving late-fee practices and Servicemembers Civil Relief Act matters. Navient funded a $30 million restitution reserve, expects approximately $42 million of additional late-fee refunds, and is required to fund a $60 million DOJ settlement fund plus a $55,000 civil penalty, subject to court approval.
- Navient retained $165 million of the $168 million regulatory reserve established in connection with these matters. Separate CFPB and state attorney general investigations remained unresolved, and no additional reserves had been established for those investigations.
- The company disclosed material derivative-related earnings volatility. Second-quarter derivative and hedging gains were $61 million, and Core Earnings excluded a $150 million net impact from derivative accounting. Management reported that cumulative derivative accounting had reduced GAAP equity by approximately $760 million after tax.
- Private education loan recovery assumptions remain a risk. The company increased its allowance for possible recovery shortfalls on partially charged-off loans by approximately $68 million during the quarter; the related allowance totaled $402 million at June 30, 2014.
- Other risks include interest-rate and basis risk, counterparty exposure, changes in student-loan regulation, litigation, servicing and compliance costs, operational failures, credit performance, and risks associated with the recently completed separation.
Investor Verification Items
- Reconcile GAAP results with non-GAAP Core Earnings and quantify the recurring earnings impact of derivative mark-to-market adjustments.
- Assess liquidity relative to the $1.2 billion of near-term unsecured maturities, below-investment-grade ratings, collateral requirements and available secured-funding capacity.
- Monitor private education loan delinquency, charge-off, forbearance and post-default recovery trends, including the adequacy of the $1.983 billion allowance.
- Track the final cost and court approval of the DOJ settlement, FDIC-related restitution and refunds, CFPB and state investigations, and related indemnification obligations to SLM BankCo.
- Use caution when comparing 2014 results with 2013 because historical results include SLM BankCo before the spin-off and 2013 included significant loan-sale and divestiture gains.