Business Context and Reporting Period
Navient Corporation filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2020. The company owns and services education loans and provides business-processing services to government and healthcare clients. Its reportable segments are Federal Education Loans, Consumer Lending, Business Processing, and Other.
At June 30, 2020, Navient owned $82.4 billion of education loans, including $60.9 billion of FFELP Loans and $21.5 billion of Private Education Loans, and serviced more than $300 billion of education loans for itself and third parties.
Key Financial Metrics
| Metric | Three months ended June 30, 2020 | Three months ended June 30, 2019 | Six months ended June 30, 2020 | Six months ended June 30, 2019 |
|---|---|---|---|---|
| Total interest income | $819 million | $1.204 billion | $1.807 billion | $2.439 billion |
| Net interest income | $300 million | $293 million | $573 million | $579 million |
| Provision for loan losses | $44 million | $68 million | $139 million | $144 million |
| Other income | $133 million | $222 million | $85 million | $441 million |
| Operating expenses | $213 million | $241 million | $463 million | $497 million |
| Net income | $125 million | $153 million | $19 million | $281 million |
| Diluted EPS | $0.64 | $0.64 | $0.10 | $1.16 |
| Core Earnings, non-GAAP | $179 million | $175 million | $272 million | $312 million |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $595 million | $522 million |
Revenue from contracts with customers was $85 million in the second quarter and $173 million for the first six months, compared with $100 million and $198 million, respectively, in the prior-year periods. The filing does not present a single consolidated “revenue” measure comparable to an industrial company because interest income is a primary component of Navient’s earnings.
- GAAP net interest margin was 1.35% in the second quarter and 1.28% for the first six months, compared with 1.23% and 1.20% in the prior-year periods.
- Core Earnings segment net interest margins were 1.07% for Federal Education Loans and 3.20% for Consumer Lending in the second quarter.
- Total assets were $91.0 billion, compared with $94.9 billion at December 31, 2019.
- Borrowings totaled $87.6 billion, consisting of $7.3 billion of short-term borrowings and $80.3 billion of long-term borrowings, compared with $90.2 billion at year-end 2019.
- Cash and cash equivalents were $1.6 billion; unrestricted cash and liquid investments, together with unencumbered FFELP and refinance loans, provided $2.4 billion of primary liquidity.
- Adjusted tangible equity was $1.1 billion, representing a 3.6% adjusted tangible equity ratio; the pro forma ratio excluding cumulative derivative mark-to-market losses was 6.0%.
- Dividends paid were $31 million, or $0.16 per share, in the quarter. No open-market share repurchases occurred in the quarter; $665 million remained under the repurchase authorization.
Material Changes Versus Prior Comparable Period
- Second-quarter GAAP net income declined 18% to $125 million, while diluted EPS remained $0.64 because average diluted shares outstanding fell 18% to 195 million.
- Six-month GAAP net income declined 93% to $19 million, primarily because derivative and hedging losses increased to $253 million from $25 million and prior-year gains on debt repurchases and loan sales did not recur.
- Core Earnings increased to $179 million from $175 million in the second quarter but declined to $272 million from $312 million for the six months.
- FFELP Loans, net, declined to $60.9 billion from $64.6 billion at year-end 2019 and $68.0 billion at June 30, 2019. Private Education Loans, net, declined to $21.5 billion from $22.2 billion at year-end 2019.
- Private Education Loan originations were $238 million in the quarter, down 72% year over year, reflecting reduced marketing and tighter credit in response to COVID-19. First-half originations were $2.1 billion, up 17% year over year.
- Federal Education Loan segment Core Earnings increased 11% to $146 million in the quarter, while Consumer Lending Core Earnings increased 2% to $87 million. Business Processing Core Earnings declined 14% to $6 million.
- Business Processing EBITDA declined to $8 million from $11 million, and its EBITDA margin declined to 13% from 17%. Four new contracts supporting unemployment benefits and contact tracing generated $20 million of second-quarter revenue and partly offset weaker activity.
- Navient adopted CECL on January 1, 2020. The adoption reduced equity by $620 million and increased the allowance for loan losses. The allowance excluding expected future recoveries was $1.949 billion at June 30, 2020.
- Private Education Loan delinquencies declined to 2.0% of loans in repayment from 5.0% in the year-ago quarter, while forbearance increased to 8.4% from 2.9%. FFELP delinquency declined to 8.2% from 10.5%, while FFELP forbearance increased to 26.6% from 12.9%.
Guidance, Outlook, Risks and Unusual Items
- Management expects Private Education Refinance Loan originations of approximately $2 billion in the second half of 2020, after reducing marketing and tightening credit during the early COVID-19 disruption.
- Management stated that it did not expect to issue additional unsecured or term ABS debt during the remainder of 2020, although it expected to refinance certain ABCP and other facilities maturing in 2020 at potentially higher costs.
- Navient had $1.2 billion of senior unsecured notes maturing within the following 12 months. Three rating agencies rated its long-term unsecured debt below investment grade.
- The company suspended payments and interest accrual on ED-owned loans through September 30, 2020 under the CARES Act. Management expected 2020 defaults to be lower than in 2019 and below prior expectations because of borrower forbearance and other relief options, but acknowledged uncertainty regarding the duration and severity of COVID-19.
- Management reported that approximately 90% of employees were working from home and that operations, loan servicing, financial reporting and internal controls had not been materially disrupted.
- COVID-19 increased expected credit losses and affected fair values, funding costs, collection activity, loan originations and business-processing volumes. A significantly worse economic downturn could require additional provisions or goodwill impairment.
- Derivative accounting produced $268 million of net losses in the first half and reduced GAAP equity by approximately $692 million cumulatively. These losses are expected to reverse over time as the derivatives mature, but earnings remain sensitive to interest rates, foreign currency movements and credit spreads.
- Navient faces CFPB, state attorney general, securities, consumer-protection and other litigation and regulatory matters. For several major consumer-protection proceedings, the company stated that potential exposure cannot currently be estimated and no reserves have been established. An adverse ruling could materially affect the company.
- The company appealed an adverse administrative-law decision concerning an Education Department Special Allowance Payment audit. A reserve had been established, and management did not currently expect a material company-wide effect.
- The filing identifies additional risks from liquidity and refinancing needs, below-investment-grade ratings, capital-market disruption, interest-rate and LIBOR transition risk, cybersecurity, regulatory change, operating failures and borrower repayment trends.
Investor Verification Priorities
- Verify the sustainability of earnings excluding volatile derivative mark-to-market effects and reconcile Core Earnings to GAAP net income.
- Monitor COVID-19-related forbearance exits, delinquency migration, charge-offs and whether the $1.949 billion CECL allowance remains adequate.
- Assess liquidity against the $1.2 billion of near-term unsecured maturities, facility maturities, collateral requirements and potential increases in refinancing costs.
- Review the impact of the 3.6% adjusted tangible equity ratio, the 6.0% pro forma ratio, CECL adoption and future capital distributions.
- Track Private Education Loan refinancing volumes, credit tightening, marketing levels and management’s second-half 2020 origination expectation.
- Evaluate the status and potential financial exposure of CFPB, state attorney general, securities litigation and the Education Department audit appeal.
- Consider the distinction between GAAP results and non-GAAP Core Earnings, including the company’s stated limitations on comparability.