Navient Corporation 10-Q Summary
Business context and reporting period
Navient is an education-loan asset manager and servicer, private education-loan originator, and provider of government and healthcare business-processing services. The filing covers the three and six months ended June 30, 2018; financial statements are unaudited and presented under U.S. GAAP.
- Reportable segments: Federal Education Loans, Consumer Lending, Business Processing, and Other.
- Navient serviced approximately 12 million education-loan customers, including approximately 6.0 million accounts under its Department of Education contract, and served more than 600 government and healthcare clients.
- Education-loan assets totaled $99.2 billion net at June 30, 2018, comprising $76.6 billion of FFELP Loans and $22.6 billion of Private Education Loans.
Financial performance and key metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total interest income | $1,227 million | $1,070 million | $2,399 million | $2,085 million |
| Net interest income | $298 million | $351 million | $626 million | $691 million |
| Provision for loan losses | $112 million | $105 million | $199 million | $212 million |
| Other income | $136 million | $162 million | $348 million | $314 million |
| Operating expenses | $201 million | $230 million | $476 million | $469 million |
| Net income attributable to Navient | $83 million | $112 million | $210 million | $200 million |
| Diluted EPS | $0.31 | $0.39 | $0.78 | $0.69 |
| Core Earnings net income | $131 million | $123 million | $238 million | $230 million |
| Diluted Core Earnings EPS | $0.49 | $0.43 | $0.89 | $0.79 |
Q2 GAAP net income margin relative to total interest income was approximately 6.8%, compared with 10.5% in the prior-year quarter. This is a simple ratio and is not a reported company revenue margin.
- Federal Education Loans Core Earnings were $148 million in Q2, up 7%; Consumer Lending Core Earnings were $66 million, up 65%; Business Processing Core Earnings were $8 million, up 33%; and Other recorded a $91 million loss.
- Business Processing revenue was $65 million in Q2, up 23%, with healthcare services revenue up 33%. Six-month EBITDA was $26 million, or a 19% margin, versus $16 million and 16% in the prior-year period.
- Federal Education Loan Core Earnings net interest margin was 0.82% for the six months, versus 0.80%; Consumer Lending net interest margin was 3.22%, unchanged from the prior-year period.
- Private Education Loan charge-offs were $75 million in Q2, down from $122 million; the charge-off rate declined to 1.3% from 2.3%.
Cash flow, balance sheet, debt and liquidity
| Balance-sheet metric | June 30, 2018 | December 31, 2017 |
|---|---|---|
| Total assets | $108.9 billion | $115.0 billion |
| Cash and cash equivalents | $1.6 billion | $1.5 billion |
| Restricted cash and cash equivalents | $3.4 billion | $3.1 billion |
| Total borrowings | $103.4 billion | $109.8 billion |
| Long-term borrowings | $98.7 billion | $105.0 billion |
| Total equity | $3.7 billion | $3.5 billion |
- Six-month operating cash flow was $482 million, compared with $630 million in 2017.
- Investing activities provided $5.8 billion, primarily from education-loan repayments exceeding acquisitions. Financing activities used $5.9 billion.
- Total cash, cash equivalents and restricted cash increased to $5.0 billion from $4.6 billion at June 30, 2017.
- Unrestricted cash and liquid investments plus unencumbered FFELP Loans totaled $2.1 billion at June 30, 2018. The company also reported $6.4 billion of unencumbered tangible assets and $10.0 billion of encumbered net assets in consolidated financing entities.
- Unsecured borrowings were $13.0 billion, and $2.2 billion of senior unsecured notes mature within the next twelve months. Three credit-rating agencies rated the company’s long-term unsecured debt below investment grade.
- During Q2, Navient issued $997 million of FFELP Loan ABS, $521 million of Private Education Loan ABS, and $500 million of unsecured debt; it retired or repurchased $1.3 billion of senior unsecured debt.
- The company paid $0.16 per common share, or $42 million, in Q2. A $60 million share-purchase derivative settled on July 2, 2018 for 4.3 million shares; remaining repurchase authority was $100 million after settlement.
Material changes versus prior comparable periods
- Q2 GAAP net income fell 26% because net interest income declined $53 million, loan-loss provisions increased $7 million, and derivative losses increased $15 million. Lower operating expenses and lower taxes partly offset the decline.
- Six-month GAAP net income increased 5%, supported by lower loan-loss provisions, a $49 million improvement in derivative results, and lower taxes, despite a $65 million decline in net interest income.
- Interest expense increased 29% in Q2 and 27% for the six months, reflecting higher funding costs. The consolidated GAAP net interest margin declined to 1.11% from 1.23% for Q2 and to 1.16% from 1.21% for the six months.
- FFELP Loans, net, declined from $81.7 billion at year-end 2017 to $76.6 billion; Private Education Loans, net, declined from $23.4 billion to $22.6 billion.
- FFELP delinquency as a percentage of loans in repayment increased to 13.0% from 12.7% at year-end, while Private Education Loan delinquency remained 5.9% versus 6.0% at June 30, 2017.
- Navient adopted ASC 606 in 2018. The change increased asset-recovery revenue and operating expense by $18 million each for the six months, with no net-income effect, and accelerated recognition of $9 million of revenue and $6 million of expenses on a business-processing contract.
- The company released a $40 million contingency reserve in Q2 because a loss was no longer considered probable. Q2 also included $2 million of restructuring expense.
Guidance, outlook, management commentary, risks and unusual items
- No specific quantitative full-year earnings guidance is provided in the filing. Management expects the education-loan portfolios to generate significant earnings and cash flow over their remaining lives and expects portfolio cash flows to exceed future debt-service obligations.
- Management highlighted private education refinance lending as a growth opportunity. Q2 originations were $629 million and first-half originations were $1.1 billion; the June 30 balance was $1.8 billion.
- The Department of Education servicing contract expires in 2019. The company submitted a bid for the next-generation servicing platform, but the solicitation remains subject to a bid-protest process and timing and outcome are uncertain.
- Management expects the cost of adopting the 2020 current-expected-credit-loss standard to increase loan-loss allowances, potentially materially, particularly for Private Education and FFELP Loans; the impact was still under evaluation.
- Derivative mark-to-market results remain volatile. Derivative accounting reduced Core Earnings to GAAP income by $51 million in Q2 and $20 million for the six months, net of related tax effects and other adjustments.
- Material risks include funding availability and costs, below-investment-grade ratings, interest-rate and basis risk, Private Education Loan credit losses, regulatory changes, cybersecurity and operating-system failures, competition, litigation, and the expiration or repricing of government contracts.
- Navient faces CFPB and multiple state attorney general lawsuits alleging consumer-protection and servicing violations. The company denies the allegations, has not established reserves because potential exposure is not estimable, and states that adverse rulings could materially affect results, liquidity or cash flows.
- An Education Department OIG audit regarding Special Allowance Payments remains on appeal with no ruling reported. The company has a reserve and does not currently expect a material company-wide effect.
Important facts for investors to verify
- Whether the company can refinance or repay the $2.2 billion of senior unsecured debt maturing within twelve months while maintaining adequate liquidity.
- The renewal, replacement, or loss economics of the Department of Education servicing contract expiring in 2019.
- The ultimate cost and timing of CFPB and state attorney general litigation, related indemnification obligations, and the absence of reserves for those matters.
- Future FFELP temporary charge-off estimates, Private Education Loan delinquency and charge-off trends, and the adequacy of the $1.4 billion total loan-loss allowance.
- The effect of rising funding costs, interest-rate and basis mismatches, and volatile derivative valuations on GAAP earnings and capital.
- The eventual impact of the 2020 expected-credit-loss accounting standard on allowances, retained earnings and regulatory or lender metrics.
- The sustainability of Core Earnings, which exclude selected derivative mark-to-market effects and goodwill/intangible amortization and are not a GAAP measure.