Navient Corporation 10-Q Summary: First Quarter 2014
Business context and reporting period
Form 10-Q for the three months ended March 31, 2014. The filing was submitted during Navient’s separation from SLM Corporation, completed April 30, 2014. Because Navient is treated as the accounting successor, the historical consolidated results are those of Existing SLM and include both the education-loan business and the consumer-banking business before the spin-off. Pro forma information is provided to illustrate Navient as a standalone company.
Navient’s principal businesses are FFELP student loans, private education loans, loan servicing, and asset recovery. FFELP loans are substantially federally insured or guaranteed; private education loans carry substantially greater borrower and cosigner credit risk.
Key financial metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Total interest income | $1,296 million | $1,366 million | Down 5% |
| Net interest income | $766 million | $795 million | Down 4% |
| Provision for loan losses | $185 million | $241 million | Down 23% |
| Net interest income after provisions | $581 million | $554 million | Up 5% |
| Other income | $170 million | $250 million | Down 32% |
| Total expenses | $396 million | $248 million | Up 60% |
| Net income attributable to Navient | $219 million | $346 million | Down 37% |
| Diluted EPS | $0.49 | $0.74 | Down 34% |
| Common dividend per share | $0.15 | $0.15 | Unchanged |
GAAP net interest margin was 2.06%, compared with 1.89% in the prior-year quarter. Core Earnings, a non-GAAP measure that excludes specified derivative-accounting and goodwill/intangible effects, were $163 million, or $0.36 diluted EPS, versus $283 million, or $0.61 diluted EPS, in Q1 2013.
Cash provided by operating activities was $558 million, compared with $531 million in Q1 2013. Investing activities provided $992 million, while financing activities used $2.998 billion. Cash and cash equivalents declined from $5.190 billion at December 31, 2013 to $3.742 billion at March 31, 2014.
| Balance-sheet metric | March 31, 2014 | December 31, 2013 |
|---|---|---|
| Total assets | $156.472 billion | $159.543 billion |
| FFELP loans, net | $102.635 billion | $104.588 billion |
| Private education loans, net | $38.157 billion | $37.512 billion |
| Total borrowings | $147.803 billion | $150.443 billion |
| Total equity | $5.598 billion | $5.642 billion |
Unsecured borrowings totaled approximately $27.3 billion, including $17.9 billion of senior unsecured debt. Secured borrowings totaled approximately $118.4 billion. Primary liquidity sources included $3.877 billion of unrestricted cash and liquid investments and $2.836 billion of unencumbered FFELP loans at March 31, 2014. The company also reported $12.7 billion of maximum additional capacity under FFELP loan facilities.
Material changes versus the prior comparable period
- Net income declined $127 million, primarily because of a $103 million additional reserve for pending regulatory matters, the absence of a $55 million gain on a 2013 FFELP securitization residual-interest sale, the absence of $23 million of debt-repurchase gains, higher operating expenses, and higher separation costs.
- These items were partly offset by a $56 million reduction in loan-loss provisions and a $23 million improvement in net derivative and hedging results.
- Average FFELP loans declined approximately $18 billion year over year, reducing FFELP interest income and servicing-related economics. The decline reflected portfolio amortization and the 2013 sale of residual interests associated with approximately $12 billion of securitized FFELP loans.
- Private education loan credit trends improved: total delinquencies fell to 6.9% of loans in repayment from 7.8%, greater-than-90-day delinquencies fell to 3.4% from 3.9%, and the annualized charge-off rate declined to 2.8% from 3.0%.
- Private education loan originations increased to $1.530 billion from $1.411 billion, although Navient’s standalone business could not originate private education loans until 2019 under the separation agreement.
- Common share repurchases totaled $200 million for approximately 8 million shares, fully using the applicable repurchase authorization. Average diluted shares declined to 435 million from 458 million.
Guidance, outlook, commentary, risks, and unusual items
Management’s primary 2014 objective was completing the separation and establishing Navient as a standalone public company. The filing does not provide a detailed standalone earnings forecast. Management expected FFELP portfolio amortization to generate significant cash flow and planned to pursue FFELP acquisitions, third-party servicing, and asset-recovery opportunities.
- Standalone operating expenses were expected to increase by approximately $30 million to $45 million annually. Estimated nonrecurring transition costs were approximately $195 million, including approximately $30 million of severance; $26 million was recorded in Q1 2014.
- Regulatory matters were material. The company recorded an additional $103 million reserve in Q1 2014, following a $70 million reserve established at December 31, 2013. Potential amounts discussed included $30 million for certain FDIC-related restitution, $42 million of voluntary late-fee refunds, and a proposed $60 million SCRA settlement fund. Final costs remained uncertain.
- The CFPB was investigating disclosures and late-fee assessments. No reserve was established for that matter because the potential amount could not be estimated.
- Under the separation agreement, Navient assumed or indemnified specified liabilities arising from the regulatory matters, except for fines or penalties directly levied against Sallie Mae Bank.
- On April 30, 2014, Fitch, Moody’s, and S&P took negative rating actions. All three agencies rated the company’s long-term unsecured debt below investment grade, increasing refinancing and funding-cost risk.
- The company issued approximately $850 million of senior unsecured bonds, $2.0 billion of FFELP asset-backed securities, and $676 million of private education loan asset-backed securities during the quarter. A new $8 billion FFELP asset-backed commercial-paper facility was also established.
- Derivative valuations remain volatile. Q1 2014 included a $180 million unrealized gain on derivatives within the Core Earnings reconciliation, while cumulative derivative accounting had reduced GAAP equity by approximately $854 million after tax at March 31, 2014.
- Key ongoing risks include private-loan credit losses and recovery shortfalls, regulatory and litigation exposure, access to capital markets, credit-rating downgrades, interest-rate and basis risk, derivative-counterparty exposure, portfolio runoff, and execution of the separation.
Most important facts for investors to verify
- Reconcile historical Existing SLM results with Navient’s standalone pro forma results; Q1 historical GAAP net income was $219 million, while pro forma Navient net income was $208 million and pro forma Core Earnings were $151 million.
- Confirm the final accounting and balance-sheet effects of the April 30, 2014 spin-off, including the transfer of approximately $1.7 billion of consumer-banking net assets and the treatment of preferred stock.
- Track final settlements, restitution, penalties, and additional reserves related to the FDIC, DOJ, SCRA, and CFPB matters.
- Assess refinancing capacity and future interest expense after the below-investment-grade credit-rating actions and the approximately $1.0 billion of senior unsecured debt maturing within twelve months.
- Monitor private education loan delinquencies, charge-offs, troubled debt restructurings, partially charged-off loan recoveries, and the $334 million allowance for potential recovery shortfalls.
- Evaluate the sustainability of earnings after excluding nonrecurring gains, derivative-accounting volatility, separation costs, and the benefit from lower loan-loss provisions.