Business Context and Reporting Period
Navient Corporation filed an unaudited Form 10-Q for the three months ended March 31, 2015. Navient is a loan management, servicing and asset recovery company with approximately $131.4 billion of student loans, including $102.4 billion of FFELP loans and $29.0 billion of Private Education Loans, and services more than $300 billion of student loans for over 12 million customers.
Navient was spun off from SLM Corporation on April 30, 2014. Because Navient is treated as the accounting successor, the March 31, 2014 GAAP comparison includes pre-spin-off SLM BankCo operations, while management's non-GAAP “Core Earnings” presentation excludes those operations. This limits direct comparability of reported GAAP results.
Financial Results and Key Metrics
| Metric | Q1 2015 | Q1 2014 or March 31, 2015 |
|---|---|---|
| Total interest income | $1.097 billion | $1.296 billion |
| Net interest income | $583 million | $766 million |
| Provision for loan losses | $125 million | $185 million |
| Other income | $249 million | $170 million |
| Total expenses | $234 million | $396 million |
| Net income attributable to Navient | $292 million | $219 million |
| Diluted EPS | $0.72 | $0.49 |
| Core Earnings, non-GAAP | $194 million; $0.48 diluted EPS | $142 million; $0.33 diluted EPS |
| GAAP net interest margin | 1.69% | 2.06% |
| Return on assets | 0.85% | 0.59% |
| Operating cash flow | $499 million | $558 million |
At March 31, 2015, total assets were $143.9 billion, total liabilities were $139.8 billion and total equity was $4.1 billion. Cash and cash equivalents were $2.051 billion, while unrestricted cash and liquid investments totaled $2.058 billion. Total borrowings were $136.4 billion, consisting of $4.1 billion of short-term borrowings and $132.3 billion of long-term borrowings; secured borrowings represented approximately 87% of debt.
Primary liquidity, including unrestricted cash and liquid investments and unencumbered FFELP Loans, was $3.858 billion. The company reported $11.9 billion of total unencumbered assets and $12.5 billion of maximum additional capacity under FFELP loan facilities. A Private Education Loan asset-backed commercial paper facility had $653 million of available capacity and matured in June 2015. Approximately $2.5 billion of senior unsecured notes matured within the following twelve months.
Material Changes Versus the Prior Comparable Period
- GAAP net income increased 33% to $292 million, and diluted EPS increased 47% to $0.72, primarily reflecting lower operating expenses, lower loan-loss provisions and higher derivative gains.
- Net interest income declined 24% to $583 million. Private Education Loan interest income decreased 29% to $456 million, reflecting a smaller portfolio and lower margins. Total ending student loans declined from $140.8 billion to $131.4 billion year over year.
- Loan-loss provisions declined 32% to $125 million. Private Education Loan provisions decreased to $120 million from $175 million, while FFELP provisions decreased to $5 million from $10 million.
- Operating expenses declined 37% to $230 million, primarily because Q1 2014 included $103 million of regulatory settlement expenses and costs associated with the spin-off. Excluding regulatory matters, management reported a $33 million decrease in operating expenses.
- Net derivative and hedging gains were $71 million versus an $8 million loss in Q1 2014. Core Earnings excluded a $166 million net impact from derivative accounting, making reported GAAP earnings materially sensitive to market valuations.
- Business Services Core Earnings declined to $86 million from $116 million. Asset recovery revenue decreased 20% to $89 million, partly because the Bipartisan Budget Act reduced fees paid for rehabilitated defaulted FFELP loans. The decline was partly offset by the Gila LLC acquisition.
- FFELP Loans Core Earnings increased to $85 million from $64 million, while Private Education Loans Core Earnings increased to $77 million from $74 million, supported by lower provisions and operating costs.
- Navient acquired a 97.9% controlling interest in Gila LLC in February 2015 for approximately $181 million net of cash acquired. Gila provides asset recovery and business process outsourcing services to government and municipal clients.
- Navient repurchased 14.7 million shares for $300 million, paid a $0.16 per-share dividend and had $700 million remaining under its $1 billion repurchase authorization at quarter-end.
Outlook, Risks, Contingencies and Unusual Items
- Management expects the FFELP and Private Education Loan portfolios to generate cash as they amortize and intends to pursue selective loan acquisitions, servicing opportunities and asset recovery opportunities. No specific full-year earnings guidance is provided in the filing.
- Private Education Loans carry the company's full credit risk. The portfolio had a $1.849 billion allowance for loan losses, equal to 5.9% of ending total loans, and a 2.9% annualized charge-off rate. The portfolio also included $10.426 billion of troubled debt restructurings.
- FFELP Loans are substantially federally insured or guaranteed, but the company generally remains exposed to up to 3% of losses. FFELP delinquencies were 15.9% of loans in repayment, compared with 14.2% in the March 2014 comparison; greater-than-90-day delinquencies were 8.4% versus 7.5%.
- Regulatory investigations and inquiries remain outstanding, including matters involving the CFPB, state attorneys general, New York Department of Financial Services and the Department of Education. The filing states that potential exposure cannot currently be estimated for several matters and that no additional reserves have been established for those investigations.
- Reserves related to FDIC and DOJ matters totaled $177 million when established; $73 million remained at March 31, 2015. The DOJ approved a distribution plan on April 15, 2015, with disbursements expected to begin in Q2 2015.
- The Department of Education's audit of Special Allowance Payments remained unresolved, with an appeal deadline extended to May 31, 2015. Navient believes its billing practices were proper.
- Pioneer Credit Recovery's Department of Education contract expired on February 21, 2015, and no new account placements were received. A related court challenge was dismissed on April 16, 2015, and the company was evaluating an appeal while responding to a new contract solicitation.
- Interest-rate, basis, foreign-currency and liquidity risks are significant. A hypothetical 25-basis-point increase in funding indices was estimated to reduce annual pre-tax earnings by $315 million before unrealized derivative effects. Three rating agencies rated the company's long-term unsecured debt below investment grade.
- Derivative accounting produced substantial volatility: cumulative derivative accounting effects reduced GAAP equity by approximately $505 million at March 31, 2015, while net derivative liabilities were $1.115 billion on a total basis.
Most Important Facts for Investors to Verify
- Reconcile GAAP earnings of $292 million with Core Earnings of $194 million and assess the sustainability of the $166 million derivative-accounting adjustment.
- Review the comparability impact of the April 2014 spin-off and the exclusion of SLM BankCo from Core Earnings.
- Monitor Private Education Loan charge-offs, delinquencies, troubled debt restructurings, recovery shortfalls and the adequacy of the $1.849 billion allowance.
- Assess refinancing requirements for the $2.5 billion of unsecured debt maturing within twelve months, available secured capacity and below-investment-grade ratings.
- Track the resolution and possible financial impact of CFPB, state, NYDFS, Department of Education and other regulatory matters, including the remaining $73 million reserve.
- Evaluate the effect of reduced federal rehabilitation fees and the loss or renewal of Pioneer’s Department of Education contract on Business Services revenue.
- Confirm post-quarter financing activity, including the April 2015 issuance of $997 million of FFELP loan ABS and repurchase of $520 million of unsecured debt.