Navient Corporation 10-Q Summary: First Quarter 2016
Business context and reporting period
Navient provides education-loan servicing, asset recovery and business-processing services. Its principal assets are federally insured or guaranteed FFELP Loans and privately held education loans. The filing covers the three months ended March 31, 2016, with comparative results for the three months ended March 31, 2015. The financial statements are unaudited and prepared under U.S. GAAP.
- Education loans serviced exceeded $300 billion for more than 12 million customers, including 6.3 million accounts serviced for the Department of Education.
- Reportable segments were FFELP Loans, Private Education Loans, Business Services and Other.
- Navient no longer originates FFELP or Private Education Loans but continues to acquire portfolios opportunistically.
Financial performance and key metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Total interest income | $1,051 million | $1,097 million | Down 4% |
| Net interest income | $486 million | $583 million | Down 17% |
| Provision for loan losses | $111 million | $125 million | Down 11% |
| Net interest income after provisions | $375 million | $458 million | Down 18% |
| Other income | $160 million | $249 million | Down 36% |
| Total expenses | $251 million | $234 million | Up 7% |
| GAAP net income attributable to Navient | $181 million | $292 million | Down 38% |
| Diluted GAAP EPS | $0.53 | $0.72 | Down $0.19 |
| Core Earnings net income | $147 million | $194 million | Down 24% |
| Diluted Core Earnings EPS | $0.43 | $0.48 | Down $0.05 |
GAAP net income was pressured by lower net interest income, weaker derivative-related gains and lower other income. Core Earnings excluded $54 million of net derivative-accounting adjustments and $4 million of goodwill and acquired-intangible amortization or impairment, net of tax effects. Core Earnings is a non-GAAP measure and is not necessarily comparable with similarly titled measures of other companies.
- GAAP net interest margin was 1.53%, compared with 1.69% in the prior-year quarter.
- Core Earnings net interest margin was 0.81% for FFELP Loans and 3.56% for Private Education Loans, versus 0.88% and 3.74%, respectively, in Q1 2015.
- FFELP Loan net interest margin on a GAAP basis was 1.12%; Private Education Loan net interest margin was 3.49%.
- Servicing revenue increased to $82 million from $77 million. Asset recovery and business-processing revenue increased to $90 million from $89 million.
- Operating expenses increased to $247 million from $230 million, partly because of the Gila LLC and Xtend Healthcare acquisitions. Excluding regulatory-related costs and acquisition expenses, management reported cost reductions from operating initiatives.
Balance sheet, credit quality, cash flow and liquidity
- Total assets were $131.4 billion at March 31, 2016, down from $134.1 billion at December 31, 2015.
- Net FFELP Loans were $95.0 billion, down from $96.5 billion at year-end 2015 and $102.4 billion at March 31, 2015.
- Net Private Education Loans were $25.5 billion, down from $26.4 billion at year-end 2015 and $29.0 billion at March 31, 2015.
- Total education loans, net, were $120.6 billion, compared with $122.9 billion at December 31, 2015 and $131.4 billion a year earlier.
- Total borrowings were $125.3 billion, consisting of $2.4 billion short-term and $122.9 billion long-term borrowings. Senior unsecured debt totaled $14.1 billion.
- Total equity was $3.8 billion, compared with $4.0 billion at December 31, 2015. Treasury stock increased to $1.6 billion following share repurchases.
- Cash and cash equivalents were $1.2 billion at quarter-end, down from $1.6 billion at December 31, 2015. Unrestricted cash and liquid investments plus unencumbered FFELP Loans totaled $1.9 billion.
- Operating activities provided $342 million of cash; investing activities provided $2.2 billion; financing activities used $3.0 billion. Cash decreased by $426 million during the quarter.
- Management cited $360 million of operating cash flow in its liquidity discussion, reflecting a presentation difference from the consolidated cash-flow statement.
- Private Education Loan delinquencies were 6.2% of loans in repayment, down from 6.9% a year earlier; greater-than-90-day delinquencies were 3.2%, down from 3.6%.
- FFELP Loan delinquencies were 14.1% of loans in repayment, down from 15.9% a year earlier; greater-than-90-day delinquencies were 7.0%, down from 8.4%.
- Private Education Loan charge-offs declined to $144 million from $190 million, while the allowance declined to $1.4 billion from $1.8 billion at March 31, 2015.
Material changes versus the prior comparable period
- GAAP net income declined $111 million, primarily because net interest income decreased $97 million, derivative-related gains decreased $70 million, other income decreased $20 million and operating expenses increased $17 million.
- Lower loan balances and higher funding costs reduced net interest margins. Average total education loans fell to $122.3 billion from $133.7 billion.
- Credit trends improved, reducing the loan-loss provision by $14 million and private-loan charge-offs by $46 million.
- Share repurchases reduced diluted weighted-average shares to 343 million from 405 million, partially offsetting the decline in earnings per share.
- Navient acquired approximately $1.5 billion of education loans, issued $1.1 billion of FFELP ABS and $488 million of Private Education Loan ABS, and retired or repurchased $1.0 billion of senior unsecured debt.
- The FFELP asset-backed commercial paper facility was increased to $7.5 billion and extended to March 2018.
Guidance, outlook, management commentary, risks and unusual items
- No specific quantitative full-year earnings guidance was provided in the filing. Management expects loan portfolios to generate cash flow as they amortize and intends to pursue opportunistic portfolio acquisitions and additional servicing, asset recovery and business-processing contracts.
- Management expects cash flows from education-loan portfolios to exceed future debt-service obligations, but liquidity depends on access to capital markets, securitization execution, portfolio repayments and available collateral.
- Three rating agencies rated Navient’s long-term unsecured debt below investment grade. Approximately $53 billion of affiliated FFELP ABS was on credit watch by Moody’s or Fitch at March 31, 2016.
- Navient extended legal final maturities for $2.2 billion of FFELP ABS during the quarter and an additional $1.6 billion after quarter-end; total extensions reached $4.9 billion.
- The company had $1.1 billion of senior unsecured notes maturing over the next twelve months and identified cash, investments, unencumbered loans, operating cash flow, trust distributions and additional secured or unsecured financing as potential funding sources.
- Regulatory investigations continued, including matters involving the CFPB, state attorneys general and the New York Department of Financial Services. The filing states that potential exposure could not be estimated and that no additional reserves had been established for these investigations.
- Several putative class actions and securities lawsuits were pending. Management stated that the ultimate timing and financial impact could not be determined.
- Previously established reserves of $177 million related to FDIC and DOJ consent orders were substantially paid, credited or refunded by March 31, 2016, although final costs remained uncertain.
- Key risks include funding availability and cost, credit and liquidity risk, interest-rate and basis risk, derivative valuation volatility, regulatory and litigation exposure, cybersecurity and operating-system failures, changes in student-loan laws, and reputational risk associated with student-loan servicing.
Most important facts for investors to verify
- Reconcile GAAP earnings with Core Earnings, particularly the $54 million derivative-accounting adjustment and the sensitivity of reported earnings to market movements.
- Assess whether the improvement in private-loan delinquencies and charge-offs is sustainable and whether the $1.4 billion private-loan allowance remains adequate.
- Monitor refinancing capacity, ABS credit-watch actions, maturity extensions and the $1.1 billion of unsecured debt due within twelve months.
- Review unrestricted liquidity, unencumbered collateral and the availability of the FFELP and Private Education Loan facilities, including the $630 million available under the private-loan ABCP facility.
- Track CFPB, state, NYDFS and Department of Education matters, including the unresolved Special Allowance Payment audit and pending litigation.
- Evaluate the effect of continued portfolio runoff, funding-cost increases and the company’s $555 million remaining share-repurchase authorization on capital and liquidity.