Navient Corporation 2015 Form 10-K Summary
Business context and reporting period
Navient filed its annual report for the fiscal year ended December 31, 2015. The company is a loan management, servicing, asset recovery, and business processing provider serving more than 12 million customers and servicing over $300 billion of education loans.
Reportable segments are FFELP Loans, Private Education Loans, Business Services, and Other. Navient is the accounting successor to SLM Corporation; therefore, pre-spin-off GAAP comparisons include historical consumer banking operations that were distributed to SLM BankCo in April 2014. Management also reports non-GAAP “Core Earnings,” which exclude selected spin-off effects, derivative mark-to-market volatility, and goodwill or acquired-intangible amortization.
Key financial metrics
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Net interest income | $2.221 billion | $2.667 billion | Down 17% |
| Provision for loan losses | $561 million | $628 million | Down 11% |
| Net income attributable to Navient | $997 million | $1.149 billion | Down 13% |
| Diluted EPS | $2.61 | $2.69 | Down 3% |
| Core Earnings | $694 million | $818 million | Down 15% |
| Core diluted EPS | $1.82 | $1.93 | Down 6% |
| GAAP net interest margin | 1.64% | 1.89% | Down 25 basis points |
| Return on assets | 0.74% | 0.81% | Down 7 basis points |
| Operating cash flow from continuing operations | $1.910 billion | $1.664 billion | Up 15% |
Fourth-quarter 2015 net income attributable to Navient was $286 million, or $0.79 diluted EPS, compared with $263 million, or $0.64 diluted EPS, in fourth-quarter 2014. Fourth-quarter net interest income was $536 million and the provision for loan losses was $115 million.
At December 31, 2015, total assets were $134.1 billion, total education loans were $122.9 billion, total borrowings were $127.4 billion, and Navient stockholders’ equity was $4.0 billion. Unsecured debt was $15.1 billion, down from $17.4 billion at year-end 2014. Long-term unsecured debt was rated below investment grade by all three rating agencies.
Liquidity included $1.598 billion of unrestricted cash and liquid investments and $1.005 billion of unencumbered FFELP Loans, for $2.603 billion of primary liquidity. The company reported $1.9 billion of operating cash flow for 2015 and expected to repay $1.1 billion of senior unsecured notes maturing within twelve months.
Portfolio and segment performance
- FFELP Loans: Net balance of $96.5 billion, down from $104.5 billion. Core net interest margin was 0.84%, down from 0.90%. Delinquencies declined to 15.3% of loans in repayment from 16.6%; the charge-off rate declined to 0.05% from 0.08%. Approximately 97% to 98% of qualifying principal and accrued interest is generally insured or guaranteed, subject to program requirements and risk sharing.
- Private Education Loans: Net balance of $26.4 billion, down from $29.8 billion. Core net interest margin was 3.67%, down from 3.94%. Delinquencies declined to 7.2% of loans in repayment from 8.1%, while the adjusted charge-off rate remained 2.6%. Navient bears the full credit risk on this portfolio.
- Business Services: Segment revenue was approximately $1.02 billion, down from $1.06 billion. Core Earnings declined to $338 million from $425 million. Federal education-related revenue represented 87% of segment revenue versus 94% in 2014. Non-federal asset recovery revenue increased from $49 million to $118 million.
- Other: Core Earnings loss improved to $198 million from $257 million, primarily because regulatory-related costs declined to $19 million from $120 million.
Material changes versus the prior comparable period
- Net interest income declined primarily because of shrinking FFELP and Private Education Loan balances, lower margins, higher funding costs, and the absence of certain pre-spin-off consumer banking results.
- Private Education Loan balances declined by $3.4 billion and FFELP balances declined by $8.0 billion. The total education loan portfolio declined by $11.4 billion.
- Navient changed its Private Education Loan recovery assumptions, increasing the portion charged off at default from 73% to 79%. This reduced the receivable for partially charged-off loans by $330 million but did not increase the provision for loan losses because the amount had previously been reserved.
- Business Services revenue was pressured by a $79 million reduction related to the Bipartisan Budget Act’s reduction in guarantor rehabilitation fees. The impact was partially offset by acquisitions of Gila LLC and Xtend Healthcare.
- Operating expenses declined $69 million and restructuring expense declined $81 million, partly offsetting the decline in net interest income. The company recorded $32 million of restructuring expense, including $29 million for a management-streamlining initiative.
- Navient acquired $3.7 billion of education loans, issued $2.8 billion of FFELP asset-backed securities, $1.7 billion of Private Education Loan asset-backed securities, and $500 million of unsecured debt. It repurchased $1.7 billion of senior unsecured debt.
- The company repurchased 56.0 million common shares for $945 million, paid $240 million in common dividends, and ended the year with $755 million of remaining share-repurchase authorization.
Guidance, outlook, commentary, risks, and unusual items
Management expects the existing FFELP and Private Education Loan portfolios to generate significant cash flow as they amortize, but both portfolios and related servicing revenue are expected to decline over time because new originations have ended or are restricted. Navient continues to pursue portfolio acquisitions, third-party servicing, asset recovery, and business processing opportunities.
The Department of Education servicing contract runs through 2019, but ED indicated that it intended to begin rebidding the contracts in 2016. Navient received 15% of new loan volume in the last allocation and warned that future allocation changes could reduce its market share. The company’s asset recovery contract with ED expired in February 2015, and renewal or replacement was uncertain at filing.
- Funding and liquidity: Below-investment-grade ratings, stressed high-yield and FFELP ABS markets, higher funding costs, reduced secured facility capacity, and the need to refinance maturities could constrain liquidity. Moody’s and Fitch placed significant Navient-sponsored FFELP ABS on credit watch.
- Interest-rate and derivative risk: Basis and repricing mismatches exist between loan assets and funding liabilities. A 100-basis-point rate increase was estimated to reduce annual pre-tax income by $140 million, including derivative effects; a 300-basis-point increase was estimated to reduce it by $522 million.
- Credit risk: Private Education Loans have full borrower and cosigner credit exposure. Allowance estimates depend on defaults, recoveries, unemployment, loan seasoning, forbearance, troubled debt restructurings, and other assumptions.
- Regulatory and legal risk: Navient remains subject to CFPB, FDIC, ED, state attorney general, and other investigations. A CFPB NORA letter stated that enforcement action against Navient Solutions was under consideration and could seek restitution, penalties, and corrective action. Several class actions and regulatory matters remained unresolved, with potential exposure not estimable.
- Operational and reputational risk: The filing highlights cybersecurity, system failures, third-party vendor failures, servicing conversion errors, customer complaints, regulatory compliance, and reputational or political scrutiny.
- Unusual accounting items: GAAP income included $543 million of derivative-accounting gains excluded from Core Earnings. The filing cautions that Core Earnings is a non-GAAP measure and is not directly comparable to similarly titled measures of other companies.
Most important facts for an investor to verify
- Reconcile GAAP net income of $997 million with Core Earnings of $694 million, particularly the $543 million derivative-accounting adjustment and related tax effects.
- Assess whether declining FFELP and Private Education Loan balances, margins, and servicing revenues can be replaced through acquisitions or business-services growth.
- Review liquidity against the $1.1 billion of unsecured maturities expected within twelve months, including the availability and terms of secured facilities.
- Monitor credit ratings, FFELP ABS credit-watch actions, securitization refinancing conditions, and the reduction in FHLB facility capacity.
- Evaluate the adequacy and sensitivity of the $1.471 billion Private Education Loan allowance, including the effect of the 79% charge-off assumption and $10.6 billion of TDR recorded investment.
- Track ED servicing-contract rebidding, future loan-volume allocations, and the unresolved ED asset-recovery contract.
- Review CFPB, state, ED, FDIC, DOJ, securities litigation, and other regulatory matters; the filing does not provide clear potential-loss ranges for several matters.
- Consider the effect of $945 million of share repurchases and $240 million of dividends on tangible equity, liquidity, and future capital flexibility.