Business Context and Reporting Period
Navient Corporation filed an unaudited Form 10-Q for the three months ended March 31, 2017. The company operates four reportable segments: FFELP Loans, Private Education Loans, Business Services, and Other. It services more than 12 million education-loan customers, including 6.1 million accounts under its Department of Education contract, and provides asset recovery and business-processing services to more than 1,000 clients.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 or prior period |
|---|---|---|
| Total interest income | $1,015 million | $1,051 million |
| Net interest income | $340 million | $486 million |
| Provision for loan losses | $107 million | $111 million |
| Net interest income after provisions | $233 million | $375 million |
| Total other income | $152 million | $160 million |
| Operating expenses | $238 million | $247 million |
| Net income attributable to Navient | $88 million | $181 million |
| Diluted EPS | $0.30 | $0.53 |
| Core Earnings, non-GAAP | $107 million; $0.36 diluted EPS | $147 million; $0.43 diluted EPS |
| Operating cash flow | $350 million | $342 million |
| Cash and cash equivalents at period-end | $1,364 million | $1,168 million at March 31, 2016 |
| Total education loans, net | $107.8 billion | $120.5 billion at March 31, 2016 |
| Total borrowings | $111.7 billion | $114.7 billion at December 31, 2016 |
| Total equity | $3.7 billion | $3.7 billion at December 31, 2016 |
GAAP net interest margin was 1.19%, compared with 1.53% in the prior-year quarter. FFELP Loan net interest margin was 0.80% versus 1.12%, and Private Education Loan net interest margin was 3.15% versus 3.49%. On a Core Earnings basis, the respective margins were 0.77% and 3.16%.
At March 31, 2017, FFELP Loans were $85.3 billion net and Private Education Loans were $22.6 billion net. The Private Education Loan allowance for losses was $1.311 billion, or 5.4% of ending total loans; the FFELP allowance was $64 million, or 0.08% of ending total loans.
Material Changes Versus Comparable Periods
- GAAP net income declined 51% year over year, primarily because net interest income fell $146 million and derivative-related gains declined $17 million.
- Net interest income was pressured by higher funding credit spreads, widening between asset and funding indices, and continued portfolio amortization. Average total education loans declined to $110.3 billion from $122.3 billion.
- Interest expense increased $110 million, or 19%, despite lower average borrowings, reflecting higher funding costs.
- Private Education Loan provisions declined $9 million to $95 million, while charge-offs declined to $137 million from $144 million. However, the Private Education Loan delinquency rate increased to 6.8% from 6.2%.
- FFELP Loan credit metrics improved: delinquencies declined to 11.4% of loans in repayment from 14.1% in the prior-year quarter, and the greater-than-90-day delinquency rate declined to 6.2% from 7.0%.
- Operating expenses decreased $9 million, primarily due to operating-efficiency initiatives. Average diluted shares declined 14% to 296 million because of share repurchases.
- Business Services Core Earnings increased to $77 million from $75 million, as asset recovery and business-processing revenue rose $10 million while servicing revenue declined $14 million.
Liquidity, Capital and Financing
- Unrestricted cash and liquid investments were $1.366 billion, and unencumbered FFELP Loans were $594 million, for $1.960 billion of identified primary liquidity.
- Navient had $6.9 billion of total unencumbered assets, including $3.3 billion of unencumbered education loans, and $10.8 billion of net assets in consolidated variable-interest entities.
- Senior unsecured debt totaled $14.0 billion; the filing states that three credit-rating agencies rated the company’s long-term unsecured debt below investment grade.
- During the quarter, Navient issued $1.9 billion of FFELP asset-backed securities and $843 million of unsecured debt, and retired or repurchased $568 million of senior unsecured debt.
- The FFELP asset-backed commercial paper facility maturity was extended to April 2019, with maximum capacity reduced to $6.75 billion. The Private Education Loan ABCP facility had $209 million of available capacity at March 31, 2017.
- The company paid a $0.16 per-share dividend and repurchased 7.4 million shares for $110 million. Remaining repurchase authorization was $490 million.
Outlook, Commentary, Risks and Unusual Items
- No specific full-year earnings guidance is provided in the filing. Management expects the education-loan portfolios to generate significant cash flow as they amortize and intends to pursue opportunistic portfolio acquisitions.
- In April 2017, Navient agreed to purchase a $6.9 billion JPMorgan Chase education-loan portfolio, consisting of $3.7 billion of FFELP Loans and $3.2 billion of Private Education Loans, with closing expected in the second quarter of 2017.
- Core Earnings are a non-GAAP measure that excludes certain derivative mark-to-market effects, goodwill and acquired-intangible-asset accounting, and specified historical Spin-Off items. Core Earnings are not comparable to GAAP or necessarily to similarly named measures at other companies.
- Derivative accounting reduced first-quarter 2017 GAAP results by $23 million relative to Core Earnings, compared with a $54 million positive adjustment in the prior-year quarter. Derivative valuations remain sensitive to interest rates, foreign-exchange movements and credit spreads.
- The CFPB and the Attorneys General of Illinois and Washington filed civil actions in January 2017 alleging violations of federal and state consumer-protection laws. Navient filed motions to dismiss; the company states that potential exposure cannot currently be estimated and that no reserves have been established. An adverse outcome could materially affect financial position, liquidity, results or cash flows.
- Other litigation, regulatory investigations, an ED Special Allowance Payment audit appeal, and potential indemnification obligations to SLM BankCo remain outstanding. The FDIC lifted a prior consent order effective March 23, 2017.
- Key ongoing risks include funding availability and costs, below-investment-grade credit ratings, interest-rate and basis risk, private-loan credit losses, regulatory changes, litigation, cybersecurity, operating-system failures and changes in government servicing or collections contracts.
- The company adopted new stock-compensation guidance in 2017, reducing first-quarter income-tax expense by $3 million. It expects the future credit-loss standard, effective January 1, 2020, to increase allowances and potentially materially change loan-loss accounting.
Important Facts for Investors to Verify
- Reconcile GAAP net income of $88 million with Core Earnings of $107 million and assess the sustainability of earnings excluding derivative volatility.
- Monitor funding spreads, interest-rate basis mismatches, unsecured debt refinancing needs and the availability of secured facilities.
- Evaluate Private Education Loan delinquency, charge-off and allowance trends, including the $10.7 billion of troubled-debt-restructuring loans and $800 million receivable for partially charged-off loans.
- Assess the financing, closing conditions and expected impact of the $6.9 billion JPMorgan Chase portfolio acquisition.
- Track the CFPB and state Attorneys General litigation, related reserves, potential restitution or penalties, and the company’s indemnification obligations to SLM BankCo.
- Review the renewal and competitive status of Department of Education servicing and collection contracts, including the Direct Student Loan Program servicing RFP and other contracts subject to rebidding.
- Consider the effect of continued portfolio amortization on net interest income, servicing revenue, operating scale and future cash generation.