Navient Corporation 2018 Q3 Form 10-Q Summary
Business context and reporting period
Navient provides education-loan asset management, loan servicing, asset recovery, and business-processing services for government, healthcare, and other clients. Its reportable segments are Federal Education Loans, Consumer Lending, Business Processing, and Other. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018, with comparisons to the same periods in 2017 and to December 31, 2017 for balance-sheet items.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Total interest income | $1,241 million | $1,140 million | $3,639 million | $3,224 million |
| Net interest income | $306 million | $355 million | $932 million | $1,046 million |
| Provision for loan losses | $85 million | $105 million | $284 million | $317 million |
| Other income | $205 million | $263 million | $553 million | $577 million |
| Total expenses | $279 million | $244 million | $780 million | $724 million |
| Net income attributable to Navient | $114 million | $176 million | $323 million | $376 million |
| Diluted EPS | $0.43 | $0.64 | $1.21 | $1.32 |
| Core Earnings net income | $140 million | $152 million | $379 million | $382 million |
- Profitability: Q3 GAAP net income declined 35% year over year; nine-month net income declined 14%. Core Earnings declined 8% in Q3 and 1% for the nine-month period. The filing reports consolidated GAAP net interest margin of 1.17% for both Q3 and nine months, versus 1.23% and 1.22%, respectively, in the comparable 2017 periods.
- Loan portfolio: Net FFELP Loans were $74.3 billion and net Private Education Loans were $22.4 billion at September 30, 2018, producing a total net education-loan portfolio of $96.7 billion. The portfolio declined from $107.3 billion at September 30, 2017 and $105.1 billion at December 31, 2017.
- Credit metrics: FFELP delinquency was 11.4% of loans in repayment, down from 12.2% a year earlier; forbearance was 12.4%, down from 15.2%. Private Education Loan delinquency was 6.3%, up from 5.7%, while forbearance declined to 3.9% from 5.4%.
- Allowances and charge-offs: The total loan-loss allowance was $1.315 billion at quarter-end, including $1.226 billion for Private Education Loans and $79 million for FFELP Loans. Q3 private-loan charge-offs, excluding a $32 million accounting-related adjustment, were $116 million versus $96 million in Q3 2017.
- Cash flow and liquidity: Nine-month operating cash flow was $655 million, compared with $914 million in 2017. Investing activities provided $8.199 billion, primarily from loan repayments, while financing activities used $8.252 billion. Cash, cash equivalents, and restricted cash totaled $5.248 billion at September 30, 2018, including unrestricted cash and liquid investments of $2.145 billion.
- Debt: Total borrowings were $101.1 billion, consisting of $5.0 billion short-term and $96.1 billion long-term borrowings, compared with $109.8 billion at December 31, 2017. Senior unsecured debt was $12.9 billion, including $2.2 billion maturing within the following twelve months. Three rating agencies rated Navient’s long-term unsecured debt below investment grade.
- Capital returns: Navient paid a quarterly dividend of $0.16 per share and $126 million of dividends during the first nine months. It repurchased 6.9 million shares for $95 million in Q3 and had $565 million of remaining repurchase authorization at quarter-end.
Material changes versus prior comparable periods
- Net interest income decreased $49 million in Q3 and $114 million for nine months, primarily because of the natural paydown of the education-loan portfolio and higher funding costs.
- Asset recovery and business-processing revenue decreased $51 million in Q3 and $54 million for nine months, principally because Q3 2017 included $47 million of previously deferred asset-recovery revenue recognized after a contract termination.
- Operating expenses increased 7% in Q3 and 3% for nine months. Management attributed adjusted expense reductions to cost-saving initiatives, partly offset by acquisition-related costs, regulatory costs, ASC 606-related costs, and First Data transition costs.
- Income-tax expense declined $60 million in Q3 and $108 million for nine months. The effective tax rate was approximately 23% in both 2018 periods versus approximately 35% in 2017, largely reflecting the Tax Cuts and Jobs Act.
- Private Education Loan provision expense decreased $20 million in Q3 and $61 million for nine months, while FFELP provision expense increased $30 million for nine months due to a higher temporary charge-off estimate.
- Business Processing revenue increased 16% to $64 million in Q3 and 32% to $201 million for nine months. Segment EBITDA was $8 million in Q3 and $34 million for nine months, with margins of 13% and 17%, respectively.
Guidance, outlook, commentary, risks, and unusual items
- Management expects the Federal Education Loans and Consumer Lending portfolios to generate significant earnings and cash flow over their remaining lives. Reported weighted-average lives were approximately seven years for FFELP Loans and six years for Private Education Loans.
- Navient originated $903 million of Private Education Refinance Loans in Q3 and $2.032 billion for the nine months. The company identifies refinancing and expansion of Business Processing services as growth opportunities.
- The Department of Education servicing contract expires in 2019. Navient and its partners advanced to Phase II of the Department’s next-generation servicing procurement, but the filing states that timing and outcome remain uncertain.
- Navient entered a strategic agreement with First Data involving its student-loan technology platform and recorded technology-sale and transition-services revenue. The agreement also generated transition costs during the period.
- In Q3, Navient wrote off a $16 million toll-services relationship intangible asset after receiving notice of contract termination. It concluded that the related $136 million of goodwill was not impaired.
- A $40 million contingency reserve was released in Q2 2018 after management concluded the related loss was no longer probable.
- Navient faces CFPB, Department of Education, state attorney general, securities, consumer-protection, and other litigation and regulatory matters. The company states that the timing and ultimate exposure of several proceedings cannot be estimated, no reserves have been established for certain matters, and an adverse ruling could materially affect results, liquidity, or cash flows.
- Key financial risks include below-investment-grade unsecured ratings, refinancing and capital-market access, rising financing costs, interest-rate and basis risk, private-loan credit losses, regulatory and litigation exposure, servicing-contract renewal risk, cybersecurity and systems failures, and changes in education-loan laws or regulations.
- The company expects the 2020 current expected credit loss standard to increase loan-loss allowances, potentially materially, but had not quantified the impact in this filing.
- Core Earnings is a non-GAAP measure that excludes specified derivative mark-to-market effects and goodwill and acquired-intangible-asset accounting. It should not be treated as a substitute for GAAP results.
Important facts for investors to verify
- Confirm the refinancing plan for the $2.2 billion of senior unsecured notes maturing within twelve months and the availability of secured and unsecured funding.
- Monitor the Department of Education servicing-contract procurement, renewal risk, and the financial effect of any servicing-platform transition.
- Reconcile private-loan delinquency, forbearance, charge-off, recovery, and allowance trends, including the $32 million change in the default charge-off percentage.
- Assess the sustainability of cash distributions and share repurchases against operating cash flow, debt maturities, collateral requirements, and below-investment-grade funding costs.
- Track CFPB, state attorney general, securities litigation, indemnification obligations to Sallie Mae, and the unresolved Department of Education Special Allowance Payments audit.
- Evaluate the sensitivity of earnings to interest rates and funding indices; management estimated that a 100-basis-point rate increase would reduce annual after-tax earnings by $38 million under the filing’s stated assumptions.
- Review the impact of ASC 606, the forthcoming credit-loss standard, acquisitions, cost-saving initiatives, and the First Data agreement on recurring revenue and expenses.