Navient Corporation Form 10-Q Summary
Business context and reporting period
Navient Corporation filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. The company provides education-loan asset management, loan servicing, asset recovery and business-processing services for education, government, health-care and other public-sector clients. Its principal reportable segments are FFELP Loans, Private Education Loans, Business Services and Other.
At September 30, 2017, Navient serviced approximately 12 million education-loan customers, including 6.1 million accounts under its Department of Education contract, and held a net education-loan portfolio of $107.3 billion.
Financial performance and key metrics
| Metric | Three months ended September 30, 2017 | Three months ended September 30, 2016 | Nine months ended September 30, 2017 | Nine months ended September 30, 2016 |
|---|---|---|---|---|
| Total interest income | $1,140 million | $1,039 million | $3,224 million | $3,118 million |
| Net interest income | $355 million | $412 million | $1,046 million | $1,327 million |
| Provision for loan losses | $105 million | $106 million | $317 million | $327 million |
| Net interest income after provisions | $250 million | $306 million | $729 million | $1,000 million |
| Total other income | $263 million | $311 million | $577 million | $594 million |
| Net income attributable to Navient | $176 million | $230 million | $376 million | $535 million |
| Diluted EPS | $0.64 | $0.73 | $1.32 | $1.63 |
| Core Earnings net income | $152 million | $157 million | $382 million | $458 million |
| Core Earnings diluted EPS | $0.55 | $0.50 | $1.34 | $1.39 |
Operating expenses were $238 million in the third quarter and $707 million for the first nine months, compared with $228 million and $706 million, respectively, in the comparable periods. The third-quarter effective tax rate was approximately 35%, compared with 39% in the prior-year quarter.
- Third-quarter Core Earnings net interest margins were 0.71% for FFELP Loans and 3.57% for Private Education Loans.
- GAAP net interest margin was 1.23% for the third quarter and 1.22% for the first nine months, compared with 1.35% and 1.42%, respectively, in the prior-year periods.
- FFELP Loans, net, totaled $83.9 billion; Private Education Loans, net, totaled $23.4 billion.
- The allowance for loan losses was $1.36 billion at September 30, 2017, including $1.29 billion for Private Education Loans and $61 million for FFELP Loans.
- Private Education Loan delinquencies were 5.7% of loans in repayment, down from 6.9% at September 30, 2016. FFELP Loan delinquencies were 12.2%, up from 11.3% on the comparable date.
- Cash and cash equivalents were $1.25 billion. Total unrestricted cash and liquid investments were $1.25 billion, and unencumbered FFELP Loans were $553 million, providing reported primary liquidity of $1.80 billion.
- Operating activities generated $914 million of cash during the first nine months, compared with $1.11 billion in the prior-year period. Cash and cash equivalents decreased by $5 million during the period.
- Total borrowings were $111.8 billion, comprising $3.3 billion of short-term borrowings and $108.6 billion of long-term borrowings. Secured borrowings represented approximately 88% of Core Earnings debt.
Material changes versus the prior comparable period
- Third-quarter GAAP net income declined 23% and nine-month GAAP net income declined 30%, primarily because of lower net interest income and lower derivative-related gains.
- Net interest income declined $57 million in the quarter and $281 million year to date. Higher funding costs, portfolio amortization, reduced floor income and a $28 million cumulative adjustment for faster prepayment assumptions were important contributors.
- The prepayment adjustment reduced FFELP Loan interest income by $34 million and increased Private Education Loan interest income by $6 million in the third quarter, reducing total net interest income by $28 million.
- Asset recovery and business-processing revenue increased $60 million in the quarter and $79 million year to date. The increase included recognition of $47 million of previously deferred revenue after termination of a default-aversion services contract effective December 31, 2017.
- Derivative and hedging gains declined to $25 million in the quarter from $137 million and were a $16 million loss for the first nine months compared with a $111 million gain in the prior-year period.
- Core Earnings diluted EPS increased to $0.55 from $0.50 in the quarter, principally reflecting higher fee revenue and a lower share count despite lower Core Earnings net income.
- Navient acquired $8.6 billion of education loans during the first nine months, including $6.5 billion in June 2017. The June portfolio included $3.5 billion of FFELP Loans and $3.0 billion of Private Education Loans.
- Navient acquired Duncan Solutions for approximately $86 million in July 2017. It also announced an agreement to acquire Earnest for approximately $155 million in cash, with closing expected in the fourth quarter of 2017.
- Navient repurchased 29.6 million shares for $440 million during the first nine months and paid $133 million of dividends. On October 4, 2017, it suspended the remaining share-repurchase program through year-end 2018 to direct capital toward education lending and book value growth.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide a formal quantitative earnings or revenue guidance range. Management expects education-loan portfolios to generate substantial cash flow over their remaining lives and plans to pursue education-loan acquisitions and private-loan refinancing opportunities. The planned Earnest acquisition is intended to expand refinancing origination capabilities.
- Liquidity depends on operating cash flow, loan repayments, securitization-trust distributions, secured facilities and access to unsecured and asset-backed capital markets. Approximately $1.4 billion of senior unsecured notes mature within the next twelve months.
- Three credit-rating agencies rate Navient’s long-term unsecured debt below investment grade. A downgrade could increase funding costs, reduce market access or increase collateral requirements.
- Private Education Loans carry substantially more borrower credit risk than FFELP Loans, while FFELP Loans are generally subject to a maximum 3% loss exposure under federal guarantees.
- The company is subject to CFPB and state Attorneys General litigation alleging violations of consumer-protection and servicing laws. Motions to dismiss in the CFPB and Washington matters were denied; the Illinois matter remained unresolved at filing. Navient stated that potential exposure could not be estimated and that no reserves had been established for these cases.
- Navient faces continuing regulatory inquiries, including matters involving the CFPB, state authorities, the New York Department of Financial Services and an open Department of Education audit concerning Special Allowance Payments.
- Derivative valuations are sensitive to interest rates, foreign-exchange rates, credit spreads and other market factors and may cause significant earnings volatility. GAAP derivative accounting produced a $36 million gain in the quarter but a $2 million loss for the first nine months.
- Private Education Loan delinquencies and forbearance were affected by natural-disaster relief, including approximately $112 million of delinquent loans placed into forbearance.
- The company expects the adoption of the current expected credit loss standard in 2020 to increase its allowance for loan losses, potentially materially, although the impact was not yet quantified.
Most important facts for investors to verify
- Whether the $47 million deferred-revenue recognition is nonrecurring and how the related contract termination affects future Business Services revenue.
- The sustainability of net interest margins given higher funding costs, portfolio amortization, prepayment speeds, floor-income trends and basis risk.
- The credit performance and reserve sufficiency of the Private Education Loan portfolio, particularly the $3.0 billion acquired in June 2017 for which no allowance had been recorded because of purchase discounts.
- Liquidity and refinancing capacity relative to the $1.4 billion of senior unsecured debt maturing within twelve months and the company’s below-investment-grade ratings.
- Potential financial exposure from CFPB and state Attorneys General litigation, indemnification obligations to SLM BankCo and the unresolved Department of Education audit.
- Completion, purchase-price allocation and expected financial contribution of Duncan Solutions and Earnest.
- The effect of suspending share repurchases on capital deployment, book value, earnings per share and future shareholder returns.
- The distinction between GAAP results and non-GAAP Core Earnings, which exclude certain derivative-accounting effects and acquired-intangible amortization and may not be comparable with other companies’ measures.