Navient Corporation 2017 Second-Quarter Form 10-Q Summary
Business context and reporting period
Navient provides education-loan asset management, loan servicing, asset recovery, and business-processing services for education, government, health-care, and other public-sector clients. The unaudited filing covers the three and six months ended June 30, 2017, with comparisons to the corresponding 2016 periods.
- Principal segments: FFELP Loans, Private Education Loans, Business Services, and Other.
- At June 30, 2017, Navient serviced more than 12 million education-loan customers and approximately $300 billion of education loans, including 6 million accounts under its Department of Education contract.
- Net education-loan assets totaled $110.4 billion: $86.1 billion of FFELP Loans and $24.2 billion of Private Education Loans.
Financial results and key metrics
| Metric | Three months ended June 30, 2017 | Three months ended June 30, 2016 | Six months ended June 30, 2017 | Six months ended June 30, 2016 |
|---|---|---|---|---|
| Total interest income | $1,070 million | $1,028 million | $2,085 million | $2,080 million |
| Net interest income | $351 million | $429 million | $691 million | $915 million |
| Provision for loan losses | $105 million | $110 million | $212 million | $221 million |
| Net interest income after provisions | $246 million | $319 million | $479 million | $694 million |
| Total other income | $162 million | $123 million | $314 million | $283 million |
| Operating and other expenses | $236 million | $236 million | $480 million | $488 million |
| Net income attributable to Navient | $112 million | $125 million | $200 million | $305 million |
| Diluted EPS | $0.39 | $0.38 | $0.69 | $0.91 |
| Core Earnings | $123 million | $154 million | $230 million | $301 million |
- Second-quarter GAAP return on assets was 0.39%; six-month return on assets was 0.35%.
- GAAP net interest margin was 1.23% for the quarter and 1.21% for the six months, versus 1.38% and 1.46%, respectively, in the comparable 2016 periods.
- Core Earnings net interest margins were 0.80% for FFELP Loans and 3.28% for Private Education Loans in the second quarter, compared with 0.85% and 3.50%, respectively, in 2016.
- Net cash provided by operating activities was $625 million for the six months, compared with $771 million in 2016. Investing activities provided $1.878 billion, while financing activities used $2.603 billion. Cash and cash equivalents ended at $1.153 billion.
- At June 30, total borrowings were $114.696 billion, consisting of $3.918 billion short-term and $110.778 billion long-term borrowings. Senior unsecured debt totaled $14.295 billion.
- Total assets were $120.354 billion and total equity was $3.564 billion. Unrestricted cash and liquid investments were $1.156 billion, and unencumbered FFELP Loans were $936 million, for stated primary liquidity of $2.092 billion.
Material changes versus prior comparable periods
- Second-quarter GAAP net income declined 10% to $112 million, while diluted EPS increased modestly because average diluted shares declined 13% to 285 million following share repurchases.
- Six-month GAAP net income declined 34% to $200 million, primarily because net interest income fell $224 million. Higher funding credit spreads and portfolio amortization reduced margins and interest income.
- Second-quarter net interest income declined $78 million despite a $42 million increase in interest income, because interest expense increased $120 million. Six-month interest expense increased $229 million.
- Asset recovery and business-processing revenue increased 10% in the second quarter and 10% for the six months, principally from higher non-education asset-recovery volume.
- Private Education Loan provision expense declined to $95 million for the quarter and $190 million for the six months. Excluding the June acquisition, management reported lower delinquencies and charge-offs.
- FFELP Loans, net, declined from $87.730 billion at December 31, 2016 to $86.140 billion at June 30, 2017. Private Education Loans, net, increased from $23.340 billion to $24.223 billion.
- In June 2017, Navient acquired a $6.5 billion unpaid-principal portfolio consisting of $3.5 billion of FFELP Loans and $3.0 billion of Private Education Loans. The six-month filing reports $7.9 billion of education-loan acquisitions.
- During the six months, Navient repurchased 18.3 million shares for $275 million and paid $91 million of dividends. Remaining repurchase authorization was $325 million.
Guidance, outlook, commentary, risks, and unusual items
- The filing does not provide a specific quantitative earnings or revenue guidance range. Management expects the loan portfolios to generate significant earnings and cash flow as they amortize and intends to pursue opportunistic acquisitions.
- Management expects to fund $1.9 billion of senior unsecured notes maturing within the next twelve months using cash, operating cash flow, loan repayments, securitization-trust distributions, secured facilities, ABS issuance, and potentially additional unsecured debt.
- Three credit-rating agencies rated Navient’s long-term unsecured debt below investment grade. Management identified access to capital markets, funding costs, credit ratings, collateral requirements, and market disruptions as important liquidity risks.
- Navient extended or expanded several facilities, including its FFELP asset-backed commercial paper facility, a Private Education Loan facility, a new $2.0 billion Private Education Loan facility, and two repurchase facilities totaling $1.2 billion. In July 2017, it issued an additional $1.0 billion of FFELP ABS.
- Core Earnings is a non-GAAP measure that excludes specified derivative-accounting volatility and goodwill/acquired-intangible amortization or impairment. Second-quarter adjustments reduced Core Earnings by $11 million to reconcile to GAAP; six-month adjustments reduced Core Earnings by $30 million.
- Derivative and hedging results remain volatile. Net derivative losses were $25 million in the second quarter and $41 million for the six months. Cumulative derivative accounting reduced GAAP equity by approximately $115 million at June 30, 2017.
- Loan-credit risk remains concentrated in the Private Education Loan portfolio, which carries the borrower and cosigner credit risk. The allowance was $1.286 billion, or 4.9% of ending total Private Education Loans; the second-quarter charge-off rate was 2.3%.
- FFELP Loans are substantially federally insured or guaranteed, but delinquencies were 12.8% of loans in repayment and loans in forbearance were 12.3% of loans in repayment and forbearance at June 30, 2017.
- Navient and subsidiaries face CFPB and Illinois and Washington Attorneys General litigation alleging violations of consumer-protection and related laws. The company stated that potential exposure could not be estimated and no related reserves had been established; an adverse outcome could materially affect results, liquidity, or cash flow.
- The FDIC lifted the consent order applicable to Navient Solutions effective March 23, 2017. The Department of Justice consent-order work continued, although substantially all of the related $177 million reserve had been paid or credited by June 30, 2017.
- The Department of Education Direct Student Loan servicing procurement and related bid protests remain unresolved. The filing also describes pending collection-contract litigation and other regulatory inquiries.
- Navient acquired Duncan Solutions for approximately $80 million on July 31, 2017. The filing text does not provide post-acquisition financial results for this transaction.
- Management identified interest-rate and basis risk, funding-spread volatility, cybersecurity, system failures, regulatory changes, litigation, competition, portfolio credit performance, and potential loss or repricing of government servicing contracts as principal risks.
Most important facts for investors to verify
- Whether lower net interest margins and higher funding costs persist as the loan portfolio amortizes and newly acquired portfolios are financed.
- The credit performance, allowance adequacy, delinquency trends, charge-offs, and recoveries of the Private Education Loan portfolio, including the June 2017 acquisition.
- Liquidity available against the $1.9 billion of senior unsecured debt maturities and the company’s ability to refinance at acceptable spreads.
- The ultimate financial impact of CFPB, state Attorneys General, Department of Education, and related litigation and regulatory matters, for which the filing states that exposure is not currently estimable.
- The outcome of the Department of Education servicing procurement, bid protests, collection-contract proceedings, and other government-contract opportunities.
- The distinction between GAAP earnings and Core Earnings, particularly the effect of derivative marks, hedge accounting, and other non-GAAP adjustments.
- The sustainability of dividends, share repurchases, and future portfolio acquisitions in light of low tangible equity, below-investment-grade unsecured ratings, and refinancing needs.