Navient Corporation: Q3 2016 Form 10-Q Summary
Business context and reporting period
Navient is a loan management, servicing and asset recovery company. Its principal activities are financing and servicing Federal Family Education Loan Program (FFELP) loans, financing and servicing private education loans, and providing business services, asset recovery and loan servicing to public and private-sector clients. The unaudited filing covers the three and nine months ended September 30, 2016, with comparisons to the corresponding 2015 periods.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Interest income | $1,039 million | $1,077 million | $3,118 million | $3,238 million |
| Net interest income | $412 million | $553 million | $1,327 million | $1,685 million |
| Provision for loan losses | $106 million | $123 million | $327 million | $446 million |
| Net interest income after provisions | $306 million | $430 million | $1,000 million | $1,239 million |
| Other income | $311 million | $181 million | $594 million | $631 million |
| Net income attributable to Navient | $230 million | $237 million | $535 million | $711 million |
| Diluted EPS | $0.73 | $0.63 | $1.63 | $1.83 |
| Core Earnings net income | $157 million | $174 million | $458 million | $523 million |
| Core Earnings diluted EPS | $0.50 | $0.47 | $1.39 | $1.34 |
Q3 GAAP net interest margin was 1.35%, compared with 1.64% in Q3 2015. Core Earnings net interest margins were 0.87% for FFELP loans and 3.48% for private education loans. Return on assets was 0.75% on a GAAP basis and 0.51% on a Core Earnings basis.
- At September 30, 2016, net FFELP loans were $90.1 billion and net private education loans were $24.0 billion, for a total net education loan portfolio of $114.2 billion.
- Total assets were $125.3 billion, down from $134.1 billion at December 31, 2015.
- Total borrowings were $119.2 billion, including $14.5 billion of senior unsecured debt and $104.4 billion of secured borrowings.
- Cash and cash equivalents were $1.8 billion. Total unrestricted cash and liquid investments plus unencumbered FFELP loans were $2.8 billion, compared with $2.6 billion at year-end 2015.
- Net cash provided by operating activities was $1.1 billion for the first nine months of 2016, compared with $1.5 billion in the prior-year period.
- Net cash provided by investing activities was $8.5 billion, while financing activities used $9.4 billion. Cash increased by $229 million to $1.8 billion.
- Total equity was $3.7 billion, compared with $4.0 billion at December 31, 2015.
- Navient repurchased 47.1 million shares for $575 million and paid $154 million of common dividends during the first nine months. The quarterly dividend was $0.16 per share, and $180 million remained under the repurchase authorization at September 30.
Material changes versus the prior comparable period
- Q3 net income declined 3% to $230 million, but diluted EPS increased to $0.73 from $0.63 because average diluted shares outstanding fell by 59 million, primarily due to share repurchases.
- Q3 net interest income declined $141 million, reflecting portfolio amortization, lower average loan balances and lower margins. Interest expense increased $103 million.
- Q3 provision expense declined $17 million, primarily because of improving private education loan credit quality, delinquencies and charge-offs.
- Q3 derivative and hedging gains increased to $137 million from $20 million. These volatile gains contributed materially to GAAP results; $139 million of derivative-accounting adjustments increased GAAP income relative to Core Earnings.
- Q3 asset recovery and business processing revenue increased $12 million to $97 million, helped by Gila LLC and Xtend Healthcare acquisitions, partly offset by lower education-loan recovery volume.
- For the first nine months, GAAP net income declined 25% to $535 million. Net interest income fell $358 million, servicing revenue fell $28 million and operating expenses increased $23 million, partly offset by lower loan-loss provisions, improved derivative results and the absence of $32 million of prior-year restructuring expense.
- FFELP loan delinquencies fell to 11.3% of loans in repayment from 15.9% in the comparable period, while forbearance declined to 12.7% from 14.7%.
- Private education loan delinquencies declined to 6.9% from 7.4%, greater-than-90-day delinquencies declined to 3.2% from 3.4%, and the charge-off rate declined to 1.9% from 2.3%.
Guidance, outlook, risks and unusual items
The filing does not provide a formal full-year earnings or revenue guidance range. Management expects the loan portfolios to generate substantial earnings and cash flow as they amortize, while continuing to pursue opportunistic loan acquisitions and third-party servicing, asset recovery and business processing contracts.
- Navient issued $3.9 billion of FFELP asset-backed securities, $488 million of private education loan asset-backed securities and $1.3 billion of unsecured debt during the first nine months.
- Approximately $1.5 billion of senior unsecured notes mature in the next twelve months. Management expects to fund these obligations through cash, operating cash flow, principal collections, securitization-trust distributions and available financing facilities.
- Three rating agencies rated Navient's long-term unsecured debt below investment grade. The filing highlights higher financing costs, constrained access to capital markets and potential additional collateral requirements as liquidity risks.
- Credit-watch and downgrade actions affected certain non-recourse FFELP asset-backed securities because of concerns regarding payment by legal final maturity dates. The filing also identifies risks from interest-rate and basis-index movements, derivative valuations, borrower credit performance, regulatory changes, cybersecurity, operational failures and reputational pressure related to student-loan servicing.
- Navient remained involved in CFPB, state attorney general and New York Department of Financial Services investigations. Potential exposure could include restitution, penalties and corrective action; the filing states that a potential range of loss was not estimable and no additional reserves had been established for these investigations.
- Several putative class actions and securities lawsuits remained pending. Management stated that outcomes and potential losses could not currently be predicted, although it did not believe known contingencies would have a material adverse effect on consolidated results.
- The company corrected its method for amortizing education-loan premiums and discounts. The estimated effect is a $2 million reduction to the unamortized premium balance and a $1 million reduction to net income, expected to be recorded in Q4 2016; management considers the effect immaterial.
- Core Earnings is a non-GAAP measure that excludes specified derivative-accounting volatility, acquired-intangible amortization and certain Spin-Off-related items. Q3 2016 Core Earnings were $157 million versus GAAP net income of $230 million.
Most important facts for investors to verify
- Whether the decline in net interest income and loan balances continues to offset improving credit performance and lower provisions.
- Access to unsecured and asset-backed funding, refinancing of the $1.5 billion of near-term senior notes, and the effect of below-investment-grade ratings on funding costs.
- Remaining credit-watch and downgrade exposure in Navient-sponsored FFELP asset-backed securities and the ability to extend legal final maturities.
- Resolution, reserves and potential financial exposure related to CFPB, state, NYDFS and Department of Education matters, as well as pending litigation.
- The sustainability of cash flow available for dividends, share repurchases and acquisitions after debt service and collateral requirements.
- The reconciliation between GAAP results and Core Earnings, particularly the recurring effect of derivative-accounting volatility.
- The outcome of the Department of Education's servicing-platform request for proposals and the related impact on Business Services revenue.