Business Context and Reporting Period
Navient Corporation filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2015. Navient provides student-loan management, servicing and asset-recovery services. Its principal operating segments are FFELP Loans, Private Education Loans, Business Services and Other. The company serviced more than $300 billion of student loans for more than 12 million customers.
Comparisons with 2014 are affected by the April 30, 2014 spin-off of SLM BankCo. GAAP historical results include pre-spin-off consumer-banking operations, while management’s non-GAAP “Core Earnings” exclude those operations and certain derivative, restructuring and acquired-intangible items.
Financial Metrics
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total interest income | $1,064 million | $1,175 million | $2,161 million | $2,471 million |
| Net interest income | $549 million | $662 million | $1,132 million | $1,429 million |
| Provision for loan losses | $198 million | $165 million | $323 million | $350 million |
| Net income attributable to Navient | $182 million | $307 million | $474 million | $526 million |
| Diluted EPS | $0.47 | $0.71 | $1.20 | $1.20 |
| Core Earnings | $154 million | $241 million | $348 million | $383 million |
| Core Earnings diluted EPS | $0.40 | $0.56 | $0.88 | $0.89 |
| Operating cash flow | Not separately provided | Not separately provided | $1,055 million | $1,113 million |
GAAP net interest margin was 1.61% in the quarter and 1.65% for the six-month period, compared with 1.87% and 1.97%, respectively, in the prior-year periods. GAAP FFELP Loan net interest margin was 1.19% for the quarter, while Private Education Loan net interest margin was 3.52%. Core Earnings margins were 0.81% for FFELP Loans and 3.55% for Private Education Loans.
- June 30, 2015 assets were $140.2 billion, including $100.3 billion of net FFELP Loans and $28.1 billion of net Private Education Loans.
- Total borrowings were $133.3 billion, consisting of $3.0 billion short-term and $130.4 billion long-term borrowings. Senior unsecured debt totaled $16.2 billion.
- Cash and cash equivalents were $1.6 billion. Reported primary liquidity was $2.7 billion, comprising $1.6 billion of unrestricted cash and liquid investments and $1.0 billion of unencumbered FFELP Loans.
- Six-month financing included $2.8 billion of FFELP asset-backed securities, $689 million of Private Education Loan asset-backed securities and $500 million of unsecured debt.
- Six-month shareholder distributions included $124 million of common dividends and $600 million of common-stock repurchases. The company had $400 million remaining under its $1 billion repurchase authorization at June 30, 2015.
Material Changes Versus the Prior Comparable Period
- Q2 GAAP net income fell $125 million, or 41%, primarily from lower net interest income, higher loan-loss provisions, lower derivative gains and lower asset-recovery revenue.
- Six-month GAAP net income declined $52 million, or 10%. Net interest income fell $297 million, partly reflecting the spin-off, lower Private Education Loan balances and margins, and lower FFELP Loan margins.
- Private Education Loan interest income declined 19% in Q2 and 25% for six months as balances and margins contracted. The net Private Education Loan portfolio declined to $28.1 billion from $29.8 billion at December 31, 2014.
- Private Education Loan provision expense increased to $191 million in Q2 from $145 million. Delinquencies were 6.8% of loans in repayment, compared with 7.1% in the year-ago period, while greater-than-90-day delinquencies increased to 3.3% from 3.2%.
- Servicing revenue increased 45% in Q2 and 34% for six months, partly due to increased recovery expectations on previously assessed late fees and higher third-party servicing activity.
- Asset-recovery revenue declined 25% in Q2 and 23% for six months, primarily because the Bipartisan Budget Act reduced fees paid to guarantor agencies for rehabilitated defaulted FFELP Loans.
- Q2 restructuring expense was $29 million, primarily severance and related costs for a management-streamlining initiative expected to be substantially complete by December 31, 2015.
- Navient acquired a 97.9% controlling interest in Gila LLC for approximately $185 million in February 2015. Gila contributed to Business Services revenue and expenses, but the purchase-price allocation remained incomplete at quarter-end.
Outlook, Commentary, Risks and Unusual Items
Management expects FFELP and Private Education Loan portfolios to generate significant cash as they amortize and intends to pursue portfolio acquisitions, third-party servicing and asset-recovery opportunities. No specific consolidated earnings or revenue guidance is provided in the filing.
- The company expects to fund obligations through cash, operating cash flow, loan repayments, securitization-trust distributions, additional unsecured debt and secured facilities. Approximately $1.6 billion of senior unsecured notes mature within the next twelve months.
- Private Education Loan charge-off treatment changed from 73% to 79% of defaulted balances. The change reduced the partially charged-off receivable by $330 million without affecting provision expense because the amount had previously been reserved.
- Derivative accounting produced a $83 million Q2 gain and a $249 million six-month gain that was excluded from Core Earnings. These amounts remain subject to substantial interest-rate and foreign-exchange volatility.
- Three rating agencies rated Navient’s long-term unsecured debt below investment grade. A downgrade could increase funding costs, reduce market access or increase collateral requirements.
- Regulatory investigations and inquiries remain outstanding involving state attorneys general, the Consumer Financial Protection Bureau and the New York Department of Financial Services. The filing states that potential exposure cannot currently be estimated and no additional reserves have been established for these matters.
- Previously established regulatory reserves totaled $177 million; substantially all related amounts had been paid, credited or refunded by June 30, 2015, although final costs remained uncertain.
- Pioneer Credit Recovery’s ED asset-recovery contract expired February 21, 2015, and no new placements were received. Related litigation was dismissed and appealed; the company submitted a response to a new ED request for proposals, with no assurance of an award or future volume.
- Navient remains exposed to litigation, regulatory examinations, changes in student-loan law, government-contract risk, cybersecurity and operational failures, customer credit performance, prepayment speeds, interest-rate mismatches and derivative-counterparty risk.
Important Facts for Investors to Verify
- Reconcile GAAP earnings with Core Earnings and assess the recurring impact of derivative marks, spin-off adjustments and restructuring costs.
- Monitor Private Education Loan delinquencies, charge-offs, recoveries, troubled-debt restructurings and the adequacy of the $1.5 billion allowance.
- Assess refinancing capacity for the $1.6 billion of unsecured debt maturing within twelve months and the effect of below-investment-grade ratings on funding costs.
- Track the outcome of CFPB, state, NYDFS and ED matters, including the OIG Special Allowance Payment audit and related indemnification obligations.
- Verify whether Gila integration and the ED servicing and asset-recovery contracts generate the expected revenue and cash flow.
- Evaluate the sustainability of dividends and share repurchases relative to liquidity, debt amortization and collateral requirements.