NAVIENT CORP quarterly report, Q2 FY2016

Navient Corporation 2016 Q2 Form 10-Q Summary

Business context and reporting period

Navient is a loan management, servicing and asset recovery company. Its principal businesses are FFELP Loans, Private Education Loans, Business Services and corporate/other activities. The company services more than $300 billion of education loans for more than 12 million customers and provides asset recovery and business-processing services to public- and private-sector clients.

This unaudited Form 10-Q covers the three and six months ended June 30, 2016, with comparisons to the corresponding 2015 periods. The company no longer originates FFELP or Private Education Loans but continues to acquire portfolios and expects its loan portfolios to generate cash as they amortize.

Financial performance and key metrics

Metric	Q2 2016	Q2 2015	Six months 2016	Six months 2015
Total interest income	$1,028 million	$1,064 million	$2,080 million	$2,161 million
Net interest income	$429 million	$549 million	$915 million	$1,132 million
Provision for loan losses	$110 million	$198 million	$221 million	$323 million
Net interest income after provisions	$319 million	$351 million	$694 million	$809 million
Total other income	$123 million	$201 million	$283 million	$450 million
Net income attributable to Navient	$125 million	$182 million	$305 million	$474 million
Diluted EPS	$0.38	$0.47	$0.91	$1.20
Core Earnings net income	$154 million	$154 million	$301 million	$348 million
Core Earnings diluted EPS	$0.47	$0.40	$0.90	$0.88

GAAP net income declined 31% year over year in the quarter and 36% for the first six months. Core Earnings were flat in the quarter but declined 13% year to date. GAAP results included a $32 million negative derivative-accounting adjustment in Q2 2016, versus an $83 million positive adjustment in Q2 2015. Core Earnings exclude certain derivative mark-to-market effects, Spin-Off-related items and goodwill and acquired-intangible amortization or impairment.

Q2 servicing revenue was $71 million, down 33% year over year; asset recovery and business-processing revenue was $101 million, up 2%.
Operating expenses were $230 million in Q2 and $478 million for the first six months, compared with $225 million and $456 million, respectively, in the prior-year periods.
Q2 GAAP net interest margin was 1.38%, compared with 1.61%; the six-month margin was 1.46%, compared with 1.65%.
Core Earnings net interest margin was 0.85% for FFELP Loans and 3.50% for Private Education Loans in Q2, compared with 0.81% and 3.55%, respectively, in Q2 2015.
Return on assets was 0.40% for Q2 and 0.49% for the first six months on a GAAP basis.

Balance sheet, credit quality, debt and liquidity

Total assets were $128.4 billion at June 30, 2016, down from $134.1 billion at December 31, 2015.
Net FFELP Loans were $92.6 billion, down from $96.5 billion at year-end. Net Private Education Loans were $24.7 billion, down from $26.4 billion.
Total education loans, net, were $117.4 billion versus $122.9 billion at year-end and $128.4 billion at June 30, 2015.
Total borrowings were $122.0 billion, including $119.6 billion of long-term borrowings. Senior unsecured debt was $13.9 billion, down from $15.1 billion at year-end.
Cash and cash equivalents were $1.4 billion, compared with $1.6 billion at December 31, 2015. Unrestricted cash and liquid investments plus unencumbered FFELP Loans provided $2.3 billion of primary liquidity.
Maximum additional capacity under FFELP Loan other facilities was $2.9 billion at June 30, 2016, down from $11.5 billion a year earlier. The Private Education Loan ABCP facility had $388 million of available capacity after its maximum size was reduced to $750 million and maturity extended to June 2017.
FFELP Loans were 86.8% current among loans in repayment; total delinquencies were 13.2%, down from 15.3% at December 31, 2015. FFELP Loans are substantially federally insured or guaranteed, subject to a maximum loss exposure described by management as 3%.
Private Education Loans were 93.9% current among loans in repayment; total delinquencies were 6.1%, down from 6.5% at year-end and 6.8% at June 30, 2015. Greater-than-90-day delinquencies were 2.9%, compared with 3.3% a year earlier.
The allowance for loan losses was $1.5 billion at June 30, 2016, including $1.4 billion for Private Education Loans. Private Education Loan charge-offs were $127 million in Q2 and $271 million year to date.
Stockholders’ equity was $3.7 billion, down from $4.0 billion at year-end, reflecting share repurchases, dividends and accumulated other comprehensive losses.

Cash flow, financing and capital allocation

Operating cash flow was $771 million for the six months ended June 30, 2016, compared with $1.1 billion in 2015.
Investing activities provided $5.4 billion, primarily from loan repayments, partially offset by $2.2 billion of education-loan acquisitions.
Financing activities used $6.4 billion, including $6.6 billion of repayments of borrowings collateralized by loans in trust, $2.0 billion of net ABCP repayment, $375 million of share repurchases and $105 million of dividends.
Cash and cash equivalents declined $217 million during the first six months.
Navient issued $2.9 billion of FFELP asset-backed securities and $488 million of Private Education Loan ABS, retired or repurchased $1.2 billion of senior unsecured debt, and completed a $478 million Private Education Loan ABS repurchase facility.
The company paid quarterly dividends of $0.16 per share and repurchased 32.8 million shares for $375 million during the first six months. Remaining repurchase authorization was $380 million at June 30, 2016.

Material changes versus the prior comparable period

Net interest income fell $120 million in Q2 and $217 million year to date, driven by smaller loan balances and higher funding costs. Average total education loans declined to $119.6 billion from $130.5 billion in Q2 2015.
Interest expense increased 16% in Q2 and 13% year to date despite lower average borrowings, reflecting higher funding rates and costs.
Loan-loss provisions decreased $88 million in Q2 and $102 million year to date, primarily because of improved Private Education Loan delinquency, charge-off and expected-loss trends.
Servicing revenue declined largely because the prior-year period included a benefit from increased recovery expectations for previously assessed servicing fees.
Asset recovery and business-processing revenue benefited from the Gila LLC and Xtend Healthcare acquisitions, but was partly offset by lower education-loan recovery volumes and legislative reductions in certain fees.
Q2 and year-to-date results had no restructuring expense, compared with $29 million and $32 million, respectively, in the prior-year periods.
Common shares outstanding declined materially because of ongoing repurchases; average diluted shares fell by 59 million in Q2 and 61 million year to date.
In 2015, Navient changed the portion of Private Education Loans charged off at default from 73% to 79%, reducing the receivable for partially charged-off loans by $330 million. This unusual item affected the 2015 comparison but did not represent a 2016 provision.

Outlook, management commentary and risks

The filing does not provide a formal full-year earnings or revenue guidance range. Management expects the FFELP and Private Education Loan portfolios to produce significant cash flow as they amortize and intends to pursue opportunistic loan acquisitions, third-party servicing, asset recovery and business-processing contracts. Management also expects to return excess capital through dividends and share repurchases, subject to liquidity and market conditions.

Navient expects to fund the next twelve months’ needs, including approximately $1.1 billion of senior unsecured debt maturities, with cash, investments, unencumbered FFELP Loans, operating cash flow, loan principal repayments, securitization-trust distributions and available secured facilities. However, three rating agencies rate its long-term unsecured debt below investment grade, and recent market conditions have adversely affected the cost and availability of unsecured and FFELP ABS financing.

Moody’s and Fitch had placed $56.2 billion and $50.5 billion, respectively, of non-recourse FFELP ABS sponsored by affiliates on credit watch because of concerns that trust cash flows may not repay all bonds by legal final maturity.
Navient extended legal final maturities for $3.6 billion of FFELP securitization bonds during Q2 and $6.8 billion in total.
Navient was one of three companies selected in July 2016 to proceed in the second stage of the Department of Education’s Direct Student Loan Program servicing-platform RFP. The scope, economics, timing and outcome were not yet known.
The Pioneer Credit Recovery contract with ED expired in February 2015. Litigation regarding the related procurement was remanded for further proceedings, but there was no assurance of a new or renewed contract.
Ongoing CFPB, state attorney general and New York Department of Financial Services investigations could result in restitution, penalties or corrective action. The company stated that potential exposure could not be estimated and that no additional reserves had been established for these matters.
Pending lawsuits include borrower class actions and securities class actions consolidated in Delaware. The filing states that potential loss ranges could not be estimated.
Key operating risks include funding availability and cost, interest-rate and basis risk, derivative volatility, credit losses on Private Education Loans, regulatory and legislative changes, cybersecurity and systems failures, customer-service and reputational risk, and dependence on government contracts and payments.
Management stated that, based on current knowledge, pending litigation and regulatory matters were not expected to have a material adverse effect on consolidated financial position, liquidity, results of operations or cash flows, but outcomes remain uncertain.

Most important facts for investors to verify

Whether loan-loss improvements, particularly in Private Education Loans, persist as the portfolio seasons and amortizes.
The sustainability of liquidity given below-investment-grade unsecured ratings, lower secured-facility availability and upcoming debt maturities.
The effect of FFELP ABS credit-watch actions and additional legal-maturity extensions on refinancing costs and access to capital markets.
The outcome and economics of the Department of Education servicing-platform RFP and the status of Pioneer’s government-contract litigation.
Potential financial exposure from CFPB, state and NYDFS investigations, the OIG Special Allowance Payment audit, and borrower and securities litigation.
The extent to which reported earnings are affected by volatile derivative mark-to-market adjustments and the comparability limitations of non-GAAP Core Earnings.
Whether share repurchases and dividends remain appropriate in light of declining equity, cash balances and available liquidity.
The effect of future interest-rate, funding-index and foreign-exchange movements on net interest margin, earnings and collateral requirements.