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NAVIENT CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 1, 2014

The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Registration Statement on Form 10, as amended (our "Form 10"), filed with the Securities and Exchange Commission (the "SEC") on April 10, 2014, and declared effective on April 14, 2014. This Quarterly Report on Form 10-Q contains "forward-looking" statements and information based on management's current expectations as of the date of this document. Statements that are not historical facts, including statements about our beliefs, opinions, or expectations and statements that assume or are dependent upon future events, are forward-looking statements. Forward-looking statements are subject to risks, uncertainties, assumptions and other factors that may cause actual results to be materially different from those reflected in such forward-looking statements. These factors include, among others, the risks and uncertainties set forth in Item 1A "Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q, our Form 10 and our subsequent filings with the SEC; increases in financing costs; limits on liquidity; increases in costs associated with compliance with laws and regulations; changes in accounting standards and the impact of related changes in significant accounting estimates; any adverse outcomes in any significant litigation to which we are a party; credit risk associated with our exposure to third parties, including counterparties to our derivative transactions; and changes in the terms of student loans and the educational credit marketplace (including changes resulting from new laws and the implementation of existing laws). We could also be affected by, among other things: changes in our funding costs and availability; reductions to our credit ratings or the credit ratings of the United States of America; failures of our operating systems or infrastructure, including those of third-party vendors; damage to our reputation; failures to successfully implement cost-cutting initiatives and adverse effects of such initiatives on our business; risks associated with the recently completed separation of Navient and SLM Corporation into two, distinct publicly traded companies, including failure to achieve the expected benefits of the separation; changes in the demand for educational financing or in financing preferences of lenders, educational institutions, students and their families; changes in law and regulations with respect to the student lending business and financial institutions generally; increased competition from banks and other consumer lenders; the creditworthiness of our customers; changes in the general interest rate environment, including the rate relationships among relevant money-market instruments and those of our earning assets versus our funding arrangements; changes in general economic conditions; our ability to successfully effectuate any acquisitions and other strategic initiatives; and changes in the demand for debt management services. The preparation of our consolidated financial statements also requires management to make certain estimates and assumptions including estimates and assumptions about future events. These estimates or assumptions may prove to be incorrect. All forward-looking statements contained in this report are qualified by these cautionary statements and are made only as of the date of this document. We do not undertake any obligation to update or revise these forward-looking statements to conform the statement to actual results or changes in our expectations.



Definitions for certain capitalized terms used but not otherwise defined in this Quarterly Report on Form 10-Q can be found in our Form 10.

Through this discussion and analysis, we intend to provide the reader with some narrative context for how our management views our consolidated financial statements, additional context within which to assess our operating results, and information on the quality and variability of our earnings, liquidity and cash flows.



Presentation of Information

Unless the context otherwise requires, references in this Management's Discussion and Analysis of Financial Condition and Results of Operations to:

"We," "our," "us," or the "Company" with respect to any period on or prior

to the date of the Spin-Off means and refers to Old SLM and its

consolidated subsidiaries as constituted prior to the Spin-Off, and any

references to "Navient," "we," "our," "us," or the "Company" with respect

to any period after the date of the Spin-Off means and refers to Navient

and its consolidated subsidiaries. 43



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"Old SLM" refers to SLM Corporation, as it existed prior to the Spin-Off,

and its consolidated subsidiaries. As part of an internal corporate

reorganization of Old SLM, Old SLM was merged into a limited liability

company and became a subsidiary of Navient, changing its name to "Navient,

LLC."



Navient's historical business and operations refer to Old SLM's portfolio

of FFELP and Private Education Loans not held by Sallie Mae Bank, together

with the servicing and asset recovery businesses that were retained by or transferred to Navient in connection with the internal corporate reorganization.



"SLM BankCo" refers to New BLC Corporation, which became the publicly

traded successor to Old SLM on April 29, 2014 by virtue of a merger pursuant to Section 251(g) of the Delaware General Corporation Law ("DGCL"), and its consolidated subsidiaries. Following consummation of the



merger, New BLC Corporation changed its name to SLM Corporation. After the

Spin-Off, SLM BankCo's business consists primarily of the consumer banking

business previously operated by Old SLM, which includes Sallie Mae Bank and

its portfolio of Private Education Loans, a new Private Education Loan servicing business and the Upromise Rewards business.



"Spin-Off" collectively refers to the internal reorganization of Old SLM on

April 29, 2014 and the distribution of all of the shares of common stock of

Navient to the holders of shares of SLM BankCo on April 30, 2014.

Spin-Off of Navient

On April 30, 2014, the previously announced separation of Navient from SLM BankCo was completed. The separation was effected through the distribution by SLM BankCo, on a one-to-one basis, of all the shares of common stock of Navient to the holders of shares of SLM Bank Co common stock, as of the close of business on April 22, 2014, the record date for the distribution. As a result of the distribution, Navient is an independent, publicly traded company that operates the education loan management, servicing and asset recovery business previously operated by Old SLM. Navient is comprised primarily of Old SLM's portfolios of education loans that were not held in Sallie Mae Bank at the time of the separation, as well as servicing and asset recovery activities on those loans and loans held by third parties. The consumer banking business, SLM BankCo, is comprised primarily of Sallie Mae Bank and its Private Education Loan origination business, the Private Education Loans it holds and a related servicing business. To implement the separation and distribution of Navient, an internal corporate reorganization of Old SLM was effected, pursuant to which, on April 29, 2014, SLM BankCo replaced Old SLM as the parent holding company pursuant to a holding company merger. In accordance with Section 251(g) of the DGCL, by action of the Old SLM board of directors and without a shareholder vote, Old SLM was merged into Navient, LLC, a wholly owned subsidiary of Old SLM, with Navient, LLC surviving. Immediately following the effective time of the merger, SLM BankCo changed its name to "SLM Corporation." As part of the internal corporate reorganization and pursuant to the merger, all of the outstanding shares of Old SLM Series A preferred stock and Series B preferred stock were converted, on a one-to-one basis, into substantially identical shares of SLM BankCo preferred stock. Following the merger, the assets and liabilities associated with the education loan management, servicing and asset recovery business were transferred to Navient, and those assets and liabilities associated with the consumer banking were transferred to SLM BankCo. The Spin-Off is intended to be tax-free and on July 9, 2014, Navient received a private letter ruling from the Internal Revenue Service confirming the tax-free status of the Spin-Off and the related internal reorganization transactions. For further information on the Spin-Off and all related matters, please refer to our Form 10. Due to the relative significance of Navient to Old SLM, among other factors, for financial reporting purposes Navient is treated as the "accounting spinnor" and therefore is the "accounting successor" to Old SLM, notwithstanding the legal form of the Spin-Off. As a result, the historical financial statements of Old SLM prior to the distribution on April 30, 2014 are the historical financial statements of Navient. For that reason the historical financial information related to periods on or prior to April 30, 2014 contained in this Quarterly Report on Form 10-Q is that of Old SLM, which includes the consolidated results of both the loan management, servicing and asset recovery business (Navient) and the consumer banking business (SLM BankCo). Since 44



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Navient is the "accounting spinnor," the GAAP financial statements of Navient reflect the deemed distribution of SLM BankCo to SLM BankCo's stockholders on April 30, 2014, notwithstanding the legal form of the Spin-Off in which Navient common stock was distributed to the stockholders of SLM BankCo. The following table shows the condensed balance sheet of SLM BankCo that the financial statements of Navient reflect as a shareholder distribution on April 30, 2014: (Dollars in millions) April 30, 2014 Assets FFELP Loans, net $ 1,380 Private Education Loans, net 7,204 Investments 139 Cash and cash equivalents 2,170 Other assets 883 Total assets $ 11,776 Liabilities Short-term borrowings $ 6,491 Long-term borrowings 2,750 Other liabilities 825 Total liabilities 10,066 Equity Preferred stock Series A 165 Series B 400 Common equity 1,145 Total equity(1) 1,710 Total liabilities and equity $ 11,776 (1) In addition to the $1,710 million of consumer banking business net assets distributed, we also removed $41 million of goodwill from our balance



sheet as required under ASC 350 in connection with the distribution. This

goodwill was allocated to the consumer banking business based on relative

fair value. This total of $1,751 million is the amount that appears on

our consolidated statement of changes in stockholders' equity in

connection with the deemed distribution of the consumer banking business.

Navient's Business



Navient is a loan management, servicing and asset recovery company.

Navient holds the largest portfolio of education loans insured or guaranteed under the FFELP, as well as the largest portfolio of Private Education Loans. FFELP Loans are insured or guaranteed by state or not-for-profit agencies and are also protected by contractual rights to recovery from the United States pursuant to guaranty agreements among ED and these agencies. Private Education Loans are education loans to students or their families that are non-federal loans and not insured or guaranteed under FFELP. Private Education Loans bear the full credit risk of the customer and any cosigner and are made primarily to bridge the gap between the cost of higher education and the amount funded through financial aid, federal loans or students' and families' resources. As of June 30, 2014 approximately 86 percent of the FFELP Loans and 59 percent of the Private Education Loans held by Navient were funded to term with non-recourse, long-term securitization debt through the use of securitization trusts. Navient services its own portfolio of education loans, as well as those owned by banks, credit unions, non-profit education lenders and ED. Navient is one of four large servicers to ED under its Direct Student Loan Program ("DSLP"). It provides asset recovery services on its own portfolio (consisting of both education loans as well as other asset classes), and for guaranty agencies (which serve as intermediaries between the U.S. federal 45



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government and FFELP lenders and are responsible for paying claims on defaulted FFELP Loans), ED and other clients.

As of June 30, 2014, Navient's principal assets consisted of:

$99.7 billion in FFELP Loans, with a student loan spread of 0.98 percent

for the quarter ended June 30, 2014 on a "Core Earnings" basis and a weighted average life of 7.6 years;



$30.3 billion in Private Education Loans, with a student loan spread of

4.10 percent for the quarter ended June 30, 2014 on a "Core Earnings" basis

and a weighted average life of 7.0 years;



a leading student loan servicing platform that services loans for more than

12 million FFELP Loan, DSLP loan and Private Education Loan customers

(including cosigners), including 5.8 million customer accounts serviced

under Navient's contract with ED; and



a leading student loan asset recovery platform with an outstanding

inventory of contingent asset recovery receivables of approximately $16.3 billion, of which approximately $13.5 billion was student loans and the remainder was other debt.



Navient's Strengths and Opportunities

Navient possesses a number of competitive advantages that distinguishes it from its competitors, including:

Large, high quality asset base with predictable cash flows. At June 30, 2014, Navient's$130 billion student loan portfolio is 80 percent funded to term and is expected to produce consistent and predictable cash flows over the remaining life of the portfolio. Navient's$100 billion portfolio of FFELP Loans bears a maximum three-percent loss exposure due to the federal guarantee. Navient's$30 billion portfolio of Private Education Loans bears the full credit risk of the borrower and cosigner. Navient expects that cash flows from its FFELP Loan and Private Education Loan portfolios will significantly exceed future debt service obligations. Efficient and large scale servicing platform. Navient is the largest servicer of education loans, servicing more than 12 million customers with over $300 billion of loans. Navient has demonstrated scalable infrastructure with capacity to add volume at a low cost. Navient's premier market share and tested servicing and asset recovery infrastructure make it well-positioned to expand its servicing and asset recovery businesses to additional third-party FFELP, federal, Private Education and other loan portfolios. Superior operating performance. Navient has demonstrated superior default prevention performance and industry leading asset recovery services. Navient ranks first in cumulative default prevention performance according to an analysis of ED's servicing contract results statistics since the start of the contract in 2009. Federal loan customers with loans serviced by Navient default at a rate 30 percent lower than the national average. Navient prides itself on a robust compliance culture driven by a "customer first" approach.



Strong capital return. As a result of the significant cash flow and capital generation, Navient expects to return excess capital to stockholders through dividends and share repurchases.

Meaningful growth opportunities. Navient will pursue opportunistic acquisitions of FFELP and Private Education Loan portfolios as well as additional ED and third-party servicing and asset recovery fee income opportunities. Navient will leverage its large-scale servicing platform, superior default prevention and asset recovery performance, operating efficiency and regulatory compliance and risk management infrastructure in pursuing these and other growth opportunities.



Navient's Approach to Assisting Students and Families in Repaying their Education Loans

Navient has a leading student loan servicing platform that services loans for more than 12 million FFELP Loan, DSLP loan and Private Education Loan customers (including cosigners), including 5.8 million customer accounts serviced under Navient's contract with ED. Employee emphasis is placed on providing service with 46



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accuracy, courtesy, consistency and empathy. If we fall short, we make it a priority to correct our mistake, and we make it a priority to prevent it from happening again.

We understand managing repayment of education loans is critical for students to achieve their educational goals, recognize their full earning potential and develop a strong credit profile. A key indicator of future success in loan repayment is graduation. Navient encourages customers to plan for the full cost of their education to increase their likelihood of completing their course of study because we know that those who drop out or do not complete their course of study are more likely to default on their education loans. When it comes to repaying education loans, customer success means making steady progress toward repayment, instead of falling behind on payments. Our experience has taught us that the transition from school to full repayment requires making and carrying out a financial plan. For many, this is their first borrowing experience. For new graduates, salaries grow over time, typically making payments easier to handle as their career progresses. It is also not uncommon for some to return to school, experience illness or encounter temporary interruptions in earnings. To help customers manage these realities, Navient makes customer success and default prevention top priorities. Contact and counseling keep customers on track, and we believe we go beyond what is required in our efforts to assist customers with past-due student loan payments. That outreach pays off: approximately 90 percent of federal loan customers we reach successfully utilize the options available to them to resolve their delinquency. As a result of our outreach, the federal education loans Navient services default at rates 30 percent better than the national average.



Selected Historical Financial Information and Ratios

Although SLM BankCo is the entity that distributed the shares of Navient common stock to SLM BankCo common stockholders, for financial reporting purposes, Navient is treated as the "accounting spinnor" and therefore Navient, and not SLM BankCo, is the "accounting successor" to Old SLM. Hence, the following GAAP financial information to the extent related to periods on or prior to April 30, 2014 reflects the historical results of operations and financial condition of Old SLM, which is the accounting predecessor of Navient. For a discussion of how "Core Earnings" results are different than GAAP results, see "'Core Earnings' - Definitions and Limitations" and "Differences between 'Core Earnings' and GAAP." 47



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Table of Contents Three Months Ended Six Months Ended June 30, June 30, (In millions, except per share data) 2014 2013 2014 2013 GAAP Basis Net income attributable to Navient Corporation $ 307$ 543$ 526$ 889 Diluted earnings per common share attributable to Navient Corporation $ .71$ 1.20$ 1.20$ 1.94 Weighted average shares used to compute diluted earnings per common share 430 448 432 453 Return on assets .87 % 1.35 % .72 % 1.08 % Ending FFELP Loans, net $ 99,730$ 108,491$ 99,730$ 108,491 Ending Private Education Loans, net 30,324 37,116



30,324 37,116

Ending total student loans, net $ 130,054$ 145,607



$ 130,054$ 145,607

Average FFELP Loans $ 100,926$ 113,981$ 102,322$ 117,896 Average Private Education Loans 33,811 38,154 36,364 38,279 Average total student loans $ 134,737$ 152,135$ 138,686$ 156,175 "Core Earnings" Basis(1) Net income attributable to Navient Corporation $ 241$ 447$ 383$ 709 Diluted earnings per common share attributable to Navient Corporation $ .56$ 1.00$ .89$ 1.56 Weighted average shares used to compute diluted earnings per common share 430 448 432 453 Return on assets .70 % 1.17 % .56 % .91 % Ending FFELP Loans, net $ 99,730$ 107,331$ 99,730$ 107,331 Ending Private Education Loans, net 30,324 31,781



30,324 31,781

Ending total student loans, net $ 130,054$ 139,112



$ 130,054$ 139,112

Average FFELP Loans $ 100,467$ 112,891$ 101,393$ 116,831 Average Private Education Loans 31,408 32,619 31,467 32,411 Average total student loans $ 131,875$ 145,510$ 132,860$ 149,242 (1) "Core Earnings" are non-GAAP financial measures and do not represent a comprehensive basis of accounting. For a greater explanation of "Core Earnings," see the section titled "'Core Earnings' - Definition and Limitations" and subsequent sections.



Overview

Navient is a loan management, servicing and asset recovery company. Navient holds the largest portfolio of student loans issued or guaranteed under the FFELP. Navient is also the largest holder of Private Education Loans. Navient services and performs asset recovery services on these loans for its own accounts, for guaranty agencies, and for loans owned by ED, financial institutions, banks, credit unions and non-profit education lenders.

The following discussion and analysis presents a review of our business and operations as of and for the quarter and six months ended June 30, 2014.

We monitor and assess our ongoing operations and results based on the following four reportable segments: (1) FFELP Loans (2) Private Education Loans, (3) Business Services and (4) Other. Our segment presentation excludes the results of the consumer banking business distributed on April 30, 2014. See "'Core Earnings' - Definition and Limitations" for further discussion.

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FFELP Loans Segment

In the FFELP Loans segment, we acquire and finance FFELP Loans. Even though FFELP Loans are no longer originated, we continue to seek to acquire FFELP Loan portfolios to leverage our servicing scale to generate incremental earnings and cash flow. In this segment, we primarily earn net interest income on the FFELP Loan portfolio. This segment is expected to generate significant amounts of cash as the portfolio amortizes.



Private Education Loans Segment

In this segment, we acquire, finance and service Private Education Loans. Even though we no longer originate Private Education Loans, we continue to seek to acquire Private Education Loan portfolios to leverage our servicing scale to generate incremental earnings and cash flow. In this segment, we primarily earn net interest income on the Private Education Loan portfolio (after provision for loan losses). This segment is expected to generate significant amounts of cash as the portfolio amortizes. Business Services Segment Our Business Services segment generates its revenue from servicing our FFELP Loan portfolio as well as providing servicing and asset recovery services for loans on behalf of Guarantors of FFELP Loans and other institutions, including ED. Other



Our Other segment primarily consists of activities of our holding company, including the repurchase of debt, the corporate liquidity portfolio and all overhead. We also include results from certain smaller wind-down and discontinued operations within this segment.

Key Financial Measures

Our operating results are primarily driven by net interest income from our student loan portfolios (which include financing costs), provision for loan losses, the revenues and expenses generated by our service businesses, and gains and losses on subsidiary sales, loan sales and debt repurchases. We manage and assess the performance of each business segment separately as each is focused on different customers and each derives its revenue from different activities and services. A brief summary of our key financial measures (net interest income; provisions for loan losses; charge-offs and delinquencies; servicing and asset recovery revenues; other income (loss); and operating expenses) can be found in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Form 10.



Second-Quarter 2014 Summary of Results

We report financial results on a GAAP basis and also present certain "Core Earnings" performance measures. Our management, board of directors, credit rating agencies, lenders and investors use these "Core Earnings" measures to monitor our business performance. See "'Core Earnings' - Definition and Limitations" for a further discussion and a complete reconciliation between GAAP net income and "Core Earnings." Second-quarter 2014 GAAP net income was $307 million ($0.71 diluted earnings per share), versus net income of $543 million ($1.20 diluted earnings per share) in the second-quarter 2013. The changes in GAAP net income are impacted by the same "Core Earnings" items discussed below, as well as changes in net income attributable to (1) the financial results attributable to the operations of the consumer banking business prior to the Spin-Off on April 30, 2014 and related restructuring and reorganization expense incurred in connection with the Spin-Off, (2) unrealized, mark-to-market gains/losses on derivatives and (3) goodwill and acquired intangible asset amortization and impairment. These items are recognized in GAAP but have not been included in "Core Earnings" results. Second-quarter 2014 GAAP results included gains of $150 million from derivative accounting treatment that are excluded from "Core Earnings" results, compared with gains of $143 million in the year-ago 49



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period. See "Differences between 'Core Earnings' and GAAP" for a complete reconciliation between GAAP net income and "Core Earnings."

"Core Earnings" for the second-quarter 2014 were $241 million ($0.56 diluted earnings per share), compared with $447 million ($1.00 diluted earnings per share) for the year-ago quarter.

Last year, management undertook a series of actions to improve shareholder value, including the sale of residual interests in several FFELP securitization trusts, the divestiture of two subsidiaries, debt repurchases, and the strategic separation of Navient from Old SLM, which was completed on April 30, 2014. Adjusting for these transactions, second quarter 2014 "Core Earnings" increased $0.04 per share compared to the year-ago quarter, primarily due to increased servicing and asset recovery revenue and lower provisions for loan losses. The table below summarizes the impact of these items on "Core Earnings":



Impact of items related to improving shareholder value

Three Months Three Months Increase Ended Ended (Decrease) in (Dollars in millions) June 30, 2014 June 30, 2013 "Core Earnings" Gains from sales of residual interests in FFELP securitization trusts $ - $ 257 $ (257 ) Gains from sales of subsidiaries, net of tax - 38 (38 ) Debt repurchase gains - 19 (19 ) Other items Three Months Three Months Increase Ended Ended (Decrease) in (Dollars in millions) June 30, 2014 June 30, 2013 "Core Earnings" Servicing, asset recovery and other revenue $ 214 $ 178 $ 36 Provisions for loan losses 155 202 47 Operating expenses 195 185 (10 ) Net interest income before provisions for loan losses 522 576 (54 )



In addition, during the first six months of 2014, we:

issued $2.7 billion of FFELP asset-backed securities ("ABS"), $676 million

of Private Education Loan ABS and $850 million of unsecured bonds; closed on a new $8 billion FFELP Loan asset-backed commercial paper



("ABCP") facility that matures in January 2016. This facility replaced an

existing $5.5 million FFELP ABCP facility which was retired in January

2014;



closed a $1.0 billion Private Education Loan ABS commercial paper facility.

The facility, which matures in June 2015, will be available for Private

Education Loan refinancing and acquisitions;



repurchased 12.2 million common shares for $265 million on the open market

(8.3 million common shares for $200 million pre-Spin-Off, and 3.9 million

common shares for $65 million post-Spin-Off); and



authorized $400 million in May 2014 to be utilized in a new common share

repurchase program. Results of Operations We present the results of operations below first on a consolidated basis in accordance with GAAP. Following our discussion of consolidated earnings results on a GAAP basis, we present our results on a segment basis. We have four business segments: FFELP Loans, Private Education Loans, Business Services and Other. Since these segments operate in distinct business environments and we manage and evaluate the financial performance of these segments using non-GAAP financial measures, these segments are presented on a "Core Earnings" basis (see "'Core Earnings' - Definition and Limitations"). 50



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