Business Context and Reporting Period
Nelnet, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2019, compared with the same periods in 2018. The company operates student-loan servicing and systems, education technology and payment processing, communications, and asset-generation and management businesses. Its lending portfolio is primarily federally insured student loans.
Financial Results and Key Metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Total interest income | $238.9 million | $239.9 million | $736.3 million | $672.0 million |
| Total other income | $219.1 million | $216.6 million | $607.4 million | $671.7 million |
| Total interest income plus other income | $458.1 million | $456.5 million | $1.3437 billion | $1.3437 billion |
| Net interest income | $66.5 million | $59.8 million | $185.1 million | $184.8 million |
| Net income attributable to Nelnet | $33.2 million | $42.9 million | $99.4 million | $206.3 million |
| Basic and diluted EPS | $0.83 | $1.05 | $2.48 | $5.04 |
| Operating cash flow | Not separately provided | Not separately provided | $142.9 million | $193.6 million |
Q3 income before taxes was $42.0 million versus $57.0 million, and the effective tax rate was 21.0% versus 24.4%. Management expects a 2019 effective tax rate of approximately 20% to 22%.
Net interest income after loan-loss provision was $56.5 million in Q3 and $159.1 million for the first nine months. The loan-loss provision was $10.0 million in Q3 and $26.0 million year to date, compared with $10.5 million and $18.0 million, respectively, in the prior-year periods.
Reported loan servicing and systems revenue increased to $113.3 million in Q3 and $342.2 million year to date. Education technology, services, and payment processing revenue increased to $74.3 million and $213.8 million. Communications revenue increased to $16.5 million and $46.8 million.
As of September 30, 2019, total assets were $23.94 billion, loans receivable were $21.07 billion, bonds and notes payable were $20.91 billion, cash and cash equivalents were $161.0 million, and total equity was $2.35 billion. The allowance for loan losses was $66.4 million.
The reported Q3 core loan spread was 1.17%, compared with 1.30% in Q3 2018; the reported loan spread was 1.04%, compared with 0.90%. Education technology before-tax operating margin was 34.4%, compared with 25.4%; loan servicing and systems margin was 15.9%, compared with 10.4%.
Material Changes Versus Prior Comparable Period
- Net income attributable to Nelnet declined 23% in Q3 and 52% for the first nine months. The year-to-date decline was driven principally by derivative market value losses, debt-extinguishment costs, lower derivative settlements, and higher consumer-loan loss provisions.
- Derivative market value adjustments were a $5.6 million expense in Q3 and a $73.3 million expense for the first nine months, compared with expenses of $5.2 million and income of $49.9 million in the prior-year periods. Excluding these adjustments, management-reported net income was $37.5 million in Q3 and $155.1 million year to date, versus $46.9 million and $168.4 million.
- The company recognized $14.0 million of Q3 expense and $15.8 million year-to-date expense from early extinguishment of asset-backed notes.
- Consumer-loan purchases increased to $298.1 million year to date from $80.4 million, contributing to consumer-loan provisions of $20.0 million versus $6.0 million.
- The loan portfolio declined to $21.1 billion from $22.5 billion at December 31, 2018, while debt declined from $22.2 billion to $20.9 billion.
- Loan servicing and systems benefited from Great Lakes integration efficiencies, while education technology benefited from the Tuition Management Systems acquisition and operating leverage. Communications revenue grew, but ALLO remained loss-making.
Cash Flow, Debt, Liquidity, Outlook, and Risks
- Operating cash flow was $142.9 million for the first nine months, down from $193.6 million. Investing activities provided $1.19 billion, primarily reflecting loan repayments net of purchases; financing activities used $1.39 billion.
- The company had $382.5 million available under an unsecured line of credit and $17.0 million available under a secured line of credit. FFELP warehouse facilities had $260.6 million available, and the consumer-loan warehouse had $56.0 million available at September 30.
- During the second and third quarters, the company extinguished $768.5 million of notes, released approximately $1.15 billion of previously encumbered loans and accrued interest, and generated $369.0 million of net cash proceeds through refinancing. One FFELP warehouse facility's liquidity provisions were scheduled to expire November 20, 2019.
- Management expects ALLO to remain dilutive while it expands its fiber network; fourth-quarter 2019 ALLO network capital expenditures were estimated at approximately $13.0 million. ALLO reported a $16.9 million year-to-date net loss but positive year-to-date EBITDA of $3.7 million.
- The Department of Education extended Nelnet and Great Lakes servicing contracts to December 15, 2019. Nelnet's servicing Authority to Operate expired December 13, 2019 and was under review. The outcome and timing of the Department's NextGen procurement process were uncertain.
- Management forecast approximately $1.88 billion of future undiscounted cash flows from loans in asset-backed securitizations, but the estimate is sensitive to prepayments, defaults, interest rates, and LIBOR-based funding spreads.
- LIBOR discontinuation after 2021 could materially affect funding costs, net interest income, derivative values, asset values, and cash flows because substantial loan assets, debt, and derivatives were LIBOR-indexed.
- The company adopted ASC 842 leases on January 1, 2019, recognizing $33.7 million of lease liabilities and $32.8 million of right-of-use assets. It expects adoption of the current expected credit loss standard on January 1, 2020 to increase the loan-loss allowance, although the ultimate impact was not yet clear.
- Subsequent to quarter-end, the company sold $179.3 million of consumer loans and expected to recognize a $15.5 million pretax gain in Q4 2019.
Most Important Facts for Investors to Verify
- Renewal, modification, or replacement of the Department of Education servicing contracts and Nelnet's Authority to Operate.
- The impact and implementation timing of the 2020 expected-credit-loss standard.
- Actual fourth-quarter consumer-loan sale gain and resulting warehouse-facility balances.
- Performance of consumer-loan credit metrics and whether provisions continue to rise with portfolio growth.
- Liquidity and refinancing capacity for warehouse facilities, asset-backed securitizations, and near-term maturities.
- Exposure to LIBOR transition, basis risk, derivative collateral requirements, and volatility in reported earnings.
- ALLO customer growth, capital spending, EBITDA progression, and continuing earnings dilution.
- Assumptions supporting the $1.88 billion securitization cash-flow forecast, particularly prepayment and interest-rate sensitivities.