Business Context and Reporting Period
Nelnet, Inc. filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2018. The company operates student loan servicing and systems, education technology and payment processing, communications, and asset generation and management businesses. Dollar amounts are in thousands except per-share data.
Key Financial Metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Total interest income | $239,948 | $196,887 | $671,995 | $573,789 |
| Total other income | $216,577 | $140,104 | $671,699 | $359,361 |
| Net interest income | $59,773 | $75,237 | $184,821 | $232,002 |
| Net income attributable to Nelnet | $42,927 | $46,303 | $206,287 | $125,065 |
| Basic and diluted EPS | $1.05 | $1.11 | $5.04 | $2.97 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $193,557 | $237,088 |
- Q3 2018 implied total reported revenue, comprising interest income and other income, was approximately $456.5 million; nine-month implied total was approximately $1.344 billion.
- Provision for loan losses increased to $10.5 million in Q3 and $18.0 million for nine months, compared with $6.7 million and $10.7 million, respectively.
- Effective tax rates declined to 24.44% in Q3 and 23.50% for nine months, compared with 35.57% and 36.00%, respectively, primarily because of the Tax Cuts and Jobs Act.
- Core loan spread increased to 1.30% in Q3 from 1.19%; nine-month core loan spread increased to 1.29% from 1.23%.
- As of September 30, 2018, loans receivable totaled $22.528 billion, total assets were $25.105 billion, and shareholders’ equity was $2.317 billion.
- Bonds and notes payable totaled $22.251 billion, compared with $21.357 billion at December 31, 2017.
- Cash and cash equivalents were $83.5 million, supplemented by $723.3 million of restricted cash and $57.4 million of available-for-sale investments.
Material Changes Versus the Prior Comparable Period
- Net income attributable to Nelnet increased 75% for the first nine months, although Q3 declined 7% year over year. The nine-month increase reflected the Great Lakes acquisition, higher core loan spread, lower taxes, and favorable derivative fair-value results.
- Net interest income declined 21% in Q3 and 20% for nine months because funding costs rose faster than interest income and the average loan balance declined.
- Loan servicing and systems revenue increased to $112.6 million in Q3 and $327.3 million for nine months, versus $56.0 million and $167.1 million, primarily due to the acquisition of Great Lakes and higher servicing volumes.
- Education technology, services, and payment processing revenue increased 16% in Q3 and 12% for nine months. Its before-tax operating margin declined to 25.4% from 26.3% in Q3 and to 28.4% from 30.9% for nine months, primarily because of increased product and software investment.
- Communications revenue increased to $11.8 million in Q3 and $31.3 million for nine months, but the segment remained loss-making, with a nine-month net loss of $22.9 million.
- Operating cash flow declined from $237.1 million to $193.6 million for nine months. Investing cash flow changed from $2.246 billion provided in 2017 to $936.5 million used in 2018, while financing cash flow changed from $2.568 billion used to $796.3 million provided.
- Great Lakes was acquired on February 7, 2018 for $150.0 million in cash. The acquisition added $75.3 million of intangible assets and $15.0 million of goodwill, and increased amortization and integration costs.
- The company adopted ASC Topic 606 retrospectively. Payment-processing revenue is now presented gross with related direct costs separately; management states that adoption did not affect cash flows or ongoing net income materially.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management expected an effective tax rate of approximately 23% to 24% for the remainder of 2018.
- ALLO expected approximately $25 million of network capital expenditures during the fourth quarter of 2018 and expected the Communications segment to remain dilutive while its network expanded. ALLO incurred $66.8 million of capital expenditures in the first nine months.
- On October 16, 2018, the company terminated its proprietary payment-processing platform investment and expected to record an approximately $8 million impairment charge in Q4 2018. Existing payment-processing revenue and customers were not expected to be affected; contract termination and severance costs were expected to be immaterial.
- Nelnet and Great Lakes government servicing contracts were scheduled to expire June 16, 2019. The company was participating in the Department of Education’s NextGen procurement processes but could not predict their timing, nature, or outcome.
- The company serviced approximately $464.9 billion of government-owned, FFELP, private education, and consumer loans as of September 30, 2018, compared with $211.4 billion at December 31, 2017.
- Key risks include student loan portfolio runoff and credit performance, interest-rate and basis risk, derivative valuation volatility, refinancing and securitization-market access, warehouse-facility renewals, government servicing-contract procurement, integration of Great Lakes, cybersecurity, regulatory requirements, and ALLO expansion execution.
- Two FFELP warehouse facilities had $705.1 million outstanding and $344.9 million available as of September 30, 2018. Subsequent to quarter-end, one facility was amended, including changes to liquidity and maturity dates.
- The company completed four asset-backed securitizations totaling approximately $2.5 billion during the first nine months of 2018 and expected to continue accessing the securitization market as conditions permitted.
Most Important Facts for Investors to Verify
- Whether Nelnet or its servicing partners receive new Department of Education contracts before the current contracts expire in June 2019.
- The realized contribution and integration costs of the Great Lakes acquisition, including servicing volumes, margins, amortization, and platform-conversion costs.
- The sustainability of the 1.29% nine-month core loan spread amid rising funding costs, declining floor income, and continued loan portfolio runoff.
- The adequacy of the $60.2 million allowance for loan losses, particularly for federally insured and growing consumer-loan portfolios.
- The actual Q4 2018 impairment and any additional costs from terminating the proprietary payment-processing platform.
- Liquidity and refinancing capacity, including warehouse-facility renewals, securitization-market access, derivative collateral requirements, and the $190.0 million available under the unsecured line of credit.
- ALLO’s capital requirements, customer growth, cash-flow trajectory, and continued earnings dilution during network expansion.