Nelnet, Inc. Form 10-Q Summary
Business context and reporting period
Nelnet is a diversified education-related services and loan asset management company. Its principal segments are Loan Servicing and Systems, Education Technology, Services, and Payment Processing, Communications, and Asset Generation and Management. This unaudited Form 10-Q covers the three and six months ended June 30, 2018, compared with the same periods in 2017. Unless otherwise noted, amounts are in thousands.
Key financial metrics
| Metric | Three months ended June 30, 2018 | Three months ended June 30, 2017 | Six months ended June 30, 2018 | Six months ended June 30, 2017 |
|---|---|---|---|---|
| Total interest income | $229.2 million | $193.1 million | $432.0 million | $376.9 million |
| Net interest income | $57.7 million | $79.8 million | $125.0 million | $156.8 million |
| Total other income | $200.2 million | $91.1 million | $455.1 million | $219.3 million |
| Income before taxes | $63.1 million | $40.7 million | $212.2 million | $117.4 million |
| Net income attributable to Nelnet | $49.4 million | $28.7 million | $163.4 million | $78.8 million |
| Basic and diluted EPS | $1.21 | $0.68 | $3.99 | $1.86 |
- Loan servicing and systems revenue was $114.5 million in the second quarter and $214.7 million for the first six months, compared with $56.9 million and $111.1 million, respectively, in 2017.
- Education technology, services, and payment processing revenue increased to $48.7 million for the quarter and $109.0 million year to date, versus $43.5 million and $99.5 million in the comparable periods.
- Communications revenue increased to $10.3 million for the quarter and $19.5 million year to date, while the segment remained loss-making.
- Net interest income after provision for loan losses was $54.2 million for the quarter and $117.5 million year to date. The provision for loan losses was $3.5 million and $7.5 million, respectively.
- Net income attributable to Nelnet increased 72% in the second quarter and 107% for the first six months. Results included material derivative fair-value effects and the contribution from the Great Lakes acquisition.
- Management’s non-GAAP net income excluding derivative market value and foreign currency transaction adjustments was $53.2 million, or $1.30 per share, in the second quarter, and $121.5 million, or $2.97 per share, for the first six months.
Financial position, debt, and liquidity
- Total assets were $25.21 billion at June 30, 2018, compared with $23.96 billion at December 31, 2017. Loans receivable, net, were $22.71 billion versus $21.81 billion.
- Total bonds and notes payable were $22.47 billion, compared with $21.36 billion at year-end. The fair value of this debt was $22.68 billion.
- Cash and cash equivalents were $67.9 million. Restricted cash was $741.7 million, and restricted cash due to customers was $154.8 million.
- Available-for-sale investments had a fair value of $81.8 million. The $350 million unsecured line of credit had $170 million outstanding and $180 million available; its maturity was extended to June 22, 2023.
- FFELP warehouse facilities had $1.70 billion outstanding and approximately $127.3 million of capacity available at June 30, 2018. Asset-backed securitizations completed during the first six months totaled $983.6 million of principal.
- Net cash provided by operating activities was $71.6 million, compared with $174.9 million in the prior-year period. Investing activities used $1.09 billion, while financing activities provided $1.04 billion. Cash, cash equivalents, and restricted cash ended at $964.4 million.
- The company repurchased 315,794 Class A shares for $16.3 million during the first six months and paid $13.0 million in dividends, or $0.32 per share. A third-quarter dividend of $0.16 per share was declared.
Material changes versus the prior comparable period
- On February 7, 2018, Nelnet acquired Great Lakes Educational Loan Services for $150 million in cash. Great Lakes added substantial government, FFELP, and private-loan servicing operations. The acquisition contributed to higher servicing revenue, salaries, operating expenses, depreciation, and amortization.
- Great Lakes and Nelnet servicing contracts with the U.S. Department of Education were scheduled to expire June 16, 2019. The companies submitted a joint response to the Department’s Phase One federal student-loan servicing procurement.
- Loan servicing volume increased substantially after the acquisition. At June 30, 2018, Nelnet and Great Lakes together serviced approximately $418.1 billion of government-owned loans, and the company reported $470.7 billion of total loans serviced, compared with $211.4 billion at December 31, 2017.
- The company adopted ASC Topic 606 using full retrospective application. The principal presentation effect was recording certain payment-services revenue gross and presenting related direct costs separately; management stated that the effect on ongoing net income was immaterial.
- The Tax Cuts and Jobs Act reduced the effective tax rate to 21.46% for the quarter and 23.25% for the first six months, compared with 35.81% and 36.25% in 2017. Management expected an effective tax rate of approximately 23% to 24% for the remainder of 2018.
- Net interest income declined despite higher interest income because interest expense increased substantially as funding costs rose. Core loan spread was 1.29% for both the quarter and six-month period, compared with 1.28% and 1.26%, respectively, in 2017.
- Derivative and foreign-currency adjustments shifted from a $27.5 million expense in the second quarter of 2017 to a $4.9 million expense in 2018, and from a $31.0 million expense to a $55.1 million gain for the first six months.
Guidance, outlook, risks, and unusual items
- Management expects the $22.7 billion loan portfolio to amortize over approximately 20 years, with a weighted-average remaining life of 7.4 years. It expects Asset Generation and Management earnings to decline over time as the FFELP portfolio amortizes and interest rates rise.
- ALLO Communications is expected to remain dilutive to consolidated earnings while it expands its fiber network. ALLO incurred $45.1 million of capital expenditures in the first six months and expected approximately $45.0 million of additional network expenditures in the second half of 2018.
- Nelnet filed applications to establish Nelnet Bank, a Utah-chartered industrial bank. Approval was uncertain and expected to take an extended period; the proposed bank would require an initial $100 million capital commitment if approved.
- Management forecasts approximately $1.98 billion of future undiscounted cash flows from its securitized loan portfolio, including approximately $1.34 billion expected through 2022. The forecast is sensitive to prepayments, defaults, forbearance, interest rates, and the spread between one- and three-month LIBOR.
- Key risks include loss or modification of Department of Education servicing contracts, integration and technology execution risks related to Great Lakes, interest-rate and basis risk, funding and securitization-market conditions, loan delinquencies and defaults, regulatory changes, cybersecurity, litigation, and the continued capital requirements of ALLO.
- The filing reported no material changes to previously disclosed legal proceedings or risk factors, and management concluded that disclosure controls and procedures were effective as of June 30, 2018.
Important facts for investors to verify
- Progress and outcome of the Department of Education’s federal student-loan servicing procurement and the effect of any contract awards or losses after June 16, 2019.
- Whether Great Lakes integration and the combined servicing platform deliver expected cost savings and servicing-volume benefits.
- Trends in funding costs, LIBOR basis spreads, fixed-rate floor income, derivative settlements, and recurring earnings excluding volatile fair-value adjustments.
- Actual operating cash flow, warehouse-facility availability, securitization execution, and changes to the $1.98 billion projected securitization cash-flow estimate.
- ALLO’s customer additions, capital expenditures, operating losses, and funding requirements.
- Status of the Nelnet Bank charter application and the potential $100 million capital commitment.
- Effects of the forthcoming lease standard and expected-loss credit standard, including the potential increase in the allowance for loan losses beginning in 2020.