Nelnet, Inc. Form 10-Q Summary
Business context and reporting period
Nelnet provides student-loan financing and servicing, tuition payment processing and campus commerce, and enrollment services. The company also earns net interest income from a federally insured student-loan portfolio. This unaudited report covers the three and nine months ended September 30, 2013, compared with the same periods in 2012.
Financial performance and key metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Total interest income | $160.2 million | $151.7 million | $476.9 million | $457.9 million |
| Net interest income after loan-loss provision | $99.9 million | $80.3 million | $290.1 million | $236.7 million |
| Total other income | $101.2 million | $83.5 million | $384.1 million | $269.4 million |
| Operating expenses | $107.6 million | $104.9 million | $317.4 million | $324.3 million |
| Income before taxes | $93.5 million | $58.8 million | $356.9 million | $181.8 million |
| Net income attributable to Nelnet | $62.8 million | $36.8 million | $232.2 million | $121.4 million |
| Basic and diluted EPS | $1.35 | $0.78 | $4.98 | $2.56 |
Q3 net income attributable to Nelnet increased approximately 71%, while nine-month net income increased approximately 91%. The effective tax rate was 32.6% in Q3 2013 versus 37.2% in Q3 2012, and 34.8% for the first nine months versus 33.0% in the prior-year period. Third-quarter tax expense benefited by $4.1 million from resolution of uncertain tax positions, and interest expense benefited by a $1.3 million reversal related to tax-position resolutions.
Management's non-GAAP net income excluding derivative market-value and foreign-currency adjustments was $69.0 million, or $1.48 per share, in Q3 2013, compared with $53.1 million, or $1.12 per share, in Q3 2012. For the first nine months, the measure was $202.5 million, or $4.35 per share, compared with $159.3 million, or $3.36 per share.
The core student-loan spread increased to 1.57% in Q3 2013 from 1.44% and to 1.53% for the nine months from 1.43%. Net fixed-rate floor income was $37.8 million in Q3 and $109.6 million for the nine months, broadly consistent with the prior-year year-to-date amount of $109.8 million.
Balance sheet, cash flow, debt and liquidity
- Student loans receivable, net, were $24.7 billion at September 30, 2013, compared with $24.8 billion at December 31, 2012. The company acquired $2.2 billion of FFELP loans during the first nine months, including $1.1 billion in Q3.
- Total assets were $26.5 billion and total liabilities were $25.2 billion. Shareholders' equity was $1.4 billion, up from $1.2 billion at year-end 2012.
- Bonds and notes payable were $24.9 billion, down from $25.1 billion at December 31, 2012. Debt was entirely variable-rate, with carrying amounts including $23.5 billion of variable-rate asset-backed securitization debt and $1.3 billion of FFELP warehouse facilities.
- Cash and investments totaled $284.1 million, including $51.4 million of cash and cash equivalents. The company generated $202.6 million of operating cash flow in the first nine months, compared with $260.6 million in 2012.
- Investing activities provided $93.9 million, while financing activities used $311.2 million. Cash and cash equivalents declined to $51.4 million from $66.0 million at year-end.
- The unsecured credit line was increased to $275 million and extended to March 28, 2018. At September 30, $75 million was outstanding and $200 million was available.
- Four warehouse facilities had aggregate maximum financing of $2.25 billion, with $1.28 billion outstanding and $972.4 million available at quarter-end. The NHELP-I facility was terminated on October 1, 2013, reducing aggregate maximum capacity to $1.8 billion.
- The company completed five asset-backed securitizations totaling $3.2 billion during the first nine months.
Material changes versus the prior comparable period
- Profitability improved substantially, driven by higher student-loan net interest income, improved funding spreads, increased servicing revenue, and lower amortization expense.
- Loan and guaranty servicing revenue rose to $64.6 million in Q3 and $180.3 million year to date, primarily from growth in government servicing and guaranty collection revenue.
- Tuition payment processing and campus commerce revenue increased to $19.9 million in Q3 and $61.7 million year to date, with higher managed payment plans and customer volumes.
- Enrollment services revenue declined to $22.6 million in Q3 and $76.3 million year to date because of regulatory uncertainty and reduced marketing spending by for-profit education customers. The segment remained approximately breakeven for Q3 and generated $0.7 million of pre-tax income year to date, versus a prior-year loss.
- Derivative market-value and foreign-currency adjustments were a $9.96 million expense in Q3 2013 versus a $26.2 million expense in Q3 2012, but represented a $47.8 million gain for the first nine months versus a $61.2 million loss in the prior-year period.
- The company repurchased $84.7 million face amount of its own asset-backed debt during the first nine months and recognized $10.9 million of gains. It also repurchased 390,376 Class A shares for $13.0 million and paid $13.9 million of dividends.
Outlook, commentary, risks and unusual items
- The Department of Education notified Nelnet of its intent to exercise an option to extend the government servicing contract through June 16, 2019, subject to availability of government funds. The contract had generated $26.0 million of Q3 revenue and $68.4 million year-to-date revenue.
- Management expects significant fixed-rate floor income to continue if short-term interest rates remain low. Higher rates could reduce floor income and compress margins, although derivatives are used to mitigate interest-rate exposure.
- Management estimates approximately $2.10 billion of future undiscounted cash flows from FFELP loans financed in asset-backed securitizations. The estimate depends on prepayments, defaults, interest rates and other assumptions; doubling the assumed prepayment rate could reduce the forecast by approximately $210 million to $270 million, while a wider LIBOR basis spread could reduce it by approximately $110 million to $150 million.
- Key risks include interest-rate basis and repricing risk, derivative valuation and collateral requirements, securitization and warehouse-funding availability, loan prepayments and defaults, the runoff of legacy FFELP portfolios, government funding and contract volumes, operational and information-system failures, and litigation.
- Three putative class-action matters remained unresolved; no class had been certified. The company stated that accrued amounts were immaterial and that a reasonably possible loss range could not be estimated.
- On October 31, 2013, after quarter-end, Nelnet purchased GCO Education Loan Funding Trust-II, obtaining residual rights in $1.6 billion of FFELP loans. The related loans and debt will be consolidated in subsequent financial statements.
- The company reported no material changes to previously disclosed risk factors, and management concluded that disclosure controls and procedures were effective.
Important facts for investors to verify
- Whether the Department of Education contract extension receives funding and its servicing volumes and economics are sustained.
- The sensitivity of net interest income, floor income and projected $2.10 billion of cash flows to interest rates, LIBOR basis spreads, prepayments and defaults.
- Renewal and refinancing of warehouse liquidity provisions, compliance with financial covenants, and continued access to asset-backed securitization markets.
- The financial impact of the October 31, 2013 acquisition and consolidation of the $1.6 billion FFELP loan trust.
- Enrollment Services revenue trends, customer concentration, regulatory developments and the segment's ability to maintain profitability.
- Potential exposure from putative class actions, loan repurchase obligations, derivative collateral calls and related-party transactions.