Nelnet, Inc. 2012 Form 10-K Summary
Business context and reporting period
Nelnet is an education services company operating in four segments: Student Loan and Guaranty Servicing, Tuition Payment Processing and Campus Commerce, Enrollment Services, and Asset Generation and Management. The filing covers the fiscal year ended December 31, 2012, with comparative results for 2011 and 2010. Although the request identifies 2012 Q4, this is an annual Form 10-K; fourth-quarter information is included only as unaudited quarterly data.
The company no longer originates new FFELP loans following legislation effective July 1, 2010. Its existing FFELP portfolio, fee-based servicing businesses, and purchases of loan portfolios remain central to results. At year-end, Nelnet owned a $24.8 billion student loan portfolio and serviced $97.5 billion of loans for 5.7 million borrowers.
Financial performance and key metrics
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Net interest income | $345.3 million | $364.6 million | Down 5.3% |
| Net interest income after loan-loss provision | $323.8 million | $343.3 million | Down 5.7% |
| Loan and guaranty servicing revenue | $209.7 million | $175.7 million | Up 19.4% |
| Tuition payment and campus commerce revenue | $74.4 million | $67.8 million | Up 9.8% |
| Enrollment services revenue | $117.9 million | $130.5 million | Down 9.6% |
| Net income attributable to Nelnet | $178.0 million | $204.3 million | Down 12.9% |
| Diluted earnings per share | $3.74 | $4.23 | Down 11.6% |
| Operating cash flow | $299.3 million | $310.9 million | Down 3.7% |
| Core student loan spread | 1.44% | 1.52% | Down 8 basis points |
| Effective tax rate | 35.0% | 36.5% | Down 150 basis points |
Reported net income included a $47.4 million pretax expense for derivative fair-value and foreign-currency adjustments, compared with a $17.8 million expense in 2011. Excluding the related after-tax adjustments, management reported non-GAAP net income of $207.4 million, or $4.38 per share, versus $215.4 million, or $4.47 per share, in 2011.
Total assets were $26.6 billion, including $24.8 billion of net student loans. Bonds and notes payable totaled $25.1 billion. Nelnet shareholders’ equity was $1.17 billion, tangible shareholders’ equity was $1.04 billion, and book value per common share was $25.00. The company reported $149.3 million of cash and investments, including $66.0 million of cash and cash equivalents.
The allowance for loan losses increased to $51.9 million from $48.5 million. The provision for loan losses was $21.5 million, including $22.0 million for federally insured loans partially offset by a $0.5 million benefit for non-federally insured loans.
Material changes versus the prior comparable period
- Fee-based revenue excluding intersegment servicing revenue increased to $402.1 million from $373.9 million, led by government servicing, guaranty collections, software services, and tuition-payment growth.
- Government servicing revenue increased 36.3% to $69.5 million. Nelnet ranked first among four private-sector servicers and received a 30% allocation of new Department of Education borrower volume for the August 2012-August 2013 period, compared with 16% in the prior two years.
- Enrollment Services revenue and profitability deteriorated as regulatory uncertainty reduced marketing spending by for-profit schools. The segment reported a $3.7 million net loss and recorded a $2.8 million impairment of student list costs.
- Nelnet purchased $3.9 billion of FFELP loans during 2012, including $3.0 billion in the fourth quarter, but lost $936.4 million of FFELP loans through the Department’s special direct-consolidation initiative.
- The variable student loan spread declined to 0.82% from 0.92%, primarily because of wider asset-liability index spreads and higher funding costs. Fixed-rate floor income remained substantial at $145.3 million, compared with $144.5 million in 2011.
- Operating expenses increased to $433.6 million from $407.7 million, reflecting investment and staffing for government servicing, hosted software, consolidation-related activity, and tuition-payment growth.
- The company repurchased 806,023 Class A shares for $22.8 million and paid $1.40 per share in dividends, including a $1.00 special dividend. It also repurchased $136.1 million of debt for a $4.0 million gain.
Debt, liquidity, outlook, and risks
Most student loan debt is funded through asset-backed securitizations intended to match the maturity of the underlying loans. At December 31, 2012, secured debt included $22.2 billion of asset-backed securities, $1.6 billion of FFELP warehouse borrowings, and $1.3 billion under the Department of Education Conduit Program. The company also had $55.0 million outstanding and $195.0 million available under a $250.0 million unsecured line of credit maturing in 2016.
Warehouse facilities had $245.8 million of unused capacity and $126.3 million of equity support posted. Their liquidity provisions expire in 2013 and 2014, with final maturities in 2015 and 2016. Failure to renew or refinance these facilities, comply with covenants, or provide additional collateral could increase funding costs or accelerate repayment obligations. The Conduit Program borrowings were refinanced after year-end on February 28, 2013.
Management estimated approximately $1.97 billion of future undiscounted cash flows from loans funded in asset-backed securitizations. This estimate depends on prepayments, defaults, interest rates, deferments, forbearances, and basis-spread assumptions. A prepayment rate twice the forecast assumption could reduce projected cash flow by approximately $290 million to $350 million; a wider LIBOR basis spread could reduce it by approximately $50 million to $90 million.
Management expected continued significant fixed-rate floor income if short-term interest rates remained low. It expected a 2013 effective tax rate of 36% to 38% and planned to continue regular quarterly dividends, subject to earnings, capital requirements, financial condition, and restrictions under the Hybrid Securities.
- Key risks include the runoff of the FFELP portfolio and related servicing revenue, future federal policy and regulatory changes, and potential additional direct-loan consolidation.
- The Department of Education servicing contract runs through June 2014, with one five-year renewal option controlled by the Department. Management anticipated renewal but stated that renewal was not assured.
- Interest-rate basis and repricing risk remains significant because loan assets and funding reset on different indices and schedules. Derivatives do not qualify for hedge accounting, so fair-value changes can materially affect earnings.
- Derivative liabilities were $70.9 million and collateral posted to counterparties was $63.1 million. Material adverse market movements could require additional collateral.
- Loan delinquencies increased, particularly in rehabilitation loans. The company is exposed to credit losses on non-federally insured loans and repurchase obligations for certain loans sold or participated to third parties.
- The Enrollment Services segment remains exposed to for-profit school regulation, marketing restrictions, and weaker customer demand.
- Cybersecurity, system outages, privacy breaches, regulatory compliance, litigation, and dependence on major customers and vendors could adversely affect operations.
- Michael S. Dunlap beneficially controlled 67.7% of voting rights, creating substantial governance and minority-shareholder concentration risk. Transactions with affiliated Union Bank generated $11.9 million of net income impact in 2012 and present potential conflicts of interest.
A putative class-action lawsuit against Peterson’s Nelnet alleges violations of the Telephone Consumer Protection Act involving advertising faxes. The complaint alleges more than $5 million of statutory damages, or more than $15 million if trebled, but no class had been certified and the company stated that a meaningful loss estimate could not be made.
Investor verification checklist
- Reconcile GAAP net income of $178.0 million with management’s $207.4 million non-GAAP figure and assess recurring versus market-driven derivative and foreign-currency effects.
- Review the sustainability of $145.3 million of fixed-rate floor income and sensitivity to higher interest rates, LIBOR basis changes, and prepayments.
- Verify warehouse-facility renewal, covenant compliance, refinancing plans, and the post-year-end refinancing of Conduit Program borrowings.
- Evaluate the Department of Education contract renewal risk, future borrower-volume allocations, and the expiration of the significant hosted-servicing contract in December 2013.
- Monitor FFELP portfolio runoff, direct-consolidation activity, loan delinquencies, allowance adequacy, and non-federally insured loan repurchase exposure.
- Assess whether Enrollment Services can stabilize revenue amid for-profit-school regulatory pressure and whether the $2.8 million impairment signals further weakness.
- Review related-party transactions with Union Bank, concentrated voting control, and the pending Peterson’s TCPA litigation.