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Nelnet, Inc. 2006 Annual Report (10-K) Summary

Business Context and Reporting Period

This report covers the fiscal year ended December 31, 2006. Nelnet, Inc. is a vertically integrated education planning and financing company. Its primary business involves originating, acquiring, holding, and servicing student loans, predominantly under the Federal Family Education Loan Program (FFELP). The company operates through five segments: Asset Generation and Management, Student Loan and Guaranty Servicing, Tuition Payment Processing and Campus Commerce, Enrollment Services and List Management, and Software and Technical Services.

Key Financial Metrics

Note: Fee-based revenues totaled $308 million in 2006, representing 50% of total revenue, up from 22% in 2004.

Material Changes vs. Prior Period

• Significant Decline in Net Income: Net income dropped 62% to $68.2 million from $181.1 million in 2005. This was primarily driven by a $31.1 million impairment charge and a $21.7 million charge related to a settlement with the Department of Education.
• Portfolio Growth: The student loan portfolio grew 17.4% to $23.8 billion, driven by $6.7 billion in loan originations and acquisitions.
• Spread Compression: The core student loan spread narrowed to 1.42% from 1.51% due to a higher mix of lower-yielding consolidation loans and the elimination of certain special allowance payments.
• Derivative Volatility: GAAP results included a $31.1 million loss from derivative market value adjustments and foreign currency fluctuations, which are excluded from the company's non-GAAP "base net income" measure.

Guidance, Outlook, and Risks

Management Commentary & Outlook: Management expects continued loan spread compression in 2007. The company is focusing on revenue diversification through fee-based services to reduce reliance on government programs. A quarterly dividend of $0.07 per share was declared in February 2007.

Key Risks and Contingencies:

• Department of Education Settlement: In January 2007, Nelnet settled an audit regarding 9.5% special allowance payments. The settlement eliminated future 9.5% payments on certain loans, resulting in a $21.7 million impairment charge in 2006.
• EDULINX Contract Loss: The Government of Canada notified Nelnet's subsidiary, EDULINX, that its contract would not be renewed upon expiration in March 2008. This resulted in a $9.4 million impairment charge in 2006.
• Legislative Risk: Proposed changes to the Higher Education Act could reduce special allowance payments, increase lender fees, and alter risk-sharing provisions, potentially negatively impacting profitability.
• Liquidity and Funding: The company relies heavily on asset-backed securitizations and warehouse facilities. While historically renewed, there is no assurance these facilities will be maintained or expanded.
• Interest Rate Risk: Mismatches between asset and liability reset dates create basis risk, though the company uses derivatives to manage this exposure.

Investor Verification Checklist

• Settlement Impact: Verify the long-term revenue impact of the Department of Education settlement eliminating 9.5% special allowance payments.
• EDULINX Transition: Monitor the transition plan and potential further charges related to the loss of the Canadian government contract in 2008.
• Spread Trends: Analyze the trajectory of the core student loan spread, specifically the impact of the growing consolidation loan portfolio (72% of total) on yields.
• Derivative Exposure: Review the volatility of derivative mark-to-market adjustments and their effect on GAAP earnings versus "base net income."
• Legislative Developments: Track Congress's reauthorization of the Higher Education Act and potential changes to the FFEL Program.