Nelnet, Inc. Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2023; filed November 7, 2023. Results are unaudited and should be read with the 2022 Form 10-K. Nelnet operates loan servicing and systems, education technology and payment processing, asset generation and management, Nelnet Bank, renewable energy, communications, and investment businesses.
Financial Performance and Position
| Metric | Q3 2023 | Q3 2022 | 9M 2023 | 9M 2022 |
|---|---|---|---|---|
| Total interest income | $284.6 million | $203.1 million | $834.5 million | $479.9 million |
| Net interest income | $77.4 million | $76.5 million | $194.8 million | $231.6 million |
| Provision for loan losses | $10.7 million | $9.7 million | $54.5 million | $18.6 million |
| Other income, net | $252.1 million | $318.7 million | $764.5 million | $990.4 million |
| Income before taxes | $53.0 million | $127.1 million | $113.8 million | $476.0 million |
| Net income attributable to Nelnet | $45.3 million | $104.8 million | $100.1 million | $376.6 million |
| Basic and diluted EPS | $1.21 | $2.80 | $2.67 | $9.99 |
| Operating cash flow | Not separately provided | Not separately provided | $353.2 million | $656.9 million |
Interest income increased substantially because of higher interest rates, but higher funding costs, lower loan balances, reduced loan spreads, increased credit-loss provisions, and lower derivative-related gains reduced profitability. The effective tax rate was 19.1% in the quarter and 22.7% for the nine-month period; management expects a 21% to 23% effective tax rate for the remainder of 2023.
- Assets were $17.2 billion at September 30, 2023, down from $19.4 billion at December 31, 2022.
- Loans and accrued interest receivable, net, were $13.9 billion, compared with $15.2 billion at year-end 2022.
- Bonds and notes payable declined to $12.4 billion from $14.6 billion.
- Total cash, cash equivalents, and restricted cash were $792.5 million, down from $1.36 billion at year-end 2022.
- Shareholders’ equity attributable to Nelnet was $3.29 billion; total equity was $3.26 billion.
- The allowance for loan losses was $110.1 million, down from $131.8 million at December 31, 2022, while nine-month provision expense increased materially due primarily to newly originated or acquired loans.
Liquidity, Debt, and Cash Flow
- Cash provided by operating activities was $353.2 million for the first nine months, versus $656.9 million in the prior-year period.
- Investing activities provided $1.31 billion, primarily from loan repayments and securities sales. Financing activities used $2.22 billion, principally for debt repayments of $3.00 billion.
- Management identified approximately $1.39 billion of liquidity sources at September 30, including $179.5 million of net cash, $348.2 million of unencumbered available-for-sale securities, $231.3 million of unencumbered private, consumer, and other loans, $138.4 million of unencumbered repurchased debt securities, and $495.0 million of unused unsecured line capacity.
- The $495.0 million unsecured line of credit had no outstanding balance and matures September 22, 2026.
- Warehouse facilities had $1.47 billion outstanding and $215.8 million of availability for FFELP facilities; the private education facility was fully drawn at $38.2 million.
- Nelnet Bank had $947.4 million of deposits, including $229.3 million of intercompany deposits, and reported a 12.7% leverage ratio against the FDIC-required 12% level.
Material Changes Versus Prior Comparable Period
- Q3 net income attributable to Nelnet fell 57% to $45.3 million; nine-month net income fell 73% to $100.1 million.
- Q3 net interest income was broadly stable, but nine-month net interest income declined 16% because higher interest expense and lower average loan balances offset higher loan yields.
- Loan servicing and systems revenue declined to $127.9 million in Q3 and $389.1 million for nine months, compared with $134.2 million and $395.4 million, respectively. Drivers included lower Department of Education pricing and borrower transfers.
- Education technology, services, and payment processing revenue increased to $113.8 million in Q3 and $357.3 million for nine months, driven by tuition payment plans, payment processing, customer growth, and the NextGen acquisition.
- Loan-sale gains increased to $32.7 million for nine months from $5.6 million, reflecting sales of approximately $482.0 million of loans.
- Derivative market value adjustments declined from a $251.2 million gain in the prior-year nine-month period to an $8.0 million expense in 2023. The company terminated its $2.8 billion floor-income hedge portfolio in March 2023, reducing expected future derivative volatility.
- Net loan spread declined to 0.92% for nine months from 1.44%; core loan spread declined to 1.16% from 1.54%.
- Loan servicing volume declined to $539.3 billion and 16.2 million borrowers at September 30, 2023, from $587.5 billion and 17.6 million borrowers at December 31, 2022.
Outlook, Commentary, Risks, and Unusual Items
- The Department of Education extended the legacy servicing contracts through December 2024. Nelnet expects the new Unified Servicing and Data Solution contract to begin servicing operations in the second quarter of 2024. Management expects lower blended revenue per borrower under the new contract, although additional fees may be earned for change requests and other support services.
- Nelnet received a new five-year base-period USDS contract with potential two-year, two-year, and one-year extensions. The Department will allocate more than 37 million borrowers among five servicers based on service and performance; Nelnet has no volume projection for a new remote-hosted customer.
- Up to one million government borrowers were transferred to another servicer, and former remote-hosted Department borrowers were fully removed from Nelnet’s platform by July 2023. Future software-services revenue will be negatively affected until new USDS activity begins.
- Federal student loan payments resumed September 1, 2023 after the CARES Act payment pause. Extraordinary call volume and web traffic adversely affected service levels, and Nelnet began hiring additional associates. Costs are expected to increase beginning in the fourth quarter.
- The company recorded a $25.9 million non-cash expense in Q2 from early redemption of asset-backed debt and write-off of unamortized debt discounts.
- Q3 included a $5.0 million impairment charge related primarily to unused office space and a $4.8 million deconversion revenue item from a remote-hosted customer leaving the platform.
- Solar construction has incurred low or negative margins on certain projects; management expects margins to improve as existing contracts conclude and new-project revenue increases.
- The company has $265.9 million of additional solar tax-equity commitments, of which $128.7 million is expected to be funded by syndication partners. Solar investments generated $13.5 million of losses during the first nine months.
- ALLO generated a $49.7 million nine-month loss under the HLBV method. Nelnet holds preferred ALLO interests of $145.9 million earning a 6.25% return; the return increases if the interests are not redeemed by April 2024 and escalates further beginning in 2025. Nelnet expects additional capital contributions may be required.
- Key risks include borrower defaults and delinquencies, accelerated FFELP prepayments and consolidation, interest-rate and SOFR basis risk, liquidity and refinancing risk, government contract volumes and pricing, regulatory and banking requirements, cybersecurity and operational failures, investment losses, solar tax-credit recapture, ALLO funding needs, litigation, and future student-loan forgiveness programs.
Important Investor Verification Items
- Verify future borrower allocations, pricing, implementation timing, and cost requirements under the USDS servicing contract.
- Assess whether government servicing volumes, remote-hosted software revenue, and FFELP runoff assumptions support management’s outlook.
- Review allowance adequacy and delinquency trends, particularly the elevated non-Nelnet Bank consumer-loan net charge-off rate of 4.59% for nine months and the 3.00% Nelnet Bank consumer-loan rate.
- Reconcile liquidity sources with warehouse maturities, repurchase-agreement obligations, debt covenants, and collateral or margin requirements.
- Evaluate sensitivity to SOFR/index mismatches, prepayment rates, and changes in loan spreads.
- Monitor ALLO’s escalating preferred return, contingent payment obligation, potential capital calls, and the company’s solar funding commitments.
- Distinguish recurring operating earnings from derivative valuation changes, loan-sale gains, investment results, impairment charges, and other unusual items.