Nelnet, Inc. Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2023, compared with the same periods in 2022. The interim financial statements are unaudited and prepared under U.S. GAAP.
Business Context
Nelnet operates loan servicing and systems, education technology and payment processing, asset generation and management, Nelnet Bank, solar construction and related investment businesses. A significant portion of earnings and cash flow comes from a portfolio of primarily federally insured student loans, while fee-based education businesses provide additional diversification.
Key Financial Metrics
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Total interest income | $284.0 million | $151.6 million | $550.0 million | $276.8 million |
| Net interest income | $50.9 million | $77.9 million | $117.4 million | $155.1 million |
| Provision for loan losses | $9.6 million | $9.4 million | $43.9 million | $9.0 million |
| Total other income, net | $247.2 million | $267.3 million | $512.3 million | $671.7 million |
| Income before taxes | $29.6 million | $108.4 million | $60.9 million | $349.0 million |
| Net income attributable to Nelnet | $28.3 million | $85.1 million | $54.8 million | $271.8 million |
| Basic and diluted EPS | $0.75 | $2.26 | $1.46 | $7.18 |
- Fee-based revenue: Loan servicing and systems revenue was $122.0 million in Q2 and $261.2 million year to date, essentially flat year to date versus 2022. Education technology, services and payment processing revenue increased to $109.9 million in Q2 and $243.5 million year to date, from $91.0 million and $203.3 million, respectively.
- Solar construction: Revenue was $4.7 million in Q2 and $13.4 million year to date following the July 2022 acquisition of GRNE Solar. Related service costs were $9.1 million in Q2 and $17.4 million year to date.
- Margins and earnings quality: Higher loan and investment yields increased interest income, but sharply higher funding costs, lower loan balances, reduced fixed-rate floor income, increased credit provisions and lower derivative gains reduced profitability. Management reported non-GAAP net income excluding derivative market value adjustments of $26.7 million in Q2 and $81.7 million year to date, compared with $54.4 million and $130.3 million, respectively, in 2022.
- Effective tax rate: 27.1% in Q2 and 25.5% year to date, versus 23.0% in both comparable 2022 periods. Management expects an effective tax rate of approximately 24% to 25% for the remainder of 2023.
Financial Position, Debt and Liquidity
- Total assets were $17.8 billion at June 30, 2023, down from $19.4 billion at December 31, 2022. Net loans and accrued interest receivable were $14.4 billion, compared with $15.2 billion at year-end.
- Total liabilities were $14.6 billion and total equity was $3.25 billion at June 30, 2023.
- Bonds and notes payable declined to $13.1 billion from $14.6 billion at year-end. The debt portfolio included $11.1 billion of asset-backed securitization debt and $1.6 billion of warehouse facilities.
- The company had $121.8 million of cash and cash equivalents, including $96.9 million held at a related party. Cash, cash equivalents and restricted cash totaled $814.0 million, down from $1.36 billion at December 31, 2022.
- Management identified approximately $1.26 billion of sources of liquidity, including $106.1 million of unrestricted cash and cash equivalents, $367.7 million of unencumbered available-for-sale debt securities, $231.1 million of unencumbered private, consumer and other loans, $56.2 million of unencumbered repurchased debt securities and $495.0 million of unused capacity under an unsecured line of credit maturing in September 2026.
- Nelnet Bank had $871.4 million of deposits and a 12.7% leverage ratio at June 30, 2023. The company expects to make additional capital contributions to the bank in future periods.
Cash Flow
| Six months ended June 30 | 2023 | 2022 |
|---|---|---|
| Operating cash flow | $199.0 million | $483.7 million |
| Investing cash flow | $890.3 million | $837.0 million |
| Financing cash flow | $(1.63) billion | $(1.34) billion |
| Net change in cash, cash equivalents and restricted cash | $(543.6) million | $(20.1) million |
Financing outflows primarily reflected $2.42 billion of debt repayments, partially offset by $806.1 million of new debt issuance. Investing inflows included loan repayments, asset sales and available-for-sale securities sales.
Material Changes Versus the Prior Comparable Period
- Interest income increased substantially because of higher market rates, but interest expense rose even faster as funding costs increased. Core loan spread declined to 1.06% in Q2 and 1.31% year to date, from 1.61% and 1.53%, respectively.
- The federally insured loan portfolio continued to run off. Asset Generation and Management loans declined to $13.2 billion from $14.2 billion at December 31, 2022 and $15.9 billion at June 30, 2022.
- Provision for loan losses increased to $43.9 million year to date, primarily from initial allowances for consumer loans originated or acquired during the period. The allowance balance was $114.3 million at June 30, 2023.
- Nelnet recognized $27.3 million of gains on loan sales year to date, compared with $3.0 million in the prior-year period.
- In April 2023, the company redeemed $188.6 million of asset-backed debt before maturity and recognized a $25.9 million non-cash expense from writing off the remaining debt discount.
- On March 15, 2023, the company terminated its $2.8 billion notional portfolio of derivatives hedging fixed-rate floor income. Management expects future derivative market value adjustments to be less substantial.
- Education technology revenue grew, but margins were pressured by investments in technology and customer experience and growth in lower-margin instructional services.
- Government loan servicing volume declined to $519.3 billion and 14.9 million borrowers at June 30, 2023, from $545.4 billion and 15.7 million borrowers at December 31, 2022.
Guidance, Outlook and Risks
- The Department of Education awarded Nelnet a new Unified Servicing and Data Solution contract with a five-year base period and potential extensions. New-system servicing is expected to go live in 2024, while legacy servicing contracts were extended through December 2024.
- Management expects lower blended revenue per borrower under the new contract, although additional revenue may arise from change requests, consolidations and other support services. Cybersecurity and other required system investments will offset some platform-consolidation savings.
- Up to one million government borrowers were transferred to another servicer, and remote-hosted government borrowers were transferred off Nelnet’s platform during the second quarter and July 2023. Future software-services revenue will be negatively affected.
- Federal student loan payments and interest accruals were scheduled to resume in September 2023. Revenue per borrower may increase from CARES Act forbearance levels under legacy contracts, but future loan forgiveness, repayment changes or consolidation activity could reduce servicing revenue and accelerate FFELP portfolio runoff.
- LIBOR publication ceased on June 30, 2023. The company expects affected assets, debt and derivatives to transition to SOFR-based rates and does not expect a significant impact on its securitization cash flow forecast, although basis and repricing risks remain.
- As of June 30, 2023, the company was committed to fund an additional $319.2 million of solar tax equity investments, partially offset by expected syndication partner funding of $120.5 million. Solar investments generated accelerated initial losses under the HLBV method.
- ALLO voting-interest losses were $32.4 million year to date. The company also has preferred ALLO interests of $145.9 million earning a 6.25% annual return; the return increases if the interests are not redeemed by the applicable dates under amended terms. A contingent payment obligation to SDC ranges from $25 million to $35 million if specified disposition returns are achieved.
- Key risks include interest-rate and funding spread volatility, loan prepayments and credit losses, liquidity and collateral requirements, government contract volumes and pricing, regulatory and capital requirements for Nelnet Bank, cybersecurity and operational failures, investment valuation changes, solar tax-credit recapture and litigation or regulatory developments.
Investor Verification Checklist
- Verify the pace of government borrower transfers, the final servicing volume allocation under the USDS contract and the effect on future servicing revenue and margins.
- Monitor FFELP portfolio runoff, loan prepayments, consumer-loan delinquencies, charge-offs and allowance adequacy.
- Reconcile reported GAAP earnings with non-GAAP earnings excluding derivative market value adjustments and assess the remaining derivative exposure.
- Review debt maturities, warehouse-facility renewals, repurchase-agreement collateral requirements and available unrestricted liquidity.
- Assess the sustainability of education technology growth and margins, particularly as the EANS instructional-services program is expected to end in September 2024.
- Evaluate additional capital commitments and potential losses associated with Nelnet Bank, ALLO, solar investments and other strategic investments.
- Confirm the effects of the LIBOR-to-SOFR transition on loan yields, funding costs, derivatives and securitization cash flows.