Nelnet, Inc. 2014 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
Nelnet, Inc. is an education services company operating in asset management and finance, student loan servicing, tuition payment processing and campus commerce, and enrollment services. The filing covers the unaudited three months ended March 31, 2014, compared with the three months ended March 31, 2013. The company’s $25.6 billion student loan portfolio was primarily federally insured and was expected to amortize over approximately 20 years.
Key Financial Metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Total interest income | $158.9 million | $157.2 million | Up $1.7 million |
| Net interest income | $98.9 million | $98.8 million | Essentially flat |
| Net interest income after loan-loss provision | $96.4 million | $93.8 million | Up $2.6 million |
| Total other income | $125.9 million | $119.9 million | Up $6.0 million |
| Income before taxes | $114.9 million | $106.8 million | Up 7.6% |
| Net income attributable to Nelnet | $73.8 million | $68.1 million | Up 8.4% |
| Basic and diluted EPS | $1.59 | $1.46 | Up 8.9% |
| Operating cash flow | $88.6 million | $85.0 million | Up $3.6 million |
| Effective tax rate | 35.5% | 36.0% | Down 0.5 percentage points |
Net income excluding derivative market value and foreign currency adjustments was $72.6 million, or $1.56 per share, compared with $62.3 million, or $1.34 per share, in the prior-year quarter. Management uses this non-GAAP measure to improve comparability because derivative and foreign-currency valuation changes can be volatile.
Balance Sheet, Debt and Liquidity
- Total assets were $27.5 billion at March 31, 2014, compared with $27.8 billion at December 31, 2013.
- Student loans receivable, net, were $25.6 billion, down from $25.9 billion at year-end 2013.
- Bonds and notes payable were $25.6 billion, down from $26.0 billion at December 31, 2013. Substantially all debt was variable-rate.
- Cash and cash equivalents increased to $107.1 million from $63.3 million. Cash and investments totaled $273.3 million, excluding restricted cash and investments.
- The company had no borrowings under its $275.0 million unsecured line of credit at March 31, 2014, leaving the full amount available at that date.
- FFELP warehouse facilities had $772.4 million outstanding and approximately $977.6 million available within aggregate maximum financing capacity of $1.75 billion.
- Net cash provided by operating activities was $88.6 million. Investing activities provided $340.5 million, primarily reflecting loan repayments and investment sales, while financing activities used $385.3 million, primarily because debt repayments exceeded new debt issuance.
- Debt secured by student loan assets and related collateral totaled approximately $25.7 billion. Asset-backed securitizations funded approximately 96.9% of the FFELP portfolio.
Material Changes Versus the Prior Comparable Period
- Loan and guaranty servicing revenue increased to $64.8 million from $55.6 million, primarily because of higher volume under the U.S. Department of Education servicing contract.
- Tuition payment processing and campus commerce revenue increased to $25.2 million from $23.4 million, reflecting more payment plans, higher transaction volume, and new school customers.
- Enrollment services revenue declined to $22.0 million from $29.0 million because regulatory uncertainty in the for-profit college industry reduced customer marketing spending.
- Other income increased to $18.1 million from $9.4 million, including higher investment advisory fees and investment gains.
- The loan-loss provision declined to $2.5 million from $5.0 million, which management attributed primarily to improving economic conditions.
- Operating expenses were broadly stable at $107.4 million versus $106.9 million. Higher salaries and benefits were largely offset by lower enrollment-services costs.
- Core student loan spread declined to 1.44% from 1.50%, driven by recent consolidation loan acquisitions with lower margins but longer terms. Fixed-rate floor income, net of derivative settlements, increased to $37.8 million from $35.7 million.
- Serviced loan volume increased to $147.9 billion from $112.8 billion, while the Department of Education servicing contract generated $29.9 million of revenue versus $20.3 million.
Outlook, Commentary, Risks and Unusual Items
- The Department of Education notified Nelnet of its intent to extend the principal servicing contract through June 16, 2019; the extension remained subject to the availability of government funds.
- Federal budget provisions effective July 1, 2014 were expected to reduce payments to guaranty agencies for rehabilitation of defaulted FFELP loans. Management expected related rehabilitation collection revenue to decline.
- Management expected significant fixed-rate floor income to continue if short-term interest rates remained low. Q1 2014 fixed-rate floor income, net of hedging settlements, was $37.8 million.
- The company completed three asset-backed securitizations totaling $1.7 billion during the first four months of 2014 and expected to continue accessing securitization markets, subject to market conditions.
- On April 25, 2014, after the reporting date, Nelnet acquired $3.6 billion of FFELP student loans and related assets. The transaction required an aggregate cash purchase price of $139 million, funded with operating cash and the unsecured line of credit.
- On April 30, 2014, the company completed a $719.8 million securitization. At that date, warehouse borrowings were $1.1 billion and approximately $1.2 billion remained available.
- After the April acquisition, the unsecured line of credit had $160.0 million outstanding and $115.0 million available.
- Interest-rate, basis, repricing, liquidity, securitization-market, loan prepayment and default risks remain significant. A 100-basis-point increase in rates was estimated to reduce quarterly pre-tax income by $5.0 million after derivative settlement effects; a 30-basis-point adverse funding-index mismatch was estimated to reduce quarterly pre-tax income by $6.6 million.
- Forecasted future undiscounted cash flows from loans in asset-backed securitizations were approximately $2.17 billion, but the estimate was sensitive to prepayment and interest-rate assumptions.
- Non-federally insured loans delinquent 31 days or more represented 12.8% at March 31, 2014, versus 20.5% a year earlier.
- The company disclosed several putative class-action matters. No class had been certified, two matters were subject to settlements in principle for immaterial amounts, and management could not estimate reasonably possible losses beyond accrued amounts in a meaningful range.
- No material changes to previously disclosed risk factors were reported. Disclosure controls were deemed effective, and no material change in internal control over financial reporting was identified.
Important Facts for Investors to Verify
- Confirm the final accounting treatment, funding impact, and earnings contribution of the April 2014 $3.6 billion FFELP acquisition.
- Monitor renewal and funding availability for the Department of Education servicing contract, including the requirement for government funds.
- Assess the effect of July 2014 reductions in FFELP rehabilitation payments on servicing and guaranty-collection revenue.
- Reconcile the reported $25.6 billion debt balance with warehouse maturities, securitization obligations, variable-rate exposure, and available liquidity.
- Evaluate the sustainability of fixed-rate floor income and the sensitivity of earnings to interest rates, basis spreads, prepayments, and loan defaults.
- Track the decline in enrollment-services revenue and whether cost reductions can offset continuing pressure on margins.
- Review legal proceedings, repurchase obligations, derivative collateral requirements, and restrictions on dividends or subsidiary cash transfers.