Nelnet, Inc. 10-Q Summary: Quarter Ended September 30, 2007
Business Context and Reporting Period
This is a Quarterly Report (Form 10-Q) for Nelnet, Inc., a vertically-integrated education planning and financing company. The report covers the three and nine months ended September 30, 2007. The Company operates 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. The period was significantly impacted by the enactment of the College Cost Reduction Act of 2007, disruptions in the debt and secondary markets, and a strategic restructuring initiative.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2007 | Nine Months Ended Sep 30, 2007 | Units |
|---|---|---|---|
| Net Interest Income | $64,399 | $200,359 | Thousands |
| Provision for Loan Losses | $18,340 | $23,628 | Thousands |
| Total Other Income (Expense) | $100,124 | $264,756 | Thousands |
| Total Operating Expenses | $173,445 | $415,320 | Thousands |
| Net Income (Loss) | $(15,689) | $13,845 | Thousands |
| Diluted EPS (Net Income/Loss) | $(0.32) | $0.28 | Per Share |
| Student Loans Receivable (Net) | $26,596,123 | $26,596,123 | Thousands (Balance Sheet) |
| Bonds and Notes Payable | $28,234,147 | $28,234,147 | Thousands (Balance Sheet) |
| Cash and Cash Equivalents | $157,092 | $157,092 | Thousands (Balance Sheet) |
| Net Cash Provided by Operating Activities | N/A | $272,070 | Thousands |
Material Changes vs. Prior Period
- Net Income Decline: The Company reported a net loss of $15.7 million for the quarter ended September 30, 2007, compared to a net loss of $22.4 million in the same period of 2006. For the nine months, net income was $13.8 million, a significant decrease from $75.5 million in the prior year.
- Legislative Impact: The College Cost Reduction Act, signed into law on September 27, 2007, reduced special allowance payments and eliminated "Exceptional Performer" status. This resulted in a $39.4 million impairment charge on goodwill and intangible assets and a $15.7 million increase in the provision for loan losses during the quarter.
- Restructuring Charges: The Company initiated a restructuring plan to reduce costs, recording $15.0 million in charges during the quarter (total estimated charge of $20.5 million for 2007).
- Discontinued Operations: The sale of EDULINX Canada Corporation in May 2007 resulted in a net loss of $8.1 million, reported as discontinued operations.
- Derivative Gains: Significant volatility in "Other Income" was driven by derivative market value adjustments. The Company recorded a gain of $72.7 million from derivative fair value changes in the quarter, compared to a loss of $83.5 million in the prior year quarter.
- Core Spread Compression: The core student loan spread decreased to 1.05% for the quarter (from 1.34% in 2006) due to increased cost of funds from credit market disruptions and the elimination of 9.5% special allowance payments.
Guidance, Outlook, and Risks
- Restructuring Outlook: Management expects the restructuring plan to be substantially completed in the fourth quarter of 2007, with estimated annual expense savings of up to $25 million beginning in 2008.
- Legislative Risks: The College Cost Reduction Act is expected to reduce the annual yield on FFELP loans originated after October 1, 2007, by 70 to 80 basis points. Further legislative proposals could negatively impact revenues.
- Market Disruptions: Unprecedented disruptions in debt and secondary markets have increased borrowing costs and reduced liquidity. The Company's Secured Liquidity Notes facility is currently inactive due to market conditions, though warehouse capacity was increased via commercial paper conduits.
- Regulatory Investigations: The Company is cooperating with investigations by the New York Attorney General and the U.S. Department of Education regarding preferred lender lists and prohibited inducements. The Company has agreed to adopt codes of conduct and contribute to educational funds.
- Dividends: The Company paid a quarterly dividend of $0.07 per share in the third quarter and plans to continue quarterly payments subject to earnings and capital requirements.
Investor Verification Checklist
- Legislative Impact Quantification: Verify the long-term impact of the College Cost Reduction Act on the student loan spread and future yield projections.
- Derivative Valuation: Review the fair value adjustments of derivative instruments, which caused significant volatility in reported earnings but are excluded from management's "base net income" metric.
- Liquidity Position: Assess the sustainability of the loan portfolio growth given the disruption in the asset-backed securities market and the reliance on commercial paper conduits.
- Allowance for Loan Losses: Confirm the adequacy of the allowance given the elimination of the Exceptional Performer status and the resulting increase in risk share (from 99% to 97-98% reimbursement).
- Restructuring Execution: Monitor the realization of the projected $25 million in annual cost savings and the completion of the workforce reduction.
- Regulatory Outcomes: Track the status of ongoing investigations by state attorneys general and the Department of Education for potential fines or operational restrictions.