Nelnet, Inc. 2019 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
Nelnet, Inc. reported unaudited results for the three months ended March 31, 2019, compared with the three months ended March 31, 2018. The company operates student loan servicing and systems, education technology and payment processing, communications, and education loan asset management businesses. Its $21.9 billion loan portfolio consists primarily of federally insured student loans.
Key Financial Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total interest income | $250.6 million | $202.9 million | Up 23.5% |
| Net interest income | $58.8 million | $67.3 million | Down 12.6% |
| Net interest income after loan-loss provision | $51.8 million | $63.3 million | Down 18.2% |
| Total other income | $206.1 million | $254.9 million | Down 19.1% |
| Income before taxes | $53.0 million | $149.2 million | Down 64.4% |
| Net income attributable to Nelnet | $41.6 million | $113.9 million | Down 63.5% |
| Basic and diluted EPS | $1.03 | $2.78 | Down $1.75 |
| Operating cash flow | $(139.7) million | $58.0 million | Declined $197.6 million |
GAAP results were significantly affected by a $30.6 million derivative market value loss in 2019, compared with a $60.0 million derivative market value gain in 2018. Excluding derivative market value adjustments, net income attributable to Nelnet was $64.8 million, or $1.61 per share, compared with $68.3 million, or $1.67 per share, in the prior-year quarter.
Revenue increased in the fee-based businesses: loan servicing and systems revenue rose to $114.9 million from $100.1 million; education technology, services, and payment processing revenue rose to $79.2 million from $60.2 million; and communications revenue rose to $14.5 million from $9.2 million.
The company’s core loan spread increased slightly to 1.30% from 1.29%, while the average loan balance increased to $22.3 billion from $21.9 billion. The loan portfolio had a weighted average remaining life of 8.7 years and is expected to amortize over approximately 20 years.
As of March 31, 2019, total assets were $24.7 billion, including $21.9 billion of net loans receivable. Total debt carrying value was $21.8 billion, down from $22.2 billion at December 31, 2018. Total equity was $2.3 billion. Cash and cash equivalents were $74.9 million, supplemented by $52.7 million of available-for-sale investments and $62.5 million of availability under the unsecured line of credit.
Material Changes Versus the Prior Comparable Period
- Interest income increased because of higher loan yields, higher interest rates, and a larger average loan balance, but interest expense increased more rapidly because of higher funding costs and greater average debt.
- The provision for loan losses increased to $7.0 million from $4.0 million, primarily because of increased consumer loan purchases. The consumer loan provision rose to $5.0 million from $2.0 million.
- Derivative results shifted from a $60.0 million market value gain to a $30.6 million loss, substantially reducing GAAP earnings.
- Other income declined because 2018 included significant investment gains, while 2019 included a $0.4 million net loss on investments and notes receivable.
- Loan servicing and systems results benefited from a full quarter of Great Lakes operations, compared with approximately two months in Q1 2018. The segment’s pretax operating margin declined to 17.0% from 18.6% as the company incurred additional integration, procurement, and systems-development costs.
- Education technology results benefited from the November 2018 Tuition Management Systems acquisition, operating leverage, and the termination of a proprietary payment-processing platform. Pretax operating margin increased to 43.0% from 37.8%.
- Communications revenue increased, and the segment’s net loss narrowed to $4.8 million from $7.0 million. ALLO generated positive EBITDA of $1.0 million versus negative EBITDA of $1.8 million.
- Operating cash flow turned negative, primarily because of derivative collateral payments, increases in accrued interest receivable and other assets, timing of accounts receivable collections, and a $153.2 million reduction in amounts due to customers.
- The company repurchased 301,327 Class A shares for $16.4 million and paid $7.2 million in dividends, or $0.18 per share.
Guidance, Outlook, Risks, and Unusual Items
- Management expects a 2019 effective tax rate of approximately 21% to 23%.
- Nelnet and Great Lakes Department of Education servicing contracts were scheduled to expire June 16, 2019. The Department provided a non-binding indication of intent to extend them through December 15, 2019, but a formal extension required a signed modification. Nelnet Servicing’s Authority to Operate was also under review and scheduled to expire May 31, 2019.
- The company submitted a response for the NextGen Enhanced Processing Solution and intended to participate in teams responding to other NextGen components. The timing and outcome of the procurement were uncertain.
- Management expects additional costs for government-loan platform integration, Department procurement activities, and new private education and consumer loan systems, which may reduce future loan-servicing margins.
- ALLO expects approximately $40 million of additional network capital expenditures during the remainder of 2019. Management expects the communications segment to remain dilutive to consolidated earnings while it expands its network and customer base.
- Estimated future undiscounted cash flows from the asset-backed securitization portfolio were approximately $2.16 billion, including approximately $1.14 billion expected through 2023. The estimate increased from $2.10 billion at December 31, 2018 but depends on prepayment, default, interest-rate, and other assumptions.
- Approximately 95.3% of the loan portfolio was included in asset-backed securitizations. The company had $792.7 million outstanding under FFELP warehouse facilities, with $207.3 million available, and $63.7 million outstanding under a consumer-loan warehouse facility, with $36.3 million available.
- Key risks include interest-rate and basis risk, derivative collateral requirements, refinancing and securitization-market access, potential replacement of LIBOR after 2021, loan prepayments and defaults, changes in federal student-loan programs, cybersecurity, regulatory requirements, litigation, and the outcome of the Department’s servicing procurement.
- The company adopted ASC Topic 842 for leases on January 1, 2019, recognizing $32.8 million of right-of-use assets and $33.7 million of lease liabilities and deconsolidating certain previously consolidated sale-leaseback entities.
- Beginning January 1, 2020, the expected-credit-loss standard is expected to increase the allowance for loan losses; the filing states that the impact remains under evaluation.
Important Facts for Investors to Verify
- Confirm whether the Department of Education formally extended the Nelnet and Great Lakes servicing contracts and renewed Nelnet Servicing’s Authority to Operate.
- Track the outcome and timing of the NextGen servicing procurement and its potential effect on servicing volumes and revenue.
- Reconcile GAAP earnings with management’s derivative-adjusted results and monitor future derivative fair-value volatility and collateral requirements.
- Assess consumer-loan growth, delinquencies, charge-offs, and the adequacy of the $61.8 million allowance for loan losses.
- Monitor warehouse-facility renewals, securitization execution, debt maturities, and available liquidity.
- Evaluate assumptions underlying the $2.16 billion securitization cash-flow forecast, particularly prepayment rates, basis spreads, interest rates, and LIBOR transition effects.
- Verify ALLO’s network capital spending, customer penetration, EBITDA progression, and continuing earnings dilution.
- Consider the effect of the 2020 expected-credit-loss accounting change on equity, earnings, and regulatory or financing metrics.