NELNET INC quarterly report, Q1 FY2015

Nelnet, Inc. Form 10-Q Summary

Business context and reporting period

Nelnet provides student-loan servicing, tuition payment processing, education planning, enrollment services, and asset-management products. It also earns interest income from a federally insured student-loan portfolio. This unaudited report covers the three months ended March 31, 2015, compared with the three months ended March 31, 2014. Dollar amounts are in thousands unless otherwise stated.

Key financial metrics

Metric	Q1 2015	Q1 2014	Change
Total interest income	$174.1 million	$158.9 million	Up $15.3 million
Net interest income	$102.6 million	$98.9 million	Up $3.7 million
Net interest income after loan-loss provision	$100.6 million	$96.4 million	Up $4.2 million
Total other income	$117.1 million	$125.9 million	Down $8.8 million
Operating expenses	$115.2 million	$107.4 million	Up $7.9 million
Income before income taxes	$102.4 million	$114.9 million	Down $12.5 million
Net income attributable to Nelnet	$64.8 million	$73.8 million	Down $9.0 million
Basic and diluted EPS	$1.40	$1.59	Down $0.19
Net cash provided by operating activities	$129.3 million	$88.6 million	Up $40.7 million

Net income attributable to Nelnet excluding derivative market value and foreign-currency adjustments was $63.4 million, or $1.37 per share, compared with $72.6 million, or $1.56 per share, in the prior-year quarter. The effective tax rate increased to 36.75% from 35.50%.

Balance sheet, debt, and liquidity

Student loans receivable were $27.9 billion at March 31, 2015, compared with $28.0 billion at December 31, 2014. The portfolio included $28.0 billion of gross loans, net of discounts and allowances.
Total assets were $30.0 billion and total liabilities were $28.2 billion at March 31, 2015.
Bonds and notes payable were $27.8 billion, down from $28.0 billion at December 31, 2014. Debt was substantially variable-rate, with carrying amounts of $28.2 billion before discounts.
Cash and cash equivalents were $100.0 million, supplemented by $146.8 million of available-for-sale and trading investments.
The $350.0 million unsecured line of credit had no borrowings outstanding and was fully available through June 30, 2019.
FFELP warehouse facilities had $1.0 billion outstanding and $989.7 million available under aggregate commitments of $2.0 billion. The company had provided $55.2 million of equity support.
The company completed two asset-backed securitizations totaling approximately $1.3 billion during the quarter.
Forecast future undiscounted cash flows from FFELP loans funded in asset-backed securitizations were approximately $2.27 billion, including $588.5 million of overcollateralization. Management noted that this estimate depends on prepayment, default, interest-rate, and other assumptions.

Cash flow and capital allocation

Operating cash flow increased to $129.3 million from $88.6 million. Investing activities provided $31.8 million, versus $340.5 million in the prior-year period, while financing activities used $191.6 million, versus $385.3 million. Cash decreased by $30.4 million during the quarter to $100.0 million.

The company acquired $836.1 million of student loans and purchased $49.95 million of investments and notes receivable.
Debt repayments of $1.46 billion exceeded new debt issuance of $1.29 billion.
The company repurchased 175,798 Class A shares for $7.9 million, or $45.16 per share.
The company paid a $0.10 per-share quarterly dividend, totaling $4.6 million, and declared a second-quarter dividend of $0.10 per share.
The company repurchased $11.9 million par value of Hybrid Securities and recognized a $2.5 million gain.

Material changes versus the prior comparable period

Interest income rose primarily because of a larger average student-loan portfolio and higher fixed-rate floor income, but interest expense also increased because of higher average debt and funding costs.
Loan and guaranty servicing revenue declined to $57.8 million from $64.8 million. Rehabilitation collection revenue fell to $7.4 million from $13.4 million following federal budget reductions affecting guaranty-agency payments.
Government servicing revenue increased to $32.4 million from $29.9 million. The Department of Education servicing contract covered approximately $140.8 billion of loans and 5.9 million borrowers at March 31, 2015.
Tuition payment processing and campus commerce revenue increased to $34.7 million from $25.2 million, primarily due to the RenWeb acquisition and higher customer and transaction volumes.
Enrollment services revenue declined to $17.9 million from $22.0 million, including the discontinuation of inquiry-generation services in August 2014.
Other income declined to $6.9 million from $18.1 million, mainly because of lower investment advisory fees and investment gains.
Salaries and benefits increased to $61.1 million from $52.5 million, while loan servicing fees increased to $7.7 million from $5.4 million.
Asset Generation and Management net income increased to $49.6 million from $45.4 million. However, the core student-loan spread declined to 1.41% from 1.44%, primarily because recent consolidation-loan acquisitions carried lower margins.
Net fixed-rate floor income increased to $46.2 million from $37.8 million because of additional loans earning floor income and lower derivative settlement payments.
Student Loan and Guaranty Servicing net income fell to $6.3 million from $13.9 million, and its before-tax operating margin declined to 14.3% from 28.5%.
Tuition Payment Processing and Campus Commerce net income increased to $7.4 million from $5.6 million; its before-tax margin was 34.3%, or 40.5% excluding intangible amortization.

Guidance, outlook, risks, and unusual items

Management expects fixed-rate floor income to remain significant if short-term interest rates remain low, but higher rates could reduce floor income and compress margins before loans reset to variable rates.
Management expects Student Loan and Guaranty Servicing margins to tighten as Department of Education servicing volumes grow and legacy commercial portfolios run off. Federal budget reductions are expected to continue pressuring guaranty-collection revenue.
The company intends to use liquidity for FFELP and private education-loan acquisitions, strategic investments, debt and share repurchases, and dividends.
Nelnet committed to purchase up to $150.0 million of private education loans from CommonBond; $15.2 million had been purchased by March 31, 2015. The company was developing a private-loan warehouse facility, and failure to obtain financing could limit purchases and adversely affect liquidity.
Interest-rate, basis, repricing, foreign-currency, securitization, prepayment, default, and funding-market risks remain material. A hypothetical 100-basis-point rate increase was estimated to reduce quarterly pre-tax net income by $11.8 million after derivative-settlement effects.
The company’s $27.9 billion loan portfolio is expected to amortize over approximately 25 years. FFELP loans represented the substantial majority of the portfolio, and no new FFELP loans may be originated under the program after July 1, 2010.
The Consumer Financial Protection Bureau was conducting its initial supervisory examination of large nonbank student-loan servicers, including Nelnet. Potential penalties, settlements, regulatory actions, or required practice changes could not be estimated.
An appeal remained pending in the Keating Telephone Consumer Protection Act litigation. The company stated that no class had been certified and that a reasonably possible loss could not be estimated.
The company made a $40.5 million equity investment in Hudl, a related-party investment involving a company director and the executive chairman.
Management reported effective disclosure controls and no material changes to internal control over financial reporting. No material changes were reported to the risk factors in the 2014 Form 10-K.

Most important facts for investors to verify

Whether servicing-contract volumes and pricing offset continued declines in guaranty rehabilitation and legacy FFELP servicing revenue.
The sustainability of $46.2 million of quarterly net fixed-rate floor income and the effect of changing interest rates on loan spreads and derivatives.
Actual cash generation and funding availability as warehouse facilities mature and the company continues acquiring loans.
The assumptions supporting the $2.27 billion forecast of future FFELP securitization cash flows, particularly prepayment rates, basis spreads, defaults, and interest rates.
Credit performance, private-loan delinquencies, repurchase obligations, and the $51.2 million allowance for loan losses.
The outcome and potential financial impact of the CFPB examination and pending litigation.
The terms, governance, and valuation of the $40.5 million related-party Hudl investment.
The effect of continued margin pressure in Student Loan and Guaranty Servicing and lower core spreads in Asset Generation and Management.