Nelnet, Inc. Form 10-Q Summary
Business context and reporting period
Nelnet is an education services company operating in asset management and finance, student loan servicing, tuition payment processing and campus commerce, and enrollment services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2014, compared with the same periods in 2013. Unless otherwise stated, amounts are in thousands except per-share data.
Financial performance and key metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Total interest income | $189.4 million | $160.2 million | $525.2 million | $476.9 million |
| Net interest income after loan-loss provision | $115.5 million | $99.9 million | $318.1 million | $290.1 million |
| Total other income | $133.8 million | $101.2 million | $385.1 million | $384.1 million |
| Income before taxes | $131.9 million | $93.5 million | $365.6 million | $356.9 million |
| Net income attributable to Nelnet | $85.2 million | $62.8 million | $234.0 million | $232.2 million |
| Basic and diluted EPS | $1.84 | $1.35 | $5.03 | $4.98 |
| Operating expenses | $117.4 million | $107.6 million | $337.6 million | $317.4 million |
- Q3 net income attributable to Nelnet increased approximately 36%; nine-month net income increased approximately 1%.
- Reported Q3 results benefited from a $29.0 million pretax derivative market-value and foreign-currency gain, compared with a $10.0 million loss in Q3 2013. Excluding these items, net income attributable to Nelnet was $67.2 million, or $1.45 per share, versus $69.0 million, or $1.48 per share, in Q3 2013.
- For the nine-month period, adjusted net income excluding derivative market-value and foreign-currency adjustments was $210.0 million, or $4.52 per share, compared with $202.5 million, or $4.35 per share.
- Net interest income increased as the student loan portfolio expanded and fixed-rate floor income rose. Net interest income after derivative settlements was $112.7 million in Q3 and $306.8 million for nine months.
- Fixed-rate floor income, net of derivative settlements, was $49.2 million in Q3 and $130.7 million for nine months, compared with $37.8 million and $109.6 million, respectively, in the prior-year periods.
- Core student loan spread was 1.53% in Q3 2014 versus 1.57% in Q3 2013; the nine-month spread was 1.48% versus 1.53%.
Financial position, cash flow, debt and liquidity
- Student loans receivable, net, were $28.7 billion at September 30, 2014, up from $25.9 billion at December 31, 2013. The portfolio’s gross balance was $28.9 billion and is expected to amortize over approximately 25 years.
- Total assets were $30.7 billion and total equity was $1.66 billion at September 30, 2014, compared with $27.8 billion and $1.44 billion, respectively, at year-end 2013.
- Bonds and notes payable were $28.7 billion, compared with $26.0 billion at December 31, 2013. Debt is predominantly variable rate and is principally secured by student loan assets.
- Cash and cash equivalents were $74.6 million. Cash and investments, including restricted and unrestricted investments as described by management, totaled $222.4 million.
- Net cash provided by operating activities was $263.1 million for the first nine months of 2014, compared with $202.6 million in the prior-year period. Investing activities used $557.5 million, while financing activities provided $305.7 million.
- The company had a $350.0 million unsecured line of credit available through June 30, 2019, with no borrowings outstanding at September 30, 2014. FFELP warehouse facilities had $787.0 million outstanding and $963.0 million available.
- Six asset-backed securitizations totaling approximately $3.2 billion were completed during the first nine months of 2014. Approximately 97.1% of the FFELP portfolio was funded through asset-backed securitizations at quarter-end.
- The allowance for loan losses was $52.0 million at September 30, 2014, compared with $55.1 million at December 31, 2013. The Q3 provision was $2.0 million, versus $5.0 million in Q3 2013.
- Nelnet repurchased 327,296 Class A shares for $13.3 million during the first nine months and paid $13.9 million in common dividends. A $0.10 per-share fourth-quarter dividend was declared.
Material changes versus the prior comparable period
- Loan interest increased 18% in Q3 and 10% for nine months, reflecting higher average loan balances, greater floor income and discount accretion, partly offset by higher consolidation rebate fees.
- Interest expense increased 30% in Q3 and 17% for nine months because of higher average debt and funding costs.
- Loan and guaranty servicing revenue declined to $52.7 million in Q3 from $64.6 million, primarily because of lower guaranty collection, rehabilitation and software-services revenue. Government servicing revenue increased to $31.2 million from $26.0 million.
- Tuition payment processing and campus commerce revenue increased 33% in Q3 and 19% for nine months, partly due to the RenWeb acquisition and higher payment-plan and campus-commerce activity.
- Enrollment services revenue was broadly stable in Q3 but declined 15% for nine months. The company discontinued inquiry-generation services effective August 29, 2014.
- Q3 operating expenses increased 9%, driven principally by salaries and benefits and amortization associated with business expansion and acquisitions.
- Nelnet acquired RenWeb on June 3, 2014, for initial consideration of $44.0 million plus $2.3 million of estimated contingent consideration. The acquisition added $37.2 million of intangible assets and $9.1 million of goodwill.
- The Department of Education extended Nelnet’s major servicing contract through June 16, 2019. Beginning September 1, 2014, pricing and loan-allocation metrics were revised, with allocation based on borrower satisfaction and repayment performance.
Guidance, outlook, risks and unusual items
- Management expects significant fixed-rate floor income to continue if short-term interest rates remain low, but higher rates could reduce floor income and compress margins. A 100-basis-point rate increase was estimated to reduce nine-month pretax income by $27.1 million after derivative-settlement effects.
- Management expects Student Loan and Guaranty Servicing margins to tighten as lower-margin Department servicing volume grows and legacy commercial programs run off. Q3 before-tax operating margin declined to 12.1% from 29.0%.
- Federal budget provisions effective July 1, 2014 reduced payments to guaranty agencies for rehabilitation activity, negatively affecting collection revenue.
- The Department projected 3.1 million new borrowers for the August 15, 2014-February 28, 2015 period; based on prior performance metrics, Nelnet was allocated 26% of new volume. Not-for-profit servicers are expected to receive 25% of new borrower accounts beginning in early 2015, reducing available allocation for private servicers.
- Key risks include interest-rate and basis risk, securitization and refinancing access, student-loan prepayments and defaults, changes in federal education programs, operational and information-system failures, regulatory compliance, and litigation.
- The Consumer Financial Protection Bureau was conducting an initial supervisory examination of Nelnet. The company could not estimate any potential financial or other impact from adverse regulatory action.
- Certain putative class-action matters remained unresolved or subject to appeal, although no class had been certified in the cases described and the company had accrued only an immaterial amount. Management stated that a meaningful estimate of additional reasonably possible losses could not be made.
- The filing states that operating results for the interim period are not necessarily indicative of full-year 2014 results and provides no formal quantitative earnings guidance.
Investor verification checklist
- Verify the sustainability of earnings excluding derivative and foreign-currency valuation adjustments.
- Monitor fixed-rate floor income, derivative settlements, LIBOR basis spreads and the sensitivity of earnings to higher interest rates.
- Review the Department of Education contract’s revised allocation metrics, pricing, renewal terms and competitive servicing volumes.
- Assess the availability and cost of asset-backed securitization and warehouse financing relative to the company’s loan-acquisition plans.
- Track student-loan delinquencies, prepayments, consolidation activity, allowance coverage and the $2.39 billion projected future securitization cash flow.
- Evaluate the integration and performance of RenWeb and the effect of acquisitions on margins and amortization.
- Follow CFPB examination developments, regulatory changes affecting guaranty agencies, and the status of pending litigation.