Nelnet, Inc. Form 10-Q Summary
Business context and reporting period
Nelnet, Inc. is a diversified education-focused company with businesses in student loan servicing, education technology and payment processing, communications, and loan asset management. The filing reports unaudited results for the three and six months ended June 30, 2019, compared with the corresponding 2018 periods. The company filed the Form 10-Q on August 8, 2019.
Financial performance and key metrics
| Metric | Three months ended June 30, 2019 | Three months ended June 30, 2018 | Six months ended June 30, 2019 | Six months ended June 30, 2018 |
|---|---|---|---|---|
| Total interest income | $246.8 million | $229.2 million | $497.4 million | $432.0 million |
| Net interest income | $59.8 million | $57.7 million | $118.6 million | $125.0 million |
| Provision for loan losses | $9.0 million | $3.5 million | $16.0 million | $7.5 million |
| Total other income | $182.1 million | $200.2 million | $388.3 million | $455.1 million |
| Income before income taxes | $30.9 million | $63.1 million | $83.9 million | $212.2 million |
| Net income attributable to Nelnet | $24.6 million | $49.4 million | $66.2 million | $163.4 million |
| Basic and diluted EPS | $0.61 | $1.21 | $1.65 | $3.99 |
GAAP net income attributable to Nelnet declined 50% for the quarter and 59% for the six-month period. The principal driver was derivative market value adjustments, which produced losses of $37.1 million in the quarter and $67.6 million year to date, compared with losses of $4.9 million and gains of $55.1 million, respectively, in the prior-year periods.
Excluding derivative market value adjustments, non-GAAP net income attributable to Nelnet was $52.8 million, or $1.32 per share, for the quarter and $117.6 million, or $2.92 per share, for the six months, compared with $53.2 million, or $1.30 per share, and $121.5 million, or $2.97 per share, respectively, in 2018.
- Loan servicing and systems revenue was $114.0 million for the quarter and $228.9 million year to date, compared with $114.5 million and $214.7 million in 2018.
- Education technology, services, and payment processing revenue increased to $60.3 million for the quarter and $139.5 million year to date, from $48.7 million and $109.0 million. Growth reflected the Tuition Management Systems acquisition, higher payment volumes, and organic customer growth.
- Communications revenue increased to $15.8 million for the quarter and $30.3 million year to date, from $10.3 million and $19.5 million. ALLO Communications remained loss-making but improved its EBITDA to $1.2 million for the quarter and $2.3 million year to date.
- Net interest income after provision for loan losses decreased to $50.8 million for the quarter and $102.6 million year to date, from $54.2 million and $117.5 million.
- The effective tax rate was 20.1% for the quarter and 21.0% year to date. Management expected a 2019 effective tax rate of approximately 21% to 23%.
Financial position, cash flow, debt, and liquidity
| Balance sheet metric | June 30, 2019 | December 31, 2018 |
|---|---|---|
| Total assets | $24.22 billion | $25.22 billion |
| Loans receivable, net | $21.46 billion | $22.38 billion |
| Cash and cash equivalents | $84.4 million | $121.3 million |
| Restricted cash, including amounts due to customers | $969.6 million | $1.07 billion |
| Bonds and notes payable | $21.29 billion | $22.22 billion |
| Total equity | $2.33 billion | $2.31 billion |
- Net cash used in operating activities was $17.8 million for the six months, compared with $71.6 million provided in 2018. The decline reflected lower net income, $77.2 million of net derivative clearinghouse payments, and a $90.7 million reduction in amounts due to customers.
- Investing activities provided $855.5 million, primarily from loan repayments and claims exceeding loan purchases.
- Financing activities used $976.0 million, including $2.01 billion of debt repayments, $14.4 million of dividends, and $40.0 million of share repurchases, partially offset by $1.09 billion of debt issuance.
- Cash, cash equivalents, and restricted cash totaled $1.05 billion at June 30, 2019, down from $1.19 billion at December 31, 2018.
- The $382.5 million unsecured line of credit had $260.0 million outstanding and $122.5 million available. A new $22.0 million secured line of credit had $5.0 million outstanding and $17.0 million available.
- Two FFELP warehouse facilities had $777.3 million outstanding and $222.7 million available. The consumer loan warehouse facility had $117.1 million outstanding and $82.9 million available.
- The company held $52.9 million of available-for-sale student loan asset-backed securities and $15.0 million par value of its own asset-backed securities.
Material changes versus the prior comparable period
- The loan portfolio declined to $21.6 billion from $22.5 billion at December 31, 2018 and $22.9 billion at June 30, 2018, reflecting repayments, consolidation activity, and portfolio runoff.
- Consumer loan purchases rose sharply to $184.8 million in the first six months, compared with $37.6 million in the prior-year period. The related provision for consumer loan losses increased to $12.0 million from $3.5 million.
- Core loan spread declined to 1.21% for the quarter and 1.25% year to date, from 1.29% in both 2018 periods. The average loan balance also declined to $21.8 billion for the quarter from $23.0 billion.
- Loan servicing and systems operating margin improved to 17.5% for the quarter and 17.2% year to date, from 13.8% and 16.0%, primarily due to Great Lakes integration efficiencies.
- Education technology, services, and payment processing before-tax operating margin increased to 24.8% for the quarter and 35.1% year to date, from 19.8% and 29.8%, due to operating leverage and cost reductions.
- ALLO’s net loss improved to $4.9 million for the quarter and $9.7 million year to date, from $8.1 million and $15.1 million. Revenue growth and the elimination of certain intercompany interest expense contributed to the improvement.
- The company repurchased 720,467 Class A shares for $40.0 million during the first six months and had 4.8 million shares remaining under its repurchase authorization at June 30, 2019. The quarterly dividend was $0.18 per share, and a third-quarter dividend of $0.18 was declared.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected the FFELP loan portfolio to amortize over approximately 20 years, with a weighted-average remaining life of 8.7 years. Management also stated that income from the asset generation and management segment will decline over time as the portfolio runs off.
- The company estimated approximately $2.13 billion of future undiscounted cash flows from loans in asset-backed securitizations as of June 30, 2019. This forecast depends materially on prepayments, defaults, forbearance, and future interest rates.
- The company had extinguished $93.0 million of notes in one Turbo Transaction and expected to extinguish approximately $579 million of additional notes in the third quarter. These transactions were expected to release approximately $909 million of loans and accrued interest, generate approximately $300 million of cash after refinancing, and produce approximately $15 million of third-quarter expense.
- ALLO had $27.0 million of capital expenditures in the first six months and expected approximately $25 million of additional network capital expenditures during the remainder of 2019, subject to customer demand.
- Federal student loan servicing contracts for Nelnet Servicing and Great Lakes were extended to December 15, 2019. Nelnet Servicing’s Authority to Operate expired August 30, 2019 and was under review. The company could not predict the outcome of the review or the Department of Education’s NextGen servicing procurement process.
- Approximately $19.6 billion of FFELP loan assets and $19.4 billion of FFELP asset-backed debt were indexed to LIBOR. The expected phaseout of LIBOR after 2021 creates uncertainty regarding funding costs, net interest income, asset values, derivatives, and securitization cash flows.
- Other principal risks include interest-rate and basis risk, derivative collateral requirements, loan defaults and prepayments, financing-market access, cybersecurity and operational failures, regulatory changes, litigation, and the ability to expand ALLO’s fiber network.
- The company adopted ASC Topic 842, Leases, on January 1, 2019, recognizing $31.8 million of operating lease right-of-use assets and $32.8 million of operating lease liabilities at June 30, 2019. The adoption also resulted in deconsolidation of certain sale-leaseback entities.
- Beginning January 1, 2020, the company will adopt the current expected credit loss standard. Management expects the standard to increase the allowance for loan losses but had not quantified the impact.
- On July 26, 2019, the company entered into a $16.0 million, 14% promissory note with Hudl, whose CEO and co-founder serves on Nelnet’s board. The note was subordinated to existing Hudl obligations held by Union Bank and Trust Company, a related party.
Most important facts for an investor to verify
- Whether federal servicing contracts, Nelnet Servicing’s Authority to Operate, and the NextGen procurement process preserve the company’s servicing volumes and revenue.
- The actual third-quarter cost and cash proceeds from the planned Turbo Transaction extinguishments.
- Trends in consumer loan purchases, delinquencies, charge-offs, and provisions for loan losses.
- The sustainability of core loan spread and the effect of portfolio runoff, floor income, interest rates, and LIBOR replacement.
- Liquidity after debt repayments, share repurchases, dividends, ALLO capital expenditures, and additional loan acquisitions.
- The impact of the current expected credit loss standard upon adoption on January 1, 2020.
- Whether ALLO can achieve positive earnings while funding continued network expansion and customer acquisition.