Business Context and Reporting Period
Nelnet, Inc. filed this unaudited Form 10-Q for the three months ended March 31, 2018. The company operates student loan servicing and systems, education technology and payment processing, communications, and student loan asset management businesses. The reporting period includes Great Lakes Educational Loan Services from its February 7, 2018 acquisition date.
Financial Results and Key Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Interest income | $202.9 million | $183.8 million | +10.4% |
| Net interest income | $67.3 million | $76.9 million | -12.5% |
| Net interest income after loan-loss provision | $63.3 million | $75.9 million | -16.6% |
| Total other income | $254.9 million | $128.1 million | +99.0% |
| Income before taxes | $149.2 million | $76.7 million | +94.5% |
| Net income attributable to Nelnet | $113.9 million | $50.0 million | +127.7% |
| Basic and diluted EPS | $2.78 | $1.18 | +135.6% |
| Operating cash flow | $58.0 million | $47.8 million | +21.2% |
- The effective tax rate declined to 24.0% from 36.5%, primarily due to the Tax Cuts and Jobs Act.
- GAAP earnings included $60.0 million of derivative market-value gains, compared with a $1.2 million derivative market-value loss in the prior-year period, and $6.8 million of net gains on investments.
- Management’s non-GAAP net income excluding derivative market-value and foreign-currency adjustments was $68.3 million, or $1.67 per share, versus $52.2 million, or $1.23 per share, in Q1 2017.
- Core loan spread increased to 1.29% from 1.23%; excluding consumer loans, Q1 2018 core loan spread was 1.25%.
- Education technology, services, and payment processing revenue increased to $60.2 million from $56.0 million; its pre-tax operating margin declined to 37.8% from 40.5%.
- Loan servicing and systems revenue increased to $100.1 million from $54.2 million, substantially reflecting the Great Lakes acquisition. The segment’s pre-tax operating margin was 18.6% in both periods.
- Communications revenue increased to $9.2 million from $5.1 million, while the segment’s net loss widened to $7.0 million from $2.8 million.
Financial Position, Debt, and Liquidity
- Total assets were $23.90 billion at March 31, 2018, compared with $23.96 billion at December 31, 2017. Loans receivable were $21.56 billion, down from $21.81 billion.
- Total debt carrying value was $21.23 billion, compared with $21.36 billion at year-end. Debt fair value was $21.48 billion.
- Cash and cash equivalents were $69.3 million. Restricted cash was $727.5 million, and cash, cash equivalents, and restricted cash totaled $925.3 million.
- The company had $150.0 million outstanding and $200.0 million available under its $350.0 million unsecured line of credit at March 31, 2018.
- FFELP warehouse facilities had $339.1 million outstanding and $660.9 million available under aggregate capacity of $1.0 billion at March 31, 2018.
- Financing cash flows used $177.1 million, including $901.0 million of debt repayments, partly offset by $756.7 million of new debt issuance.
- Investing cash flow was $102.3 million, including $109.2 million spent on the Great Lakes acquisition and $607.9 million of loan purchases.
- Management forecast approximately $1.96 billion of future undiscounted cash flows from the asset-backed securitization portfolio, including approximately $1.34 billion over the next five years. This forecast depends on prepayment, default, and interest-rate assumptions.
Material Changes, Outlook, and Unusual Items
- Nelnet acquired 100% of Great Lakes for $150.0 million in cash. Great Lakes contributed $43.5 million of revenue and $11.9 million of net income from acquisition through March 31, 2018. The transaction added $72.3 million of identifiable intangible assets and $19.7 million of goodwill.
- The company acquired the remaining 50% of GreatNet Solutions, reducing shareholders’ equity by $19.1 million, including a $13.4 million reduction in retained earnings.
- Government servicing contracts for Nelnet Servicing and Great Lakes were scheduled to expire June 16, 2019. Nelnet and Great Lakes submitted a joint response to the Department of Education’s Phase One servicing procurement on April 17, 2018. The filing does not establish whether either company will receive future awards.
- As of March 31, 2018, Nelnet and Great Lakes serviced approximately $470.8 billion of loans, compared with $211.4 billion at December 31, 2017.
- ALLO incurred $17.9 million of capital expenditures in Q1 and expected approximately $65.0 million of additional network expenditures for the remainder of 2018. Management expected the communications segment to remain dilutive to consolidated earnings during the network build-out.
- From April 1 through May 8, 2018, the company acquired $1.86 billion of unsecuritized federally insured student loans. Warehouse capacity was increased to $2.3 billion; as of May 8, $2.1 billion was outstanding and $0.2 billion remained available.
- The company adopted ASC Topic 606 using full retrospective application, presenting certain payment-processing revenue gross with related direct costs separately. The filing states that adoption did not materially affect net income or cash flows.
- The company paid a $0.16-per-share quarterly dividend and repurchased 222,174 Class A shares for $11.4 million. A second-quarter dividend of $0.16 per share was declared.
- Key risks include interest-rate and basis risk, derivative collateral requirements, loan prepayments and defaults, funding and securitization-market access, declining FFELP loan balances, federal servicing-contract renewals, cybersecurity, regulatory and litigation exposure, and the integration and expected benefits of Great Lakes.
Important Facts for Investors to Verify
- Assess recurring earnings excluding the $60.0 million derivative market-value gain, investment gains, acquisition-related contributions, and tax-rate benefits.
- Monitor the Department of Education servicing procurement and the June 2019 contract expirations, which could materially affect servicing revenue and loan volumes.
- Evaluate liquidity after the subsequent $1.86 billion loan purchases, including warehouse utilization, unsecured-line availability, and future securitization access.
- Review sensitivity to interest-rate movements, LIBOR basis spreads, declining fixed-rate floor income, and potential derivative collateral calls.
- Evaluate Great Lakes integration, amortization of acquired intangible assets, and the sustainability of its contribution to loan-servicing results.
- Assess ALLO’s continuing capital requirements, operating losses, and expected 2018 network expenditures.
- Review the company’s assumptions underlying the $1.96 billion securitization cash-flow forecast, particularly prepayment and interest-rate scenarios.