Nelnet, Inc. 2016 Form 10-K Summary
Business context and reporting period
Annual report for the fiscal year ended December 31, 2016, filed February 27, 2017. Nelnet provides student loan servicing, tuition payment processing and campus commerce solutions, communications services through Allo, and student loan asset management. The company operates through four reportable segments: Loan Systems and Servicing, Tuition Payment Processing and Campus Commerce, Communications, and Asset Generation and Management.
Nelnet no longer originates new FFELP loans following the 2010 legislative change, but continues to own and service existing portfolios. At year-end, it owned a $24.9 billion student loan portfolio and serviced $194.8 billion of loans for 7.6 million borrowers. The Department of Education accounted for approximately 20% of 2016 revenue.
Key financial metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net interest income | $372.6 million | $431.9 million | Down $59.3 million |
| Net interest income after loan-loss provision | $359.1 million | $421.7 million | Down $62.7 million |
| Loan systems and servicing revenue | $214.8 million | $239.9 million | Down $25.0 million |
| Tuition payment and campus commerce revenue | $132.7 million | $120.4 million | Up $12.4 million |
| Communications revenue | $17.7 million | Not applicable | Allo included for the first full year |
| Income before taxes | $398.8 million | $420.6 million | Down $21.8 million |
| Net income attributable to Nelnet | $256.8 million | $268.0 million | Down 4.2% |
| Diluted EPS | $6.02 | $5.89 | Up 2.2% |
| Operating cash flow | $325.3 million | $391.4 million | Down $66.1 million |
| Core student loan spread | 1.28% | 1.43% | Down 15 basis points |
GAAP results included a $71.7 million pre-tax gain from derivative market-value and foreign-currency adjustments. Excluding the related after-tax impact, management reported net income of $212.3 million, or $4.97 per share, compared with $250.2 million, or $5.50 per share, in 2015.
- Fixed-rate floor income, net of derivative settlements, was $152.3 million versus $184.7 million in 2015.
- The allowance for loan losses was $51.8 million at year-end; 2016 provision expense was $13.5 million.
- Cash and cash equivalents were $69.7 million, supplemented by $106.6 million of available-for-sale and trading investments.
- Carrying value of bonds and notes payable was $24.7 billion; total debt obligations before discounts and issuance costs were approximately $25.1 billion.
- No amounts were outstanding under the $350.0 million unsecured line of credit, which matured in 2021.
- Nelnet shareholders’ equity was $2.06 billion, and total assets were $27.18 billion.
Material changes versus prior comparable period
- Net interest income declined primarily because the student loan portfolio amortized, the core spread narrowed, floor income decreased, and funding costs increased. The average student loan balance fell to $26.9 billion from $28.6 billion.
- Loan systems and servicing revenue declined as two FFELP guaranty clients exited or terminated their relationships. Guaranty servicing and collection revenue fell to $9.6 million from $56.9 million, and no guaranty revenue remained after June 30, 2016.
- Department of Education servicing revenue increased to $151.7 million from $133.2 million, supported by portfolio mix, disability-discharge applications, and transferred borrowers.
- Tuition payment and campus commerce revenue increased due to higher tuition-plan activity, campus-commerce transaction volume, new school customers, and continued RenWeb contribution.
- Allo generated $17.7 million of revenue but a $5.9 million net loss and negative $2.2 million EBITDA as it expanded its fiber network, including the Lincoln, Nebraska build-out.
- Nelnet purchased only $356.1 million of student loans in 2016, compared with $4.0 billion in 2015, while the portfolio continued to run off.
- The company corrected an error in its loan premium and discount amortization method, recording an $8.2 million pre-tax increase in interest income, or $5.1 million after tax. Management concluded the impact on current and prior periods was immaterial.
- Nelnet redeemed certain debt securities before maturity and recognized $7.4 million of additional interest expense from writing off remaining debt discounts.
- Nelnet repurchased 2.0 million shares for $69.1 million and paid $21.2 million of dividends, or $0.50 per share.
Guidance, outlook, risks and unusual items
Management expected net income in 2017 through 2019 to decline from 2016 levels because of continued FFELP portfolio runoff and anticipated increases in interest rates. Management also expected Allo to remain dilutive for several years while it incurs network construction, depreciation, and customer-acquisition costs. Allo expected approximately $80 million of 2017 network capital expenditures, compared with $38.8 million in 2016.
The Department of Education servicing contract expires June 16, 2019. Nelnet and Great Lakes formed GreatNet Solutions, a 50/50 joint venture, and GreatNet submitted a Phase II response for the Department’s proposed single servicing-platform procurement in January 2017. Loss of the existing contract or failure to obtain a replacement could materially reduce revenue.
- FFELP interest income and third-party FFELP servicing revenue are expected to decline as the legacy portfolio pays down.
- Interest-rate basis and repricing mismatches could compress spreads, particularly because loan assets and funding reset on different indices and schedules.
- Higher rates could reduce floor income; derivatives may create significant mark-to-market volatility and collateral requirements.
- Three FFELP warehouse facilities had $1.7 billion outstanding and $447.6 million available. Liquidity provisions expire in 2017 and 2018, with final maturities from 2018 to 2019.
- Slower student loan prepayments, securitization-market disruption, rating downgrades, or weaker-than-expected portfolio cash flows could impair liquidity and refinancing access.
- The company is subject to extensive Department of Education, CFPB, federal, state, privacy, payment-processing, and telecommunications regulation.
- Cybersecurity, system outages, third-party vendor failures, litigation, servicing deficiencies, and potential loss of federal loan guarantees remain material operational risks.
- Allo faces construction, rights-of-way, competitive pricing, programming-cost, regulatory, and customer-adoption risks.
- Nelnet reported no material off-balance-sheet arrangements and stated that pending litigation and regulatory matters were not expected to have a material adverse effect based on current information.
Most important facts for investors to verify
- Whether GreatNet receives the replacement Department of Education servicing contract and how the procurement process affects Nelnet’s existing contract.
- The pace of FFELP portfolio runoff, student loan prepayments, and future opportunities to acquire additional portfolios.
- Sensitivity of net interest income and floor income to LIBOR spreads, interest-rate increases, and derivative valuations.
- Renewal and refinancing of warehouse liquidity facilities and compliance with related financial covenants.
- Allo’s progress toward breakeven, customer growth, network construction costs, and actual 2017 capital expenditures.
- Trends in servicing revenue after the loss of guaranty clients and the concentration represented by the Department of Education.
- Allowance adequacy for federally insured and private education loans, including the $1.2 billion rehabilitated-loan portfolio.
- Effects of securitization rating actions, maturity extensions, and access to asset-backed financing.
- Unrecognized tax benefits of $28.0 million and the company’s controlling-shareholder and related-party arrangements with Union Bank and Hudl.