Business context and reporting period
Nelnet, Inc. filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2016. The company operates student loan asset management and servicing, tuition payment processing and campus commerce, communications through Allo, and other investment activities. The filing was signed August 4, 2016.
The largest business remains the asset generation and management portfolio, consisting primarily of federally insured student loans. Nelnet also acquired 92.5% of Allo Communications on December 31, 2015 and began reporting its operations in 2016.
Financial performance and condition
| Metric | Three months ended June 30, 2016 | Three months ended June 30, 2015 | Six months ended June 30, 2016 | Six months ended June 30, 2015 |
|---|---|---|---|---|
| Total interest income | $186.3 million | $177.7 million | $378.3 million | $351.9 million |
| Net interest income | $92.2 million | $105.1 million | $193.8 million | $207.7 million |
| Net interest income after loan-loss provision | $90.2 million | $102.9 million | $189.3 million | $203.5 million |
| Total other income | $58.4 million | $124.2 million | $143.3 million | $241.3 million |
| Income before taxes | $41.2 million | $111.3 million | $113.7 million | $213.8 million |
| Net income attributable to Nelnet | $26.2 million | $70.9 million | $74.1 million | $135.7 million |
| Basic and diluted EPS | $0.61 | $1.54 | $1.73 | $2.94 |
Operating expenses were $107.4 million in the second quarter and $218.9 million for the first six months, compared with $115.8 million and $231.1 million, respectively, in the prior-year periods. The reported effective tax rate was 36.51% for the quarter and 34.75% for the six months.
Management’s non-GAAP net income excluding derivative market value and foreign currency adjustments was $48.0 million, or $1.13 per share, in the second quarter and $109.7 million, or $2.56 per share, for the six months, compared with $63.5 million, or $1.38 per share, and $126.9 million, or $2.75 per share, respectively, in 2015.
- Net cash provided by operating activities was $175.2 million for the six months, compared with $192.0 million in 2015.
- Investing activities provided $1.63 billion, primarily from student loan repayments, while financing activities used $1.81 billion, primarily for debt repayment.
- Cash and cash equivalents were $59.3 million at June 30, 2016, compared with $63.5 million at December 31, 2015. Available-for-sale and trading investments had a fair value of $141.5 million.
- Student loans receivable were $26.54 billion, down from $28.32 billion at year-end 2015. The allowance for loan losses was $48.8 million.
- Bonds and notes payable were $26.40 billion, down from $28.11 billion at year-end 2015. The fair value of this debt was $25.51 billion.
- Total equity was $1.91 billion at June 30, 2016.
Material changes versus the prior comparable period
- Second-quarter net income attributable to Nelnet declined 63.1%, and six-month net income declined 45.4%. EPS declined to $0.61 from $1.54 for the quarter and to $1.73 from $2.94 for the six months.
- Derivative market value and foreign currency adjustments produced a $35.2 million pretax expense in the second quarter and a $57.4 million expense for the six months, versus pretax income of $11.9 million and $14.1 million, respectively, in the comparable 2015 periods. These noncash and market-sensitive items were the primary driver of the GAAP earnings decline.
- Net interest income declined despite higher interest income because interest expense increased to $94.1 million in the quarter and $184.5 million in the six months, compared with $72.6 million and $144.2 million, respectively. Management cited higher funding costs and lower average debt balances.
- Loan and guaranty servicing revenue declined to $54.4 million in the quarter and $106.7 million in the six months, primarily because guaranty servicing and collection contracts ended. The remaining guaranty customer exited the FFELP guaranty business on June 30, 2016, leaving no remaining guaranty servicing or collection revenue.
- Tuition payment processing and campus commerce revenue increased to $30.5 million for the quarter and $69.1 million for the six months, driven by more payment plans, transaction volume and school customers.
- Allo contributed $4.5 million of communications revenue in the quarter and $8.8 million for the six months, but generated net losses of $0.7 million and $1.1 million, respectively.
- Student loan servicing volume increased to $183.6 billion from $169.9 billion at June 30, 2015, while the owned student loan portfolio declined as repayments and portfolio runoff exceeded acquisitions.
- Core student loan spread declined to 1.29% in the second quarter from 1.41% in the prior-year quarter. Net fixed-rate floor income declined to $39.5 million from $45.1 million for the quarter and to $80.1 million from $91.3 million for the six months.
- Nelnet repurchased 1,611,041 Class A shares for $52.5 million during the six months and paid $10.2 million of dividends, or $0.24 per share.
Guidance, outlook, risks and unusual items
- Management expected Student Loan and Guaranty Servicing margins to continue decreasing following the loss of the remaining guaranty servicing and collection customer. The segment’s pretax margin was 25.1% in the quarter and 22.9% for the six months.
- GreatNet Solutions, a 50/50 joint venture with Great Lakes, was one of three entities selected to proceed to Phase II of the Department of Education’s procurement for a potential single federal student loan servicing solution. The current Department contract expires June 16, 2019; there is no assurance GreatNet will receive the new contract.
- Allo is expected to be dilutive to consolidated earnings in 2016 because of network capital expenditures, depreciation and customer acquisition costs. The company planned approximately $50 million of Allo network capital expenditures for 2016; Allo spent $12.0 million during the first six months.
- Management forecast approximately $2.37 billion of future undiscounted cash flows from FFELP loans funded in asset-backed securitizations. The forecast is sensitive to prepayments, defaults, forbearance, interest rates and the spread between one-month and three-month LIBOR. A doubling of assumed prepayment rates could reduce the forecast by approximately $260 million to $320 million.
- Three FFELP warehouse facilities had $1.81 billion outstanding and $313.3 million available. The private education loan warehouse facility had $221.1 million outstanding and $53.9 million available; its liquidity provisions expire October 28, 2016 and final maturity is April 28, 2017.
- A $75.0 million collateralized line of credit matures October 31, 2016. The company also had $105.0 million outstanding and $245.0 million available under a $350.0 million unsecured line of credit maturing October 30, 2020.
- Derivative liabilities were $101.8 million at June 30, 2016, with $110.7 million of collateral deposited with counterparties or a clearinghouse. Significant adverse market movements could require additional collateral.
- Key risks include basis and repricing risk, declining FFELP loan balances and floor income, refinancing and securitization-market access, government contract allocations, regulatory and cybersecurity risks, credit losses, Allo integration and expansion risk, litigation and compliance matters, and changes in government student loan programs.
- The filing states that there were no material changes to previously reported legal proceedings or risk factors and no material off-balance-sheet arrangements. Disclosure controls were considered effective.
Important facts for investors to verify
- Whether GreatNet ultimately wins the Department of Education servicing contract and how future federal servicing allocations affect revenue.
- The sustainability of student loan spreads and fixed-rate floor income as interest rates, LIBOR basis spreads and the loan portfolio change.
- Renewal or refinancing of warehouse liquidity provisions and the October 2016 maturities, including the private education loan facility and collateralized line of credit.
- The accuracy and sensitivity of the $2.37 billion securitized FFELP cash-flow forecast to prepayments, defaults and interest-rate assumptions.
- Allo’s customer growth, network buildout, capital requirements and path to profitability.
- The effect of derivative fair-value volatility and foreign currency remeasurement on GAAP earnings and liquidity requirements.
- The impact of the loss of guaranty servicing and collection revenue on recurring segment margins.
- The remaining authorization and pace of share repurchases, dividend capacity and restrictions under credit agreements and Hybrid Securities.