Business Context and Reporting Period
Nelnet, Inc. provides student-loan servicing, tuition payment processing, education planning, campus commerce, asset management, and earns interest on a federally insured student-loan portfolio. This unaudited Form 10-Q covers the three and six months ended June 30, 2015, compared with the corresponding 2014 periods.
Financial Performance and Key Metrics
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total interest income | $177.7 million | $176.9 million | $351.9 million | $335.8 million |
| Net interest income after loan-loss provision | $102.9 million | $106.2 million | $203.5 million | $202.6 million |
| Total other income | $124.2 million | $125.3 million | $241.3 million | $251.3 million |
| Income before taxes | $111.3 million | $118.8 million | $213.8 million | $233.7 million |
| Net income attributable to Nelnet | $70.9 million | $75.0 million | $135.7 million | $148.8 million |
| Basic and diluted EPS | $1.54 | $1.61 | $2.94 | $3.20 |
| Operating cash flow | Not separately provided | Not separately provided | $192.0 million | $156.5 million |
Q2 net income attributable to Nelnet declined approximately 5.4%, while six-month net income declined approximately 8.8%. The effective tax rate was 36.3% in Q2 and 36.5% for the six-month period.
- Student-loan and guaranty servicing revenue decreased to $63.8 million in Q2 and $121.6 million year to date, primarily because of lower rehabilitation collection revenue.
- Tuition payment processing and campus commerce revenue increased to $27.7 million in Q2 and $62.4 million year to date, benefiting from the RenWeb acquisition and higher transaction volumes.
- Enrollment services revenue declined to $17.2 million in Q2 and $35.0 million year to date.
- Net fixed-rate floor income increased to $45.1 million in Q2 and $91.3 million year to date, compared with $43.6 million and $81.5 million, respectively, in 2014.
- Core student-loan spread was 1.41% in Q2 and for the first six months, compared with 1.46% and 1.45%, respectively, in the comparable 2014 periods.
- Total operating expenses increased to $115.8 million in Q2 and $231.1 million year to date, driven primarily by salaries, servicing volume, and amortization.
Financial Position, Debt, and Liquidity
- Student loans receivable were $28.1 billion at June 30, 2015, compared with $28.0 billion at December 31, 2014. The portfolio was approximately 95.6% federally insured loans.
- Total assets were $30.25 billion and total equity was $1.81 billion at June 30, 2015.
- Bonds and notes payable totaled $28.07 billion, compared with $28.03 billion at year-end 2014. The estimated fair value of this debt was $27.66 billion.
- Cash and cash equivalents were $182.3 million, and available-for-sale and trading investments had a fair value of $117.8 million.
- The $350.0 million unsecured line of credit had $100.0 million outstanding and $250.0 million available, with maturity on June 30, 2019.
- FFELP warehouse facilities had $1.19 billion outstanding and $809.3 million available. A new $275.0 million private education loan warehouse facility had $89.3 million outstanding and $185.7 million available.
- Operating cash flow was $192.0 million. Investing activities provided $324.3 million, while financing activities used $464.4 million, including debt repayments, dividends, and share repurchases.
- The company repurchased 1.17 million Class A shares for $51.0 million during the first six months, including 998,210 shares for $43.1 million in Q2. It paid $9.2 million in dividends, or $0.20 per share, during the period.
Material Changes, Outlook, and Unusual Items
- Federal budget changes reduced payments to guaranty agencies for rehabilitating defaulted FFELP loans. Rehabilitation collection revenue fell to $18.9 million for the six months from $30.7 million in 2014.
- A significant guaranty-servicing client, responsible for $21.3 million of related revenue in the first six months and $48.5 million in 2014, notified Nelnet that it would not renew its contract expiring October 31, 2015. Management expects this loss to tighten Student Loan and Guaranty Servicing margins.
- That segment’s before-tax operating margin fell to 19.4% in Q2 and 16.9% year to date, from 26.6% and 27.5%, respectively. Management expects further pressure as legacy commercial portfolios run off and Department of Education servicing becomes a larger portion of the mix.
- Nelnet acquired a residual interest in a securitization trust containing approximately $504.2 million of federally insured loans and $448.9 million of related debt. It also committed to purchase up to $150.0 million of private education loans from CommonBond; $64.2 million had been purchased by June 30.
- On August 3, 2015, after quarter-end, Nelnet acquired residual interests in two trusts containing approximately $1.5 billion of FFELP loans and related debt, funded with operating cash and the unsecured line of credit.
- Derivative market value and foreign-currency adjustments produced $11.9 million of Q2 income and $14.1 million of six-month income, but management excludes these volatile items in its non-GAAP presentation. Net income excluding these adjustments was $63.5 million in Q2 and $126.9 million year to date.
- Nelnet terminated $5.5 billion of 1:3 basis-swap notional during the first six months and received $51.9 million in proceeds.
- Management expects significant floor income to continue if short-term interest rates remain low. A rise in rates or wider basis between funding and asset indices could reduce earnings and forecasted portfolio cash flows.
- Forecasted undiscounted cash flows from FFELP loans financed in asset-backed securitizations were approximately $2.32 billion, including $618.4 million of overcollateralization. The forecast is sensitive to prepayments, defaults, interest rates, and funding spreads.
- Management stated that no material off-balance-sheet arrangements existed and that disclosure controls were effective as of June 30, 2015.
Key Investor Verification Items
- Assess the revenue and margin impact of the nonrenewal of the major guaranty-servicing contract after October 31, 2015.
- Review the sustainability of fixed-rate floor income and sensitivity to higher interest rates, LIBOR basis changes, and derivative settlements.
- Verify liquidity and refinancing capacity for warehouse facilities, particularly the private education facility’s June 2016 liquidity expiration and December 2016 final maturity.
- Evaluate the assumptions supporting the $2.32 billion securitization cash-flow forecast, including prepayment and interest-rate assumptions.
- Incorporate the August 3, 2015 acquisition of approximately $1.5 billion of FFELP loans and related debt in subsequent-period leverage and liquidity analysis.
- Review credit performance of the growing private education loan portfolio, including the increase in its allowance for loan losses.
- Consider concentration in the Department of Education servicing contract, regulatory and federal-budget changes, securitization-market access, operational systems, and derivative collateral requirements.
- Review the related-party $40.5 million investment in Hudl and the associated governance and valuation disclosures.