Nelnet, Inc. 2013 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2013; filed February 27, 2014. The filing is an annual report, not a standalone quarterly filing, although fourth-quarter information is provided.
Business context
Nelnet is an education services company operating in four principal areas: student loan and guaranty servicing, tuition payment processing and campus commerce, enrollment services, and asset generation and management. Its asset portfolio is primarily composed of federally guaranteed FFELP student loans, while growth is increasingly dependent on fee-based servicing and education technology businesses.
- Student loan portfolio: $25.9 billion at year-end, amortizing over approximately 20 years; 99.7% was federally insured.
- Student loans serviced: $138.2 billion for nearly 7 million borrowers, including $110.5 billion for 5.3 million borrowers under the Department of Education contract.
- The company no longer originates new FFELP loans following the 2010 federal legislative changes, but continues to acquire existing portfolios.
Financial performance and key metrics
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Net interest income | $413.9 million | $345.3 million | +$68.6 million |
| Net interest income after loan-loss provision | $395.4 million | $323.8 million | +$71.6 million |
| Loan and guaranty servicing revenue | $243.4 million | $209.7 million | +16.1% |
| Tuition payment processing and campus commerce revenue | $80.7 million | $74.4 million | +8.4% |
| Enrollment services revenue | $98.1 million | $117.9 million | -16.8% |
| Net income attributable to Nelnet | $302.7 million | $178.0 million | +70.0% |
| Basic and diluted EPS | $6.50 | $3.76 | +73.0% |
| Operating cash flow | $387.2 million | $299.3 million | +$87.9 million |
- Income before taxes was $465.5 million, compared with $274.5 million in 2012; the effective tax rate was 34.8%.
- Core student loan spread increased to 1.54% from 1.44%, primarily because of a more favorable relationship between asset and funding indices.
- Fixed-rate floor income, net of derivative settlements, was $148.4 million, compared with $145.3 million in 2012.
- Total operating expenses declined modestly to $429.0 million from $433.6 million. Depreciation and amortization fell to $18.3 million from $33.6 million as certain intangible assets became fully amortized.
- Year-end assets were $27.8 billion, bonds and notes payable were $26.0 billion, and Nelnet shareholders’ equity was $1.44 billion. The shareholders’ equity-to-assets ratio increased to 5.20% from 4.38%.
- Cash and investments totaled $255.3 million, including $63.3 million of cash and cash equivalents and $192.0 million of investments.
Material changes versus the prior comparable period
- Profitability improved substantially: Net income benefited from higher student loan net interest income, stronger fee-based operating performance, increased investment advisory income, lower financing costs, and higher debt-repurchase gains.
- Servicing expanded: Loan servicing revenue rose with increased Department of Education volume and higher guaranty collection revenue. Serviced loan volume increased from $97.5 billion to $138.2 billion.
- Enrollment Services weakened: Revenue declined due to regulatory uncertainty affecting marketing to prospective students at for-profit schools and customer shifts toward lower-cost marketing channels. The segment nevertheless returned to a small profit, with net income of $0.6 million versus a $3.7 million loss.
- Tuition processing improved: Revenue and net income increased as the number of managed tuition payment plans grew and operating efficiencies improved.
- Funding profile changed: The Department of Education Conduit Program was fully refinanced and paid down in February 2013. The company completed five asset-backed securitizations totaling $3.2 billion during 2013.
- Capital returns were lower than in 2012: Nelnet repurchased 393,259 shares for $13.1 million and paid $18.6 million in dividends, versus 806,023 shares repurchased and $66.2 million of dividends in 2012, which included a $1.00 special dividend.
Guidance, outlook, risks and unusual items
- The Department of Education notified Nelnet of its intent to extend the major servicing contract through June 2019, subject to availability of government funds. The contract represented 23% of fee-based revenue in 2013 and generated $97.4 million of revenue during the year.
- Management expects significant fixed-rate floor income to continue if short-term interest rates remain low, but rising rates could compress spreads and reduce floor income.
- FFELP-related interest income, guaranty servicing revenue, and software revenue are expected to decline over time as legacy loan portfolios pay down. The company intends to offset this runoff through government servicing, loan acquisitions, and growth in fee-based businesses.
- Beginning July 1, 2014, federal budget provisions reduce guaranty-agency retention on successfully rehabilitated FFELP loans from 37% to 16%. Nelnet generated $54.2 million of rehabilitation revenue in 2013 and expects guaranty agencies to reduce rehabilitation activity.
- Three FFELP warehouse facilities had $1.4 billion outstanding and $353.7 million of unused capacity at year-end. Liquidity provisions were scheduled to expire in 2014, although subsequent amendments extended certain dates. Failure to renew or refinance could increase funding costs or trigger repayment obligations.
- Derivative instruments do not qualify for hedge accounting. Derivative and foreign-currency adjustments produced a net pretax gain of $48.6 million in 2013, compared with a $47.4 million loss in 2012, materially affecting reported earnings. Management’s non-GAAP net income excluding these adjustments was $272.5 million versus $207.4 million.
- Other risks include basis and repricing risk, student loan prepayments and defaults, loss of federal guarantees from servicing deficiencies, cybersecurity and operational disruptions, regulatory and CFPB oversight, litigation, tax uncertainties, and dependence on the Department of Education.
- Michael S. Dunlap beneficially controlled 67.4% of voting rights. Related-party transactions with Union Bank generated a net aggregate income impact of $16.6 million in 2013 and create potential conflicts of interest.
- KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management concluded disclosure controls and internal controls were effective at year-end.
Most important facts for investors to verify
- Whether the Department of Education contract extension through 2019 is finalized and funded, and how future servicing allocations depend on performance metrics.
- The pace of FFELP portfolio runoff, federal consolidation activity, prepayments, and new loan acquisition opportunities.
- The effect of the July 2014 guaranty-rehabilitation payment reduction on collection revenue and operating margins.
- Core student loan spread performance under changing LIBOR relationships, funding costs, and interest-rate scenarios.
- Renewal, refinancing, covenant compliance, and required equity support for the warehouse facilities.
- The sustainability of earnings excluding derivative mark-to-market gains and other unusual items.
- Enrollment Services’ exposure to for-profit education regulation and whether cost reductions can offset continued revenue pressure.
- Potential exposure from litigation, tax positions, loan repurchase obligations, related-party arrangements, and cybersecurity incidents.