Nelnet, Inc. 2011 Form 10-K Summary
Business context and reporting period
Nelnet is an education services company with four operating segments: Student Loan and Guaranty Servicing, Tuition Payment Processing and Campus Commerce, Enrollment Services, and Asset Generation and Management. The filing covers the fiscal year ended December 31, 2011; fourth-quarter information is included in the filing’s unaudited quarterly data.
Effective July 1, 2010, federal law eliminated new FFELP loan originations and directed new federal originations to the Federal Direct Loan Program. Nelnet therefore continues to manage its existing FFELP portfolio while expanding fee-based servicing, payment-processing, software, and enrollment businesses.
Financial performance and key metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Net interest income | $364.6 million | $371.1 million | Down 1.8% |
| Fee-based revenue | $373.9 million | $358.6 million | Up 4.3% |
| Income before taxes | $321.8 million | $302.5 million | Up 6.4% |
| Net income | $204.3 million | $189.0 million | Up 8.1% |
| Diluted earnings per share | $4.23 | $3.81 | Up 11.0% |
| Core student loan spread | 1.52% | 1.48% | Up 4 basis points |
| Cash flow from operations | $310.9 million | $194.9 million | Up $116.0 million |
Total interest income was $592.9 million and total other income was $386.1 million. Net income represented approximately 20.9% of these combined reported income categories, although the filing does not present a consolidated revenue margin as a primary operating measure.
- Loan and guaranty servicing revenue increased 10.8% to $175.7 million, primarily due to higher Department of Education servicing volume, rehabilitation collections, and hosted software servicing.
- Tuition payment processing and campus commerce revenue increased 13.3% to $67.8 million. Segment base net income increased 24.7% to $12.6 million, and its operating margin improved to 32.0% before corporate overhead.
- Enrollment services revenue declined 6.7% to $130.5 million. Interactive marketing revenue fell as for-profit schools reduced marketing spending amid regulatory uncertainty; the segment reported base net income of $0.8 million versus a $15.9 million loss in 2010.
- Fixed-rate floor income, net of derivative settlements, increased to $144.5 million from $132.2 million, benefiting from historically low interest rates and the July 2011 acquisition of residual interests in $1.9 billion of consolidation loans.
- The provision for loan losses declined to $21.3 million from $22.7 million. The allowance for loan losses was $48.5 million at year-end.
Fourth-quarter information
For the fourth quarter of 2011, net income was $64.9 million, or $1.37 diluted earnings per share, compared with net income of $85.1 million, or $1.75 diluted earnings per share, in the fourth quarter of 2010. Fourth-quarter 2011 net interest income was $93.3 million, after a $7.0 million provision for loan losses.
Balance sheet, debt and liquidity
| Balance-sheet metric | December 31, 2011 | December 31, 2010 |
|---|---|---|
| Student loans receivable, net | $24.30 billion | $23.95 billion |
| Total assets | $25.85 billion | $25.89 billion |
| Bonds and notes payable | $24.43 billion | $24.67 billion |
| Shareholders’ equity | $1.07 billion | $0.91 billion |
| Cash and cash equivalents | $42.6 million | $283.8 million |
At December 31, 2011, management identified $470.4 million of primary liquidity, including cash and investments, unencumbered private student loan assets, asset-backed security investments, and $210.0 million available under an unsecured line of credit. Operating cash flow was positive, but cash and cash equivalents declined by $241.2 million during the year, primarily because of debt repayments and capital-management activities.
- Asset-backed securitization debt was $21.2 billion, with maturities extending from 2015 through 2048.
- FFELP warehouse facilities had $824.4 million outstanding and required $58.5 million of equity support.
- The Department of Education Conduit had $2.34 billion outstanding and $84.7 million of operating cash advanced by Nelnet; the program expires May 8, 2014.
- The company’s $750.0 million unsecured line had $64.4 million outstanding at year-end. Subsequent to year-end, it was replaced by a $250.0 million facility maturing in 2016; $210.0 million was available as of February 17, 2012.
- Approximately 87% of the FFELP portfolio, or $21.1 billion, was funded through asset-backed securitizations. Management forecast approximately $1.81 billion of future undiscounted cash flows from the securitized portfolio, subject to prepayment, default, interest-rate, and other assumptions.
Material changes versus the prior comparable period
- Fee-based revenue grew 4.3%, partially offsetting the gradual decline in the legacy FFELP portfolio and related servicing activities.
- Student Loan and Guaranty Servicing revenue benefited from the Department of Education contract and new hosted software volume, while third-party FFELP servicing volume declined.
- Core student loan spread improved to 1.52% from 1.48%, primarily because of higher fixed-rate floor income, although variable student loan spread declined.
- Gain on loan sales and debt repurchases fell sharply to $8.3 million from $78.6 million. The 2010 amount included substantial debt-repurchase gains and gains on sales of loans to the Department.
- Operating expenses declined to $407.7 million from $503.5 million. The 2010 period included $26.6 million of goodwill impairment, $6.0 million of restructuring expense, and a $55.0 million legal settlement; no comparable charges were recorded in 2011.
- Nelnet purchased $2.8 billion of FFELP student loans in 2011, compared with $3.4 billion in 2010, and repurchased 1.4 million shares for $27.1 million.
- Shareholders’ equity increased 17.6% to $1.07 billion, while the equity-to-assets ratio improved to 4.12% from 3.50%.
Guidance, outlook, risks and unusual items
- Management expects significant fixed-rate floor income to continue if short-term interest rates remain low, but rising rates could reduce floor income and compress spreads. Derivative instruments mitigate, but do not eliminate, this risk.
- Nelnet intends to elect a statutory change for approximately $23.4 billion of FFELP loans that would replace the commercial-paper index with one-month LIBOR for Special Allowance Payments. Management expected the new formula to be available in the second quarter of 2012.
- The Department of Education servicing contract runs through June 2014, with one optional five-year renewal. Nelnet received a 16% allocation of new borrower volume and ranked fourth among the four private-sector servicers based on disclosed performance metrics. Failure to improve performance or obtain renewal could materially reduce revenue.
- New regulations affecting for-profit schools, including gainful-employment and marketing-related requirements, could reduce Enrollment Services demand, increase compliance costs, and expand contractual liability. Approximately 80% of Enrollment Services interactive marketing revenue was generated from for-profit schools.
- Warehouse liquidity provisions expire in 2012 and 2013, and the associated facilities mature in 2014 and 2015. Failure to renew or refinance could increase funding costs or trigger accelerated repayment.
- All Auction Rate Securities sponsored by the company remained in failed-auction status, potentially increasing interest costs above historical levels.
- Federal student loan delinquencies increased. Among federally insured loans in repayment, the current percentage declined to 84.2% from 87.2%, while loans delinquent 91 days or more increased to 8.6% from 6.1%.
- Derivative fair values included $92.2 million of assets and $43.8 million of liabilities. Derivative mark-to-market losses and foreign-currency adjustments reduced 2011 income by $25.6 million, and the instruments do not qualify for hedge accounting.
- A putative class action alleging violations of the Telephone Consumer Protection Act remained unresolved. The filing states that a meaningful estimate of potential loss could not be made.
- Related-party transactions with Union Bank, an entity associated with Nelnet’s controlling shareholders, included loan participations, servicing, cash management, investment services, and operating accounts. Management disclosed potential conflicts of interest and stated that some arrangements were not subject to competitive bids.
Most important facts for investors to verify
- Whether the Department of Education servicing allocation and contract renewal prospects improve before the 2014 contract expiration.
- The pace of FFELP portfolio runoff, prepayments, Department consolidation activity, and the resulting effect on interest income and future cash flows.
- Actual versus forecasted cash flows from securitized student loans, including sensitivity to higher prepayment rates and wider commercial-paper/LIBOR spreads.
- Renewal and refinancing of warehouse and conduit funding facilities, compliance with financial covenants, and required equity support.
- The sustainability of fixed-rate floor income and the earnings impact of higher interest rates or adverse derivative valuations.
- Enrollment Services exposure to for-profit schools and the financial effect of gainful-employment and marketing regulations.
- Delinquency trends, allowance adequacy, and repurchase obligations on sold or participated non-federally insured loans.
- The terms, pricing, and governance of related-party arrangements with Union Bank and the degree of control held by the company’s principal shareholders.