Nelnet, Inc. Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and nine months ended September 30, 2012, filed November 8, 2012. Nelnet provides student-loan financing and servicing, tuition payment processing and campus-commerce services, and enrollment services. Its Asset Generation and Management segment earns interest spread on a predominantly federally insured student-loan portfolio, while fee-based businesses include student-loan and guaranty servicing, tuition payment processing, campus commerce, and enrollment services.
All dollar amounts below are in thousands, except per-share amounts and percentages. The interim financial statements are unaudited. Management changed segment performance reporting from non-GAAP “base net income” to GAAP net income in 2012 and restated prior-period segment information.
Financial performance and key metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Total interest income | $151,668 | $157,627 | $457,864 | $435,501 |
| Net interest income | $85,266 | $96,761 | $254,689 | $271,274 |
| Net interest income after loan-loss provision | $80,266 | $91,511 | $236,689 | $257,024 |
| Other income | $83,493 | $85,128 | $269,384 | $265,843 |
| Operating expenses | $104,937 | $104,778 | $324,320 | $304,967 |
| Income before taxes | $58,822 | $71,861 | $181,753 | $217,900 |
| Net income attributable to Nelnet | $36,828 | $47,451 | $121,363 | $139,456 |
| Diluted EPS | $0.77 | $0.98 | $2.55 | $2.87 |
GAAP net income declined 22.4% in the third quarter and 13.0% for the first nine months. Management reported adjusted net income excluding derivative market-value and foreign-currency adjustments of $53,087, or $1.12 per diluted share, in Q3 2012, compared with $56,062, or $1.16, in Q3 2011; for nine months, the comparable figures were $159,284, or $3.36 per share, versus $157,799, or $3.25.
- Fee-based revenue increased 5.6% to $117,729 in Q3 and 7.5% to $353,084 for nine months. Student-loan and guaranty servicing revenue rose 25.2% and 24.4%, respectively; tuition payment and campus-commerce revenue rose 6.9% and 11.3%.
- Enrollment-services revenue declined 13.6% in Q3 and 9.5% for nine months, primarily because regulatory uncertainty reduced for-profit school marketing spending.
- Net interest income after provision for loan losses and derivative settlements declined 18.0% in Q3 to $75,215 and 7.9% for nine months to $229,779. The Q3 core student-loan spread was 1.44%, versus 1.59% in the prior-year quarter; the nine-month spread was 1.43%, versus 1.52%.
- Fixed-rate floor income, net of derivative settlements, was $34,736 in Q3 and $109,812 for nine months, compared with $40,598 and $105,081, respectively.
- Derivative market-value and foreign-currency adjustments were a net expense of $31,275 in Q3 and $68,073 for nine months, compared with expenses of $13,631 and $37,002 in the prior-year periods.
- The effective tax rate was 37.2% in Q3 and 33.0% for nine months, compared with 34.0% and 36.0%, respectively. Enacted state tax changes reduced nine-month tax expense by $3,400.
Balance sheet, cash flow, debt, and liquidity
- Total assets were $24.409 billion at September 30, 2012, down from $25.852 billion at December 31, 2011. Student loans receivable declined to $22.559 billion from $24.298 billion.
- Total equity increased to $1.176 billion from $1.066 billion. Book value per common share was $24.85, versus $22.62 at year-end 2011 and $21.31 at September 30, 2011. Tangible equity was $1.045 billion and tangible book value per share was $22.07.
- Bonds and notes payable declined to $22.884 billion from $24.435 billion. Debt fair value was $22.191 billion at September 30, 2012, below its $22.884 billion carrying value.
- Operating cash flow was $260,597 for the first nine months, compared with $211,946 in the prior-year period. Investing activities provided $1.375 billion, while financing activities used $1.585 billion. Cash and cash equivalents increased to $93,674 from $42,570 at year-end.
- Management reported $629.8 million of primary liquidity, comprising cash, investments, unencumbered private student-loan assets, asset-backed security investments, and $250.0 million available under the unsecured line of credit.
- The company had $499.4 million outstanding under three FFELP warehouse facilities, with $750.6 million available. A new $250.0 million unsecured line of credit entered in February 2012 had no borrowings at quarter-end and matures February 17, 2016. A $50.0 million secured line of credit was fully drawn.
- Debt consisted primarily of variable-rate obligations. Approximately 99.9% of debt instruments were variable-rate at September 30, 2012. Derivative liabilities were $80.3 million, and $70.3 million was posted as collateral to derivative counterparties.
Material changes versus the prior comparable period
- The student-loan portfolio continued to run off following elimination of new FFELP originations in 2010. During the first nine months, Nelnet acquired $898.6 million of FFELP loans but lost $1.172 billion of consolidation loans to external parties, including $875.4 million related to the Department of Education’s special direct-consolidation initiative.
- Variable student-loan spread weakened because of widening between the indices used for loan earnings and debt funding. Interest expense rose 23.7% for nine months despite lower average debt, as the cost of funds increased.
- Loan and guaranty servicing benefited from higher Department of Education volumes, increased rehabilitation collections, and hosted servicing software revenue. The company ranked first in the Department’s servicing survey and received 30% of new Department loan volume for the August 2012-August 2013 period, up from 16% in the prior two years.
- Operating expenses increased 18.4% in Q3? The filing reports total operating expenses of $104,937 versus $104,778; for nine months, expenses increased 6.3% to $324,320. Excluding enrollment-service costs and rehabilitation collection costs, expenses increased 4.1% in Q3 and 10.3% for nine months.
- Federally insured loan delinquencies improved from December 31, 2011, but remained above September 30, 2011 levels in some categories. The federally insured loan allowance was $35.6 million, and the non-federally insured allowance was $12.6 million against a $29.3 million non-federally insured portfolio.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected continued significant fixed-rate floor income if short-term interest rates remained low, but rising rates could reduce floor income and compress margins. The company remains exposed to basis and repricing risk because student-loan assets and funding reset on different indices and schedules.
- Management estimated future undiscounted cash flows from FFELP loans funded through asset-backed securitizations at approximately $1.88 billion. The estimate depends on prepayments, defaults, interest rates, and other assumptions; doubling the assumed prepayment rate would reduce the forecast by approximately $300 million to $360 million, while a wider LIBOR basis spread could reduce it by approximately $60 million to $100 million.
- The company expects to continue purchasing FFELP portfolios, accessing securitization markets, and using liquidity for acquisitions, investments, debt repurchases, stock repurchases, and dividends. Management cautioned that securitization volumes may be more limited and pricing less favorable than before the 2007 credit-market disruption.
- The company expected a Q4 2012 effective tax rate of 36.0% to 37.0%.
- On October 11 and November 8, 2012, the company completed asset-backed securitizations of $937.5 million and $1.2 billion and purchased $1.1 billion of FFELP loans from third parties through November 8.
- On November 8, 2012, the board declared a $1.10-per-share dividend, consisting of a regular $0.10 dividend and a special $1.00 dividend, payable November 27, 2012.
- Peterson’s Nelnet faces a putative TCPA class action involving alleged unsolicited advertising faxes. The complaint alleges more than 10,000 potential faxes and statutory damages exceeding $5 million, or more than $15 million if trebled. No class had been certified, and management stated that a reasonably possible loss or range could not be estimated.
- Warehouse facilities contain financial covenants and liquidity provisions. Failure to renew liquidity provisions or comply with covenants could increase borrowing costs, restrict new financing, or accelerate repayment obligations. The company reported compliance with its unsecured-line covenants at September 30, 2012.
- The company’s disclosure controls were effective, and no material change in internal control over financial reporting was reported.
Most important facts for investors to verify
- Whether student-loan runoff, consolidation activity, and future FFELP acquisitions change portfolio balances and net interest margins.
- The sustainability of fixed-rate floor income and the sensitivity of earnings, collateral requirements, and liquidity to interest-rate and LIBOR-basis movements.
- Renewal or refinancing of warehouse facilities and the Department of Education Conduit Program, including covenant compliance and securitization-market access.
- Growth and margins in fee-based businesses, especially Department servicing volumes, hosted software contracts, tuition-payment services, and enrollment services exposed to for-profit education regulation.
- The assumptions supporting the $1.88 billion projected FFELP cash flow and the potential impact of higher prepayments, defaults, or wider funding spreads.
- The outcome and potential exposure from the Peterson’s TCPA litigation and any regulatory inquiries.
- The effect of the $1.10-per-share special dividend and subsequent loan purchases on capital, liquidity, and future distributions.