NELNET INC. 10-Q Summary: Quarter Ended June 30, 2010
Business Context and Reporting Period
This report covers the quarterly period ended June 30, 2010, for NELNET, INC., a transaction processing and finance company focused on education-related products and services. The company operates through four primary segments: Student Loan and Guaranty Servicing, Tuition Payment Processing and Campus Commerce, Enrollment Services, and Asset Generation and Management. A critical legislative development impacting the company is the Reconciliation Act of 2010, signed March 30, 2010, which prohibits new Federal Family Education Loan Program (FFELP) loan originations effective July 1, 2010, shifting all new federal loans to the Direct Loan Program.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2010 | Six Months Ended June 30, 2009 |
|---|---|---|---|
| Net Income | $49,993,000 | $104,315,000 | $33,658,000 |
| Earnings Per Share (Diluted) | $0.99 | $2.08 | $0.68 |
| Net Interest Income | $97,414,000 | $182,523,000 | $85,615,000 |
| Total Other Income | $96,996,000 | $207,506,000 | $174,989,000 |
| Total Operating Expenses | $108,221,000 | $211,925,000 | $189,927,000 |
| Cash and Cash Equivalents | $274,761,000 | $274,761,000 | $366,827,000 |
| Total Assets | $28,568,023,000 | $28,568,023,000 | $25,876,427,000 |
| Total Debt (Bonds and Notes Payable) | $27,428,772,000 | $27,428,772,000 | $24,805,289,000 |
Material Changes vs. Prior Period
- Profitability Surge: Net income for the six months ended June 30, 2010, increased 210% compared to the same period in 2009 ($104.3 million vs. $33.7 million). This was driven by a 113% increase in net interest income and a 39.9% increase in gains on debt repurchases.
- Interest Rate Environment: Net interest income improved significantly due to the tightening of the commercial paper/LIBOR spread and lower interest expense on variable-rate debt. The core student loan spread increased to 1.49% for the six months ended June 30, 2010, compared to 1.02% in 2009.
- Fee-Based Revenue Growth: Total revenue from fee-based businesses increased 19.1% year-over-year for the six-month period, driven by growth in Student Loan and Guaranty Servicing (22.5%) and Enrollment Services (19.4%).
- Loan Portfolio Expansion: The company purchased approximately $1.9 billion of FFELP student loans from third parties in the second quarter of 2010. Student loans receivable held for investment increased to $24.7 billion.
- Derivative Volatility: While derivative settlements resulted in a net expense of $5.8 million for the six months ended June 30, 2010, this was a significant improvement over the $33.9 million income recognized in the prior year period, reflecting changes in fair value and foreign currency adjustments.
Guidance, Outlook, and Risks
- FFELP Transition: The company will cease originating new FFELP loans after June 30, 2010. It expects to recognize a pre-tax gain of approximately $30 million to $33 million in the fourth quarter of 2010 from selling $2.0 billion of loans held for sale to the Department of Education under the Purchase Program.
- Direct Loan Servicing: The company is servicing $12.9 billion of loans for 1.5 million borrowers under a contract with the Department of Education. It anticipates increased volume as the Department allocates $116 billion in new Direct Loan originations for the 2010-2011 academic year.
- Legislative Risks: The Dodd-Frank Act and proposed Department of Education rulemaking regarding incentive compensation and misrepresentation pose potential compliance costs and operational risks, particularly for the Enrollment Services segment serving for-profit schools.
- Interest Rate Risk: The company remains exposed to basis risk and repricing risk due to mismatches between asset indices (commercial paper/T-bills) and liability indices (LIBOR). Rising interest rates could reduce "floor income" earned on fixed-rate loans.
- Legal Proceedings: The company is a defendant in a "qui tam" action (United States ex rel Oberg v. Nelnet, Inc. et al) alleging false claims for special allowance payments. The company is vigorously contesting the matter, which is set for trial in August 2010.
Key Facts for Investor Verification
- Debt Repurchase Gains: Verify the sustainability of the $18.9 million gain on debt repurchases recognized in the first six months of 2010, as management noted opportunities to repurchase debt at less than par are becoming more limited.
- FFELP Loan Sale Timing: Confirm the timing and execution of the expected $2.0 billion loan sale to the Department of Education in Q4 2010, which is critical for realizing the projected $30-$33 million gain.
- Derivative Valuation: Monitor the volatility of derivative fair value adjustments, which impacted earnings by $8.9 million (expense) in the first six months of 2010 compared to $5.0 million (expense) in 2009, driven largely by foreign currency re-measurement of Euro-denominated notes.
- Restructuring Costs: Track the remaining $3.4 million of restructuring charges expected to be recognized in the third and fourth quarters of 2010 related to office consolidations and severance.
- Liquidity Covenants: Verify continued compliance with financial covenants on the $750 million unsecured line of credit and the FFELP warehouse facility, particularly regarding consolidated net worth and adjusted EBITDA ratios.