Nelnet, Inc. 10-Q Summary
Reporting period: Three and nine months ended September 30, 2020; filed November 5, 2020. The filing is unaudited and should be read with the 2019 Form 10-K. Nelnet operates loan servicing, education technology and payment processing, communications, and asset generation and management businesses.
Financial Results and Key Metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Total interest income | $139.7 million | $238.9 million | $480.8 million | $736.3 million |
| Net interest income | $81.3 million | $66.5 million | $203.0 million | $185.1 million |
| Net interest income after loan-loss provision | $87.1 million | $56.5 million | $129.6 million | $159.1 million |
| Total other income/expense | $225.5 million | $219.1 million | $667.2 million | $607.4 million |
| Income before taxes | $90.3 million | $42.0 million | $148.3 million | $125.9 million |
| Net income attributable to Nelnet | $71.5 million | $33.2 million | $117.5 million | $99.4 million |
| EPS, basic and diluted | $1.86 | $0.83 | $2.99 | $2.48 |
| Operating cash flow | Not separately provided | Not separately provided | $173.0 million | $142.9 million |
- Q3 net income attributable to Nelnet increased 115% year over year; nine-month net income increased 18%.
- The effective tax rate was 21.1% in Q3 and 20.5% for the first nine months, compared with 21.0% for the comparable 2019 periods.
- Q3 core loan spread, including derivative settlements, was 1.46%, compared with 1.17% in Q3 2019. Nine-month core loan spread was 1.28%, compared with 1.23%.
- Loan servicing and systems revenue was $113.8 million in Q3 and $337.6 million for nine months, broadly lower year to date than 2019. Education technology revenue was $74.1 million in Q3 and $217.1 million year to date. Communications revenue rose to $20.2 million in Q3 and $57.4 million year to date.
- The education technology segment’s before-tax operating margin was 30.8% in Q3 and 35.2% year to date, compared with 34.4% and 34.9%, respectively, in 2019. The loan servicing segment’s before-tax operating margin declined to 10.7% in Q3 and 11.2% year to date from 15.9% and 16.8%.
Balance Sheet, Debt, and Liquidity
- Total assets were $22.2 billion at September 30, 2020, down from $23.7 billion at December 31, 2019.
- Loans and accrued interest receivable were $20.1 billion, compared with $21.4 billion at year-end 2019. The loan portfolio was primarily federally insured student loans and is expected to amortize over approximately 20 years, with a weighted-average remaining life of 8.8 years.
- The allowance for loan losses was $185.9 million, compared with $61.9 million at December 31, 2019. The company adopted CECL on January 1, 2020, increasing the allowance by $91.0 million and reducing retained earnings, net of tax, by $18.9 million.
- Bonds and notes payable were $19.2 billion, down from $20.5 billion at December 31, 2019. The majority of the debt funds asset-backed student loan securitizations.
- Cash and cash equivalents were $96.3 million. Available-for-sale investments had a fair value of approximately $179.0 million. The company also had a fully available $455.0 million unsecured line of credit maturing in December 2024 and $17.0 million available under a secured line of credit.
- Cash, cash equivalents, and restricted cash totaled $901.5 million at September 30, 2020, down from $1.2 billion at year-end 2019. Investing activities provided $953.6 million, while financing activities used $1.45 billion, primarily because debt repayments exceeded new debt issuance.
- The company repurchased 1.59 million Class A shares for $73.1 million year to date and had approximately 3.25 million shares remaining under its authorization. It paid a $0.20 per-share third-quarter dividend and declared a $0.22 per-share fourth-quarter dividend.
Material Changes Versus Prior Period
- Interest expense fell substantially due to lower funding costs and reduced average debt, supporting higher net interest income despite lower loan interest income and a smaller loan portfolio.
- Q3 results benefited from a $14.8 million gain on the sale of consumer loans, a $5.8 million negative loan-loss provision, and the absence of the $14.0 million debt-extinguishment expense recorded in Q3 2019.
- Nine-month results included a $51.0 million gain from the remeasurement of the company’s Hudl investment, $33.0 million of consumer-loan sale gains, $34.1 million of investment impairments, and a $73.5 million loan-loss provision.
- Q3 fixed-rate floor income increased to $36.6 million from $12.7 million, reflecting lower interest rates. However, related derivative settlements were a $3.6 million expense in Q3 2020 versus $7.1 million of income in Q3 2019.
- Loan servicing revenue was pressured by COVID-19 borrower relief, lower consolidation activity, suspended late fees, and reduced delinquency-related activity. Communications revenue increased with customer and network growth, although the segment remained loss-making.
Guidance, Outlook, Risks, and Unusual Items
- Management expects servicing revenue per Department of Education borrower to return to pre-COVID-19 levels in the first quarter of 2021, but expects ongoing pressure while borrower payment and interest suspensions remain in effect.
- Management expects minimal future interest income in the education technology segment if interest rates remain at current levels.
- Management expects approximately $24.0 million of pre-tax solar investment losses in the fourth quarter of 2020, subject to investment activity and HLBV allocations.
- The Department of Education indicated an intent to extend Nelnet and Great Lakes servicing contracts from December 14, 2020 to approximately June 15, 2021, but the notice was non-binding. The company’s proposals in certain NextGen procurements were unsuccessful, and it intended to respond to the new Interim Servicing Solution solicitation. Department servicing revenue represented 30% of 2019 revenue, making contract renewal and future awards material risks.
- COVID-19 could result in additional loan-loss provisions, investment impairments, lower servicing and education-related revenue, operational disruptions, cybersecurity exposures, and liquidity pressure. Borrower forbearance and relief measures remained significant, although federally insured loans in forbearance declined to $1.9 billion, or 10.0% of that portfolio, at September 30, 2020.
- Interest-rate, basis, repricing, derivative, and LIBOR-transition risks are material. A 100-basis-point increase in interest rates was estimated to reduce Q3 2020 pre-tax net income by $13.7 million after derivative-settlement effects; a 300-basis-point increase was estimated to reduce it by $24.0 million.
- Subsequent to quarter-end, ALLO received approximately $197.0 million from SDC and paid Nelnet $160.0 million to redeem preferred units. Upon regulatory approval, Nelnet expected to deconsolidate ALLO and estimated incremental pre-tax income of approximately $230 million, although the amount and timing were uncertain.
- On November 2, 2020, Nelnet Bank launched after receiving FDIC insurance and a Utah industrial bank charter. Nelnet funded it with $100.0 million of capital and a $40.0 million pledged deposit, and assumed ongoing capital and liquidity support obligations.
Investor Verification Checklist
- Verify the formal extension and eventual replacement of the Department of Education servicing contracts, including the outcome of the ISS solicitation.
- Assess whether COVID-19 borrower relief expirations lead to higher delinquencies, defaults, servicing costs, or additional CECL provisions.
- Reconcile reported GAAP earnings with non-GAAP results excluding derivative market-value adjustments, loan-sale gains, Hudl gains, investment impairments, and solar losses.
- Monitor the amortization of the FFELP loan portfolio, future loan acquisitions, securitization cash flows, and refinancing availability.
- Review ALLO’s regulatory approval, deconsolidation accounting, redemption proceeds, contingent payment obligation, and resulting ownership interests.
- Evaluate Nelnet Bank’s capital requirements, liquidity support commitments, loan growth, and regulatory execution.
- Verify exposure to LIBOR replacement, interest-rate basis risk, derivative collateral requirements, and changes in the value of investment and securitization interests.