Nelnet, Inc. 2019 Form 10-K Summary
Business context and reporting period
Nelnet filed its annual report for the fiscal year ended December 31, 2019. The company operates four reportable segments: Loan Servicing and Systems (LSS), Education Technology, Services, and Payment Processing (ETS&PP), Communications through ALLO, and Asset Generation and Management (AGM).
Nelnet remains significantly exposed to its legacy Federal Family Education Loan Program (FFELP) portfolio, although new FFELP originations have been prohibited since July 1, 2010. The company is diversifying through government loan servicing, education technology and payment processing, fiber communications, and private education and consumer lending.
Key financial metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Net interest income | $249.4 million | $254.4 million | Down 2.0% |
| Loan servicing and systems revenue | $455.3 million | $440.0 million | Up 3.5% |
| ETS&PP revenue | $277.3 million | $222.0 million | Up 24.9% |
| Communications revenue | $64.3 million | $44.7 million | Up 43.9% |
| Total other income | $831.2 million | $832.5 million | Approximately flat |
| Income before taxes | $176.7 million | $286.3 million | Down 38.3% |
| Net income attributable to Nelnet | $141.8 million | $227.9 million | Down 37.8% |
| Basic and diluted EPS | $3.54 | $5.57 | Down 36.5% |
| Operating cash flow | $298.9 million | $270.9 million | Up 10.4% |
| Core loan spread | 1.18% | 1.32% | Down 14 basis points |
GAAP earnings were materially affected by a $76.2 million net derivative market-value loss in 2019, compared with a $1.0 million gain in 2018. Excluding derivative market-value adjustments, net income attributable to Nelnet was $199.7 million in 2019 versus $227.1 million in 2018.
Financial position, debt, and liquidity
- Loans receivable, net, were $20.67 billion at December 31, 2019, down from $22.38 billion. The portfolio was approximately 97.7% federally insured, with a weighted-average remaining life of 8.8 years.
- Total assets were $23.71 billion and Nelnet shareholders’ equity was $2.39 billion, including noncontrolling interests. Book value per common share was $60.07; tangible book value per share was $54.07.
- Bonds and notes payable were $20.53 billion, compared with $22.22 billion at year-end 2018. Total contractual debt obligations, before interest and including certain facilities, were approximately $20.80 billion.
- Cash and cash equivalents were $133.9 million. Available-for-sale investments, primarily student loan asset-backed securities, had a fair value of $52.7 million.
- The unsecured line of credit was increased to $455.0 million and extended to December 16, 2024. At year-end, $50.0 million was outstanding and $405.0 million was available.
- Two FFELP warehouse facilities had $778.1 million outstanding and $271.9 million available. Their liquidity provisions expired in May 2020, creating a refinancing and renewal risk.
- Net cash used in financing activities was $1.79 billion, primarily reflecting debt repayments. Net cash provided by investing activities was $1.52 billion.
Material changes versus the prior comparable period
- LSS revenue increased primarily because 2019 included a full year of Great Lakes operations, compared with approximately eleven months in 2018. LSS net income increased to $58.8 million from $53.7 million.
- ETS&PP revenue rose to $277.3 million from $222.0 million, and net income increased to $47.3 million from $25.4 million. The improvement reflected the TMS acquisition, customer growth, operating leverage, and savings after terminating a proprietary payment-processing platform. The segment’s pretax operating margin increased to 31.8% from 20.6%.
- ALLO revenue increased to $64.3 million from $44.7 million. The Communications segment reduced its net loss to $23.5 million from $28.7 million and generated positive EBITDA of $6.2 million versus negative EBITDA of $4.5 million. Residential households served increased 28% to approximately 47,744.
- AGM net income declined to $88.0 million from $183.8 million. The decrease reflected lower average loan balances, lower core loan spread, reduced floor-income settlements, higher consumer-loan loss provisions, debt-extinguishment costs, and derivative valuation losses.
- Fixed-rate floor income, including derivative settlements, declined to $89.9 million from $121.7 million. The company purchased $1.53 billion of federally insured loans, $71.5 million of private education loans, and $405.7 million of consumer loans during 2019.
- During 2019, Nelnet extinguished $1.05 billion of asset-backed notes before maturity, incurred $16.7 million of related costs, released $1.45 billion of previously encumbered student loans and accrued interest, and generated $387.1 million of net cash proceeds after refinancing.
- Nelnet repurchased 726,273 shares for $40.4 million and paid $29.5 million in dividends, or $0.74 per share. Approximately 4.8 million shares remained authorized for repurchase at year-end.
Guidance, outlook, risks, and unusual items
- Management expects LSS operating margin and net income to decline significantly in 2020 because of increased service and security requirements under Department of Education contracts and costs related to the Next Generation Financial Services Environment procurement.
- Nelnet’s current Department servicing contracts run through December 14, 2020, with potential discretionary extensions through December 14, 2021. The Department represented $343.6 million, or 30% of 2019 revenue. The timing and outcome of the NextGen procurement remain uncertain.
- Management expects ALLO to remain dilutive to consolidated earnings while it expands its fiber network and adds customers. Planned 2020 ALLO network capital expenditures were approximately $35 million to $45 million.
- The FFELP portfolio is expected to amortize over approximately 20 years, causing interest income and related servicing revenue to decline over time. Management expects near-term reinvestment opportunities may not generate historical FFELP returns.
- Interest-rate and basis risk remain significant. Approximately $18.9 billion of FFELP assets and $18.4 billion of related debt were indexed to one-month or three-month LIBOR. The uncertain replacement of LIBOR after 2021 could affect funding costs, asset values, net interest income, derivatives, and securitization cash flows.
- Credit risk is increasing as private education and consumer loan portfolios expand. The allowance for loan losses was $61.9 million, and 2019 provision expense was $39.0 million, including $31.0 million for consumer loans.
- The company expected adoption of the Current Expected Credit Loss standard on January 1, 2020 to increase the allowance for loan losses by approximately $60 million to $80 million and reduce retained earnings, net of tax, by approximately $10 million to $20 million.
- GAAP results included $16.7 million of debt-extinguishment expense and a $17.3 million pretax gain from consumer-loan sales. Derivative instruments do not qualify for hedge accounting, creating substantial period-to-period earnings volatility.
- Other principal risks include cybersecurity and privacy incidents, regulatory and litigation exposure, loss of federal loan guarantees from servicing deficiencies, competition, ALLO construction and programming costs, tax-credit recapture risk, and dependence on related-party arrangements with Union Bank.
- Nelnet filed an application to establish Nelnet Bank, a Utah-chartered industrial bank. The filing states that the timing and outcome of the application were uncertain.
Important facts for investors to verify
- Outcome and timing of the Department of Education’s NextGen procurement and any extension or replacement of the current servicing contracts.
- Renewal or refinancing of FFELP warehouse liquidity provisions and compliance with related financial covenants.
- Actual impact of CECL adoption on the allowance, retained earnings, and future provisions.
- Exposure to LIBOR transition risk, derivative collateral requirements, and changes in loan spread.
- Sustainability of ETS&PP growth and margins after the TMS acquisition and payment-platform restructuring.
- ALLO’s progress toward profitability, customer penetration, network expansion, and 2020 capital-expenditure targets.
- Future runoff of FFELP balances, prepayment rates, consolidation activity, and the company’s ability to replace declining interest income.
- Consumer-loan delinquency trends, charge-offs, allowance adequacy, and returns on newly acquired private and consumer loans.
- Terms and financial effects of related-party transactions, including the Union Bank participation agreement and loan purchases.