NELNET INC. 10-Q Summary: Quarter Ended March 31, 2011
Business Context and Reporting Period
This report covers the quarterly period ended March 31, 2011. NELNET, Inc. is an education services company operating in four core segments: Student Loan and Guaranty Servicing, Tuition Payment Processing and Campus Commerce, Enrollment Services, and Asset Generation and Management. The company no longer originates new Federal Family Education Loan Program (FFELP) loans following the Reconciliation Act of 2010, which took effect on July 1, 2010, shifting new federal originations to the Direct Loan Program.
Key Financial Metrics
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Net Income | $54.9 million | $54.3 million |
| Earnings Per Share (Diluted) | $1.13 | $1.08 |
| Total Interest Income | $138.1 million | $136.0 million |
| Net Interest Income | $85.8 million | $85.1 million |
| Provision for Loan Losses | $3.8 million | $5.0 million |
| Total Operating Expenses | $99.6 million | $103.7 million |
| Net Cash Provided by Operating Activities | $81.7 million | $2.7 million |
| Cash and Cash Equivalents (End of Period) | $48.1 million | $330.1 million |
| Total Assets | $25.3 billion | $25.9 billion (Dec 31, 2010) |
| Total Liabilities | $24.3 billion | $25.0 billion (Dec 31, 2010) |
| Shareholders' Equity | $955.4 million | $906.6 million (Dec 31, 2010) |
Material Changes vs. Prior Period
- Net Income: Increased slightly by $0.6 million (1.1%) compared to Q1 2010, driven by a lower provision for loan losses and reduced corporate debt interest expense, partially offset by lower gains on debt repurchases.
- Operating Expenses: Decreased by $4.1 million (3.9%) year-over-year, primarily due to the elimination of restructuring expenses recorded in 2010 and reduced amortization of intangible assets.
- Fee-Based Revenue: Total revenue from fee-based businesses increased by 1.9% to $93.7 million. Tuition Payment Processing revenue grew 11.4%, while Student Loan Servicing revenue declined 1.9% due to reduced FFELP servicing volume.
- Derivative Activity: The company recorded a net gain of $66.5 million from changes in the fair value of derivatives, largely offset by a $65.3 million foreign currency transaction loss related to Euro-denominated notes.
- Liquidity: Cash and cash equivalents decreased significantly from $283.8 million at year-end 2010 to $48.1 million at March 31, 2011, due to debt repayments and loan acquisitions.
Guidance, Outlook, and Risks
- Fixed Rate Floor Income: The company continues to earn significant "fixed rate floor income" ($31.7 million net in Q1 2011) due to historically low interest rates. Management anticipates this will continue if rates remain low, but notes that rising rates would reduce this income.
- Debt Repurchases: The company repurchased $63.2 million of debt in Q1 2011, realizing a gain of $7.0 million. Management notes that opportunities to repurchase debt at less than par are becoming more limited as capital markets improve.
- Legislative Impact: The phase-out of FFELP originations continues to impact the Asset Generation segment. The company is focusing on purchasing existing FFELP portfolios and expanding government servicing contracts.
- Legal Proceedings: A class action lawsuit regarding alleged violations of the Telephone Consumer Protection Act (TCPA) regarding unsolicited faxes was filed against a subsidiary. The company intends to contest the suit vigorously; no loss estimate can be made at this time.
- Market Risk: The company faces basis risk and repricing risk due to mismatches between asset indices (Commercial Paper/Treasury Bills) and liability indices (LIBOR). Sensitivity analysis indicates a 100 basis point increase in interest rates would increase pre-tax net income by approximately $3.5 million due to derivative settlements.
Key Facts for Investor Verification
- Derivative Valuation Volatility: Verify the impact of unrealized gains/losses on derivatives ($66.5 million gain in Q1 2011) on reported earnings, as these do not qualify for hedge accounting and create significant earnings volatility.
- Non-Federally Insured Loan Quality: Review the allowance for loan losses on non-federally insured loans, which stands at 40.63% of the portfolio, significantly higher than the 0.14% allowance for federally insured loans.
- Debt Maturities and Covenants: Confirm compliance with financial covenants on the $750 million unsecured line of credit (maturing May 2012) and the FFELP warehouse facility (liquidity provisions expiring July 2011).
- Fee-Based Growth Sustainability: Assess the sustainability of growth in Tuition Payment Processing and Enrollment Services segments as the company transitions away from FFELP lending.
- Foreign Currency Exposure: Monitor the re-measurement of Euro-denominated bonds and the effectiveness of cross-currency swaps in hedging this exposure.