Nelnet, Inc. Form 10-Q Summary
Business context and reporting period
Nelnet is a diversified education-focused company with reportable segments comprising Loan Servicing and Systems, Education Technology, Services and Payment Processing, Asset Generation and Management, and Nelnet Bank. It also owns investments in communications, renewable energy, real estate, and venture capital. This unaudited filing covers the three months ended March 31, 2023, compared with the three months ended March 31, 2022. The filing was signed May 8, 2023.
Key financial metrics
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Interest income | $266.0 million | $125.2 million | Up $140.8 million |
| Net interest income | $66.5 million | $77.1 million | Down $10.6 million |
| Provision for loan losses | $34.3 million | Negative provision of $0.4 million | Adverse $34.7 million |
| Other income, net | $265.1 million | $404.4 million | Down $139.3 million |
| Income before taxes | $31.3 million | $240.6 million | Down $209.3 million |
| Net income attributable to Nelnet | $26.5 million | $186.6 million | Down 85.8% |
| GAAP diluted EPS | $0.71 | $4.91 | Down $4.20 |
| Non-GAAP EPS excluding derivative market value adjustments | $1.47 | $1.99 | Down $0.52 |
| Cash flow from operations | $122.8 million | $275.3 million | Down $152.5 million |
The filing does not present a single consolidated revenue figure comparable to a conventional operating company because Nelnet reports interest income, fee revenue, investment gains and losses, and derivative results separately. Loan servicing and systems revenue was $139.2 million, education technology, services and payment processing revenue was $133.6 million, and solar construction revenue was $8.7 million.
- Total assets were $18.1 billion at March 31, 2023, down from $19.4 billion at December 31, 2022.
- Loans and accrued interest receivable, net, were $14.6 billion, down from $15.2 billion at year-end 2022.
- Bonds and notes payable were $13.4 billion, down from $14.6 billion at year-end 2022.
- Total equity was $3.2 billion, compared with $3.2 billion at December 31, 2022.
- Net cash, cash equivalents, and restricted cash ended at $898.0 million, compared with $1.36 billion at December 31, 2022.
- Net cash provided by investing activities was $723.9 million, while financing activities used $1.31 billion, primarily because of debt repayments.
Segment performance and margins
- Loan Servicing and Systems: Before-tax income rose to $25.2 million from $12.1 million. Before-tax operating margin increased to 17.1% from 8.3%, primarily because of lower salaries and other operating expenses following staffing reductions. Revenue was $139.2 million, broadly comparable with $136.4 million in the prior-year quarter.
- Education Technology, Services and Payment Processing: Before-tax income increased to $37.6 million from $33.1 million. Revenue increased to $133.6 million from $112.3 million, driven by higher tuition payment plans, payment processing volumes, education technology revenue, the NextGen acquisition, and instructional services. Net revenue after direct service costs was $85.9 million, with a reported before-tax margin excluding net interest income of 36.8%, down from 42.7%.
- Asset Generation and Management: The segment reported a before-tax loss of $0.2 million versus income of $213.4 million. Results were affected by a $37.4 million derivative market value loss, a $31.9 million loan-loss provision, lower average loan balances, and higher funding costs. Excluding derivative market value adjustments, segment net income was $28.3 million versus $51.4 million.
- Nelnet Bank: The segment reported a before-tax loss of $0.1 million versus income of $1.0 million. Net interest income increased to $5.0 million from $2.2 million, but the provision for loan losses increased to $2.4 million from $0.4 million and investment income declined.
Material changes versus the prior comparable period
- Higher market interest rates increased loan and investment interest income but also materially increased interest expense and funding costs.
- Core loan spread increased to 1.57% from 1.45%, but average Asset Generation and Management loan balances declined to approximately $14.0 billion from $17.2 billion.
- Gross fixed-rate floor income fell to $1.1 million from $29.0 million. Derivative settlements increased to $23.3 million from a $2.8 million expense, but the company terminated its $2.8 billion notional floor-income hedge portfolio on March 15, 2023.
- The allowance for loan losses increased to $134.7 million from $131.8 million at year-end 2022. The increase primarily reflected weaker economic assumptions and newly originated or acquired loans, especially consumer loans.
- The company acquired additional Hudl interests for $31.5 million, contributed $8.4 million of equity to ALLO, and recorded a $20.2 million ALLO voting-interest loss versus a $13.1 million loss in Q1 2022.
- GRNE Solar, acquired in July 2022, contributed $8.7 million of solar construction revenue and $8.3 million of related costs.
- The company reduced staff in response to delays in federal student-loan repayment initiatives, lower servicing prices, and expected borrower transfers. It recorded $2.7 million of the estimated $4.3 million restructuring charge in the first quarter.
Guidance, outlook, risks, contingencies, and unusual items
- No formal consolidated earnings guidance was provided. Management expects continued pressure on student-loan servicing revenue from borrower transfers, lower contract pricing, and the transition to the Department of Education's Unified Servicing and Data Solution framework.
- Nelnet Diversified Solutions received a new five-year base-period federal servicing contract on April 24, 2023, with possible extensions. The new structure has tiered pricing and management expects blended revenue per borrower to decline versus legacy contracts, although additional fees may be earned for change requests, consolidations, and support services.
- The Department of Education indicated that legacy servicing contracts would be extended from December 2023 to December 2024 while the new servicing environment is implemented. Up to one million borrowers and approximately 1.4 million borrowers serviced for a remote hosted customer were expected to transfer away from the company's platform by the end of the second quarter of 2023.
- Broad-based federal student-debt relief remained subject to litigation. Nelnet estimated that forgiveness of $10,000 or $20,000 per borrower across all government-owned loans could reduce serviced borrowers by approximately 4.5 million or 7.7 million, respectively, although actual effects could be lower.
- The company had $1.24 billion of stated liquidity sources at March 31, 2023, including $179.9 million of cash outside Nelnet Bank, $82.9 million of unencumbered available-for-sale debt securities, $285.4 million of unencumbered private, consumer, and other loans, $200.3 million of unencumbered repurchased debt securities, and $495.0 million of unused unsecured line capacity. Approximately $260 million of the line was available for purposes other than reducing existing recourse debt because of financial covenants.
- Warehouse facilities had $1.05 billion outstanding in aggregate. A new $250.0 million FFELP warehouse facility was obtained on April 3, 2023.
- Nelnet Bank had approximately $869.8 million of deposits and a 12.6% Community Bank Leverage Ratio, above the FDIC-required 12% level. The parent remains obligated to provide capital and liquidity support under agreements with the FDIC.
- In April 2023, the company redeemed $188.6 million of FFELP asset-backed securities and recognized a $25.9 million non-cash debt-discount write-off.
- Available-for-sale debt securities had $35.2 million of net unrealized losses and $852.6 million of fair value in an unrealized-loss position. Management concluded the losses were not credit-related and stated it had the intent and ability to hold the securities.
- Key risks include interest-rate and basis risk, LIBOR transition risk, loan prepayments and defaults, funding and margin requirements, servicing-contract and borrower-volume changes, regulatory requirements, cybersecurity and system disruptions, ALLO and solar investment performance, tax-credit recapture, and litigation.
Important facts for investors to verify
- Actual borrower volumes, pricing, implementation timing, and profitability under the new federal USDS servicing contract.
- The pace and financial effect of borrower transfers, Great Lakes platform consolidation, and related cost savings expected primarily in 2024.
- Loan prepayment rates, consumer-loan credit performance, allowance adequacy, and the effect of changing economic assumptions.
- Refinancing and margin requirements for warehouse facilities, repurchase agreements, and other secured debt.
- The sustainability of earnings excluding derivative market value adjustments after termination of the floor-income hedge portfolio.
- ALLO's ability to redeem the company's preferred interests by April 2024; otherwise, the preferred return increases from 6.25% to 10.00%.
- Future capital contributions required for Nelnet Bank, ALLO, solar investments, and other strategic initiatives.
- The effect of federal student-debt relief litigation and any future payment-pause, forgiveness, consolidation, or repayment-policy changes.