Nelnet, Inc. Form 10-Q Summary
Business Context and Reporting Period
Nelnet is an education services company with businesses in student loan financing, loan servicing, tuition payment processing and campus commerce, and enrollment services. The filing covers the three and six months ended June 30, 2012, compared with the corresponding 2011 periods. The financial statements are unaudited.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2012 | Year-over-Year Change | Six Months Ended June 30, 2012 | Year-over-Year Change |
|---|---|---|---|---|
| Total interest income | $152.0 million | +8.8% | $306.2 million | +10.2% |
| Net interest income | $84.6 million | -4.7% | $169.4 million | -2.9% |
| Net interest income after loan-loss provision | $77.6 million | -7.1% | $156.4 million | -5.5% |
| Total other income | $87.1 million | +15.6% | $185.9 million | +2.9% |
| Operating expenses | $108.2 million | +7.6% | $219.4 million | +9.6% |
| Net income attributable to Nelnet | $41.4 million | +11.5% | $84.5 million | -8.1% |
| Diluted EPS | $0.87 | +$0.11 | $1.78 | -$0.11 |
| Net cash from operating activities | Not presented for the quarter | — | $161.3 million | -$6.9 million |
GAAP income before taxes was $56.4 million for the quarter and $122.9 million for the six-month period. The effective tax rates were 26.4% and 31.0%, respectively. State tax law changes reduced second-quarter tax expense by $4.6 million. Management expected an effective tax rate of 36% to 37% for the second half of 2012.
Management reported non-GAAP net income excluding derivative market value and foreign currency adjustments of $53.5 million, or $1.13 per share, for the quarter, and $106.2 million, or $2.24 per share, for the six months. These measures exclude market-driven derivative and foreign-currency effects and should not be viewed as GAAP results.
Financial Position, Debt, and Liquidity
- Total assets were $25.27 billion at June 30, 2012, down 2.3% from December 31, 2011.
- Net student loans receivable were $23.50 billion, down 3.3%; federally insured loans represented substantially all of the portfolio.
- Total bonds and notes payable were $23.84 billion, down 2.4% from year-end.
- Total equity was $1.14 billion, up 7.4%; total equity represented 4.53% of total assets.
- Cash and cash equivalents were $56.3 million, while investments were $74.1 million. Management reported total primary liquidity of $557.5 million, including $240.0 million available under the unsecured line of credit, $23.17 million of unencumbered private student loan assets, and other asset-backed securities.
- The company entered into a new $250.0 million unsecured line of credit in February 2012; $10.0 million was outstanding and $240.0 million was available at June 30. A prior $750.0 million facility was repaid and terminated.
- A new $50.0 million secured line of credit was entered into in April 2012 and was fully drawn at quarter-end.
- FFELP warehouse facilities had $829.4 million outstanding and $420.6 million available. Their liquidity provisions expire between January and October 2013, with final maturities in 2015.
- Management estimated approximately $1.87 billion of future undiscounted cash flows from FFELP loans in asset-backed securitizations, subject to assumptions regarding prepayments, defaults, interest rates, and other factors.
Material Changes Versus Prior Comparable Period
- Fee-based revenue increased 9.2% in the second quarter and 8.4% for the first six months. Loan and guaranty servicing revenue rose 25.5% and 24.0%, respectively, driven by higher government servicing, guaranty rehabilitation collections, and hosted software services.
- Tuition payment processing and campus commerce revenue increased 14.0% for the quarter and 13.5% year to date, reflecting more managed payment plans and campus commerce customers.
- Enrollment services revenue declined 8.1% for the quarter and 7.3% year to date because regulatory uncertainty affecting for-profit schools reduced inquiry generation and agency marketing spending. The segment reported a net loss of $1.0 million in the quarter and $1.7 million year to date.
- Net interest income declined despite higher interest income because interest expense increased 32.2% for the quarter and 32.3% year to date. The core student loan spread narrowed to 1.43% from 1.51% in the second quarter of 2011.
- Fixed-rate floor income, net of derivative settlements, increased to $37.0 million for the quarter and $75.1 million year to date, benefiting from historically low interest rates and the July 2011 acquisition of residual interests in consolidation loans.
- Loan-loss provision increased to $7.0 million for the quarter and $13.0 million year to date, primarily due to higher delinquencies relative to the prior-year periods.
- Derivative market value and foreign currency adjustments produced a net expense of $21.6 million for the quarter and $36.8 million year to date. The six-month expense was materially higher than the $23.4 million expense in the prior-year period.
- Operating expenses increased 7.6% for the quarter and 9.6% year to date, reflecting personnel and other costs supporting government servicing, hosted software, the Special Direct Consolidation program, and payment-processing growth.
- The company completed two asset-backed securitizations totaling $676.9 million during the quarter and repurchased $17.6 million par value of asset-backed debt, recognizing a $0.9 million gain.
- The company adopted new fair-value and comprehensive-income presentation standards in 2012. Management also changed segment performance reporting from non-GAAP “base net income” to GAAP net income, with prior periods restated.
Guidance, Outlook, Risks, and Unusual Items
- Management expected continued significant fixed-rate floor income if short-term interest rates remained low, but higher rates could reduce floor income and compress margins.
- Management intended to use liquidity for FFELP loan acquisitions, strategic investments and acquisitions, debt repurchases, stock repurchases, and dividends. No formal earnings guidance was provided.
- The company’s major risks include interest-rate basis and repricing risk, derivative valuation volatility, foreign-currency exposure, loan defaults and delinquencies, changing student-loan laws and government programs, refinancing and securitization-market access, and the availability or renewal of warehouse liquidity.
- All company auction-rate securities were in failed-auction status and could remain so for an extended period or permanently.
- At June 30, 2012, derivative liabilities had a fair value of $62.2 million and the company had posted $55.7 million of collateral. Management did not expect ordinary interest-rate movements to materially impair liquidity, but adverse movements could require additional collateral.
- The company’s debt facilities contain financial covenants. Management stated that it was in compliance at June 30, 2012; a default under FFELP warehouse facilities could accelerate the unsecured line of credit.
- A putative class-action lawsuit against Peterson’s Nelnet alleges violations of the Telephone Consumer Protection Act involving advertising faxes. The court had not certified a class, a renewed motion to dismiss was filed in May 2012, and management stated that a reasonably possible loss could not be estimated.
- Management stated that there were no material changes to the risk factors disclosed in the 2011 Form 10-K and that disclosure controls and procedures were effective.
Investor Verification Items
- Reconcile GAAP earnings with management’s non-GAAP earnings excluding derivative and foreign-currency adjustments.
- Monitor the core student loan spread, fixed-rate floor income, interest-rate basis risk, and the effect of rising rates on earnings.
- Verify renewal or refinancing plans for warehouse facilities and the Department of Education Conduit Program, including the May 2014 conduit maturity.
- Assess delinquency trends, loan-loss provisions, repurchase obligations, and the concentration of federally insured loans.
- Evaluate the sustainability of government servicing revenue and the expected margin effect as government-serviced loans become a larger share of the portfolio.
- Track enrollment-services demand, regulatory developments affecting for-profit schools, and the segment’s continuing losses.
- Review collateral requirements and valuation volatility for derivatives, including cross-currency swaps.
- Follow developments in the Peterson’s TCPA litigation and any related potential class certification or loss exposure.