Nelnet, Inc. Form 10-Q Summary
Business context and reporting period
Nelnet provides student-loan financing and servicing, tuition-payment processing, campus-commerce services, enrollment services, and related software. The filing covers the three and nine months ended September 30, 2011; financial statement amounts are in thousands unless otherwise noted.
Effective July 1, 2010, federal loan originations moved from the FFEL Program to the Department of Education’s Direct Loan Program. Nelnet therefore no longer originates new FFELP loans but continues to manage its existing portfolio, purchase eligible loans, and expand fee-based services.
Financial performance and key metrics
| Metric | Q3 2011 | Q3 2010 | Change |
|---|---|---|---|
| Total interest income | $157.6 million | $160.5 million | Down 1.8% |
| Net interest income | $96.8 million | $92.2 million | Up 4.9% |
| Net interest income after loan-loss provision | $91.5 million | $86.7 million | Up 5.5% |
| Other income | $85.1 million | $73.0 million | Up 16.6% |
| Operating expenses | $104.8 million | $160.3 million | Down 34.6% |
| Income before taxes | $71.9 million | $(0.6) million | Improved materially |
| Net income | $47.5 million | $(0.4) million | Improved materially |
| Diluted EPS | $0.98 | $(0.01) | Improved materially |
- For the nine months, net income was $139.5 million versus $103.9 million in 2010, while diluted EPS was $2.87 versus $2.08.
- Nine-month net interest income after loan-loss provision was $257.0 million, down 0.4%; total other income was $265.8 million, down 5.2%.
- Net interest income after loan-loss provision and derivative settlements was $91.8 million in Q3 and $249.6 million for the nine months.
- Fixed-rate floor income, net of derivative settlements, was $40.6 million in Q3 and $105.1 million for the nine months, contributing 0.65% and 0.59%, respectively, to student-loan spread.
- Fee-based revenue was $94.9 million in Q3, up 6.5%, and $277.4 million for the nine months, up 2.1%. Q3 servicing revenue rose 11.7% and tuition-payment/campus-commerce revenue rose 15.4%, while enrollment-services revenue declined 2.6%.
- The reported Q3 2011 effective tax rate was 34.0%, versus 38.0% in Q3 2010; the nine-month rate was 36.0%, versus 37.5%.
Cash flow, balance sheet, debt, and liquidity
- Net cash provided by operating activities was $211.9 million for the nine months, compared with $15.8 million in 2010.
- Investing activities provided $1.13 billion, primarily from student-loan repayments, sales, and a decrease in restricted cash and investments.
- Financing activities used $1.53 billion, including $2.39 billion of debt repayments partially offset by $995.6 million of new debt issuance.
- Cash and cash equivalents declined to $92.1 million at September 30, 2011 from $283.8 million at December 31, 2010.
- Total assets were $26.24 billion, including $24.64 billion of net student loans, up 2.9% from year-end. Total liabilities were $25.22 billion and shareholders’ equity was $1.01 billion, up 11.6%.
- Bonds and notes payable totaled $24.93 billion on the balance sheet; contractual debt obligations, before discounts, totaled $25.09 billion.
- Primary liquidity sources totaled $311.4 million, comprising cash, trading securities, unencumbered loans, and asset-backed-security investments. The company also reported $558.6 million available under its unsecured line of credit excluding the Lehman Brothers commitment.
- The $750 million unsecured line of credit had $149.4 million outstanding and terminates May 8, 2012. The company was in compliance with its financial covenants at quarter-end.
Material changes versus the prior comparable period
- Profitability improved sharply because Q3 2010 included a $55.0 million litigation settlement charge and $4.8 million of restructuring expense; neither item was recorded in Q3 2011.
- Operating expenses excluding those unusual 2010 items increased 4.2% in Q3 but decreased 2.0% for the nine months. Salaries and benefits increased, while depreciation and amortization declined.
- Nelnet purchased approximately $2.7 billion of FFELP loans during the first nine months, including the July purchase and consolidation of a residual interest in $1.9 billion of federally insured consolidation loans.
- Student-loan receivables increased despite repayments and external consolidations. The loan portfolio’s allowance declined to $45.8 million from $50.2 million at September 30, 2010, while federally insured loans delinquent 91 days or more increased to 7.7% of loans in repayment from 6.1% at year-end 2010.
- The company repurchased $74.8 million notional amount of debt for a $7.0 million gain, compared with a $28.8 million gain in the first nine months of 2010. It also repurchased 1.12 million common shares for $21.1 million.
- Derivative market-value and foreign-currency adjustments remained volatile, producing a $13.6 million Q3 expense and a $37.0 million nine-month expense in 2011, compared with expenses of $35.4 million and $44.3 million, respectively, in the comparable periods.
Guidance, outlook, commentary, and risks
- Management expects to continue growing fee-based revenue, controlling costs, maximizing the existing loan portfolio, and using liquidity for loan acquisitions, investments, debt repurchases, share repurchases, and dividends.
- More than 9.5 million borrowers were hosted on the company’s servicing-software platforms as of October 31, 2011; additional software-services revenue was expected to begin in Q4 2011.
- Management expects continued servicing-margin compression as lower-margin Department of Education servicing becomes a larger portion of the servicing portfolio.
- Management expects significant floor income to continue if short-term interest rates remain low, but higher rates could reduce floor income and compress spreads. The company remains exposed to basis and repricing mismatches between student-loan assets and primarily LIBOR-based funding.
- Management estimated approximately $1.83 billion of future undiscounted cash flows from loans in asset-backed securitizations. The estimate would decline by approximately $370 million to $430 million under a prepayment assumption twice the forecast rate, and by approximately $80 million to $120 million if the assumed LIBOR-to-commercial-paper spread doubled.
- A new short-term federal consolidation program beginning in January 2012 could accelerate prepayments. Nelnet believed less than $3 billion of its $24.7 billion owned FFELP portfolio and less than $700 million of $5.5 billion serviced for third parties could be eligible, potentially reducing interest and servicing revenue.
- Risks include the limited availability or higher cost of securitization and warehouse funding, the May 2012 unsecured-line maturity, failed auctions affecting auction-rate securities, covenant compliance, loan delinquencies and repurchase obligations, regulatory changes affecting for-profit colleges, and the potential effects of the U.S. sovereign-credit downgrade.
- Peterson’s Nelnet faced a putative TCPA class action regarding advertising faxes. No class had been certified, and management stated that a reasonably possible loss could not currently be estimated.
Most important facts for investors to verify
- Whether the federal consolidation program materially increases prepayments and reduces Nelnet’s student-loan spread or servicing volume.
- The sustainability of $105.1 million of nine-month net floor income in a changing interest-rate environment.
- Refinancing and renewal plans for the $2.4 billion Department of Education Conduit borrowing, warehouse facilities, and the $149.4 million unsecured line.
- The effect of failed auction-rate securities and capital-market conditions on funding costs, collateral, and liquidity.
- Trends in federally insured and non-federally insured delinquencies, loan-loss provisions, and the $19.9 million loan-repurchase obligation.
- The distinction between GAAP net income and management’s non-GAAP “base net income,” which excludes selected derivative, foreign-currency, and intangible-amortization effects.