Nelnet, Inc. 10-Q Summary: Quarter Ended September 30, 2010
Business Context and Reporting Period
This report covers the quarterly period ended September 30, 2010, for Nelnet, Inc., a transaction processing and finance company focused on education-related products and services. The company operates through four primary segments: Student Loan and Guaranty Servicing, Tuition Payment Processing and Campus Commerce, Enrollment Services, and Asset Generation and Management. The reporting period was significantly impacted by the enactment of the Health Care and Education Reconciliation Act of 2010, which prohibited new loan originations under the Federal Family Education Loan Program (FFELP) effective July 1, 2010.
Key Financial Metrics
| Metric | Three Months Ended Sept 30, 2010 | Nine Months Ended Sept 30, 2010 | Units |
|---|---|---|---|
| Total Interest Income | $160,456 | $453,081 | Thousands |
| Net Interest Income | $92,213 | $274,736 | Thousands |
| Total Other Income | $72,980 | $280,486 | Thousands |
| Total Operating Expenses | $160,287 | $372,212 | Thousands |
| Net Income (Loss) | $(368) | $103,947 | Thousands |
| Earnings Per Share (Diluted) | $(0.01) | $2.08 | Per Share |
| Total Assets | $28,586,579 | N/A | Thousands |
| Total Liabilities | $27,741,965 | N/A | Thousands |
| Shareholders' Equity | $844,614 | N/A | Thousands |
| Cash and Cash Equivalents | $316,361 | N/A | Thousands |
Material Changes vs. Prior Period
- Net Income Volatility: The company reported a net loss of $368,000 for the quarter, a significant decline from the $46.4 million net income reported in the same period in 2009. This was primarily driven by a one-time litigation settlement charge.
- Litigation Settlement: A $55.0 million pre-tax charge was recorded in the third quarter to settle a "qui tam" action (Oberg v. Nelnet). This charge is the primary driver of the quarterly loss.
- Fee-Based Revenue Growth: Excluding the litigation charge, fee-based revenue grew 19.1% year-over-year for both the three and nine-month periods, driven by increased government servicing volume and enrollment services.
- Net Interest Income: Net interest income increased 33.3% for the quarter and 77.5% for the nine-month period compared to 2009, largely due to improved student loan spreads and lower interest expense on debt.
- Derivative Adjustments: The company recorded a net expense of $35.4 million related to derivative market value and foreign currency adjustments for the quarter, compared to income of $7.7 million in the prior year quarter.
Guidance, Outlook, and Risks
- Legislative Impact (FFELP): The company no longer originates new FFELP loans. It expects net interest income and fee-based revenue from FFELP to decline over time as the portfolio pays down. However, it anticipates opportunities to purchase FFELP portfolios from exiting lenders and expand third-party servicing.
- Direct Loan Servicing: The company is servicing $21.8 billion of loans under a contract with the Department of Education. It expects to be allocated 16% of new loan volume for the second year of the contract based on performance metrics.
- Fixed Rate Floor Income: The company continues to earn significant fixed rate floor income ($34.2 million net for the quarter) due to historically low interest rates. This income is expected to continue if rates remain low but is subject to legislative changes and interest rate resets.
- Liquidity and Debt: The company has $27.4 billion in bonds and notes payable. It maintains a $750 million unsecured line of credit with $51.2 million available (excluding a Lehman Brothers commitment). The company expects to access the asset-backed securities market to refinance maturing debt.
- Dividends: The Board declared a fourth-quarter cash dividend of $0.49 per share, including a catch-up payment for suspended dividends in 2008 and 2009.
- Risks: Key risks include interest rate basis risk (mismatch between asset yields and funding costs), changes in government regulations (Dodd-Frank Act), and the potential for future litigation or regulatory fines.
Investor Verification Checklist
- Litigation Settlement Deductibility: Verify the company's expectation that the $55 million settlement is fully tax-deductible, as the IRS may challenge this position.
- FFELP Portfolio Run-off: Monitor the rate of decline in FFELP-related revenue and the success of the company's strategy to acquire third-party portfolios to offset this decline.
- Derivative Valuation: Review the sensitivity of earnings to interest rate and foreign currency fluctuations, given the significant mark-to-market adjustments on derivatives.
- Debt Refinancing: Assess the company's ability to refinance its substantial debt obligations, particularly the $2.0 billion Department of Education Participation Program debt and maturing asset-backed securities, in the current credit market environment.
- Government Servicing Contract Performance: Track the company's performance metrics under the Direct Loan servicing contract to ensure it maintains its allocation of new loan volume.