Nelnet, Inc. 2020 First-Quarter Form 10-Q Summary
Business context and reporting period
Nelnet reported results for the three months ended March 31, 2020, compared with the same period in 2019. Its principal businesses are loan servicing and systems, education technology and payment processing, communications, and asset generation and management, which includes a primarily federally insured student-loan portfolio.
The quarter was materially affected by the COVID-19 pandemic, declining interest rates, increased expected credit losses, market volatility, and the adoption of the current expected credit loss methodology on January 1, 2020.
Financial performance and key metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Total interest income | $189.2 million | $250.6 million | Down $61.4 million |
| Net interest income | $55.1 million | $58.8 million | Down $3.7 million |
| Provision for loan losses | $76.3 million | $7.0 million | Up $69.3 million |
| Loan servicing and systems revenue | $112.7 million | $114.9 million | Down $2.2 million |
| Education technology, services, and payment processing revenue | $83.7 million | $79.2 million | Up $4.5 million |
| Communications revenue | $18.2 million | $14.5 million | Up $3.6 million |
| Net income attributable to Nelnet | $(40.5) million | $41.6 million | Declined $82.1 million |
| Basic and diluted EPS | $(1.01) | $1.03 | Declined $2.04 |
| Net cash used in operating activities | $144.5 million | $139.7 million | Higher use of $4.8 million |
Additional unusual items included an $18.2 million pretax gain on the sale of consumer loans, $34.1 million of impairment expense, and a $20.6 million loss from derivative market value adjustments. Excluding derivative market value adjustments, net loss attributable to Nelnet was $24.9 million, or $0.62 per share, versus income of $64.8 million, or $1.61 per share, in the prior-year quarter. The filing also presents other non-GAAP measures; these should not be viewed as substitutes for GAAP results.
Core loan spread declined to 1.02% from 1.30%, while loan spread excluding derivative settlements was 0.94% versus 0.95%. The education technology segment's pretax operating margin increased to 44.9% from 43.0%. The loan servicing and systems segment's pretax operating margin declined to 10.8% from 17.0%.
Balance sheet, debt, and liquidity
- Total assets were $23.28 billion at March 31, 2020, compared with $23.71 billion at December 31, 2019.
- Loans and accrued interest receivable, net of allowance, were $21.16 billion, down from $21.40 billion at year-end 2019. The portfolio included $20.19 billion of federally insured loans, $274.2 million of private education loans, and $145.8 million of consumer loans.
- The allowance for loan losses increased to $208.9 million from $61.9 million at year-end 2019. At March 31, 2020, the allowance represented 0.7% of federally insured loans, 8.4% of private education loans, and 26.8% of consumer loans.
- Bonds and notes payable were $20.47 billion, compared with $20.53 billion at December 31, 2019. Most debt funds student-loan asset-backed securitizations and is variable-rate debt.
- Cash and cash equivalents were $204.8 million. Available-for-sale investments had a fair value of $57.1 million.
- The $455.0 million unsecured line of credit had $100.0 million outstanding and $355.0 million available. A $22.0 million secured line had $5.0 million outstanding and $17.0 million available.
- Warehouse capacity available at March 31, 2020 was $767.5 million for FFELP loans, $114.5 million for private education loans, and $132.9 million for consumer loans.
- Cash, cash equivalents, and restricted cash totaled $1.10 billion at March 31, 2020, down from $1.22 billion at December 31, 2019.
Management stated that cash, anticipated operating cash flow, and available financing were expected to be sufficient for operating needs for the foreseeable future. However, the company used $144.5 million in operating cash during the quarter, primarily reflecting a $217.9 million decrease in amounts due to education customers.
Material changes versus the prior comparable period
- Interest income declined primarily because of lower loan yields and a smaller average loan balance; interest expense also declined because of lower funding costs and debt balances.
- Provision for loan losses increased by $69.3 million, including an estimated $63.0 million incremental provision related to COVID-19-driven expected defaults.
- COVID-19-related impairment expense totaled $34.1 million, including $26.3 million on beneficial interests in consumer-loan securitizations and $7.8 million on venture-capital investments.
- The company sold $124.2 million of consumer loans and recorded an $18.2 million pretax gain.
- Operating expenses increased to $190.9 million from $179.1 million, driven primarily by higher salaries and benefits, depreciation, and service and security costs.
- Communications revenue increased with customer and network expansion, although the segment remained loss-making. ALLO generated $3.2 million of EBITDA versus $1.0 million in the prior-year quarter.
- Loan servicing volume increased to $477.4 billion from $472.1 billion at March 31, 2019, while total servicing borrowers declined to 14.9 million from 15.4 million.
Comparability is limited because ASC 326 was adopted prospectively for 2020 results. The adoption increased the allowance for loan losses by $91.0 million and reduced retained earnings, net of tax, by $18.9 million; the 2019 allowance reflected the prior incurred-loss model.
Guidance, outlook, commentary, and risks
- Management expected variable loan spread to improve as debt repriced at lower interest rates during the second quarter. It also expected higher gross fixed-rate floor income, partly offset by lower derivative settlements.
- The company expected its 2020 effective tax rate to range from 20% to 23%.
- The company did not expect the CARES Act to reduce total 2020 revenue under Department of Education servicing contracts, although revenue was expected to be lower in the second and third quarters and higher in the fourth quarter than in the corresponding prior periods.
- Management expected lower future servicing revenue from FFELP, private education, and consumer loans because of borrower relief, reduced delinquency activity, suspended fees, and delayed collection activity.
- The company anticipated minimal future interest income in its education technology segment if interest rates remained at then-current levels, and warned that lower school enrollments could reduce demand for its services.
- ALLO expected approximately $30 million of network capital expenditures for April through December 2020, subject to customer demand.
- Department of Education servicing contracts generated $85.1 million of revenue in the quarter and were scheduled to expire December 14, 2020, with potential extensions through December 14, 2021. The company’s EPS proposal in the NextGen procurement was excluded from the competitive range; the company filed GAO protests, while the BPO award remained pending.
- If the EPS decision stands, Nelnet and Great Lakes could be required to migrate portfolios to another provider and restructure the loan servicing business. Failure to retain or replace these contracts could materially reduce revenue.
- COVID-19 could produce additional loan-loss provisions, investment impairments, lower servicing and payment-processing revenue, operational and cybersecurity challenges, liquidity pressure, and reduced dividends or capital returns.
- Approximately $18.8 billion of FFELP assets and $18.5 billion of related debt were indexed to LIBOR. The filing noted significant uncertainty regarding LIBOR's availability after 2021 and potential effects on assets, funding, derivatives, and projected cash flows.
- Nelnet Bank received conditional FDIC and Utah regulatory approvals but still required readiness review and other approvals before commencing operations. The company planned an initial $100.0 million capital commitment.
Most important facts for investors to verify
- Whether COVID-19-related delinquencies, forbearances, defaults, and additional credit-loss provisions exceed management's assumptions.
- Whether the company retains, extends, or replaces its Department of Education servicing contracts and the ultimate outcome of its GAO protests.
- Changes in loan spread, LIBOR transition exposure, derivative collateral requirements, and asset-backed securitization cash-flow forecasts.
- Actual operating cash generation after seasonal customer-fund movements and the company's ability to refinance or securitize warehouse-funded loans.
- School enrollment trends and their effects on education technology, payment-processing volumes, and future revenue.
- Whether ALLO's network expansion achieves sufficient customer growth to offset substantial capital expenditures and depreciation.
- Progress toward launching Nelnet Bank and the amount and timing of the required capital commitment.