Nelnet, Inc. — Q1 2017 Form 10-Q Summary
Business context and reporting period
Nelnet provides student loan servicing, tuition payment processing and campus commerce services, communications services, and student loan asset management. This unaudited report covers the three months ended March 31, 2017, compared with the same period in 2016. The company’s largest financial asset was a $24.0 billion student loan portfolio, primarily federally insured loans, that is expected to amortize over approximately 25 years.
Financial performance and key metrics
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Total interest income | $183.8 million | $192.0 million |
| Net interest income | $76.9 million | $101.6 million |
| Net interest income after loan-loss provision | $75.9 million | $99.1 million |
| Total other income | $115.7 million | $84.9 million |
| Income before income taxes | $76.7 million | $72.5 million |
| Net income attributable to Nelnet | $50.0 million | $48.0 million |
| Basic and diluted EPS | $1.18 | $1.11 |
| Net cash from operating activities | $73.8 million | $104.5 million |
- Effective tax rate was 36.50%, compared with 33.75% in Q1 2016.
- Core student loan spread declined to 1.23% from 1.34%; fixed-rate floor income, net of derivative settlements, declined to $32.0 million from $40.6 million.
- Total operating expenses increased to $115.0 million from $111.5 million, including higher salaries and benefits and higher depreciation and amortization.
- At March 31, 2017, total assets were $26.1 billion, shareholders’ equity was $2.1 billion, and total equity was $2.1 billion.
Liquidity, debt and cash flow
- Cash and cash equivalents were $108.2 million, supplemented by $123.6 million of available-for-sale and trading investments.
- Bonds and notes payable were $23.6 billion, compared with $24.7 billion at December 31, 2016. The majority of debt funded student loan assets through asset-backed securitizations and warehouse facilities.
- The company had $35.0 million outstanding and $315.0 million available under its $350.0 million unsecured line of credit, which matures December 12, 2021.
- FFELP warehouse facilities had $1.6 billion outstanding and approximately $516.4 million of borrowing capacity available at March 31, 2017.
- Investing activities generated $1.1 billion, principally from student loan repayments and a decrease in restricted cash. Financing activities used $1.1 billion, principally for debt repayments.
- Allo’s Q1 capital expenditures were $16.7 million. Management anticipated approximately $80 million of total Allo network capital expenditures for 2017, subject to customer demand.
Material changes versus the prior comparable period
- GAAP net income attributable to Nelnet increased 4.3% to $50.0 million, and EPS increased to $1.18 from $1.11, despite lower net interest income.
- Net interest income decreased primarily because of student loan portfolio runoff, lower floor income, a lower student loan spread, and higher funding costs.
- Other income increased substantially because Q1 2017 included a $5.0 million gain from debt repurchases and the effects of the new accounting treatment for centrally cleared derivative variation margin. Derivative and foreign-currency items remained volatile.
- Management’s non-GAAP net income excluding derivative market value adjustments, foreign-currency adjustments, and centrally cleared variation-margin settlements was $52.2 million, down from $61.7 million.
- Loan Systems and Servicing revenue increased to $54.2 million from $52.3 million, but segment net income declined to $7.4 million from $8.2 million. The segment serviced $200.3 billion of loans at March 31, 2017, versus $182.2 billion a year earlier.
- Tuition Payment Processing and Campus Commerce revenue increased to $43.6 million from $38.7 million, while pretax operating margin declined to 40.1% from 42.1% because of continued product and systems investment.
- Communications revenue increased to $5.1 million from $4.3 million, but the segment’s net loss widened to $2.8 million from $0.4 million as the network expansion continued.
- The student loan portfolio declined from $27.7 billion at March 31, 2016 to $24.2 billion at March 31, 2017. Q1 2017 loan acquisitions were $52.2 million, compared with $111.0 million in Q1 2016.
- The company redeemed $29.7 million principal amount of Hybrid Securities for $25.3 million and recognized a $4.4 million pretax gain. Remaining Hybrid Securities totaled $20.5 million.
Guidance, outlook, risks and unusual items
- Management expects the Communications segment to remain dilutive to consolidated earnings for the next several years because of network construction, depreciation, and customer acquisition costs.
- Management expects significant floor income to continue if short-term interest rates remain low, but noted that rising rates reduced Q1 2017 floor income and could compress student loan margins.
- GreatNet, a 50/50 joint venture with Great Lakes, submitted its Phase II response for a new Department of Education servicing contract. The Department subsequently withdrew certain prior policy memoranda, and the venture was awaiting further direction. The existing Department contract was scheduled to expire June 16, 2019.
- The company’s forecasted undiscounted cash flows from student loans in asset-backed securitizations were approximately $2.02 billion. Management cautioned that prepayment rates, defaults, forbearance, and interest-rate assumptions could materially change this estimate.
- Key risks include student loan portfolio runoff and credit performance, interest-rate and basis risk, derivative collateral requirements, financing and securitization market access, changes in federal student loan policy, loss or modification of servicing contracts, cybersecurity and operational failures, regulatory changes, litigation, and risks associated with Allo’s expansion.
- No material changes were reported to the legal proceedings or risk factors disclosed in the 2016 Form 10-K. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting.
Investor verification checklist
- Verify the sustainability of student loan spreads and floor income as the portfolio amortizes and interest rates change.
- Reconcile GAAP earnings with management’s non-GAAP earnings and assess the volatility of derivative and foreign-currency adjustments.
- Monitor the Department of Education servicing procurement process and the June 2019 contract expiration risk.
- Review warehouse facility renewals, securitization-market access, debt maturities, collateral requirements, and available liquidity.
- Assess Allo’s planned approximately $80 million 2017 capital program, continuing losses, customer growth, and expected funding needs.
- Evaluate the effects of continued portfolio runoff, limited loan acquisitions, delinquency trends, and future credit-loss provisions.