Business Context and Reporting Period
Nelnet, Inc. is an education services company with businesses in student-loan financing, loan servicing, tuition payment processing and campus commerce, and enrollment services. This Form 10-Q covers the three and six months ended June 30, 2013, with comparisons to the corresponding 2012 periods. The filing was dated August 8, 2013; interim financial statements are unaudited.
Financial Performance and Position
| Metric | Three months ended June 30, 2013 | Three months ended June 30, 2012 | Six months ended June 30, 2013 | Six months ended June 30, 2012 |
|---|---|---|---|---|
| Total interest income | $159.5 million | $152.0 million | $316.7 million | $306.2 million |
| Net interest income after loan-loss provision | $96.4 million | $77.6 million | $190.2 million | $156.4 million |
| Total other income | $163.1 million | $87.1 million | $283.0 million | $185.9 million |
| Operating expenses | $102.9 million | $108.2 million | $209.8 million | $219.4 million |
| Income before taxes | $156.6 million | $56.4 million | $263.4 million | $122.9 million |
| Net income attributable to Nelnet | $101.2 million | $41.4 million | $169.3 million | $84.5 million |
| Basic and diluted EPS | $2.17 | $0.87 | $3.63 | $1.78 |
- Six-month net income attributable to Nelnet increased approximately 100% year over year; second-quarter net income increased approximately 144%.
- Derivative market value and foreign-currency adjustments contributed $40.2 million of pretax income in the second quarter and $41.3 million for the first six months, compared with pretax expenses of $21.6 million and $36.8 million, respectively, in the prior-year periods.
- Net income excluding derivative market value and foreign-currency adjustments was $71.1 million, or $1.53 per share, in the second quarter and $133.5 million, or $2.86 per share, for the first six months, compared with $53.5 million, or $1.13 per share, and $106.2 million, or $2.24 per share, respectively, in 2012.
- Core student-loan spread was 1.52% in the second quarter and 1.51% for the first six months, compared with 1.43% for the second quarter and first six months of 2012, respectively.
- Net fixed-rate floor income was $36.1 million in the second quarter and $71.8 million for the first six months, compared with $37.0 million and $75.1 million in the prior-year periods.
Segment and Operating Trends
- Student Loan and Guaranty Servicing revenue increased 14.7% in the second quarter and 13.5% for the first six months. Segment net income increased 48.1% and 55.7%, respectively; before-tax operating margins were 30.8% and 28.9%, versus 22.3% and 19.8% in 2012.
- Tuition Payment Processing and Campus Commerce revenue increased 9.0% in the second quarter and 7.8% for the first six months. Segment net income increased 55.7% and 35.2%; before-tax operating margins were 19.6% and 29.9%, versus 13.8% and 23.8%.
- Enrollment Services revenue declined 16.4% in the second quarter and 12.4% for the first six months because of regulatory uncertainty and lower marketing spending by for-profit college customers. Cost reductions moved the segment to net income of $0.2 million in the quarter and $0.4 million for the six months, from losses in the comparable 2012 periods.
- The company was servicing approximately $116.8 billion of student loans at June 30, 2013, compared with $85.5 billion a year earlier, including $89.2 billion for the Department of Education for 4.4 million borrowers.
Cash Flow, Debt, Liquidity, and Capital
- Net cash provided by operating activities was $153.2 million for the six months ended June 30, 2013, compared with $161.3 million in 2012. Ending cash and cash equivalents were $68.6 million, compared with $56.3 million at June 30, 2012.
- Management reported cash and investments of $245.8 million at June 30, 2013. The company also had $275.0 million available under its unsecured line of credit, with no borrowings outstanding.
- Student loans receivable were $24.6 billion at June 30, 2013, down from $24.8 billion at December 31, 2012. Bonds and notes payable were $24.7 billion, down from $25.1 billion.
- Four FFELP warehouse facilities had aggregate maximum financing capacity of $2.0 billion; $1.0 billion was outstanding and $1.0 billion was available. Liquidity provisions for the facilities expire between October 2013 and June 2014.
- The company completed four asset-backed securitizations totaling $2.8 billion during the first six months, including $1.2 billion in the second quarter. The Department of Education Conduit balance was refinanced and paid in full during February 2013.
- Net cash used in financing activities was $425.1 million, including $3.5 billion of debt repayments, $3.1 billion of debt issuance, $9.3 million of dividends, and $9.0 million of stock repurchases.
- At June 30, 2013, total equity was $1.32 billion. The company repurchased 279,156 Class A shares for $9.0 million during the first six months and had 3,985,408 shares remaining under its authorization.
Material Changes, Outlook, and Risks
- Management expects the FFELP portfolio to amortize over approximately 20 years and estimates approximately $2.10 billion of future undiscounted cash flows from loans financed in asset-backed securitizations. This estimate includes approximately $488.8 million of overcollateralization and depends on assumptions about prepayments, defaults, interest rates, and borrower behavior.
- Management intends to use liquidity for additional FFELP loan acquisitions, strategic investments, debt and stock repurchases, and dividends. A third-quarter dividend of $0.10 per share was declared, subject to applicable conditions.
- The Department of Education servicing contract runs through June 2014 and contains a five-year renewal option. Management anticipates renewal, but the filing states that renewal is not assured.
- Management expects significant fixed-rate floor income to continue if short-term interest rates remain low. Rising rates could reduce floor income and compress margins, although derivatives hedge a substantial portion of this exposure.
- Key market risks include interest-rate basis and repricing mismatches, derivative valuation and collateral requirements, foreign-currency exposure from Euro-denominated notes, changes in student-loan prepayments and defaults, and the availability and cost of securitization and warehouse financing.
- Non-federally insured loans had 31-days-or-greater delinquency of 27.1% at June 30, 2013, compared with 28.6% at December 31, 2012 and 22.7% at June 30, 2012. The allowance for loan losses was $51.6 million.
- The company was involved in three putative class-action proceedings. No class had been certified, and management stated that a meaningful estimate of reasonably possible losses could not currently be made.
- The filing identifies no material changes to previously reported risk factors, and management concluded that disclosure controls were effective as of June 30, 2013.
Investor Verification Priorities
- Separate recurring operating performance from the substantial quarter-to-quarter volatility in derivative and foreign-currency gains and losses.
- Verify renewal, pricing, volume, and performance terms for the Department of Education servicing contract before its June 2014 expiration.
- Monitor warehouse-facility liquidity renewal dates, covenant compliance, advance rates, and the company’s ability to access securitization markets.
- Reconcile the $2.10 billion projected securitization cash flow to actual prepayment, default, interest-rate, and basis-spread experience.
- Assess the sustainability of fixed-rate floor income and the sensitivity of earnings to higher rates and wider funding-index spreads.
- Track Enrollment Services revenue trends, customer concentration, regulatory developments affecting for-profit colleges, and the December 2013 expiration of a significant remote-hosting customer contract.
- Review the unresolved putative class actions, non-federally insured loan delinquencies, repurchase obligations, and related-party transactions, including the aircraft purchase and partial sale.