Nelnet, Inc. 2018 Form 10-K Summary
Business context and reporting period
Nelnet filed its annual report for the fiscal year ended December 31, 2018. The company operates four reportable segments: Loan Servicing and Systems, Education Technology, Services and Payment Processing, Communications, and Asset Generation and Management. Its businesses include student-loan servicing, education payment and software solutions, fiber communications through ALLO, and ownership and management of primarily federally insured student loans.
The filing includes fourth-quarter results and comparisons for the years ended December 31, 2018, 2017, and 2016. The company acquired Great Lakes Educational Loan Services on February 7, 2018, and Tuition Management Systems in November 2018.
Key financial metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Net interest income | $254.4 million | $305.2 million | Down $50.9 million |
| Loan servicing and systems revenue | $440.0 million | $223.0 million | Up $217.0 million |
| Education technology, services and payment processing revenue | $222.0 million | $193.2 million | Up $28.8 million |
| Communications revenue | $44.7 million | $25.7 million | Up $18.9 million |
| Net income attributable to Nelnet | $227.9 million | $173.2 million | Up $54.7 million |
| Basic and diluted EPS | $5.57 | $4.14 | Up $1.43 |
| Net cash provided by operating activities | $270.9 million | $322.3 million | Down $51.4 million |
Fourth-quarter 2018 net income attributable to Nelnet was $21.6 million, or $0.53 per diluted share, compared with $48.1 million, or $1.17 per share, in the fourth quarter of 2017. Fourth-quarter results were affected by a $29.8 million net expense from derivative market value and settlement activity, compared with a $7.0 million net gain in the prior-year quarter.
Total interest income was $924.3 million and interest expense was $669.9 million. The provision for loan losses increased to $23.0 million from $14.5 million, primarily because of the expanding consumer-loan portfolio. Core loan spread, a non-GAAP measure, increased to 1.32% from 1.23%; net fixed-rate floor income was $121.7 million, including $64.9 million of derivative settlements.
At December 31, 2018, total assets were $25.2 billion, loans receivable were $22.4 billion, bonds and notes payable were $22.2 billion, and Nelnet shareholders’ equity was $2.3 billion. Book value per common share was $57.24 and tangible book value per share was $50.51. The company reported a 20.5% effective tax rate, compared with 27.3% in 2017, and expects a future effective tax rate of approximately 23% to 24%.
Material changes versus the prior comparable period
- Great Lakes added substantial government servicing revenue. Loan servicing and systems revenue increased to $440.0 million, including $168.3 million of Great Lakes government-servicing revenue from the acquisition date through year-end. The segment’s net income attributable to Nelnet increased to $53.7 million from $29.6 million, although its operating margin declined to 14.3% from 18.0% because of acquisition-related amortization, integration costs, and higher staffing.
- The Department of Education represented approximately 30% of 2018 revenue, or $325.4 million. Nelnet and Great Lakes together serviced approximately $412.2 billion of Department-owned loans for approximately 13.3 million borrowers at year-end.
- Education technology revenue grew across tuition payment plans, payment processing, and education technology and services. The segment’s reported pre-tax operating margin declined to 20.6% from 26.7%, primarily reflecting a $7.8 million impairment charge related to termination of a proprietary payment-processing platform. Excluding that charge, the 2018 margin was 25.4%.
- ALLO revenue increased 73.7% to $44.7 million, and households served increased to approximately 37,351 from 20,428. However, Communications reported a $28.7 million net loss and negative $4.5 million of EBITDA as the fiber network build-out continued.
- The average loan balance declined to $22.6 billion from $23.6 billion, but the company acquired $3.9 billion of loans during 2018, including $3.7 billion of federally insured student loans. The loan portfolio was 98.5% federally insured and had a weighted-average remaining life of 8.7 years.
- Net income excluding derivative market value and foreign-currency adjustments was $227.1 million, or $5.55 per share, compared with $185.1 million, or $4.43 per share, in 2017. This non-GAAP comparison excludes significant period-to-period derivative and foreign-currency volatility.
Liquidity, debt, outlook, and risks
Cash and cash equivalents were $121.3 million, and available-for-sale investments had a fair value of $53.0 million. The company had a $382.5 million unsecured line of credit maturing June 22, 2023, of which $310.0 million was outstanding and $72.5 million was available. Asset-backed securitizations funded approximately 94.7% of the loan portfolio. Management estimated approximately $2.1 billion of future undiscounted cash flows from the securitization portfolio, including approximately $1.3 billion over the next five years.
Two FFELP warehouse facilities had $986.9 million outstanding and $213.1 million available. Their liquidity provisions expired in May 2019, creating a refinancing and collateral-support risk. The company stated that failure to renew or replace the facilities could increase funding costs, require additional equity, accelerate repayment, or result in loss of collateral. A February 2019 securitization refinanced approximately $496.8 million of student loans, and a January 2019 consumer-loan warehouse facility initially funded $98.1 million.
Management expects additional 2019 costs for integration of the Nelnet and Great Lakes government-loan processing systems, responses to Department procurement activities, and development of private education and consumer loan systems. These investments are expected to reduce operating margins from recent historical levels. ALLO’s Lincoln build-out was expected to be substantially complete in the first quarter of 2019, with approximately $50 million of 2019 expenditures anticipated compared with $87.5 million in 2018.
Principal risks include expiration or non-renewal of Department servicing contracts, uncertain outcomes of the NextGen procurement process, declining FFELP balances and related interest and servicing revenue, interest-rate and basis risk, derivative collateral requirements, LIBOR replacement after 2021, refinancing risk, consumer-loan credit losses, cybersecurity and privacy incidents, regulatory enforcement, litigation, technology integration, ALLO construction and competitive risks, and related-party transactions. The company’s Department contracts were scheduled to expire June 16, 2019; management could not predict the timing or outcome of replacement solicitations.
Most important facts for investors to verify
- Whether Nelnet and Great Lakes retained or replaced their Department of Education servicing contracts and how future servicing-volume allocations affected revenue.
- Renewal or refinancing of the FFELP warehouse facilities and the effect on collateral, liquidity, and funding costs.
- The pace of FFELP portfolio runoff, loan acquisitions, prepayments, and the sustainability of the 1.32% core loan spread.
- Consumer-loan delinquency and charge-off trends, allowance adequacy, and the effect of the expected 2020 credit-loss accounting standard.
- Progress and cost of the new government-loan servicing platform and private education and consumer-loan technology investments.
- ALLO’s customer growth, capital expenditures, operating losses, network completion, and ability to reach positive EBITDA.
- Exposure to LIBOR transition, interest-rate movements, derivative collateral calls, and changes in securitization cash-flow assumptions.
- The company’s ongoing regulatory, legal, cybersecurity, privacy, and related-party exposures, including its relationship with Union Bank and the controlling voting position of Executive Chairman Michael S. Dunlap.