Nelnet, Inc. — Form 10-Q Summary
Business context and reporting period
Nelnet is an education services company providing student-loan financing and servicing, tuition payment processing, campus commerce, and enrollment services. The filing covers the unaudited three months ended March 31, 2012, compared with the same period in 2011. The company no longer originates new FFELP loans following legislation effective July 1, 2010, but continues to manage its existing portfolio and pursue loan acquisitions.
Financial performance and position
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Loan interest income | $153.1 million | $137.4 million | 11.4% |
| Net interest income | $84.9 million | $85.8 million | (1.1%) |
| Net interest income after loan-loss provision | $78.9 million | $82.0 million | (3.9%) |
| Fee-based revenue | $120.1 million | Approximately $111.6 million | 7.6% |
| Total other income | $98.8 million | $105.4 million | (6.2%) |
| Operating expenses | $111.2 million | $99.6 million | 11.6% |
| Income before taxes | $66.5 million | $87.8 million | (24.2%) |
| Net income attributable to Nelnet | $43.1 million | $54.9 million | (21.4%) |
| Diluted EPS | $0.91 | $1.13 | (19.5%) |
| Operating cash flow | $100.6 million | $81.7 million | 22.9% |
GAAP net margin was approximately 22.3% using management’s defined total revenue of $193.1 million. Management reported net income excluding derivative market-value and foreign-currency adjustments of $52.7 million, or $1.11 per share, versus $54.2 million, or $1.12 per share, in Q1 2011. The filing does not present a single consolidated operating margin.
At March 31, 2012, total assets were $25.45 billion, including $23.84 billion of net student loans. Bonds and notes payable totaled $24.06 billion, down from $24.43 billion at December 31, 2011. Shareholders’ equity was $1.11 billion, and book value per common share was $23.41 versus $19.71 a year earlier. Cash and cash equivalents were $60.7 million; management reported total primary liquidity of $495.1 million, including $200 million available under the new unsecured line of credit.
The core student-loan spread was 1.43%, compared with 1.46% in Q1 2011. Fixed-rate floor income, net of derivative settlements, increased to $38.1 million from $31.7 million. The provision for loan losses rose to $6.0 million from $3.8 million. The allowance for loan losses was $48.4 million, including a $11.7 million allowance against non-federally insured loans.
Material changes versus the prior comparable period
- Fee-based revenue increased 7.6%, led by higher government and guaranty servicing revenue and growth in tuition payment and campus commerce services.
- Enrollment services revenue declined 6.5%, and the segment’s net loss increased to $0.8 million from $0.2 million, reflecting regulatory uncertainty and reduced marketing spending by for-profit schools.
- Interest expense increased 32.5% to $69.3 million, while the average cost of funds increased to 1.02% from 0.83%.
- Operating expenses increased primarily to support government servicing, hosted servicing software, the Special Direct Consolidation program, and expanded tuition-payment operations.
- Q1 2011 included an $8.3 million gain from loan sales and debt repurchases; no comparable gain was recorded in Q1 2012.
- Derivative market-value and foreign-currency adjustments changed from $1.1 million of income to $15.4 million of expense. The principal unfavorable item was a $32.2 million foreign-currency loss from remeasurement of Euro-denominated notes, partly offset by derivative valuation gains.
- The student-loan portfolio declined 1.9% from year-end 2011 to $23.91 billion before premiums, discounts, and allowances. The portfolio was approximately 99.9% federally insured by balance.
- Management discontinued using “base net income” for segment reporting and began using GAAP net income; prior-period segment results were restated.
Guidance, outlook, risks, contingencies, and unusual items
- Management expects significant fixed-rate floor income to continue if short-term interest rates remain low, but rising rates could reduce floor income and compress spreads.
- The company forecast approximately $1.81 billion of future undiscounted cash flow from FFELP loans in asset-backed securitizations. Management cautioned that higher prepayments or a wider LIBOR-to-commercial-paper spread could reduce this forecast by approximately $290 million to $350 million and $60 million to $100 million, respectively.
- Approximately $23.0 billion of FFELP loans elected to change their Special Allowance Payment index from commercial paper to one-month LIBOR effective April 1, 2012, which management believes will reduce basis risk.
- Three FFELP warehouse facilities had $960.0 million outstanding and $290.0 million available. Liquidity provisions for one facility expired July 1, 2012; failure to renew could increase costs, restrict new financing, and require refinancing by final maturity.
- The company entered into a new $250 million unsecured credit facility maturing February 17, 2016; $50 million was drawn and $200 million was available at March 31, 2012. The company reported compliance with applicable financial covenants.
- On April 12, 2012, the company entered into a separate $50 million collateralized line of credit maturing April 12, 2014.
- Funding and liquidity remain dependent on asset-backed securitization markets, warehouse facilities, the Department of Education Conduit Program, operating cash flow, and lender performance. The company noted that securitization access may be less reliable and more expensive than before the credit-market disruption.
- The company had $42.3 million of derivative liabilities and had posted $35.4 million of collateral to derivative counterparties. Interest-rate, basis, foreign-currency, counterparty, and collateral requirements could affect earnings and liquidity.
- Non-federally insured loans had a 46.94% allowance rate and 22.1% of loans in repayment were at least 91 days delinquent, compared with 12.7% a year earlier.
- Peterson’s Nelnet faces a putative class-action claim under the Telephone Consumer Protection Act. The complaint alleges more than 10,000 noncompliant faxes and seeks statutory damages exceeding $5 million, potentially exceeding $15 million if trebled. No class had been certified, and the company stated that a reasonably possible loss could not be estimated.
- Subsequent state tax-law changes are expected to reduce income-tax expense by approximately $4.6 million in Q2 2012.
- The company paid a $0.10 per-share dividend during the quarter and declared another $0.10 per-share dividend for payment in June 2012, subject to applicable conditions.
Most important facts to verify
- Reconcile GAAP net income of $43.1 million with management’s $52.7 million adjusted figure and assess the recurring versus nonrecurring effects of derivatives and currency movements.
- Monitor the sustainability of the $38.1 million of floor income and the 1.43% core student-loan spread under changing interest rates and basis spreads.
- Review warehouse-facility renewals, covenant compliance, Conduit refinancing plans, and access to securitization markets.
- Assess delinquency trends, the high allowance rate on non-federally insured loans, and repurchase obligations of $18.4 million.
- Evaluate whether higher fee-based revenue can offset rising servicing costs and continued weakness in enrollment services.
- Update the potential exposure from the Peterson’s TCPA litigation and other regulatory inquiries.
- Confirm the effect of the subsequent $4.6 million tax benefit and the April 12, 2012 collateralized credit line in later filings.