NELNET INC. 10-Q Summary: Quarter Ended September 30, 2008
Business Context and Reporting Period
This report covers the quarterly period ended September 30, 2008. NELNET, Inc. is an education planning and financing company operating through five segments: Student Loan and Guaranty Servicing, Tuition Payment Processing and Campus Commerce, Enrollment Services and List Management, Software and Technical Services, and Asset Generation and Management. The company operates in a highly regulated environment, heavily influenced by federal student loan programs (FFELP) and capital market conditions.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2008 | Nine Months Ended Sep 30, 2008 |
|---|---|---|
| Net Interest Income | $59.6 million | $149.4 million |
| Net Income (Loss) | $23.8 million | $(2.3) million |
| Earnings Per Share (Basic/Diluted) | $0.48 | $(0.05) |
| Total Assets | $28.97 billion | $28.97 billion |
| Total Liabilities | $28.36 billion | $28.36 billion |
| Shareholders' Equity | $609.7 million | $609.7 million |
| Cash and Cash Equivalents | $325.0 million | $325.0 million |
| Student Loans Receivable (Net) | $26.38 billion | $26.38 billion |
| Bonds and Notes Payable | $28.00 billion | $28.00 billion |
Note: The company reported a net loss for the nine-month period primarily due to a $47.4 million loss on the sale of student loans in the first quarter.
Material Changes vs. Prior Period
- Profitability: The company returned to profitability in the third quarter ($23.8 million net income) compared to a net loss of $15.7 million in the same period in 2007. However, the nine-month period ended with a net loss of $2.3 million, compared to net income of $13.8 million in 2007.
- Loan Sales: A significant $47.4 million loss was recognized in the first quarter of 2008 from the sale of $1.29 billion in student loans. This was driven by disruptions in the debt and secondary markets, forcing sales at approximately 98% of par value.
- Operating Expenses: Excluding restructuring and impairment charges, operating expenses decreased by 12.9% ($15.3 million) for the quarter and 15.6% ($56.4 million) for the nine months compared to 2007, reflecting cost-saving restructuring initiatives.
- Fee-Based Revenue: Revenue from fee-based businesses increased 6.4% to $76.7 million for the quarter, driven by growth in tuition payment processing and enrollment services.
- Derivatives: The company recorded a $119.9 million expense related to changes in the fair value of derivative instruments for the quarter, compared to $72.7 million income in the prior year quarter.
Guidance, Outlook, and Risks
Liquidity and Funding: The company faces significant liquidity challenges due to the disruption of credit markets. On July 31, 2008, the company did not renew the liquidity provisions of its FFELP warehouse facility, converting it to a term facility. Consequently, the company cannot fund new loan originations through this facility. It has pivoted to using the Department of Education's Participation Program and an agreement with Union Bank to fund new originations.
Equity Support Requirements: The FFELP warehouse facility requires mark-to-market advance rates. As of November 7, 2008, the company had posted $374.6 million in equity funding support. Continued volatility in loan valuations could require additional equity support, potentially triggering a default if the company cannot provide it.
Legal and Regulatory:
- Investigations: The company's subsidiary, Shockley Financial Corp., is under investigation by the DOJ, SEC, and various state attorneys general regarding municipal derivative bid practices. The company is also subject to inquiries regarding preferred lender lists and direct-to-consumer marketing.
- Lehman Brothers: Lehman Brothers Bank represents 7% of the company's unsecured line of credit. Following Lehman's bankruptcy filing, the company has experienced funding delays from this lender, reducing available capacity on the line of credit.
Dividends: The company temporarily suspended its quarterly dividend program on May 21, 2008.
Investor Verification Checklist
- Warehouse Facility Amendment: Verify the status of the amendment process with Banc of America Securities to place a floor on collateral valuation in the FFELP warehouse facility.
- Equity Support Capacity: Assess the company's ability to meet future equity funding support requirements for its warehouse facilities given the current credit market volatility.
- Lehman Brothers Exposure: Monitor the resolution of funding delays from Lehman Brothers Bank and the impact on the company's unsecured line of credit availability.
- Department of Education Programs: Track the implementation details and long-term viability of the Department of Education's Participation and Purchase Programs as the primary funding source for new loans.
- Derivative Valuation: Review the impact of continued interest rate and currency fluctuations on the fair value of the company's derivative portfolio, which significantly impacts reported earnings.