Nelnet, Inc. 2020 Second-Quarter Form 10-Q Summary
Business context and reporting period
Nelnet is a diversified education-focused company with businesses in student-loan servicing, education technology and payment processing, communications, and asset generation and management. This unaudited Form 10-Q covers the three and six months ended June 30, 2020, compared with the corresponding 2019 periods. COVID-19, borrower-relief measures, low interest rates, and uncertainty surrounding Department of Education servicing contracts were major themes.
Financial performance and key metrics
| Metric | Three months ended June 30, 2020 | Three months ended June 30, 2019 | Six months ended June 30, 2020 | Six months ended June 30, 2019 |
|---|---|---|---|---|
| Total interest income | $151.9 million | $246.8 million | $341.1 million | $497.4 million |
| Net interest income | $66.6 million | $59.8 million | $121.7 million | $118.6 million |
| Provision for loan losses | $3.0 million | $9.0 million | $79.3 million | $16.0 million |
| Other income/expense | $251.0 million | $182.1 million | $441.7 million | $388.3 million |
| Income before taxes | $107.9 million | $30.9 million | $58.0 million | $83.9 million |
| Net income attributable to Nelnet | $86.5 million | $24.6 million | $46.0 million | $66.2 million |
| Basic and diluted EPS | $2.21 | $0.61 | $1.16 | $1.65 |
Second-quarter net income increased substantially, primarily because of a $51.0 million pretax gain on the Hudl investment, higher loan spread and derivative settlements, and lower derivative fair-value losses. Six-month net income declined because of COVID-19-related credit provisions and investment impairments, lower loan balances and spreads, and weaker loan-servicing results.
- Fee-based revenue included loan servicing and systems revenue of $111.0 million in the second quarter and $223.8 million for the first half; education technology, services, and payment processing revenue of $59.3 million and $143.0 million; and communications revenue of $19.0 million and $37.2 million, respectively.
- Core loan spread was 1.35% in the second quarter and 1.19% for the first half, compared with 1.21% and 1.25% in the comparable 2019 periods. Loan spread including derivative settlements was 1.23% and 1.09%, compared with 0.96% and 0.95%.
- Operating expenses were $185.7 million in the second quarter and $376.6 million for the first half, versus $181.1 million and $360.2 million, respectively.
- ALLO communications revenue increased, but the segment reported net losses of $5.4 million in the second quarter and $10.9 million for the first half. ALLO EBITDA was $3.8 million and $7.0 million, respectively.
Cash flow, balance sheet, debt, and liquidity
- At June 30, 2020, total assets were $22.6 billion, down from $23.7 billion at December 31, 2019. Loans and accrued interest receivable were $20.5 billion, compared with $21.4 billion.
- Bonds and notes payable were $19.7 billion, down from $20.5 billion. Total equity was $2.34 billion, compared with $2.39 billion at year-end.
- Cash and cash equivalents were $67.5 million. Including restricted cash, total cash, cash equivalents, and restricted cash were $921.3 million, down from $1.22 billion at December 31, 2019.
- Operating activities used $105.6 million during the first half, compared with $17.8 million used in 2019. Excluding the $169.2 million decrease in amounts due to customers, operating activities generated $63.6 million.
- Investing activities provided $717.3 million, while financing activities used $913.0 million. The company completed three FFELP asset-backed securitizations totaling approximately $1.1 billion.
- The company had a $455.0 million unsecured line of credit, with $30.0 million outstanding and $425.0 million available. A $22.0 million secured line had $5.0 million outstanding and $17.0 million available.
- Warehouse capacity available at June 30, 2020 was $348.9 million for FFELP loans, $92.6 million for private education loans, and $126.4 million for consumer loans.
- Management stated that cash and anticipated annual operating cash flow should fund operations and business activities for the foreseeable future, while noting that COVID-19, funding-market conditions, and capital deployment could affect liquidity.
Material changes versus the prior comparable period
- Interest income fell sharply because of lower loan yields, lower interest rates, and a smaller average loan portfolio. Lower funding costs partly offset the decline, allowing net interest income to increase modestly.
- The six-month loan-loss provision increased by $63.3 million year over year, primarily from a $63.0 million incremental first-quarter provision related to COVID-19 economic forecasts and lifetime expected losses under CECL.
- Nelnet adopted CECL on January 1, 2020, increasing the allowance for loan losses by $91.0 million and reducing retained earnings, net of tax, by $18.9 million. Management cautioned that 2020 and 2019 credit-loss results are not directly comparable.
- The allowance for loan losses was $209.4 million at June 30, 2020, including reserves equal to 0.7% of federally insured loans, 8.7% of private education loans, and 26.2% of consumer loans.
- Federally insured loans in forbearance increased to $5.4 billion, or 27.7% of the portfolio, from $1.3 billion, or 6.6%, at December 31, 2019. Private education loans in forbearance increased to $21.9 million, or 7.5%, from $3.1 million, or 1.3%.
- Loan servicing and systems net income decreased to $11.1 million in the second quarter and $21.4 million for the first half, from $17.0 million and $33.7 million. The segment cited COVID-19-related revenue pressure and increased service and security costs.
- Communications revenue increased 20.6% in the second quarter and 22.7% for the first half, while communications losses widened modestly because of depreciation and network investment.
- The company repurchased 1.5 million Class A shares for $68.5 million during the first half, primarily in the second quarter, and paid a $0.20-per-share dividend. The board declared another $0.20-per-share dividend for the third quarter.
Guidance, outlook, commentary, risks, and unusual items
- Management expected a 2020 effective tax rate of approximately 19% to 21%.
- Management expected gross fixed-rate floor income to remain elevated because of low interest rates, partly offset by higher settlements on related hedges. It also expected variable loan spread to improve as debt repriced at lower rates.
- The company anticipated a pretax gain of approximately $14.8 million in the third quarter from the subsequent sale of $60.8 million of consumer loans.
- Department of Education servicing contracts expire December 14, 2020, with potential six-month extensions through December 14, 2021. The Department rejected Nelnet’s EPS proposal and deemed its BPO proposal ineligible. Nelnet filed GAO protests; a decision on the BPO protests was expected by October 22, 2020. Loss or unfavorable modification of these contracts could materially reduce revenue.
- The CARES Act suspended payments and interest on Department-owned federal student loans through September 30, 2020. Nelnet expected lower servicing revenue in the second and third quarters and higher revenue in the fourth quarter, and did not anticipate a negative full-year revenue effect at the time of filing.
- COVID-19 could result in additional loan-loss provisions, impairments, lower servicing and education-technology demand, operational and cybersecurity challenges, and weaker cash flows. Rating-agency actions and increased forbearance had also reduced liquidity in the FFELP securitization market.
- Nelnet Bank had received FDIC and Utah regulatory approvals subject to conditions and readiness review. The company expected potential operations by the fourth quarter of 2020, committed initial capital of $100 million, and agreed to maintain capital, liquidity support, and a $40 million pledged deposit.
- The company recognized $34.4 million of first-half impairment expense, primarily $26.3 million on consumer-loan securitization interests and $7.8 million on venture investments, plus a $0.3 million second-quarter real-estate impairment.
- LIBOR exposure remained significant: approximately $18.0 billion of FFELP assets and $17.8 billion of FFELP debt were indexed to one- or three-month LIBOR. The transition away from LIBOR after 2021 could affect spreads, derivatives, liquidity, and securitization cash-flow forecasts.
Most important facts for investors to verify
- Whether Nelnet’s Department of Education servicing contracts are extended, replaced, or materially modified through the NextGen procurement process.
- Future COVID-19 effects on forbearance, delinquencies, expected credit losses, investment impairments, and securitization cash flows.
- The sustainability of the Hudl-related investment gain and the expected $14.8 million consumer-loan-sale gain, which are unusual or nonrecurring items.
- Liquidity availability, warehouse-facility renewals, securitization-market access, debt maturities, and potential collateral requirements for derivatives.
- Progress, capital requirements, and regulatory conditions related to Nelnet Bank.
- Effects of LIBOR replacement and interest-rate basis risk on loan spread, hedge settlements, earnings, and projected securitization cash flows.
- Whether ALLO can expand its network and improve profitability while funding approximately $20 million of anticipated second-half 2020 capital expenditures.