Nelnet, Inc. FY2017 Form 10-K Summary
Business context and reporting period
Nelnet is a diversified education-services and loan-asset-management company reporting for the fiscal year ended December 31, 2017. Its four reportable segments are Loan Systems and Servicing, Tuition Payment Processing and Campus Commerce, Communications, and Asset Generation and Management.
The company remains substantially dependent on its legacy federally insured FFELP student-loan portfolio, although it is expanding fee-based education services, private education and consumer lending, and fiber-optic communications through ALLO. New FFELP originations ended in 2010; the existing portfolio is expected to amortize over approximately 20 years and had a weighted-average remaining life of 7.5 years at year-end.
Key financial metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net interest income | $305.2 million | $372.6 million | Down $67.3 million |
| Loan Systems and Servicing revenue | $223.0 million | $214.8 million | Up $8.2 million |
| Tuition Payment Processing and Campus Commerce revenue | $145.8 million | $132.7 million | Up $13.0 million |
| Communications revenue | $25.7 million | $17.7 million | Up $8.0 million |
| Income before taxes | $226.7 million | $398.8 million | Down $172.1 million |
| Net income attributable to Nelnet | $173.2 million | $256.8 million | Down 32.6% |
| Basic and diluted EPS | $4.14 | $6.02 | Down 31.2% |
| Net cash provided by operating activities | $227.5 million | $325.3 million | Down $97.7 million |
| Core loan spread | 1.23% | 1.28% | Down 5 basis points |
Net income attributable to Nelnet excluding derivative market-value and foreign-currency adjustments was $185.1 million, or $4.43 per share, compared with $212.3 million, or $4.97 per share, in 2016. The filing presents this as a non-GAAP measure for comparability.
- Fixed-rate floor income, net of derivative settlements, was $117.3 million, down from $152.3 million.
- Loan Systems and Servicing net income attributable to Nelnet was $29.6 million, with a 13.2% pretax operating margin, compared with $38.0 million and 23.6% in 2016.
- Tuition Payment Processing and Campus Commerce net income was $23.9 million, with a 26.5% pretax operating margin, compared with $21.5 million and 26.2%.
- Communications generated a $16.5 million net loss and negative $9.4 million of EBITDA, compared with a $5.9 million net loss and negative $2.2 million of EBITDA in 2016.
- Asset Generation and Management net income was $129.2 million, down from $214.5 million, primarily because of loan-portfolio runoff, lower floor income, higher funding costs, and a lower loan spread.
Balance sheet, debt, and liquidity
- Loans receivable, net, were $21.8 billion at December 31, 2017, down from $24.9 billion. The portfolio included $21.7 billion of federally insured loans, $212.2 million of private education loans, and $62.1 million of consumer loans.
- Approximately 98.8% of the student-loan portfolio was federally insured. The allowance for loan losses was $54.6 million, and 2017 provision expense was $14.5 million.
- Total assets were $24.0 billion, compared with $27.2 billion. Shareholders’ equity attributable to Nelnet was $2.15 billion, and book value per common share was $52.67.
- Bonds and notes payable had a carrying value of $21.36 billion. Consolidated debt obligations before discounts and issuance costs were approximately $21.73 billion, with $21.29 billion issued through asset-backed securitizations and $336.0 million outstanding under FFELP warehouse facilities.
- Cash and cash equivalents were $66.8 million. Available-for-sale investments had a fair value of $80.9 million.
- The company had a $350.0 million unsecured line of credit, of which $10.0 million was drawn and $340.0 million was available. The company reported compliance with applicable debt covenants.
- Approximately 98.1% of the loan portfolio was included in asset-backed securitizations. Management estimated future undiscounted cash flows from the securitized portfolio of approximately $1.92 billion, including approximately $1.34 billion expected over the next five years.
Material changes versus the prior comparable period
- Net income declined sharply as higher interest expense and portfolio runoff more than offset growth in fee-based revenue. Interest expense increased to $465.2 million from $388.2 million as funding costs rose.
- The loan portfolio declined by approximately $3.1 billion. Repayments, claims, and other reductions totaled $2.26 billion, while consolidation loans lost to external parties totaled $1.13 billion.
- Government servicing revenue increased to $155.8 million from $151.7 million, while private education and consumer-loan servicing revenue increased to $28.1 million from $15.6 million. FFELP guaranty servicing and collection revenue ended after the remaining customer exited the business in 2016.
- Loan Systems and Servicing incurred $12.6 million of pretax costs for the GreatNet government-servicing platform under development, contributing to lower segment margins.
- Tuition Payment Processing and Campus Commerce revenue increased with higher managed payment plans, campus-commerce transactions, and new school customers, but the company incurred $5.7 million of net operating costs for new PaymentSpring products and services.
- ALLO revenue rose 45% to $25.7 million, but its net loss widened because of network expansion, depreciation, personnel, and customer-acquisition costs. ALLO capital expenditures were $115.1 million.
- The company sold Peterson’s on December 31, 2017 for $5.0 million in cash and recorded a $3.6 million goodwill impairment charge.
- The Tax Cuts and Jobs Act reduced 2017 income-tax expense by $19.3 million through deferred-tax remeasurement. The effective tax rate was 27.25%, versus 35.50% in 2016.
- The company repurchased 1.47 million shares for $68.9 million during 2017 and paid $0.58 per common share in dividends.
Guidance, outlook, risks, and unusual items
- Management expects the effective tax rate to be approximately 23% to 24% beginning in 2018, subject to further tax-law guidance and other developments.
- Management expects the FFELP portfolio and related interest income, FFELP servicing revenue, and related software revenue to continue declining as loans amortize. It also expects higher interest rates to reduce floor income and increase funding costs.
- ALLO expects to remain dilutive to consolidated earnings while it builds its fiber network. The company anticipated approximately $75.0 million of ALLO network capital expenditures in 2018, although actual spending may vary with customer demand.
- On February 7, 2018, after the reporting period, Nelnet acquired Great Lakes Educational Loan Services for $150.0 million in cash. Great Lakes was servicing $224.4 billion of government-owned loans for 7.5 million borrowers at December 31, 2017. The acquisition was financed with existing cash and borrowings under the unsecured line of credit.
- The Department of Education servicing contract generated $155.8 million, or 21% of 2017 revenue, and was scheduled to expire June 16, 2019. The Department initiated a new procurement process in February 2018, and Nelnet intended to respond. Failure to retain or replace the contract could materially reduce revenue and future servicing opportunities.
- Key risks include interest-rate basis and repricing risk, derivative mark-to-market volatility, prepayments and loan runoff, warehouse-funding maturities, securitization-market access, cybersecurity and operational failures, regulatory and consumer-protection exposure, litigation, and the loss of federal loan guarantees if servicing requirements are not met.
- The company’s executive chairman beneficially controlled 77.7% of voting rights. Transactions with related party Union Bank generated $12.5 million of pretax income for Nelnet in 2017 and present potential conflicts of interest.
- KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting.
Most important facts for investors to verify
- Retention, renewal terms, economics, and performance requirements of the Department of Education servicing contract, including the post-2019 procurement outcome.
- Integration costs, financing, borrower volumes, and expected synergies from the Great Lakes acquisition.
- Sensitivity of loan spread, floor income, liquidity, collateral requirements, and earnings to LIBOR movements and other interest-rate changes.
- Runoff rates, prepayments, delinquency trends, allowance adequacy, and the eventual credit performance of newly acquired private education and consumer loans.
- ALLO’s customer additions, network-buildout costs, capital expenditures, EBITDA path, and ability to achieve acceptable returns on fiber investments.
- The effect of the new revenue-recognition presentation on reported Tuition Payment Processing and Campus Commerce revenue and expenses; the filing states that 2017 and 2016 payment-service costs of $47.4 million and $43.0 million, respectively, will be presented separately.
- Potential changes to the provisional tax accounting resulting from the Tax Cuts and Jobs Act and the company’s $22.4 million reserve for uncertain tax positions.
- Related-party transactions, including Union Bank funding arrangements and investments involving Hudl and company directors or controlling shareholders.