Nelnet, Inc. — Form 10-Q Summary
Business context and reporting period
Nelnet filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. The company operates student loan servicing, tuition payment processing and campus commerce, communications, and student loan asset-management businesses. The Communications segment reflects the December 2015 acquisition of Allo Communications. The filing was signed November 9, 2016.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Total interest and other income | $341.3 million | $277.1 million | $862.8 million | $870.2 million |
| Net interest income after loan-loss provision | $93.8 million | $109.0 million | $283.1 million | $312.5 million |
| Income before taxes | $132.1 million | $76.0 million | $245.8 million | $289.7 million |
| Net income attributable to Nelnet | $84.3 million | $49.0 million | $158.4 million | $184.6 million |
| Basic and diluted EPS | $1.98 | $1.09 | $3.70 | $4.03 |
| Operating cash flow | Not separately provided | Not separately provided | $258.8 million | $307.4 million |
Q3 net income increased primarily because of a $42.3 million pretax derivative market-value and foreign-currency gain, compared with a $24.8 million loss in the prior-year quarter. Excluding these items, net income was $58.1 million, or $1.36 per share, versus $64.3 million, or $1.43 per share, in Q3 2015. For the nine months, adjusted net income was $167.8 million, or $3.92 per share, versus $191.3 million, or $4.18 per share.
- Q3 total operating expenses were $106.8 million, down from $120.9 million; nine-month expenses were $325.7 million, down from $352.0 million.
- Interest expense increased to $96.4 million in Q3 and $280.8 million for nine months, from $77.2 million and $221.3 million, respectively, primarily due to higher funding costs.
- The core student loan spread was 1.26% in Q3 2016 versus 1.45% in Q3 2015; the nine-month spread was 1.30% versus 1.43%.
- Fixed-rate floor income, net of derivative settlements, declined to $36.4 million in Q3 and $116.5 million for nine months, from $48.2 million and $139.5 million, respectively.
- At September 30, 2016, student loans receivable were $25.6 billion, down from $28.3 billion at December 31, 2015. The allowance for loan losses was $51.6 million.
- Total assets were $27.7 billion and total equity was $2.0 billion at September 30, 2016, compared with $30.4 billion and $1.9 billion, respectively, at year-end 2015.
- Bonds and notes payable declined to $25.3 billion from $28.1 billion at year-end 2015. Debt fair value was $24.8 billion versus carrying value of $25.3 billion.
- Cash and cash equivalents were $67.2 million, and available-for-sale and trading investments had a fair value of $112.6 million. The $350.0 million unsecured line of credit was undrawn and available.
Material changes versus the prior comparable period
- Loan and guaranty servicing revenue declined to $54.4 million in Q3 and $161.1 million for nine months, from $61.5 million and $183.2 million. Guaranty servicing and collection revenue ended after the remaining client exited the business on June 30, 2016.
- Government servicing revenue increased to $40.2 million in Q3 and $112.5 million for nine months, from $33.2 million and $99.3 million. Nelnet serviced approximately $161.7 billion for 6.0 million borrowers under the Department of Education contract.
- Tuition payment processing and campus commerce revenue increased to $33.1 million in Q3 and $102.2 million for nine months, from $30.4 million and $92.8 million, driven by higher payment plans, transaction volumes, and customer additions.
- Allo contributed $4.3 million of Q3 revenue and $13.2 million for nine months, but generated net losses of $2.2 million and $3.3 million, respectively. Allo incurred $24.6 million of capital expenditures during the first nine months.
- The student loan portfolio continued to amortize. Nine-month loan acquisitions were $238.6 million versus $3.8 billion in 2015.
- Nelnet repurchased 1.8 million Class A shares for $60.1 million during the first nine months and paid $15.3 million of dividends. The company declared a fourth-quarter dividend of $0.14 per share.
- In Q3, Nelnet corrected an error in its student loan premium and discount amortization method. The correction reduced the net loan discount balance by $8.2 million and increased after-tax net income by $5.2 million; management characterized the impact on current and prior periods as immaterial.
Guidance, outlook, risks, contingencies, and unusual items
- Management expects Allo to remain dilutive to consolidated earnings while it expands its fiber network. Planned network capital expenditures were approximately $50 million for 2016 and approximately $90 million for 2017, subject to customer demand.
- The Department of Education is procuring a single federal student loan servicing platform. Nelnet and Great Lakes formed the 50/50 GreatNet joint venture, which was selected to participate in Phase II. Responses were due December 12, 2016, with an anticipated award in February 2017. Nelnet’s existing Department contract expires June 16, 2019.
- On October 12, 2016, Nelnet completed a $426.0 million asset-backed securitization, primarily to refinance loans in FFELP warehouse facilities.
- A private education loan warehouse facility had $206.6 million outstanding and $68.4 million available at September 30. Its liquidity provisions were subsequently extended to December 21, 2016; absent renewal, the facility could become a higher-cost term facility and require refinancing by April 28, 2017.
- A $75.0 million collateralized line of credit expired October 31, 2016 and was repaid using operating cash and borrowings under the unsecured line of credit.
- Key risks include student loan portfolio runoff, basis and repricing risk, declining floor income as rates rise, derivative collateral requirements, securitization-market access, rating-agency actions, warehouse refinancing, regulatory changes, cybersecurity, litigation, and the outcome of the Department of Education servicing procurement.
- Management forecast approximately $2.17 billion of future undiscounted cash flows from FFELP loans in asset-backed securitizations. The forecast could decline by approximately $220 million to $280 million under a materially higher prepayment assumption and by approximately $70 million to $110 million under a wider funding-index spread.
- There were no material changes to previously disclosed legal proceedings or risk factors, and management concluded disclosure controls were effective.
Important facts for investors to verify
- Reconcile GAAP earnings with adjusted earnings excluding derivative and foreign-currency volatility, including the $5.2 million after-tax accounting correction.
- Monitor the Department of Education’s single-servicer procurement and the potential effect on Nelnet’s government servicing volumes and revenue.
- Assess the sustainability of floor income and the effect of higher interest rates, basis spreads, and derivative settlements on student loan margins.
- Verify refinancing and liquidity plans for warehouse facilities, particularly the private education loan facility maturing April 28, 2017.
- Evaluate Allo’s capital requirements, operating losses, customer growth, and progress toward network expansion.
- Review assumptions underlying the $2.17 billion securitization cash-flow forecast, including prepayments, defaults, interest rates, and rating-agency actions.