NELNET INC quarterly report, Q1 FY2016

Nelnet, Inc. Form 10-Q Summary

Business context and reporting period

Nelnet filed an unaudited Form 10-Q for the three months ended March 31, 2016, compared with the three months ended March 31, 2015. The company operates student loan asset management and servicing, tuition payment processing and campus commerce, communications, and other investment businesses. Its largest financial exposure remains a $27.5 billion student loan portfolio, primarily federally insured FFELP loans.

Key financial metrics

Metric	Q1 2016	Q1 2015	Change
Total interest income	$192.0 million	$174.1 million	+10.3%
Net interest income after provision	$99.1 million	$100.6 million	-1.5%
Total other income	$84.9 million	$117.1 million	-27.5%
Income before taxes	$72.5 million	$102.4 million	-29.3%
Net income attributable to Nelnet	$48.0 million	$64.8 million	-26.0%
Basic and diluted EPS	$1.11	$1.40	-20.7%
Operating cash flow	$104.5 million	$129.3 million	-19.2%

Net income excluding derivative market value and foreign currency adjustments was $61.7 million, or $1.43 per share, versus $63.4 million, or $1.37 per share, in the prior-year quarter. The company identifies this non-GAAP measure as useful for period-to-period comparability.

Core student loan spread declined to 1.34% from 1.41%; fixed-rate floor income net of derivative settlements declined to $40.6 million from $46.2 million.
Interest expense increased to $90.4 million from $71.6 million, primarily due to higher funding costs.
Total operating expenses declined to $111.5 million from $115.2 million, although salaries and benefits and depreciation increased.
The effective tax rate was 33.75%, compared with 36.75%, partly due to the resolution of certain tax positions.
Cash and cash equivalents were $51.0 million at March 31, 2016, supplemented by $127.2 million of available-for-sale and trading investments.
Bonds and notes payable totaled $27.35 billion, down from $28.11 billion at December 31, 2015. The company also had $260.0 million available under a $350.0 million unsecured line of credit.
Total assets were $29.59 billion and total equity was $1.89 billion at March 31, 2016.

Cash flow, capital allocation, and liquidity

Operating activities generated $104.5 million. Investing activities provided $729.7 million, primarily reflecting student loan repayments and sales of securities, while financing activities used $846.7 million, including $858.1 million of debt repayments, $52.1 million of share repurchases, and $5.1 million of dividends. Cash therefore declined by $12.5 million during the quarter.

Nelnet repurchased 1,599,099 Class A shares for $52.1 million, or $32.56 per share. The board had authorized repurchases of up to five million shares through May 24, 2018, with 1,664,223 shares remaining authorized at quarter-end. The company paid a $0.12 per-share quarterly dividend and declared another $0.12 dividend payable in June 2016.

Management expects approximately $2.36 billion of future undiscounted cash flows from FFELP loans financed in asset-backed securitizations, including approximately $732.3 million of overcollateralization. This forecast depends on assumptions regarding prepayments, defaults, forbearance, interest rates, and basis spreads.

Material changes versus the prior comparable period

Net income attributable to Nelnet decreased $16.8 million, driven principally by lower other income, higher interest expense, lower floor income, and a $28.7 million net loss from derivative market value and foreign currency adjustments.
Loan interest increased to $190.0 million from $171.9 million, but the benefit was largely offset by higher interest expense and lower fixed-rate floor income.
Loan and guaranty servicing revenue fell to $52.3 million from $57.8 million. A major guaranty servicing client contract expired in October 2015, and the remaining guaranty client planned to exit the FFELP guaranty business on June 30, 2016.
Tuition payment processing and campus commerce revenue increased to $38.7 million from $34.7 million, and its pretax margin improved to 42.1% from 38.4%.
Communications revenue of $4.3 million was added following the December 31, 2015 acquisition of Allo Communications. Allo recorded a $0.4 million net loss and $0.7 million of EBITDA in the quarter.
Nelnet sold Sparkroom LLC on February 1, 2016. The company recognized an approximately $3.0 million gain and retained the Peterson’s digital marketing and content businesses.
The student loan portfolio declined to $27.52 billion net from $28.32 billion at year-end 2015. Private education loans increased to $294.6 million from $267.6 million.
The company changed its segment overhead allocation methodology effective January 1, 2016 and restated prior-period segment information for comparability.

Guidance, outlook, risks, and unusual items

Management expects Allo to be dilutive to consolidated earnings during 2016 because of upfront network capital expenditures and depreciation. Planned 2016 network capital expenditures are approximately $50 million, subject to customer demand.
Management expects significant fixed-rate floor income to continue if short-term interest rates remain low, but higher rates could reduce floor income and compress margins.
The Department of Education changed the comparison group used for new loan-servicing allocations, reducing Nelnet’s government allocation from 13% to 8% for March 1 through June 30, 2016. New servicing metrics were expected by July 1, 2016.
The Department’s current servicing contract expires June 16, 2019. In April 2016, the Department began procurement of a single servicing solution covering federal student financial aid, creating significant contract and volume uncertainty.
Nelnet’s remaining guaranty servicing client planned to exit the FFELP guaranty business on June 30, 2016; after that date, the company expected no remaining guaranty servicing or collection revenue.
The private education loan warehouse facility was amended after quarter-end. Liquidity provisions now expire October 28, 2016, and the facility’s final maturity is April 28, 2017. Failure to renew liquidity provisions could increase costs and require refinancing.
FFELP warehouse facilities had $1.89 billion outstanding against $2.13 billion of maximum capacity, with approximately $235.4 million available. One facility’s liquidity provisions expired April 29, 2016 and were amended on April 29, 2016.
Derivative liabilities were $62.4 million, with $53.7 million of collateral deposited. Adverse interest-rate movements could increase collateral requirements.
Key risks include interest-rate and basis risk, student loan prepayments and defaults, securitization-market liquidity, regulatory and legislative changes, servicing contract losses, cybersecurity and systems failures, litigation, and integration and expansion risks related to Allo.
The filing states that there were no material changes to previously disclosed legal proceedings or risk factors, and no material off-balance-sheet arrangements.

Important facts for investors to verify

Progress and outcome of the Department of Education’s single-servicer procurement and related changes in Nelnet’s loan allocations.
Actual loss of guaranty servicing and collection revenue after June 30, 2016.
Renewal or refinancing of warehouse-facility liquidity provisions, particularly the private education loan facility by October 28, 2016.
Sustainability of fixed-rate floor income and the effect of rising rates, basis spreads, and derivative settlements on earnings.
Allo’s network expansion, capital spending, customer growth, and path to profitability.
Whether the company’s projected $2.36 billion of securitized FFELP cash flows change materially as prepayment, default, or interest-rate assumptions evolve.
Future use of liquidity for acquisitions, loan purchases, dividends, debt repurchases, and stock repurchases.