DBRS: Nelnet’s 3Q Underlying Results Slightly Higher QoQ; Segment Performance within Expectations

Summary:
• For 3Q15, Nelnet reported underlying net income of $64.3 million, 1% higher linked-quarter, as higher net interest income and adjusted non-interest income more than offset growth in operating expenses.
• By segment, performance was solid as evidenced by margin expansion, growth in the loan portfolio, further expansion in the servicing portfolio for the Department of Education (the ED), and positive operating leverage in the Tuition Payment Processing and Campus Commerce (TPP & CC) segment.
• DBRS rates Nelnet, Inc. Senior Unsecured Debt at BBB (low) with a Stable trend.

DBRS, Inc. (DBRS) views Nelnet, Inc.’s (Nelnet or the Company) underlying 3Q15 financial results as acceptable with solid performance across all segments. For 3Q15, Nelnet reported net income of $49.0 million, down from $71.0 million in the prior quarter largely due to adverse derivative market value and foreign currency adjustments. Excluding the impact of derivative market value and foreign currency adjustments, Nelnet generated underlying net income, of $64.3 million, slightly higher sequentially.

By segment, results were solid with the Company’s largest segment, Asset Generation and Management (AGM) reporting 5% growth quarter-on-quarter (QoQ) in net income to $52.0 million, excluding the impact of derivative market value and foreign currency adjustments. The improved sequential results were achieved despite an 8% reduction in revenue to $107.0 million. Net interest income was higher QoQ due to improved margins and higher student loan balances. The outstanding student loan portfolio grew sequentially due to acquisition activity of FFELP student loans and slower organic attrition of the existing portfolio. The core student loan spread expanded 4 basis points QoQ to 1.45% on a higher variable student loan yield and improved contributions from fixed rate floor income.

In DBRS’s view, Nelnet continues to make progress on its strategy to broaden the suite of products offered to colleges and other educational institutions as demonstrated by the improved performance of the Company’s TPP & CC segment. For the quarter, TPP & CC generated solid results with revenues 10% higher QoQ reflecting growth in the customer base, as well as expansion in the number of managed tuition plans and an increase in campus commerce transactions and volumes. Importantly, segment margins improved due to positive operating leverage. Meanwhile, results in Corporate and Other were lower QoQ as the improving capital markets reduced opportunities for the Company’s investment advisory subsidiary to generate fees.

Student Loan Servicing and Guaranty (LGS) segment results were modestly lower QoQ as FFELP rehabilitation revenue was reduced reflecting federal legislative changes to the fees paid for collection services, while revenue for servicing loans for the ED were stable. Lower revenue combined with an increase in employee costs due to higher headcount to support the growing ED servicing portfolio resulted in tighter operating margins, albeit at a still respectable 15.0%. DBRS notes, as previously announced, Nelnet’s contract with its largest guaranty servicing client, which accounted for most of the Company’s guaranty servicing revenue, expired on October 31, 2015. As such, DBRS expects that revenues and earnings for the LGS segment will be lower going forward, although the overall impact is viewed by DBRS as manageable from an earnings perspective, as the relationship accounted for just 5% of 2014 total revenues, and there will be some offsetting costs removed from Nelnet’s expense base.

DBRS rates Nelnet, Inc. Senior Unsecured Debt rating at BBB (low) with a Stable trend.

Note:
All figures are in U.S. dollars unless otherwise noted.