DBRS Confirms Nelnet, Inc.’s Long-Term Issuer Rating at BBB (low); Trend Stable

DBRS, Inc. (DBRS) confirmed the ratings of Nelnet, Inc. (Nelnet or the Company), including its Long-Term Issuer Rating and Long-Term Senior Debt, both at BBB (low). Nelnet’s Support Assessment is unchanged at SA3, reflecting DBRS’s view that systemic support is not expected and as such, the Company’s Intrinsic Assessment is BBB (low), equalized with the final rating. The trend for all ratings is Stable.

KEY RATING CONSIDERATIONS
The ratings consider the Company’s solid franchise in education-related services, acceptable earnings generation capacity, gradually diversifying revenue mix, low credit risk profile and prudent capital management. The ratings also consider Nelnet’s reliance on secured forms of funding, the large concentration of the Department of Education (the ED)-related servicing revenue, the uncertainty regarding the outcome of the ED’s new servicing contract procurement process, as well as the Company’s restrained earnings growth prospects due to the inherent runoff of its FFELP portfolio.

The Stable trend reflects DBRS’s expectation that Nelnet’s solid earnings generation capacity will persist while firmly growing its fee-based businesses that should partially offset the declining spread-related earnings generated from the FFELP student loan portfolio that remains in run-off. The Stable trend also reflects DBRS’s expectation that the Company will continue to maintain adequate liquidity to conduct its current businesses or to capture upcoming business opportunities while at the same time maintaining prudent capital management and appropriate leverage levels.

RATING DRIVERS
A strengthening of the Company’s franchise due to business growth initiatives resulting in a growing and diversified revenue mix with lower ED-related concentration could have positive ratings implications. Furthermore, better visibility on the new ED servicing contract suggesting that Nelnet’s positioning in government servicing has not been materially degraded, may result in upward ratings pressures. Additionally, a diversified funding profile including a meaningful reduction in secured forms of funding would also be viewed favorably from a ratings perspective. Conversely, a significant reduction of fee-based earnings indicative of diminished competitive positioning or business profitability, or aggressive capital management resulting in a weakened capital position could have negative implications to the ratings. Moreover, a sizable acquisition outside of the Company’s core competencies or expansion into other products or businesses that would meaningfully alter the Company’s risk profile could result in adverse ratings implications.

RATING RATIONALE
DBRS views the Company’s market leading franchise in the education services market as supportive of the ratings. Nelnet’s solid franchise in the education-related services market is underpinned by its top-tier position as the largest student loan servicer for the ED and a preeminent provider of school management and payment solutions, serving nearly half of the private faith-based K-12 schools and approximately 20% of colleges and universities in the U.S. The Company has a sizable student loan portfolio as the second largest holder of FFELP student loans and it is also the market leader with over 70% market share as a payment and commerce provider to Australian higher education institutions. DBRS views Nelnet’s acquisition of Great Lakes Education Loan Services (Great Lakes) as fortifying Nelnet’s position as a market leader in the student loan servicing industry while enhancing its competitiveness during the ED’s solicitation process for the new servicing contract.

Nelnet has solid earnings generation capacity, underpinned by a well-balanced and increasingly diversified revenue composition that are supportive of current ratings levels. Furthermore, the Company’s earnings provide a robust cushion to absorb credit losses, contributing to a resilient profitability. Quality of earnings is good, driven by the recurring fee-based revenue and attractive margins due to the scalability of its servicing business and the integrated nature of its technology product offerings. Conversely, the large concentration of ED-related servicing revenue and the declining spread income due to the ongoing runoff of the FFELP portfolio restrains the Company’s earnings growth prospects in the near-to-medium term and thereby constitute a ratings constraint. However, the addition of Great Lakes and the growing fee-based businesses should help alleviate the revenue pressure from the shrinking pool of interest earning assets. Indeed, in 2017, non-spread income (excluding debt repurchase gains and the impact of derivatives and FX and discontinued businesses) totaled $434.7 million, accounting for 58.7% of total adjusted revenue, compared to $409.6 million and 52.4%, respectively, in 2016. DBRS notes that on a pro-forma basis, after including Great Lakes servicing revenue of approximately $230 million in 2017, the Company’s estimated non-spread revenue would have comprised 68.5% of total adjusted revenue.

DBRS considers Nelnet’s overall low risk profile as supportive of the ratings. Nelnet’s low risk profile is underpinned by the modest and predictable credit risk exposure on its FFELP student loan portfolio, which benefits from a federal government guarantee and comprises nearly the entirety (98.7%) of the Company’s total loans. Additionally, the Company’s fee-based businesses do not meaningfully contribute to credit risk. Conversely, DBRS considers operational risk a greater risk for Nelnet due to the Company’s sizable servicing operations, as well as being the largest servicer for the ED, following the acquisition of Great Lakes. Nonetheless, DBRS views the Company’s operational risk as properly managed given its expertise, scale, long track record in loan servicing and platform enhancement investments.

DBRS sees Nelnet’s funding profile as appropriate for its business model mix and well aligned with its asset base. However, the Company’s reliance on secured forms of funding does constrain the ratings. Furthermore, the Company’s liquidity is viewed as sufficient to support its fee generating businesses while allowing it to opportunistically acquire portfolios or other add-on strategic acquisitions. Nelnet has demonstrated a consistent and balanced utilization of its available liquidity sources while it has managed to source additional liquidity when business opportunities arise. Nelnet’s liquidity is also enhanced by the substantial residual cash flows from the Company’s student loans financed in asset-backed securitizations. As of March 31, 2018, the Company’s estimated undiscounted future cash flows were $1.96 billion, including $886.9 million of overcollateralization. Importantly, nearly 68% of those cash flows are expected to be generated over the next five years. Positively, the Company’s initiative to pursue a bank charter would enable it to capture internet deposits and further diversifying its funding profile and business offerings over the long term.

DBRS views Nelnet’s capital levels as appropriate given its low risk profile and the continued growth in its non-capital intensive business services segments. The Company’s capitalization is also supported by strong and consistent capital generation capacity and prudent capital management. Nelnet’s capitalization continues to strengthen, with the Company’s tangible common equity-to-tangible assets ratio at 8.38% as of March 31, 2018, up two basis points (bps) from the preceding quarter, and 92 bps higher than the year ago period.

Notes:
All figures are in U.S. Dollars unless otherwise noted.

The applicable methodologies are the Global Methodology for Rating Finance Companies (November 2017), which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Yanni Koulouriotis, CFA, Vice President – Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG – Global FIG
Initial Rating Date: July 30, 2014
Most Recent Rating Update: August 28, 2017

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

For more information on this credit or on this industry, visit www.dbrs.com.