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 sound franchise in education-related business services, solid earnings generation capacity, modest credit risk exposure, appropriate liquidity management and acceptable capitalization. The ratings also consider Nelnet’s limited earnings growth trajectory due to the Federal Family Education Loan Program’s (FFELP) portfolio ongoing runoff, the uncertainty associated with the outcome of the Department of Education’s (the ED) new servicing contract procurement process as well as the Company’s key reliance on secured forms of funding.

The Stable trend reflects DBRS’s expectation that the Company will continue to generate solid earnings while growing its fee-based businesses that DBRS anticipates will partially offset the declining earnings generated from the FFELP student loan portfolio. The Stable trend also reflects DBRS’s expectation that the Nelnet will continue to effectively manage its liquidity and funding sources while maintaining appropriate capitalization and sensible capital management.

RATING DRIVERS
Positive rating implications could develop should Nelnet be awarded a portion of the new ED servicing contract that supports the viability of the Company’s government-related servicing business. Furthermore, a growing contribution from the Company’s fee-based businesses alleviating the contracting net interest income associated with the FFELP portfolio’s run-off could result in upward ratings pressures. Moreover, further diversification of the funding profile could result in upward movement to the ratings. Conversely, a substantial weakening of the Nelnet’s earnings generation capacity indicative of diminished competitive positioning could have negative implications for the ratings. Additionally, a sizable acquisition or expansion beyond the Company’s core competencies that would meaningfully alter its risk profile could result in adverse ratings implications.

RATING RATIONALE
DBRS considers Nelnet’s sound franchise in the education-related services market as supportive of the ratings. The Company has a leading position and substantial scale in student loan servicing. Following the February 2018 acquisition of Great Lakes Education Loan Services (Great Lakes), Nelnet is the largest student loan servicer for the ED. Nelnet also has a sizable student loan portfolio underpinned by its position as the second largest holder of FFELP student loans. Further, the Company is a preeminent school services provider including education support solutions and tuition payment management. Nelnet is the market leader in the K-12 private school market serving nearly half of the private faith-based K-12 schools and approximately a third of all private K-12 schools in the U.S. In the higher education market, the Company’s leading market position was further bolstered with the acquisition of Tuition Management Services (TMS) in November 2018. Nelnet provides services to approximately 30% of colleges and universities in the U.S., up from nearly 20% prior to the TMS acquisition.

The Company has solid earnings generation capacity underpinned by an increasingly diversified mix of revenues. However, the ongoing run-off of the FFELP portfolio limits the Company’s earnings growth prospects in the near-to-medium term. To offset this headwind, Nelnet has made significant strides in expanding its fee-based businesses organically and through acquisitions. Indeed, in 2018, the net revenue of its fee-based businesses accounted for approximately 62% of total net revenue (excluding debt repurchase gains and derivative market value adjustments), up from 52% in 2017. Moreover, Nelnet’s opportunistic loan portfolio purchases in 2018 of $3.7 billion of FFELP loans helped alleviate the revenue pressure from the shrinking pool of interest earning assets related to FFELP loans. Nelnet’s income before provision and taxes (IBPT) has consistently provided a solid cushion to absorb the credit losses produced by its loan portfolio, as well as other unexpected losses.

The Company’s largely low risk profile is a key consideration in the ratings. Nelnet’s credit risk exposure is very modest given that nearly its entire loan portfolio (98%) is comprised of FFELP student loans which are federally guaranteed to at least 97% of principal and accrued interest at default. DBRS considers regulatory and operational risks as being a greater risk for Nelnet due to its sizable government-related servicing operations and student loan portfolio. Nevertheless, DBRS deems such risks as well-managed given the Company’s expertise, scale, and long track record in student loan servicing, which has been further supported by platform enhancement initiatives. Client concentration risk is considered elevated for Nelnet since the ED servicing contract comprised approximately 32% of its net revenue in 2018. In DBRS’s view, a potential outright loss of the ED contract would be a setback for the Company’s franchise, yet potentially a manageable one in regards to bottom-line impact due to the thin profit margins typically associated with such contracts.

Nelnet has a narrow funding profile relying on secured forms of funding. However, DBRS views the Company’s funding profile as well-suited for its business model and asset base. Nelnet has effectively managed the magnitude and availability of its liquidity sources to support its operations while enabling it to pursue bolt-on or strategic acquisitions and portfolio purchases when opportunities arise. As of March 31, 2019, the Company had total liquidity of approximately $434 million comprised of cash and available for sale investments as well as available capacity in warehouse facilities and its unsecured line of credit. Corporate liquidity is also supported by the sizeable estimated undiscounted future cash flows of approximately $2.2 billion from the Company’s student loan asset-backed securitizations, with approximately 53% of these cash flows expected to be generated over the next five years. Further, Nelnet has been diligently pursuing the solicitation of select asset-backed securitizations in order to unlock the associated excess collateral and thereby enhancing its liquidity and funding flexibility.

DBRS views the Company’s capitalization as acceptable and well-aligned with its growing fee-based business segments which are less capital intensive as well as from its low risk profile resulting in an ample cushion to absorb losses under stressed conditions. Nelnet’s capitalization is also underpinned by solid capital generation capacity and sensible capital management that is appropriate for its business needs. Overall, the Company’s capitalization continues to strengthen, with a tangible common equity-to-tangible assets (TCE) ratio of 8.45% as of March 31, 2019, up 26 basis points (bps) from the preceding quarter, and 7 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 Non-Bank Financial Institutions (November 2018), which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents and S&P Global Market Intelligence. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality

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

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

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