NELNET INC - Quarter Report: 2019 September (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2019
or
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 001-31924
NELNET, INC.
(Exact name of registrant as specified in its charter)
Nebraska | 84-0748903 | ||||||||||
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||||||||||
121 South 13th Street, Suite 100 | |||||||||||
Lincoln, | Nebraska | 68508 | |||||||||
(Address of principal executive offices) | (Zip Code) |
(402) 458-2370
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol | Name of each exchange on which registered | ||||||
Class A Common Stock, Par Value $0.01 per Share | NNI | New York Stock Exchange |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☒ Accelerated filer ☐
Non-accelerated filer ☐ Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of October 31, 2019, there were 28,416,724 and 11,279,641 shares of Class A Common Stock and Class B Common Stock, par value $0.01 per share, outstanding, respectively (excluding a total of 11,305,731 shares of Class A Common Stock held by wholly owned subsidiaries).
NELNET, INC.
FORM 10-Q
INDEX
September 30, 2019
Item 1. | |||||||||||
Item 2. | |||||||||||
Item 3. | |||||||||||
Item 4. | |||||||||||
Item 1. | |||||||||||
Item 1A. | |||||||||||
Item 2. | |||||||||||
Item 6. | |||||||||||
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NELNET, INC. AND SUBSIDIARIES | |||||||||||||||||||||||||||||
CONSOLIDATED BALANCE SHEETS | |||||||||||||||||||||||||||||
(Dollars in thousands, except share data) | |||||||||||||||||||||||||||||
(unaudited) | |||||||||||||||||||||||||||||
As of | As of | ||||||||||||||||||||||||||||
September 30, 2019 | December 31, 2018 | ||||||||||||||||||||||||||||
Assets: | |||||||||||||||||||||||||||||
Loans receivable (net of allowance for loan losses of $66,417 and $60,388, respectively) | $ | 21,071,441 | 22,377,142 | ||||||||||||||||||||||||||
Cash and cash equivalents: | |||||||||||||||||||||||||||||
Cash and cash equivalents - not held at a related party | 20,897 | 9,472 | |||||||||||||||||||||||||||
Cash and cash equivalents - held at a related party | 140,082 | 111,875 | |||||||||||||||||||||||||||
Total cash and cash equivalents | 160,979 | 121,347 | |||||||||||||||||||||||||||
Investments and notes receivable | 212,416 | 249,370 | |||||||||||||||||||||||||||
Restricted cash | 667,919 | 701,366 | |||||||||||||||||||||||||||
Restricted cash - due to customers | 309,309 | 369,678 | |||||||||||||||||||||||||||
Accrued interest receivable | 736,901 | 679,197 | |||||||||||||||||||||||||||
Accounts receivable (net of allowance for doubtful accounts of $4,482 and $3,271, respectively) | 67,079 | 59,531 | |||||||||||||||||||||||||||
Goodwill | 156,912 | 156,912 | |||||||||||||||||||||||||||
Intangible assets, net | 89,499 | 114,290 | |||||||||||||||||||||||||||
Property and equipment, net | 342,401 | 344,784 | |||||||||||||||||||||||||||
Other assets | 121,806 | 45,533 | |||||||||||||||||||||||||||
Fair value of derivative instruments | 57 | 1,818 | |||||||||||||||||||||||||||
Total assets | $ | 23,936,719 | 25,220,968 | ||||||||||||||||||||||||||
Liabilities: | |||||||||||||||||||||||||||||
Bonds and notes payable | $ | 20,910,190 | 22,218,740 | ||||||||||||||||||||||||||
Accrued interest payable | 52,345 | 61,679 | |||||||||||||||||||||||||||
Other liabilities | 310,210 | 256,092 | |||||||||||||||||||||||||||
Due to customers | 309,309 | 369,678 | |||||||||||||||||||||||||||
Total liabilities | 21,582,054 | 22,906,189 | |||||||||||||||||||||||||||
Commitments and contingencies | |||||||||||||||||||||||||||||
Equity: | |||||||||||||||||||||||||||||
Nelnet, Inc. shareholders' equity: | |||||||||||||||||||||||||||||
Preferred stock, $0.01 par value. Authorized 50,000,000 shares; no shares issued or outstanding | — | — | |||||||||||||||||||||||||||
Common stock: | |||||||||||||||||||||||||||||
Class A, $0.01 par value. Authorized 600,000,000 shares; issued and outstanding 28,411,506 shares and 28,798,464 shares, respectively | 284 | 288 | |||||||||||||||||||||||||||
Class B, convertible, $0.01 par value. Authorized 60,000,000 shares; issued and outstanding 11,279,641 shares and 11,459,641 shares, respectively | 113 | 115 | |||||||||||||||||||||||||||
Additional paid-in capital | 3,678 | 622 | |||||||||||||||||||||||||||
Retained earnings | 2,343,185 | 2,299,556 | |||||||||||||||||||||||||||
Accumulated other comprehensive earnings | 2,890 | 3,883 | |||||||||||||||||||||||||||
Total Nelnet, Inc. shareholders' equity | 2,350,150 | 2,304,464 | |||||||||||||||||||||||||||
Noncontrolling interests | 4,515 | 10,315 | |||||||||||||||||||||||||||
Total equity | 2,354,665 | 2,314,779 | |||||||||||||||||||||||||||
Total liabilities and equity | $ | 23,936,719 | 25,220,968 | ||||||||||||||||||||||||||
Supplemental information - assets and liabilities of consolidated education and other lending variable interest entities: | |||||||||||||||||||||||||||||
Loans receivable | $ | 21,069,156 | 22,359,655 | ||||||||||||||||||||||||||
Restricted cash | 650,673 | 677,611 | |||||||||||||||||||||||||||
Loan accrued interest receivable and other assets | 736,768 | 679,735 | |||||||||||||||||||||||||||
Bonds and notes payable | (21,143,811) | (22,146,374) | |||||||||||||||||||||||||||
Accrued interest payable and other liabilities | (212,160) | (163,327) | |||||||||||||||||||||||||||
Net assets of consolidated education and other lending variable interest entities | $ | 1,100,626 | 1,407,300 |
See accompanying notes to consolidated financial statements.
2
NELNET, INC. AND SUBSIDIARIES | |||||||||||||||||||||||
CONSOLIDATED STATEMENTS OF INCOME | |||||||||||||||||||||||
(Dollars in thousands, except share data) | |||||||||||||||||||||||
(unaudited) | |||||||||||||||||||||||
Three months ended | Nine months ended | ||||||||||||||||||||||
September 30, | September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
Interest income: | |||||||||||||||||||||||
Loan interest | $ | 229,063 | 232,320 | 709,618 | 653,414 | ||||||||||||||||||
Investment interest | 9,882 | 7,628 | 26,701 | 18,581 | |||||||||||||||||||
Total interest income | 238,945 | 239,948 | 736,319 | 671,995 | |||||||||||||||||||
Interest expense: | |||||||||||||||||||||||
Interest on bonds and notes payable | 172,488 | 180,175 | 551,221 | 487,174 | |||||||||||||||||||
Net interest income | 66,457 | 59,773 | 185,098 | 184,821 | |||||||||||||||||||
Less provision for loan losses | 10,000 | 10,500 | 26,000 | 18,000 | |||||||||||||||||||
Net interest income after provision for loan losses | 56,457 | 49,273 | 159,098 | 166,821 | |||||||||||||||||||
Other income: | |||||||||||||||||||||||
Loan servicing and systems revenue | 113,286 | 112,579 | 342,169 | 327,265 | |||||||||||||||||||
Education technology, services, and payment processing revenue | 74,251 | 58,409 | 213,753 | 167,372 | |||||||||||||||||||
Communications revenue | 16,470 | 11,818 | 46,770 | 31,327 | |||||||||||||||||||
Other income | 13,439 | 16,673 | 38,658 | 44,808 | |||||||||||||||||||
Derivative market value adjustments and derivative settlements, net | 1,668 | 17,098 | (33,959) | 100,927 | |||||||||||||||||||
Total other income | 219,114 | 216,577 | 607,391 | 671,699 | |||||||||||||||||||
Cost of services: | |||||||||||||||||||||||
Cost to provide education technology, services, and payment processing services | 25,671 | 19,087 | 62,601 | 44,087 | |||||||||||||||||||
Cost to provide communications services | 5,236 | 4,310 | 15,096 | 11,892 | |||||||||||||||||||
Total cost of services | 30,907 | 23,397 | 77,697 | 55,979 | |||||||||||||||||||
Operating expenses: | |||||||||||||||||||||||
Salaries and benefits | 116,670 | 114,172 | 338,942 | 321,932 | |||||||||||||||||||
Depreciation and amortization | 27,701 | 22,992 | 76,398 | 62,943 | |||||||||||||||||||
Loan servicing fees to third parties | 3,382 | 3,087 | 9,431 | 9,428 | |||||||||||||||||||
Other expenses | 54,947 | 45,194 | 138,131 | 119,020 | |||||||||||||||||||
Total operating expenses | 202,700 | 185,445 | 562,902 | 513,323 | |||||||||||||||||||
Income before income taxes | 41,964 | 57,008 | 125,890 | 269,218 | |||||||||||||||||||
Income tax expense | 8,829 | 13,882 | 26,429 | 63,369 | |||||||||||||||||||
Net income | 33,135 | 43,126 | 99,461 | 205,849 | |||||||||||||||||||
Net loss (income) attributable to noncontrolling interests | 77 | (199) | (38) | 438 | |||||||||||||||||||
Net income attributable to Nelnet, Inc. | $ | 33,212 | 42,927 | 99,423 | 206,287 | ||||||||||||||||||
Earnings per common share: | |||||||||||||||||||||||
Net income attributable to Nelnet, Inc. shareholders - basic and diluted | $ | 0.83 | 1.05 | 2.48 | 5.04 | ||||||||||||||||||
Weighted average common shares outstanding - basic and diluted | 39,877,129 | 40,988,965 | 40,098,346 | 40,942,177 |
See accompanying notes to consolidated financial statements.
3
NELNET, INC. AND SUBSIDIARIES | |||||||||||||||||||||||
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME | |||||||||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||||
(unaudited) | |||||||||||||||||||||||
Three months ended | Nine months ended | ||||||||||||||||||||||
September 30, | September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
Net income | $ | 33,135 | 43,126 | 99,461 | 205,849 | ||||||||||||||||||
Other comprehensive (loss) income: | |||||||||||||||||||||||
Available-for-sale securities: | |||||||||||||||||||||||
Unrealized holding (losses) gains arising during period, net | (334) | 2,438 | (1,306) | 964 | |||||||||||||||||||
Reclassification adjustment for gains recognized in net income, net of losses | — | (765) | — | (817) | |||||||||||||||||||
Income tax effect | 80 | (402) | 313 | (46) | |||||||||||||||||||
Total other comprehensive (loss) income | (254) | 1,271 | (993) | 101 | |||||||||||||||||||
Comprehensive income | 32,881 | 44,397 | 98,468 | 205,950 | |||||||||||||||||||
Comprehensive loss (income) attributable to noncontrolling interests | 77 | (199) | (38) | 438 | |||||||||||||||||||
Comprehensive income attributable to Nelnet, Inc. | $ | 32,958 | 44,198 | 98,430 | 206,388 |
See accompanying notes to consolidated financial statements.
4
NELNET, INC. AND SUBSIDIARIES | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(Dollars in thousands, except share data) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(unaudited) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Nelnet, Inc. Shareholders | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Preferred stock shares | Common stock shares | Preferred stock | Class A common stock | Class B common stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive (loss) earnings | Noncontrolling interests | Total equity | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Class A | Class B | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Balance as of June 30, 2018 | — | 29,331,002 | 11,468,587 | $ | — | 293 | 115 | 2,586 | 2,271,171 | 2,704 | 9,834 | 2,286,703 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Issuance of noncontrolling interests | — | — | — | — | — | — | — | — | — | 326 | 326 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Net income | — | — | — | — | — | — | — | 42,927 | — | 199 | 43,126 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other comprehensive income | — | — | — | — | — | — | — | — | 1,271 | — | 1,271 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Distribution to noncontrolling interests | — | — | — | — | — | — | — | — | — | (95) | (95) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cash dividend on Class A and Class B common stock - $0.16 per share | — | — | — | — | — | — | — | (6,525) | — | — | (6,525) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Issuance of common stock, net of forfeitures | — | 14,086 | — | — | — | — | 580 | — | — | — | 580 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Compensation expense for stock based awards | — | — | — | — | — | — | 1,934 | — | — | — | 1,934 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Repurchase of common stock | — | (3,297) | — | — | — | — | (192) | — | — | — | (192) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Balance as of September 30, 2018 | — | 29,341,791 | 11,468,587 | $ | — | 293 | 115 | 4,908 | 2,307,573 | 3,975 | 10,264 | 2,327,128 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Balance as of June 30, 2019 | — | 28,399,526 | 11,279,641 | $ | — | 284 | 113 | 1,670 | 2,317,115 | 3,144 | 4,292 | 2,326,618 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Issuance of noncontrolling interests | — | — | — | — | — | — | — | — | — | 4,165 | 4,165 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Net income (loss) | — | — | — | — | — | — | — | 33,212 | — | (77) | 33,135 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other comprehensive loss | — | — | — | — | — | — | — | — | (254) | — | (254) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Distribution to noncontrolling interests | — | — | — | — | — | — | — | — | — | (3,865) | (3,865) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cash dividend on Class A and Class B common stock - $0.18 per share | — | — | — | — | — | — | — | (7,142) | — | — | (7,142) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Issuance of common stock, net of forfeitures | — | 15,345 | — | — | — | — | 524 | — | — | — | 524 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Compensation expense for stock based awards | — | — | — | — | — | — | 1,705 | — | — | — | 1,705 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Repurchase of common stock | — | (3,365) | — | — | — | — | (221) | — | — | — | (221) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Balance as of September 30, 2019 | — | 28,411,506 | 11,279,641 | $ | — | 284 | 113 | 3,678 | 2,343,185 | 2,890 | 4,515 | 2,354,665 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Balance as of December 31, 2017 | — | 29,341,517 | 11,468,587 | $ | — | 293 | 115 | 521 | 2,143,983 | 4,617 | 15,858 | 2,165,387 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Issuance of noncontrolling interests | — | — | — | — | — | — | — | — | — | 847 | 847 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Net income (loss) | — | — | — | — | — | — | — | 206,287 | — | (438) | 205,849 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other comprehensive income | — | — | — | — | — | — | — | — | 101 | — | 101 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Distribution to noncontrolling interests | — | — | — | — | — | — | — | — | — | (351) | (351) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cash dividends on Class A and Class B common stock - $0.48 per share | — | — | — | — | — | — | — | (19,539) | — | — | (19,539) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Issuance of common stock, net of forfeitures | — | 319,365 | — | — | 3 | — | 4,662 | — | — | — | 4,665 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Compensation expense for stock based awards | — | — | — | — | — | — | 4,526 | — | — | — | 4,526 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Repurchase of common stock | — | (319,091) | — | — | (3) | — | (4,801) | (11,716) | — | — | (16,520) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Impact of adoption of new accounting standards | — | — | — | — | — | — | — | 2,007 | (743) | — | 1,264 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Acquisition of noncontrolling interest | — | — | — | — | — | — | — | (13,449) | — | (5,652) | (19,101) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Balance as of September 30, 2018 | — | 29,341,791 | 11,468,587 | $ | — | 293 | 115 | 4,908 | 2,307,573 | 3,975 | 10,264 | 2,327,128 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Balance as of December 31, 2018 | — | 28,798,464 | 11,459,641 | $ | — | 288 | 115 | 622 | 2,299,556 | 3,883 | 10,315 | 2,314,779 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Issuance of noncontrolling interests | — | — | — | — | — | — | — | — | — | 4,217 | 4,217 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Net income | — | — | — | — | — | — | — | 99,423 | — | 38 | 99,461 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other comprehensive loss | — | — | — | — | — | — | — | — | (993) | — | (993) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Distribution to noncontrolling interests | — | — | — | — | — | — | — | — | — | (3,978) | (3,978) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cash dividends on Class A and Class B common stock - $0.54 per share | — | — | — | — | — | — | — | (21,546) | — | — | (21,546) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Issuance of common stock, net of forfeitures | — | 156,874 | — | — | 1 | — | 4,400 | — | — | — | 4,401 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Compensation expense for stock based awards | — | — | — | — | — | — | 4,663 | — | — | — | 4,663 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Repurchase of common stock | — | (723,832) | — | — | (7) | — | (6,007) | (34,248) | — | — | (40,262) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Impact of adoption of new accounting standard | — | — | — | — | — | — | — | — | — | (6,077) | (6,077) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Conversion of common stock | — | 180,000 | (180,000) | — | 2 | (2) | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Balance as of September 30, 2019 | — | 28,411,506 | 11,279,641 | $ | — | 284 | 113 | 3,678 | 2,343,185 | 2,890 | 4,515 | 2,354,665 |
See accompanying notes to consolidated financial statements.
5
NELNET, INC. AND SUBSIDIARIES | |||||||||||
CONSOLIDATED STATEMENTS OF CASH FLOWS | |||||||||||
(Dollars in thousands) | |||||||||||
(unaudited) | |||||||||||
Nine months ended | |||||||||||
September 30, | |||||||||||
2019 | 2018 | ||||||||||
Net income attributable to Nelnet, Inc. | $ | 99,423 | 206,287 | ||||||||
Net income (loss) attributable to noncontrolling interests | 38 | (438) | |||||||||
Net income | 99,461 | 205,849 | |||||||||
Adjustments to reconcile net income to net cash provided by operating activities, net of acquisition: | |||||||||||
Depreciation and amortization, including debt discounts and loan premiums and deferred origination costs | 142,519 | 136,816 | |||||||||
Loan discount accretion | (27,554) | (31,315) | |||||||||
Provision for loan losses | 26,000 | 18,000 | |||||||||
Derivative market value adjustments | 73,265 | (49,909) | |||||||||
Payments from termination of derivative instruments, net | (13,940) | — | |||||||||
(Payments to) proceeds from clearinghouse - initial and variation margin, net | (59,967) | 46,418 | |||||||||
Loss on extinguishment of debt | 15,815 | — | |||||||||
Gain from sale of loans | (1,712) | — | |||||||||
Gain from debt repurchases | (136) | (359) | |||||||||
Gain from investments and notes receivable, net | (4,891) | (9,106) | |||||||||
Deferred income tax (benefit) expense | (9,592) | 23,574 | |||||||||
Non-cash compensation expense | 4,948 | 4,781 | |||||||||
Impairment expense | — | 3,907 | |||||||||
Other | (141) | (30) | |||||||||
Increase in accrued interest receivable | (57,864) | (193,926) | |||||||||
Increase in accounts receivable | (7,637) | (15,328) | |||||||||
(Increase) decrease in other assets | (21,976) | 49,255 | |||||||||
(Decrease) increase in accrued interest payable | (9,334) | 10,619 | |||||||||
Increase (decrease) in other liabilities | 56,023 | (7,159) | |||||||||
(Decrease) increase in due to customers | (60,369) | 1,470 | |||||||||
Net cash provided by operating activities | 142,918 | 193,557 | |||||||||
Cash flows from investing activities, net of acquisition: | |||||||||||
Purchases of loans | (1,360,873) | (3,187,434) | |||||||||
Purchases of loans from a related party | (32,580) | (44,522) | |||||||||
Net proceeds from loan repayments, claims, capitalized interest, and other | 2,628,156 | 2,484,596 | |||||||||
Proceeds from sale of loans | 42,215 | 23,712 | |||||||||
Purchases of available-for-sale securities | (1,010) | (38,064) | |||||||||
Proceeds from sales of available-for-sale securities | 169 | 58,594 | |||||||||
Purchases of investments and issuance of notes receivable | (70,600) | (49,216) | |||||||||
Proceeds from investments and notes receivable | 54,819 | 21,461 | |||||||||
Purchases of property and equipment | (67,681) | (96,480) | |||||||||
Business acquisition, net of cash and restricted cash acquired | — | (109,152) | |||||||||
Net cash provided by (used in) investing activities | 1,192,615 | (936,505) | |||||||||
Cash flows from financing activities: | |||||||||||
Payments on bonds and notes payable | (3,718,851) | (2,149,449) | |||||||||
Proceeds from issuance of bonds and notes payable | 2,410,363 | 3,004,848 | |||||||||
Payments of debt issuance costs | (10,527) | (10,953) | |||||||||
Payment of debt extinguishment costs | (14,030) | — | |||||||||
Dividends paid | (21,546) | (19,539) | |||||||||
Repurchases of common stock | (40,262) | (16,520) | |||||||||
Proceeds from issuance of common stock | 1,171 | 993 | |||||||||
Acquisition of noncontrolling interest | — | (13,449) | |||||||||
Issuance of noncontrolling interests | 4,138 | 768 | |||||||||
Distribution to noncontrolling interests | (173) | (351) | |||||||||
Net cash (used in) provided by financing activities | (1,389,717) | 796,348 | |||||||||
Net (decrease) increase in cash, cash equivalents, and restricted cash | (54,184) | 53,400 | |||||||||
Cash, cash equivalents, and restricted cash, beginning of period | 1,192,391 | 942,066 | |||||||||
Cash, cash equivalents, and restricted cash, end of period | $ | 1,138,207 | 995,466 | ||||||||
6
NELNET, INC. AND SUBSIDIARIES | |||||||||||
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) | |||||||||||
(Dollars in thousands) | |||||||||||
(unaudited) | |||||||||||
Nine months ended | |||||||||||
September 30, | |||||||||||
2019 | 2018 | ||||||||||
Supplemental disclosures of cash flow information: | |||||||||||
Cash disbursements made for interest | $ | 518,557 | 425,782 | ||||||||
Cash disbursements (refunds received) for income taxes, net | $ | 14,820 | (6,491) | ||||||||
Noncash investing and financing activity: | |||||||||||
Receipt of beneficial interest in consumer loan securitization | $ | 7,921 | — | ||||||||
Distribution to noncontrolling interest | $ | 3,805 | — |
Supplemental disclosures of noncash activities regarding the adoption of the new lease standard on January 1, 2019 are contained in note 1.
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported in the consolidated balance sheets to the total of the amounts reported in the consolidated statements of cash flows.
As of | As of | As of | As of | ||||||||||||||||||||
September 30, 2019 | December 31, 2018 | September 30, 2018 | December 31, 2017 | ||||||||||||||||||||
Total cash and cash equivalents | $ | 160,979 | 121,347 | 83,537 | 66,752 | ||||||||||||||||||
Restricted cash | 667,919 | 701,366 | 723,338 | 688,193 | |||||||||||||||||||
Restricted cash - due to customers | 309,309 | 369,678 | 188,591 | 187,121 | |||||||||||||||||||
Cash, cash equivalents, and restricted cash | $ | 1,138,207 | 1,192,391 | 995,466 | 942,066 |
See accompanying notes to consolidated financial statements.
7
NELNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts, unless otherwise noted)
(unaudited)
1. Basis of Financial Reporting
The accompanying unaudited consolidated financial statements of Nelnet, Inc. and subsidiaries (the “Company”) as of September 30, 2019 and for the three and nine months ended September 30, 2019 and 2018 have been prepared on the same basis as the audited consolidated financial statements for the year ended December 31, 2018 and, in the opinion of the Company’s management, the unaudited consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of results of operations for the interim periods presented. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results for the year ending December 31, 2019. The unaudited consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (the "2018 Annual Report").
Accounting Standard Adopted in 2019
In the first quarter of 2019, the Company adopted the following new accounting standard:
Leases
In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Codification Topic 842, Leases ("ASC Topic 842"). The standard requires the identification of arrangements that should be accounted for as leases by lessees and the disclosure of key information about leasing arrangements. The standard establishes a right-of-use ("ROU") model that requires a lessee to recognize a ROU asset and lease liability for all leases with a term longer than twelve months and classify the lease as operating or financing, with the income statement reflecting lease expense for operating leases and amortization/interest expense for financing leases.
The Company adopted the standard effective January 1, 2019, using the effective date as its date of initial application. Consequently, financial information is not updated and the disclosures required under the new standard are not provided for dates and periods before January 1, 2019. The Company elected to utilize the ‘package of practical expedients’, which permitted it to not reassess under the new standard its prior conclusions about lease identification, lease classification, and initial direct costs.
The most significant impact of the standard relates to (1) the recognition of new ROU assets and lease liabilities on the Company's balance sheet; (2) the deconsolidation of assets and liabilities for certain sale-leaseback transactions arising from build-to-suit lease arrangements for which construction was completed and the Company is leasing the constructed assets that did not qualify for sale accounting prior to the adoption of the new standard; and (3) significant new disclosures about the Company’s leasing activities. The build-to-suit lease arrangements have been reassessed as operating leases as of the effective date under ASC Topic 842.
8
Adoption of the new standard resulted in recognizing lease liabilities of $33.7 million based on the present value of the remaining minimum rental payments. In addition, the Company recognized ROU assets of $32.8 million, which corresponds to the lease liabilities reduced by deferred rent expense as of the effective date. The Company also deconsolidated total assets of $43.8 million and total liabilities of $34.8 million for entities that had been consolidated due to sale-leaseback transactions that failed to qualify for recognition as sales under the prior guidance. Deconsolidation of these entities reduced noncontrolling interests by $6.1 million. The cumulative effect of the changes made to the Company's consolidated balance sheet as of January 1, 2019 for the adoption of the new lease standard was as follows:
Balances at December 31, 2018 | Adjustments from adoption of new lease standard | Balances at January 1, 2019 | |||||||||||||||
Assets | |||||||||||||||||
Cash and cash equivalents | $ | 121,347 | (646) | 120,701 | |||||||||||||
Investments and notes receivable | 249,370 | (23,134) | 226,236 | ||||||||||||||
Accounts receivable | 59,531 | (89) | 59,442 | ||||||||||||||
Property and equipment, net | 344,784 | (16,974) | 327,810 | ||||||||||||||
Other assets | 45,533 | 32,804 | 78,337 | ||||||||||||||
Liabilities | |||||||||||||||||
Bonds and notes payable | 22,218,740 | (33,182) | 22,185,558 | ||||||||||||||
Other liabilities | 256,092 | 31,220 | 287,312 | ||||||||||||||
Equity | |||||||||||||||||
Noncontrolling interests | 10,315 | (6,077) | 4,238 |
At the inception of an arrangement, the Company determines if the arrangement is, or contains, a lease and records the lease in the consolidated financial statements upon lease commencement, which is the date when the underlying asset is made available by the lessor. The Company primarily leases dark fiber to support its telecommunications operations and office and data center space. Leases with an initial term of 12 months or less are not recorded on the balance sheet. The lease expense for these leases is recognized on a straight-line basis over the lease term. All other lease assets and lease liabilities are recognized based on the present value of lease payments over the lease term at the commencement date. When the discount rate implicit in the lease cannot be readily determined, the Company uses its incremental borrowing rate.
The Company has elected to utilize the practical expedient to account for lease and non-lease components together as a single, combined lease component for its office and data center space. In addition, the Company has identified itself as the lessor in its Communications operating segment for services provided to customers that include customer-premise equipment. The Company has also elected to utilize the practical expedient to account for those services and associated leases as a single, combined component. The non-lease services are 'predominant' in those contracts. Therefore, the combined component is considered a single performance obligation under ASC Topic 606, Revenue from Contracts with Customers.
Most leases include one or more options to renew, with renewal terms that can be extended. The exercise of lease renewal options for the majority of leases is at the Company's discretion. Renewal options that the Company is reasonably certain to exercise are included in the lease term.
Certain leases include escalating rental payments or rental payments adjusted periodically for inflation. None of the lease agreements include any residual value guarantees, a transfer of title, or a purchase option that is reasonably certain to be exercised.
The following table provides supplemental balance sheet information related to leases:
As of | |||||
September 30, 2019 | |||||
Operating lease ROU assets, which is included in "other assets" on the consolidated balance sheet | $ | 34,264 | |||
Operating lease liabilities, which is included in "other liabilities" on the consolidated balance sheet | $ | 35,237 |
9
The following table provides components of lease expense:
Three months ended September 30, 2019 | Nine months ended September 30, 2019 | ||||||||||
Rental expense, which is included in "other expenses" on the consolidated statements of income (a) | $ | 2,776 | 8,276 | ||||||||
Rental expense, which is included in "cost to provide communications services" on the consolidated statements of income (a) | 428 | 1,138 | |||||||||
Total operating rental expense | $ | 3,204 | 9,414 |
(a) Includes short-term and variable lease costs, which are immaterial.
The following table provides supplemental cash flow information related to leases:
Nine months ended September 30, 2019 | |||||
Cash paid for amounts included in the measurement of lease liabilities: | |||||
Operating cash outflows related to operating leases | $ | 7,307 | |||
Supplemental noncash activity: | |||||
Operating ROU assets obtained in exchange for lease obligations, excluding impact of adoption | $ | 7,972 |
Weighted average remaining lease term and discount rate are shown below:
As of | |||||
September 30, 2019 | |||||
Weighted average remaining lease term (years) | 7.2 | ||||
Weighted average discount rate | 3.95 | % |
Maturity of lease liabilities are shown below:
2019 (October 1 - December 31) | $ | 2,638 | |||
2020 | 9,916 | ||||
2021 | 6,803 | ||||
2022 | 4,652 | ||||
2023 | 3,640 | ||||
2024 and thereafter | 12,996 | ||||
Total lease payments | 40,645 | ||||
Imputed interest | (5,408) | ||||
Total | $ | 35,237 |
The Company adopted the new lease standard using the effective date as its date of initial application as noted above, and as required, the following disclosure is provided for periods prior to adoption. Future minimum lease payments as of December 31, 2018 are shown below:
2019 | $ | 9,181 | |||
2020 | 8,261 | ||||
2021 | 5,776 | ||||
2022 | 3,745 | ||||
2023 | 2,904 | ||||
2024 and thereafter | 5,479 | ||||
Total minimum lease payments | $ | 35,346 |
10
2. Loans Receivable and Allowance for Loan Losses
Loans receivable consisted of the following:
As of | As of | ||||||||||
September 30, 2019 | December 31, 2018 | ||||||||||
Federally insured student loans: | |||||||||||
Stafford and other | $ | 4,720,338 | 4,969,667 | ||||||||
Consolidation | 15,975,499 | 17,186,229 | |||||||||
Total | 20,695,837 | 22,155,896 | |||||||||
Private education loans | 189,912 | 225,975 | |||||||||
Consumer loans | 321,199 | 138,627 | |||||||||
21,206,948 | 22,520,498 | ||||||||||
Loan discount, net of unamortized loan premiums and deferred origination costs | (36,483) | (53,572) | |||||||||
Non-accretable discount | (32,607) | (29,396) | |||||||||
Allowance for loan losses: | |||||||||||
Federally insured loans | (37,676) | (42,310) | |||||||||
Private education loans | (9,882) | (10,838) | |||||||||
Consumer loans | (18,859) | (7,240) | |||||||||
$ | 21,071,441 | 22,377,142 |
On May 1, 2019, the Company sold $47.7 million (par value) of consumer loans to an unrelated third party who securitized such loans. The Company recognized a $1.7 million (pre-tax) gain as part of this transaction. As partial consideration received for the consumer loans sold, the Company received an approximate 11 percent residual interest in the consumer loan securitization that is included in "investments and notes receivable" on the Company's consolidated balance sheet.
Subsequent to September 30, 2019, the Company made the decision to sell an additional $179.3 million (par value) of consumer loans to an unrelated third party who securitized such loans. As of September 30, 2019, these loans were classified as held for investment and are included in the table above. As partial consideration received for the consumer loans sold, the Company received an approximate 29 percent residual interest in the consumer loan securitization. The Company will recognize a gain in the fourth quarter of 2019 of $15.5 million (pre-tax) from the sale of these loans.
11
Activity in the Allowance for Loan Losses
The provision for loan losses represents the periodic expense of maintaining an allowance sufficient to absorb losses, net of recoveries, inherent in the portfolio of loans. Activity in the allowance for loan losses is shown below.
Balance at beginning of period | Provision for loan losses | Charge-offs | Recoveries | Loan sale and other | Balance at end of period | ||||||||||||||||||||||||||||||
Three months ended September 30, 2019 | |||||||||||||||||||||||||||||||||||
Federally insured loans | $ | 39,056 | 2,000 | (3,380) | — | — | 37,676 | ||||||||||||||||||||||||||||
Private education loans | 10,157 | — | (459) | 184 | — | 9,882 | |||||||||||||||||||||||||||||
Consumer loans | 13,378 | 8,000 | (2,759) | 240 | — | 18,859 | |||||||||||||||||||||||||||||
$ | 62,591 | 10,000 | (6,598) | 424 | — | 66,417 | |||||||||||||||||||||||||||||
Three months ended September 30, 2018 | |||||||||||||||||||||||||||||||||||
Federally insured loans | $ | 37,263 | 8,000 | (2,210) | — | — | 43,053 | ||||||||||||||||||||||||||||
Private education loans | 11,664 | — | (535) | 124 | — | 11,253 | |||||||||||||||||||||||||||||
Consumer loans | 4,788 | 2,500 | (1,403) | 26 | — | 5,911 | |||||||||||||||||||||||||||||
$ | 53,715 | 10,500 | (4,148) | 150 | — | 60,217 | |||||||||||||||||||||||||||||
Nine months ended September 30, 2019 | |||||||||||||||||||||||||||||||||||
Federally insured loans | $ | 42,310 | 6,000 | (10,634) | — | — | 37,676 | ||||||||||||||||||||||||||||
Private education loans | 10,838 | — | (1,529) | 573 | — | 9,882 | |||||||||||||||||||||||||||||
Consumer loans | 7,240 | 20,000 | (7,417) | 536 | (1,500) | 18,859 | |||||||||||||||||||||||||||||
$ | 60,388 | 26,000 | (19,580) | 1,109 | (1,500) | 66,417 | |||||||||||||||||||||||||||||
Nine months ended September 30, 2018 | |||||||||||||||||||||||||||||||||||
Federally insured loans | $ | 38,706 | 12,000 | (8,653) | — | 1,000 | 43,053 | ||||||||||||||||||||||||||||
Private education loans | 12,629 | — | (1,846) | 470 | — | 11,253 | |||||||||||||||||||||||||||||
Consumer loans | 3,255 | 6,000 | (3,376) | 32 | — | 5,911 | |||||||||||||||||||||||||||||
$ | 54,590 | 18,000 | (13,875) | 502 | 1,000 | 60,217 |
12
Loan Status and Delinquencies
Delinquencies have the potential to adversely impact the Company’s earnings through increased servicing and collection costs and account charge-offs. The table below shows the Company’s loan delinquency amounts.
As of September 30, 2019 | As of December 31, 2018 | As of September 30, 2018 | |||||||||||||||||||||||||||||||||
Federally insured loans: | |||||||||||||||||||||||||||||||||||
Loans in-school/grace/deferment | $ | 1,243,705 | $ | 1,298,493 | $ | 1,410,902 | |||||||||||||||||||||||||||||
Loans in forbearance | 1,391,482 | 1,430,291 | 1,487,107 | ||||||||||||||||||||||||||||||||
Loans in repayment status: | |||||||||||||||||||||||||||||||||||
Loans current | 15,646,231 | 86.7 | % | 16,882,252 | 86.9 | % | 16,921,119 | 86.8 | % | ||||||||||||||||||||||||||
Loans delinquent 31-60 days | 662,431 | 3.8 | 683,084 | 3.5 | 689,454 | 3.5 | |||||||||||||||||||||||||||||
Loans delinquent 61-90 days | 402,197 | 2.2 | 427,764 | 2.2 | 412,639 | 2.1 | |||||||||||||||||||||||||||||
Loans delinquent 91-120 days | 279,524 | 1.5 | 283,831 | 1.5 | 347,013 | 1.8 | |||||||||||||||||||||||||||||
Loans delinquent 121-270 days | 795,230 | 4.4 | 806,692 | 4.2 | 853,224 | 4.4 | |||||||||||||||||||||||||||||
Loans delinquent 271 days or greater | 275,037 | 1.4 | 343,489 | 1.7 | 269,285 | 1.4 | |||||||||||||||||||||||||||||
Total loans in repayment | 18,060,650 | 100.0 | % | 19,427,112 | 100.0 | % | 19,492,734 | 100.0 | % | ||||||||||||||||||||||||||
Total federally insured loans | $ | 20,695,837 | $ | 22,155,896 | $ | 22,390,743 | |||||||||||||||||||||||||||||
Private education loans: | |||||||||||||||||||||||||||||||||||
Loans in-school/grace/deferment | $ | 3,944 | $ | 4,320 | $ | 3,550 | |||||||||||||||||||||||||||||
Loans in forbearance | 2,242 | 1,494 | 1,577 | ||||||||||||||||||||||||||||||||
Loans in repayment status: | |||||||||||||||||||||||||||||||||||
Loans current | 173,883 | 94.7 | % | 208,977 | 95.0 | % | 156,383 | 95.2 | % | ||||||||||||||||||||||||||
Loans delinquent 31-60 days | 3,011 | 1.6 | 3,626 | 1.6 | 1,796 | 1.1 | |||||||||||||||||||||||||||||
Loans delinquent 61-90 days | 1,370 | 0.7 | 1,560 | 0.7 | 1,155 | 0.7 | |||||||||||||||||||||||||||||
Loans delinquent 91 days or greater | 5,462 | 3.0 | 5,998 | 2.7 | 5,006 | 3.0 | |||||||||||||||||||||||||||||
Total loans in repayment | 183,726 | 100.0 | % | 220,161 | 100.0 | % | 164,340 | 100.0 | % | ||||||||||||||||||||||||||
Total private education loans | $ | 189,912 | $ | 225,975 | $ | 169,467 | |||||||||||||||||||||||||||||
Consumer loans: | |||||||||||||||||||||||||||||||||||
Loans in repayment status: | |||||||||||||||||||||||||||||||||||
Loans current | $ | 315,708 | 98.3 | % | $ | 136,130 | 98.2 | % | $ | 110,885 | 98.5 | % | |||||||||||||||||||||||
Loans delinquent 31-60 days | 2,249 | 0.7 | 1,012 | 0.7 | 905 | 0.8 | |||||||||||||||||||||||||||||
Loans delinquent 61-90 days | 1,617 | 0.5 | 832 | 0.6 | 355 | 0.3 | |||||||||||||||||||||||||||||
Loans delinquent 91 days or greater | 1,625 | 0.5 | 653 | 0.5 | 402 | 0.4 | |||||||||||||||||||||||||||||
Total loans in repayment | 321,199 | 100.0 | % | 138,627 | 100.0 | % | 112,547 | 100.0 | % | ||||||||||||||||||||||||||
Total consumer loans | $ | 321,199 | $ | 138,627 | $ | 112,547 |
13
3. Bonds and Notes Payable
The following tables summarize the Company’s outstanding debt obligations by type of instrument:
As of September 30, 2019 | |||||||||||||||||
Carrying amount | Interest rate range | Final maturity | |||||||||||||||
Variable-rate bonds and notes issued in FFELP loan asset-backed securitizations: | |||||||||||||||||
Bonds and notes based on indices | $ | 18,961,410 | 2.20% - 3.81% | 11/25/24 - 9/26/67 | |||||||||||||
Bonds and notes based on auction | 773,726 | 3.02% - 3.84% | 3/22/32 - 11/26/46 | ||||||||||||||
Total FFELP variable-rate bonds and notes | 19,735,136 | ||||||||||||||||
Fixed-rate bonds and notes issued in FFELP loan asset-backed securitization | 374,500 | 2.53% / 3.45% | 10/25/67 | ||||||||||||||
FFELP warehouse facilities | 739,448 | 2.22% / 2.26% | 11/20/20 / 5/31/22 | ||||||||||||||
Consumer loan warehouse facility | 144,022 | 2.23% | 4/23/22 | ||||||||||||||
Variable-rate bonds and notes issued in private education loan asset- backed securitizations | 82,338 | 3.40% / 3.77% | 12/26/40 / 6/25/49 | ||||||||||||||
Fixed-rate bonds and notes issued in private education loan asset-backed securitization | 53,368 | 3.60% / 5.35% | 12/26/40 / 12/28/43 | ||||||||||||||
Unsecured line of credit | — | — | 6/22/23 | ||||||||||||||
Unsecured debt - Junior Subordinated Hybrid Securities | 20,381 | 5.46% | 9/15/61 | ||||||||||||||
Other borrowings | 45,465 | 2.77% - 3.85% | 10/7/19 - 5/30/22 | ||||||||||||||
21,194,658 | |||||||||||||||||
Discount on bonds and notes payable and debt issuance costs | (284,468) | ||||||||||||||||
Total | $ | 20,910,190 |
As of December 31, 2018 | |||||||||||||||||
Carrying amount | Interest rate range | Final maturity | |||||||||||||||
Variable-rate bonds and notes issued in FFELP loan asset-backed securitizations: | |||||||||||||||||
Bonds and notes based on indices | $ | 20,192,123 | 2.59% - 4.52% | 11/25/24 - 2/25/67 | |||||||||||||
Bonds and notes based on auction | 793,476 | 2.84% - 3.55% | 3/22/32 - 11/26/46 | ||||||||||||||
Total FFELP variable-rate bonds and notes | 20,985,599 | ||||||||||||||||
FFELP warehouse facilities | 986,886 | 2.65% / 2.71% | 5/20/20 / 5/31/21 | ||||||||||||||
Variable-rate bonds and notes issued in private education loan asset-backed securitization | 50,720 | 4.26% | 12/26/40 | ||||||||||||||
Fixed-rate bonds and notes issued in private education loan asset-backed securitization | 63,171 | 3.60% / 5.35% | 12/26/40 / 12/28/43 | ||||||||||||||
Unsecured line of credit | 310,000 | 3.92% - 4.01% | 6/22/23 | ||||||||||||||
Unsecured debt - Junior Subordinated Hybrid Securities | 20,381 | 6.17% | 9/15/61 | ||||||||||||||
Other borrowings | 120,342 | 3.05% - 5.22% | 1/3/19 - 12/15/45 | ||||||||||||||
22,537,099 | |||||||||||||||||
Discount on bonds and notes payable and debt issuance costs | (318,359) | ||||||||||||||||
Total | $ | 22,218,740 |
14
FFELP Warehouse Facilities
The Company funds the majority of its Federal Family Education Loan Program (the "FFEL Program" or "FFELP") loan acquisitions using its FFELP warehouse facilities. Student loan warehousing allows the Company to buy and manage student loans prior to transferring them into more permanent financing arrangements.
As of September 30, 2019, the Company had two FFELP warehouse facilities as summarized below.
NFSLW-I (a) | NHELP-II (b) | Total | ||||||||||||||||||
Maximum financing amount | $ | 500,000 | 500,000 | 1,000,000 | ||||||||||||||||
Amount outstanding | 387,510 | 351,938 | 739,448 | |||||||||||||||||
Amount available | $ | 112,490 | 148,062 | 260,552 | ||||||||||||||||
Expiration of liquidity provisions | November 20, 2019 | May 31, 2020 | ||||||||||||||||||
Final maturity date | November 20, 2020 | May 31, 2022 | ||||||||||||||||||
Advanced as equity support | $ | 22,238 | 25,853 | 48,091 |
(a) On March 8, 2019, the Company decreased the maximum financing amount for this warehouse facility to $500 million. On May 16, 2019, the Company extended the expiration of liquidity provisions to November 20, 2019, and extended the maturity date to November 20, 2020.
(b) On May 30, 2019, the Company extended the expiration of liquidity provisions to May 31, 2020, and extended the maturity date to May 31, 2022.
Asset-Backed Securitizations
The following table summarizes the asset-backed securitization transactions completed during the first nine months of 2019.
2019-1 | 2019-2 | Private education loan 2019-A | 2019-3 | 2019-4 | 2019-5 | Total | ||||||||||||||||||||||||||||||||||||||||||||||||||
Class A-1 Notes | Class A-2 Notes | 2019-1 total | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Date securities issued | 2/27/19 | 2/27/19 | 2/27/19 | 4/30/19 | 6/25/19 | 7/24/19 | 8/22/19 | 9/25/19 | ||||||||||||||||||||||||||||||||||||||||||||||||
Total original principal amount | $ | 35,700 | 448,000 | 496,800 | 416,100 | 47,159 | 498,300 | 418,600 | 374,500 | 2,251,459 | ||||||||||||||||||||||||||||||||||||||||||||||
Class A senior notes: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total principal amount | $ | 35,700 | 448,000 | 483,700 | 405,000 | 47,159 | 485,800 | 408,000 | 364,500 | 2,194,159 | ||||||||||||||||||||||||||||||||||||||||||||||
Bond discount | — | — | — | — | — | — | — | (114) | (114) | |||||||||||||||||||||||||||||||||||||||||||||||
Issue price | $ | 35,700 | 448,000 | 483,700 | 405,000 | 47,159 | 485,800 | 408,000 | 364,386 | 2,194,045 | ||||||||||||||||||||||||||||||||||||||||||||||
Cost of funds | 1-month LIBOR plus 0.30% | 1-month LIBOR plus 0.75% | 1-month LIBOR plus 0.90% | Prime rate less 1.60% | 1-month LIBOR plus 0.80% | 1-month LIBOR plus 0.87% | 2.53% | |||||||||||||||||||||||||||||||||||||||||||||||||
Final maturity date | 4/25/67 | 4/25/67 | 6/27/67 | 6/25/49 | 8/25/67 | 9/26/67 | 10/25/67 | |||||||||||||||||||||||||||||||||||||||||||||||||
Class B subordinated notes: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total principal amount | 13,100 | 11,100 | 12,500 | 10,600 | 10,000 | 57,300 | ||||||||||||||||||||||||||||||||||||||||||||||||||
Bond discount | — | — | — | — | (4) | (4) | ||||||||||||||||||||||||||||||||||||||||||||||||||
Issue price | 13,100 | 11,100 | 12,500 | 10,600 | 9,996 | 57,296 | ||||||||||||||||||||||||||||||||||||||||||||||||||
Cost of funds | 1-month LIBOR plus 1.40% | 1-month LIBOR plus 1.50% | 1-month LIBOR plus 1.55% | 1-month LIBOR plus 1.65% | 3.45% | |||||||||||||||||||||||||||||||||||||||||||||||||||
Final maturity date | 4/25/67 | 6/27/67 | 8/25/67 | 9/26/67 | 10/25/67 | |||||||||||||||||||||||||||||||||||||||||||||||||||
On June 7, 2019, the Company extinguished all $93.0 million of the notes included in one of its FFELP asset-backed securitizations prior to the notes' contractual maturity. The Company paid a $1.4 million premium to extinguish the notes and wrote off $0.4 million of debt issuance costs. In total, the Company recognized a $1.8 million expense to extinguish the notes, which is included in other expenses on the consolidated statements of income.
During the third quarter of 2019, the Company extinguished an additional $675.6 million of notes payable included in certain FFELP asset-backed securitizations prior to the notes' contractual maturities. To extinguish the notes, the Company paid a premium of $12.6 million and wrote off $1.4 million of debt issuance costs. In total, the Company recognized $14.0 million in expenses in the third quarter of 2019 to extinguish these notes, which is included in other expenses on the consolidated statements of income.
15
Consumer Loan Warehouse Facility
On January 11, 2019, the Company obtained a consumer loan warehouse facility with an aggregate maximum financing amount available of $100.0 million, an advance rate of 70 or 75 percent depending on the type of collateral and subject to certain concentration limits, and a maturity date of January 10, 2022. On April 25, 2019, the Company amended the agreement for this warehouse facility to increase the aggregate maximum financing amount available to $200.0 million, extend the expiration of liquidity provisions to April 23, 2021, and extend the final maturity date to April 23, 2022. As of September 30, 2019, $144.0 million was outstanding under this warehouse facility and $56.0 million was available for future funding. Additionally, as of September 30, 2019, the Company had $50.2 million advanced as equity support under this facility.
Unsecured Line of Credit
The Company has a $382.5 million unsecured line of credit that has a maturity date of June 22, 2023. As of September 30, 2019, no amount was outstanding under the line of credit. The line of credit provides that the Company may increase the aggregate financing commitments, through the existing lenders and/or through new lenders, up to a total of $400.0 million, subject to certain conditions.
Other Borrowings
During 2017, the Company entered into a repurchase agreement, the proceeds of which are collateralized by FFELP asset-backed security investments. Included in "other borrowings" as of September 30, 2019 and December 31, 2018, was $40.5 million and $41.4 million, respectively, subject to this repurchase agreement.
During 2018, the Company entered into a repurchase agreement, the proceeds of which were collateralized by private education loans. On June 25, 2019, the Company terminated this repurchase agreement. Included in "other borrowings" as of December 31, 2018 was $45.0 million subject to this repurchase agreement.
On May 30, 2019, the Company entered into a $22.0 million secured line of credit agreement with a maturity date of May 30, 2022 and an interest rate of one-month LIBOR plus 1.75%. As of September 30, 2019, $5.0 million was outstanding under this line of credit and $17.0 million was available for future use. The line of credit is secured by several Company-owned properties.
The Company had other notes payable included in its consolidated financial statements which were issued by partnerships for certain real estate development projects. Although the Company's ownership interests in these partnerships are 50 percent or less, because the Company was the developer of and is a current tenant in the associated buildings, the operating results of these partnerships were included in the Company's consolidated financial statements. On January 1, 2019, the Company adopted a new accounting standard for leases (see note 1). As a result of the adoption of this new standard, these real estate entities were deconsolidated, including $33.9 million of related debt. Prior to January 1, 2019, this debt was included in "other borrowings."
4. Derivative Financial Instruments
The Company uses derivative financial instruments to manage interest rate risk. Derivative instruments used as part of the Company's risk management strategy are further described in note 5 of the notes to consolidated financial statements included in the 2018 Annual Report. A tabular presentation of such derivatives outstanding as of September 30, 2019 and December 31, 2018 is presented below.
Basis Swaps
The following table summarizes the Company’s outstanding basis swaps in which the Company receives three-month LIBOR set discretely in advance and pays one-month LIBOR plus or minus a spread as defined in the agreements (the "1:3 Basis Swaps").
16
Notional amount | ||||||||||||||
As of September 30, | As of December 31, | |||||||||||||
Maturity | 2019 | 2018 | ||||||||||||
2019 | $ | — | 3,500,000 | |||||||||||
2020 | 1,000,000 | 1,000,000 | ||||||||||||
2021 | 250,000 | 250,000 | ||||||||||||
2022 (a) | 2,000,000 | 2,000,000 | ||||||||||||
2023 | 750,000 | 750,000 | ||||||||||||
2024 | 1,750,000 | 250,000 | ||||||||||||
2026 | 1,150,000 | 1,150,000 | ||||||||||||
2027 (b) | 250,000 | 375,000 | ||||||||||||
2028 (b) | — | 325,000 | ||||||||||||
2029 (b) | — | 100,000 | ||||||||||||
2031 (b) | — | 300,000 | ||||||||||||
$ | 7,150,000 | 10,000,000 |
(a) $750 million of the notional amount of these derivatives have forward effective start dates in May 2020.
(b) During the third quarter of 2019, the Company terminated $125 million (notional amount), $325 million (notional amount), $100 million (notional amount), and $300 million (notional amount) of 1:3 Basis Swaps that had a maturity date in 2027, 2028, 2029, and 2031, respectively, and received $0.5 million in net proceeds.
The weighted average rate paid by the Company on the 1:3 Basis Swaps as of September 30, 2019 and December 31, 2018 was one-month LIBOR plus 9.7 basis points and 9.4 basis points, respectively.
Interest Rate Swaps – Floor Income Hedges
The following table summarizes the outstanding derivative instruments used by the Company to economically hedge loans earning fixed rate floor income.
As of September 30, 2019 | As of December 31, 2018 | |||||||||||||||||||||||||
Maturity | Notional amount | Weighted average fixed rate paid by the Company (a) | Notional amount | Weighted average fixed rate paid by the Company (a) | ||||||||||||||||||||||
2019 | $ | 500,000 | 1.12 | % | $ | 3,250,000 | 0.97 | % | ||||||||||||||||||
2020 | 1,500,000 | 1.01 | 1,500,000 | 1.01 | ||||||||||||||||||||||
2021 | 600,000 | 2.15 | 100,000 | 2.95 | ||||||||||||||||||||||
2022 (b) | 250,000 | 1.65 | — | — | ||||||||||||||||||||||
2023 | 150,000 | 2.25 | 400,000 | 2.24 | ||||||||||||||||||||||
2024 | — | — | 300,000 | 2.28 | ||||||||||||||||||||||
2027 | — | — | 25,000 | 2.35 | ||||||||||||||||||||||
$ | 3,000,000 | 1.37 | % | $ | 5,575,000 | 1.18 | % |
(a) For all interest rate derivatives, the Company receives discrete three-month LIBOR.
(b) These derivatives have forward effective start dates in June 2021.
During the first and third quarters of 2019, the Company received $2.1 million and paid $16.5 million, respectively, to terminate $100.0 million (notional amount) and $700.0 million (notional amount), respectively, of floor income interest rate swaps prior to their final maturity.
Interest Rate Swap Options – Floor Income Hedges
During 2014 and 2018, the Company paid $9.1 million and $4.6 million, respectively, for interest rate swap options to economically hedge loans earning fixed rate floor income. The interest rate swap options gave the Company the right, but not the obligation, to enter into interest rate swaps during the third quarter of 2019 in which the Company would pay a weighted average fixed amount of 3.21 percent and receive discrete one-month or three-month LIBOR. The Company did not exercise its rights on these options, and such swap options expired.
17
Interest Rate Caps
In June 2015 and June 2019, the Company paid $2.9 million and $0.3 million, respectively, for interest rate cap contracts to mitigate a rise in interest rates and its impact on earnings related to its student loan portfolio earning a fixed rate. In the event that the one-month LIBOR or three-month LIBOR rate rises above the applicable strike rate, the Company would receive monthly payments related to the spread difference. The following table summarizes these derivative instruments as of September 30, 2019.
Notional Amount | Strike rate | Maturity date | ||||||||||||
$ | 125,000 | 2.50% (1-month LIBOR) | July 15, 2020 | |||||||||||
150,000 | 4.99 (1-month LIBOR) | July 15, 2020 | ||||||||||||
500,000 | 2.25 (3-month LIBOR) | September 25, 2020 |
Consolidated Financial Statement Impact Related to Derivatives
Balance Sheet
The following table summarizes the fair value of the Company’s derivatives as reflected in the consolidated balance sheets. There is no difference between the gross amounts of recognized assets presented in the consolidated balance sheets related to the Company's derivative portfolio and the net amount when excluding derivatives subject to enforceable master netting arrangements and cash collateral received.
Fair value of asset derivatives | Fair value of liability derivatives | ||||||||||||||||||||||
As of September 30, 2019 | As of December 31, 2018 | As of September 30, 2019 | As of December 31, 2018 | ||||||||||||||||||||
Interest rate swap options - floor income hedges | $ | — | 1,465 | — | — | ||||||||||||||||||
Interest rate caps | 57 | 353 | — | — | |||||||||||||||||||
Total | $ | 57 | 1,818 | — | — |
Income Statement Impact
The following table summarizes the components of "derivative market value adjustments and derivative settlements, net" included in the consolidated statements of income.
Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
Settlements: | |||||||||||||||||||||||
1:3 basis swaps | $ | 234 | 3,361 | 3,375 | 4,676 | ||||||||||||||||||
Interest rate swaps - floor income hedges | 7,064 | 19,087 | 35,931 | 46,752 | |||||||||||||||||||
Interest rate swaps - hybrid debt hedges | — | (124) | — | (410) | |||||||||||||||||||
Total settlements - income | 7,298 | 22,324 | 39,306 | 51,018 | |||||||||||||||||||
Change in fair value: | |||||||||||||||||||||||
1:3 basis swaps | 6,636 | 1,283 | 4,427 | 12,058 | |||||||||||||||||||
Interest rate swaps - floor income hedges | (12,094) | (7,427) | (75,657) | 34,008 | |||||||||||||||||||
Interest rate swap options - floor income hedges | (1) | (31) | (1,465) | 437 | |||||||||||||||||||
Interest rate caps | (171) | 119 | (570) | 567 | |||||||||||||||||||
Interest rate swaps - hybrid debt hedges | — | 830 | — | 2,839 | |||||||||||||||||||
Total change in fair value - (expense) income | (5,630) | (5,226) | (73,265) | 49,909 | |||||||||||||||||||
Derivative market value adjustments and derivative settlements, net - income (expense) | $ | 1,668 | 17,098 | (33,959) | 100,927 |
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5. Investments and Notes Receivable
A summary of the Company's investments and notes receivable follows:
As of September 30, 2019 | As of December 31, 2018 | ||||||||||||||||||||||||||||||||||||||||||||||
Amortized cost | Gross unrealized gains | Gross unrealized losses | Fair value | Amortized cost | Gross unrealized gains | Gross unrealized losses | Fair value | ||||||||||||||||||||||||||||||||||||||||
Investments (at fair value): | |||||||||||||||||||||||||||||||||||||||||||||||
Student loan asset-backed and other debt securities - available-for-sale | $ | 48,772 | 3,802 | — | 52,574 | 47,931 | 5,109 | — | 53,040 | ||||||||||||||||||||||||||||||||||||||
Equity securities | 13,913 | 4,114 | (725) | 17,302 | 12,909 | 5,145 | (407) | 17,647 | |||||||||||||||||||||||||||||||||||||||
Total investments (at fair value) | $ | 62,685 | 7,916 | (725) | 69,876 | 60,840 | 10,254 | (407) | 70,687 | ||||||||||||||||||||||||||||||||||||||
Other Investments and Notes Receivable (not measured at fair value): | |||||||||||||||||||||||||||||||||||||||||||||||
Venture capital and funds: | |||||||||||||||||||||||||||||||||||||||||||||||
Measurement alternative | 71,752 | 70,939 | |||||||||||||||||||||||||||||||||||||||||||||
Equity method | 11,396 | 19,230 | |||||||||||||||||||||||||||||||||||||||||||||
Other | 850 | 900 | |||||||||||||||||||||||||||||||||||||||||||||
Total venture capital and funds | 83,998 | 91,069 | |||||||||||||||||||||||||||||||||||||||||||||
Real estate: | |||||||||||||||||||||||||||||||||||||||||||||||
Equity method | 44,995 | 29,168 | |||||||||||||||||||||||||||||||||||||||||||||
Other | 1,372 | 34,211 | |||||||||||||||||||||||||||||||||||||||||||||
Total real estate | 46,367 | 63,379 | |||||||||||||||||||||||||||||||||||||||||||||
Beneficial interest in consumer loan securitization | 5,755 | — | |||||||||||||||||||||||||||||||||||||||||||||
Tax liens and affordable housing | 6,420 | 7,862 | |||||||||||||||||||||||||||||||||||||||||||||
Notes receivable | — | 16,373 | |||||||||||||||||||||||||||||||||||||||||||||
Total investments and notes receivable (not measured at fair value) | 142,540 | 178,683 | |||||||||||||||||||||||||||||||||||||||||||||
Total investments and notes receivable | $ | 212,416 | 249,370 |
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6. Intangible Assets
Intangible assets consist of the following:
Weighted average remaining useful life as of September 30, 2019 (months) | |||||||||||||||||
As of | As of | ||||||||||||||||
September 30, 2019 | December 31, 2018 | ||||||||||||||||
Amortizable intangible assets, net: | |||||||||||||||||
Customer relationships (net of accumulated amortization of $53,926 and $33,968, respectively) | 80 | $ | 78,527 | 98,484 | |||||||||||||
Trade names (net of accumulated amortization of $8,367 and $5,825, respectively) | 92 | 8,326 | 10,868 | ||||||||||||||
Computer software (net of accumulated amortization of $2,741 and $15,420, respectively) | 17 | 2,646 | 4,938 | ||||||||||||||
Total - amortizable intangible assets, net | 80 | $ | 89,499 | 114,290 |
The Company recorded amortization expense on its intangible assets of $8.0 million and $7.9 million during the three months ended September 30, 2019 and 2018, respectively, and $24.8 million and $21.9 million during the nine months ended September 30, 2019 and 2018, respectively. The Company will continue to amortize intangible assets over their remaining useful lives. As of September 30, 2019, the Company estimates it will record amortization expense as follows:
2019 (October 1 - December 31) | $ | 7,967 | |||
2020 | 29,515 | ||||
2021 | 18,761 | ||||
2022 | 7,172 | ||||
2023 | 6,925 | ||||
2024 and thereafter | 19,159 | ||||
$ | 89,499 |
7. Goodwill
The carrying amount of goodwill as of December 31, 2018 and September 30, 2019 by reportable operating segment was as follows:
Loan Servicing and Systems | Education Technology, Services, and Payment Processing | Communications | Asset Generation and Management | Corporate and Other Activities | Total | ||||||||||||||||||||||||||||||
Goodwill balance | $ | 23,639 | 70,278 | 21,112 | 41,883 | — | 156,912 |
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8. Property and Equipment
Property and equipment consisted of the following:
As of | As of | ||||||||||||||||
Useful life | September 30, 2019 | December 31, 2018 | |||||||||||||||
Non-communications: | |||||||||||||||||
Computer equipment and software | 1-5 years | $ | 161,420 | 137,705 | |||||||||||||
Building and building improvements | 5-48 years | 38,621 | 50,138 | ||||||||||||||
Office furniture and equipment | 1-10 years | 24,354 | 22,796 | ||||||||||||||
Leasehold improvements | 1-15 years | 10,193 | 9,327 | ||||||||||||||
Transportation equipment | 5-10 years | 5,049 | 5,123 | ||||||||||||||
Land | — | 1,400 | 3,328 | ||||||||||||||
Construction in progress | — | 3,740 | 3,578 | ||||||||||||||
244,777 | 231,995 | ||||||||||||||||
Accumulated depreciation - non-communications | (147,266) | (123,003) | |||||||||||||||
Non-communications, net property and equipment | 97,511 | 108,992 | |||||||||||||||
Communications: | |||||||||||||||||
Network plant and fiber | 4-15 years | 246,971 | 215,787 | ||||||||||||||
Customer located property | 3-4 years | 25,966 | 21,234 | ||||||||||||||
Central office | 5-15 years | 17,499 | 15,688 | ||||||||||||||
Transportation equipment | 4-10 years | 6,728 | 6,580 | ||||||||||||||
Computer equipment and software | 1-5 years | 5,443 | 4,943 | ||||||||||||||
Other | 1-39 years | 3,391 | 3,219 | ||||||||||||||
Land | — | 70 | 70 | ||||||||||||||
Construction in progress | — | 2,051 | 6,344 | ||||||||||||||
308,119 | 273,865 | ||||||||||||||||
Accumulated depreciation - communications | (63,229) | (38,073) | |||||||||||||||
Communications, net property and equipment | 244,890 | 235,792 | |||||||||||||||
Total property and equipment, net | $ | 342,401 | 344,784 |
The Company recorded depreciation expense on its property and equipment of $19.7 million and $15.1 million during the three months ended September 30, 2019 and 2018, respectively, and $51.6 million and $41.1 million during the nine months ended September 30, 2019 and 2018, respectively.
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9. Earnings per Common Share
Presented below is a summary of the components used to calculate basic and diluted earnings per share. The Company applies the two-class method in computing both basic and diluted earnings per share, which requires the calculation of separate earnings per share amounts for common stock and unvested share-based awards. Unvested share-based awards that contain nonforfeitable rights to dividends are considered securities which participate in undistributed earnings with common stock.
Three months ended September 30, | |||||||||||||||||||||||||||||||||||
2019 | 2018 | ||||||||||||||||||||||||||||||||||
Common shareholders | Unvested restricted stock shareholders | Total | Common shareholders | Unvested restricted stock shareholders | Total | ||||||||||||||||||||||||||||||
Numerator: | |||||||||||||||||||||||||||||||||||
Net income attributable to Nelnet, Inc. | $ | 32,778 | 434 | 33,212 | 42,354 | 573 | 42,927 | ||||||||||||||||||||||||||||
Denominator: | |||||||||||||||||||||||||||||||||||
Weighted-average common shares outstanding - basic and diluted | 39,356,311 | 520,818 | 39,877,129 | 40,441,783 | 547,182 | 40,988,965 | |||||||||||||||||||||||||||||
Earnings per share - basic and diluted | $ | 0.83 | 0.83 | 0.83 | 1.05 | 1.05 | 1.05 |
Nine months ended September 30, | |||||||||||||||||||||||||||||||||||
2019 | 2018 | ||||||||||||||||||||||||||||||||||
Common shareholders | Unvested restricted stock shareholders | Total | Common shareholders | Unvested restricted stock shareholders | Total | ||||||||||||||||||||||||||||||
Numerator: | |||||||||||||||||||||||||||||||||||
Net income attributable to Nelnet, Inc. | $ | 98,125 | 1,298 | 99,423 | 203,881 | 2,406 | 206,287 | ||||||||||||||||||||||||||||
Denominator: | |||||||||||||||||||||||||||||||||||
Weighted-average common shares outstanding - basic and diluted | 39,574,868 | 523,478 | 40,098,346 | 40,464,638 | 477,539 | 40,942,177 | |||||||||||||||||||||||||||||
Earnings per share - basic and diluted | $ | 2.48 | 2.48 | 2.48 | 5.04 | 5.04 | 5.04 | ||||||||||||||||||||||||||||
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10. Segment Reporting
See note 14 of the notes to consolidated financial statements included in the 2018 Annual Report for a description of the Company's operating segments. The following tables include the results of each of the Company's operating segments reconciled to the consolidated financial statements.
Three months ended September 30, 2019 | |||||||||||||||||||||||||||||||||||||||||
Loan Servicing and Systems | Education Technology, Services, and Payment Processing | Communications | Asset Generation and Management | Corporate and Other Activities | Eliminations | Total | |||||||||||||||||||||||||||||||||||
Total interest income | $ | 532 | 3,499 | — | 233,225 | 2,859 | (1,171) | 238,945 | |||||||||||||||||||||||||||||||||
Interest expense | 51 | 12 | — | 171,485 | 2,110 | (1,171) | 172,488 | ||||||||||||||||||||||||||||||||||
Net interest income (expense) | 481 | 3,487 | — | 61,740 | 749 | — | 66,457 | ||||||||||||||||||||||||||||||||||
Less provision for loan losses | — | — | — | 10,000 | — | — | 10,000 | ||||||||||||||||||||||||||||||||||
Net interest income (loss) after provision for loan losses | 481 | 3,487 | — | 51,740 | 749 | — | 56,457 | ||||||||||||||||||||||||||||||||||
Other income: | |||||||||||||||||||||||||||||||||||||||||
Loan servicing and systems revenue | 113,286 | — | — | — | — | — | 113,286 | ||||||||||||||||||||||||||||||||||
Intersegment servicing revenue | 11,611 | — | — | — | — | (11,611) | — | ||||||||||||||||||||||||||||||||||
Education technology, services, and payment processing revenue | — | 74,251 | — | — | — | — | 74,251 | ||||||||||||||||||||||||||||||||||
Communications revenue | — | — | 16,470 | — | — | — | 16,470 | ||||||||||||||||||||||||||||||||||
Other income | 2,291 | — | 532 | 3,384 | 7,231 | — | 13,439 | ||||||||||||||||||||||||||||||||||
Derivative settlements, net | — | — | — | 7,298 | — | — | 7,298 | ||||||||||||||||||||||||||||||||||
Derivative market value adjustments, net | — | — | — | (5,630) | — | — | (5,630) | ||||||||||||||||||||||||||||||||||
Total other income | 127,188 | 74,251 | 17,002 | 5,052 | 7,231 | (11,611) | 219,114 | ||||||||||||||||||||||||||||||||||
Cost of services: | |||||||||||||||||||||||||||||||||||||||||
Cost to provide education technology, services, and payment processing services | — | 25,671 | — | — | — | — | 25,671 | ||||||||||||||||||||||||||||||||||
Cost to provide communications services | — | — | 5,236 | — | — | — | 5,236 | ||||||||||||||||||||||||||||||||||
Total cost of services | — | 25,671 | 5,236 | — | — | — | 30,907 | ||||||||||||||||||||||||||||||||||
Operating expenses: | |||||||||||||||||||||||||||||||||||||||||
Salaries and benefits | 69,209 | 23,826 | 5,763 | 394 | 17,479 | — | 116,670 | ||||||||||||||||||||||||||||||||||
Depreciation and amortization | 8,565 | 2,997 | 10,926 | — | 5,212 | — | 27,701 | ||||||||||||||||||||||||||||||||||
Loan servicing fees to third parties | — | — | — | 3,382 | — | — | 3,382 | ||||||||||||||||||||||||||||||||||
Other expenses | 16,686 | 5,325 | 3,842 | 15,672 | 13,422 | — | 54,947 | ||||||||||||||||||||||||||||||||||
Intersegment expenses, net | 12,955 | 3,194 | 701 | 11,678 | (16,917) | (11,611) | — | ||||||||||||||||||||||||||||||||||
Total operating expenses | 107,415 | 35,342 | 21,232 | 31,126 | 19,196 | (11,611) | 202,700 | ||||||||||||||||||||||||||||||||||
Income (loss) before income taxes | 20,254 | 16,725 | (9,466) | 25,666 | (11,216) | — | 41,964 | ||||||||||||||||||||||||||||||||||
Income tax (expense) benefit | (4,861) | (4,014) | 2,272 | (6,160) | 3,935 | — | (8,829) | ||||||||||||||||||||||||||||||||||
Net income (loss) | 15,393 | 12,711 | (7,194) | 19,506 | (7,281) | — | 33,135 | ||||||||||||||||||||||||||||||||||
Net loss (income) attributable to noncontrolling interests | — | — | — | — | 77 | — | 77 | ||||||||||||||||||||||||||||||||||
Net income (loss) attributable to Nelnet, Inc. | $ | 15,393 | 12,711 | (7,194) | 19,506 | (7,204) | — | 33,212 | |||||||||||||||||||||||||||||||||
Total assets as of September 30, 2019 | $ | 222,606 | 413,076 | 306,743 | 22,520,688 | 685,998 | (212,392) | 23,936,719 |
23
Three months ended September 30, 2018 | |||||||||||||||||||||||||||||||||||||||||
Loan Servicing and Systems | Education Technology, Services, and Payment Processing | Communications | Asset Generation and Management | Corporate and Other Activities | Eliminations | Total | |||||||||||||||||||||||||||||||||||
Total interest income | $ | 381 | 1,513 | 1 | 236,039 | 6,860 | (4,846) | 239,948 | |||||||||||||||||||||||||||||||||
Interest expense | — | 3 | 4,174 | 176,874 | 3,968 | (4,846) | 180,175 | ||||||||||||||||||||||||||||||||||
Net interest income (expense) | 381 | 1,510 | (4,173) | 59,165 | 2,892 | — | 59,773 | ||||||||||||||||||||||||||||||||||
Less provision for loan losses | — | — | — | 10,500 | — | — | 10,500 | ||||||||||||||||||||||||||||||||||
Net interest income (loss) after provision for loan losses | 381 | 1,510 | (4,173) | 48,665 | 2,892 | — | 49,273 | ||||||||||||||||||||||||||||||||||
Other income: | |||||||||||||||||||||||||||||||||||||||||
Loan servicing and systems revenue | 112,579 | — | — | — | — | — | 112,579 | ||||||||||||||||||||||||||||||||||
Intersegment servicing revenue | 12,290 | — | — | — | — | (12,290) | — | ||||||||||||||||||||||||||||||||||
Education technology, services, and payment processing revenue | — | 58,409 | — | — | — | — | 58,409 | ||||||||||||||||||||||||||||||||||
Communications revenue | — | — | 11,818 | — | — | — | 11,818 | ||||||||||||||||||||||||||||||||||
Other income | 1,948 | — | 950 | 3,267 | 10,508 | — | 16,673 | ||||||||||||||||||||||||||||||||||
Derivative settlements, net | — | — | — | 22,448 | (124) | — | 22,324 | ||||||||||||||||||||||||||||||||||
Derivative market value adjustments, net | — | — | — | (6,056) | 830 | — | (5,226) | ||||||||||||||||||||||||||||||||||
Total other income | 126,817 | 58,409 | 12,768 | 19,659 | 11,214 | (12,290) | 216,577 | ||||||||||||||||||||||||||||||||||
Cost of services: | |||||||||||||||||||||||||||||||||||||||||
Cost to provide education technology, services, and payment processing services | — | 19,087 | — | — | — | — | 19,087 | ||||||||||||||||||||||||||||||||||
Cost to provide communications services | — | — | 4,310 | — | — | — | 4,310 | ||||||||||||||||||||||||||||||||||
Total cost of services | — | 19,087 | 4,310 | — | — | — | 23,397 | ||||||||||||||||||||||||||||||||||
Operating expenses: | |||||||||||||||||||||||||||||||||||||||||
Salaries and benefits | 70,440 | 19,972 | 4,554 | 424 | 18,782 | — | 114,172 | ||||||||||||||||||||||||||||||||||
Depreciation and amortization | 8,957 | 3,435 | 6,167 | — | 4,433 | — | 22,992 | ||||||||||||||||||||||||||||||||||
Loan servicing fees to third parties | — | — | — | 3,087 | — | — | 3,087 | ||||||||||||||||||||||||||||||||||
Other expenses | 19,638 | 4,943 | 3,151 | 845 | 16,616 | — | 45,194 | ||||||||||||||||||||||||||||||||||
Intersegment expenses, net | 15,029 | 2,494 | 598 | 12,378 | (18,208) | (12,290) | — | ||||||||||||||||||||||||||||||||||
Total operating expenses | 114,064 | 30,844 | 14,470 | 16,734 | 21,623 | (12,290) | 185,445 | ||||||||||||||||||||||||||||||||||
Income (loss) before income taxes | 13,134 | 9,988 | (10,185) | 51,590 | (7,517) | — | 57,008 | ||||||||||||||||||||||||||||||||||
Income tax (expense) benefit | (3,152) | (2,397) | 2,444 | (12,381) | 1,604 | — | (13,882) | ||||||||||||||||||||||||||||||||||
Net income (loss) | 9,982 | 7,591 | (7,741) | 39,209 | (5,913) | — | 43,126 | ||||||||||||||||||||||||||||||||||
Net loss (income) attributable to noncontrolling interests | — | — | — | — | (199) | — | (199) | ||||||||||||||||||||||||||||||||||
Net income (loss) attributable to Nelnet, Inc. | $ | 9,982 | 7,591 | (7,741) | 39,209 | (6,112) | — | 42,927 | |||||||||||||||||||||||||||||||||
Total assets as of September 30, 2018 | $ | 276,153 | 243,497 | 271,370 | 23,927,156 | 723,985 | (337,236) | 25,104,925 |
24
Nine months ended September 30, 2019 | |||||||||||||||||||||||||||||||||||||||||
Loan Servicing and Systems | Education Technology, Services, and Payment Processing | Communications | Asset Generation and Management | Corporate and Other Activities | Eliminations | Total | |||||||||||||||||||||||||||||||||||
Total interest income | $ | 1,579 | 7,175 | 3 | 723,388 | 7,170 | (2,995) | 736,319 | |||||||||||||||||||||||||||||||||
Interest expense | 70 | 32 | — | 544,319 | 9,796 | (2,995) | 551,221 | ||||||||||||||||||||||||||||||||||
Net interest income (expense) | 1,509 | 7,143 | 3 | 179,069 | (2,626) | — | 185,098 | ||||||||||||||||||||||||||||||||||
Less provision for loan losses | — | — | — | 26,000 | — | — | 26,000 | ||||||||||||||||||||||||||||||||||
Net interest income (loss) after provision for loan losses | 1,509 | 7,143 | 3 | 153,069 | (2,626) | — | 159,098 | ||||||||||||||||||||||||||||||||||
Other income: | |||||||||||||||||||||||||||||||||||||||||
Loan servicing and systems revenue | 342,169 | — | — | — | — | — | 342,169 | ||||||||||||||||||||||||||||||||||
Intersegment servicing revenue | 35,426 | — | — | — | — | (35,426) | — | ||||||||||||||||||||||||||||||||||
Education technology, services, and payment processing revenue | — | 213,753 | — | — | — | — | 213,753 | ||||||||||||||||||||||||||||||||||
Communications revenue | — | — | 46,770 | — | — | — | 46,770 | ||||||||||||||||||||||||||||||||||
Other income | 6,642 | — | 1,019 | 11,796 | 19,200 | — | 38,658 | ||||||||||||||||||||||||||||||||||
Derivative settlements, net | — | — | — | 39,306 | — | — | 39,306 | ||||||||||||||||||||||||||||||||||
Derivative market value adjustments, net | — | — | — | (73,265) | — | — | (73,265) | ||||||||||||||||||||||||||||||||||
Total other income | 384,237 | 213,753 | 47,789 | (22,163) | 19,200 | (35,426) | 607,391 | ||||||||||||||||||||||||||||||||||
Cost of services: | |||||||||||||||||||||||||||||||||||||||||
Cost to provide education technology, services, and payment processing services | — | 62,601 | — | — | — | — | 62,601 | ||||||||||||||||||||||||||||||||||
Cost to provide communications services | — | — | 15,096 | — | — | — | 15,096 | ||||||||||||||||||||||||||||||||||
Total cost of services | — | 62,601 | 15,096 | — | — | — | 77,697 | ||||||||||||||||||||||||||||||||||
Operating expenses: | |||||||||||||||||||||||||||||||||||||||||
Salaries and benefits | 201,924 | 69,656 | 15,692 | 1,153 | 50,517 | — | 338,942 | ||||||||||||||||||||||||||||||||||
Depreciation and amortization | 26,236 | 9,832 | 26,025 | — | 14,305 | — | 76,398 | ||||||||||||||||||||||||||||||||||
Loan servicing fees to third parties | — | — | — | 9,431 | — | — | 9,431 | ||||||||||||||||||||||||||||||||||
Other expenses | 52,732 | 16,440 | 11,184 | 19,667 | 38,107 | — | 138,131 | ||||||||||||||||||||||||||||||||||
Intersegment expenses, net | 40,317 | 9,642 | 2,081 | 35,630 | (52,244) | (35,426) | — | ||||||||||||||||||||||||||||||||||
Total operating expenses | 321,209 | 105,570 | 54,982 | 65,881 | 50,685 | (35,426) | 562,902 | ||||||||||||||||||||||||||||||||||
Income (loss) before income taxes | 64,537 | 52,725 | (22,286) | 65,025 | (34,111) | — | 125,890 | ||||||||||||||||||||||||||||||||||
Income tax (expense) benefit | (15,489) | (12,654) | 5,349 | (15,606) | 11,971 | — | (26,429) | ||||||||||||||||||||||||||||||||||
Net income (loss) | 49,048 | 40,071 | (16,937) | 49,419 | (22,140) | — | 99,461 | ||||||||||||||||||||||||||||||||||
Net loss (income) attributable to noncontrolling interests | — | — | — | — | (38) | — | (38) | ||||||||||||||||||||||||||||||||||
Net income (loss) attributable to Nelnet, Inc. | $ | 49,048 | 40,071 | (16,937) | 49,419 | (22,178) | — | 99,423 | |||||||||||||||||||||||||||||||||
Total assets as of September 30, 2019 | $ | 222,606 | 413,076 | 306,743 | 22,520,688 | 685,998 | (212,392) | 23,936,719 |
25
Nine months ended September 30, 2018 | |||||||||||||||||||||||||||||||||||||||||
Loan Servicing and Systems | Education Technology, Services, and Payment Processing | Communications | Asset Generation and Management | Corporate and Other Activities | Eliminations | Total | |||||||||||||||||||||||||||||||||||
Total interest income | $ | 931 | 2,927 | 3 | 662,881 | 17,673 | (12,420) | 671,995 | |||||||||||||||||||||||||||||||||
Interest expense | — | 3 | 9,987 | 480,729 | 8,875 | (12,420) | 487,174 | ||||||||||||||||||||||||||||||||||
Net interest income (expense) | 931 | 2,924 | (9,984) | 182,152 | 8,798 | — | 184,821 | ||||||||||||||||||||||||||||||||||
Less provision for loan losses | — | — | — | 18,000 | — | — | 18,000 | ||||||||||||||||||||||||||||||||||
Net interest income (loss) after provision for loan losses | 931 | 2,924 | (9,984) | 164,152 | 8,798 | — | 166,821 | ||||||||||||||||||||||||||||||||||
Other income: | |||||||||||||||||||||||||||||||||||||||||
Loan servicing and systems revenue | 327,265 | — | — | — | — | — | 327,265 | ||||||||||||||||||||||||||||||||||
Intersegment servicing revenue | 34,670 | — | — | — | — | (34,670) | — | ||||||||||||||||||||||||||||||||||
Education technology, services, and payment processing revenue | — | 167,372 | — | — | — | — | 167,372 | ||||||||||||||||||||||||||||||||||
Communications revenue | — | — | 31,327 | — | — | — | 31,327 | ||||||||||||||||||||||||||||||||||
Other income | 5,196 | — | 950 | 9,391 | 29,272 | — | 44,808 | ||||||||||||||||||||||||||||||||||
Derivative settlements, net | — | — | — | 51,428 | (410) | — | 51,018 | ||||||||||||||||||||||||||||||||||
Derivative market value adjustments, net | — | — | — | 47,070 | 2,839 | — | 49,909 | ||||||||||||||||||||||||||||||||||
Total other income | 367,131 | 167,372 | 32,277 | 107,889 | 31,701 | (34,670) | 671,699 | ||||||||||||||||||||||||||||||||||
Cost of services: | |||||||||||||||||||||||||||||||||||||||||
Cost to provide education technology, services, and payment processing services | — | 44,087 | — | — | — | — | 44,087 | ||||||||||||||||||||||||||||||||||
Cost to provide communications services | — | — | 11,892 | — | — | — | 11,892 | ||||||||||||||||||||||||||||||||||
Total cost of services | — | 44,087 | 11,892 | — | — | — | 55,979 | ||||||||||||||||||||||||||||||||||
Operating expenses: | |||||||||||||||||||||||||||||||||||||||||
Salaries and benefits | 198,411 | 58,552 | 13,284 | 1,183 | 50,502 | — | 321,932 | ||||||||||||||||||||||||||||||||||
Depreciation and amortization | 23,237 | 10,062 | 16,585 | — | 13,058 | — | 62,943 | ||||||||||||||||||||||||||||||||||
Loan servicing fees to third parties | — | — | — | 9,428 | — | — | 9,428 | ||||||||||||||||||||||||||||||||||
Other expenses | 51,591 | 14,950 | 8,811 | 2,982 | 40,686 | — | 119,020 | ||||||||||||||||||||||||||||||||||
Intersegment expenses, net | 43,968 | 7,630 | 1,802 | 34,943 | (53,672) | (34,670) | — | ||||||||||||||||||||||||||||||||||
Total operating expenses | 317,207 | 91,194 | 40,482 | 48,536 | 50,574 | (34,670) | 513,323 | ||||||||||||||||||||||||||||||||||
Income (loss) before income taxes | 50,855 | 35,015 | (30,081) | 223,505 | (10,075) | — | 269,218 | ||||||||||||||||||||||||||||||||||
Income tax (expense) benefit | (12,399) | (8,404) | 7,220 | (53,641) | 3,855 | — | (63,369) | ||||||||||||||||||||||||||||||||||
Net income (loss) | 38,456 | 26,611 | (22,861) | 169,864 | (6,220) | — | 205,849 | ||||||||||||||||||||||||||||||||||
Net loss (income) attributable to noncontrolling interests | 808 | — | — | — | (371) | — | 438 | ||||||||||||||||||||||||||||||||||
Net income (loss) attributable to Nelnet, Inc. | $ | 39,264 | 26,611 | (22,861) | 169,864 | (6,591) | — | 206,287 | |||||||||||||||||||||||||||||||||
Total assets as of September 30, 2018 | $ | 276,153 | 243,497 | 271,370 | 23,927,156 | 723,985 | (337,236) | 25,104,925 |
26
11. Disaggregated Revenue and Deferred Revenue
The following tables provide disaggregated revenue by service offering and/or customer type for the Company's fee-based reportable operating segments.
Loan Servicing and Systems
Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
Government servicing - Nelnet | $ | 38,645 | 38,907 | 118,744 | 118,015 | ||||||||||||||||||
Government servicing - Great Lakes | 46,234 | 45,671 | 139,285 | 122,107 | |||||||||||||||||||
Private education and consumer loan servicing | 9,561 | 10,007 | 28,026 | 31,990 | |||||||||||||||||||
FFELP servicing | 6,089 | 7,422 | 19,208 | 24,259 | |||||||||||||||||||
Software services | 10,493 | 8,201 | 30,255 | 24,461 | |||||||||||||||||||
Outsourced services and other | 2,264 | 2,371 | 6,651 | 6,433 | |||||||||||||||||||
Loan servicing and systems revenue | $ | 113,286 | 112,579 | 342,169 | 327,265 |
Education Technology, Services, and Payment Processing
Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
Tuition payment plan services | $ | 25,760 | 19,771 | 80,589 | 63,209 | ||||||||||||||||||
Payment processing | 35,138 | 26,956 | 85,428 | 62,908 | |||||||||||||||||||
Education technology and services | 13,067 | 11,419 | 46,872 | 40,411 | |||||||||||||||||||
Other | 286 | 263 | 864 | 844 | |||||||||||||||||||
Education technology, services, and payment processing revenue | $ | 74,251 | 58,409 | 213,753 | 167,372 |
Communications
Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
Internet | $ | 9,899 | 6,453 | 27,641 | 16,541 | ||||||||||||||||||
Television | 4,068 | 3,380 | 12,020 | 9,241 | |||||||||||||||||||
Telephone | 2,487 | 1,962 | 7,062 | 5,482 | |||||||||||||||||||
Other | 16 | 23 | 47 | 63 | |||||||||||||||||||
Communications revenue | $ | 16,470 | 11,818 | 46,770 | 31,327 | ||||||||||||||||||
Residential revenue | $ | 12,397 | 8,896 | 35,351 | 23,367 | ||||||||||||||||||
Business revenue | 4,025 | 2,861 | 11,256 | 7,779 | |||||||||||||||||||
Other | 48 | 61 | 163 | 181 | |||||||||||||||||||
Communications revenue | $ | 16,470 | 11,818 | 46,770 | 31,327 |
Other Income
The following table provides the components of "other income" on the consolidated statements of income:
Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
Borrower late fee income | $ | 3,196 | 3,253 | 9,870 | 8,994 | ||||||||||||||||||
Management fee revenue | 2,084 | 1,756 | 6,007 | 4,673 | |||||||||||||||||||
Gain on investments and notes receivable, net of losses | 1,948 | 2,503 | 5,779 | 10,291 | |||||||||||||||||||
Investment advisory services | 753 | 1,183 | 2,194 | 4,169 | |||||||||||||||||||
Other | 5,458 | 7,978 | 14,808 | 16,681 | |||||||||||||||||||
Other income | $ | 13,439 | 16,673 | 38,658 | 44,808 |
27
Deferred Revenue
Activity in the deferred revenue balance, which is included in "other liabilities" on the consolidated balance sheets, is shown below:
Loan Servicing and Systems | Education Technology, Services, and Payment Processing | Communications | Corporate and Other Activities | Total | |||||||||||||||||||||||||
Three months ended September 30, 2019 | |||||||||||||||||||||||||||||
Balance, beginning of period | $ | 3,315 | 21,489 | 3,080 | 1,611 | 29,495 | |||||||||||||||||||||||
Deferral of revenue | 881 | 42,752 | 9,302 | 953 | 53,888 | ||||||||||||||||||||||||
Recognition of revenue | (1,149) | (21,820) | (9,158) | (850) | (32,977) | ||||||||||||||||||||||||
Balance, end of period | $ | 3,047 | 42,421 | 3,224 | 1,714 | 50,406 | |||||||||||||||||||||||
Three months ended September 30, 2018 | |||||||||||||||||||||||||||||
Balance, beginning of period | $ | 3,771 | 17,989 | 2,149 | 1,751 | 25,660 | |||||||||||||||||||||||
Deferral of revenue | 1,591 | 34,252 | 6,567 | 2,764 | 45,174 | ||||||||||||||||||||||||
Recognition of revenue | (1,754) | (17,049) | (6,342) | (2,858) | (28,003) | ||||||||||||||||||||||||
Balance, end of period | $ | 3,608 | 35,192 | 2,374 | 1,657 | 42,831 | |||||||||||||||||||||||
Nine months ended September 30, 2019 | |||||||||||||||||||||||||||||
Balance, beginning of period | $ | 4,413 | 30,556 | 2,551 | 1,602 | 39,122 | |||||||||||||||||||||||
Deferral of revenue | 2,761 | 81,484 | 26,366 | 2,530 | 113,141 | ||||||||||||||||||||||||
Recognition of revenue | (4,127) | (69,619) | (25,693) | (2,418) | (101,857) | ||||||||||||||||||||||||
Balance, end of period | $ | 3,047 | 42,421 | 3,224 | 1,714 | 50,406 | |||||||||||||||||||||||
Nine months ended September 30, 2018 | |||||||||||||||||||||||||||||
Balance, beginning of period | $ | 4,968 | 24,164 | 1,665 | 1,479 | 32,276 | |||||||||||||||||||||||
Deferral of revenue | 2,555 | 65,940 | 17,916 | 4,869 | 91,280 | ||||||||||||||||||||||||
Recognition of revenue | (3,915) | (54,912) | (17,207) | (4,691) | (80,725) | ||||||||||||||||||||||||
Balance, end of period | $ | 3,608 | 35,192 | 2,374 | 1,657 | 42,831 |
12. Major Customer
Nelnet Servicing, LLC ("Nelnet Servicing"), a subsidiary of the Company, earns loan servicing revenue from a servicing contract with the Department of Education (the "Department"). Revenue earned by Nelnet Servicing related to this contract was $38.6 million and $38.9 million for the three months ended September 30, 2019 and 2018, and $118.7 million and $118.0 million for the nine months ended September 30, 2019 and 2018, respectively.
In addition, Great Lakes Educational Loan Services, Inc. ("Great Lakes"), which was acquired by the Company on February 7, 2018, also earns loan servicing revenue from a similar servicing contract with the Department. Revenue earned by Great Lakes related to this contract was $46.2 million and $45.7 million for the three months ended September 30, 2019 and 2018, respectively, and $139.3 million for the nine months ended September 30, 2019. Revenue of $122.1 million was earned for the period from February 7, 2018 to September 30, 2018.
Nelnet Servicing and Great Lakes' servicing contracts with the Department previously provided for expiration on June 16, 2019. On May 15, 2019, Nelnet Servicing and Great Lakes each received a Modification of Contract from the Department's Office of Federal Student Aid ("FSA") pursuant to which FSA extended the expiration date of the current contracts to December 15, 2019.
In addition, Nelnet Servicing's current Authority to Operate as a loan servicer for the Department expires on December 13, 2019, and is currently under review for renewal. The Company cannot predict the timing or outcome of this review.
28
FSA is conducting a contract procurement process entitled Next Generation Financial Services Environment (“NextGen”) for a new framework for the servicing of all student loans owned by the Department. On January 15, 2019, FSA issued solicitations for three NextGen components:
•NextGen Enhanced Processing Solution ("EPS")
•NextGen Business Process Operations ("BPO")
•NextGen Optimal Processing Solution ("OPS")
On April 1, 2019 and October 4, 2019, the Company responded to the EPS component. In addition, on August 1, 2019, the Company responded to the BPO component. The Company is also part of a team that has responded and intends to respond to various aspects of the OPS component. The Company cannot predict the timing, nature, or outcome of these solicitations.
13. Related Party Transactions (dollar amounts in this note are not in thousands)
On July 26, 2019, the Company, as lender, received a $16.0 million promissory note from Hudl, of which David R. Graff, a member of the Company's Board of Directors, is CEO, co-founder, and a director. The promissory note carried a 14 percent interest rate and was due 180 days from the date of issuance. In connection with this promissory note, the Company entered into a Subordination Agreement with Union Bank and Trust Company ("Union Bank"), a related party, effective as of July 26, 2019, which required the Company to subordinate its promissory note from Hudl to existing notes Union Bank holds from Hudl. The $16.0 million promissory note from Hudl was paid in full to the Company in August 2019.
During the third quarter of 2019, the Company, Farmers & Merchants Investment Inc. (the parent of Union Bank) ("F&M"), and the holding company of BankFirst of Norfolk, Nebraska (BankFirst), of which Michael S. Dunlap is a member of the Board of Directors, co-invested $0.7 million, $2.1 million, and $2.1 million, respectively, in a Company-managed limited liability company that invests in renewable energy. As part of these transactions, the Company receives management and performance fees under a management agreement. During the third quarter of 2019, the Company earned a total of approximately $138,000 of management fees under this agreement, allocable in equal amounts of approximately $69,000 to the investments of each of F&M and BankFirst.
14. Fair Value
The following tables present the Company’s financial assets and liabilities that are measured at fair value on a recurring basis.
As of September 30, 2019 | As of December 31, 2018 | ||||||||||||||||||||||||||||||||||
Level 1 | Level 2 | Total | Level 1 | Level 2 | Total | ||||||||||||||||||||||||||||||
Assets: | |||||||||||||||||||||||||||||||||||
Investments: | |||||||||||||||||||||||||||||||||||
Student loan and other asset-backed securities - available-for-sale | $ | — | 52,471 | 52,471 | — | 52,936 | 52,936 | ||||||||||||||||||||||||||||
Equity securities | 3,263 | — | 3,263 | 2,722 | — | 2,722 | |||||||||||||||||||||||||||||
Equity securities measured at net asset value (a) | 14,039 | 14,925 | |||||||||||||||||||||||||||||||||
Debt securities - available-for-sale | 103 | — | 103 | 104 | — | 104 | |||||||||||||||||||||||||||||
Total investments | 3,366 | 52,471 | 69,876 | 2,826 | 52,936 | 70,687 | |||||||||||||||||||||||||||||
Derivative instruments | — | 57 | 57 | — | 1,818 | 1,818 | |||||||||||||||||||||||||||||
Total assets | $ | 3,366 | 52,528 | 69,933 | 2,826 | 54,754 | 72,505 | ||||||||||||||||||||||||||||
(a) In accordance with the Fair Value Measurements Topic of the FASB Accounting Standards Codification, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy.
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The following table summarizes the fair values of all of the Company’s financial instruments on the consolidated balance sheets:
As of September 30, 2019 | |||||||||||||||||||||||||||||
Fair value | Carrying value | Level 1 | Level 2 | Level 3 | |||||||||||||||||||||||||
Financial assets: | |||||||||||||||||||||||||||||
Loans receivable | $ | 21,892,651 | 21,071,441 | — | — | 21,892,651 | |||||||||||||||||||||||
Cash and cash equivalents | 160,979 | 160,979 | 160,979 | — | — | ||||||||||||||||||||||||
Investments (at fair value) | 69,876 | 69,876 | 3,366 | 52,471 | — | ||||||||||||||||||||||||
Beneficial interest in consumer loan securitization | 5,755 | 5,755 | — | — | 5,755 | ||||||||||||||||||||||||
Restricted cash | 667,919 | 667,919 | 667,919 | — | — | ||||||||||||||||||||||||
Restricted cash – due to customers | 309,309 | 309,309 | 309,309 | — | — | ||||||||||||||||||||||||
Accrued interest receivable | 736,901 | 736,901 | — | 736,901 | — | ||||||||||||||||||||||||
Derivative instruments | 57 | 57 | — | 57 | — | ||||||||||||||||||||||||
Financial liabilities: | |||||||||||||||||||||||||||||
Bonds and notes payable | 20,824,456 | 20,910,190 | — | 20,824,456 | — | ||||||||||||||||||||||||
Accrued interest payable | 52,345 | 52,345 | — | 52,345 | — | ||||||||||||||||||||||||
Due to customers | 309,309 | 309,309 | 309,309 | — | — | ||||||||||||||||||||||||
As of December 31, 2018 | |||||||||||||||||||||||||||||
Fair value | Carrying value | Level 1 | Level 2 | Level 3 | |||||||||||||||||||||||||
Financial assets: | |||||||||||||||||||||||||||||
Loans receivable | $ | 23,521,171 | 22,377,142 | — | — | 23,521,171 | |||||||||||||||||||||||
Cash and cash equivalents | 121,347 | 121,347 | 121,347 | — | — | ||||||||||||||||||||||||
Investments (at fair value) | 70,687 | 70,687 | 2,826 | 52,936 | — | ||||||||||||||||||||||||
Notes receivable | 16,373 | 16,373 | — | 16,373 | — | ||||||||||||||||||||||||
Restricted cash | 701,366 | 701,366 | 701,366 | — | — | ||||||||||||||||||||||||
Restricted cash – due to customers | 369,678 | 369,678 | 369,678 | — | — | ||||||||||||||||||||||||
Accrued interest receivable | 679,197 | 679,197 | — | 679,197 | — | ||||||||||||||||||||||||
Derivative instruments | 1,818 | 1,818 | — | 1,818 | — | ||||||||||||||||||||||||
Financial liabilities: | |||||||||||||||||||||||||||||
Bonds and notes payable | 22,270,462 | 22,218,740 | — | 22,270,462 | — | ||||||||||||||||||||||||
Accrued interest payable | 61,679 | 61,679 | — | 61,679 | — | ||||||||||||||||||||||||
Due to customers | 369,678 | 369,678 | 369,678 | — | — | ||||||||||||||||||||||||
The methodologies for estimating the fair value of financial assets and liabilities are described in note 20 of the notes to consolidated financial statements included in the 2018 Annual Report.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Management’s Discussion and Analysis of Financial Condition and Results of Operations is for the three and nine months ended September 30, 2019 and 2018. All dollars are in thousands, except per share amounts, unless otherwise noted.)
The following discussion and analysis provides information that the Company’s management believes is relevant to an assessment and understanding of the consolidated results of operations and financial condition of the Company. The discussion should be read in conjunction with the Company’s consolidated financial statements included in the 2018 Annual Report.
Forward-looking and cautionary statements
This report contains forward-looking statements and information that are based on management's current expectations as of the date of this document. Statements that are not historical facts, including statements about the Company's plans and expectations for future financial condition, results of operations or economic performance, or that address management's plans and objectives for future operations, and statements that assume or are dependent upon future events, are forward-looking statements. The words “anticipate,” “assume,” “believe,” “continue,” “could,” “estimate,” “expect,” “forecast,” “future,” “intend,” “may,” “plan,” “potential,” “predict,” “scheduled,” “should,” “will,” “would,” and similar expressions, as well as statements in future tense, are intended to identify forward-looking statements.
The forward-looking statements are based on assumptions and analyses made by management in light of management's experience and its perception of historical trends, current conditions, expected future developments, and other factors that management believes are appropriate under the circumstances. These statements are subject to known and unknown risks,
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uncertainties, assumptions, and other factors that may cause the actual results and performance to be materially different from any future results or performance expressed or implied by such forward-looking statements. These factors include, among others, the risks and uncertainties set forth in the “Risk Factors” section of the 2018 Annual Report and elsewhere in this report, and include such risks and uncertainties as:
•loan portfolio risks such as interest rate basis and repricing risk resulting from the fact that the interest rate characteristics of the student loan assets do not match the interest rate characteristics of the funding for those assets, the risk of loss of floor income on certain student loans originated under the Federal Family Education Loan Program (the "FFEL Program" or "FFELP"), risks related to the use of derivatives to manage exposure to interest rate fluctuations, uncertainties regarding the expected benefits from purchased securitized and unsecuritized FFELP, private education, and consumer loans and initiatives to purchase additional FFELP, private education, and consumer loans, and risks from changes in levels of loan prepayment or default rates;
•financing and liquidity risks, including risks of changes in the general interest rate environment, including the availability of any relevant money market index rate such as LIBOR or the relationship between the relevant money market index rate and the rate at which the Company's assets and liabilities are priced, and in the securitization and other financing markets for loans, including adverse changes resulting from unanticipated repayment trends on student loans in FFELP securitization trusts that could accelerate or delay repayment of the associated bonds, which may increase the costs or limit the availability of financings necessary to purchase, refinance, or continue to hold student loans;
•risks from changes in the educational credit and services markets resulting from changes in applicable laws, regulations, and government programs and budgets, such as the expected decline over time in FFELP loan interest income and fee-based revenues due to the discontinuation of new FFELP loan originations in 2010 and potential government initiatives or legislative proposals to consolidate existing FFELP loans to the Federal Direct Loan Program or otherwise allow FFELP loans to be refinanced with Federal Direct Loan Program loans;
•the uncertain nature of the expected benefits from the acquisition of Great Lakes Educational Loan Services, Inc. ("Great Lakes") on February 7, 2018 and the ability to successfully integrate technology and other activities and successfully maintain and increase allocated volumes of student loans serviced under existing and any future servicing contracts with the U.S. Department of Education (the "Department"), which current contracts accounted for 30 percent of the Company's revenue in 2018, risks to the Company related to the Department's initiatives to procure new contracts for federal student loan servicing, including the risk that the Company or Company teams may not be successful in obtaining contracts, risks related to the development by the Company of a new student loan servicing platform, including risks as to whether the expected benefits from the new platform will be realized, and risks related to the Company's ability to comply with agreements with third-party customers for the servicing of Federal Direct Loan Program, FFELP, and private education and consumer loans;
•risks related to a breach of or failure in the Company's operational or information systems or infrastructure, or those of third-party vendors, including cybersecurity risks related to the potential disclosure of confidential student loan borrower and other customer information, the potential disruption of the Company's systems or those of third-party vendors or customers, and/or the potential damage to the Company's reputation resulting from cyber-breaches;
•uncertainties inherent in forecasting future cash flows from student loan assets and related asset-backed securitizations;
•risks and uncertainties related to the ability of ALLO Communications LLC to successfully expand its fiber network and market share in existing service areas and additional communities and manage related construction risks;
•risks and uncertainties related to initiatives to pursue additional strategic investments and acquisitions, including investments and acquisitions that are intended to diversify the Company both within and outside of its historical core education-related businesses, as well as other strategic initiatives; and
•risks and uncertainties associated with litigation matters and with maintaining compliance with the extensive regulatory requirements applicable to the Company's businesses, reputational and other risks, including the risk of increased regulatory costs, resulting from the politicization of student loan servicing, and uncertainties inherent in the estimates and assumptions about future events that management is required to make in the preparation of the Company's consolidated financial statements.
All forward-looking statements contained in this report are qualified by these cautionary statements and are made only as of the date of this document. Although the Company may from time to time voluntarily update or revise its prior forward-looking statements to reflect actual results or changes in the Company's expectations, the Company disclaims any commitment to do so except as required by securities laws.
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OVERVIEW
The Company is a diverse company with a focus on delivering education-related products and services and loan asset management. The largest operating businesses engage in student loan servicing; education technology, services, and payment processing; and communications. A significant portion of the Company's revenue is net interest income earned on a portfolio of federally insured student loans. The Company also makes investments to further diversify the Company both within and outside of its historical core education-related businesses, including, but not limited to, investments in real estate and early-stage and emerging growth companies.
GAAP Net Income and Non-GAAP Net Income, Excluding Adjustments
The Company prepares its financial statements and presents its financial results in accordance with U.S. GAAP. However, it also provides additional non-GAAP financial information related to specific items management believes to be important in the evaluation of its operating results and performance. A reconciliation of the Company's GAAP net income to net income, excluding derivative market value adjustments, and a discussion of why the Company believes providing this additional information is useful to investors, is provided below.
Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
GAAP net income attributable to Nelnet, Inc. | $ | 33,212 | 42,927 | 99,423 | 206,287 | ||||||||||||||||||
Realized and unrealized derivative market value adjustments | 5,630 | 5,226 | 73,265 | (49,909) | |||||||||||||||||||
Tax effect (a) | (1,351) | (1,254) | (17,584) | 11,978 | |||||||||||||||||||
Net income attributable to Nelnet, Inc., excluding derivative market value adjustments (b) | $ | 37,491 | 46,899 | 155,104 | 168,356 | ||||||||||||||||||
Earnings per share: | |||||||||||||||||||||||
GAAP net income attributable to Nelnet, Inc. | $ | 0.83 | 1.05 | 2.48 | 5.04 | ||||||||||||||||||
Realized and unrealized derivative market value adjustments | 0.14 | 0.12 | 1.83 | (1.22) | |||||||||||||||||||
Tax effect (a) | (0.03) | (0.03) | (0.44) | 0.29 | |||||||||||||||||||
Net income attributable to Nelnet, Inc., excluding derivative market value adjustments (b) | $ | 0.94 | 1.14 | 3.87 | 4.11 |
(a) The tax effects are calculated by multiplying the realized and unrealized derivative market value adjustments by the applicable statutory income tax rate.
(b) "Derivative market value adjustments" includes both the realized portion of gains and losses (corresponding to variation margin received or paid on derivative instruments that are settled daily at a central clearinghouse) and the unrealized portion of gains and losses that are caused by changes in fair values of derivatives which do not qualify for "hedge treatment" under GAAP. "Derivative market value adjustments" does not include "derivative settlements" that represent the cash paid or received during the current period to settle with derivative instrument counterparties the economic effect of the Company's derivative instruments based on their contractual terms.
The accounting for derivatives requires that changes in the fair value of derivative instruments be recognized currently in earnings, with no fair value adjustment of the hedged item, unless specific hedge accounting criteria is met. Management has structured all of the Company’s derivative transactions with the intent that each is economically effective; however, the Company’s derivative instruments do not qualify for hedge accounting. As a result, the change in fair value of derivative instruments is reported in current period earnings with no consideration for the corresponding change in fair value of the hedged item. Under GAAP, the cumulative net realized and unrealized gain or loss caused by changes in fair values of derivatives in which the Company plans to hold to maturity will equal zero over the life of the contract. However, the net realized and unrealized gain or loss during any given reporting period fluctuates significantly from period to period.
The Company believes these point-in-time estimates of asset and liability values related to its derivative instruments that are subject to interest rate fluctuations are subject to volatility mostly due to timing and market factors beyond the control of management, and affect the period-to-period comparability of the results of operations. Accordingly, the Company’s management utilizes operating results excluding these items for comparability purposes when making decisions regarding the Company’s performance and in presentations with credit rating agencies, lenders, and investors. Consequently, the Company reports this non-GAAP information because the Company believes that it provides additional information regarding operational and performance indicators that are closely assessed by management. There is no comprehensive, authoritative guidance for the presentation of such non-GAAP information, which is only meant to supplement GAAP results by providing additional information that management utilizes to assess performance.
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GAAP net income decreased for the three and nine months ended September 30, 2019 compared to the same periods in 2018 primarily due to the following factors:
•The recognition of a net loss for the nine months ended September 30, 2019, as compared to a net gain in 2018, related to changes in the fair values of derivative instruments that do not qualify for hedge accounting;
•The recognition of $14.0 million ($10.7 million after tax) of expenses during the three months ended September 30, 2019 and $15.8 million ($12.0 million after tax) of expenses during the nine months ended September 30, 2019 to extinguish notes payable in certain asset-backed securitizations prior to the notes' contractual maturities;
•A decrease in derivative settlements received by the Company due to a decrease in the notional amount of derivatives outstanding used by the Company to hedge loans earning fixed rate floor income; and
•An increase in the provision for loan losses related to the Company's growing portfolio of consumer loans.
These factors were partially offset by the contribution to net income from the Company's Loan Servicing and Systems and Education Technology, Services, and Payment Processing operating segments.
Operating Results
The Company earns net interest income on its loan portfolio, consisting primarily of FFELP loans, in its Asset Generation and Management ("AGM") operating segment. This segment is expected to generate a stable net interest margin and significant amounts of cash as the FFELP portfolio amortizes. As of September 30, 2019, the Company had a $21.1 billion loan portfolio that management anticipates will amortize over the next approximately 20 years and has a weighted average remaining life of 8.8 years. The Company actively works to maximize the amount and timing of cash flows generated by its FFELP portfolio and seeks to acquire additional loan assets to leverage its servicing scale and expertise to generate incremental earnings and cash flow. However, due to the continued amortization of the Company’s FFELP loan portfolio, over time, the Company's net income generated by the AGM segment will continue to decrease. The Company currently believes that in the short-term it will most likely not be able to invest the excess cash generated from the FFELP loan portfolio into assets that immediately generate the rates of return historically realized from that portfolio.
In addition, the Company earns fee-based revenue through the following reportable operating segments:
•Loan Servicing and Systems ("LSS") - referred to as Nelnet Diversified Solutions ("NDS")
•Education Technology, Services, and Payment Processing ("ETS&PP") - referred to as Nelnet Business Solutions ("NBS")
•Communications - referred to as ALLO Communications ("ALLO")
Other business activities and operating segments that are not reportable are combined and included in Corporate and Other Activities ("Corporate"). Corporate and Other Activities also includes income earned on certain investments and interest expense incurred on unsecured debt transactions.
The information below provides the operating results for each reportable operating segment and Corporate and Other Activities for the three and nine months ended September 30, 2019 and 2018 (dollars in millions). See "Results of Operations" for each reportable operating segment under this Item 2 for additional detail.
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![nni-20190930_g1.jpg](https://www.sec.gov/Archives/edgar/data/0001258602/000125860219000066/nni-20190930_g1.jpg)
(a) Revenue includes intersegment revenue earned by LSS as a result of servicing loans for AGM.
(b) Total revenue includes "net interest income" and "total other income" from the Company's segment statements of income, excluding the impact from changes in fair values of derivatives. Net income excludes changes in fair values of derivatives, net of tax. For information regarding the exclusion of the impact from changes in fair values of derivatives, see "GAAP Net Income and Non-GAAP Net Income, Excluding Adjustments" above.
Certain events and transactions from 2018 and 2019, which have impacted or will impact the operating results of the Company and its operating segments, are discussed below.
Loan Servicing and Systems
•On February 7, 2018, the Company acquired Great Lakes. The operating results of Great Lakes are reported in the Company's consolidated financial statements from the date of acquisition. Thus, there are nine months of Great Lakes' operations included in the nine months ended September 30, 2019 as compared to approximately eight months of activity in the nine months ended September 30, 2018.
•Nelnet Servicing, LLC ("Nelnet Servicing") and Great Lakes have student loan servicing contracts awarded by the Department in June 2009 to provide servicing for loans owned by the Department. As of September 30, 2019, Nelnet Servicing was servicing $184.4 billion of student loans for 5.6 million borrowers under its contract, and Great Lakes was servicing $240.3 billion of student loans for 7.4 million borrowers under its contract. These contracts previously provided for expiration on June 16, 2019. On May 15, 2019, Nelnet Servicing and Great Lakes each received a Modification of Contract from the Department's Office of Federal Student Aid ("FSA") pursuant to which FSA extended the expiration date of the current contracts to December 15, 2019.
In addition, Nelnet Servicing's current Authority to Operate as a loan servicer for the Department expires on December 13, 2019 and is currently under review for renewal. The Company cannot predict the timing or outcome of this review.
FSA is conducting a contract procurement process entitled Next Generation Financial Services Environment (“NextGen”) for a new framework for the servicing of all student loans owned by the Department. On January 15, 2019, FSA issued solicitations for three NextGen components:
•NextGen Enhanced Processing Solution ("EPS")
•NextGen Business Process Operations ("BPO")
•NextGen Optimal Processing Solution ("OPS")
On April 1, 2019 and October 4, 2019, the Company responded to the EPS component. In addition, on August 1, 2019, the Company responded to the BPO component. The Company is also part of a team that has responded and intends to respond to various aspects of the OPS component. The Company cannot predict the timing, nature, or outcome of these solicitations.
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•For the three months ended September 30, 2019 and 2018, and nine months ended September 30, 2019 and 2018, the before tax and noncontrolling interest operating margin (income before income taxes and noncontrolling interest divided by revenue) was 15.9 percent, 10.4 percent, 16.8 percent, and 14.1 percent, respectively. The third quarter of 2018 included an impairment charge of $3.9 million ($3.0 million after tax). The remaining increase in operating margin in the 2019 periods as compared to the same periods in 2018 was due primarily to efficiencies gained as a result of the completion of certain integration activities related to the Great Lakes acquisition.
Education Technology, Services, and Payment Processing
•On November 20, 2018, the Company acquired Tuition Management Systems ("TMS"), a services company that offers tuition payment plans, billing services, payment technology solutions, and refund management to educational institutions. The TMS acquisition added 380 higher education schools and 170 K-12 schools to the Company’s customer base. The results of TMS’ operations are reported in the Company’s consolidated financial statements from the date of acquisition.
•For the three months ended September 30, 2019 and 2018 and nine months ended September 30, 2019 and 2018, before tax operating margin (income before income taxes divided by net revenue) was 34.4 percent, 25.4 percent, 34.9 percent, and 28.4 percent, respectively. The increase in the before tax operating margin in the 2019 periods as compared to the same periods in 2018 was due to operating leverage and cost reductions resulting from the Company's decision in October 2018 to terminate its investment in a proprietary payment processing platform.
Communications
•ALLO recognized losses of $7.2 million and $16.9 million for the three and nine months ended September 30, 2019, respectively, as compared to losses of $7.7 million and $22.9 million for the same periods in 2018, respectively. The decrease in ALLO's net loss in 2019, as compared to 2018, was primarily due to a decrease in interest expense. ALLO recognized $4.2 million and $10.0 million of interest expense to Nelnet, Inc. (parent company) during the three and nine months ended September 30, 2018, respectively. Subsequent to October 1, 2018, ALLO will not report interest expense in its income statement related to amounts contributed to ALLO from Nelnet, Inc. due to a recapitalization of ALLO.
•ALLO's management uses earnings (loss) before interest, income taxes, depreciation, and amortization ("EBITDA") to eliminate certain non-cash and non-operating items in order to consistently measure performance from period to period. For the three months ended September 30, 2019 and 2018, ALLO had positive EBITDA of $1.5 million and $0.2 million, respectively, and for the nine months ended September 30, 2019 and 2018, ALLO had positive EBITDA of $3.7 million and negative EBITDA of $3.5 million, respectively. EBITDA is a supplemental non-GAAP performance measure which the Company believes provides useful additional information regarding a key metric used by management to assess ALLO's performance. See "Communications Operating Segment - Results of Operations - Summary and Comparison of Operating Results" below for additional information regarding the computation and use of EBITDA for ALLO.
•ALLO has made significant investments in its communications network and currently provides fiber directly to homes and businesses in communities in Nebraska and Colorado. ALLO plans to continue to increase market share and revenue in its existing markets and is currently evaluating opportunities to expand to other communities in the Midwest. During the second quarter of 2019, ALLO announced plans to expand its network to make services available in Breckenridge, Colorado. ALLO began providing services in Lincoln, Nebraska in September 2016 as part of a multi-year project to pass substantially all commercial and residential properties in the community. As of the end of the first quarter of 2019, the build-out of the Lincoln community was substantially complete. For the nine months ended September 30, 2019, ALLO's capital expenditures were $37.2 million. The Company anticipates total ALLO network capital expenditures in the fourth quarter of 2019 will be approximately $13.0 million. However, this amount could change based on customer demand for ALLO's services.
•The Company currently anticipates ALLO's operating results will be dilutive to the Company's consolidated earnings as it continues to develop and add customers to its network in Lincoln, Nebraska and other communities, due to large upfront capital expenditures and associated depreciation and upfront customer acquisition costs.
Asset Generation and Management
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•For the third quarter of 2019, the AGM segment recognized net interest income of $61.7 million, compared with $59.2 million for the same period in 2018. The Company maintains an overall risk management strategy that incorporates the use of derivative instruments to reduce the economic effect of interest rate volatility. The AGM segment recognized income from derivative settlements of $7.3 million during the third quarter of 2019, compared with income of $22.4 million for the same period in 2018. Derivative settlements for each applicable period should be evaluated with the Company's net interest income. Net interest income and derivative settlements for the AGM segment totaled $69.0 million and $81.6 million in the third quarter of 2019 and 2018, respectively.
•The Company's average balance of loans decreased to $21.6 billion for the third quarter of 2019, compared with $23.0 billion for the same period in 2018. Loan spread increased to 1.04 percent for the quarter ended September 30, 2019, compared with 0.90 percent for the same period in 2018. Core loan spread, which includes the impact of derivative settlements, decreased to 1.17 percent for the quarter ended September 30, 2019, compared with 1.30 percent for the same period in 2018. Core loan spread, a non-GAAP measure, is computed as set forth in "Asset Generation and Management Operating Segment - Results of Operations - Loan Spread Analysis" below. Management believes core loan spread is a useful supplemental non-GAAP measure that reflects adjustments for derivative settlements related to net interest income (loan spread). However, there is no comprehensive authoritative guidance for the presentation of this measure, which is only meant to supplement GAAP results by providing additional information that management utilizes to assess performance.
The Company recognized $19.7 million and $32.7 million in fixed rate floor income during the three months ended September 30, 2019 and 2018, respectively (which includes $7.1 million and $19.1 million, respectively, of settlement payments received on derivatives used to hedge student loans earning fixed rate floor income). Fixed rate floor income contributed 36 basis points and 57 basis points of core loan spread for the three months ended September 30, 2019 and 2018, respectively. The decrease in gross fixed rate floor income was due to higher interest rates in 2019 as compared to 2018, and the decrease in derivative settlement payments received on derivatives used to hedge student loans earning fixed rate floor income was due to a decrease in the notional amount of derivatives outstanding in 2019 as compared to 2018, partially offset by higher interest rates.
•Provision for loan losses was $10.0 million and $10.5 million for the three months ended September 30, 2019 and 2018, respectively, and $26.0 million and $18.0 million for the nine months ended September 30, 2019 and 2018, respectively.
Provision for loan losses for federally insured loans was $2.0 million and $8.0 million for the three months ended September 30, 2019 and 2018, respectively, and $6.0 million and $12.0 million for the nine months ended September 30, 2019 and 2018, respectively. During the third quarter of 2018, the Company determined an additional allowance was necessary related to a portfolio of federally insured loans that were purchased in 2013 and 2014, and recognized $5.0 million in provision expense related to these loans.
Provision for loan losses for consumer loans was $8.0 million and $2.5 million for the three months ended September 30, 2019 and 2018, respectively, and $20.0 million and $6.0 million for the nine months ended September 30, 2019 and 2018, respectively. The increase in provision was a result of the increased amount of consumer loan purchases during 2019. The Company purchased $298.1 million of consumer loans during the nine months ended September 30, 2019 ($113.3 million of which were purchased during the third quarter) compared to $80.4 million during the same period in 2018 ($42.8 million during the third quarter of 2018).
•The Company recognized $14.0 million of expenses during the three months ended September 30, 2019 and $15.8 million of expenses during the nine months ended September 30, 2019 related to the extinguishment of notes payable in certain asset-backed securitizations prior to the notes' contractual maturities (as further described below). These expenses consisted of premium payments made by the Company of $12.6 million and $14.0 million during the three and nine months ended September 30, 2019, respectively, and the write-off of $1.4 million and $1.8 million of debt issuance costs during the three and nine months ended September 30, 2019, respectively.
Corporate and Other Activities
•The Company adopted a new lease accounting standard effective January 1, 2019. The most significant impact of the standard to the Company relates to (1) the recognition of new right-of-use ("ROU") assets and lease liabilities on its balance sheet primarily for office, data center, and dark fiber operating leases; (2) the deconsolidation of assets and liabilities for certain sale-leaseback transactions arising from build-to-suit lease arrangements for which construction was completed and the Company is leasing the constructed assets that did not qualify for sale accounting prior to the adoption of the new standard; and (3) significant new disclosures about the Company’s leasing activities.
Adoption of the new standard resulted in recognizing lease liabilities of $33.7 million based on the present value of the remaining minimum rental payments. In addition, the Company recognized ROU assets of $32.8 million, which corresponds to the lease liabilities reduced by deferred rent expense as of the effective date. The Company also deconsolidated total assets of $43.8 million and total liabilities of $34.8 million for entities that had been consolidated
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due to sale-leaseback transactions that failed to qualify for recognition as sales under the prior guidance. Deconsolidation of these entities reduced noncontrolling interests by $6.1 million.
Liquidity and Capital Resources
•As of September 30, 2019, the Company had cash and cash equivalents of $161.0 million. In addition, the Company had a portfolio of available-for-sale investments, consisting primarily of student loan asset-backed securities, with a fair value of $52.6 million as of September 30, 2019.
•As of September 30, 2019, the Company's $382.5 million unsecured line of credit had no amount outstanding and $382.5 million was available for future use. During the second quarter of 2019, the Company entered into a $22.0 million secured line of credit agreement, and as of September 30, 2019, this line of credit had $5.0 million outstanding and $17.0 million available for future use.
•The Company has repurchased certain of its own asset-backed securities (bonds and notes payable) in the secondary market. For accounting purposes, these notes are eliminated in consolidation and are not included in the Company's consolidated financial statements. However, these securities remain legally outstanding at the trust level and the Company could sell these notes to third parties or redeem the notes at par as cash is generated by the trust estate. Upon a sale of these notes to third parties, the Company would obtain cash proceeds equal to the market value of the notes on the date of such sale. As of September 30, 2019, the Company holds $15.0 million (par value) of its own asset-backed securities.
•During the nine months ended September 30, 2019, the Company generated $142.9 million of cash from operating activities.
•The majority of the Company’s portfolio of student loans is funded in asset-backed securitizations that will generate significant earnings and cash flow over the life of these transactions. As of September 30, 2019, the Company currently expects future undiscounted cash flows from its securitization portfolio to be approximately $1.88 billion.
•Certain of the Company’s asset-backed securitizations were structured as “Turbo Transactions” which required all cash generated from the student loans (including excess spread) to be directed toward payment of interest and any outstanding principal generally until such time as all principal on the notes had been paid in full. Once the notes in such transactions were paid in full, the remaining unencumbered student loans (and other remaining assets, if any) in the securitization would be released to the Company, at which time the Company would have the option to refinance or sell these assets, or retain them on the balance sheet as unencumbered assets.
During the second and third quarters of 2019, the Company extinguished a total of $768.5 million of notes payable in certain asset-backed securitizations, including six of the Company's seven Turbo Transactions, prior to the notes' contractual maturities, resulting in the release of $1.15 billion in student loans and accrued interest receivable that were previously encumbered in the asset-backed securitizations. Upon extinguishment of the notes payable throughout the second and third quarters, the Company refinanced the student loans in its FFELP warehouse facilities and new asset-backed securitizations, resulting in net cash proceeds of $369.0 million. The Company used a portion of these proceeds to pay down the outstanding balance on its unsecured line of credit.
The cash proceeds generated by the debt extinguishments provide the Company with increased liquidity and the opportunity to invest the previously underutilized capital at higher returns.
•On January 11, 2019, the Company obtained a consumer loan warehouse facility with an aggregate maximum financing amount available of $100.0 million. On April 25, 2019, the Company amended the agreement for this warehouse facility to increase the aggregate maximum financing amount available to $200.0 million and extend the final maturity date to April 23, 2022. As of September 30, 2019, $144.0 million was outstanding under this facility and $56.0 million was available for future funding.
•During the first nine months of 2019, the Company completed five FFELP asset-backed securitizations totaling $2.2 billion (par value). The proceeds from these transactions were used primarily to refinance student loans included in the Company's FFELP warehouse facilities and unencumbered student loans from the extinguishment of certain asset-backed securitizations.
•On June 25, 2019, the Company completed a private education loan asset-backed securitization totaling $47.2 million (par value). The proceeds from this transaction were used to refinance private education loans previously funded via a private loan repurchase agreement that was terminated on June 25, 2019.
37
•During the nine months ended September 30, 2019, the Company repurchased a total of 723,832 shares of Class A common stock for $40.3 million ($55.62 per share), including 3,365 shares of Class A common stock repurchased during the three months ended September 30, 2019 for $0.2 million ($65.81 per share).
On May 8, 2019, the Board of Directors authorized a new stock repurchase program to repurchase up to a total of five million shares of the Company's Class A common stock during the three-year period ending May 7, 2022. The five million shares authorized under the new program include the remaining unrepurchased shares from the prior program, which the new program replaces. As of September 30, 2019, 4.8 million shares remained authorized for repurchase under the Company's stock repurchase program.
•During the nine months ended September 30, 2019, the Company paid cash dividends of $21.5 million ($0.54 per share), including $7.1 million ($0.18 per share) paid during the three months ended September 30, 2019. In addition, the Company's Board of Directors has declared a fourth quarter 2019 cash dividend on the Company's outstanding shares of Class A and Class B common stock of $0.20 per share. The fourth quarter cash dividend will be paid on December 13, 2019 to shareholders of record at the close of business on November 29, 2019.
•The Company intends to use its liquidity position to capitalize on market opportunities, including FFELP, private education, and consumer loan acquisitions; strategic acquisitions and investments; expansion of ALLO’s telecommunications network; and capital management initiatives, including stock repurchases, debt repurchases, and dividend distributions. The timing and size of these opportunities will vary and will have a direct impact on the Company’s cash and investment balances.
Subsequent Event
•Subsequent to September 30, 2019, the Company made the decision to sell $179.3 million (par value) of consumer loans to an unrelated third party who securitized such loans. As partial consideration received for the consumer loans sold, the Company received an approximate 29 percent residual interest in the consumer loan securitization. The Company will recognize a gain in the fourth quarter of 2019 of $15.5 million (pre-tax) from the sale of these loans.
CONSOLIDATED RESULTS OF OPERATIONS
An analysis of the Company's operating results for the three and nine months ended September 30, 2019 compared to the same periods in 2018 is provided below.
The Company’s operating results are primarily driven by the performance of its existing portfolio and the revenues generated by its fee-based businesses and the costs to provide such services. The performance of the Company’s portfolio is driven by net interest income (which includes financing costs) and losses related to credit quality of the assets, along with the cost to administer and service the assets and related debt.
The Company operates as distinct reportable operating segments as described above. For a reconciliation of the reportable segment operating results to the consolidated results of operations, see note 10 of the notes to consolidated financial statements included under Part I, Item 1 of this report. Since the Company monitors and assesses its operations and results based on these segments, the discussion following the consolidated results of operations is presented on a reportable segment basis.
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Three months ended | Nine months ended | ||||||||||||||||||||||||||||
September 30, | September 30, | Additional information | |||||||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||||||||
Loan interest | $ | 229,063 | 232,320 | 709,618 | 653,414 | Decrease for the three months ended September 30, 2019 as compared to the same period in 2018 was due to a decrease in the average balance of loans, partially offset by an increase in the gross yield earned on loans. Increase for the nine months ended September 30, 2019 as compared to the same period in 2018, was due primarily to an increase in the gross yield earned on loans, partially offset by a decrease in the average balance of loans and a decrease in gross fixed rate floor income due to higher interest rates in 2019 as compared to 2018. | |||||||||||||||||||||||
Investment interest | 9,882 | 7,628 | 26,701 | 18,581 | Includes income from unrestricted interest-earning deposits and investments and funds in asset-backed securitizations. Increase was due to increases in interest-earning investments and interest rates. | ||||||||||||||||||||||||
Total interest income | 238,945 | 239,948 | 736,319 | 671,995 | |||||||||||||||||||||||||
Interest expense | 172,488 | 180,175 | 551,221 | 487,174 | Decrease for the three months ended September 30, 2019 as compared to the same period in 2018 was due to a decrease in the average balance of debt outstanding, partially offset by an increase in cost of funds. Increase for the nine months ended September 30, 2019 as compared to the same period in 2018 was due to an increase in cost of funds, partially offset by a decrease in the average balance of debt outstanding. | ||||||||||||||||||||||||
Net interest income | 66,457 | 59,773 | 185,098 | 184,821 | See table below for additional analysis. | ||||||||||||||||||||||||
Less provision for loan losses | 10,000 | 10,500 | 26,000 | 18,000 | Represents the periodic expense of maintaining an allowance appropriate to absorb losses inherent in the portfolio of loans. See AGM operating segment - results of operations. | ||||||||||||||||||||||||
Net interest income after provision for loan losses | 56,457 | 49,273 | 159,098 | 166,821 | |||||||||||||||||||||||||
Other income: | |||||||||||||||||||||||||||||
LSS revenue | 113,286 | 112,579 | 342,169 | 327,265 | See LSS operating segment - results of operations. | ||||||||||||||||||||||||
ETS&PP revenue | 74,251 | 58,409 | 213,753 | 167,372 | See ETS&PP operating segment - results of operations. | ||||||||||||||||||||||||
Communications revenue | 16,470 | 11,818 | 46,770 | 31,327 | See Communications operating segment - results of operations. | ||||||||||||||||||||||||
Other income | 13,439 | 16,673 | 38,658 | 44,808 | See table below for the components of "other income." | ||||||||||||||||||||||||
Derivative settlements, net | 7,298 | 22,324 | 39,306 | 51,018 | The Company maintains an overall risk management strategy that incorporates the use of derivative instruments to reduce the economic effect of interest rate volatility. Derivative settlements for each applicable period should be evaluated with the Company's net interest income. See table below for additional analysis. | ||||||||||||||||||||||||
Derivative market value adjustments, net | (5,630) | (5,226) | (73,265) | 49,909 | Includes the realized and unrealized gains and losses that are caused by changes in fair values of derivatives which do not qualify for "hedge treatment" under GAAP. The majority of the derivative market value adjustments related to the changes in fair value of the Company's floor income interest rate swaps. Such changes reflect that a decrease in the forward yield curve during a reporting period results in a decrease in the fair value of the Company's floor income interest rate swaps, and an increase in the forward yield curve during a reporting period results in an increase in the fair value of the Company's floor income interest rate swaps. | ||||||||||||||||||||||||
Total other income | 219,114 | 216,577 | 607,391 | 671,699 | |||||||||||||||||||||||||
Cost of services: | |||||||||||||||||||||||||||||
Cost to provide education technology, services, and payment processing services | 25,671 | 19,087 | 62,601 | 44,087 | Represents primarily direct costs to provide payment processing services in the ETS&PP operating segment. | ||||||||||||||||||||||||
Cost to provide communications services | 5,236 | 4,310 | 15,096 | 11,892 | Represents costs of services primarily associated with television programming costs in the Communications operating segment. | ||||||||||||||||||||||||
Total cost of services | 30,907 | 23,397 | 77,697 | 55,979 | |||||||||||||||||||||||||
Operating expenses: | |||||||||||||||||||||||||||||
Salaries and benefits | 116,670 | 114,172 | 338,942 | 321,932 | Increase was due to increases in personnel as a result of the TMS acquisition and to support the organic growth in revenue in the ETS&PP operating segment, and increases in personnel at ALLO to support customer and network expansion. These items were partially offset by a decrease in salaries and benefits in the ETS&PP operating segment due to the Company's decision in October 2018 to terminate its investment in a proprietary processing platform. Part of the increase in the nine months ended September 30, 2019 compared to the same period in 2018 was due to an increase in personnel as a result of the acquisition of Great Lakes on February 7, 2018 (nine months of expenses in 2019 as compared to approximately eight months in 2018). See each individual operating segment results of operations discussion for additional information. | ||||||||||||||||||||||||
Depreciation and amortization | 27,701 | 22,992 | 76,398 | 62,943 | Increase was primarily due to additional depreciation expense at ALLO and the acquisition of Great Lakes on February 7, 2018. See each individual operating segment results of operations discussion for additional information. | ||||||||||||||||||||||||
Loan servicing fees to third parties | 3,382 | 3,087 | 9,431 | 9,428 | Represents fees paid to third-party loan servicers. Servicing fees paid to the LSS operating segment for servicing loans for the AGM operating segment are eliminated for the consolidated financial statement presentation. |
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Other expenses | 54,947 | 45,194 | 138,131 | 119,020 | Other expenses includes expenses necessary for operations, such as postage and distribution, consulting and professional fees, occupancy, communications, and certain information technology-related costs. Increase was primarily due to the AGM operating segment recognizing $14.0 million of expenses during the three months ended September 30, 2019 and $15.8 million of expenses during the nine months ended September 30, 2019 to extinguish notes payable from certain asset-backed securitizations prior to their contractual maturities. See each individual operating segment results of operations discussion for additional information. | ||||||||||||||||||||||||
Total operating expenses | 202,700 | 185,445 | 562,902 | 513,323 | |||||||||||||||||||||||||
Income before income taxes | 41,964 | 57,008 | 125,890 | 269,218 | |||||||||||||||||||||||||
Income tax expense | 8,829 | 13,882 | 26,429 | 63,369 | The effective tax rate was 21.0% and 24.4% for the three months ended September 30, 2019 and 2018, respectively, and 21.0% and 23.5% for the nine months ended September 30, 2019 and 2018, respectively. Decrease in the effective tax rate was due to a reduction in state tax costs. The Company currently expects its effective tax rate for 2019 will range between 20 and 22 percent. | ||||||||||||||||||||||||
Net income | 33,135 | 43,126 | 99,461 | 205,849 | |||||||||||||||||||||||||
Net loss (income) attributable to noncontrolling interests | 77 | (199) | (38) | 438 | |||||||||||||||||||||||||
Net income attributable to Nelnet, Inc. | $ | 33,212 | 42,927 | 99,423 | 206,287 | ||||||||||||||||||||||||
Additional information: | |||||||||||||||||||||||||||||
Net income attributable to Nelnet, Inc. | $ | 33,212 | 42,927 | 99,423 | 206,287 | ||||||||||||||||||||||||
Derivative market value adjustments, net | 5,630 | 5,226 | 73,265 | (49,909) | See "Overview - GAAP Net Income and Non-GAAP Net Income, Excluding Adjustments" above for additional information about non-GAAP net income, excluding derivative market value adjustments. | ||||||||||||||||||||||||
Tax effect | (1,351) | (1,254) | (17,584) | 11,978 | |||||||||||||||||||||||||
Net income attributable to Nelnet, Inc., excluding derivative market value adjustments | $ | 37,491 | 46,899 | 155,104 | 168,356 |
The following table summarizes the components of “net interest income” and “derivative settlements, net.”
Derivative settlements represent the cash paid or received during the current period to settle with derivative instrument counterparties the economic effect of the Company's derivative instruments based on their contractual terms. Derivative accounting requires that net settlements with respect to derivatives that do not qualify for "hedge treatment" under GAAP be recorded in a separate income statement line item below net interest income. The Company maintains an overall risk management strategy that incorporates the use of derivative instruments to reduce the economic effect of interest rate volatility. As such, management believes derivative settlements for each applicable period should be evaluated with the Company’s net interest income as presented in the table below. Net interest income (net of settlements on derivatives) is a non-GAAP financial measure, and the Company reports this non-GAAP information because the Company believes that it provides additional information regarding operational and performance indicators that are closely assessed by management. There is no comprehensive, authoritative guidance for the presentation of such non-GAAP information, which is only meant to supplement GAAP results by providing additional information that management utilizes to assess performance. See note 4 of the notes to consolidated financial statements included under Part I, Item 1 of this report for additional information on the Company's derivative instruments, including the net settlement activity recognized by the Company for each type of derivative for the periods presented in the table under the caption "Income Statement Impact" in note 4 and in the table below.
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Three months ended September 30, | Nine months ended September 30, | Additional information | |||||||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||||||||
Variable loan interest margin | $ | 46,051 | 42,455 | 134,312 | 129,756 | Represents the yield the Company receives on its loan portfolio less the cost of funding these loans. Variable loan spread is also impacted by the amortization/accretion of loan premiums and discounts and the 1.05% per year consolidation loan rebate fee paid to the Department. See AGM operating segment - results of operations. | |||||||||||||||||||||||
Settlements on associated derivatives | 234 | 3,361 | 3,375 | 4,676 | Represents the net settlements received related to the Company’s 1:3 basis swaps. | ||||||||||||||||||||||||
Variable loan interest margin, net of settlements on derivatives | 46,285 | 45,816 | 137,687 | 134,432 | |||||||||||||||||||||||||
Fixed rate floor income | 12,685 | 13,659 | 33,950 | 45,359 | The Company has a portfolio of student loans that are earning interest at a fixed borrower rate which exceeds the statutorily defined variable lender rates, generating fixed rate floor income. See Item 3, "Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk" for additional information. | ||||||||||||||||||||||||
Settlements on associated derivatives | 7,064 | 19,087 | 35,931 | 46,752 | Represents the net settlements received related to the Company’s floor income interest rate swaps. | ||||||||||||||||||||||||
Fixed rate floor income, net of settlements on derivatives | 19,749 | 32,746 | 69,881 | 92,111 | |||||||||||||||||||||||||
Investment interest | 9,882 | 7,628 | 26,701 | 18,581 | |||||||||||||||||||||||||
Corporate debt interest expense | (2,161) | (3,969) | (9,865) | (8,875) | Includes interest expense on the Junior Subordinated Hybrid Securities and unsecured line of credit. Decrease for the three months ended September 30, 2019 compared to the same period in 2018 was due primarily to a decrease in the average balance outstanding on the Company's unsecured line of credit. Increase for the nine months ended September 30, 2019 compared to the same period in 2018 was due to an increase in interest rates and in the average balance outstanding on the Company's unsecured line of credit. | ||||||||||||||||||||||||
Non-portfolio related derivative settlements | — | (124) | — | (410) | Represents the net settlements paid related to the Company’s hybrid debt hedges. | ||||||||||||||||||||||||
Net interest income (net of settlements on derivatives) | $ | 73,755 | 82,097 | 224,404 | 235,839 |
The following table summarizes the components of "other income."
Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
Borrower late fee income | $ | 3,196 | 3,253 | 9,870 | 8,994 | ||||||||||||||||||
Management fee revenue (a) | 2,084 | 1,756 | 6,007 | 4,673 | |||||||||||||||||||
Gain on investments and notes receivable, net of losses (b) | 1,948 | 2,503 | 5,779 | 10,291 | |||||||||||||||||||
Investment advisory services (c) | 753 | 1,183 | 2,194 | 4,169 | |||||||||||||||||||
Other | 5,458 | 7,978 | 14,808 | 16,681 | |||||||||||||||||||
Other income | $ | 13,439 | 16,673 | 38,658 | 44,808 |
(a) Represents revenue earned from providing administrative support services to Great Lakes’ former parent company in accordance with a contract that expired in October 2019. The increase for the nine months ended September 30, 2019 as compared to the same period in 2018 was due to nine months of revenue under this contract in 2019 as compared to approximately eight months of revenue (from the Great Lakes acquisition date) in 2018.
(b) During the first quarter of 2018, the Company recognized unrealized gains totaling $6.7 million related to the change in fair value of certain equity securities.
(c) The Company provides investment advisory services through Whitetail Rock Capital Management, LLC, the Company's SEC-registered investment advisor subsidiary, under various arrangements and earns annual fees of 25 basis points on the majority of the outstanding balance of investments and up to 50 percent of the gains from the sale of securities or securities being called prior to the full contractual maturity for which it provides advisory services. As of September 30, 2019, the outstanding balance of investments subject to these arrangements was $966.7 million. The decrease in advisory fees in 2019 as compared to 2018 was the result of a decrease in performance fees earned.
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LOAN SERVICING AND SYSTEMS OPERATING SEGMENT – RESULTS OF OPERATIONS
The Company purchased Great Lakes on February 7, 2018. The results of Great Lakes' operations are reported in the Company's consolidated financial statements from the date of acquisition.
Loan Servicing Volumes
As of | |||||||||||||||||||||||||||||||||||||||||||||||
December 31, 2017 | March 31, 2018 | June 30, 2018 | September 30, 2018 | December 31, 2018 | March 31, 2019 | June 30, 2019 | September 30, 2019 | ||||||||||||||||||||||||||||||||||||||||
Servicing volume (dollars in millions): | |||||||||||||||||||||||||||||||||||||||||||||||
Nelnet: | |||||||||||||||||||||||||||||||||||||||||||||||
Government | $ | 172,669 | 176,605 | 176,179 | 179,283 | 179,507 | 183,093 | 181,682 | 184,399 | ||||||||||||||||||||||||||||||||||||||
FFELP | 27,262 | 26,969 | 37,599 | 37,459 | 36,748 | 35,917 | 35,003 | 33,981 | |||||||||||||||||||||||||||||||||||||||
Private and consumer | 11,483 | 12,116 | 15,016 | 15,466 | 15,666 | 16,065 | 16,025 | 16,286 | |||||||||||||||||||||||||||||||||||||||
Great Lakes: | |||||||||||||||||||||||||||||||||||||||||||||||
Government | — | 242,063 | 241,902 | 232,741 | 232,694 | 237,050 | 236,500 | 240,268 | |||||||||||||||||||||||||||||||||||||||
FFELP (a) | — | 11,136 | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
Private and consumer (a) | — | 1,927 | 31 | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
Total | $ | 211,414 | 470,816 | 470,727 | 464,949 | 464,615 | 472,125 | 469,210 | 474,934 | ||||||||||||||||||||||||||||||||||||||
Number of servicing borrowers: | |||||||||||||||||||||||||||||||||||||||||||||||
Nelnet: | |||||||||||||||||||||||||||||||||||||||||||||||
Government | 5,877,414 | 5,819,286 | 5,745,181 | 5,805,307 | 5,771,923 | 5,708,582 | 5,592,989 | 5,635,653 | |||||||||||||||||||||||||||||||||||||||
FFELP | 1,420,311 | 1,399,280 | 1,787,419 | 1,754,247 | 1,709,853 | 1,650,785 | 1,588,530 | 1,529,392 | |||||||||||||||||||||||||||||||||||||||
Private and consumer | 502,114 | 508,750 | 672,520 | 692,763 | 696,933 | 699,768 | 693,410 | 701,299 | |||||||||||||||||||||||||||||||||||||||
Great Lakes: | |||||||||||||||||||||||||||||||||||||||||||||||
Government | — | 7,456,830 | 7,378,875 | 7,486,311 | 7,458,684 | 7,385,284 | 7,300,691 | 7,430,165 | |||||||||||||||||||||||||||||||||||||||
FFELP (a) | — | 461,553 | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
Private and consumer (a) | — | 118,609 | 3,987 | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
Total | 7,799,839 | 15,764,308 | 15,587,982 | 15,738,628 | 15,637,393 | 15,444,419 | 15,175,620 | 15,296,509 | |||||||||||||||||||||||||||||||||||||||
Number of remote hosted borrowers: | 2,812,713 | 6,207,747 | 6,145,981 | 6,406,923 | 6,393,151 | 6,332,261 | 6,211,132 | 6,457,296 |
(a) During the second quarter of 2018, the Company converted Great Lakes' FFELP and private education servicing volume to Nelnet Servicing's platform to leverage the efficiencies of supporting more volume on fewer systems.
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Summary and Comparison of Operating Results
Three months ended September 30, | Nine months ended September 30, | Additional information | |||||||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||||||||
Net interest income | $ | 481 | 381 | 1,509 | 931 | Increase was due to additional interest earnings on cash deposits due to a higher balance of cash deposits and higher interest rates in 2019 as compared to 2018. | |||||||||||||||||||||||
Loan servicing and systems revenue | 113,286 | 112,579 | 342,169 | 327,265 | See table below for additional analysis. | ||||||||||||||||||||||||
Intersegment servicing revenue | 11,611 | 12,290 | 35,426 | 34,670 | Represents revenue earned by the LSS operating segment as a result of servicing loans for the AGM operating segment. Increase for the nine months ended September 30, 2019 compared to the same period in 2018 was due to the acquisition of Great Lakes on February 7, 2018. Prior to the acquisition, Great Lakes was a third-party servicer to the Company's AGM operating segment. Over time, FFELP intersegment servicing revenue will decrease as AGM's' FFELP portfolio runs off. | ||||||||||||||||||||||||
Other income | 2,291 | 1,948 | 6,642 | 5,196 | Represents primarily revenue earned from providing administrative support services to Great Lakes’ former parent company in accordance with a contract that expired in October 2019. Increase in the nine months ended September 30, 2019 compared to the same period in 2018 was due to nine months of revenue in 2019 as compared to approximately eight months of revenue (from the Great Lakes acquisition date) in 2018. | ||||||||||||||||||||||||
Total other income | 127,188 | 126,817 | 384,237 | 367,131 | |||||||||||||||||||||||||
Salaries and benefits | 69,209 | 70,440 | 201,924 | 198,411 | Decrease for the three months ended September 30, 2019 compared to the same period in 2018 was due to the completion of certain integration activities related to the Great Lakes acquisition. Increase in the nine months ended September 30, 2019 compared to the same period in 2018 was due to nine months of salaries and benefits from the Great Lakes acquisition included in 2019 as compared to approximately eight months of expenses (from the Great Lakes acquisition date) in 2018, partially offset by the reduction of expenses from integration activities. | ||||||||||||||||||||||||
Depreciation and amortization | 8,565 | 8,957 | 26,236 | 23,237 | Increase in depreciation and amortization for the nine months ended September 30, 2019 as compared to the same period in 2018 was primarily due to the acquisition of Great Lakes on February 7, 2018. | ||||||||||||||||||||||||
Other expenses | 16,686 | 19,638 | 52,732 | 51,591 | Excluding a $3.9 million impairment charge related to external software development costs recognized by the Company during the three months ended September 30, 2018, other expenses were $16.7 million and $15.7 million for the three months ended September 30, 2019 and 2018, respectively, and $52.7 million and $47.7 million for the nine months ended September 30, 2019 and 2018, respectively. Increase was due to the Great Lakes acquisition on February 7, 2018. | ||||||||||||||||||||||||
Intersegment expenses | 12,955 | 15,029 | 40,317 | 43,968 | Intersegment expenses represent costs for certain corporate activities and services that are allocated to each operating segment based on estimated use of such activities and services. Decrease for the three and nine months ended September 30, 2019 as compared to the same periods in 2018 was due to the completion of certain integration activities related to the Great Lakes acquisition. | ||||||||||||||||||||||||
Total operating expenses | 107,415 | 114,064 | 321,209 | 317,207 | |||||||||||||||||||||||||
Income before income taxes | 20,254 | 13,134 | 64,537 | 50,855 | |||||||||||||||||||||||||
Income tax expense | (4,861) | (3,152) | (15,489) | (12,399) | Reflects income tax expense at an effective tax rate of 24% on income before taxes and the net loss attributable to noncontrolling interest. | ||||||||||||||||||||||||
Net income | 15,393 | 9,982 | 49,048 | 38,456 | |||||||||||||||||||||||||
Net loss attributable to noncontrolling interest | — | — | — | 808 | Represented 50 percent of the net loss of the GreatNet joint venture that was attributable to Great Lakes prior to the Company's acquisition of Great Lakes on February 7, 2018. | ||||||||||||||||||||||||
Net income attributable to Nelnet, Inc. | $ | 15,393 | 9,982 | 49,048 | 39,264 | ||||||||||||||||||||||||
Before tax and noncontrolling interest operating margin | 15.9 | % | 10.4 | % | 16.8 | % | 14.1 | % | Excluding the impairment of external software development costs recognized during the three months ended September 30, 2018 as discussed above, before tax and noncontrolling interest operating margin was 13.4% and 15.1% for the three and nine months ended September 30, 2018, respectively. Increase in margin in 2019 as compared to the same periods in 2018 was due primarily to operating leverage and efficiencies gained as a result of the completion of certain integration activities related to the Great Lakes acquisition. |
43
Loan servicing and systems revenue
Three months ended September 30, | Nine months ended September 30, | Additional information | |||||||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||||||||
Government servicing - Nelnet | $ | 38,645 | 38,907 | 118,744 | 118,015 | Represents revenue from Nelnet Servicing's Department servicing contract. Revenue increased due to a shift in the portfolio of loans serviced to a greater portion of loans in higher paying repayment statuses, and decreased due to a decrease in the number of servicing borrowers. The combination of these factors resulted in revenue remaining consistent in 2019 as compared to the same periods in 2018. | |||||||||||||||||||||||
Government servicing - Great Lakes | 46,234 | 45,671 | 139,285 | 122,107 | Represents revenue from the Great Lakes' Department servicing contract from the date of acquisition, February 7, 2018. Revenue increased due to a shift in the portfolio of loans serviced to a greater portion of loans in higher paying repayment statuses, partially offset by a decrease in the number of servicing borrowers. Increase in revenue for the nine months ended September 30, 2019 compared to the same period in 2018 was also due to nine months of revenue in 2019 as compared to approximately eight months (from the Great Lakes acquisition date) of revenue in 2018. | ||||||||||||||||||||||||
Private education and consumer loan servicing | 9,561 | 10,007 | 28,026 | 31,990 | Excluding $4.6 million in revenue earned in the first quarter of 2018 related to a private loan customer deconverting from the Great Lakes servicing platform subsequent to the Company’s acquisition of Great Lakes on February 7, 2018, private education and consumer loan servicing revenue was $28.0 million and $27.4 million for the nine months ended September 30, 2019 and 2018, respectively. The increase in revenue was due to nine months of revenue in 2019 as compared to approximately eight months (from the Great Lakes acquisition date) of revenue in 2018 and an increase in loan servicing volume from existing and new clients. These items were partially offset by a decrease in revenue as a result of the change in portfolio mix of private education and consumer loans. The decrease in revenue for the three months ended September 30, 2019 as compared to the same period in 2018 was due to the change in portfolio mix of private education and consumer loans, partially offset by an increase in loan servicing volume from existing and new clients. | ||||||||||||||||||||||||
FFELP servicing | 6,089 | 7,422 | 19,208 | 24,259 | Decrease was due to portfolio runoff and purchases of third-party FFELP portfolios by the Company's AGM operating segment. These items were partially offset by the acquisition of Great Lakes (nine months of revenue during the nine months ended September 30, 2019 as compared to eight months (from the Great Lakes acquisition date) of revenue in 2018). Revenue earned by the LSS operating segment for servicing loans for the AGM operating segment is included in "intersegment servicing revenue." Over time, FFELP servicing revenue will decrease as third-party customers' FFELP portfolios run off. | ||||||||||||||||||||||||
Software services | 10,493 | 8,201 | 30,255 | 24,461 | Historically, the majority of software services revenue related to providing hosted student loan servicing. As a result of the Great Lakes acquisition, LSS added a significant unrelated third-party FFELP guaranty hosted servicing customer. Increase in the three and nine months ended September 30, 2019 as compared to the same periods in 2018 was due to an increase in providing hosted guaranty services to the new guaranty servicing customer. In addition, the increase in revenue for the nine months ended 2019 as compared to the same period in 2018 was due to nine months of revenue from the new guaranty hosted servicing customer in 2019 as compared to approximately eight months (from the Great Lakes acquisition date) of revenue in 2018. | ||||||||||||||||||||||||
Outsourced services and other | 2,264 | 2,371 | 6,651 | 6,433 | The majority of this revenue relates to providing contact center outsourcing activities. | ||||||||||||||||||||||||
Loan servicing and systems revenue | $ | 113,286 | 112,579 | 342,169 | 327,265 |
44
EDUCATION TECHNOLOGY, SERVICES, AND PAYMENT PROCESSING OPERATING SEGMENT – RESULTS OF OPERATIONS
As discussed further in the Company's 2018 Annual Report, this segment of the Company’s business is subject to seasonal fluctuations which correspond, or are related to, the traditional school year. Based on the timing of revenue recognition and when expenses are incurred, revenue and pre-tax operating margin are higher in the first quarter as compared to the remainder of the year.
On November 20, 2018, the Company acquired TMS, a services company that offers tuition payment plans, billing services, payment technology solutions, and refund management to educational institutions. The TMS acquisition added 380 higher education schools and 170 K-12 schools to the Company’s customer base. The results of TMS’ operations are reported in the Company’s consolidated financial statements from the date of acquisition.
Summary and Comparison of Operating Results
Three months ended September 30, | Nine months ended September 30, | Additional information | |||||||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||||||||
Net interest income | $ | 3,487 | 1,510 | 7,143 | 2,924 | Increase was due to additional interest earnings on cash deposits due to a higher balance of cash deposits and higher interest rates in 2019 as compared to 2018. | |||||||||||||||||||||||
Education technology, services, and payment processing revenue | 74,251 | 58,409 | 213,753 | 167,372 | See table below for additional information. | ||||||||||||||||||||||||
Cost to provide education technology, services, and payment processing services | 25,671 | 19,087 | 62,601 | 44,087 | See table below for additional information. | ||||||||||||||||||||||||
Salaries and benefits | 23,826 | 19,972 | 69,656 | 58,552 | Increase was due to the acquisition of TMS along with additional personnel to support the increase in services provided to customers, partially offset by cost reductions due to the Company's decision in October 2018 to terminate its investment in a proprietary payment processing platform. | ||||||||||||||||||||||||
Depreciation and amortization | 2,997 | 3,435 | 9,832 | 10,062 | Amortization of intangible assets related to business acquisitions was $2.8 million for the three months ended September 30, 2019 and 2018, respectively, and $9.3 million and $8.2 million for the nine months ended September 30, 2019 and 2018, respectively. | ||||||||||||||||||||||||
Other expenses | 5,325 | 4,943 | 16,440 | 14,950 | Increase was due to the acquisition of TMS and additional costs to support the increase in services provided to customers, partially offset by cost reductions due to the Company's decision in October 2018 to terminate its investment in a proprietary payment processing platform. | ||||||||||||||||||||||||
Intersegment expenses | 3,194 | 2,494 | 9,642 | 7,630 | Intersegment expenses represent costs for certain corporate activities and services that are allocated to each operating segment based on estimated use of such activities and services. | ||||||||||||||||||||||||
Total operating expenses | 35,342 | 30,844 | 105,570 | 91,194 | |||||||||||||||||||||||||
Income before income taxes | 16,725 | 9,988 | 52,725 | 35,015 | |||||||||||||||||||||||||
Income tax expense | (4,014) | (2,397) | (12,654) | (8,404) | Represents income tax expense at an effective tax rate of 24%. | ||||||||||||||||||||||||
Net income | $ | 12,711 | 7,591 | 40,071 | 26,611 |
45
Education technology, services, and payment processing revenue
The following table provides disaggregated revenue by service offering and before tax operating margin for each reporting period.
Three months ended September 30, | Nine months ended September 30, | Additional information | |||||||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||||||||
Tuition payment plan services | $ | 25,760 | 19,771 | 80,589 | 63,209 | Increase was due to an increase in the number of managed tuition payment plans resulting from the acquisition of TMS and the addition of new school customers. | |||||||||||||||||||||||
Payment processing | 35,138 | 26,956 | 85,428 | 62,908 | Increase was due to the acquisition of TMS and an increase in payments volume from new and existing school and non-education customers. | ||||||||||||||||||||||||
Education technology and services | 13,067 | 11,419 | 46,872 | 40,411 | Increase was due to an increase in the number of customers using the Company’s school administration software and services, higher revenues from financial needs assessment services, and the acquisition of TMS. Additionally, FACTS Education Solutions has experienced growth in the number of students and teachers receiving its professional development and educational instruction services. | ||||||||||||||||||||||||
Other | 286 | 263 | 864 | 844 | |||||||||||||||||||||||||
Education technology, services, and payment processing revenue | 74,251 | 58,409 | 213,753 | 167,372 | |||||||||||||||||||||||||
Cost to provide education technology, services, and payment processing services | 25,671 | 19,087 | 62,601 | 44,087 | Costs primarily relate to payment processing revenue. Increase was due to the acquisition of TMS and an increase in payments volume from new and existing school and non-education customers. | ||||||||||||||||||||||||
Net revenue | $ | 48,580 | 39,322 | 151,152 | 123,285 | ||||||||||||||||||||||||
Before tax operating margin | 34.4 | % | 25.4 | % | 34.9 | % | 28.4 | % | Before tax operating margin (income before income taxes divided by net revenue) increased due to operating leverage and cost reductions due to the Company's decision in October 2018 to terminate its investment in a proprietary payment processing platform. |
46
COMMUNICATIONS OPERATING SEGMENT – RESULTS OF OPERATIONS
Summary and Comparison of Operating Results
Three months ended September 30, | Nine months ended September 30, | Additional information | |||||||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||||||||
Net interest income (expense) | $ | — | (4,173) | 3 | (9,984) | See note (a) below for additional information. | |||||||||||||||||||||||
Communications revenue | 16,470 | 11,818 | 46,770 | 31,327 | Communications revenue is derived primarily from the sale of pure fiber optic services to residential and business customers in Nebraska and Colorado, including internet, television, and telephone services. Increase was primarily due to additional residential households served. See additional financial and operating data for ALLO in the tables below. | ||||||||||||||||||||||||
Other income | 532 | 950 | 1,019 | 950 | |||||||||||||||||||||||||
Total other income | 17,002 | 12,768 | 47,789 | 32,277 | |||||||||||||||||||||||||
Cost to provide communications services | 5,236 | 4,310 | 15,096 | 11,892 | Cost of services are primarily associated with television programming costs. Other costs include connectivity, franchise, and other regulatory costs directly related to providing internet and voice services. | ||||||||||||||||||||||||
Salaries and benefits | 5,763 | 4,554 | 15,692 | 13,284 | As of December 31, 2017, September 30, 2018, December 31, 2018, and September 30, 2019, ALLO had 508, 527, 550, and 544 employees, respectively, including part-time employees. ALLO also uses temporary employees in the normal course of business. Certain costs qualify for capitalization as ALLO develops its network. | ||||||||||||||||||||||||
Depreciation and amortization | 10,926 | 6,167 | 26,025 | 16,585 | Depreciation reflects the allocation of the costs of ALLO's property and equipment over the period in which such assets are used. A significant amount of property and equipment purchases have been made to support the Lincoln, Nebraska network expansion. The gross property and equipment balances related to this segment as of December 31, 2017, September 30, 2018, December 31, 2018, and September 30, 2019 were $186.4 million, $253.2 million, $273.9 million and $308.1 million, respectively. Amortization reflects the allocation of costs related to intangible assets recorded at fair value as of the date the Company acquired ALLO over their estimated useful lives. | ||||||||||||||||||||||||
Other expenses | 3,842 | 3,151 | 11,184 | 8,811 | Other expenses includes selling, general, and administrative expenses necessary for operations, such as advertising, occupancy, professional services, construction materials, and personal property taxes. Increase was due to expansion of the Lincoln, Nebraska network and number of households served. | ||||||||||||||||||||||||
Intersegment expenses | 701 | 598 | 2,081 | 1,802 | Intersegment expenses represent costs for certain corporate activities and services that are allocated to each operating segment based on estimated use of such activities and services. | ||||||||||||||||||||||||
Total operating expenses | 21,232 | 14,470 | 54,982 | 40,482 | |||||||||||||||||||||||||
Loss before income taxes | (9,466) | (10,185) | (22,286) | (30,081) | |||||||||||||||||||||||||
Income tax benefit | 2,272 | 2,444 | 5,349 | 7,220 | Represents income tax benefit at an effective tax rate of 24%. | ||||||||||||||||||||||||
Net loss | $ | (7,194) | (7,741) | (16,937) | (22,861) | The Company anticipates this operating segment will be dilutive to consolidated earnings as it continues to develop and add customers to its network in Lincoln, Nebraska and other communities, due to large upfront capital expenditures and associated depreciation and upfront customer acquisition costs. | |||||||||||||||||||||||
Additional information: | |||||||||||||||||||||||||||||
Net loss | $ | (7,194) | (7,741) | (16,937) | (22,861) | ||||||||||||||||||||||||
Net interest (income) expense | — | 4,173 | (3) | 9,984 | |||||||||||||||||||||||||
Income tax benefit | (2,272) | (2,444) | (5,349) | (7,220) | |||||||||||||||||||||||||
Depreciation and amortization | 10,926 | 6,167 | 26,025 | 16,585 | |||||||||||||||||||||||||
Earnings (loss) before interest, income taxes, depreciation, and amortization (EBITDA) | $ | 1,460 | 155 | 3,736 | (3,512) | For additional information regarding this non-GAAP measure, see the table below. |
(a) Nelnet, Inc. (parent company) previously provided a line of credit to ALLO for network capital expenditures and related expenses. In 2016 and 2017, the outstanding amount owed by ALLO to Nelnet, Inc. and the related interest expense incurred by ALLO and the interest income recognized by Nelnet, Inc. under the line of credit was eliminated in the Company's consolidated financial statements. On January 1, 2018, Nelnet, Inc. contributed equity to ALLO with an associated guaranteed payment and ALLO used the proceeds from this capital contribution to pay off all of the outstanding balance on the line of credit, including all accrued and unpaid interest. For financial reporting purposes, the guaranteed payment recorded by ALLO was classified as debt and such debt and the guaranteed return paid to Nelnet, Inc. (reflected as interest expense for ALLO) was eliminated in the consolidated financial statements. On October 1, 2018, the guaranteed payment was replaced with a yield-based preferred return of future earnings on the contributed equity. For financial reporting purposes, the preferred interest recorded by ALLO is classified as equity and the preferred return on the preferred interest is not treated by ALLO as interest expense. Accordingly, subsequent to October 1, 2018, ALLO will not report interest expense in its income statement related to amounts contributed to ALLO from Nelnet, Inc.
47
Certain financial and operating data for ALLO is summarized in the tables below.
Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||||||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||||||||||||||||||||||||||
Residential revenue | $ | 12,397 | 75.3 | % | $ | 8,896 | 75.3 | % | $ | 35,351 | 75.6 | % | $ | 23,367 | 74.6 | % | |||||||||||||||||||||||||||||||
Business revenue | 4,025 | 24.4 | 2,861 | 24.2 | 11,256 | 24.1 | 7,779 | 24.8 | |||||||||||||||||||||||||||||||||||||||
Other | 48 | 0.3 | 61 | 0.5 | 163 | 0.3 | 181 | 0.6 | |||||||||||||||||||||||||||||||||||||||
Communications revenue | $ | 16,470 | 100.0 | % | $ | 11,818 | 100.0 | % | $ | 46,770 | 100.0 | % | $ | 31,327 | 100.0 | % | |||||||||||||||||||||||||||||||
Internet | $ | 9,899 | 60.1 | % | $ | 6,453 | 54.6 | % | $ | 27,641 | 59.1 | % | $ | 16,541 | 52.8 | % | |||||||||||||||||||||||||||||||
Television | 4,068 | 24.7 | 3,380 | 28.6 | 12,020 | 25.7 | 9,241 | 29.5 | |||||||||||||||||||||||||||||||||||||||
Telephone | 2,487 | 15.1 | 1,962 | 16.6 | 7,062 | 15.1 | 5,482 | 17.5 | |||||||||||||||||||||||||||||||||||||||
Other | 16 | 0.1 | 23 | 0.2 | 47 | 0.1 | 63 | 0.2 | |||||||||||||||||||||||||||||||||||||||
Communications revenue | $ | 16,470 | 100.0 | % | $ | 11,818 | 100.0 | % | $ | 46,770 | 100.0 | % | $ | 31,327 | 100.0 | % | |||||||||||||||||||||||||||||||
Net loss | $ | (7,194) | (7,741) | (16,937) | (22,861) | ||||||||||||||||||||||||||||||||||||||||||
EBITDA (a) | 1,460 | 155 | 3,736 | (3,512) | |||||||||||||||||||||||||||||||||||||||||||
Capital expenditures | 10,187 | 21,728 | 37,185 | 66,816 |
As of September 30, 2019 | As of June 30, 2019 | As of March 31, 2019 | As of December 31, 2018 | As of September 30, 2018 | As of June 30, 2018 | As of March 31, 2018 | As of December 31, 2017 | ||||||||||||||||||||||||||||||||||||||||
Residential customer information: | |||||||||||||||||||||||||||||||||||||||||||||||
Households served | 45,228 | 42,760 | 40,338 | 37,351 | 32,529 | 27,643 | 23,541 | 20,428 | |||||||||||||||||||||||||||||||||||||||
Households passed (b) | 137,269 | 132,984 | 127,253 | 122,396 | 110,687 | 98,538 | 84,475 | 71,426 | |||||||||||||||||||||||||||||||||||||||
Households served/passed | 32.9 | % | 32.2 | % | 31.7 | % | 30.5 | % | 29.4 | % | 28.1 | % | 27.9 | % | 28.6 | % | |||||||||||||||||||||||||||||||
Total households in current markets and new markets announced (c) | 159,974 | 159,974 | 152,840 | 152,840 | 142,602 | 137,500 | 137,500 | 137,500 |
(a) Earnings (loss) before interest, income taxes, depreciation, and amortization ("EBITDA") is a supplemental non-GAAP performance measure that is frequently used in capital-intensive industries such as telecommunications. ALLO's management uses EBITDA to compare ALLO's performance to that of its competitors and to eliminate certain non-cash and non-operating items in order to consistently measure performance from period to period. EBITDA excludes interest and income taxes because these items are associated with a company's particular capitalization and tax structures. EBITDA also excludes depreciation and amortization expense because these non-cash expenses primarily reflect the impact of historical capital investments, as opposed to the cash impacts of capital expenditures made in recent periods, which may be evaluated through cash flow measures. The Company reports EBITDA for ALLO because the Company believes that it provides useful additional information for investors regarding a key metric used by management to assess ALLO's performance. There are limitations to using EBITDA as a performance measure, including the difficulty associated with comparing companies that use similar performance measures whose calculations may differ from ALLO's calculations. In addition, EBITDA should not be considered a substitute for other measures of financial performance, such as net income or any other performance measures derived in accordance with GAAP. A reconciliation of EBITDA from net income (loss) under GAAP is presented under "Summary and Comparison of Operating Results" in the table above.
(b) Represents the number of single residence homes, apartments, and condominiums that ALLO already serves and those in which ALLO has the capacity to connect to its network distribution system without further material extensions to the transmission lines, but have not been connected.
(c) During the second quarter of 2019, ALLO announced plans to expand its network to make services available in Breckenridge, Colorado. ALLO is now in ten communities, including eight in Nebraska and two in Colorado.
48
ASSET GENERATION AND MANAGEMENT OPERATING SEGMENT – RESULTS OF OPERATIONS
Loan Portfolio
As of September 30, 2019, the Company had a $21.1 billion loan portfolio, consisting primarily of federally insured loans, that management anticipates will amortize over the next approximately 20 years and has a weighted average remaining life of 8.8 years. For a summary of the Company’s loan portfolio as of September 30, 2019 and December 31, 2018, see note 2 of the notes to consolidated financial statements included under Part I, Item 1 of this report.
Loan Activity
The following table sets forth the activity of loans:
Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
Beginning balance | $ | 21,590,836 | 22,856,285 | 22,520,498 | 21,995,877 | ||||||||||||||||||
Loan acquisitions: | |||||||||||||||||||||||
Federally insured student loans | 248,542 | 591,196 | 1,088,649 | 3,124,154 | |||||||||||||||||||
Private education loans | 3,804 | — | 3,804 | 194 | |||||||||||||||||||
Consumer loans | 113,338 | 42,819 | 298,092 | 80,385 | |||||||||||||||||||
Total loan acquisitions | 365,684 | 634,015 | 1,390,545 | 3,204,733 | |||||||||||||||||||
Repayments, claims, capitalized interest, and other | (497,762) | (502,474) | (1,875,948) | (1,714,820) | |||||||||||||||||||
Consolidation loans lost to external parties | (251,810) | (292,749) | (780,467) | (789,321) | |||||||||||||||||||
Loans sold | — | (22,320) | (47,680) | (23,712) | |||||||||||||||||||
Ending balance | $ | 21,206,948 | 22,672,757 | 21,206,948 | 22,672,757 |
Allowance for Loan Losses and Loan Delinquencies
The Company maintains an allowance that management believes is appropriate to absorb losses, net of recoveries, inherent in the portfolio of loans, which results in periodic provisions for loan losses. Delinquencies have the potential to adversely impact the Company’s earnings through increased servicing and collection costs and account charge-offs.
For a summary of the activity in the allowance for loan losses for the three and nine months ended September 30, 2019 and 2018, and a summary of the Company's loan delinquency amounts as of September 30, 2019, December 31, 2018, and September 30, 2018, see note 2 of the notes to consolidated financial statements included under Part I, Item 1 of this report.
Provision for loan losses for federally insured loans was $2.0 million and $8.0 million for the three months ended September 30, 2019 and 2018, respectively, and $6.0 million and $12.0 million for the nine months ended September 30, 2019 and 2018, respectively. During the three months ended September 30, 2018, the Company determined an additional allowance was necessary related to a $2.2 billion (principal balance as of September 30, 2018) portfolio of federally insured loans that were purchased in 2013 and 2014, and recognized $5.0 million in provision expense related to these loans.
The Company did not record a provision for private education loan losses for the three or nine months ended September 30, 2019 and 2018.
Provision for loan losses for consumer loans was $8.0 million and $2.5 million for the three months ended September 30, 2019 and 2018, respectively, and $20.0 million and $6.0 million for the nine months ended September 30, 2019 and 2018, respectively. The increase in provision in 2019 as compared to the comparable periods in 2018 was a result of the increased amount of consumer loan purchases during the 2019 periods as reflected in the "Loan Activity" table above.
49
Loan Spread Analysis
The following table analyzes the loan spread on the Company’s portfolio of loans, which represents the spread between the yield earned on loan assets and the costs of the liabilities and derivative instruments used to fund the assets. The spread amounts included in the following table are calculated by using the notional dollar values found in the table under the caption "Net interest income after provision for loan losses, net of settlements on derivatives" below, divided by the average balance of loans or debt outstanding.
Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
Variable loan yield, gross | 4.78 | % | 4.57 | % | 4.94 | % | 4.40 | % | |||||||||||||||
Consolidation rebate fees | (0.83) | (0.83) | (0.83) | (0.84) | |||||||||||||||||||
Discount accretion, net of premium and deferred origination costs amortization | 0.02 | 0.03 | 0.02 | 0.04 | |||||||||||||||||||
Variable loan yield, net | 3.97 | 3.77 | 4.13 | 3.60 | |||||||||||||||||||
Loan cost of funds - interest expense | (3.16) | (3.10) | (3.35) | (2.89) | |||||||||||||||||||
Loan cost of funds - derivative settlements (a) (b) | 0.00 | 0.06 | 0.02 | 0.03 | |||||||||||||||||||
Variable loan spread | 0.81 | 0.73 | 0.80 | 0.74 | |||||||||||||||||||
Fixed rate floor income, gross | 0.23 | 0.23 | 0.21 | 0.27 | |||||||||||||||||||
Fixed rate floor income - derivative settlements (a) (c) | 0.13 | 0.34 | 0.22 | 0.28 | |||||||||||||||||||
Fixed rate floor income, net of settlements on derivatives | 0.36 | 0.57 | 0.43 | 0.55 | |||||||||||||||||||
Core loan spread (d) | 1.17 | % | 1.30 | % | 1.23 | % | 1.29 | % | |||||||||||||||
Average balance of loans | $ | 21,600,850 | 22,971,361 | 21,917,298 | 22,600,841 | ||||||||||||||||||
Average balance of debt outstanding | 21,371,482 | 22,557,437 | 21,632,256 | 22,165,059 |
Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
Core loan spread | 1.17 | % | 1.30 | % | 1.23 | % | 1.29 | % | |||||||||||||||
Derivative settlements (1:3 basis swaps) | 0.00 | (0.06) | (0.02) | (0.03) | |||||||||||||||||||
Derivative settlements (fixed rate floor income) | (0.13) | (0.34) | (0.22) | (0.28) | |||||||||||||||||||
Loan spread | 1.04 | % | 0.90 | % | 0.99 | % | 0.98 | % |
(a) Derivative settlements represent the cash paid or received during the current period to settle with derivative instrument
counterparties the economic effect of the Company's derivative instruments based on their contractual terms. Derivative accounting requires that net settlements with respect to derivatives that do not qualify for "hedge treatment" under GAAP be recorded in a separate income statement line item below net interest income. The Company maintains an overall risk management strategy that incorporates the use of derivative instruments to reduce the economic effect of interest rate volatility. As such, management believes derivative settlements for each applicable period should be evaluated with the Company’s net interest income (loan spread) as presented in this table. The Company reports this non-GAAP information because it believes that it provides additional information regarding operational and performance indicators that are closely assessed by management. There is no comprehensive, authoritative guidance for the presentation of such non-GAAP information, which is only meant to supplement GAAP results by providing additional information that management utilizes to assess performance. See note 4 of the notes to consolidated financial statements included under Part I, Item 1 of this report for additional information on the Company's derivative instruments, including the net settlement activity recognized by the Company for each type of derivative for the periods presented in the table under the caption "Income Statement Impact" in note 4 and in this table.
(b) Derivative settlements include the net settlements received related to the Company’s 1:3 basis swaps.
(c) Derivative settlements include the net settlements received related to the Company’s floor income interest rate swaps.
(d) Core loan spread, excluding consumer loans, would have been 1.03% and 1.25% for the three months ended September 30, 2019 and 2018, respectively, and 1.12% and 1.25% for the nine months ended September 30, 2019 and 2018, respectively. Other than consumer loans funded in the Company's consumer loan warehouse facility that was
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obtained on January 11, 2019, consumer loans were and continue to be funded by the Company using operating cash, until they can be funded in a secured financing transaction. Consumer loans funded with operating cash do not have a cost of funds (debt) associated with them. The average balance of consumer loans outstanding for the three months ended September 30, 2019 and 2018 and nine months ended September 30, 2019 and 2018 was $279.4 million, $91.0 million, $217.1 million, and $79.9 million, respectively. The average balance outstanding on the consumer loan warehouse facility for the three and nine months ended September 30, 2019 was $196.2 million and $138.3 million, respectively.
A trend analysis of the Company's core and variable loan spreads is summarized below.
![nni-20190930_g2.jpg](https://www.sec.gov/Archives/edgar/data/0001258602/000125860219000066/nni-20190930_g2.jpg)
(a) The interest earned on the majority of the Company's FFELP student loan assets is indexed to the one-month LIBOR rate. The Company funds a large portion of its assets with three-month LIBOR indexed floating rate securities. The relationship between the indices in which the Company earns interest on its loans and funds such loans has a significant impact on loan spread. This table (the right axis) shows the difference between the Company's liability base rate and the one-month LIBOR rate by quarter. See Item 3, “Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk,” which provides additional detail on the Company’s FFELP student loan assets and related funding for those assets.
Variable loan spread increased during the three and nine months ended September 30, 2019 as compared to the same periods in 2018 due to the impact of the Company's consumer loan portfolio. Variable loan spread without consumer loans was 0.67% and 0.68% for the three months ended September 30, 2019 and 2018, respectively, and 0.69% and 0.70% the nine months ended September 30, 2019 and 2018, respectively.
The difference between variable loan spread and core loan spread is fixed rate floor income. A summary of fixed rate floor income and its contribution to core loan spread follows:
Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
Fixed rate floor income, gross | $ | 12,685 | 13,659 | 33,950 | 45,359 | ||||||||||||||||||
Derivative settlements (a) | 7,064 | 19,087 | 35,931 | 46,752 | |||||||||||||||||||
Fixed rate floor income, net | $ | 19,749 | 32,746 | 69,881 | 92,111 | ||||||||||||||||||
Fixed rate floor income contribution to spread, net | 0.36 | % | 0.57 | % | 0.43 | % | 0.55 | % |
(a) Includes settlement payments on derivatives used to hedge student loans earning fixed rate floor income.
The decrease in gross fixed rate floor income for the three and nine months ended September 30, 2019 compared to the same periods in 2018 was due to higher interest rates in 2019 as compared to 2018. The Company has a portfolio of derivative instruments in which the Company pays a fixed rate and receives a floating rate to economically hedge loans earning fixed rate floor income. See Item 3, “Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk,” which provides additional detail on the Company’s portfolio earning fixed rate floor income and the derivatives used by the Company to hedge these loans.
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Summary and Comparison of Operating Results
Three months ended September 30, | Nine months ended September 30, | Additional information | |||||||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||||||||
Net interest income after provision for loan losses | $ | 51,740 | 48,665 | 153,069 | 164,152 | See table below for additional analysis. | |||||||||||||||||||||||
Other income | 3,384 | 3,267 | 11,796 | 9,391 | The Company sold a portfolio of consumer loans during the second quarter of 2019 and recognized a gain of $1.7 million. The remaining component of other income is primarily earned from borrower late fees. | ||||||||||||||||||||||||
Derivative settlements, net | 7,298 | 22,448 | 39,306 | 51,428 | The Company maintains an overall risk management strategy that incorporates the use of derivative instruments to reduce the economic effect of interest rate volatility. Derivative settlements for each applicable period should be evaluated with the Company's net interest income as reflected in the table below. | ||||||||||||||||||||||||
Derivative market value adjustments, net | (5,630) | (6,056) | (73,265) | 47,070 | Includes the realized and unrealized gains and losses that are caused by changes in fair values of derivatives which do not qualify for "hedge treatment" under GAAP. The majority of the derivative market value adjustments related to the changes in fair value of the Company's floor income interest rate swaps. Such changes reflect that a decrease in the forward yield curve during a reporting period results in a decrease in the fair value of the Company's floor income interest rate swaps, and an increase in the forward yield curve during a reporting period results in an increase in the fair value of the Company's floor income interest rate swaps. | ||||||||||||||||||||||||
Total other income | 5,052 | 19,659 | (22,163) | 107,889 | |||||||||||||||||||||||||
Salaries and benefits | 394 | 424 | 1,153 | 1,183 | |||||||||||||||||||||||||
Loan servicing fees to third parties | 3,382 | 3,087 | 9,431 | 9,428 | Represents fees paid to third-party loan servicers. Servicing fees paid to the LSS operating segment are included in "intersegment expenses" below. | ||||||||||||||||||||||||
Other expenses | 15,672 | 845 | 19,667 | 2,982 | The Company recognized $14.0 million of expenses during the three months ended September 30, 2019 and $15.8 million of expenses during the nine months ended September 30, 2019 to extinguish asset-backed notes from certain securitizations prior to their contractual maturities. | ||||||||||||||||||||||||
Intersegment expenses | 11,678 | 12,378 | 35,630 | 34,943 | Amounts include fees paid to the LSS operating segment for the servicing of the Company’s loan portfolio. These amounts exceed the actual cost of servicing the loans. Intersegment expenses also include costs for certain corporate activities and services that are allocated to each operating segment based on estimated use of such activities and services. | ||||||||||||||||||||||||
Total operating expenses | 31,126 | 16,734 | 65,881 | 48,536 | Excluding the expenses recognized by the Company related to the extinguishment of debt securities prior to their contractual maturities (as described above), total operating expenses were 32 basis points and 29 basis points of the average balance of loans for the three months ended September 30, 2019 and 2018, respectively, and 30 basis points and 29 basis points for the nine months ended September 30, 2019 and 2018, respectively. | ||||||||||||||||||||||||
Income before income taxes | 25,666 | 51,590 | 65,025 | 223,505 | |||||||||||||||||||||||||
Income tax expense | (6,160) | (12,381) | (15,606) | (53,641) | Represents income tax expense at an effective tax rate of 24%. | ||||||||||||||||||||||||
Net income | $ | 19,506 | 39,209 | 49,419 | 169,864 | ||||||||||||||||||||||||
Additional information: | |||||||||||||||||||||||||||||
Net income | $ | 19,506 | 39,209 | 49,419 | 169,864 | ||||||||||||||||||||||||
Derivative market value adjustments, net | 5,630 | 6,056 | 73,265 | (47,070) | See "Overview - GAAP Net Income and Non-GAAP Net Income, Excluding Adjustments" above for additional information about non-GAAP net income, excluding derivative market value adjustments. The decrease in net income, excluding derivative market value adjustments, for the three and nine months ended September 30, 2019 as compared to the same periods in 2018 was due to debt extinguishment costs incurred in 2019, a decrease in the average balance of loans outstanding, a decrease in core loan spread, and an increase in provision for loan losses for consumer loans as a result of the increased amount of consumer loan purchases in 2019 as compared to 2018. | ||||||||||||||||||||||||
Tax effect | (1,351) | (1,453) | (17,584) | 11,297 | |||||||||||||||||||||||||
Net income, excluding derivative market value adjustments | $ | 23,785 | 43,812 | 105,100 | 134,091 |
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Net interest income after provision for loan losses, net of settlements on derivatives
The following table summarizes the components of "net interest income after provision for loan losses" and "derivative settlements, net."
Three months ended September 30, | Nine months ended September 30, | Additional information | |||||||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||||||||
Variable interest income, gross | $ | 260,089 | 264,675 | 809,097 | 742,938 | Decrease for the three months ended September 30, 2019 as compared to the same period in 2018 was due to a decrease in the average balance of loans, partially offset by an increase in the gross yield earned on loans. Increase for the nine months ended September 30, 2019 as compared to the same period in 2018 was due to an increase in the gross yield earned on loans, partially offset by a decrease in the average balance of loans. | |||||||||||||||||||||||
Consolidation rebate fees | (44,717) | (47,868) | (136,855) | (143,091) | Decrease was due to a decrease in the average consolidation loan balance. | ||||||||||||||||||||||||
Discount accretion, net of premium and deferred origination costs amortization | 1,006 | 1,855 | 3,426 | 8,207 | Net discount accretion is due to the Company's purchases of loans at a net discount over the last several years. However, due to more recent purchases in 2018 and 2019 at a net premium, the net discount accretion has decreased in 2019 as compared to 2018. | ||||||||||||||||||||||||
Variable interest income, net | 216,378 | 218,662 | 675,668 | 608,054 | |||||||||||||||||||||||||
Interest on bonds and notes payable | (170,327) | (176,207) | (541,356) | (478,298) | Decrease for the three months ended September 30, 2019 as compared to the same period in 2018 was due to a decrease in the average balance of debt outstanding, partially offset by an increase in cost of funds. Increase for the nine months ended September 30, 2019 as compared to the same period in 2018 was due to an increase in cost of funds, partially offset by a decrease in the average balance of debt outstanding. | ||||||||||||||||||||||||
Derivative settlements, net (a) | 234 | 3,361 | 3,375 | 4,676 | Derivative settlements include the net settlements received related to the Company’s 1:3 basis swaps. | ||||||||||||||||||||||||
Variable loan interest margin, net of settlements on derivatives (a) | 46,285 | 45,816 | 137,687 | 134,432 | |||||||||||||||||||||||||
Fixed rate floor income, gross | 12,685 | 13,659 | 33,950 | 45,359 | Fixed rate floor income decreased due to higher interest rates in 2019 as compared to 2018. | ||||||||||||||||||||||||
Derivative settlements, net (a) | 7,064 | 19,087 | 35,931 | 46,752 | Derivative settlements include the settlements received related to the Company's floor income interest rate swaps. The decrease in settlements for the three and nine months ended September 30, 2019 as compared to the same periods in 2018 was due to a decrease in the notional amount of derivatives outstanding, partially offset by higher interest rates in 2019 as compared to 2018. | ||||||||||||||||||||||||
Fixed rate floor income, net of settlements on derivatives (a) | 19,749 | 32,746 | 69,881 | 92,111 | |||||||||||||||||||||||||
Core loan interest income (a) | 66,034 | 78,562 | 207,568 | 226,543 | |||||||||||||||||||||||||
Investment interest | 4,162 | 3,719 | 13,770 | 9,467 | Increase was due to a higher balance of interest-earning investments and higher interest rates in 2019 as compared to 2018. | ||||||||||||||||||||||||
Intercompany interest | (1,158) | (668) | (2,963) | (2,430) | |||||||||||||||||||||||||
Provision for loan losses - federally insured loans | (2,000) | (8,000) | (6,000) | (12,000) | See "Allowance for Loan Losses and Loan Delinquencies" included above under "Asset Generation and Management Operating Segment - Results of Operations." | ||||||||||||||||||||||||
Provision for loan losses - consumer loans | (8,000) | (2,500) | (20,000) | (6,000) | |||||||||||||||||||||||||
Net interest income after provision for loan losses (net of settlements on derivatives) (a) | $ | 59,038 | 71,113 | 192,375 | 215,580 |
(a) Derivative settlements represent the cash paid or received during the current period to settle with derivative instrument counterparties the economic effect of the Company's derivative instruments based on their contractual terms. Derivative accounting requires that net settlements on derivatives that do not qualify for "hedge treatment" under GAAP be recorded in a separate income statement line item below net interest income. The Company maintains an overall risk management strategy that incorporates the use of derivative instruments to reduce the economic effect of interest rate volatility. As such, management believes derivative settlements for each applicable period should be evaluated with the Company’s net interest income as presented in this table. Core loan interest income and net interest
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income after provision for loan losses (net of settlements on derivatives) are non-GAAP financial measures, and the Company reports this non-GAAP information because the Company believes that it provides additional information regarding operational and performance indicators that are closely assessed by management. There is no comprehensive, authoritative guidance for the presentation of such non-GAAP information, which is only meant to supplement GAAP results by providing additional information that management utilizes to assess performance. See note 4 of the notes to consolidated financial statements included under Part I, Item 1 of this report for additional information on the Company's derivative instruments, including the net settlement activity recognized by the Company for each type of derivative referred to in the "Additional information" column of this table, for the periods presented in the table under the caption "Income Statement Impact" in note 4 and in this table.
LIBOR Benchmark Transition
As of September 30, 2019, the interest earned on a principal amount of $19.2 billion in the Company’s FFELP student loan asset portfolio was indexed to one-month LIBOR, and the interest paid on a principal amount of $19.0 billion of the Company’s FFELP student loan asset-backed debt securities was indexed to one-month or three-month LIBOR. In addition, the majority of the Company’s derivative financial instrument transactions used to manage LIBOR interest rate risks are indexed to LIBOR. The United Kingdom’s Financial Conduct Authority, which regulates LIBOR, has publicly announced that it intends to stop persuading or compelling banks to submit information to the administrator of LIBOR after 2021. Accordingly, there is significant uncertainty regarding the availability of LIBOR as a benchmark rate after 2021, and any market transition away from the current LIBOR framework could result in significant changes to the interest rate characteristics of the Company's LIBOR-indexed assets and funding for those assets, as well as the Company’s LIBOR-indexed derivative instruments.
Although the indentures for student loan asset-backed debt securities issued in the Company’s most recent LIBOR-indexed securitization transactions include new interest rate determination fallback provisions emerging in the market for new issuances of LIBOR-indexed debt securities, many of the contracts for the Company’s existing LIBOR-indexed assets, liabilities, and derivative instruments from historical transactions do not include provisions that contemplated the possibility of a permanent discontinuation of LIBOR and clearly specified a method for transitioning from LIBOR to an alternative benchmark rate, and it is not yet known how the market in general, specific counterparties in particular, the courts, or regulators will address the significant complexities and uncertainties involved in a transition away from LIBOR to an alternative benchmark rate. Specifically, the Department has not yet indicated any market transition away from the current LIBOR framework for paying special allowance payments to holders of FFELP assets. As a result, the Company cannot predict the impact that a transition from LIBOR to an alternative benchmark rate would have on the Company’s existing LIBOR-indexed assets, liabilities, and derivative instruments, but such impact could have material adverse effects on the value, performance, and related cash flows of such LIBOR-indexed items, including the Company’s funding costs, net interest income, loan and other asset values, and asset-liability management strategies. See Item 1A, "Risk Factors - Loan Portfolio - Interest rate risk - replacement of LIBOR as a benchmark rate" in the Company's 2018 Annual Report.
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LIQUIDITY AND CAPITAL RESOURCES
The Company’s Loan Servicing and Systems and Education Technology, Services, and Payment Processing operating segments are non-capital intensive and both produce positive operating cash flows. As such, a minimal amount of debt and equity capital is allocated to these segments and any liquidity or capital needs are satisfied using cash flow from operations. Therefore, the following Liquidity and Capital Resources discussion is concentrated on the Company’s liquidity and capital needs to meet existing debt obligations in the Asset Generation and Management operating segment and capital needs to expand ALLO's communications network in the Communications operating segment.
Sources of Liquidity
As of September 30, 2019, the Company had cash and cash equivalents of $161.0 million. The Company also had a portfolio of available-for-sale investments, consisting primarily of student loan asset-backed securities, with a fair value of $52.6 million as of September 30, 2019.
The Company also has a $382.5 million unsecured line of credit that matures on June 22, 2023. As of September 30, 2019, no amounts were outstanding on the unsecured line of credit and $382.5 million was available for future use. The line of credit provides that the Company may increase the aggregate financing commitments, through the existing lenders and/or through new lenders, up to a total of $400.0 million, subject to certain conditions. In addition, on May 30, 2019, the Company entered into a $22.0 million secured line of credit agreement that matures on May 30, 2022. As of September 30, 2019, the secured line of credit had $5.0 million outstanding with $17.0 million available for future use.
The Company has repurchased certain of its own asset-backed securities (bonds and notes payable) in the secondary market. For accounting purposes, these notes are eliminated in consolidation and are not included in the Company's consolidated financial statements. However, these securities remain legally outstanding at the trust level and the Company could sell these notes to third parties or redeem the notes at par as cash is generated by the trust estate. Upon a sale of these notes to third parties, the Company would obtain cash proceeds equal to the market value of the notes on the date of such sale. As of September 30, 2019, the Company holds $15.0 million (par value) of its own asset-backed securities.
The Company intends to use its liquidity position to capitalize on market opportunities, including FFELP, private education, and consumer loan acquisitions; strategic acquisitions and investments; expansion of ALLO's telecommunications network; and capital management initiatives, including stock repurchases, debt repurchases, and dividend distributions. The timing and size of these opportunities will vary and will have a direct impact on the Company's cash and investment balances.
Cash Flows
During the nine months ended September 30, 2019, the Company generated $142.9 million in operating activities, compared to $193.6 million for the same period in 2018. The decrease in cash flows from operating activities was due to:
•The decrease in net income;
•Adjustments to net income for the impact of deferred taxes;
•Net payments to the derivative clearinghouse in 2019 of $60.0 million compared to net proceeds received in 2018 of $46.4 million related to the Company's derivative portfolio; and
•The impact of changes to other assets, accrued interest payable, and due to customers during the nine months ended September 30, 2019 as compared to the same period in 2018.
These factors were partially offset by:
•The adjustments to net income for derivative market value adjustments; and
•The impact of changes to accrued interest receivable and other liabilities during the nine months ended September 30, 2019 as compared to the same period in 2018.
The primary items included in the statement of cash flows for investing activities are the purchase and repayment of loans. The primary items included in financing activities are the proceeds from the issuance of and payments on bonds and notes payable used to fund loans. Cash provided by investing activities and used in financing activities for the nine months ended September 30, 2019 was $1.2 billion and $1.4 billion, respectively. Cash used in investing activities and provided by financing activities for the nine months ended September 30, 2018 was $0.9 billion and $0.8 billion, respectively. Investing and financing activities are further addressed in the discussion that follows.
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Liquidity Needs and Sources of Liquidity Available to Satisfy Debt Obligations Secured by Loan Assets and Related Collateral
The following table shows the Company's debt obligations outstanding that are secured by loan assets and related collateral.
As of September 30, 2019 | |||||||||||
Carrying amount | Final maturity | ||||||||||
Bonds and notes issued in asset-backed securitizations | $ | 20,245,342 | 11/25/24 - 10/25/67 | ||||||||
FFELP and consumer loan warehouse facilities | 883,470 | 11/20/20 - 5/31/22 | |||||||||
$ | 21,128,812 |
Bonds and Notes Issued in Asset-backed Securitizations
The majority of the Company’s portfolio of student loans is funded in asset-backed securitizations that are structured to substantially match the maturity of the funded assets, thereby minimizing liquidity risk. Cash generated from student loans funded in asset-backed securitizations provide the sources of liquidity to satisfy all obligations related to the outstanding bonds and notes issued in such securitizations. In addition, due to (i) the difference between the yield the Company receives on the loans and cost of financing within these transactions, and (ii) the servicing and administration fees the Company earns from these transactions, the Company has created a portfolio that will generate earnings and significant cash flow over the life of these transactions.
As of September 30, 2019, based on cash flow models developed to reflect management’s current estimate of, among other factors, prepayments, defaults, deferment, forbearance, and interest rates, the Company currently expects future undiscounted cash flows from its portfolio to be approximately $1.88 billion as detailed below.
The forecasted cash flow presented below includes all loans funded in asset-backed securitizations as of September 30, 2019. As of September 30, 2019, the Company had $20.1 billion of loans included in asset-backed securitizations, which represented 94.9 percent of its total loan portfolio. The forecasted cash flow does not include cash flows that the Company expects to receive related to loans funded in its warehouse facilities as of September 30, 2019, private education and consumer loans funded with operating cash, and loans acquired subsequent to September 30, 2019.
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Asset-backed Securitization Cash Flow Forecast
$1.88 billion
(dollars in millions)
![nni-20190930_g3.jpg](https://www.sec.gov/Archives/edgar/data/0001258602/000125860219000066/nni-20190930_g3.jpg)
The forecasted future undiscounted cash flows of approximately $1.88 billion include approximately $1.01 billion (as of September 30, 2019) of overcollateralization included in the asset-backed securitizations. These excess net asset positions are reflected variously in the following balances in the consolidated balance sheet: "loans receivable," "restricted cash," and "accrued interest receivable." The difference between the total estimated future undiscounted cash flows and the overcollateralization of approximately $0.87 billion, or approximately $0.66 billion after income taxes based on the estimated effective tax rate, is expected to be accretive to the Company's September 30, 2019 balance of consolidated shareholders' equity.
Certain of the Company’s asset-backed securitizations are structured as “Turbo Transactions” which require all cash generated from the student loans (including excess spread) to be directed toward payment of interest and any outstanding principal generally until such time as all principal on the notes has been paid in full. Once the notes in such transactions are paid in full, the remaining unencumbered student loans (and other remaining assets, if any) in the securitization will be released to the Company, at which time the Company will have the option to refinance or sell these assets, or retain them on the balance sheet as unencumbered assets.
The Company uses various assumptions, including prepayments and future interest rates, when preparing its cash flow forecast. These assumptions are further discussed below.
Prepayments: The primary variable in establishing a life of loan estimate is the level and timing of prepayments. Prepayment rates equal the amount of loans that prepay annually as a percentage of the beginning of period balance, net of scheduled principal payments. A number of factors can affect estimated prepayment rates, including the level of consolidation activity, borrower default rates, and utilization of debt management options such as income-based repayment, deferments, and forbearance. Should any of these factors change, management may revise its assumptions, which in turn would impact the projected future cash flow. The Company’s cash flow forecast above assumes prepayment rates that are generally consistent with those utilized in the Company’s recent asset-backed securitization transactions. If management used a prepayment rate assumption two times greater than what was used to forecast the cash flow, the cash flow forecast would be reduced by approximately $130 million to $160 million.
Interest rates: The Company funds a large portion of its student loans with three-month LIBOR indexed floating rate securities. Meanwhile, the interest earned on the Company’s student loan assets is indexed primarily to a one-month LIBOR rate. The different interest rate characteristics of the Company’s loan assets and liabilities funding these assets result in basis risk. The Company’s cash flow forecast assumes three-month LIBOR will exceed one-month LIBOR by 12 basis points for the life of the portfolio, which approximates the historical relationship between these indices. If the forecast is computed assuming
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a spread of 24 basis points between three-month and one-month LIBOR for the life of the portfolio, the cash flow forecast would be reduced by approximately $70 million to $90 million. As the percentage of the Company's outstanding debt financed by three-month LIBOR declines, the Company's basis risk will be reduced.
There is significant uncertainty regarding the availability of LIBOR as a benchmark rate after 2021, and any market transition away from the current LIBOR framework could result in significant changes to the forecasted cash flows from the Company's asset-backed securitizations. See "Asset Generation and Management Operating Segment - Results of Operations - LIBOR Benchmark Transition" above and Item 1A, "Risk Factors - Loan Portfolio - Interest rate risk - replacement of LIBOR as a benchmark rate" in the Company's 2018 Annual Report.
The Company uses the current forward interest rate yield curve to forecast cash flows. A change in the forward interest rate curve would impact the future cash flows generated from the portfolio. An increase in future interest rates will reduce the amount of fixed rate floor income the Company is currently receiving. The Company attempts to mitigate the impact of a rise in short-term rates by hedging interest rate risks. The forecasted cash flow does not include cash flows the Company expects to pay/receive related to derivative instruments used by the Company to manage interest rate risk. See Item 3, "Quantitative and Qualitative Disclosures About Market Risk — Interest Rate Risk."
Extinguishment of Certain Turbo Transactions
On June 7, 2019, the Company paid a premium of $1.4 million to extinguish $93.0 million of notes payable in one of its Turbo Transactions (prior to the notes' contractual maturity). This transaction resulted in the release of $152.7 million of student loans and accrued interest receivable that were previously encumbered in the asset-backed securitization. The Company refinanced the student loans in its FFELP warehouse facilities, resulting in net cash proceeds of $57.5 million. The Company also wrote off $0.4 million of the remaining debt issuance costs associated with this securitization. In total, the Company recognized a $1.8 million expense in the second quarter of 2019 to extinguish these notes.
During the third quarter of 2019, the Company extinguished an additional $675.6 million of notes payable in certain asset-backed securitizations, including five of its remaining six Turbo Transactions, prior to the notes' contractual maturities. These transactions resulted in the release of $996.4 million in student loans and accrued interest receivable that were previously encumbered in the asset-backed securitizations. To extinguish the notes, the Company paid a premium of $12.6 million and wrote off $1.4 million of debt issuance costs associated with these securitizations. In total, the Company recognized $14.0 million in expenses in the third quarter of 2019 to extinguish these notes. Upon extinguishment of the notes payable throughout the third quarter, the Company refinanced the student loans in its FFELP warehouse facilities and new asset-backed securitizations, resulting in net cash proceeds of $311.5 million. The Company used a portion of these proceeds to pay down the outstanding balance on its unsecured line of credit.
The cash proceeds generated by the debt extinguishments provide the Company with increased liquidity and the opportunity to invest the previously underutilized capital at higher returns.
FFELP and Consumer Loan Warehouse Facilities
The Company funds a portion of its FFELP loan acquisitions using its FFELP warehouse facilities. Student loan warehousing allows the Company to buy and manage student loans prior to transferring them into more permanent financing arrangements. As of September 30, 2019, the Company had two FFELP warehouse facilities with an aggregate maximum financing amount available of $1.00 billion, of which $0.74 billion was outstanding, and $0.26 billion was available for additional funding. One warehouse facility has a static advance rate until the expiration date of the liquidity provisions (November 20, 2019). In the event the liquidity provisions are not extended, the valuation agent has the right to perform a one-time mark to market on the underlying loans funded in this facility, subject to a floor. The loans would then be funded at this new advance rate until the final maturity date of the facility (November 20, 2020). The other warehouse facility has static advance rates that requires initial equity for loan funding and does not require increased equity based on market movements. As of September 30, 2019, the Company had $48.1 million advanced as equity support on these facilities. For further discussion of the Company's FFELP warehouse facilities outstanding at September 30, 2019, see note 3 of the notes to consolidated financial statements included under Part I, Item 1 of this report.
On January 11, 2019, the Company obtained a consumer loan warehouse facility with an aggregate maximum financing amount available of $100.0 million, an advance rate of 70 or 75 percent depending on the type of collateral and subject to certain concentration limits, and a maturity date of January 10, 2022. On April 25, 2019, the Company amended the agreement for this warehouse facility to increase the aggregate maximum financing amount available to $200.0 million, extend the expiration of liquidity provisions to April 23, 2021, and extend the final maturity date to April 23, 2022. As of September 30, 2019, $144.0 million was outstanding under this facility and $56.0 million was available for future funding. Additionally, as of September 30, 2019, the Company had $50.2 million advanced as equity support under this facility.
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On October 17, 2019, the Company sold $179.3 million (par value) of consumer loans to an unrelated third party of which a portion of such loans were funded in the consumer loan warehouse. After completion of this loan sale, the outstanding balance under the consumer loan warehouse was $69.9 million, $130.1 million was available for future funding, and $18.6 million was advanced as equity support. For further discussion of this loan sale, see note 2 of the notes to consolidated financial statements included under Part I, Item 1 of this report.
Upon termination or expiration of the FFELP and consumer loan warehouse facilities, the Company would expect to access the securitization market, obtain replacement warehouse facilities, use operating cash, consider the sale of assets, or transfer collateral to satisfy any remaining obligations.
Other Uses of Liquidity
The Company no longer originates new FFELP loans, but continues to acquire FFELP loan portfolios from third parties and believes additional loan purchase opportunities exist, including opportunities to purchase private education and consumer loans.
The Company plans to fund additional loan acquisitions using current cash and investments; using its Union Bank participation agreement (as described below); using its FFELP and consumer loan warehouse facilities (as described above); increasing the capacity under existing and/or establishing new warehouse facilities; and continuing to access the asset-backed securities market.
Union Bank Participation Agreement
The Company maintains an agreement with Union Bank, a related party, as trustee for various grantor trusts, under which Union Bank has agreed to purchase from the Company participation interests in student loans. As of September 30, 2019, $708.7 million of loans were subject to outstanding participation interests held by Union Bank, as trustee, under this agreement. The agreement automatically renews annually and is terminable by either party upon five business days' notice. This agreement provides beneficiaries of Union Bank’s grantor trusts with access to investments in interests in student loans, while providing liquidity to the Company. The Company can participate loans to Union Bank to the extent of availability under the grantor trusts, previously up to $750.0 million or an amount in excess of $750.0 million if mutually agreed to by both parties. In August 2019, this agreement was amended to increase the maximum participation level to $900.0 million or an amount in excess of $900.0 million if mutually agreed to by both parties. Loans participated under this agreement have been accounted for by the Company as loan sales. Accordingly, the participation interests sold are not included on the Company’s consolidated balance sheets.
Asset-Backed Securities Transactions
During the first nine months of 2019, the Company completed five FFELP asset-backed securitizations totaling $2.2 billion (par value). In addition, on October 30, 2019, the Company completed an asset-backed securitization totaling $145.2 million (par value). The proceeds from these transactions were used primarily to refinance student loans included in the Company's FFELP warehouse facilities and unencumbered student loans from the extinguishment of certain asset-backed securitizations. On June 25, 2019, the Company completed a private education loan asset-backed securitization totaling $47.2 million (par value). The proceeds from this transaction were used to refinance private education loans previously funded via a private loan repurchase agreement that was terminated on June 25, 2019. See note 3 of the notes to consolidated financial statements included under Part I, Item I of this report for additional information on these securitizations.
Depending on future market conditions, the Company currently anticipates continuing to access the asset-backed securitization market. Such asset-backed securitization transactions would be used to refinance loans included in its warehouse facilities, loans purchased from third parties, and/or student loans in its existing asset-backed securitizations.
Liquidity Impact Related to Hedging Activities
The Company utilizes derivative instruments to manage interest rate sensitivity. By using derivative instruments, the Company is exposed to market risk which could impact its liquidity. Based on the derivative portfolio outstanding as of September 30, 2019, the Company does not currently anticipate any movement in interest rates having a material impact on its capital or liquidity profile, nor does the Company expect that any movement in interest rates would have a material impact on its ability to meet potential collateral deposits with its counterparties and/or variation margin payments with its third-party clearinghouse. However, if interest rates move materially and negatively impact the fair value of the Company's derivative portfolio or if the Company enters into additional derivatives for which the fair value becomes negative, the Company could be required to deposit additional collateral with its derivative instrument counterparties and/or pay variation margin to a third-party clearinghouse. The collateral deposits or variation margin, if significant, could negatively impact the Company's liquidity and capital resources. In addition, clearing rules require the Company to post amounts of liquid collateral when executing new
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derivative instruments, which could prevent or limit the Company from utilizing additional derivative instruments to manage interest rate sensitivity and risks. See note 4 of the notes to consolidated financial statements included under Part I, Item 1 of this report for additional information on the Company's derivative portfolio.
Liquidity Impact Related to the Communications Operating Segment
ALLO has made significant investments in its communications network and currently provides fiber directly to homes and businesses in communities in Nebraska and Colorado. ALLO plans to continue to increase market share and revenue in its existing markets and is currently evaluating opportunities to expand to other communities in the Midwest. ALLO began providing services in Lincoln, Nebraska in September 2016 as part of a multi-year project to pass substantially all commercial and residential properties in the community. As of the end of the first quarter of 2019, the build-out of the Lincoln community was substantially complete. For the nine months ended September 30, 2019, ALLO's capital expenditures were $37.2 million. The Company anticipates total ALLO network capital expenditures in the fourth quarter of 2019 will be approximately $13.0 million. However, this amount could change based on customer demand for ALLO's services. The Company currently plans to use cash from operating activities and its third-party unsecured line of credit to fund ALLO's capital expenditures, as well as potentially other third-party financing alternatives.
Other Debt Facilities
As discussed above, the Company has a $382.5 million unsecured line of credit with a maturity date of June 22, 2023. As of September 30, 2019, no amounts were outstanding on the line of credit and $382.5 million was available for future use. On May 30, 2019, the Company entered into a $22.0 million secured line of credit agreement with a maturity date of May 30, 2022. As of September 30, 2019, the secured line of credit had $5.0 million outstanding with $17.0 million available for future use. The line of credit is secured by several Company-owned properties. Upon the maturity date of these facilities in 2022 and 2023, there can be no assurance that the Company will be able to maintain these lines of credit, increase the amount outstanding under the lines, or find alternative funding if necessary.
The Company has issued Junior Subordinated Hybrid Securities (the "Hybrid Securities") that have a final maturity of September 15, 2061. The Hybrid Securities are unsecured obligations of the Company. As of September 30, 2019, the Company had $20.4 million of Hybrid Securities that remain outstanding.
During 2017, the Company entered into a repurchase agreement, the proceeds of which are collateralized by FFELP asset-backed security investments. As of September 30, 2019, $40.5 million was subject to the outstanding repurchase agreement. On October 11, 2019, the Company fully paid down the outstanding balance on this repurchase agreement.
For further discussion of these debt facilities described above, see note 3 of the notes to consolidated financial statements included under Part I, Item 1 of this report.
Stock Repurchases
On May 8, 2019, the Board of Directors authorized a new stock repurchase program to repurchase up to a total of five million shares of the Company's Class A common stock during the three-year period ending May 7, 2022. The five million shares authorized under the new program include the remaining unrepurchased shares from the prior program, which the new program replaces. As of September 30, 2019, 4,803,877 shares remained authorized for repurchase under the Company's stock repurchase program. Shares may be repurchased from time to time depending on various factors, including share prices and other potential uses of liquidity. Shares repurchased by the Company during the three months ended March 31, 2019, June 30, 2019, and September 30, 2019 are shown below. Certain of these repurchases were made pursuant to a trading plan adopted by the Company in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934. For additional information on stock repurchases during the third quarter of 2019, see "Stock Repurchases" under Part II, Item 2 of this report.
Total shares repurchased | Purchase price (in thousands) | Average price of shares repurchased (per share) | |||||||||||||||
Quarter ended March 31, 2019 | 301,327 | $ | 16,358 | 54.29 | |||||||||||||
Quarter ended June 30, 2019 | 419,140 | 23,683 | 56.50 | ||||||||||||||
Quarter ended September 30, 2019 | 3,365 | 221 | 65.81 | ||||||||||||||
Total | 723,832 | $ | 40,262 | 55.62 |
Included in the shares repurchased during the quarter ended June 30, 2019 in the table above are a total of 180,000 shares of Class A common stock the Company purchased on June 17, 2019 from one of the Company's significant shareholders, Shelby J. Butterfield, the widow of Stephen F. Butterfield, the Company's former Vice-Chairman and significant shareholder who
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passed away in April 2018, and from the Butterfield Family Trust, an estate planning trust for the family of Mr. Butterfield. The shares were purchased at a discount to the closing market price of the Company's Class A common stock as of June 17, 2019, and the transaction was separately approved by the Company's Board of Directors. Immediately prior to the Company's repurchase of such shares from Ms. Butterfield and the Butterfield Family Trust, the repurchased shares were shares of the Company's Class B common stock that Ms. Butterfield and the Butterfield Family Trust converted to shares of Class A common stock.
Dividends
On September 13, 2019, the Company paid a third quarter 2019 cash dividend on the Company's Class A and Class B common stock of $0.18 per share. In addition, the Company's Board of Directors has declared a fourth quarter 2019 cash dividend on the Company's outstanding shares of Class A and Class B common stock of $0.20 per share. The fourth quarter cash dividend will be paid on December 13, 2019 to shareholders of record at the close of business on November 29, 2019.
The Company currently plans to continue making regular quarterly dividend payments, subject to future earnings, capital requirements, financial condition, and other factors. In addition, the payment of dividends is subject to the terms of the Company’s outstanding Hybrid Securities, which generally provide that if the Company defers interest payments on those securities it cannot pay dividends on its capital stock.
RECENT ACCOUNTING PRONOUNCEMENTS
Allowance for Loan Losses
In June 2016, the FASB issued accounting guidance regarding the measurement of credit losses on financial instruments, which will change the way entities recognize impairment of many financial assets by requiring immediate recognition of estimated credit losses expected to occur over the asset's remaining life. The estimate of credit losses under the new guidance considers historical experience, current conditions, and reasonable and supportable forecasts of future conditions. The new guidance provides significant flexibility and permits companies to use judgment in selecting the approach that is most appropriate in their circumstances. The Company currently uses an incurred loss model when calculating its allowance for loan losses. As a result, the Company expects the new guidance will increase the allowance for loan losses. This guidance will be effective for the Company beginning January 1, 2020. Upon adoption, a cumulative effect adjustment to retained earnings will be recorded.
The new guidance will primarily impact the allowance for loan losses related to the Company’s federally insured student loans, which represented approximately 97.6 percent of the Company’s total loan portfolio as of September 30, 2019 and for which the Company’s loss exposure is limited by the applicable federal government guarantee, private education loans, and consumer loans. Implementation efforts are underway including researching key interpretive issues, evaluating accounting policies, developing and validating loss models, and revising internal controls to meet the requirements of the new guidance. This guidance represents a significant change from existing GAAP, and may result in significant changes to the Company's accounting for the allowance for loan losses. The Company is continuing to evaluate the impact this pronouncement will have on its ongoing financial reporting. The extent of the impact upon adoption will depend on the characteristics of the Company's loan portfolio, economic conditions and forecasts upon adoption, and other management judgments.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(All dollars are in thousands, except share amounts, unless otherwise noted)
Interest Rate Risk
The Company’s primary market risk exposure arises from fluctuations in its borrowing and lending rates, the spread between which could impact the Company due to shifts in market interest rates.
The following table sets forth the Company’s loan assets and debt instruments by rate characteristics:
As of September 30, 2019 | As of December 31, 2018 | ||||||||||||||||||||||
Dollars | Percent | Dollars | Percent | ||||||||||||||||||||
Fixed-rate loan assets | $ | 3,239,083 | 15.3 | % | $ | 2,792,734 | 12.4 | % | |||||||||||||||
Variable-rate loan assets | 17,967,865 | 84.7 | 19,727,764 | 87.6 | |||||||||||||||||||
Total | $ | 21,206,948 | 100.0 | % | $ | 22,520,498 | 100.0 | % | |||||||||||||||
Fixed-rate debt instruments | $ | 427,868 | 2.0 | % | $ | 88,128 | 0.4 | % | |||||||||||||||
Variable-rate debt instruments | 20,766,790 | 98.0 | 22,448,971 | 99.6 | |||||||||||||||||||
Total | $ | 21,194,658 | 100.0 | % | $ | 22,537,099 | 100.0 | % |
FFELP loans originated prior to April 1, 2006 generally earn interest at the higher of the borrower rate, which is fixed over a period of time, or a floating rate based on the special allowance payment ("SAP") formula set by the Department. The SAP rate is based on an applicable index plus a fixed spread that depends on loan type, origination date, and repayment status. The Company generally finances its student loan portfolio with variable rate debt. In low and/or declining interest rate environments, when the fixed borrower rate is higher than the SAP rate, the Company’s student loans earn at a fixed rate while the interest on the variable rate debt typically continues to reflect the low and/or declining interest rates. In these interest rate environments, the Company may earn additional spread income that it refers to as floor income.
Depending on the type of loan and when it was originated, the borrower rate is either fixed to term or is reset to an annual rate each July 1. As a result, for loans where the borrower rate is fixed to term, the Company may earn floor income for an extended period of time, which the Company refers to as fixed rate floor income, and for those loans where the borrower rate is reset annually on July 1, the Company may earn floor income to the next reset date, which the Company refers to as variable rate floor income. All FFELP loans first originated on or after April 1, 2006 effectively earn at the SAP rate, since lenders are required to rebate fixed rate floor income and variable rate floor income for those loans to the Department.
No variable rate floor income was earned by the Company during the nine months ended September 30, 2019 and 2018. A summary of fixed rate floor income earned by the Company follows.
Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||||||||||
Fixed rate floor income, gross | $ | 12,685 | 13,659 | 33,950 | 45,359 | ||||||||||||||||||
Derivative settlements (a) | 7,064 | 19,087 | 35,931 | 46,752 | |||||||||||||||||||
Fixed rate floor income, net | $ | 19,749 | 32,746 | 69,881 | 92,111 |
(a) Includes settlement payments on derivatives used to hedge student loans earning fixed rate floor income.
Gross fixed rate floor income decreased for the three and nine months ended September 30, 2019 as compared to the same periods in 2018 due to higher interest rates in 2019 as compared to 2018.
Absent the use of derivative instruments, a rise in interest rates will reduce the amount of floor income received and this has an impact on earnings due to interest margin compression caused by increasing financing costs, until such time as the federally insured loans earn interest at a variable rate in accordance with their SAP formulas. In higher interest rate environments, where the interest rate rises above the borrower rate and fixed rate loans effectively become variable rate loans, the impact of the rate fluctuations is reduced.
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The decrease in derivative settlements from the floor income interest rate swaps for the three and nine months ended September 30, 2019 as compared to the same periods in 2018 was due to a decrease in the notional amount of derivatives outstanding, partially offset by higher interest rates in 2019 as compared to 2018.
The following graph depicts fixed rate floor income for a borrower with a fixed rate of 6.75% and a SAP rate of 2.64%:
![nni-20190930_g4.jpg](https://www.sec.gov/Archives/edgar/data/0001258602/000125860219000066/nni-20190930_g4.jpg)
The following table shows the Company’s federally insured student loan assets that were earning fixed rate floor income as of September 30, 2019.
Fixed interest rate range | Borrower/lender weighted average yield | Estimated variable conversion rate (a) | Loan balance | |||||||||||||||||
4.5 - 4.99% | 4.87 | % | 2.23 | % | $ | 223,809 | ||||||||||||||
5.0 - 5.49% | 5.22 | % | 2.58 | % | 493,537 | |||||||||||||||
5.5 - 5.99% | 5.67 | % | 3.03 | % | 328,048 | |||||||||||||||
6.0 - 6.49% | 6.19 | % | 3.55 | % | 373,744 | |||||||||||||||
6.5 - 6.99% | 6.70 | % | 4.06 | % | 367,782 | |||||||||||||||
7.0 - 7.49% | 7.17 | % | 4.53 | % | 127,786 | |||||||||||||||
7.5 - 7.99% | 7.71 | % | 5.07 | % | 226,558 | |||||||||||||||
8.0 - 8.99% | 8.18 | % | 5.54 | % | 530,678 | |||||||||||||||
> 9.0% | 9.05 | % | 6.41 | % | 200,884 | |||||||||||||||
$ | 2,872,826 |
(a) The estimated variable conversion rate is the estimated short-term interest rate at which loans would convert to a variable rate. As of September 30, 2019, the weighted average estimated variable conversion rate was 4.02% and the short-term interest rate was 221 basis points.
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The following table summarizes the outstanding derivative instruments as of September 30, 2019 used by the Company to economically hedge loans earning fixed rate floor income.
Maturity | Notional amount | Weighted average fixed rate paid by the Company (a) | ||||||||||||
2019 | $ | 500,000 | 1.12 | % | ||||||||||
2020 | 1,500,000 | 1.01 | ||||||||||||
2021 | 600,000 | 2.15 | ||||||||||||
2022 (b) | 250,000 | 1.65 | ||||||||||||
2023 | 150,000 | 2.25 | ||||||||||||
$ | 3,000,000 | 1.37 | % |
(a) For all interest rate derivatives, the Company receives discrete three-month LIBOR.
(b) These derivatives have forward effective start dates in June 2021.
The Company has also entered into interest rate cap contracts to mitigate a rise in interest rates and its impact on earnings related to its student loan portfolio earning a fixed rate. In the event that the one-month LIBOR or three-month LIBOR rate rises above the applicable strike rate, the Company would receive monthly payments related to the spread difference. The following table summarizes these derivative instruments as of September 30, 2019.
Notional Amount | Strike rate | Maturity date | ||||||||||||
$125,000 | 2.50% (1-month LIBOR) | July 15, 2020 | ||||||||||||
150,000 | 4.99 (1-month LIBOR) | July 15, 2020 | ||||||||||||
500,000 | 2.25 (3-month LIBOR) | September 25, 2020 |
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The Company is also exposed to interest rate risk in the form of basis risk and repricing risk because the interest rate characteristics of the Company’s assets do not match the interest rate characteristics of the funding for those assets. The following table presents the Company’s FFELP student loan assets and related funding for those assets arranged by underlying indices as of September 30, 2019.
Index | Frequency of variable resets | Assets | Funding of student loan assets | |||||||||||||||||
1 month LIBOR (a) | Daily | $ | 19,207,383 | — | ||||||||||||||||
3 month H15 financial commercial paper | Daily | 871,804 | — | |||||||||||||||||
3 month Treasury bill | Daily | 616,650 | — | |||||||||||||||||
1 month LIBOR | Monthly | — | 10,910,687 | |||||||||||||||||
3 month LIBOR (a) | Quarterly | — | 8,050,723 | |||||||||||||||||
Auction-rate (b) | Varies | — | 773,726 | |||||||||||||||||
Asset-backed commercial paper (c) | Varies | — | 739,448 | |||||||||||||||||
Fixed rate | — | — | 374,500 | |||||||||||||||||
Other (d) | — | 1,366,431 | 1,213,184 | |||||||||||||||||
$ | 22,062,268 | 22,062,268 |
(a) The Company has certain basis swaps outstanding in which the Company receives three-month LIBOR and pays one-month LIBOR plus or minus a spread as defined in the agreements (the "1:3 Basis Swaps"). The Company entered into these derivative instruments to better match the interest rate characteristics on its student loan assets and the debt funding such assets. The following table summarizes the 1:3 Basis Swaps outstanding as of September 30, 2019.
Maturity | Notional amount | |||||||
2020 | $ | 1,000,000 | ||||||
2021 | 250,000 | |||||||
2022 (a) | 2,000,000 | |||||||
2023 | 750,000 | |||||||
2024 | 1,750,000 | |||||||
2026 | 1,150,000 | |||||||
2027 | 250,000 | |||||||
$ | 7,150,000 |
(a) $750 million of the notional amount of these derivatives have forward effective start dates in May 2020.
The weighted average rate paid by the Company on the 1:3 Basis Swaps as of September 30, 2019 was one-month LIBOR plus 9.7 basis points.
(b) As of September 30, 2019, the Company was sponsor for $773.7 million of outstanding asset-backed securities that were set and provide for interest rates to be periodically reset via a "dutch auction" (“Auction Rate Securities”). Since the auction feature has essentially been inoperable for substantially all auction rate securities since 2008, the Auction Rate Securities generally pay interest to the holder at a maximum rate as defined by the indenture. While these rates will vary, they will generally be based on a spread to LIBOR or Treasury Securities, or the Net Loan Rate as defined in the financing documents.
(c) The interest rates on the Company's warehouse facilities are indexed to asset-backed commercial paper rates.
(d) Assets include accrued interest receivable and restricted cash. Funding represents overcollateralization (equity) and other liabilities included in FFELP asset-backed securitizations and warehouse facilities.
There is significant uncertainty regarding the availability of LIBOR as a benchmark rate after 2021, and any market transition away from the current LIBOR framework could result in significant changes to the interest rate characteristics of the Company's LIBOR-indexed assets and funding for those assets. See "Asset Generation and Management Operating Segment - Results of Operations - LIBOR Benchmark Transition" above and Item 1A, "Risk Factors - Loan Portfolio - Interest rate risk - replacement of LIBOR as a benchmark rate" in the Company's 2018 Annual Report.
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Sensitivity Analysis
The following tables summarize the effect on the Company’s earnings, based upon a sensitivity analysis performed by the Company assuming hypothetical increases in interest rates of 100 basis points and 300 basis points while funding spreads remain constant. In addition, a sensitivity analysis was performed assuming the funding index increases 10 basis points and 30 basis points while holding the asset index constant, if the funding index is different than the asset index. The sensitivity analysis was performed on the Company’s variable rate assets (including loans earning fixed rate floor income) and liabilities. The analysis includes the effects of the Company’s derivative instruments in existence during these periods.
Interest rates | Asset and funding index mismatches | ||||||||||||||||||||||||||||||||||||||||||||||
Change from increase of 100 basis points | Change from increase of 300 basis points | Increase of 10 basis points | Increase of 30 basis points | ||||||||||||||||||||||||||||||||||||||||||||
Dollars | Percent | Dollars | Percent | Dollars | Percent | Dollars | Percent | ||||||||||||||||||||||||||||||||||||||||
Three months ended September 30, 2019 | |||||||||||||||||||||||||||||||||||||||||||||||
Effect on earnings: | |||||||||||||||||||||||||||||||||||||||||||||||
Decrease in pre-tax net income before impact of derivative settlements | $ | (6,119) | (14.6) | % | $ | (12,330) | (29.4) | % | $ | (2,343) | (5.6) | % | $ | (7,029) | (16.7) | % | |||||||||||||||||||||||||||||||
Impact of derivative settlements | 6,932 | 16.5 | 20,795 | 49.6 | 1,613 | 3.8 | 4,839 | 11.5 | |||||||||||||||||||||||||||||||||||||||
Increase (decrease) in net income before taxes | $ | 813 | 1.9 | % | $ | 8,465 | 20.2 | % | $ | (730) | (1.8) | % | $ | (2,190) | (5.2) | % | |||||||||||||||||||||||||||||||
Increase (decrease) in basic and diluted earnings per share | $ | 0.02 | $ | 0.16 | $ | (0.01) | $ | (0.04) | |||||||||||||||||||||||||||||||||||||||
Three months ended September 30, 2018 | |||||||||||||||||||||||||||||||||||||||||||||||
Effect on earnings: | |||||||||||||||||||||||||||||||||||||||||||||||
Decrease in pre-tax net income before impact of derivative settlements | $ | (5,285) | (9.2) | % | $ | (10,007) | (17.6) | % | $ | (2,948) | (5.2) | % | $ | (8,843) | (15.5) | % | |||||||||||||||||||||||||||||||
Impact of derivative settlements | 15,134 | 26.5 | 45,403 | 79.6 | 1,966 | 3.5 | 5,897 | 10.3 | |||||||||||||||||||||||||||||||||||||||
Increase (decrease) in net income before taxes | $ | 9,849 | 17.3 | % | $ | 35,396 | 62.0 | % | $ | (982) | (1.7) | % | $ | (2,946) | (5.2) | % | |||||||||||||||||||||||||||||||
Increase (decrease) in basic and diluted earnings per share | $ | 0.18 | $ | 0.66 | $ | (0.02) | $ | (0.05) | |||||||||||||||||||||||||||||||||||||||
Nine months ended September 30, 2019 | |||||||||||||||||||||||||||||||||||||||||||||||
Effect on earnings: | |||||||||||||||||||||||||||||||||||||||||||||||
Decrease in pre-tax net income before impact of derivative settlements | $ | (15,042) | (11.9) | % | $ | (28,881) | (22.9) | % | $ | (7,343) | (5.8) | % | $ | (22,028) | (17.5) | % | |||||||||||||||||||||||||||||||
Impact of derivative settlements | 23,122 | 18.4 | 69,366 | 55.1 | 5,167 | 4.1 | 15,501 | 12.3 | |||||||||||||||||||||||||||||||||||||||
Increase (decrease) in net income before taxes | $ | 8,080 | 6.5 | % | $ | 40,485 | 32.2 | % | $ | (2,176) | (1.7) | % | $ | (6,527) | (5.2) | % | |||||||||||||||||||||||||||||||
Increase (decrease) in basic and diluted earnings per share | $ | 0.15 | $ | 0.77 | $ | (0.04) | $ | (0.12) | |||||||||||||||||||||||||||||||||||||||
Nine months ended September 30, 2018 | |||||||||||||||||||||||||||||||||||||||||||||||
Effect on earnings: | |||||||||||||||||||||||||||||||||||||||||||||||
Decrease in pre-tax net income before impact of derivative settlements | $ | (15,559) | (5.8) | % | $ | (27,145) | (10.1) | % | $ | (8,998) | (3.3) | % | $ | (26,993) | (10.0) | % | |||||||||||||||||||||||||||||||
Impact of derivative settlements | 47,781 | 17.7 | 143,341 | 53.2 | 5,822 | 2.2 | 17,466 | 6.6 | |||||||||||||||||||||||||||||||||||||||
Increase (decrease) in net income before taxes | $ | 32,222 | 11.9 | % | $ | 116,196 | 43.1 | % | $ | (3,176) | (1.1) | % | $ | (9,527) | (3.4) | % | |||||||||||||||||||||||||||||||
Increase (decrease) in basic and diluted earnings per share | $ | 0.60 | $ | 2.16 | $ | 0.06 | $ | 0.17 |
Financial Statement Impact – Derivatives
For a table summarizing the effect of derivative instruments in the consolidated statements of income, including the components of "derivative market value adjustments and derivative settlements, net" included in the consolidated statements of income, see note 4 of the notes to consolidated financial statements included under Part I, Item 1 of this report.
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ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company’s management, with the participation of the Company's principal executive and principal financial officers, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of September 30, 2019. Based on this evaluation, the Company’s principal executive and principal financial officers concluded that the Company's disclosure controls and procedures were effective as of September 30, 2019.
Changes in Internal Control over Financial Reporting
There were no changes in the Company’s internal control over financial reporting during the fiscal quarter ended September 30, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Effective January 1, 2019, the Company implemented ASC Topic 842, Leases. As a result, management made the following significant modifications to its internal control over financial reporting environment, including changes to accounting policies and procedures, operational processes, and documentation practices:
(a) Updated policies and procedures related to accounting for lease assets and liabilities and related income and expense.
(b) Modified contract review controls to consider the new criteria for determining whether a contract is or contains a lease, specifically to clarify the definition of a lease and align with the concept of control.
(c) Added controls for reevaluating significant assumptions and judgments regarding leases on a quarterly basis.
(d) Added controls to address related required disclosures regarding leases, including significant assumptions and judgments used in applying ASC Topic 842.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There have been no material changes from the information set forth in the Legal Proceedings section of the Company's Annual Report on Form 10-K for the year ended December 31, 2018 under Item 3 of Part I of such Form 10-K.
ITEM 1A. RISK FACTORS
There have been no material changes from the risk factors described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 in response to Item 1A of Part I of such Form 10-K.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Stock Repurchases
The following table summarizes the repurchases of Class A common stock during the third quarter of 2019 by the Company or any “affiliated purchaser” of the Company, as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934.
Period | Total number of shares purchased (a) | Average price paid per share | Total number of shares purchased as part of publicly announced plans or programs (b) | Maximum number of shares that may yet be purchased under the plans or programs (b) | ||||||||||||||||||||||
July 1 - July 31, 2019 | 843 | $ | 59.87 | — | 4,803,877 | |||||||||||||||||||||
August 1 - August 31, 2019 | — | — | — | 4,803,877 | ||||||||||||||||||||||
September 1 - September 30, 2019 | 2,522 | 67.79 | — | 4,803,877 | ||||||||||||||||||||||
Total | 3,365 | $ | 65.81 | — |
(a) The total number of shares includes shares owned and tendered by employees to satisfy tax withholding obligations upon the vesting of restricted shares. Shares of Class A common stock tendered by employees to satisfy tax withholding obligations included 843 shares, 0 shares, and 2,522 shares in July, August and September 2019, respectively. Unless otherwise indicated, shares owned and tendered by employees to satisfy tax withholding obligations were purchased at the closing price of the Company's shares on the date of vesting.
(b) On May 8, 2019, the Company announced that its Board of Directors authorized a new stock repurchase program to repurchase up to a total of five million shares of the Company's Class A common stock during the three-year period ending May 7, 2022.
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Working capital and dividend restrictions/limitations
The Company's $382.5 million unsecured line of credit, which is available through June 22, 2023, imposes restrictions on the payment of dividends through covenants requiring a minimum consolidated net worth and a minimum level of unencumbered cash, cash equivalent investments, and available borrowing capacity under the line of credit. In addition, trust indentures and other financing agreements governing debt issued by the Company's education lending subsidiaries generally have limitations on the amounts of funds that can be transferred to the Company by its subsidiaries through cash dividends at certain times. Further, the payment of dividends by the Company is subject to the terms of the Company's outstanding junior subordinated hybrid securities, which generally provide that if the Company defers interest payments on those securities it cannot pay dividends on its capital stock. These provisions do not currently materially limit the Company's ability to pay dividends, and, based on the Company's current financial condition and recent results of operations, the Company does not currently anticipate that these provisions will materially limit the future payment of dividends.
ITEM 6. EXHIBITS
10.1 | |||||
10.2* | |||||
10.3* | |||||
31.1* | |||||
31.2* | |||||
32** | |||||
101.INS* | Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | ||||
101.SCH* | Inline XBRL Taxonomy Extension Schema Document | ||||
101.CAL* | Inline XBRL Taxonomy Extension Calculation Linkbase Document | ||||
101.DEF* | Inline XBRL Taxonomy Extension Definition Linkbase Document | ||||
101.LAB* | Inline XBRL Taxonomy Extension Label Linkbase Document | ||||
101.PRE* | Inline XBRL Taxonomy Extension Presentation Linkbase Document | ||||
104* | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). | ||||
* Filed herewith | |||||
** Furnished herewith | |||||
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
NELNET, INC. | ||||||||||||||
Date: | November 7, 2019 | By: | /s/ JEFFREY R. NOORDHOEK | |||||||||||
Name: | Jeffrey R. Noordhoek | |||||||||||||
Title: | Chief Executive Officer Principal Executive Officer | |||||||||||||
Date: | November 7, 2019 | By: | /s/ JAMES D. KRUGER | |||||||||||
Name: | James D. Kruger | |||||||||||||
Title: | Chief Financial Officer Principal Financial Officer and Principal Accounting Officer |
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