NELNET, INC. 
(Management's Discussion and Analysis of Financial Condition and Results of Operations is for the three months endedMarch 31, 2020 and 2019. 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 2019 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, 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 2019 Annual Report, the "Risk Factors" section of this report, and elsewhere in this report, and include such risks and uncertainties as: •risks and uncertainties related to the severity, magnitude, and duration of the COVID-19 pandemic, including changes in the macroeconomic environment and consumer behavior, restrictions on business, individual, or travel activities intended to slow the spread of the pandemic, and volatility in market conditions resulting from the pandemic, including interest rates, the value of equities, and other financial assets; •the ability to successfully maintain and increase allocated volumes of student loans serviced under existing and any future servicing contracts with theU.S. Department of Education (the "Department"), which current contracts accounted for 30 percent of the Company's revenue in 2019, risks to the Company related to the Department's initiatives to procure new contracts for federal student loan servicing, including the pending and uncertain nature of the NextGen procurement process, the uncertain timing and nature of the outcome of the Company's protest of the reported decision by the Department as to the Company's proposal for the EPS component of NextGen, the possibility that awards or other evaluations of proposals may be challenged by various interested parties and may not be finalized within the currently 27 -------------------------------------------------------------------------------- anticipated time frame or at all, risks that the Company may not be successful in obtaining any of such potential new contracts, and risks related to the Company's ability to comply with agreements with third-party customers for the servicing of Federal Direct Loan Program, Federal Family Education Loan Program (the "FFEL Program" or "FFELP"), and private education and consumer loans; •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 FFEL Program, 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 terms of education loans and 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; •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 ofALLO Communications LLC to successfully expand its fiber network and market share in existing service areas and additional communities and manage related construction risks; •risks that the conditions to the reported approval of federal deposit insurance and an industrial bank charter forNelnet Bank may not be satisfied within a reasonable timeframe or at all, thus delaying or preventingNelnet Bank from commencing operations, and the uncertain nature of the expected benefits from obtaining an industrial bank charter, including the ability to successfully launch banking operations and achieve expected market penetration; •risks related to investments in solar projects, including risks of not being able to realize tax credits which remain subject to recapture by taxing authorities; •risks and uncertainties related to other initiatives to pursue additional strategic investments, acquisitions, and other activities, including activities that are intended to diversify the Company both within and outside of its historical core education-related businesses; 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. 28 --------------------------------------------------------------------------------
OVERVIEW
The Company is a diverse company with a purpose to serve others and a vision to make customers' dreams possible by delivering customer focused products and services. The largest operating businesses engage in 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 both within and outside of its historical core education-related businesses, including, but not limited to, investments in real estate, early-stage and emerging growth companies, and renewable energy. GAAP Net Income and Non-GAAP Net Income, Excluding AdjustmentsThe Company prepares its financial statements and presents its financial results in accordance withU.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 (loss) income to net (loss) 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 March 31, 2020 2019 GAAP net (loss) income attributable to Nelnet, Inc.$ (40,532) 41,591 Realized and unrealized derivative market value adjustments 20,602 30,574 Tax effect (a) (4,944) (7,338)
Net (loss) income attributable to
$ (24,874) 64,827 Earnings per share: GAAP net (loss) income attributable to Nelnet, Inc.$ (1.01) 1.03 Realized and unrealized derivative market value adjustments 0.52 0.76 Tax effect (a) (0.13) (0.18)
Net (loss) income attributable to
$ (0.62) 1.61 (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. GAAP net income decreased to a net loss for the three months endedMarch 31, 2020 compared to the same period in 2019 primarily due to the following factors: •The recognition of an incremental provision for loan losses totaling$63.0 million ($47.9 million after tax) related to the increase in expected defaults as a result of the COVID-19 pandemic; 29 -------------------------------------------------------------------------------- •The recognition of$34.1 million ($25.9 million after-tax) of impairment charges related to the Company's beneficial interest in consumer loan securitizations and certain venture capital investments due to adverse economic conditions resulting from the COVID-19 pandemic; •The decrease in the average balance of loans due to the amortization of the FFELP loan portfolio; •The decrease in loan spread on the Company's loan portfolio and related derivative settlements; and •The decrease in net income from the Company's Loan Servicing and Systems operating segment due to incurring additional costs to meet increased service and security standards under the Department servicing contracts. These factors were partially offset by the following items: •The recognition of a$18.2 million ($13.8 million after tax) gain from the sale of consumer loans in 2020; and •A decrease in net losses related to changes in the fair values of derivative instruments that do not qualify for hedge accounting. 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 ofMarch 31, 2020 , the Company had a$20.6 billion loan portfolio that management anticipates will amortize over the next approximately 20 years and has a weighted average remaining life of 9.8 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 asNelnet Diversified Solutions ("NDS") •Education Technology, Services, and Payment Processing ("ETS&PP") - referred to as Nelnet Business Solutions ("NBS") •Communications - referred to asALLO 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. 30 -------------------------------------------------------------------------------- The information below provides the operating results for each reportable operating segment and Corporate and Other Activities for the three months endedMarch 31, 2020 and 2019 (dollars in millions). See "Results of Operations" for each reportable operating segment under this Item 2 for additional detail. [[Image Removed: nni-20200331_g1.jpg]] (a) Revenue includes intersegment revenue. (b) Total revenue includes "net interest income" and "total other income/expense" from the Company's segment statements of operations, excluding a COVID-19 related impairment expense in 2020 of$26.3 million and 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 2020, which have impacted, will impact, or could impact the operating results of the Company, are discussed below. Impacts of COVID-19 Pandemic The rapid outbreak of the respiratory disease caused by a novel strain of coronavirus, coronavirus 2019 or COVID-19 ("COVID-19"), was declared a global pandemic by theWorld Health Organization onMarch 11, 2020 and a national emergency by the President onMarch 13, 2020 . Beginning onMarch 15, 2020 , many businesses and schools closed or reduced hours throughout theU.S. to combat the spread of COVID-19, and states and local jurisdictions implemented various containment efforts, including lockdowns on non-essential business, stay-at-home orders, and shelter-in-place orders. The COVID-19 pandemic has caused significant disruption to theU.S. and world economies, including significantly higher unemployment and underemployment, significantly lower interest rates and equity market valuations, and extreme volatility in theU.S. and world markets. As a result of the COVID-19 outbreak and federal, state, and local government responses to COVID-19, we have and may in the future experience various disruptions and impacts to our businesses and results of operations. The following provides a summary of how COVID-19 has and may impact our business and operating results. Corporate The Company has implemented adjustments to its operations designed to keep employees safe and comply with federal, state, and local guidelines, including those regarding social distancing. As ofMarch 25, 2020 , the majority of our 6,600 associates were working and continue to work from home. Substantially all Company associates working from home are able to connect to their work environment virtually and continue to serve our customers. The Company has investments in real estate, early-stage and emerging growth companies (venture capital investments), and renewable energy (solar). DuringMarch 2020 , the Company identified several venture capital investments that were negatively impacted by the distressed economic conditions resulting from the COVID-19 pandemic and recognized an impairment charge on such investments of$7.8 million (pre-tax). Loan Servicing and Systems The Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), which was signed into law onMarch 27, 2020 , among other things, provides broad relief for federal student loan borrowers. Under the CARES Act, federal student loan 31 -------------------------------------------------------------------------------- payments and interest accruals were suspended untilSeptember 30, 2020 for all borrowers that have loans owned by the Department. The Department instructed servicers to apply the benefits of the law retroactively toMarch 13, 2020 , when the President declared a state of emergency related to COVID-19. As a part of the payment suspension, student loan servicers are required to report suspended payments to credit bureaus as if the customer made their payment on-time, rather than a forbearance, which would negatively affect a customer's credit report. Although the Company will receive less revenue per borrower throughSeptember 30, 2020 based on borrower status, the Company currently anticipates more borrowers being in a current status subsequent toSeptember 30, 2020 , at which time the Company's revenue per borrower will increase. Currently, the Company anticipates no adverse impact to the total amount of revenue earned for the remainder of 2020 under the Department servicing contracts as a result of the CARES Act. However, the revenue recognized in the second and third quarters is expected to be lower and revenue in the fourth quarter is expected to be higher, than in corresponding prior periods. While federal student loan payments are suspended, the Company anticipates a decrease in operating expenses due to a significant reduction of borrower statement printing and postage costs. The Company anticipates a decrease in FFELP, private education, and consumer loan servicing revenue in future periods that are impacted by the COVID-19 pandemic due to reduced or eliminated delinquency outreach to borrowers, holds on claim filings, and reduced or eliminated late fees processing. Due to decreased servicing and transaction activity as a result of suspended payments under the CARES Act as discussed above, the Company has been able to transition associates to help government entities process unemployment claims and conduct certain health tracing support activities. These contracts were awarded to the Company as a result of the Company's technology, security, compliance, and other capabilities needed to conduct such activities. Education Technology, Services, and Payment Processing This segment has been and will continue to be impacted by COVID-19 through lower interest rate levels, which reduce earnings for this business compared to recent historical results as the tuition funds held in custody for schools produce less interest earnings. If interest rates remain at current levels, the Company anticipates this segment will earn minimal interest income in future periods. Another potential impact relates to school enrollments. As a result of COVID-19, enrollments in higher education, beginning with the summer 2020 term, and for K-12 schools, beginning with the fall 2020 academic term, could be negatively impacted. A decrease in enrollment at schools served by the Company would negatively impact schools' demand for certain of the Company's products and services, which would negatively impact the Company's revenue in future periods. Communications As a result of COVID-19, ALLO has experienced increased demand from new and existing residential customers to support connectivity needs primarily for work and learn from home applications. Along with offering 60 days free for eligible customers, ALLO has partnered with school districts to provide more connectivity to students, often at discounted rates. ALLO has signed the FCC Keep Americans Connected Pledge and will not suspend customers for non-payment, will not charge late fees, and will not apply suspension fees during the periodMarch 15, 2020 toMay 15, 2020 , which may be extended. A prolonged economic downturn as a result of the COVID-19 pandemic could adversely impact customers' ability to pay for ALLO services. However, to date the impact has been minimal as the services ALLO provides are viewed as critical by both residential and business customers. Due to losses from COVID-19, in the future some businesses may not be able to re-open, which would adversely impact ALLO's results of operations and cash flow. In view of the importance of ALLO's technicians being able to connect new customers while maintaining social distance and protecting community and associate health and safety, ALLO has adjusted operational procedures by implementing associate health checks, following CDC and local health official safety protocols, facilitating customer screening, and adjusting the installation process to limit the time in the home or business as much as possible. Asset Generation and Management AGM's results were adversely impacted during the first quarter of 2020 as a result of COVID-19 due to: •A decrease in variable loan spread due to a widening of the basis between the asset and debt indices in which the Company earns interest on its loans and funds such loans. The significant widening during the first quarter of 2020 was the result of a significant decrease in interest rates during the quarter as a result of COVID-19. In a declining interest rate environment, student loan spread is compressed, due to the timing of interest rate resets on the Company's assets occurring daily in contrast to the timing of the interest resets on the Company's debt that occurs either monthly or quarterly. As the Company's debt resets at lower interest rates during the second quarter of 2020, the Company expects variable loan spread will increase from current levels. In addition, the Company anticipates receiving increased 32 -------------------------------------------------------------------------------- levels of gross fixed rate floor income on its federal insured student loan portfolio in future periods as a result of the significant drop in interest rates inMarch 2020 . This increase will be partially offset by a decrease in net settlements received on derivatives used to hedge these loans. •A$26.3 million (pre-tax) impairment charge recognized during the quarter on the Company's beneficial interest in consumer loan securitizations. As ofMarch 31, 2020 , the Company's estimate of future cash flows from the beneficial interest in consumer loan securitizations was lower than previously anticipated due to the expectation of increased consumer loan defaults within such securitizations due to the distressed economic conditions resulting from the COVID-19 pandemic. •An incremental increase in the provision for loan losses of$63.0 million (pre-tax) resulting from an increase in expected defaults due to the COVID-19 pandemic. The CARES Act, among other things, provides broad relief, effectiveMarch 13, 2020 , for borrowers that have student loans owned by theDepartment of Education . This relief package excluded FFELP, private education, and consumer loans. Although the Company's loans are excluded from the provisions of the CARES Act, the Company is providing relief for its borrowers. For the Company's federally insured loans, the Company is proactively applying a 90 day, non-capping natural disaster forbearance to any loan that is 31-269 days past due, and to any current loan upon request. For the Company's private education loans, the Company is proactively applying a 90 day non-capping natural disaster forbearance to any loan that is 80 days past due, and to any other loan upon request. Federally insured loans in forbearance increased to$2.1 billion , or 10.6% of the portfolio atMarch 31, 2020 , compared to$1.3 billion , or 6.6% of the portfolio, as ofDecember 31, 2019 . Private education loans in forbearance increased to$11.4 million , or 4.2% of the portfolio, atMarch 31, 2020 , compared to$3.1 million , or 1.3% of the portfolio, atDecember 31, 2019 . Federally insured and private education loans in forbearance continued to increase inApril 2020 to$5.2 billion , or 26.1% of the portfolio, and$35.7 million , or 13.3% of the portfolio, as ofApril 30, 2020 , respectively. The Company anticipates that loans in forbearance will continue to increase, but at a much slower rate than in March andApril 2020 . The Company currently expects this trend to reverse in June andJuly 2020 , absent any intervening policy change, when borrowers are currently scheduled to exit forbearance. Despite the COVID-19 pandemic, most borrowers continue to make payments according to their payment plans. For private education loans, the Company is delaying final demand letters and default activity, while replacing collection calls with borrower outreach on relief options. For both federally insured and private education loans, all borrower late fees are being waived and borrower payments made afterMarch 13, 2020 are refunded upon a borrower's request. All borrower relief activity was implemented in late March andApril 2020 , using an effective date ofMarch 13, 2020 . The borrower relief activity will continue untilJuly 1, 2020 , at which time the Company will review whether such policies should continue. No negative borrower reporting will be sent to credit bureaus during this time. For the majority of the Company's consumer loans, borrowers are generally being offered, upon request, a two-month deferral of payments, with an option of additional deferrals if the COVID-19 crisis continues. In addition, all fees (non-sufficient funds, late charges, check fees) and credit bureau reporting are currently suspended. The specific relief terms on the Company's consumer loan portfolio vary depending on the loan program and servicer of such loans. The Company is not contractually committed to acquire private education or consumer loans, so the Company has been and will continue to be selective as to which, if any, loans it purchases during the current period of economic uncertainty. As a result of the economic uncertainty, the Company has identified certain opportunities to deploy capital. In March andApril 2020 , the Company purchased residual interest in certain FFELP securitizations for$3.1 million and$24.0 million , respectively. Liquidity The Company currently believes its cash and anticipated cash generated from operations will be sufficient to fund its operating expenses and business activities for the foreseeable future. In addition, the Company does not currently believe the COVID-19 pandemic will have any impact regarding compliance with covenants on any of the Company's debt facilities, including its unsecured line of credit. See further discussion regarding the Company's strong liquidity position below. Other Risks and Uncertainties The COVID-19 crisis is unprecedented and continues to evolve. The extent to which COVID-19 may impact our businesses depends on future developments, which are highly uncertain, subject to various risks, and cannot be predicted with confidence, such as the ultimate geographic spread of the disease, the duration of the outbreak, travel restrictions, stay-at-home or other similar orders and social distancing inthe United States and other countries, business and/or school closures and disruptions, 33 -------------------------------------------------------------------------------- and the effectiveness of actions taken inthe United States and other countries to contain and treat the virus. For additional information on the risks and uncertainties regarding the impacts of COVID-19, see Part II, Item 1A. "Risk Factors - The COVID-19 pandemic has adversely impacted our results of operations, and could continue to adversely impact our results of operations, as well as adversely impact our businesses, financial condition, and/or cash flows" in this report. Adoption of New Accounting Standard for Credit Losses OnJanuary 1, 2020 , the Company adopted ASU No. 2016-13, Financial Instruments - Credit Losses ("ASC 326"), which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss ("CECL") methodology. The CECL methodology utilizes a lifetime "expected credit loss" measurement objective for the recognition of credit losses for financial assets measured at amortized cost at the time the financial asset is originated or acquired. The expected credit losses are adjusted each period for changes in expected lifetime credit losses. The new guidance primarily impacted the allowance for loan losses related to the Company's loan portfolio. Upon adoption, the Company recorded an increase to the allowance for loan losses of$91.0 million , which included a reclassification of the non-accretable discount balance and premiums related to loans purchased with evidence of credit deterioration, and decreased retained earnings, net of tax, by$18.9 million . Results for reporting periods beginning afterJanuary 1, 2020 are presented under ASC 326 (recognizing estimated credit losses expected to occur over the asset's remaining life) while prior period amounts continue to be reported in accordance with previously applicable GAAP (recognizing estimated credit losses using an incurred loss model); therefore, the comparative information for 2019 is not comparable to the information presented for 2020.Department of Education NextGen Procurement Nelnet Servicing, LLC ("Nelnet Servicing"), a subsidiary of the Company, earns loan servicing revenue from a servicing contract with theDepartment of Education (the "Department"). Revenue earned by Nelnet Servicing related to this contract was$38.7 million and$39.6 million for the three months endedMarch 31, 2020 and 2019, respectively. In addition,Great Lakes Educational Loan Services, Inc. ("Great Lakes"), which was acquired by the Company onFebruary 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$46.4 million and$47.1 million for the three months endedMarch 31, 2020 and 2019, respectively. Nelnet Servicing and Great Lakes' servicing contracts with the Department previously provided for expiration onJune 16, 2019 . Nelnet Servicing and Great Lakes each received extensions from the Department on their contracts throughDecember 14, 2020 . The most current contract extensions also provide the potential for two additional six-month extensions at the Department's discretion throughDecember 14, 2021 . The Department 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. OnJanuary 15, 2019 , FSA issued solicitations for three NextGen components: •NextGen Enhanced Processing Solution ("EPS") •NextGen Business Process Operations ("BPO") •NextGen Optimal Processing Solution ("OPS") OnApril 1, 2019 andOctober 4, 2019 , the Company responded to the EPS solicitation component. OnJanuary 16, 2020 , the Department released an amendment to the EPS solicitation component and the Company responded onFebruary 3, 2020 . In addition, onAugust 1, 2019 , the Company responded to the BPO solicitation component. OnJanuary 10, 2020 , the Department released an amendment to the BPO solicitation component and the Company responded onJanuary 30, 2020 . EPS is the transitional technology system and certain processing functions the Department planned to use under NextGen to service the Department's student loan customers for a period of time before eventually moving to OPS in the future. However, onApril 3, 2020 , the Department cancelled the OPS solicitation component. BPO is the back office and call center operational functions for servicing the Department's student loan customers. OnMarch 30, 2020 , the Company received a letter from the Department notifying the Company that the Company's proposal in response to the EPS component has been determined to be outside of the competitive range and will receive no further consideration for an award. OnApril 13, 2020 , the Company filed a protest with the Government Accountability Office ("GAO") challenging the Department's decision to cancel the OPS solicitation component without amending the EPS solicitation component. In addition, onApril 27, 2020 , the Company filed a supplemental protest challenging on a number of bases the Department's competitive range exclusion of the Company's proposal from the EPS solicitation component and 34 -------------------------------------------------------------------------------- requesting that the GAO restore the Company's ability to participate in the EPS solicitation. The Department has not yet awarded a contract for the EPS component. Under applicable law, as of the date of the Company's initial protest filing, the Department is subject to a stay from awarding a contract until all protests are resolved. The Company cannot predict the timing or nature of the outcome of its protests. The Department has not yet made an award on the BPO component and the Company cannot predict the timing, nature, or outcome of the BPO solicitation. If the Department's NextGen EPS decision stands, Nelnet Servicing and Great Lakes will eventually be required to migrate their portfolios onto another provider's system after an award is made, and the Company would ultimately need to restructure the Company's loan servicing segment for long-term success. If the Company is awarded a BPO contract for operational services, it would partially mitigate the impact of not being awarded the EPS component.Nelnet Bank OnMarch 18, 2020 , the Company announced that it received notification of approval from theFederal Deposit Insurance Corporation ("FDIC") Board of Directors for federal deposit insurance and theUtah Department of Financial Institutions ("UDFI") in connection with the establishment ofNelnet Bank as aUtah -chartered industrial bank.Nelnet Bank would operate as an internet bank franchise focused on the private education loan marketplace, with a home office inSalt Lake City . The approval from theFDIC and UDFI is subject to a number of conditions, including a Capital Adequacy and Liquidity Management Agreement and a Parent Company Agreement with theFDIC and compliance with the terms of the orders from theFDIC and UDFI, respectively.Nelnet Bank will have to meet a readiness review by theFDIC and UDFI before commencing operations.Nelnet Bank is also awaiting approval of its Community Reinvestment Act Plan. A timeline has not been established for these next steps in the process.Nelnet Bank will be funded with an initial capital commitment of$100.0 million from the Company.Nelnet Bank will operate as a separate subsidiary of the Company, and the industrial bank charter will allow the Company to maintain its other diversified business offerings. Liquidity •As ofMarch 31, 2020 , the Company had cash and cash equivalents of$204.8 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$57.1 million as ofMarch 31, 2020 . •The Company has a$455.0 million unsecured line of credit with a maturity date ofDecember 16, 2024 . As ofMarch 31, 2020 , the unsecured line of credit had$100.0 million outstanding and$355.0 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$550.0 million , subject to certain conditions. •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 ofMarch 31, 2020 , the Company currently expects future undiscounted cash flows from its securitization portfolio to be approximately$2.27 billion , of which approximately$1.57 billion will be generated over the next six years. •During the first three months of 2020, the Company completed three FFELP asset-backed securitizations totaling$1.1 billion . •As ofMarch 31, 2020 , the Company had$767.5 million ,$114.5 million , and$132.9 million of capacity under its FFELP, private education, and consumer loan warehouse facilities, respectively, to purchase additional loans. •The Company has a stock repurchase program to purchase up to a total of five million shares of the Company's Class A common stock during the three-year period endingMay 7, 2022 . Year to date, throughMay 7, 2020 , the Company has repurchased 791,104 shares of stock for$35.4 million ($44.73 per share). As ofMay 7, 2020 , 4.0 million shares remained authorized for repurchase under the Company's stock repurchase program. •The Company paid a first quarter 2020 cash dividend on the Company's Class A and Class B common stock of$0.20 per share. In addition, the Company's Board of Directors has declared a second quarter 2020 cash dividend on the Company's outstanding shares of Class A and Class B common stock of$0.20 per share. The second quarter cash dividend will be paid onJune 15, 2020 to shareholders of record at the close of business onJune 1, 2020 . The Company intends to use its strong liquidity position to capitalize on market opportunities, including FFELP, private education, and consumer loan acquisitions; strategic acquisitions and investments; expansion of ALLO's telecommunications 35 -------------------------------------------------------------------------------- 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. CONSOLIDATED RESULTS OF OPERATIONS An analysis of the Company's operating results for the three months endedMarch 31, 2020 compared to the same period in 2019 is provided below. The Company's operating results are primarily driven by the performance of its existing loan 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. Three months ended March 31, 2020 2019 Additional information Decrease was due primarily to decreases in the gross yield earned on loans and the average balance of loans, partially offset by an increase in fixed rate floor income due to lower interest rates in 2020 as compared Loan interest$ 181,793 242,333 to 2019. Includes income from unrestricted interest-earning deposits and investments and funds in asset-backed securitizations. Decrease was due to a decrease in Investment interest 7,398 8,253 interest rates. Total interest income 189,191 250,586 Decrease was due primarily to a decrease in cost of funds and a decrease in the average balance of debt Interest expense 134,118 191,770 outstanding. Net interest income 55,073 58,816 See table below for additional analysis. Increase was due to the increase in expected defaults as a result of the COVID-19 pandemic and an increased provision for loan losses on loans acquired in 2020 to reflect life of loan expected losses as compared to loans acquired during the first quarter of 2019 for which the provision for loan losses was Less provision for loan losses 76,299 7,000 recognized based upon an incurred loss methodology. Net interest income after provision for loan losses (21,226) 51,816 Other income/expense: LSS revenue 112,735 114,898 See LSS operating segment - results of operations. See ETS&PP operating segment - results of ETS&PP revenue 83,675 79,159 operations. See Communications operating segment - results of Communications revenue 18,181 14,543 operations. The Company sold a portfolio of consumer loans in 2020 Gain on sale of loans 18,206 - and recognized a gain of$18.2 million . See table below for the components of "other Other income 8,281 9,067 income." 2020 amount represents COVID-19 related impairments of$26.3 million and$7.8 million to the beneficial interest in consumer loan securitization investments Impairment expense (34,087) - and several venture capital investments, respectively. 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 Derivative settlements, net 4,237 19,035 additional analysis. 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. During the first quarter of 2020 and 2019, there was a significant decrease in the forward yield curve resulting in a decrease in the fair value of the Company's floor income interest rate swaps that resulted in a loss in both periods. Although the decrease in the forward yield curve was more substantial in 2020 as compared to 2019, the notional amount of derivatives outstanding during 2020 was Derivative market value adjustments, net (20,602) (30,574) much lower than compared to 2019. Total other income/expense 190,626 206,128 Cost of services: Cost to provide education technology, Represents primarily direct costs to provide payment services, and payment processing services 22,806 21,059 processing services in the ETS&PP operating segment. Represents costs of services primarily associated with television programming costs in the Cost to provide communications services 5,582 4,759 Communications operating segment. 36 -------------------------------------------------------------------------------- Total cost of services 28,388 25,818
Operating expenses:
Increase was due to (i) increases in personnel in
the LSS and corporate operating segments to meet
increased service and security standards under the
Department servicing contracts; (ii) increases in
personnel in the LSS operating segment to develop
a new private education and consumer loan
servicing system; (iii) increases in personnel to
support the growth in revenue and the development
of new technologies in the ETS&PP operating
segment; and (iv) increases in personnel at ALLO
to support customer and network expansion. See
each individual operating segment results of Salaries and benefits
119,878 111,059 operations discussion for additional information.
Increase was primarily due to additional
Depreciation and amortization 27,648 24,213 depreciation expense at ALLO.
Other expenses includes expenses necessary for
operations, such as postage and distribution,
consulting and professional fees, occupancy,
communications, and certain information
technology-related costs. See each individual
operating segment results of operations discussion Other expenses
43,384 43,816 for additional information.
Total operating expenses 190,910 179,088
(Loss) income before income taxes (49,898) 53,038
The effective tax rate was 20.0% and 21.5% for the
three months ended March 31, 2020 and 2019,
respectively. The Company currently expects its
effective tax rate for 2020 will range between 20
Income tax benefit (expense) 10,133 (11,391) and 23 percent.
Net (loss) income (39,765) 41,647
Net income attributable to
noncontrolling interests (767) (56)
Net (loss) income attributable to
Nelnet, Inc. $ (40,532) 41,591
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 2020 and 2019 periods presented in the table
under the caption "Consolidated Financial Statement Impact Related to
Derivatives - Statements of Operations" in note 4 and in the table below.
37
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Three months ended March 31,
2020 2019 Additional information
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 -
Variable loan interest margin $ 30,367 43,951 results of operations.
Represents the net settlements received related to the
Settlements on associated derivatives 2,112 2,334 Company's 1:3 basis swaps.
Variable loan interest margin, net of
settlements on derivatives 32,479 46,285
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
Fixed rate floor income 18,758 10,425 Risk - Interest Rate Risk" for additional information.
Represents the net settlements received related to the
Settlements on associated derivatives 2,125 16,701 Company's floor income interest rate swaps.
Fixed rate floor income, net of
settlements on derivatives 20,883 27,126
Investment interest 7,398 8,253
Includes interest expense on the Junior Subordinated
Hybrid Securities and unsecured line of credit.
Decrease due to a decrease in interest rates and in the
average balance outstanding on the Company's unsecured
Corporate debt interest expense (1,450) (3,813) line of credit.
Net interest income (net of
settlements on derivatives) $ 59,310 77,851
The following table summarizes the components of "other income."
Three months ended March 31,
2020 2019
Borrower late fee income (a) $ 3,188 3,512
Investment advisory services (b) 2,802 711
Management fee revenue (c) 2,243 1,872
Gain (loss) on investments, net (3,864) (427)
Other 3,912 3,399
Other income $ 8,281 9,067
(a) Represents borrower late fees earned by the AGM operating segment. The
Company anticipates borrower late fees will decrease in future periods impacted
by the COVID-19 pandemic as a result of borrower relief initiatives.
(b) The Company provides investment advisory services through Whitetail Rock
Capital Management, LLC ("WRCM"), the Company's SEC -registered investment
advisor subsidiary, under various arrangements. WRCM earns annual fees of 25
basis points on the majority of the outstanding balance of asset-backed
securities under management and up to 50 percent of the gains from the sale of
asset-backed securities or asset-backed securities being called prior to the
full contractual maturity for which it provides advisory services. As of March
31, 2020 , the outstanding balance of asset-backed securities under management
subject to these arrangements was $1.1 billion . In addition, WRCM earns annual
management fees of five basis points for certain other investments under
management. The increase in advisory fees in 2020 as compared to 2019 was the
result of an increase in performance fees earned.
(c) Represents revenue earned from providing administrative support and
marketing services primarily to Great Lakes' former parent company in accordance
with a contract that expires in January 2021 . The amount also includes revenue
earned from marketing services provided to other customers, which increased for
the three months ended March 31, 2020 as compared to the same period in 2019.
38
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LOAN SERVICING AND SYSTEMS OPERATING SEGMENT - RESULTS OF OPERATIONS
Loan Servicing Volumes
As of
December 31, March 31, June 30, September 30, December 31, March 31,
2018 2019 2019 2019 2019 2020
Servicing volume (dollars in
millions):
Nelnet:
Government $ 179,507 183,093 181,682 184,399 183,790 185,477
FFELP 36,748 35,917 35,003 33,981 33,185 32,326
Private and consumer 15,666 16,065 16,025 16,286 16,033 16,364
Great Lakes:
Government 232,694 237,050 236,500 240,268 239,980 243,205
Total $ 464,615 472,125 469,210 474,934 472,988 477,372
Number of servicing borrowers:
Nelnet:
Government 5,771,923 5,708,582 5,592,989 5,635,653 5,574,001 5,498,872
FFELP 1,709,853 1,650,785 1,588,530 1,529,392 1,478,703 1,423,286
Private and consumer 696,933 699,768 693,410 701,299 682,836 670,702
Great Lakes:
Government 7,458,684 7,385,284 7,300,691 7,430,165 7,396,657 7,344,509
Total 15,637,393 15,444,419 15,175,620 15,296,509 15,132,197 14,937,369
Number of remote hosted
borrowers: 6,393,151 6,332,261 6,211,132 6,457,296 6,433,324 6,354,158
Nelnet Servicing and Great Lakes' servicing contracts with the Department
previously provided for expiration on June 16, 2019 . Nelnet Servicing and Great
Lakes each received extensions from the Department on their contracts through
December 14, 2020 . The most current contract extensions also provide the
potential for two additional six-month extensions at the Department's discretion
through December 14, 2021 . The Department is conducting a contract procurement
process for a new framework for the servicing of all student loans owned by the
Department. See "Overview - Department of Education NextGen Procurement " above
for additional information.
39
--------------------------------------------------------------------------------Summary and Comparison of Operating Results
Three months ended March 31,
2020 2019 Additional information
Decrease was due to lower interest rates in 2020 as
Net interest income $ 273 497 compared to 2019.
Loan servicing and systems
revenue 112,735 114,898 See table below for additional information.
Represents revenue earned by the LSS operating segment
as a result of servicing loans for the AGM operating
segment. Decrease was due to the expected amortization
of AGM's FFELP portfolio. FFELP intersegment servicing
revenue will continue to decrease as AGM's FFELP
Intersegment servicing revenue 11,054 12,217 portfolio pays off.
Represents revenue earned from providing administrative
support and marketing services primarily to Great Lakes'
former parent company in accordance with a contract that
expires in January 2021. Increase was due to an increase
Other income 2,630 2,074 in marketing services provided to other customers.
Total other income 126,419 129,189
Increase was due to an increase in headcount to provide
enhanced service levels to borrowers under the Department
servicing contracts, and to develop a new private
Salaries and benefits 70,493 66,220 education and consumer loan servicing system.
Depreciation and amortization 8,848 8,871
Decrease was due to cost-savings as a result of an
increase in electronic borrower statements and
correspondence and a decrease in the provision for
Other expenses 17,489 18,928 servicing losses.
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. Increase was due to an increase
in security service levels related to the Department
Intersegment expenses 16,239 13,758 servicing contracts.
Total operating expenses 113,069 107,777
Income before income taxes 13,623 21,909
Represents income tax expense at an effective tax rate
Income tax expense (3,269) (5,258) of 24%.
Net income $ 10,354 16,651
The LSS segment incurred additional costs during the
period ended March 31, 2020 to meet increased service and
security standards under the Department servicing
contracts. As a result, the segment's net income and
operating margin decreased compared to the same period inBefore tax operating margin 10.8 % 17.0 % 2019.
Loan servicing and systems revenue
Three months ended March 31,
2020 2019 Additional information
Represents revenue from Nelnet Servicing's
Department servicing contract. Decrease was due to a
decrease in the borrowers serviced and a decrease in
revenue from the administration of the Total and
Permanent Disability (TPD) Discharge program and
fees earned from the Department for originating
Government servicing - Nelnet $ 38,650 39,640 consolidation loans.
Represents revenue from the Great Lakes' Department
Government servicing - Great servicing contract. Decrease was due to a decrease
Lakes 46,446 47,077 in the number of borrowers serviced.
Decrease was due to the change in portfolio mix of
private education and consumer loans, partially
Private education and consumer offset by an increase in loan servicing volume from
loan servicing 8,609 9,480 existing and new clients.
Decrease was due to portfolio amortization. Over
time, FFELP servicing revenue will continue to
decrease as third-party customers' FFELP portfolios
pay off. Revenue earned by the LSS operating segment
for servicing loans for the AGM operating segment is
FFELP servicing 5,614 6,695 included in "intersegment servicing revenue."
Increase was due to an increase in borrowers and
services in which the Company provides hosted FFELP
Software services 11,318 9,741 guarantee activities.
The majority of this revenue relates to providing
Outsourced services and other 2,098 2,265 contact center outsourcing activities.
Loan servicing and systems
revenue $ 112,735 114,898
40
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EDUCATION TECHNOLOGY, SERVICES, AND PAYMENT PROCESSING OPERATING SEGMENT -
RESULTS OF OPERATIONS
As discussed further in the Company's 2019 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.
Summary and Comparison of Operating Results
Three months ended March 31,
2020 2019 Additional information
Decrease was due to a decrease in interest rates in 2020
as compared with 2019, including the significant drop in
interest rates in March 2020 as a result of the COVID-19
pandemic. The decrease in interest income was partially
offset by an increase in average cash balances. If
interest rates remain at current levels, the Company
anticipates this segment will earn minimal interest
Net interest income $ 1,974 2,009 income in future periods.
Education technology, services,
and payment processing revenue 83,675 79,159 See table below for additional information.
Intersegment revenue 11 -
Total other income 83,686 79,159
Cost to provide education
technology, services, and payment
processing services 22,806 21,059 See table below for additional information.
Increase was due to an increase in the average salaries
and benefits cost per associate. In addition, the
operating segment had an increase in headcount to
support the growth of its customer base and investment
in the development of new technologies. These increases
were partially offset by a decrease in headcount due to
operating efficiencies gained related to the acquisition
Salaries and benefits 23,696 23,008 of TMS in November 2018.
Amortization of intangible assets related to business
acquisitions was $2.2 million and $3.3 million for the
three months ended March 31, 2020 and 2019,
Depreciation and amortization 2,387 3,510 respectively.
Increase was due to an additional expense to increase
allowance for doubtful accounts for the increased risk
of uncollectible balances due to distressed economic
conditions resulting from the COVID-19 pandemic.
Increase was partially offset by a decrease in travel
Other expenses 6,092 5,311 expenses in 2020 compared to 2019, due to COVID-19.
Intersegment expenses represent costs for certain
corporate activities and services that are allocated
to each operating segment based on estimated use of
Intersegment expenses, net 3,327 3,299 such activities and services.
Total operating expenses 35,502 35,128
Income before income taxes 27,352 24,981
Represents income tax expense at an effective tax rate
Income tax expense (6,565) (5,995) of 24%.
Net income $ 20,787 18,986
41--------------------------------------------------------------------------------
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 March 31,
2020 2019 Additional information
Increase was due to an increase in the number of
managed tuition payment plans. Revenue recognized
during the first quarter of 2020 is primarily
related to payment plans for the 2019-2020 academic
year for K-12 schools and the spring 2020 semester
for institutions of higher education. Fees for these
payment plans were received and are based on school
enrollments prior to the conditions arising from the
COVID-19 pandemic. As a result of COVID-19,
enrollments in higher education, beginning with the
summer 2020 term, and for K-12 schools, beginning
with the fall 2020 academic term, could be
negatively impacted. A decrease in enrollment at
schools in which the Company serves would negatively
impact tuition payment plan revenue in future
Tuition payment plan services $ 31,587 30,173 periods.
Increase was the result of higher payment volumes
processed by payment technologies from new and
existing school and non-education customers. Growth
in revenues from payment processing could be
impacted in future periods as a result of the
COVID-19 pandemic. A decline in enrollment in
institutions served may result in a corresponding
Payment processing 31,742 28,979 decline in the volume of payments processed.
Increase was due to an increase from FACTS Student
Information System ("SIS") software subscriptions.
Growth in FACTS SIS revenues were partially offset
by growth rate declines in financial needs
assessment and online enrollment and application
revenues experienced in March 2020 which coincided
with the closures of K-12 schools due to the
COVID-19 pandemic. The COVID-19 pandemic could
negatively impact enrollments and schools' demand
for certain of the Company's products and services,
which would negatively impact the Company's revenue
Education technology and services 20,054 19,709 in future periods.
Other 292 298
Education technology, services,
and payment processing revenue 83,675 79,159
Costs primarily relate to payment processing
Cost to provide education revenue. Increase was due to an increase in payments
technology, services, and payment volume from new and existing school and
processing services 22,806 21,059 non-education customers.
Net revenue $ 60,869 58,100
Before tax operating margin 44.9 % 43.0 %
42--------------------------------------------------------------------------------
COMMUNICATIONS OPERATING SEGMENT - RESULTS OF OPERATIONS Summary and Comparison of Operating Results
Three months ended March 31,
2020 2019 Additional information
Net interest income (expense) $ - 2
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 due to additional residential households and
businesses served as a result of the completion of the
Lincoln, Nebraska network build out in 2019 and
continued maturity of ALLO's existing markets. See
additional financial and operating data for ALLO in the
Communications revenue 18,181 14,543 tables below.
Other income 353 125
Total other income 18,534 14,668
Cost of services are primarily associated with
television programming costs. Other costs include
connectivity, franchise, and other regulatory costs
Cost to provide communications directly related to providing internet and voice
services 5,582 4,759 services.
Increase was due to additional residential households and
Salaries and benefits 5,416 4,737 businesses served.
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
March 31, 2020, December 31, 2019, March 31, 2019, and
December 31, 2018 were $322.5 million , $315.3 million ,
$285.8 million and $273.9 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
Depreciation and amortization 10,507 7,362 lives.
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 an increase in the number of
households and businesses served in 2020 as compared to
Other expenses 3,689 3,477 2019.
Intersegment expenses represent costs for certain
corporate activities and services that are allocated to
each operating segment based on estimated use of such
Intersegment expenses 624 664 activities and services.
Total operating expenses 20,236 16,240
Loss before income taxes (7,284) (6,329)
Represents income tax benefit at an effective tax rate
Income tax benefit 1,748 1,519 of 24%.
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
Net loss $ (5,536) (4,810) upfront customer acquisition costs.
Additional information: Net loss$ (5,536) (4,810) Net interest (income) expense - (2) Income tax benefit (1,748) (1,519) Depreciation and amortization 10,507 7,362 Earnings before interest, income taxes, depreciation, and For additional information regarding this non-GAAP amortization (EBITDA)$ 3,223 1,031 measure, see the table below. 43
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Certain financial and operating data for ALLO is summarized in the tables below.
Three months ended March 31,
2020 2019
Residential revenue $ 13,559 74.6 % $ 11,065 76.1 %
Business revenue 4,471 24.6 3,414 23.5
Other revenue 151 0.8 64 0.4
Communications revenue $ 18,181 100.0 % $ 14,543 100.0 %
Internet $ 11,199 61.6 % $ 8,449 58.1 %
Television 4,236 23.3 3,898 26.8
Telephone 2,691 14.8 2,167 14.9
Other 55 0.3 29 0.2
Communications revenue $ 18,181 100.0 % $ 14,543 100.0 %
Net loss $ (5,536) (4,810)
EBITDA (a) 3,223 1,031
Capital expenditures 7,163 11,958
As of As of As of As of As of As of
March 31, December 31, September 30, June 30, March 31, December 31,
2020 2019 2019 2019 2019 2018
Residential customer information:
Households served 49,684 47,744 45,228 42,760 40,338 37,351
Households passed (b) 143,505 140,986 137,269 132,984 127,253 122,396
Households served/passed 34.6 % 33.9 % 32.9 % 32.2 % 31.7 % 30.5 %
Total households in current
markets and new markets announced
(c) 171,121 160,884 159,974 159,974 152,840 152,840
(a) Earnings 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 . During the fourth
quarter of 2019, ALLO announced plans to expand its network to make services
available in Imperial, Nebraska . During the first quarter of 2020, ALLO
announced plans to expand its network to make services available in Norfolk,
Nebraska . ALLO is now in twelve communities, including ten in Nebraska and two
in Colorado .
44
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ASSET GENERATION AND MANAGEMENT OPERATING SEGMENT - RESULTS OF OPERATIONS
Loan Portfolio
As of March 31, 2020 , the Company had a $20.6 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 9.8 years. For a summary of the Company's loan portfolio as of March 31, 2020
and December 31, 2019 , 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 March 31,
2020 2019
Beginning balance $ 20,798,719 22,520,498
Loan acquisitions:
Federally insured student loans 349,061 270,015
Private education loans 47,605 -
Consumer loans 62,831 70,121
Total loan acquisitions 459,497 340,136
Repayments, claims, capitalized interest, and other (312,579) (504,720)
Consolidation loans lost to external parties (216,327) (273,271)
Consumer loans sold (124,245) -
Ending balance $ 20,605,065 22,082,643
Allowance for Loan Losses and Loan Delinquencies
On January 1, 2020 , the Company adopted ASU No. 2016-13, Financial Instruments -
Credit Losses ("ASC 326"), which replaces the incurred loss methodology with an
expected loss methodology that is referred to as the current expected credit
loss ("CECL") methodology.
The CECL methodology utilizes a lifetime "expected credit loss" measurement
objective for the recognition of credit losses for financial assets measured at
amortized cost at the time the financial asset is originated or acquired. The
expected credit losses are adjusted each period for changes in expected lifetime
credit losses.
Upon adoption, the Company recorded an increase to the allowance for loan losses
of $91.0 million , which included a reclassification of the non-accretable
discount balance and premiums related to loans purchased with evidence of credit
deterioration, and decreased retained earnings, net of tax, by $18.9 million .
Results for reporting periods beginning after January 1, 2020 are presented
under ASC 326 (recognizing estimated credit losses expected to occur over the
asset's remaining life) while prior period amounts continue to be reported in
accordance with previously applicable GAAP (recognizing estimated credit losses
using an incurred loss model); therefore, the comparative information for 2019
is not comparable to the information presented for 2020.
Management has determined that each of the federally insured, private education,
and consumer loan portfolios meet the definition of a portfolio segment, which
is defined as the level at which an entity develops and documents a systematic
method for determining its allowance for credit losses.
For a summary of the activity in the allowance for loan losses for the three
months ended March 31, 2020 and 2019, and a summary of the Company's loan status
and delinquency amounts as of March 31, 2020 , December 31, 2019 , and March 31,
2019 , see note 2 of the notes to consolidated financial statements included
under Part 1, Item 1 of this report.
Provision for loan losses was $76.3 million and $7.0 million for the three
months ended March 31, 2020 and 2019, respectively. The increase in the
provision for loan losses in 2020 as compared to 2019 was due to an incremental
provision in 2020 of $63.0 million for the increase in expected defaults as a
result of the COVID-19 pandemic and an increased provision for loan losses on
loans acquired in 2020 to reflect life of loan expected losses as compared to
loans acquired during the first quarter of 2019 in which the provision for loan
losses was recognized based upon an incurred loss methodology.
45
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The Company's total allowance for loan losses of $208.9 million at March 31,
2020 represents reserves equal to 0.7% of the Company's federally insured loans
(or 29.1% of the risk sharing component of the loans that is not covered by the
federal guaranty), 8.4% of the Company's private education loans, and 26.8% of
the Company's consumer loans.
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, net of settlements on derivatives" below, divided by the average balance
of loans or debt outstanding.
Three months ended
2020 2019
Variable loan yield, gross 3.98 % 5.04 %
Consolidation rebate fees (0.83) (0.84)
Discount accretion, net of premium and deferred origination costs amortization
0.01 0.03
Variable loan yield, net 3.16 4.23
Loan cost of funds - interest expense (2.58) (3.47)
Loan cost of funds - derivative settlements (a) (b) 0.04 0.04
Variable loan spread 0.62 0.80
Fixed rate floor income, gross 0.36 0.19
Fixed rate floor income - derivative settlements (a) (c) 0.04 0.31
Fixed rate floor income, net of settlements on derivatives 0.40 0.50
Core loan spread (d) 1.02 % 1.30 %
Average balance of loans $ 20,793,758 22,313,270
Average balance of debt outstanding 20,616,771 21,989,065
(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 2020 and 2019 periods presented in the table under the
caption "Consolidated Financial Statement Impact Related to Derivatives -
Statements of Operations" in note 4 and in this table.
A reconciliation of core loan spread, which includes the impact of derivative
settlements on loan spread, to loan spread without
derivative settlements follows.
Three months ended March 31,
2020 2019
Core loan spread 1.02 % 1.30 %
Derivative settlements (1:3 basis swaps) (0.04) (0.04)
Derivative settlements (fixed rate floor income) (0.04) (0.31)
Loan spread 0.94 % 0.95 %
(b) Derivative settlements consist of net settlements received related to the
Company's 1:3 basis swaps.
(c) Derivative settlements consist of net settlements received related to the
Company's floor income interest rate swaps.
(d) Core loan spread, excluding consumer loans, would have been 0.97% and 1.22%
for the three months ended March, 31, 2020
and 2019, respectively.
46
--------------------------------------------------------------------------------A trend analysis of the Company's core and variable loan spreads is summarized below.
[[Image Removed: nni-20200331_g2.jpg]]
(a) The interest earned on a large portion of the Company's FFELP student loan
assets is indexed to the one-month LIBOR rate. The Company funds a 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 decreased during the three months ended March 31, 2020 as
compared to the same period in 2019 due to a widening of the basis between the
asset and debt indices in which the Company earns interest on its loans and
funds such loans (as reflected in the table above). The significant widening
during the first quarter of 2020 was the result of a significant decrease in
interest rates during March 2020 . In a declining interest rate environment,
student loan spread is compressed, due to the timing of interest rate resets on
the Company's assets occurring daily in contrast to the timing of the interest
resets on the Company's debt that occurs either monthly or quarterly. As the
Company's debt resets at lower interest rates during the second quarter of 2020,
the Company expects variable loan spread to increase from current levels. 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.
The difference between variable loan spread and core loan spread is fixed rate
floor income earned on a portion of the Company's federally insured student loan
portfolio. A summary of fixed rate floor income and its contribution to core
loan spread follows:
Three months ended
2020 2019
Fixed rate floor income, gross $ 18,758 10,425
Derivative settlements (a) 2,125 16,701
Fixed rate floor income, net $ 20,883 27,126
Fixed rate floor income contribution to spread, net 0.40 % 0.50 %
(a) Includes settlement payments on derivatives used to hedge student loans earning fixed rate floor income.
47
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The increase in gross fixed rate floor income for the three months ended March
31, 2020 compared to the same period in 2019 was due to lower interest rates in
2020 as compared to 2019. 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. The decrease in
derivative settlements from the floor income interest rate swaps in 2020 as
compared to 2019 was due to a decrease in the notional amount of derivatives
outstanding and a decrease in interest rates. The Company anticipates receiving
increased levels of gross fixed rate floor income in future periods as a result
of the significant drop in interest rates in March 2020 . This increase will be
partially offset by a decrease in net settlements received on derivatives used
to hedge these loans. 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.
Interest Rate Risk - Replacement of LIBOR as a Benchmark Rate
As of March 31, 2020 , the interest earned on a principal amount of $18.8 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 $18.5 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. 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.
See Item 1A, "Risk Factors - Loan Portfolio - Interest rate risk - replacement
of LIBOR as a benchmark rate" in the Company's 2019 Annual Report.
48--------------------------------------------------------------------------------
Summary and Comparison of Operating Results
Three months ended March 31,
2020 2019 Additional information
Net interest income after provision
for loan losses $ (23,622) 51,068 See table below for additional analysis.
The Company sold a portfolio of consumer loans in 2020
Gain on sale of loans 18,206 - and recognized a gain of $18.2 million .
Represents primarily borrower late fees. The Company
anticipates borrower late fees will decrease in future
periods impacted by the COVID-19 pandemic as a result of
Other income 3,215 3,525 borrower relief initiatives.
The 2020 amount represents impairment of the Company's
beneficial interest in consumer loan securitization
investments. See note 5 of the notes to consolidated
financial statements included under Part I, Item 1 of
Impairment expense (26,303) - this report.
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
Derivative settlements, net 4,237 19,035 below.
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. During the first quarter of
2020 and 2019, there was a significant decrease in the
forward yield curve resulting in a decrease in the fair
value of the Company's floor income interest rate swaps
that resulted in a loss in both periods. Although the
decrease in the forward yield curve was more
substantial in 2020 as compared to 2019, the notional
Derivative market value adjustments, amount of derivatives outstanding during 2020 was much
net (20,602) (30,574) lower than compared to 2019.
Total other income/expense (21,247) (8,014)
Salaries and benefits 443 378
The primary component of other expenses is servicing fees
Other expenses 3,717 3,837 paid to third parties.
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
Intersegment expenses 11,916 12,287 use of such activities and services.
Total operating expenses, excluding the 2020 impairment
of the Company's beneficial interest in consumer loan
securitizations, were 31 basis points and 30 basis points
of the average balance of loans for the three months
Total operating expenses 16,076 16,502 ended March 31, 2020 and 2019, respectively.
(Loss) income before income taxes (60,945) 26,552
Represents income tax benefit (expense) at an effective
Income tax benefit (expense) 14,627 (6,372) tax rate of 24%.
Net (loss) income $ (46,318) 20,180
Additional information:
Net (loss) income $ (46,318) 20,180
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 to a net loss for the three months ended
March 31, 2020 as compared to the same period in 2019
was due to (i) the impairment of the Company's
beneficial interest in consumer loan securitizations
recognized in 2020; (ii) the decrease in core loan
Derivative market value adjustments, spread and the average balance of loans in 2020 as
net 20,602 30,574 compared to 2019; (iii) an incremental provision for
loan losses in 2020 of $63.0 million (pre-tax) related
to the increase in expected defaults as a result of the
COVID-19 pandemic; and (iv) an increased provision for
loan losses on loans acquired in 2020 to reflect life
of loan expected losses as compared to loans acquired
Tax effect (4,944) (7,338) during the first quarter of 2019 for which the
provision for loan losses was recognized based upon an
incurred loss methodology. These items were partially
offset by a $18.2 million (pre-tax) gain in 2020 from
the sale of consumer loans.
Net (loss) income, excluding
derivative market value adjustments $ (30,660) 43,416
49
--------------------------------------------------------------------------------Net interest income, 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 March 31,
2020 2019 Additional information
Decrease was due to a decrease in the gross yield
earned on loans and a decrease in the average
Variable interest income, gross $ 205,512 277,024 balance of loans.
Decrease was due to a decrease in the average
Consolidation rebate fees (43,137) (46,491) consolidation loan balance.
Net discount accretion is due to the Company's
Discount accretion, net of premium and purchases of loans at a net discount over the last
deferred origination costs amortization 660 1,375 several years.
Variable interest income, net 163,035 231,908
Decrease was due to a decrease in cost of funds
and a decrease in the average balance of debt
Interest on bonds and notes payable (132,668) (187,957) outstanding.
Derivative settlements include the net
settlements received related to the Company's 1:3
Derivative settlements, net (a) 2,112 2,334 basis swaps.
Variable loan interest margin, net of
settlements on derivatives (a) 32,479 46,285
Fixed rate floor income increased due to lower
Fixed rate floor income, gross 18,758 10,425 interest rates in 2020 as compared to 2019.
Derivative settlements include the settlements
received related to the Company's floor income
interest rate swaps. Decrease in settlements was
due to a decrease in the notional amount of
derivatives outstanding and lower interest rates in
Derivative settlements, net (a) 2,125 16,701 2020 as compared to 2019.
Fixed rate floor income, net of
settlements on derivatives 20,883 27,126
Core loan interest income (a) 53,362 73,411
Decrease was due to lower interest rates in 2020 as
Investment interest 4,133 4,534 compared to 2019.
Intercompany interest (581) (842)
Provision for loan losses - federally See "Allowance for Loan Losses and Loan
insured loans (39,323) (2,000) Delinquencies" included above under "Asset
Provision for loan losses - private Generation and Management Operating Segment -
education loans (9,800) - Results of Operations."
Provision for loan losses - consumer
loans (27,176) (5,000)
Excluding the incremental provision for loan losses
in 2020 of $63.0 million related to the increase in
expected defaults as a result of the COVID-19
pandemic, net interest income after provision for
loan losses (net of settlements on derivatives) for
the three months ended March 31, 2020 would have
Net interest income after provision for been $43.6 million . This decrease was due to a
loan losses (net of settlements on decrease in core loan spread and the average
derivatives) (a) $ (19,385) 70,103 balance of loans in 2020 as compared to 2019.
(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 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 2020
and 2019 periods presented in the table under the caption "Consolidated
Financial Statement Impact Related to Derivatives - Statements of Operations" in
note 4 and in this table.
50
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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 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 Company's Communications operating segment.
Sources of Liquidity
As of March 31, 2020 , the Company had cash and cash equivalents of $204.8
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 $57.1 million as of March 31, 2020 .
The Company also has a $455.0 million unsecured line of credit that matures on
December 16, 2024 . As of March 31, 2020 , there was $100.0 million outstanding on
the unsecured line of credit and $355.0 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 $550.0 million , subject to certain conditions. In addition, the
Company has a $22.0 million secured line of credit agreement that matures on
May 30, 2022 . As of March 31, 2020 , the secured line of credit had $5.0 million
outstanding and $17.0 million was available for future use.
In addition, 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 March 31, 2020 , 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
On a calendar year annual basis, the Company has historically generated positive
cash flow from operations.
As part of the Company's Education Technology, Services, and Payment Processing
operating segment, the Company collects tuition payments and subsequently remits
these payments to the appropriate schools. Cash collected for customers and the
related liability are included in the Company's consolidated balance sheet.
These accounts fluctuate with the fall and spring school terms based on the
timing of when the Company collects tuition payments from customers and remits
such payments to schools, resulting in these balances being significantly lower
as of March 31 as compared to the balances as of December 31 . The "due to
customers" liability account decreased $217.9 million and $153.2 million for the
three months ended March 31, 2020 and 2019, respectively. These decreases
negatively impacted cash used in operating activities in the Company's
consolidated statements of cash flows for these periods.
During the three months ended March 31, 2020 , the Company used $144.5 million in
operating activities, compared to using $139.7 million for the same period in
2019. Excluding the impact of the decrease in the "due to customers" liability
account, the Company generated $73.4 million from operating activities for the
three months ended March 31, 2020 , compared to generating $13.5 million from
operating activities for the same period in 2019. The increase in such cash
flows from operating activities was due to:
•Adjustments to net income (loss) for the impact of the non-cash provision for
loan losses and impairment charges; and
•The impact of changes to accounts receivable and other assets during the three
months ended March 31, 2020 as compared to the same period in 2019.
These factors were partially offset by:
•The decrease in net income to a net loss;
•The adjustments to net income for derivative market value adjustments;
51
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•Adjustments to net income (loss) for the impact of the gain from sale of loans
and deferred taxes; and
•The impact of changes to other liabilities during the three months ended March
31, 2020 as compared to the same period in 2019.
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 three months ended March 31,
2020 was $105.7 million and $83.5 million , respectively. Cash provided by
investing activities and used in financing activities for the three months ended
March 31, 2019 was $386.3 million and $387.4 million , respectively. Investing
and financing activities are further addressed in the discussion that follows.
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
Carrying amount Final maturity
Bonds and notes issued in asset-backed securitizations
5/27/25 - 4/25/68
FFELP, private education, and consumer loan warehouse
facilities 435,096 5/20/21 - 5/31/22
$ 20,610,389
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 March 31, 2020 , 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 $2.27 billion as
detailed below.
The forecasted cash flow presented below includes all loans funded in
asset-backed securitizations as of March 31, 2020 . As of March 31, 2020 , the
Company had $20.0 billion of loans included in asset-backed securitizations,
which represented 97.3 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 March 31, 2020 , private education
and consumer loans funded with operating cash, and loans acquired subsequent to
March 31, 2020 .
52
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Asset-backed Securitization Cash Flow Forecast
$2.27 billion
(dollars in millions)
[[Image Removed: nni-20200331_g3.jpg]]
The forecasted future undiscounted cash flows of approximately $2.27 billion
include approximately $1.06 billion (as of March 31, 2020 ) of
overcollateralization included in the asset-backed securitizations. These excess
net asset positions are included in the consolidated balance sheets and included
in the balances of "loans and accrued interest receivable" and "restricted
cash." The difference between the total estimated future undiscounted cash flows
and the overcollateralization of approximately $1.21 billion , or approximately
$0.92 billion after income taxes based on the estimated effective tax rate, is
expected to be accretive to the Company's March 31, 2020 balance of consolidated
shareholders' equity.
Two of the Company's asset-backed securitizations as of March 31, 2020 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 securitizations 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 $180 million to $210
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
53
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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 $45
million to $65 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 Item 1A, "Risk Factors - Loan
Portfolio - Interest rate risk - replacement of LIBOR as a benchmark rate" in
the Company's 2019 Annual Report. In addition, the COVID-19 pandemic may impact
forecasted cash flows from the Company's asset-backed securitizations. See Part
II, Item 1A. "Risk Factors - The COVID-19 pandemic has adversely impacted our
results of operations, and could continue to adversely impact our results of
operations, as well as adversely impact our businesses, financial condition,
and/or cash flows" in this 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."
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 March 31, 2020 , the Company had two FFELP warehouse
facilities with an aggregate maximum financing amount available of $1.1 billion ,
of which $0.3 billion was outstanding and $0.8 billion was available for
additional funding. One warehouse facility has a static advance rate until the
expiration date of the liquidity provisions (May 20, 2020 ). 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 (May 20, 2021 ). The other
warehouse facility has a static advance rate that requires initial equity for
loan funding and does not require increased equity based on market movements. As
of March 31, 2020 , the Company had $18.5 million advanced as equity support on
these facilities. For further discussion of the Company's FFELP warehouse
facilities outstanding at March 31, 2020 , see note 3 of the notes to
consolidated financial statements included under Part I, Item 1 of this report.
The Company has a consumer loan warehouse facility that has an aggregate maximum
financing amount available of $200.0 million , an advance rate of 70 or 75
percent depending on the type of collateral and subject to certain concentration
limits, liquidity provisions to April 23, 2021 , and a final maturity date of
April 23, 2022 . As of March 31, 2020 , $67.1 million was outstanding under this
facility and $132.9 million was available for future funding. Additionally, as
of March 31, 2020 , the Company had $29.1 million advanced as equity support
under this facility.
On February 13, 2020 , the Company closed on a private education loan warehouse
facility with an aggregate maximum financing amount available of $100.0 million .
On March 20, 2020 , the facility was amended to increase the maximum financing
amount to $200.0 million . The facility has an advance rate of 90 percent,
liquidity provisions through February 13, 2021 , and a final maturity date of
February 13, 2022 . As of March 31, 2020 , $85.5 million was outstanding under
this warehouse facility and $114.5 million was available for future funding.
Additionally, as of March 31, 2020 , the Company had $9.2 million advanced as
equity support under this facility.
Upon termination or expiration of the 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 existing 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.
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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 March 31, 2020 ,
$466.4 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, up 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 three months of 2020, the Company completed three FFELP
asset-backed securitizations totaling $1.1 billion (par value). The proceeds
from these transactions were used primarily to refinance student loans included
in the Company's FFELP warehouse facilities. See note 3 of the notes to
consolidated financial statements included under Part I, Item 1 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
March 31, 2020 , 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 make variation margin payments to its third-party
clearinghouse. However, if interest rates move materially and negatively impact
the fair value of the Company's derivative portfolio, the replacement of LIBOR
as a benchmark rate has significant adverse impacts on the Company's
derivatives, 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 make variation
margin payments to its 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 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. For the three months ended March 31,
2020 , ALLO's capital expenditures were $7.2 million . The Company currently
anticipates total ALLO network capital expenditures for the remainder of 2020
(April 1, 2020 - December 31, 2020 ) will be approximately $30 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 $455.0 million unsecured line of credit
with a maturity date of December 16, 2024 . As of March 31, 2020 , the unsecured
line of credit had $100.0 million outstanding and $355.0 million was available
for future use. The Company also has a $22.0 million secured line of credit
agreement with a maturity date of May 30, 2022 . As of March 31, 2020 , 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, 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.
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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 March 31, 2020 , the
Company had $20.4 million of Hybrid Securities that remain outstanding.
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
The Board of Directors has authorized a 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 . 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, 2020
are shown below. Such shares were repurchased from employees to satisfy tax
withholding obligations upon the vesting of restricted stock, and not as part of
the stock repurchase program.
Purchase price Average price of shares
Total shares repurchased (in thousands) repurchased (per share)
Quarter ended March 31, 2020 24,885 $ 1,253 50.36
Subsequent to March 31, 2020 , through May 7, 2020 , the Company has repurchased
791,104 shares of the Company's Class A common stock for $35.4 million ($44.73
per share). 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. As of May 7, 2020 , 4,012,773 shares remain authorized for purchase under
the Company's repurchase program.
Dividends
On March 13, 2020 , the Company paid a first quarter 2020 cash dividend on the
Company's Class A and Class B common stock of $0.20 per share. In addition, the
Company's Board of Directors has declared a second quarter 2020 cash dividend on
the Company's outstanding shares of Class A and Class B common stock of $0.20
per share. The second quarter cash dividend will be paid on June 15, 2020 to
shareholders of record at the close of business on June 1, 2020 .
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.
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