FOR RELEASE: 10/27/06
MEDIA CONTACT: Ben Kiser, 402.458.3024
INVESTOR CONTACT: Cheryl Watson, 317.469.2064
NELNET, INC. SUPPLEMENTAL FINANCIAL INFORMATION
FOR THE THIRD QUARTER 2006
The following supplemental information should be read in connection with the
third-quarter 2006 earnings press release of Nelnet, Inc. (the "Company"), dated
October 27, 2006.
Information contained in this earnings supplement, other than historical
information, may be considered forward-looking in nature and is subject to
various risks, uncertainties, and assumptions. Should one or more of these risks
or uncertainties materialize, or should underlying assumptions prove incorrect,
actual results may vary materially from those anticipated, estimated, or
expected. Among the key factors that may have a direct bearing on Nelnet's
operating results, performance, or financial condition are changes in terms of
student loans and the educational credit marketplace, changes in the demand for
educational financing or in financing preferences of educational institutions,
students and their families, or changes in the general interest rate environment
and in the securitization markets for education loans. Certain prior year
amounts have been reclassified to conform to the current period presentation.
For more information see our filings with the Securities and Exchange
Commission.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------------------- ---------------------------
SEPTEMBER 30, JUNE 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2006 2006 2005 2006 2005
------------ ------------ ------------- ------------ -------------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
Interest income:
Loan interest $ 401,704 $ 383,867 $ 247,791 $ 1,133,093 $ 671,589
Amortization of loan premiums and deferred
origination costs (21,568) (21,125) (20,041) (64,555) (52,370)
Investment interest 25,986 24,314 11,491 69,841 26,643
------------ ------------ ------------- ------------ -------------
Total interest income 406,122 387,056 239,241 1,138,379 645,862
Interest expense:
Interest on bonds and notes payable 333,766 300,844 160,243 893,559 398,045
------------ ------------ ------------- ------------ -------------
Net interest income 72,356 86,212 78,998 244,820 247,817
Less provision for loan losses 1,700 2,190 1,402 13,508 5,557
------------ ------------ ------------- ------------ -------------
Net interest income after provision
for loan losses 70,656 84,022 77,596 231,312 242,260
------------ ------------ ------------- ------------ -------------
Other income (expense):
Loan and guarantee servicing income 48,462 44,042 37,459 139,578 109,313
Other fee-based income 31,221 16,074 10,503 65,450 22,886
Software services income 4,399 4,018 1,951 11,826 6,759
Other income 13,617 2,906 2,458 18,510 5,382
Derivative market value, foreign currency,
and put option adjustments (79,941) 29,113 65,382 (11,565) 74,300
Derivative settlements, net 4,973 6,702 (2,962) 16,419 (19,049)
------------ ------------ ------------- ------------ -------------
Total other income (expense) 22,731 102,855 114,791 240,218 199,591
------------ ------------ ------------- ------------ -------------
Operating expenses:
Salaries and benefits 65,383 62,207 44,311 185,274 123,615
Other expenses 56,925 45,904 32,705 147,759 95,936
Amortization of intangible assets 6,534 6,161 1,919 18,328 4,651
------------ ------------ ------------- ------------ -------------
Total operating expenses 128,842 114,272 78,935 351,361 224,202
------------ ------------ ------------- ------------ -------------
Income (loss) before income taxes (35,455) 72,605 113,452 120,169 217,649
Income tax expense (benefit) (13,101) 26,852 41,091 44,462 78,974
------------ ------------ ------------- ------------ -------------
Net income (loss) before minority interest (22,354) 45,753 72,361 75,707 138,675
Minority interest in net earnings of subsidiaries - - (229) (242) (229)
------------ ------------ ------------- ------------ -------------
Net income (loss) $ (22,354) $ 45,753 $ 72,132 $ 75,465 $ 138,446
============ ============ ============= ============ =============
Earnings (loss) per share, basic
and diluted $ (0.42) $ 0.84 $ 1.34 $ 1.40 $ 2.58
============ ============ ============= ============ =============
Weighted average shares outstanding 53,348,466 54,297,230 53,734,218 53,959,075 53,709,801
CONDENSED CONSOLIDATED BALANCE SHEETS AND FINANCIAL DATA
AS OF AS OF AS OF
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
2006 2005 2005
------------- -------------- -------------
(UNAUDITED) (UNAUDITED)
(DOLLARS IN THOUSANDS)
Assets:
Student loans receivable, net $ 22,933,718 $ 20,260,807 $ 16,379,293
Cash, cash equivalents, and investments 1,810,839 1,645,797 1,304,261
Goodwill 188,603 99,535 67,942
Intangible assets, net 169,824 153,117 34,644
Other assets 788,336 639,366 525,185
------------- ------------- -------------
Total assets $ 25,891,320 $ 22,798,622 $ 18,311,325
============= ============= =============
Liabilities:
Bonds and notes payable $ 24,690,245 $ 21,673,620 $ 17,418,652
Other liabilities 519,814 474,884 295,582
------------- ------------- -------------
Total liabilities 25,210,059 22,148,504 17,714,234
------------- ------------- -------------
Minority interest in subsidiaries - 626 274
Shareholders' equity 681,261 649,492 596,817
------------- ------------- -------------
Total liabilities and shareholders' equity $ 25,891,320 $ 22,798,622 $ 18,311,325
============= ============= =============
Return on average total assets 0.41% 1.00% 1.10%
Return on average equity 14.1% 32.4% 34.9%
NON-GAAP PERFORMANCE MEASURES
The Company prepares financial statements in accordance with generally accepted
accounting principles ("GAAP"). In addition to evaluating the Company's
GAAP-based financial information, management also evaluates the Company on
certain non-GAAP performance measures referred to as base net income. While base
net income is not a substitute for reported results under GAAP, the Company
provides base net income as additional information regarding its financial
results.
Adjusted base net income, which excludes certain special allowance yield
adjustments and related hedging activity on the Company's portfolio of student
loans earning a minimum special allowance payment of 9.5%, is used by management
to develop the Company's financial plans, track results, and establish corporate
performance targets.
The following table provides a reconciliation of GAAP net income (loss) to base
and adjusted base net income.
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------------ ------------------------
SEPTEMBER 30, JUNE 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2006 2006 2005 2006 2005
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
GAAP net income (loss) (a) $ (22,354) $ 45,753 $ 72,132 $ 75,465 $ 138,446
Base adjustments:
Derivative market value,
foreign currency,
and put option adjustments 79,941 (29,113) (65,382) 11,565 (74,300)
Amortization of intangible assets 6,534 6,161 1,919 18,328 4,651
Non-cash stock based compensation
related to business combinations 476 477 - 1,271 -
Variable-rate floor income - - - - -
---------- ---------- ---------- ---------- ----------
Total base adjustments before income taxes 86,951 (22,475) (63,463) 31,164 (69,649)
Net tax effect (c) (31,698) 8,446 24,116 (10,391) 26,467
---------- ---------- ---------- ---------- ----------
Total base adjustments 55,253 (14,029) (39,347) 20,773 (43,182)
---------- ---------- ---------- ---------- ----------
Base net income (a) 32,899 31,724 32,785 96,238 95,264
Adjustments to base net income:
Special allowance yield adjustment (b) - (10,550) (21,766) (24,460) (77,427)
Derivative settlements, net (7,909) (7,721) 2,644 (19,794) 16,961
---------- ---------- ---------- ---------- ----------
Total adjustments to base net income
before income taxes (7,909) (18,271) (19,122) (44,254) (60,466)
Net tax effect (c) 3,006 6,943 7,266 16,817 22,977
---------- ---------- ---------- ---------- ----------
Total adjustments to base net income (4,903) (11,328) (11,856) (27,437) (37,489)
---------- ---------- ---------- ---------- ----------
Adjusted base net income (a) $ 27,996 $ 20,396 $ 20,929 $ 68,801 $ 57,775
========== ========== ========== ========== ==========
Earnings (loss) per share, basic and
diluted:
GAAP net income (loss) (a) $ (0.42) $ 0.84 $ 1.34 $ 1.40 $ 2.58
Total base adjustments 1.04 (0.25) (0.73) 0.38 (0.81)
---------- ---------- ---------- ---------- ----------
Base net income (a) 0.62 0.59 0.61 1.78 1.77
Total adjustments to base net income (0.10) (0.21) (0.22) (0.50) (0.70)
---------- ---------- ---------- ---------- ----------
Adjusted base net income (a) $ 0.52 $ 0.38 $ 0.39 $ 1.28 $ 1.07
========== ========== ========== ========== ==========
- ------------------------------------------
(a) Includes expense of $6.9 million ($4.3 million or $0.08 per share after
tax) for the nine months ended September 30, 2006, to increase the
Company's allowance for loan losses due to a provision in the Deficit
Reduction Act that increased risk sharing for student loan holders by
one percent on FFELP loans. This expense was recognized by the Company
in the first quarter 2006.
(b) As previously disclosed, pending satisfactory resolution of the October
6, 2006 letter from the Department of Education (the "Department")
related to the audit report by the Department's Office of Inspector
General regarding certain loans receiving 9.5% special allowance
payments, the Company has determined to defer recognition of the 9.5%
special allowance payments which the Department is currently withholding
payment. Income from these 9.5% special allowance payments would have
been $8.9 million ($5.5 million or $0.10 per share after tax) for the
three months ended September 30, 2006.
(c) Tax effect computed at 38%. The change in the value of the put option is
not tax effected as this is not deductible for income tax purposes.
Base net income is a non-GAAP financial measure and may not be comparable to
similarly titled measures reported by other companies. The Company's base net
income presentation does not represent another comprehensive basis of
accounting. A more detailed discussion of the differences between GAAP and base
net income follows.
DERIVATIVE MARKET VALUE, FOREIGN CURRENCY, AND PUT OPTION ADJUSTMENTS: Base net
income excludes the periodic unrealized gains and losses caused by the change in
market value on those derivatives in which the Company does not qualify for
hedge accounting. The Company maintains an overall interest rate risk management
strategy that incorporates the use of derivative instruments to reduce the
economic effect of interest rate volatility. 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 under Statement of Financial Accounting Standards No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, and thus may
adversely impact earnings.
Base net income also excludes the foreign currency transaction gain or loss
caused by the re-measurement of the Company's Euro-denominated bonds to U.S.
dollars and the change in the market value of put options issued by the Company
for certain business acquisitions.
AMORTIZATION OF INTANGIBLE ASSETS: Base net income excludes the amortization of
acquired intangibles.
NON-CASH STOCK BASED COMPENSATION RELATED TO BUSINESS COMBINATIONS: The Company
has structured certain business combinations in which the stock consideration
paid has been dependent on the sellers' continued employment with the Company.
As such, the value of the consideration paid is recognized as compensation
expense by the Company over the term of the applicable employment agreement.
Base net income excludes this expense.
VARIABLE-RATE FLOOR INCOME: Loans that reset annually on July 1 can generate
excess spread income as compared to the rate based on the special allowance
payment formula in declining interest rate environments. The Company refers to
this additional income as variable-rate floor income. There was no variable-rate
floor income in the periods presented.
STUDENT LOANS RECEIVABLE
Student loans receivable includes all student loans owned by or on behalf of the
Company and includes the unamortized cost of acquisition or origination less an
allowance for loan losses. The following table describes the components of the
Company's loan portfolio:
AS OF AS OF AS OF
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
2006 2005 2005
----------------------- ----------------------- ---------------------
PERCENT PERCENT PERCENT
DOLLARS OF TOTAL DOLLARS OF TOTAL DOLLARS OF TOTAL
------------ ---------- ------------ ---------- ----------- --------
(DOLLARS IN THOUSANDS)
Federally insured:
Stafford $ 6,290,116 27.4 % $ 6,434,655 31.8 % $ 5,623,229 34.3 %
PLUS/SLS 391,981 1.7 376,042 1.8 294,888 1.8
Consolidation 15,672,102 68.3 13,005,378 64.2 10,170,684 62.1
Non-federally insured 180,462 0.8 96,880 0.5 96,920 0.6
------------ --------- ------------- -------- ------------- --------
Total 22,534,661 98.2 19,912,955 98.3 16,185,721 98.8
Unamortized premiums and deferred
origination costs 424,151 1.9 361,242 1.8 205,656 1.3
Allowance for loan losses:
Allowance - federally insured (7,517) 0.0 (98) 0.0 (98) 0.0
Allowance - non-federally insured (17,577) (0.1) (13,292) (0.1) (11,986) (0.1)
------------ --------- ------------- -------- ------------- --------
Net $ 22,933,718 100.0 % $ 20,260,807 100.0 % $ 16,379,293 100.0 %
============ ========= ============= ======== ============= ========
The following table sets forth the loans originated or acquired through each of
the Company's channels:
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------------------ ---------------------------
SEPTEMBER 30, JUNE 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2006 2006 2005 2006 2005
------------- ------------ ------------- ------------- ------------
(DOLLARS IN THOUSANDS)
Beginning balance $ 22,012,670 $ 20,963,219 $ 15,469,689 $ 19,912,955 $ 13,299,094
Direct channel:
Consolidation loan originations 1,493,981 1,045,094 1,097,436 3,563,910 2,624,106
Less consolidation of existing
portfolio (726,700) (567,300) (559,700) (1,727,900) (1,274,100)
------------- ------------ ------------ ------------- ------------
Net consolidation loan
originations 767,281 477,794 537,736 1,836,010 1,350,006
Stafford/PLUS loan originations 385,997 151,017 239,927 843,162 567,549
Branding partner channel 94,229 326,764 43,934 841,258 1,126,788
Forward flow channel 336,775 579,701 260,072 1,268,288 901,185
Other channels 2,070 424,620 5,015 480,528 39,200
------------- ------------ ------------ ------------- ------------
Total channel acquisitions 1,586,352 1,959,896 1,086,684 5,269,246 3,984,728
Repayments, claims, capitalized
interest, and other (368,789) (453,866) (130,252) (1,187,813) (599,601)
Consolidation loans lost to
external parties (342,400) (310,800) (240,400) (923,600) (498,500)
Loans sold (353,172) (145,779) - (536,127) -
------------- ------------ ------------ ------------- ------------
Ending balance $ 22,534,661 $ 22,012,670 $ 16,185,721 $ 22,534,661 $ 16,185,721
============= ============ ============ ============= ============
INTEREST RATE SENSITIVITY
The following table shows the Company's student loan assets currently earning at
a fixed rate as of September 30, 2006:
BORROWER/
FIXED LENDER ESTIMATED
INTEREST WEIGHTED VARIABLE BALANCE
RATE AVERAGE CONVERSION OF FIXED
RANGE YIELD RATE (a) RATE ASSETS
--------- -------------- ------------ --------------
(DOLLARS IN
THOUSANDS)
8.0 - 9.0% 8.15 5.51 $ 564,227
> 9.0 9.04 6.40 402,641
9.5 floor yield 9.50 6.86 3,140,646
-----------
$ 4,107,514
===========
-----------------------
(a) The estimated variable conversion rate is the estimated short-term
interest rate at which loans would convert to variable rate.
As a portion of the Company's student loan assets earn a fixed rate, management
uses fixed-rate debt and interest rate swaps to reduce the economic effect of
interest rate volatility. The total fixed-rate student loan assets of $4.1
billion held by the Company at September 30, 2006, includes $2.5 billion of
loans purchased prior to September 30, 2004 with proceeds of tax-exempt
obligations originally issued prior to October 1, 1993 and then subsequently
sold utilizing proceeds of taxable obligations, without retiring the tax-exempt
obligations. Interest income that is generated from this $2.5 billion portfolio
in excess of income based upon standard special allowance rates is referred to
by the Company as the special allowance yield adjustment. The following table
summarizes the derivative instruments used by the Company as of September 30,
2006 to hedge this $2.5 billion loan portfolio. Since the $2.5 billion portfolio
of student loans will decrease as principal payments are made on these loans,
the Company has structured the related derivatives to expire or "amortize" in a
similar pattern.
WEIGHTED AVERAGE
FIXED RATE PAID BY
MATURITY NOTIONAL VALUES THE COMPANY
---------------- --------------- -------------------
(dollars in thousands)
2006 $ 250,000 3.16 %
2007 118,750 3.35
2008 293,750 3.78
2009 193,750 4.01
2010 687,500 4.25
2011 - -
2012 275,000 4.31
2013 525,000 4.36
------------- ----------------
Total $ 2,343,750 4.04 %
============= ================
As previously disclosed, pending satisfactory resolution of the October 6, 2006
letter from the Department of Education (the "Department") related to the audit
report by the Department's Office of Inspector General regarding certain loans
receiving 9.5% special allowance payments, the Company has determined to defer
recognition of the 9.5% special allowance payments which the Department is
currently withholding payment. The Company has maintained its portfolio of
interest rate swaps (summarized in the previous table) used to hedge the
portfolio of loans in which the Department is currently withholding the 9.5%
special allowance payments pending satisfactory resolution of this issue.
The following table summarizes the outstanding derivative instruments as of
September 30, 2006 used by the Company to hedge the remaining fixed-rate loan
portfolio.
WEIGHTED AVERAGE
FIXED RATE PAID BY
MATURITY NOTIONAL VALUES THE COMPANY
------------- ---------------- ------------------
(DOLLARS IN THOUSANDS)
2007 $ 393,750 3.45 %
2008 168,750 3.72
2009 118,750 4.01
2010 450,000 4.25
----------- ----------------
Total $ 1,131,250 3.87 %
=========== ================
In addition to the interest rate swaps with notional values of $1.1
billion summarized above, as of September 30, 2006, the Company had $466.1
million of fixed-rate debt (excluding the Company's fixed-rate unsecured debt of
$475 million) that was used by the Company to hedge fixed-rate student loan
assets.
DERIVATIVE SETTLEMENTS
The following table summarizes the components of derivative settlements.
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------------------- --------------------------
SEPTEMBER 30, JUNE 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2006 2006 2005 2006 2005
----------- ----------- ------------ ----------- --------------
(DOLLARS IN THOUSANDS)
Special allowance yield adjustment derivatives $ 7,909 $ 7,721 $ (2,644) $ 19,794 $ (16,961)
Other interest rate and basis swap derivatives 4,172 2,797 (318) 8,701 (2,088)
Cross currency interest rate swaps (5,115) (3,816) - (10,083) -
Other (a) (1,993) - - (1,993) -
----------- ----------- ----------- ----------- ------------
Derivative settlements, net $ 4,973 $ 6,702 $ (2,962) $ 16,419 $ (19,049)
=========== =========== =========== =========== ============
(a) During the three months ended September 30, 2006, the Company issued
Capital Efficient Notes ("CENts") and entered into a derivative
instrument to economically lock into a fixed interest rate prior to the
actual pricing of the transaction. Upon pricing of the CENts, the
Company terminated this derivative instrument. The consideration paid by
the Company to terminate this derivative was $2.0 million.
STUDENT LOAN SERVICING
The Company performs servicing activities for its own portfolio and third
parties. The following table summarizes the Company's loan servicing volumes:
AS OF SEPTEMBER 30, AS OF DECEMBER 31, AS OF SEPTEMBER 30,
2006 2005 2005
--------------------------------- --------------------------------- ---------------------------------
COMPANY THIRD PARTY TOTAL COMPANY THIRD PARTY TOTAL COMPANY THIRD PARTY TOTAL
----------- ----------- ---------- ---------- ----------- --------- ---------- ----------- ----------
(DOLLARS IN MILLIONS)
FFELP and private loans $ 20,772 $ 9,097 $ 29,869 $ 16,969 $ 10,020 $ 26,989 $ 14,700 $ 8,458 $ 23,158
Canadian loans (in U.S. $) - 9,348 9,348 - 8,139 8,139 - 8,118 8,118
----------- ---------- ---------- ---------- ---------- ----------- ---------- ----------- ----------
Total $ 20,772 $ 18,445 $ 39,217 $ 16,969 $ 18,159 $ 35,128 $ 14,700 $ 16,576 $ 31,276
=========== ========== ========== ========== ========== =========== ========== =========== ==========
STUDENT LOAN SPREAD
The following table analyzes the student loan spread on the Company's portfolio
of student loans. This table represents the spread on assets earned in
conjunction with the liabilities used to fund the assets, including the effects
of net derivative settlements.
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------------------- -----------------------------
SEPTEMBER 30, JUNE 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2006 2006 2005 2006 2005
------------- ------------- ------------- -------------- --------------
Student loan yield 7.91 % 7.93 % 6.94 % 7.84 % 6.72 %
Consolidation rebate fees (0.72) (0.70) (0.65) (0.71) (0.64)
Premium and deferred origination costs amortization (0.39) (0.40) (0.51) (0.41) (0.47)
------------- ------------- ------------- ------------- -------------
Student loan net yield 6.80 6.83 5.78 6.72 5.61
Student loan cost of funds (a) (5.32) (5.00) (3.83) (4.99) (3.52)
------------- ------------- ------------- ------------- -------------
Student loan spread 1.48 1.83 1.95 1.73 2.09
Special allowance yield adjustments, net of
settlements on derivatives (b) (0.14) (0.34) (0.49) (0.28) (0.55)
------------- ------------- ------------- ------------- -------------
Core student loan spread 1.34 % 1.49 % 1.46 % 1.45 % 1.54 %
============= ============= ============= ============= =============
Average balance of student loans (in thousands) $ 22,170,118 $ 21,289,877 $ 15,628,420 $ 21,268,972 $ 14,766,024
Average balance of debt outstanding (in thousands) 23,881,928 23,126,198 16,564,494 22,984,011 15,669,656
- ------------------------------------------------
(a) The student loan cost of funds includes the effects of net settlement
costs on the Company's derivative instruments (excluding the $2.0
million settlement related to the derivative instrument entered into in
connection with the issuance of the CENts).
(b) The special allowance yield adjustments represent the impact on net
spread had loans earned at statutorily defined rates under a taxable
financing. The special allowance yield adjustments include net
settlements on derivative instruments that were used to hedge this loan
portfolio earning the excess yield.