DBRS Morningstar Revises Nelnet, Inc.’s Trend to Stable from Negative; Confirms Ratings at BBB (low)

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

KEY RATING CONSIDERATIONS
The ratings confirmation and revision of the trend to Stable reflect Nelnet’s demonstrated earnings resilience while maintaining sound balance sheet fundamentals despite the challenging economic environment caused by the Coronavirus Disease (COVID-19) induced downturn. The ratings consider the Company’s sound franchise in education-related business services, good earnings generation capacity, limited credit risk exposure, suitable liquidity management and appropriate capitalization. The ratings also consider Nelnet’s constrained earnings trajectory due to the Federal Family Education Loan Program (FFELP) portfolio’s ongoing runoff and its primary reliance on secured forms of funding.

The ratings also contemplate the evolving developments in regard to the Department of Education’s (the ED) servicing contract. We view the potential ED servicing contract extension for up two additional years (to Dec. 2023) and the fact that Nelnet is once again able to pursue a future servicing contract procurement following the ED’s cancellation of the Interim Servicing Solution (ISS) solicitation in June 2021 as positive developments for the Company. However, there remains a great degree of uncertainty about the timing and form of the new solicitation process and whether Nelnet will eventually be awarded a portion of this new contract. We would consider a potential outright loss of the ED servicing contract as a setback for Nelnet’s franchise, but we expect the bottom-line impact would be fairly manageable due to the thin profit margins typically associated with such contracts as well as from the Company’s continued efforts to diversify its revenue streams.

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

RATING DRIVERS
Continued growth in the Company’s diversified revenue mix that mitigates the impact from the contracting revenue associated with the federally insured student loan portfolio’s run-off while maintaining similar risk-adjusted profitability would result in a ratings upgrade. Conversely, a substantial weakening of the Company’s earnings generation capacity or a material deterioration in its capital position would result in a ratings downgrade.

RATING RATIONALE
Nelnet has a sound franchise underpinned by its leading position in the education-related services market. The Company has substantial scale in student loan servicing. Nelnet, along with its subsidiary Great Lakes, is currently the largest servicer for the ED. Nelnet also provides servicing for private education and consumer loans for 39 third-party customers and offers backup servicing arrangements for 17 additional entities. Further, Nelnet is a preeminent school services provider including education support solutions and tuition payment management. Nelnet is the market leader in the K-12 private school market, serving nearly half of the private faith-based K-12 schools and approximately a third of all private K-12 schools in the U.S. In the higher education market, it provides services to approximately one-fifth of U.S. colleges and universities. Over the past several years, the Company has expanded its market position in these markets through targeted bolt-on acquisitions that complement its existing products and services. The launch of Nelnet Bank in November 2020 along with the associated student loan product offerings and a retail deposit platform should also be beneficial to the Company’s franchise over time.

The Company has demonstrated a good earnings generation capacity by gradually diversifying its revenue streams while mitigating the earnings pressures from the ongoing run-off of its FFELP portfolio. Nelnet has managed to significantly expand its recurring, fee-based revenue composition to approximately 73% in 2020 (as adjusted), from nearly 50% of total net revenue just a few years ago. Meanwhile, the Company’s purchases of FFELP, private education and personal loan portfolios have also partially alleviated the adverse impact from the amortizing FEELP portfolio. Despite the challenging economic environment in 2020, Nelnet’s core net income (excl. derivative market value adj.) totaled $373.8 million that included an after-tax gain of $196.5 million from the deconsolidation of its ALLO Communications segment. At the same time, operating total net revenue was largely stable. In 1Q21, core net income was approximately $76 million, after adjusting for one-time items. We expect revenue from serving K-12 schools and higher education institutions to benefit from the widespread school reopening in the fall of 2021, while the servicing revenue should improve once the government’s pandemic relief measures for direct student loans expire as currently scheduled this September.

Nelnet’s overall low risk profile is an important consideration in the rating. The Company’s credit risk exposure is very modest with 97% of its $18.6 billion loan portfolio comprised of FFELP student loans, which are federally guaranteed to at least 97% of principal and accrued interest at default. Further, at March 31, 2021, loan loss reserves for the federally insured student loan portfolio remained sizeable at 25.5% of the Company’s potential maximum risk sharing liability. While the credit risk arising from the private education loan and personal loan portfolios is currently limited, given their still small portion to the total portfolio, we expect the credit risk exposure to grow over time as a result of the organic growth of the Company’s student loan book. We anticipate the credit performance of Nelnet’s aggregate loan portfolio to continue to benefit from the strong economic growth and the accompanied robust labor market. Regulatory and operational risks present a greater risk for Nelnet due to its sizable government-related servicing operations and student loan portfolio. Nevertheless, we deem operational risk as properly managed given the Company’s expertise, scale, and long track record in student and consumer loan servicing. That said, the regulatory risk arising from a broad-based federal student loan forgiveness could adversely impact Nelnet’s long-term earnings power as a result of a potential spike in FFELP loan prepayments.

The Company’s funding profile is appropriate for its business model composition and aligns well with its asset base. Nelnet’s reliance on secured forms of funding results in a highly encumbered balance sheet. Nonetheless, the Company’s term financing through asset back securitizations limits refinancing risk and supports its liquidity as a result of the associated substantial future residual cash flows totaling $2.17 billion, on an undiscounted basis, at March 31, 2021. Over time, an expansion of Nelnet Bank’s deposit base could provide further diversification to the Company’s funding profile. Nelnet has deployed a flexible and balanced approach on utilizing its funding sources that enable it to support its operations while capitalizing on opportunistic portfolio purchases and bolt-on acquisitions. As of March 31, 2021, Nelnet had total available liquidity of approximately $1.1 billion, comprised of cash, available for sale asset-backed securities, unused borrowing capacity in warehouse facilities and from its unsecured line of credit, of which the entire maximum capacity of $455.0 million was readily available.

DBRS Morningstar views Nelnet’s capitalization as appropriate given its low overall risk profile and its expanding non-capital intensive fee-based business segments. The Company’s capital levels provide ample cushion to absorb losses under stressed conditions and still meet its financial covenants. Furthermore, Nelnet’s capitalization is bolstered by its largely consistent capital generation capacity and prudent capital management. Nelnet’s capitalization further strengthened over the past year as its tangible common equity-to-tangible assets ratio increased to 11.6% at March 31, 2021, from 9.1% at the year ago period.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at: https://www.dbrsmorningstar.com/research/373262.

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 29, 2020): https://www.dbrsmorningstar.com/research/367510/global-methodology-for-rating-non-bank-financial-institutions.
Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021):
https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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

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

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

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

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