DBRS Morningstar Confirms the Ratings of Nelnet, Inc. at BBB (low); Trend Stable

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). Nelnet’s Intrinsic Assessment (IA) is BBB (low), while its Support Assessment is SA3 resulting in the final rating being positioned in line with the IA. The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS
The ratings consider the Company’s sound franchise in education-related business services, good earnings generation capacity that is becoming more diversified, low credit risk exposure, suitable liquidity management and acceptable capitalization. The ratings also consider Nelnet’s restrained earnings growth trajectory due to the Federal Family Education Loan Program (FFELP) portfolio’s ongoing runoff as well as the uncertainty surrounding the scope and the magnitude of the contemplated student loan forgiveness initiative by the U.S. government.

If a widespread student loan forgiveness program occurs, it is expected to trigger a significant spike in prepayments and a rapid paydown of the Company’s FFELP portfolio as borrowers will have to consolidate into the government’s Direct Loan Program, even if the forgiven loan amount is a fraction of their outstanding balance. However, a more targeted scope of this initiative that entails income caps, other limitations, or if loan amount forgiveness is conducted through existing FFELP servicers, would likely serve as mitigants to the paydown of its FFELP portfolio. A hypothetical immediate and complete paydown of the FFELP portfolio would result in the Company receiving the par value of the loans prepaid associated with the ABS overcollateralization (a total of approx. $1.1 billion at March 31, 2022) while it will forgo future interest earnings for these loans (a total of approx. $550 million after-tax, undiscounted). Under this scenario, Nelnet would benefit from a substantial boost in its cash liquidity, capitalization and near-term earnings (including loan loss reserve releases). We note that a sharp paydown would only impede Nelnet’s earnings generation capacity over the medium-term, given the fact that FFELP portfolio currently has just several years of weighted average remaining life. We don’t expect a material impact to Nelnet’s long-term prospects as long as the Company retains and utilizes the excess liquidity to invest in the business.

Positively, the Company got an extension of its servicing contract (including Great Lakes) with the Department of Education (ED) for two additional years to December 2023 removing the near-term uncertainty associated with its government related servicing business. Moreover, the ED’s solicitation for the Unified Servicing and Data Solution (USDS) enables Nelnet to pursue this new servicing contract, which is expected to have a five-year duration with the option of two subsequent two-year renewals and an additional one-year renewal. While it is uncertain whether Nelnet will be awarded a portion of this new contract, we would view a potential outright loss as a setback for its 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 ongoing efforts to diversify its revenue streams.

The Stable trend reflects our expectation that the Company will continue to grow its revenue from the fee-based businesses and diversify its loan portfolio while maintaining good balance sheet fundamentals and prudent capital management. Nonetheless, worsening economic conditions caused by persistent inflationary pressures and a high interest rate environment present key downside risks to our expectations.

RATING DRIVERS
A strengthening of the Company’s franchise and earnings power stemming from the successful expansion of its fee-based businesses and Nelnet Bank would result in a ratings upgrade. Conversely, a substantial weakening of the Company’s long-term earnings generation capacity and/or aggressive capital management resulting in a weakened capital position would result in a downgrade of the ratings.

RATING RATIONALE
The Company has a sound franchise driven by its leading position in the education services market. Nelnet is a leading services provider for schools including education support solutions and tuition payment management. The Company serves nearly half of the private faith-based K-12 schools and approximately a third of all private K-12 schools in the U.S. while in the higher education market, it provides services to nearly one-fifth of U.S. colleges and universities. The launch of Nelnet Bank’s private student loan product in April 2022 for in-school undergraduate and graduate students adds to the diversification of the Company’s product offerings and should also benefit its franchise over time.

Nelnet has historically generated solid earnings despite the revenue pressures associated with the run-off of its sizeable FFELP portfolio. To mitigate this headwind, Nelnet has made significant strides in gradually diversifying its revenue streams by expanding the service providing businesses along with the launch of Nelnet Bank. After excluding derivative market value adjustments, Nelnet generated net income of $322.7 million in 2021, up from $177.3 million in 2020 (adj. for a one-time gain of ALLO). In 1Q22, core net income of $75.9 million was essentially flat YoY after adjusting for one-time items in the prior year period. With floor income declining due to the rising interest rate environment, spread income is expected to come under pressure in the near-term.

The Company has a low credit risk profile which is supportive of the ratings. Nelnet’s low risk profile stems from the modest and predictable credit risk exposure on its FFELP student loan portfolio which benefits from a federal government guarantee of at least 97% of principal and accrued interest at default and comprises nearly 96% of its $17.0 billion of total loans at March 31, 2022. Nelnet’s private education and personal loan portfolios are not guaranteed which increases credit risk, but still only comprise a very modest portion of the total loan portfolio. The Company is subject to greater operational risk given its sizeable servicing operations but we view such risks as properly managed.

We view Nelnet’s funding profile as being suitable for its business model and well-aligned with its asset base. The Company’s key reliance on secured forms of funding results in the encumbrance of its balance sheet but the term financing through asset back securitizations limits refinancing risk. The expansion of Nelnet Bank’s deposit base should gradually broaden the Company’s funding profile. Nelnet has historically demonstrated a flexible and sensible approach on utilizing its available liquidity sources to support its operations or to pursue bolt-on acquisitions. As of March 31, 2022, Nelnet has ample liquidity of nearly $1.2 billion, comprised of cash ($163 million, incl. Nelnet Bank), available for sale asset-backed securities ($368 million, excl. ABS associated with repos and participation agreement), unused borrowing capacity in warehouse facilities ($133 million) and from its unsecured line of credit ($495 million).

The Company’s capitalization is acceptable and properly aligned with its low credit risk profile resulting in an ample cushion to absorb losses under stressed conditions as well as from its less capital intensive business services segments. The Company’s capitalization continues to strengthen with a tangible common equity-to-tangible assets ratio of 13.9% as of March 31, 2022, up from to 12.8% at YE21 and 11.6% at the comparable prior year period.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/ Social/ Governance factor(s) that had a significant or relevant effect on the credit analysis

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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 2, 2021): https://www.dbrsmorningstar.com/research/383936/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 (May 17, 2022): https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

The primary sources of information used for this rating include Morningstar Inc. and Company Documents. 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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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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