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Nelnet Beats Estimate

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Nelnet Inc. reported third-quarter 2011 earnings per share of $1.22, eleven cents ahead of the Zacks Consensus Estimate but down from the prior-year quarter’s earnings by a penny.

Nelnet’s results reflected the benefits from the diversification of revenue through fee-based businesses. Provisions for loan losses as well as expenses also dropped during the quarter. However, a fall in investment interest income was the downside.

On a GAAP basis, Nelnet’s third-quarter net income stood at $47.5 million or 98 cents per share, significantly up from net loss of $0.4 million or 1 cent per share in the comparable quarter last year.

Quarter in Detail

Nelnet’s net interest income increased 5% year over year to $96.8 million in the third quarter, reflecting a drop in interest expense, partially offset by a decline in loan interest as well as investment interest income.

Moreover, other income spiked 16.6% year over year to $85.1 million, while provisions for loan losses fell to $5.3 million from $5.5 million in the prior-year quarter.

As of September 30, 2011, Nelnet’s net student loan assets were $24.6 billion. Historically low interest rates continue to help Nelnet generate substantial near-term value and cash flow from its student loan portfolio. In July 2011, the company purchased the residual interest in $1.9 billion of securitized Federal Family Education Loan Program.

Nelnet is focused on increasing its earnings through diversification. Loan and guaranty servicing revenue jumped 13.1% year over year to $37.9 million. Revenue from tuition payment processing and campus commerce business increased 15% year over year to $16.8 million. However, the company's enrollment services revenue fell 2.5% from the prior-year quarter to $35.5 million. The deterioration reflects the current regulatory uncertainty shrouding the for-profit college industry resulting in schools curtailing their expenses on marketing activities.

Nelnet started servicing federally-owned student loans for the Department of Education in September 2009. The company has experienced an increase in loans servicing and has consequently reported a growth in revenues from the servicing contract.

As of September 30, 2011, the company was servicing $44.6 billion of loans for 3 million borrowers on behalf of the Department compared with $21.8 billion of loans for 2.5 million borrowers as of September 30, 2010. Revenue from this contract expanded to $12.8 million in the reported quarter from $8.7 million in the year-ago period.

Nelnet’s operating expenses for the third quarter stood at $104.8 million, down 34.6% year over year. The company expects its operating expenses to increase over time to support revenue growth in its fee-based businesses.

The other student lender, SLM Corp. (SLM - Free Report) better known as Sallie Mae, reported third-quarter 2011 core earnings of $188 million or 36 cents per share, in line with the Zacks Consensus Estimate. However, on a GAAP basis, Sallie Mae reported third-quarter 2011 net loss of $47 million or 10 cents per share, down from a net loss of $495 million or $1.06 per share in the comparable quarter last year.

Favorable results at Sallie Mae were primarily driven by an increase in student loan originations, improved credit quality with declines in student loan delinquencies and operating expenses.

Capital Deployment Update

In the reported quarter, Nelnet repurchased 1.1 million shares of Class A common stock for $20.6 million, under the company's stock repurchase program at an average price of $18.77 per share.

Nelnet’s board of directors declared the fourth quarterly cash dividend on the company's outstanding shares of Class A common stock and Class B common stock of 10 cents per share. The dividend will be paid on December 15, 2011 to shareholders of record at the close of business as of December 1, 2011.

Our Take

Although the student loan reform law has barred the company from originating federal student loans since July 2010, Nelnet has expanded in areas that are independent of the federal program. Increasing revenues from its fee-based business and servicing of loans for the Education department should bolster its earnings.

Though its capital position is solid, we believe that concerns over the implementation of the recent financial reform act and a protracted economic recovery still continue to linger. Moreover, expenses are expected to increase with the rise in the volume of loan servicing. Yet, capital deployment efforts are encouraging and boost investors’ confidence in the stock.

Nelnet shares currently have a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. Considering the fundamentals, we are maintaining a long-term “Neutral” recommendation on the stock.

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