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

DBRS, Inc. (Morningstar DBRS) confirmed the credit 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 credit rating being positioned in line with the IA. The trend on all ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS
The credit ratings consider the Company's sound franchise in education-related business services, earnings generation resiliency, low credit-risk exposure, appropriate liquidity management, and sound capitalization. The credit 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 its primary reliance on secured forms of funding.

Since the broad-based federal student loan forgiveness initiative was struck down by the U.S. Supreme Court last year, a substantial spike in prepayments for the Company's FFELP loans has been averted. Nonetheless, some uncertainty remains regarding the scope of the Department of Education's (ED) upcoming final publication and effective date for all pending forgiveness regulations pursuant to the Higher Education Act (HEA) that could have an adverse effect on the Company's FFELP portfolio due to increased paydowns. Further, it is uncertain whether the final regulations will be challenged by litigation and the potential outcome of such action. Morningstar DBRS expects the potential of elevated FFELP loan paydowns due to the ED's aforementioned regulations to be manageable for Nelnet, even though its earnings generation would be moderately impeded over the near to medium-term. Lastly, Morningstar DBRS doesn't expect a material impact to Nelnet's long-term prospects if the Company retains and deploys to its business the excess liquidity from the higher paydowns.

The Stable trend reflects Morningstar DBRS' expectation that the Company will continue to generate solid operating results while maintaining good credit and balance sheet fundamentals. The Stable trend also incorporates some deterioration in credit performance metrics, consistent with Morningstar DBRS' expectations across all consumer lenders in its credit ratings coverage. The key downside risk to Morningstar DBRS' expectations is a contraction in U.S. economic activity and a material weakening in the labor markets because of the higher-for-longer interest rate environment.

CREDIT RATING DRIVERS
A continued diversification of the Company's revenue streams and franchise expansion through the growing Nelnet Bank accompanied by solid operating results and a prudent risk profile would result in a credit ratings upgrade. Conversely, a substantial and sustained weakening of the Company's earnings generation ability accompanied by a material deterioration of its capital position or risk profile would result in a downgrade of the credit ratings.

CREDIT RATING RATIONALE
Franchise Building Block (BB) Assessment: Good/Moderate
The Company has a sound franchise driven by its leading position in the education services market. Nelnet is the largest student loan servicer for the ED and a leading services provider for schools, including education support solutions and tuition payment management. The Company is the largest provider of tuition payment management in the K-12 market in the U.S., serving nearly half of the private and faith-based K-12 schools; while in the higher education market, it provides services to nearly one-fifth of U.S. colleges and universities. The Company has expanded its market position in these markets through organic growth and targeted bolt-on acquisitions that complement its existing products and services. Nelnet Bank's (the Bank) expanding deposit platform along with the private education loan products for undergraduate and graduate students and the other consumer loans also benefit the Company's franchise.

Earnings Building Block (BB) Assessment: Moderate
Nelnet has a track record of generating resilient earnings by steadily diversifying its revenue streams through the expansion of its service providing businesses and the Bank loan originations while mitigating the earnings pressures due to the ongoing run-off of its FFELP portfolio. Nelnet's fee-based net revenue comprised approximately 73% of total net revenue in 2023 relative to nearly 50% several years ago. For 2023, Nelnet generated $123.3 million of core net income (after excluding derivative market-value adjustments), down from $231.3 million in 2022, mostly as a result of lower net interest income due to the amortizing FFELP portfolio, lower fixed-rate floor income, and higher funding costs due to higher interest rates as well as due to accounting related losses on its tax equity investments, all of which more than offset the increase in fee revenues. In Q1 2024, core net income totaled $67.2 million, up from $54.9 million in Q1 2023, largely due to lower loan loss provisions.

Risk Building Block (BB) Assessment: Good
The Company's low-risk profile is a key consideration in the credit ratings. Nelnet's credit risk exposure is predictable and limited, primarily driven by 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 92% of its $11.3 billion of total loan portfolio at March 31, 2024. The credit risk profile is expected to gradually increase over time given the ongoing paydown of government-guaranteed portfolio. Nonetheless, Nelnet has demonstrated a measured risk appetite so far as student and personal loan originations predominantly comprise low-risk credit segments. As of March 31, 2024, approximately 85% of the Bank's originated private education loan book of $364.8 million had balances associated with a FICO score of 735+ at origination, while for the Bank's consumer and other loans of $119 million, 74% of balances were associated with a FICO score of 720+ at origination. Morningstar DBRS considers regulatory and operational risks as being rather elevated for Nelnet due to its sizable government-related servicing operations, but such risks are moderated given the Company's expertise, scale, and long track record in student loan servicing.

Funding and Liquidity Building Block (BB) Assessment: Moderate/Weak
Nelnet has a narrow funding profile due to its primary reliance on secured forms of funding, even though it is properly aligned with its asset base. Further, the growing deposit base of Nelnet Bank should broaden the Company's funding profile over time. Nelnet has historically exhibited effective management of adjusting the size and availability of its funding sources to support its operations or to pursue new opportunities. Approximately 88% of the $10.6 billion of total debt outstanding at March 31, 2024, was asset-backed debt, which limits refinancing risk with the remaining funding mostly comprised of FFELP warehouse facilities with final maturities over the next two years. As of March 31, 2024, Nelnet has ample liquidity of nearly $1.4 billion, comprising cash ($156.8 million), unencumbered available for sale (AFS) asset-backed securities ($288.9 million), unencumbered loans ($139.4 million), unencumbered repurchased ABS issued by the Company ($310.3 million), and from its unsecured line of credit ($495.0 million). In addition, the Bank held $22.9 million in cash and $445.3 million AFS asset-backed securities, which are typically not available for corporate activities outside of the Bank.

Capitalization Building Block (BB) Assessment: Moderate
The Company has sound capitalization given its low credit-risk profile and the less capital intensive business services segments, resulting in sufficient capital cushion to absorb losses under stressed conditions. Nelnet's capital position has been supported by its conservative capital management and capital accretion ability. Over the past year, the Company's capitalization metrics continued to strengthen with a tangible common equity-to-tangible assets ratio of 20.1% at March 31, 2024, up from 18.3% at YE2023 and 16.7% at the comparable prior year period.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental, Social, Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (April 15, 2024) https://dbrs.morningstar.com/research/431187. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The primary sources of information used for these credit ratings include Morningstar, Inc. and company documents. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings was of satisfactory quality.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For more information on this credit or on this industry, visit dbrs.morningstar.com.

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