NELNET INC 10-Q

ITEM 1A. RISK FACTORS The following risk factors provide supplements and updates to the risk factors described in the Company's Annual Report on Form 10-K for the year ended December 31, 2021 in response to Item 1A of Part I of such Form 10-K and the Company's Quarterly Reports on Form 10-Q for the quarters ended March 31, 2022 and June 30, 2022 in response to Item 1A of Part II of such Form 10-Qs, in order to provide information regarding (i) the Company's servicing volume and loan portfolio prepayment risks associated with recent announcements and guidance by the Department and FSA related to broad based, income-driven, and other repayment forgiveness or discharge of student loans; and (ii) a recent cybersecurity incident. Our largest fee-based customer, the Department of Education, represented 29 percent of our revenue in 2021. Failure to extend the Department contracts or obtain new Department contracts in the Department's current or other procurement processes, our inability to consistently surpass competitor performance metrics, unfavorable contract modifications or interpretations, or the loss of servicing borrower volume due to broad based debt cancellation by the Department, could significantly lower servicing revenue and hinder future service opportunities. Our subsidiaries Nelnet Servicing, LLC ("Nelnet Servicing") and Great Lakes Educational Loan Services, Inc. ("Great Lakes") are two of the current seven private sector entities that have student loan servicing contracts with the Department to service loans that include Federal Direct Loan Program loans originated directly by the Department and FFEL Program loans purchased by the Department. As of September 30, 2022, Nelnet Servicing and Great Lakes were servicing $545.5 billion of 66 government owned student loans for 15.7 million borrowers. For the year ended December 31, 2021, we recognized $360.8 million in revenue from the Department under these contracts, which represented 29 percent of our revenue, and for the nine months ended September 30, 2022, we recognized $312.4 million in revenue under these contracts. Nelnet Servicing's and Great Lakes' student loan servicing contracts with the Department are scheduled to expire on December 14, 2023. In 2017, the Department initiated a contract procurement process referred to as the Next Generation Financial Services Environment for a new framework for the servicing of all student loans owned by the Department. The Consolidated Appropriations Act, 2021 contains provisions directing certain aspects of the process, including that any new federal student loan servicing environment is required to provide for the participation of multiple student loan servicers and the allocation of borrower accounts to eligible student loan servicers based on performance. In the second quarter of 2022, the Department released a solicitation entitled Unified Servicing and Data Solution ("USDS") for the new servicing framework. We responded to the USDS solicitation. In the event that our servicing contracts are not extended beyond the current expiration date, or we are not chosen as a subsequent servicer, loan servicing revenue would decrease significantly. There are significant risks to us and uncertainties regarding the current Department contracts and potential future Department contracts, including the pending and uncertain nature of the current contract procurement process and the Department's prior awards of new contracts to other service providers; risks that we may not be successful in obtaining any new contracts with the Department; and risks and uncertainties as to the terms and requirements under a potential new contract or contracts with the Department. We cannot predict the timing, nature, or ultimate outcome of the current or any other contract procurement process by the Department. New loan volume is currently allocated among the Department servicers based on certain service level and portfolio performance metrics established by the Department and compared among all loan servicers. The amount of future allocations of new loan volume could be negatively impacted if we are unable to consistently surpass comparable competitor and/or other performance metrics. In the event the current or any future Department servicing contracts become subject to unfavorable modifications or interpretations by the Department, loan servicing revenue could decrease significantly, performance penalties could be assessed, and/or operating costs to perform the contracts could increase significantly. Additionally, we are partially dependent on the existing Department contracts to broaden servicing operations with the Department, other federal and state agencies, and commercial clients. The size and importance of these contracts provide us the scale and infrastructure needed to profitably expand into new business opportunities. Failure to extend the Department contracts beyond the current expiration date, or obtain new Department contracts, could significantly hinder future opportunities, as well as result in potential restructuring charges that may be necessary to re-align our cost structure with our servicing operations. The Department's August 24, 2022 Bulletin announcing a broad based student debt relief plan indicates the Department will provide targeted student debt cancellation to borrowers with loans held by the Department, and that borrowers whose annual income for either 2020 or 2021 was under $125,000 (for single or married, filing separately) or under $250,000 (for married couples, filing jointly or heads of household) will be eligible for otherwise unconditional loan cancellation in amounts of up to $20,000 for eligible borrowers who received a Pell Grant, or of up to $10,000 for eligible borrowers who did not receive a Pell Grant. As noted above, as of September 30, 2022, we were servicing 15.7 million borrowers under our government servicing contracts. We cannot currently estimate how many borrowers meet the eligibility requirements and other terms and conditions for one-time debt relief under the Department's announcement. If there was a broad $10,000 or $20,000 per borrower forgiveness on all government owned loans, we estimate it would decrease the number of borrowers serviced by us (based on the borrower loan information as of September 30, 2022) by approximately 4.4 million borrowers and 7.5 million borrowers, respectively. The actual impact to the number of borrowers serviced is expected to be less than these amounts due to annual income ceilings for borrowers to qualify for forgiveness and the impact of whether a Pell Grant was received on the amount of forgiveness for a borrower. On October 21, 2022, the U.S. Court of Appeals for the Eighth Circuit issued a temporary administrative stay of implementation of the Department's student debt relief plan in response to a legal challenge that was initiated by other parties (not us). Revenue earned by us under the current Department servicing contracts, and software services revenue earned by us in providing remote hosted services to other government servicers, will decrease in future periods if the Department's student debt relief program or other broad based loan forgiveness is implemented. 67 Our loan portfolio is subject to prepayment risk, which could reduce the expected cash flows and earnings on our portfolio. Higher rates of prepayments of student loans, including consolidations by the Department through the Federal Direct Loan Program or private refinancing programs, would reduce our interest income. Pursuant to the Higher Education Act, borrowers may prepay loans made under the FFEL Program at any time without penalty. Prepayments may result from consolidations of student loans by the Department through the Federal Direct Loan Program or by a lending institution through a private education or unsecured consumer loan, which historically tend to occur more frequently in low interest rate environments; from borrower defaults on federally insured loans, which will result in the receipt of a guaranty payment; and from voluntary full or partial prepayments; among other things. Legislative and executive action risk exists as Congress and the President evaluate economic stimulus packages and proposals to reauthorize the Higher Education Act. If the federal government and the Department initiate additional loan forgiveness or cancellation, other repayment options or plans, consolidation loan programs, or further extend the suspension of borrower payments under the CARES Act, such initiatives could further increase prepayments and reduce interest income. Future laws, regulations, executive actions, or other policy statements may encourage or force consolidation, create additional income-based repayment or debt forgiveness programs, create broad debt cancellation programs, or establish other policies and programs that impact prepayments on education loans. Even if a broad debt cancellation program only applied to student loans held by the Department, such program could result in a significant increase in consolidations of FFELP loans to Federal Direct Loan Program loans and a corresponding increase in prepayments with respect to our FFELP loan portfolio. For example, in October 2021, the Department announced a set of policy changes and released proposed negotiated rulemaking materials relating to the Public Service Loan Forgiveness program under its Federal Direct Loan Program, which we believe resulted in an increase in consolidations of FFELP loans into Federal Direct Loan Program loans held by the Department (which results in the loans no longer being on our balance sheet). In addition, on April 19, 2022, the Department issued a press release, and FSA posted a related public announcement, which together announced, among other things, several adjustments, updates, and other changes under income-driven repayment (“IDR”) plans for federal student loans. In the April 2022 announcements, the Department and FSA indicated that as part of these changes, any borrower with loans that have accumulated time in repayment, including time in certain forbearances and deferments, of at least 20 or 25 years will see automatic forgiveness, even if the borrower is not currently in an IDR plan, and that if a borrower has a commercially held FFEL Program loan, the borrower can only benefit from these changes if they consolidate their FFEL Program loan to a Federal Direct Loan Program loan. Further, on July 6, 2022, the Department announced the issuance of proposed regulations that would expand major student loan discharge programs under the Higher Education Act through changes related to borrower defense to repayment where there is a dispute with the higher education institution, the Public Service Loan Forgiveness program, the interest capitalization rules, and closed school discharges, as well as other matters. These changes and proposals were reflected in executive actions announced by the Department on October 25, 2022 and final regulations announced by the Department on October 31, 2022. The final regulations are to become effective on July 1, 2023, and the fact sheet accompanying the October 25, 2022 announcement indicates that if a borrower has a commercially held FFEL Program loan, the borrower must apply for consolidation to a Federal Direct Loan Program loan by May 1, 2023 to receive the IDR plan and other benefits set forth in the announcement. The fact sheet further indicated that the Department will begin forgiving loans in November 2022 for borrowers with Federal Direct Loan Program loans or FFEL Program loans held by the Department that have reached the required 20 or 25 years of payments for forgiveness under IDR plans, which may also have the effect of significantly decreasing the borrower volume under our Department servicing contracts (see the risk factor immediately above). In addition, the Department's August 24, 2022 Bulletin announced a broad based student debt relief plan for borrowers with loans held by the Department. Following the initial announcement, the Department provided more specific publicly available guidance through the FSA website on September 29, 2022, which guidance was subsequently revised and published in the Federal Register on October 12, 2022. As of November 7, 2022, the following guidance on loan forgiveness was provided on the FSA website (information on the FSA website is not incorporated by reference in this report): • All loans eligible for the CARES Act student loan payment pause are also eligible for debt relief, including loans held by the Department and guaranty agencies • As of September 29, 2022, borrowers with federal student loans not held by the Department cannot obtain one-time debt relief by consolidating those loans into Federal Direct Loan Program loans by the Department • Borrowers with FFEL Program loans not held by the Department and who applied to consolidate into the Federal Direct Loan Program prior to September 29, 2022, are eligible for one-time debt relief through the Federal Direct Loan Program, subject to meeting the other terms and conditions • The Department has indicated it is assessing whether there are alternative pathways to provide relief to borrowers with federal student loans not held by the Department, including FFEL Program loans 68 In view of this recent announcement and guidance by the Department, we do not currently expect there to be significant FFELP loan consolidation activity specifically as a result of the one-time student debt relief plan announced in the August 24, 2022 Bulletin. However, as outlined above, the Department continues to assess whether there are alternative pathways to provide relief to borrowers with student loans not held by the Department, including FFEL Program loans. Since late 2021, we have experienced accelerated run-off of our FFELP portfolio due to FFELP borrowers consolidating their loans into Federal Direct Loan Program loans as a result of the continued extension of the CARES Act payment pause on Department held loans and the initiatives offered by the Department for FFELP borrowers to consolidate their loans to qualify for loan forgiveness under the Public Service Loan Forgiveness and other programs. We currently believe the recently announced policy changes, executive actions, guidance, and other changes by the Department, other than with respect to the broad based student debt relief plan under the August 24, 2022 Bulletin for borrowers with loans held by the Department, may continue to increase FFEL Program loan prepayments. Sustained higher FFEL Program loan prepayments and/or a significant increase in FFEL Program loan prepayments could have a materially adverse impact in future periods on net interest income in our AGM operating segment, FFELP servicing revenue in our LSS operating segment, investment advisory services revenue earned by our SEC-registered investment advisor subsidiary (Whitetail Rock Capital Management, LLC) on FFELP loan asset-backed securities under management, and interest income earned on our FFELP loan asset-backed securities investments. Some variability in prepayment levels is expected, although extraordinary or extended increases in prepayment rates could have a materially adverse effect on our revenues, cash flows, profitability, and business outlook, and, as a result, could materially, adversely affect our business, financial condition, and results of operations. We cannot otherwise predict how or what programs or policies will be impacted by any actions that the Administration, Congress, or the federal government may take, the timing of when such programs or policies may be implemented, and/or the ultimate outcome thereof. In addition, any changes to government programs or policies may be legally challenged, which may impact the extent and timing these changes may have to the Company's business, financial condition, and results of operations. A cybersecurity incident we recently experienced could result in negative impacts to our business. In late July 2022, we determined the customer website portal for the primary loan servicing platform used by our remote hosted servicing clients had experienced a cybersecurity incident. We took immediate and extensive steps to secure the system, block the unauthorized activity, address the issue via additional technical and security measures, notify our insurance carriers, and launch a forensic investigation. In August 2022 our investigation confirmed unauthorized access to confidential consumer information of federal student loan borrowers serviced on our platform by Edfinancial Services and Oklahoma Student Loan Authority. Borrower name, address, email address, phone number, and Social Security number information was impacted, but no financial account or payment information was impacted. Loans serviced directly by Nelnet were not impacted by the event. The applicable regulators and affected consumers were notified and identity theft monitoring has been and continues to be offered to those affected. This event could result in liability or expense, decreased revenue, as well as risk and damage to our reputation. Any of these could have a material adverse effect on our business. 69