NELNET INC 10-K

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (All dollars are in thousands, except share amounts, unless otherwise noted) Interest Rate Risk - AGM Operating Segment AGM’s primary market risk exposure arises from fluctuations in its borrowing and lending rates, the spread between which could impact AGM due to shifts in market interest rates. The following table sets forth AGM’s loan assets and debt instruments by rate characteristics: As of December 31, 2022 As of December 31, 2021 Dollars Percent Dollars Percent Fixed-rate loan assets $ 1,339,900 9.5 % $ 7,434,068 42.6 % Variable-rate loan assets 12,829,871 90.5 10,007,722 57.4 Total $ 14,169,771 100.0 % $ 17,441,790 100.0 % Fixed-rate debt instruments $ 617,083 4.5 % $ 801,548 4.7 % Variable-rate debt instruments 13,199,327 95.5 16,279,722 95.3 Total $ 13,816,410 100.0 % $ 17,081,270 100.0 % FFELP loans originated prior to April 1, 2006 generally earn interest at the higher of the borrower rate, which is fixed over a period of time, or a floating rate based on the special allowance payment (SAP) formula set by the Department. The SAP rate is based on an applicable index plus a fixed spread that depends on loan type, origination date, and repayment status. The Company generally finances its FFELP student loan portfolio with variable rate debt. In low and/or declining interest rate environments, when the fixed borrower rate is higher than the SAP rate, the Company’s FFELP student loans earn at a fixed rate while the interest on the variable rate debt typically continues to reflect the low and/or declining interest rates. In these interest rate environments, the Company may earn additional spread income that it refers to as floor income. Depending on the type of loan and when it was originated, the borrower rate is either fixed to term or is reset to an annual rate each July 1. As a result, for loans where the borrower rate is fixed to term, the Company may earn floor income for an extended period of time, which the Company refers to as fixed rate floor income, and for those loans where the borrower rate is reset annually on July 1, the Company may earn floor income to the next reset date, which the Company refers to as variable rate floor income. All FFELP loans first originated on or after April 1, 2006 effectively earn at the SAP rate, since lenders are required to rebate fixed rate floor income and variable rate floor income for those loans to the Department. No variable-rate floor income was earned by the Company in 2022 or 2021. A summary of fixed rate floor income earned by the AGM operating segment follows. Year ended December 31, 2022 2021 Fixed rate floor income, gross $ 57,380 142,606 Derivative settlements (a) 33,149 (19,729) Fixed rate floor income, net $ 90,529 122,877 (a) Derivative settlements consist of settlements received (paid) related to the Company's derivatives used to hedge student loans earning fixed rate floor income. Gross fixed rate floor income decreased in 2022 compared with 2021 due to higher interest rates in 2022 compared with 2021. Absent the use of derivative instruments, a rise in interest rates will reduce the amount of floor income received and has an impact on earnings due to interest margin compression caused by increasing financing costs, until such time as the federally insured loans earn interest at a variable rate in accordance with their SAP formulas. In higher interest rate environments, where the interest rate rises above the borrower rate and fixed rate loans effectively become variable rate loans, the impact of the rate fluctuations is reduced. The Company enters into derivative instruments to hedge student loans earning fixed rate floor income. The increase in net derivative settlements received by the Company during 2022 compared with net derivative settlements paid in 2021, was due to an increase in interest rates, partially offset by a decrease in the notional amount of derivatives outstanding. During 2022, the Company terminated $2.4 billion in notional amount of derivatives for net proceeds of $91.8 million. 71 The following graph depicts fixed rate floor income for a borrower with a fixed rate of 6.75% and a SAP rate of 2.64%: The following table shows AGM’s federally insured student loan assets that were earning fixed rate floor income as of December 31, 2022: Fixed interest rate range Borrower/lender weighted average yield Estimated variable conversion rate (a) Loan balance 6.5 - 6.99% 6.77% 4.13% $ 135,031 7.0 - 7.49% 7.18% 4.54% 69,205 7.5 - 7.99% 7.72% 5.08% 158,317 8.0 - 8.99% 8.18% 5.54% 363,579 > 9.0% 9.05% 6.41% 139,081 $ 865,213 (a) The estimated variable conversion rate is the estimated short-term interest rate at which loans would convert to a variable rate. As of December 31, 2022, the weighted average estimated variable conversion rate was 5.30% and the short-term interest rate was 397 basis points. The following table summarizes the outstanding derivative instruments as of December 31, 2022 used by AGM to economically hedge loans earning fixed rate floor income. Maturity Notional amount Weighted average fixed rate paid by the Company (a) 2024 $ 2,000,000 0.35 % 2026 500,000 1.02 2031 100,000 1.53 2032 (b) 200,000 2.92 $ 2,800,000 0.70 % (a) For the interest rate derivatives maturing in 2032, the Company receives payments based on Secured Overnight Financing Rate (SOFR) that resets quarterly. For all other interest rate derivatives, the Company receives payments based on three-month LIBOR that resets quarterly. (b) These derivatives have forward effective start dates in November 2024. 72 AGM is also exposed to interest rate risk in the form of basis risk and repricing risk because the interest rate characteristics of AGM’s assets do not match the interest rate characteristics of the funding for those assets. The following table presents AGM’s FFELP student loan assets and related funding for those assets arranged by underlying indices as of December 31, 2022. Index Frequency of variable resets Assets Funding of student loan assets 1 month LIBOR (a) Daily $ 12,688,933 — 3 month H15 financial commercial paper Daily 454,866 — 3 month Treasury bill Daily 422,674 — 1 month LIBOR Monthly — 8,113,302 3 month LIBOR (a) Quarterly — 3,754,888 Asset-backed commercial paper (b) Varies — 978,956 Fixed rate — — 594,051 Auction-rate (c) Varies — 178,960 Other (d) — 1,661,866 1,608,182 $ 15,228,339 15,228,339 (a) The Company has certain basis swaps outstanding in which the Company receives three-month LIBOR and pays one-month LIBOR plus or minus a spread as defined in the agreements (the "1:3 Basis Swaps"). The Company entered into these derivative instruments to better match the interest rate characteristics on its student loan assets and the debt funding such assets. The following table summarizes the 1:3 Basis Swaps outstanding as of December 31, 2022. Maturity Notional amount (i) 2023 $ 750,000 2024 1,750,000 2026 1,150,000 2027 250,000 $ 3,900,000 (i) The weighted average rate paid by the Company on the 1:3 Basis Swaps as of December 31, 2022 was one-month LIBOR plus 9.7 basis points. (b) The interest rate on the Company's FFELP warehouse facility is indexed to asset-backed commercial paper rates. (c) As of December 31, 2022, the Company was sponsor for $179.0 million of outstanding asset-backed securities that were set and provide for interest rates to be periodically reset via a "dutch auction" (the “Auction Rate Securities”). Since the auction feature has essentially been inoperable for substantially all auction rate securities since 2008, the Auction Rate Securities generally pay interest to the holder at a maximum rate as defined by the indenture. While these rates will vary, they will generally be based on a spread to LIBOR or Treasury Securities, or the Net Loan Rate as defined in the financing documents. (d) Assets include accrued interest receivable and restricted cash. Funding represents overcollateralization (equity) and other liabilities included in FFELP asset-backed securitizations and warehouse facility. LIBOR is in the process of being discontinued as a benchmark rate, and the market transition away from the current LIBOR framework could result in significant changes to the interest rate characteristics of the Company's LIBOR-indexed assets and funding for those assets. See Item 1A, "Risk Factors - Loan Portfolio - Interest rate risk - replacement of LIBOR as a benchmark rate." 73 Sensitivity Analysis The following tables summarize the effect on the Company’s consolidated earnings, based upon a sensitivity analysis performed on AGM’s assets and liabilities assuming hypothetical increases in interest rates of 100 basis points and 300 basis points while funding spreads remain constant. In addition, a sensitivity analysis was performed assuming the funding index increases 10 basis points and 30 basis points while holding the asset index constant, if the funding index is different than the asset index. The sensitivity analysis was performed on AGM’s variable rate assets (including loans earning fixed rate floor income) and liabilities. The analysis includes the effects of AGM’s derivative instruments in existence during these periods. Interest rates Asset and funding index mismatches Change from increase of 100 basis points Change from increase of 300 basis points Increase of 10 basis points Increase of 30 basis points Dollars Percent Dollars Percent Dollars Percent Dollars Percent Year ended December 31, 2022 Effect on earnings: Decrease in pre-tax net income before impact of derivative settlements $ (19,344) (3.8) % $ (31,648) (6.2) % $ (4,773) (0.9) % $ (14,319) (2.8) % Impact of derivative settlements 31,561 6.2 94,685 18.6 4,895 0.9 14,682 2.9 Increase (decrease) in net income before taxes $ 12,217 2.4 % $ 63,037 12.4 % $ 122 0.0 % $ 363 0.1 % Increase (decrease) in basic and diluted earnings per share $ 0.25 $ 1.27 $ 0.00 $ 0.01 Year ended December 31, 2021 Effect on earnings: Decrease in pre-tax net income before impact of derivative settlements $ (55,957) (11.1) % $ (103,742) (20.7) % $ (6,020) (1.2) % $ (18,063) (3.6) % Impact of derivative settlements 43,059 8.6 129,176 25.7 5,961 1.2 17,884 3.6 Increase (decrease) in net income before taxes $ (12,898) (2.5) % $ 25,434 5.0 % $ (59) — % $ (179) — % Increase (decrease) in basic and diluted earnings per share $ (0.25) $ 0.50 $ (0.00 ) $ (0.00 ) Financial Statement Impact – Derivatives For a table summarizing the effect of derivative instruments in the consolidated statements of income, including the components of "derivative market value adjustments and derivative settlements, net" included in the consolidated statements of income, see note 6 of the notes to consolidated financial statements included in this report. Based on AGM’s interest rate swaps outstanding as of December 31, 2022 used to hedge loans earning fixed rate floor income, if the forward interest rate curve was 50 basis points lower for the remaining duration of these derivatives, we would have been required to pay $29.3 million in additional variation margin. In addition, if the forward basis curve between one-month and three-month LIBOR experienced a ten-basis point reduction in spread for the remaining duration of AGM’s 1:3 Basis Swaps (in which the Company pays one month LIBOR and receives three month LIBOR), we would have been required to pay $7.7 million in additional variation margin. 74 Interest Rate Risk - Nelnet Bank To manage Nelnet Bank's risk from fluctuations in market interest rates, the Company actively monitors interest rates and other interest sensitive components to minimize the impact that changes in interest rates have on the fair value of assets, net income, and cash flow. To achieve this objective, the Company manages and mitigates Nelnet Bank’s exposure to fluctuations in market interest rates through several techniques, including managing the maturity, repricing, and mix of fixed and variable rate assets and liabilities. The following table presents Nelnet Bank's loan assets, asset-backed security investments, and deposits by rate characteristics: As of December 31, 2022 As of December 31, 2021 Dollars Percent Dollars Percent Fixed-rate loan assets $ 341,776 $ 191,410 Fixed-rate investments 123,809 3,937 Total fixed-rate assets 465,585 52.2 % 195,347 38.8 % Variable-rate loan assets 78,019 66,491 Variable-rate investments 347,559 241,038 Total variable rate assets 425,578 47.8 307,529 61.2 Total assets $ 891,163 100.0 % $ 502,876 100.0 % Fixed-rate deposits $ 336,040 42.6 % $ 344,315 80.9 % Variable-rate deposits 453,604 57.4 81,085 19.1 Total deposits $ 789,644 100.0 % $ 425,400 100.0 % Interest Rate and Market Risk - Investments The following table presents the rates earned on the Company’s available-for-sale debt securities (investments) and debt facilities used to fund a portion of such investments. The table below excludes the available-for-sale debt securities (investments) held by Nelnet Bank. Year ended December 31, 2022 2021 Average balance Interest income/ expense Average yields/ rates Average balance Interest income/ expense Average yields/ rates Investments: Asset-backed securities available-for-sale (a)(b) $ 1,303,731 35,516 2.72 % $ 587,736 7,409 1.26 % Debt funding asset-backed securities available-for-sale: Participation agreement - variable rate $ 349,486 9,617 2.75 % $ 152,196 1,176 0.77 % Repurchases agreements - variable rate 481,782 12,355 2.56 223,792 1,558 0.70 $ 831,268 21,972 2.64 $ 375,988 2,734 0.73 (a) The Company has repurchased certain of its own FFELP asset-backed securities (bonds and notes payable) in the secondary market. For accounting purposes, these notes are eliminated in consolidation and are not included in the Company's consolidated financial statements. However, these securities remain legally outstanding at the trust level and the Company could sell these notes to third parties or redeem the notes at par as cash is generated by the trust estate. Upon a sale of these notes to third parties, the Company would obtain cash proceeds equal to the market value of the notes on the date of such sale. The table above includes these repurchased bonds. (b) The majority of the Company’s asset-backed securities earn floating rates with expected returns of approximately LIBOR + 100 to 350 basis points to maturity. As of December 31, 2022, $374.0 million (par value) of the Company’s asset-backed securities earn a weighted average fixed rate of 3.44%. The Company’s portfolio of asset-backed securities has limited liquidity, and the Company could incur a significant loss if the investments were sold prior to maturity at an amount less than the original purchase price. As of December 31, 2022, the net unrealized losses on the Company’s available-for-sale debt securities was $52.6 million, and the aggregate fair value of available-for-sale debt securities with unrealized losses was $1.2 billion. The Company currently has the intent and ability to retain these investments, and none of the unrealized losses were due to credit losses. See note 7 of the notes to consolidated financial statements included in this report for additional information. 75