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Item 3. Quantitative and Qualitative Disclosures About Market Risk

2023-05-08 compared with 2022-11-07 · 70 added, 68 removed, 72 unchanged (66% of the section changed)

4 unchanged sentences

The following table sets forth AGM’s loan assets and debt instruments by rate characteristics:

As of September 30, 2022 As of December 31, 2021

As of March 31, 2023 As of December 31, 2022

Dollars Percent Dollars Percent

15 unchanged sentences

A summary of fixed rate floor income earned by the AGM operating segment follows.

Three months ended September 30, Nine months ended September 30,

2022 2021 2022 2021

Three months ended March 31,

Fixed rate floor income, gross $ 1,110 28,993

2 unchanged sentences

(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 for the three and nine months ended September 30, 2022 as compared to the same periods in 2021 due to higher interest rates in 2022 as compared to 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 the three and nine months ended September 30, 2022, as compared to net derivative settlements paid during the same periods in 2021, was due to an increase in interest rates, partially offset by a decrease in the notional amount of derivatives outstanding.

Gross fixed rate floor income decreased for the three months ended March 31, 2023 compared with the same period in 2022 due to higher interest rates in 2023 compared with 2022.

The Company had a portfolio of derivative instruments in which the Company paid a fixed rate and received a floating rate to economically hedge loans earning fixed rate floor income.

The increase in net derivative settlements received by the Company during the three months ended March 31, 2023, compared with net derivative settlements paid during the same period in 2022, was due to an increase in interest rates, partially offset by a decrease in the notional amount of derivatives outstanding.

See note 4 of the notes to consolidated financial statements included under Part I, Item 1 of this report for additional information on the Company's derivative portfolio.

The Company's derivatives that hedge fixed rate floor income are cleared post-execution at a regulated clearinghouse.

Clearing is a process by which a third party, the clearinghouse, steps in between the original counterparties and guarantees the performance of both, by requiring that each post liquid collateral on an initial (initial margin) and mark-to-market (variation margin) basis to cover the clearinghouse’s potential future exposure in the event of default.

Through March 15, 2023, the Company had received cash or had a receivable from the clearinghouse related to variation margin equal to the fair value of the fixed rate floor derivatives as of March 15, 2023 of $183.2 million, which included $19.1 million related to current period settlements.

To minimize the Company's exposure to market volatility, on March 15, 2023, the Company terminated its entire derivative portfolio hedging loans earning fixed rate floor income.

As a result of terminating these derivatives, there will be no derivative settlements received on these derivatives in future periods.

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 September 30, 2022.

The following table shows AGM’s federally insured student loan assets that were earning fixed rate floor income as of March 31, 2023.

Fixed interest rate range Borrower/lender weighted average yield Estimated variable conversion rate (a) Loan balance

3 unchanged sentences

9.05% 6.41% 131,116

7.0 - 7.49% 7.17% 4.53% 87,432

7.5 - 7.99% 7.72% 5.08% 167,776

8.0 - 8.99% 8.18% 5.54% 390,549

9.05% 6.41% 150,258

(a) The estimated variable conversion rate is the estimated short-term interest rate at which loans would convert to a variable rate.

As of September 30, 2022, the weighted average estimated variable conversion rate was 4.41% and the short-term interest rate was 251 basis points.

The following table summarizes the outstanding derivative instruments as of September 30, 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

$ 2,600,000 0.52 %

(a) For all interest rate derivatives, the Company receives discrete three-month LIBOR.

As of March 31, 2023, the weighted average estimated variable conversion rate was 5.62% and the short-term interest rate was 470 basis points.

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 September 30, 2022.

The following table presents AGM’s FFELP student loan assets and related funding for those assets arranged by underlying indices as of March 31, 2023.

Index Frequency of variable resets Assets Funding of student loan assets

4 unchanged sentences

3 month LIBOR (a) Quarterly — 3,431,852

Fixed rate — — 646,956

Asset-backed commercial paper (b) Varies — 919,337

Fixed rate — — 548,642

Auction-rate (c) Varies — 142,385

3 unchanged sentences

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 September 30, 2022.

The following table summarizes the 1:3 Basis Swaps outstanding as of March 31, 2023.

Maturity Notional amount (i)

1 unchanged sentence

2026 1,150,000

(i) The weighted average rate paid by the Company on the 1:3 Basis Swaps as of September 30, 2022 was one-month LIBOR plus 9.4 basis points.

(i) The weighted average rate paid by the Company on the 1:3 Basis Swaps as of March 31, 2023 was one-month LIBOR plus 10.1 basis points.

(b) The interest rate on the Company's FFELP warehouse facility is indexed to asset-backed commercial paper rates.

(c) As of September 30, 2022, the Company was sponsor for $208.7 million of outstanding asset-backed securities that were set and provide for interest rates to be periodically reset via a "dutch auction" (“Auction Rate Securities”).

(c) As of March 31, 2023, the Company was sponsor for $142.4 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.

1 unchanged sentence

(d) Assets include accrued interest receivable and restricted cash.

Funding represents overcollateralization (equity) and other liabilities included in FFELP asset-backed securitizations and warehouse facilities.

Funding represents overcollateralization (equity) and other liabilities included in FFELP loan 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 "Interest Rate Risk - Repayment of LIBOR as a Benchmark Rate" under Item 2 above and Item 1A, "Risk Factors - Loan Portfolio - Interest rate risk - replacement of LIBOR as a benchmark rate" in the Company's 2021 Annual Report for additional information.

See Item 1A, "Risk Factors - Loan Portfolio - Interest rate risk - replacement of LIBOR as a benchmark rate" in the Company's 2022 Annual Report for additional information.

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.

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 and decreases 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

Interest rates

Change from increase of

100 basis points Change from increase of

300 basis points Increase of

10 basis points Increase of

300 basis points Change from decrease of

100 basis points Change from decrease of

300 basis points

Dollars Percent Dollars Percent Dollars Percent Dollars Percent

Three months ended September 30, 2022

Effect on earnings:

Decrease in pre-tax net income before impact of derivative settlements $ (2,396) (1.9) % $ (3,702) (2.9) % $ (1,148) (0.9) % $ (3,445) (2.7) %

Impact of derivative settlements 6,553 5.2 19,660 15.5 1,235 1.0 3,705 2.9

Increase (decrease) in net income before taxes $ 4,157 3.3 % $ 15,958 12.6 % $ 87 0.1 % $ 260 0.2 %

Increase (decrease) in basic and diluted earnings per share $ 0.08 $ 0.32 $ 0.00 $ 0.01

Three months ended September 30, 2021

Effect on earnings:

Decrease in pre-tax net income before

impact of derivative settlements $ (14,394) (21.5) % $ (27,280) (40.8) % $ (1,484) (2.2) % $ (4,453) (6.7) %

Impact of derivative settlements 12,252 18.3 36,756 55.0 1,487 2.2 4,461 6.7

Increase (decrease) in net income

before taxes $ (2,142) (3.2) % $ 9,476 14.2 % $ 3 0.0 % $ 8 0.0 %

Increase (decrease) in basic and

diluted earnings per share $ (0.04) $ 0.19 $ 0.00 $ 0.00

Nine months ended September 30, 2022

Three months ended March 31, 2023

Effect on earnings:

Decrease in pre-tax net income before

impact of derivative settlements $ (18,464) (3.9) % $ (31,854) (6.7) % $ (3,609) (0.8) % $ (10,828) (2.3) %

Impact of derivative settlements 25,008 5.3 75,025 15.8 3,912 0.8 11,733 2.5

Increase (decrease) in net income

before taxes $ 6,544 1.4 % $ 43,171 9.1 % $ 303 0.0 % $ 905 0.2 %

Increase (decrease) in basic and

diluted earnings per share $ 0.13 $ 0.87 $ 0.00 $ 0.02

Nine months ended September 30, 2021

Increase in pre-tax net income before impact of derivative settlements $ 772 2.5 % $ 4,403 14.1 % $ 76 0.2 % $ 3,650 11.7 %

Impact of derivative settlements (a) — — — — — — — —

Increase in net income before taxes $ 772 2.5 % $ 4,403 14.1 % $ 76 0.2 % $ 3,650 11.7 %

Increase in basic and diluted earnings per share $ 0.02 $ 0.09 $ 0.00 $ 0.07

(a) On March 15, 2023, the Company terminated its entire derivative portfolio hedging loans earning fixed rate floor income.

The table above excludes the impact of these derivatives for the entire period.

Asset and funding index mismatches

10 basis points Increase of

30 basis points

Dollars Percent Dollars Percent

Three months ended March 31, 2023

Effect on earnings:

Decrease in pre-tax net income before

impact of derivative settlements $ (42,749) (12.8) % $ (79,285) (23.7) % $ (4,659) (1.4) % $ (13,980) (4.2) %

Decrease in pre-tax net income before impact of derivative settlements $ (1,113) (3.6) % $ (3,339) (10.7) %

Impact of derivative settlements 777 2.5 2,330 7.5

Increase (decrease) in net income

before taxes $ (11,805) (3.5) % $ 13,546 4.1 % $ (185) (0.1) % $ (557) (0.2) %

Increase (decrease) in basic and

diluted earnings per share $ (0.23) $ 0.27 $ 0.00 $ (0.01)

Decrease in net income before taxes $ (336) (1.1) % $ (1,009) (3.2) %

Decrease in basic and diluted earnings per share $ (0.01) $ (0.02)

Interest Rate Risk - Nelnet Bank

1 unchanged sentence

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 and deposits by rate characteristics:

As of September 30, 2022 As of December 31, 2021

The following table presents Nelnet Bank's loan assets, asset-backed security investments, and deposits by rate characteristics:

As of March 31, 2023 As of December 31, 2022

Dollars Percent Dollars Percent

Fixed-rate loan assets $ 364,818 $ 341,776

Fixed-rate investments 142,152 123,809

Total fixed-rate assets 506,970 51.9 % 465,585 52.2 %

Variable-rate loan assets 74,189 78,019

Total $ 429,476 100.0 % $ 257,901 100.0 %

Variable-rate investments 395,259 347,559

Total variable rate assets 469,448 48.1 425,578 47.8

Total assets $ 976,418 100.0 % $ 891,163 100.0 %

Fixed-rate deposits $ 284,387 32.7 % $ 336,040 42.6 %

Variable-rate deposits 585,391 67.3 453,604 57.4

Total $ 751,370 100.0 % $ 425,400 100.0 %

Total deposits $ 869,778 100.0 % $ 789,644 100.0 %

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 securities (investments) held by Nelnet Bank.

Three months ended March 31,

Average balance Interest income/ expense Average yields/ rates Average balance Interest income/ expense Average yields/ rates

Asset-backed securities available-for-sale (a) (b) $ 1,309,752 17,486 5.41 % $ 1,092,640 3,242 1.20 %

Debt funding asset-backed securities available-for-sale:

Participation agreement - variable rate (c) $ 365,115 5,059 5.62 % $ 256,535 560 0.89 %

Repurchases agreements - variable rate (d) 511,759 6,768 5.36 404,040 1,031 1.03

$ 876,874 11,827 5.47 $ 660,575 1,591 0.98

(a) The Company has repurchased certain of its own FFELP loan 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 March 31, 2023, $259.4 million (par value) of the Company’s asset-backed securities earn a weighted average fixed rate of 3.23%.

(c) Interest incurred by the Company on amounts borrowed under the participation agreement is at a variable rate of LIBOR + 62.5 basis points.

(d) Interest incurred by the Company on amounts borrowed under the repurchase agreements is at a variable rate of LIBOR + 70.0 to 90.0 basis points or SOFR + 75.0 to 141.0 basis points.

The Company’s portfolio of asset-backed investment 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 March 31, 2023, the net unrealized loss on the Company’s available-for-sale debt securities was $35.2 million, and the aggregate fair value of available-for-sale debt securities with unrealized losses was $852.6 million.

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 5 of the notes to consolidated financial statements included under Part I, Item 1 of this report for additional information.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 3. Quantitative and Qualitative Disclosures About Market Risk