NELNET INC 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Management’s Discussion and Analysis of Financial Condition and Results of Operations is for the three months ended March 31, 2023 and 2022. All dollars are in thousands, except per share amounts, unless otherwise noted.) The following discussion and analysis provides information that the Company’s management believes is relevant to an assessment and understanding of the consolidated results of operations and financial condition of the Company. The discussion should be read in conjunction with the Company’s consolidated financial statements included in the 2022 Annual Report. Forward-looking and cautionary statements This report contains forward-looking statements and information that are based on management's current expectations as of the date of this document. Statements that are not historical facts, including statements about the Company's plans and expectations for future financial condition, results of operations or economic performance, or that address management's plans and objectives for future operations, and statements that assume or are dependent upon future events, are forward-looking statements. The words “anticipate,” “assume,” “believe,” “continue,” “could,” “ensure,” “estimate,” “expect,” “forecast,” “future,” “intend,” “may,” “plan,” “potential,” “predict,” “scheduled,” “should,” “will,” “would,” and similar expressions, as well as statements in future tense, are intended to identify forward-looking statements. The forward-looking statements are based on assumptions and analyses made by management in light of management's experience and its perception of historical trends, current conditions, expected future developments, and other factors that management believes are appropriate under the circumstances. These statements are subject to known and unknown risks, uncertainties, assumptions, and other factors that may cause the actual results and performance to be materially different from any future results or performance expressed or implied by such forward-looking statements. These factors include, among others, the risks and uncertainties set forth in the “Risk Factors” section of the 2022 Annual Report and include such risks and uncertainties as: • risks related to the ability to successfully maintain and increase allocated volumes of student loans serviced by the Company under existing and future servicing contracts with the U.S. Department of Education (the "Department") and risks related to the Company's ability to comply with agreements with third-party customers for the servicing of Federal Direct Loan Program, Federal Family Education Loan Program (the "FFEL Program" or FFELP), private education, and consumer loans; • loan portfolio risks such as interest rate basis and repricing risk, the risk of loss of floor income on certain student loans originated under the FFEL Program, risks related to the use of derivatives to manage exposure to interest rate fluctuations, uncertainties regarding the expected benefits from purchased securitized and unsecuritized FFELP, private education, consumer, and other loans, or investment interests therein, and initiatives to purchase additional FFELP, private education, consumer, and other loans, and risks from changes in levels of loan prepayment or default rates; • financing and liquidity risks, including risks of changes in the interest rate environment; • risks from changes in the terms of education loans and in the educational credit and services markets resulting from changes in applicable laws, regulations, and government programs and budgets; • risks related to a breach of or failure in the Company's operational or information systems or infrastructure, or those of third-party vendors; • uncertainties inherent in forecasting future cash flows from student loan assets and related asset-backed securitizations; • risks and uncertainties of the expected benefits from the November 2020 launch of Nelnet Bank operations, including the ability to successfully conduct banking operations and achieve expected market penetration; • risks related to the expected benefits to the Company from its continuing investment in ALLO Holdings, LLC (referred to collectively with its subsidiary ALLO Communications LLC as "ALLO"), and risks related to investments in solar projects, including risks of not being able to realize tax credits which remain subject to recapture by taxing authorities; • risks and uncertainties related to other initiatives to pursue additional strategic investments (and anticipated income therefrom), acquisitions, and other activities, including activities that are intended to diversify the Company both within and outside of its historical core education-related businesses; • risks and uncertainties associated with climate change; and • risks and uncertainties associated with litigation matters and with maintaining compliance with the extensive regulatory requirements applicable to the Company's businesses. 31 All forward-looking statements contained in this report are qualified by these cautionary statements and are made only as of the date of this document. Although the Company may from time to time voluntarily update or revise its prior forward-looking statements to reflect actual results or changes in the Company's expectations, the Company disclaims any commitment to do so except as required by law. OVERVIEW The Company is a diverse, innovative company with a purpose to serve others and a vision to make dreams possible. The largest operating businesses engage in loan servicing and education technology, services, and payment processing, and the Company also has a significant investment in communications. A significant portion of the Company's revenue is net interest income earned on a portfolio of federally insured student loans. The Company also makes investments to further diversify both within and outside of its historical core education-related businesses including, but not limited to, investments in early-stage and emerging growth companies, real estate, and renewable energy (solar). The Company is also actively expanding its private education, consumer, and other loan portfolios, and in November 2020 launched Nelnet Bank. GAAP Net Income and Non-GAAP Net Income, Excluding Adjustments The Company prepares its financial statements and presents its financial results in accordance with GAAP. However, it also provides additional non-GAAP financial information related to specific items management believes to be important in the evaluation of its operating results and performance. A reconciliation of the Company's GAAP net income to Non-GAAP net income, excluding derivative market value adjustments, and a discussion of why the Company believes providing this additional information is useful to investors, is provided below. Three months ended March 31, 2023 2022 GAAP net income attributable to Nelnet, Inc. $ 26,487 186,647 Realized and unrealized derivative market value adjustments 37,411 (145,734) Tax effect (a) (8,979) 34,976 Non-GAAP net income attributable to Nelnet, Inc., excluding derivative market value adjustments (b) $ 54,919 75,889 Earnings per share: GAAP net income attributable to Nelnet, Inc. $ 0.71 4.91 Realized and unrealized derivative market value adjustments 1.00 (3.83) Tax effect (a) (0.24) 0.91 Non-GAAP net income attributable to Nelnet, Inc., excluding derivative market value adjustments (b) $ 1.47 1.99 (a) The tax effects are calculated by multiplying the realized and unrealized derivative market value adjustments by the applicable statutory income tax rate. (b) "Derivative market value adjustments" includes both the realized portion of gains and losses (corresponding to variation margin received or paid on derivative instruments that are settled daily at a central clearinghouse) and the unrealized portion of gains and losses that are caused by changes in fair values of derivatives which do not qualify for "hedge treatment" under GAAP. "Derivative market value adjustments" does not include "derivative settlements" that represent the cash paid or received during the current period to settle with derivative instrument counterparties the economic effect of the Company's derivative instruments based on their contractual terms. The accounting for derivatives requires that changes in the fair value of derivative instruments be recognized currently in earnings, with no fair value adjustment of the hedged item, unless specific hedge accounting criteria is met. Management has structured all of the Company’s derivative transactions with the intent that each is economically effective; however, the Company’s derivative instruments do not qualify for hedge accounting. As a result, the change in fair value of derivative instruments is reported in current period earnings with no consideration for the corresponding change in fair value of the hedged item. Under GAAP, the cumulative net realized and unrealized gain or loss caused by changes in fair values of derivatives in which the Company plans to hold to maturity will equal zero over the life of the contract. However, the net realized and unrealized gain or loss during any given reporting period fluctuates significantly from period to period. The Comp any believes these point-in-time estimates of asset and liability values related to its derivative instruments that are subject to interest rate fluctuations are subject to volatility mostly due to timing and market factors beyond the control of management, and affect the period-to-period comparability of the results of operations. Accordingly, the Company’s management utilizes operating results excluding these items for comparability purposes when making decisions regarding the Company’s performance and in presentations with credit rating agencies, lenders, and investors. Consequently, the Company reports this non-GAAP information because the Company believes that it provides additional information regarding operational and performance indicators that are closely assessed by management. There is no comprehensive, authoritative guidance for the presentation of such non-GAAP information, which is only meant to supplement GAAP results by providing additional information that management utilizes to assess performance. 32 Operating Segments The Company's reportable operating segments are described in note 1 of the notes to consolidated financial statements included in the 2022 Annual Report. They include: • Loan Servicing and Systems (LSS) - referred to as Nelnet Diversified Services (NDS) • Education Technology, Services, and Payment Processing (ETS&PP) - referred to as Nelnet Business Services (NBS) • Asset Generation and Management (AGM) • Nelnet Bank The Company earns fee-based revenue through its NDS and NBS reportable operating segments. The Company earns net interest income on its loan portfolio, consisting primarily of FFELP loans, in its AGM reportable operating segment. This segment is expected to generate significant amounts of cash as the FFELP portfolio amortizes. The Company actively works to maximize the amount and timing of cash flows generated from its FFELP portfolio and seeks to acquire additional loan assets to leverage its servicing scale and expertise to generate incremental earnings and cash flow. On November 2, 2020, the Company obtained final approval for federal deposit insurance from the Federal Deposit Insurance Corporation (FDIC) and for a bank charter from the Utah Department of Financial Institutions (UDFI) in connection with the establishment of Nelnet Bank, and Nelnet Bank launched operations. Nelnet Bank operates as an internet industrial bank franchise focused on the private education and unsecured consumer loan markets, with a home office in Salt Lake City, Utah. Other business activities and operating segments that are not reportable are combined and included in Corporate and Other Activities ("Corporate"). Corporate also includes income earned on the majority of the Company’s investments, interest expense incurred on unsecured and other corporate related debt transactions, and certain shared service activities related to internal audit, human resources, accounting, legal, enterprise risk management, information technology, occupancy, and marketing. These shared services are allocated to each operating segment based on estimated use of such activities and services. In addition, Corporate includes corporate costs and overhead functions not allocated to operating segments, including executive management, investments in innovation, and other holding company organizational costs. 33 The information below provides the operating results (net income (loss) before taxes) for each reportable operating segment and Corporate and Other Activities for the three months ended March 31, 2023 and 2022. See "Results of Operations" for each reportable operating segment and Corporate and Other Activities under this Item 2 for additional detail. Three months ended March 31, Certain Items Impacting Comparability (All dollar amounts below are pre-tax) 2023 2022 NDS $ 25,219 12,094 • An increase in before tax operating margin in 2023 compared with 2022 due to a decrease in operating expenses, primarily salaries and benefits. In 2022, the Company was fully staffed in preparation for the resumption of federal student loan payments once the CARES Act suspension was to expire. The expiration of the CARES Act was extended multiple times throughout 2022. The Company reduced staff in January 2023 to manage excess staff due to the delays in the government's student debt relief and return to repayment programs. NBS 37,637 33,113 • The recognition of $6.0 million of interest income in 2023 compared with $0.3 million in 2022 due to higher interest rates. • A decrease in before tax operating margin, excluding net interest income, in 2023 compared with 2022 due to additional investments in the development of new services and technologies and superior customer experiences to align with the Company's strategies to grow, retain, and diversify revenue. AGM (221) 213,429 • A net loss of $37.4 million related to changes in the fair values of derivative instruments that do not qualify for hedge accounting in 2023 compared with a net gain of $145.7 million in 2022. • The recognition of $31.9 million in provision for loan losses in 2023 compared with a negative provision of $0.9 million in 2022. • A decrease of $12.6 million in net interest income due to the decrease in the average balance of loans in 2023 compared with 2022. • An increase of $4.2 million in net interest income due to an increase in core loan spread in 2023 compared with 2022. • The recognition of $11.8 million in gains from the sale of loans in 2023 compared with $3.0 million in 2022. Nelnet Bank (93) 961 Corporate (31,275) (19,013) • The recognition of a net loss of $20.2 million in 2023 related to the Company’s investment in ALLO, compared with a net loss of $13.1 million in 2022. • The recognition of net investment losses of $3.3 million in 2023 compared with net investment income and gains of $8.5 million in 2022. Income before income taxes 31,267 240,583 Income tax expense (8,250) (55,697) Net loss attributable to noncontrolling interests 3,470 1,761 Net income $ 26,487 186,647 34 CONSOLIDATED RESULTS OF OPERATIONS An analysis of the Company's consolidated operating results for the three months ended March 31, 2023 compared with the same period in 2022 is provided below. The Company’s operating results are primarily driven by the performance of its existing loan portfolio and the revenues generated by its fee-based businesses and the costs to provide such services. The performance of the Company’s portfolio is driven by net interest income (which includes financing costs) and losses related to credit quality of the assets, along with the cost to administer and service the assets and related debt. The Company operates as distinct reportable operating segments as described above. For a reconciliation of the reportable segment operating results to the consolidated results of operations, see note 10 of the notes to consolidated financial statements included under Part I, Item 1 of this report. Since the Company monitors and assesses its operations and results based on these segments, the discussion following the consolidated results of operations is presented on a reportable segment basis. Three months ended March 31, 2023 2022 Additional information Loan interest $ 225,243 111,377 Increase was due to an increase in the gross yield earned on loans, partially offset by a decrease in the average balance of loans and in gross fixed rate floor income. Investment interest 40,725 13,819 Includes income from interest-earning deposits and investments and restricted cash in asset-backed securitizations. Increase was due to an increase in interest earning investments and an increase in interest rates. Total interest income 265,968 125,196 Interest expense 199,449 48,079 Increase was due to an increase in cost of funds, partially offset by a decrease in the average balance of debt outstanding. Net interest income 66,519 77,117 Less provision (negative provision) for loan losses 34,275 (435) Represents the current period provision (negative provision) to reflect the lifetime expected credit losses related to the Company's loan portfolio. See note 2 of the notes to consolidated financial statements included under Part I, Item 1 of this report for the activity in the Company's allowance for loan losses. Net interest income after provision for loan losses 32,244 77,552 Other income (expense): LSS revenue 139,227 136,368 See LSS operating segment - results of operations. ETS&PP revenue 133,603 112,286 See ETS&PP operating segment - results of operations. Solar construction revenue 8,651 — On July 1, 2022, the Company acquired 80% of the ownership interests of GRNE Solar. GRNE Solar designs and installs residential, commercial, and utility-scale solar systems. The acquisition diversifies the Company's position in the renewable energy space to include solar construction. Other, net (14,071) 9,877 See table below for the components of "other, net." Gain on sale of loans, net 11,812 2,989 The Company sold $261.9 million (par value) of consumer and other loans during 2023 and recognized a net gain of $11.8 million. The Company sold $18.1 million (par value) of consumer loans in 2022 and recognized a gain of $3.0 million. Derivative settlements, net 23,337 (2,809) The Company maintains an overall risk management strategy that incorporates the use of derivative instruments to reduce the economic effect of interest rate volatility. Derivative settlements for each applicable period should be evaluated with the Company's net interest income. The majority of derivative settlements received in 2023 was from the Company's derivatives used to hedge loans earning fixed rate floor income. This entire derivative portfolio was terminated on March 15, 2023 to minimize the Company's exposure to market volatility. As such, there will be no derivative settlements received on this portfolio of derivatives in future periods. See AGM operating segment - results of operations. Derivative market value adjustments, net (37,411) 145,734 Includes the realized and unrealized gains and losses that are caused by changes in fair values of derivatives which do not qualify for "hedge treatment" under GAAP. The majority of the derivative market value adjustments were related to the changes in fair value of the Company's floor income interest rate swaps. Such changes reflect that a decrease in the forward yield curve during a reporting period results in a decrease in the fair value of the Company's floor income interest rate swaps, and an increase in the forward yield curve during a reporting period results in an increase in the fair value of such swaps. The entire portfolio of floor income interest rate swaps was terminated on March 15, 2023 to minimize the Company's exposure to market volatility. As such, the Company expects the derivative market value adjustments in future periods will be less substantial. Total other income (expense) 265,148 404,445 Cost of services: Cost to provide education technology, services, and payment processing services 47,704 35,545 Represents direct costs to provide payment processing and instructional services in ETS&PP. Increase was primarily due to additional instructional services costs. See ETS&PP operating segment - results of operations. Cost to provide solar construction services 8,299 — As noted above, the Company acquired GRNE Solar on July 1, 2022. These amounts represent direct costs related to GRNE providing solar construction services. Total cost of services 56,003 35,545 35 Operating expenses: Salaries and benefits 152,710 149,414 Increase was due to an increase in headcount in ETS&PP to support the growth of its customer base and the investment in the development of new technologies. This increase was partially offset by staff reductions in LSS to manage excess staff due to delays in the government's student debt relief and return to repayment programs. Depreciation and amortization 16,627 16,956 Includes depreciation of property and equipment and the amortization of intangibles from prior business acquisitions. Other expenses 40,785 39,499 Includes expenses necessary for operations, such as postage and distribution, consulting and professional fees, occupancy, communications, and certain information technology-related costs. Increase was due to an increase in expenses in ETS&PP due to higher costs for consulting, professional fees, and technology services resulting from investments in new technologies, and an increase in costs for travel and in-person hosted conferences that had previously subsided due to the COVID-19 pandemic. The increase was partially offset by a decrease in expenses in LSS due to a decrease in professional fees and facility costs. Over the last year, the Company has reduced its office space as a large number of employees continue to work from home. Total operating expenses 210,122 205,869 Income before income taxes 31,267 240,583 Income tax expense 8,250 55,697 The effective tax rate was 23.7% and 23.0% for the three months ended March 31, 2023 and 2022, respectively. Net income 23,017 184,886 Net loss attributable to noncontrolling interests 3,470 1,761 Amounts for noncontrolling interests reflect the net income/loss attributable to the holders of noncontrolling membership interests in WRCM, NextGen, multiple solar entities including, GRNE Solar, and multiple entities investing in federal opportunity zone programs. Net income attributable to Nelnet, Inc. $ 26,487 186,647 Additional information: See "Overview - GAAP Net Income and Non-GAAP Net Income, Excluding Adjustments" above for additional information about non-GAAP net income, excluding derivative market value adjustments. Net income attributable to Nelnet, Inc. $ 26,487 186,647 Derivative market value adjustments, net 37,411 (145,734) Tax effect (8,979) 34,976 Net income attributable to Nelnet, Inc., excluding derivative market value adjustments $ 54,919 75,889 The following table summarizes the components of "other, net" in "other income (expense)" on the consolidated statements of income. Three months ended March 31, 2023 2022 Additional information ALLO preferred return $ 2,249 2,117 See Corporate - results of operations. Borrower late fee income 2,247 2,431 See AGM operating segment - results of operations. Administration/sponsor fee income 1,772 2,123 See AGM operating segment - results of operations. Investment advisory services 1,612 1,282 See Corporate - results of operations. Loss from ALLO voting membership interest investment (20,213) (13,130) See Corporate - results of operations. Investment activity, net (3,577) 11,856 See Corporate - results of operations and note (a) below for additional information. Loss from solar investments (1,947) (1,030) See Corporate - results of operations. Other 3,786 4,228 Other, net $ (14,071) 9,877 (a) During the three months ended March 31, 2023, the Company recognized net investment losses of $3.6 million, including net losses of $0.3 million from venture capital investments recognized at Nelnet Bank, a gain of $0.8 million related to real estate investments at Corporate, and losses of $4.1 million primarily related to sales of investments in asset-backed securities (bonds) and marketable equity securities (a loss of $4.1 million recognized at Corporate and a loss of $0.5 million recognized at AGM partially offset by a gain of $0.5 million recognized at Nelnet Bank). During the three months ended March 31, 2022, the Company recognized net investment income and gains of $11.9 million, including $7.2 million from venture capital investments (including $4.9 million recognized at Corporate, $1.9 million recognized at AGM, and $0.4 million recognized at Nelnet Bank), $4.4 million related to real estate investments at Corporate, and $0.3 million related to investments in asset-backed securities (bonds) and marketable equity securities (a loss of $0.8 million recognized at Corporate and income of $1.1 million recognized at Nelnet Bank). The Company anticipates fluctuations in future periodic earnings resulting from investment sales and valuation adjustments. 36 LOAN SERVICING AND SYSTEMS OPERATING SEGMENT – RESULTS OF OPERATIONS Loan Servicing Volumes As of December 31, 2021 March 31, 2022 June 30, 2022 September 30, 2022 December 31, 2022 March 31, 2023 Servicing volume (dollars in millions): Government $ 478,402 507,653 542,398 545,546 545,373 537,291 FFELP 26,916 25,646 24,224 22,412 20,226 19,815 Private and consumer 23,702 23,433 22,838 22,461 21,866 21,484 Total $ 529,020 556,732 589,460 590,419 587,465 578,590 Number of servicing borrowers: Government 14,196,520 14,727,860 15,426,607 15,657,942 15,777,328 15,518,751 FFELP 1,092,066 1,034,913 977,785 910,188 829,939 819,791 Private and consumer 1,065,439 1,030,863 998,454 979,816 951,866 925,861 Total 16,354,025 16,793,636 17,402,846 17,547,946 17,559,133 17,264,403 Number of remote hosted borrowers: 4,799,368 5,487,943 5,738,381 6,025,377 6,135,760 5,048,324 Government Loan Servicing Nelnet Servicing, LLC (Nelnet Servicing) and Great Lakes Educational Loan Services, Inc. (Great Lakes), both subsidiaries of the Company, are two of the current six 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. The Company currently licenses its hosted servicing software to two of the six servicers for the Department. Contract Modifications and Award On March 22, 2023, each of Nelnet Servicing and Great Lakes received modifications of contract with an effective date of April 1, 2023 (collectively the “modifications”) from the Department. Such modifications outline the Department's amendment to the student loan servicing contracts between the Department and each of Nelnet Servicing and Great Lakes (the “servicing contracts”) to reduce the current prices earned by Nelnet Servicing and Great Lakes under the servicing contracts. Under the servicing contracts, Nelnet Servicing and Great Lakes earn a monthly fee from the Department for each unique borrower they service on behalf of the Department. The modifications reduce the monthly fee by $0.19 per borrower on certain borrower statuses. The Company's current 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. In the second quarter of 2022, the Department released a solicitation entitled Unified Servicing and Data Solution (USDS) for the new servicing framework. The Company responded to the USDS solicitation. On April 24, 2023, Nelnet Diversified Solutions, LLC (NDS), a subsidiary of the Company, received a contract award from the Department, pursuant to which NDS was selected to provide continued servicing capabilities for the Department's Office of Federal Student Aid's student aid recipients under a new USDS contract (the "New Government Servicing Contract") which will replace the existing legacy Department student loan servicing contracts that are currently scheduled to expire December 14, 2023. The New Government Servicing Contract is effective April 24, 2023 and has a five year base period, with 2 two-year and 1 one-year possible extensions. The Department's total loan servicing volume of more than 37 million existing borrowers will be allocated by the Department to NDS and four other servicers that were awarded a USDS contract. New Department borrowers will be allocated to the USDS Servicers based on service and performance levels. Under the New Government Servicing Contract, NDS will begin immediately to make required servicing platform enhancements, for which NDS will be compensated from the Department on certain of these investments. In a press release issued on April 24, 2023 by the Department's Office of Federal Student Aid (FSA), FSA indicated that servicing under the USDS contracts will go live in 2024 and to maintain stability as the new loan servicing environment gets underway, FSA will extend the current legacy servicing contracts with the Department from December 14, 2023 to December 2024. Until servicing under the USDS contracts goes live, the Company will continue to earn revenue for servicing borrowers under its current legacy servicing contracts with the Department. 37 The fee structure included in the new Department servicing contracts under USDS are structurally different than the current legacy servicing contracts with the Department. The USDS servicing contracts have multiple revenue components with tiered pricing based on borrower volume, while revenue earned under the legacy servicing contracts is primarily based on borrower status. Assuming borrower volume remains consistent under the USDS servicing contract, the Company expects revenue earned on a per borrower blended basis will decrease under the USDS contract versus the current legacy contracts. However, consistent with the current legacy contracts, the Company expects to earn additional revenue from the Department under the USDS servicing contract for change requests, consolidations, and other support services. As discussed below, during 2023, the Company will continue to transfer the Great Lakes direct loan servicing volume to the Nelnet servicing platform. The associated cost savings with moving government borrowers to one servicing platform will be partially offset under the USDS contract as the Company will incur additional costs for cybersecurity and other system specifications as required under the new contract. Loan Volume Transfers In July 2021, the Pennsylvania Higher Education Assistance Agency (PHEAA) announced its exit from the federal student loan servicing business. All applicable student loans serviced for the Department by PHEAA were transferred to successor servicers. At the time of this announcement, PHEAA serviced approximately 8.5 million borrowers under its contract. As of December 31, 2021 and 2022, approximately 603,000 and 1,910,000 PHEAA borrowers, respectively, have been transitioned to the Company's platform. In addition, over this same time period, PHEAA borrowers were transferred to other servicers to which the Company provides its servicing system (remote hosted servicing customers). Edfinancial Services, LLC ("Edfinancial"), a current servicer for the Department, utilizes Nelnet Servicing's platform to service their loans for the Department. In the fourth quarter of 2022, Nelnet Servicing and Edfinancial reached an agreement on a decommission schedule transferring Edfinancial’s direct loan servicing volume to another servicing platform. As of March 31, 2023, Edfinancial was servicing 3.5 million borrowers for the Department on the Company’s platform. In February 2023, the Department notified the Company of its intention to transfer up to one million borrowers of the Company’s existing Department servicing borrowers to another servicer, and one of the Company’s remote hosted servicing customers notified the Company the Department intends to move that customer’s servicing borrowers to a different servicing platform. As of March 31, 2023, the remote hosted servicing customer was servicing approximately 1.4 million borrowers for the Department on the Company's platform. Neither transfer decision was based on the Company’s performance. The 2023 transfers discussed above began in the first quarter of 2023 and the Company expects the transfers to be completed by the end of the second quarter of 2023. As a result of the transfers, software services revenue for remote hosted customers and government servicing revenue will decrease in future periods as borrowers are transferred off of the Company’s platform. In addition, once all remote hosted servicing transfers are complete, there will be no active Department remote hosted servicing customers using the Company’s platform. In addition, the Company continues to transfer the Great Lakes direct loan servicing volume to the Nelnet servicing platform (the GreatNet Federal servicing platform). The Company anticipates the transfer of active borrowers to be completed by the end of the second quarter of 2023 and decommissioning of the Great Lakes' platform to be completed by the end of 2023. Therefore, potential associated cost savings as a result of transferring direct loan servicing volume to one platform will not be recognized in operating results until 2024. Department of Education Debt Relief In August 2022, the Department announced a broad based student debt relief plan that would 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. Decisions by the U.S. Courts of Appeals for the Eighth Circuit and Fifth Circuit in October 2022 and November 2022, respectively, in response to legal challenges that were initiated by other parties (not the Company) have blocked implementation of the Department's broad based student debt relief plan. These cases have been appealed to the U.S. Supreme Court. As of the filing of this report, the Supreme Court has not ruled on, and the Company cannot predict the timing, nature, or ultimate outcome of, this case. The Company cannot 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, the Company estimates it would decrease the number of borrowers serviced (based on the borrower loan information as of March 31, 2023) by approximately 4.5 million borrowers and 7.7 million borrowers, respectively. The 38 actual impact to the number of borrowers serviced may 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. Revenue earned under the current Department servicing contracts will decrease in future periods if the Department's student debt relief plan or other broad based loan forgiveness is implemented. The CARES Act Under the CARES Act, beginning in March 2020, federal student loan payments and interest accruals were suspended for all borrowers that had loans owned by the Department. As a result of the CARES Act, the Company receives less servicing revenue per borrower from the Department based on the borrower forbearance status than what was earned on such accounts prior to these provisions. On April 6, 2022, the Department extended the student loans payment pause under the CARES Act from May 1, 2022 to August 31, 2022, and on August 24, 2022, the Department extended such payment pause from August 31, 2022 to December 31, 2022. On November 22, 2022, the Department again extended such payment pause until 60 days following the date the Department is permitted to implement the debt relief program or the litigation initiated by other parties is resolved. If the debt relief program has not been implemented and the litigation has not been resolved by June 30, 2023, borrower forbearances will end 60 days after June 30, 2023, and payments will resume within 60 days after that (on or before October 28, 2023). Prior to the April 2022 extension (during the fourth quarter of 2021 and first quarter of 2022), the Company earned additional revenue from the Department based on incremental work, including outbound engagement, being performed by the Company to support the anticipated Department borrowers coming out of forbearance. Effective May 1, 2022, the Department increased the monthly per borrower CARES Act forbearance rate paid to its servicers to compensate them for supplemental outreach to certain borrowers and to support the transition of borrowers back to repayment. Once borrowers transition back to repayment under the legacy government contracts, the Company anticipates revenue per borrower from the Department will increase from the current CARES Act levels. Reduction in Staff On January 18, 2023, the Company announced a reduction in staff to manage excess staff capacity due to delays in the government's student debt relief and return to repayment programs under the CARES Act (as discussed above). Approximately 350 associates who were hired within the prior six months were laid off with a 60 day notice period and approximately 210 associates were immediately terminated for performance. On March 23, 2023, the Company announced a reduction in staff due to the March 2023 government servicing contract price modifications (as discussed above) and the notification by the Department in February 2023 of its intention to transfer up to one million borrowers of the Company's existing Department servicing borrowers to another servicer (as discussed above). Approximately 550 associates who work in LSS, including some in related shared services areas that support LSS, were notified their positions were being eliminated. The Company estimates incurring a charge of $4.3 million related to the staff reductions, of which $2.7 million was recognized in the first quarter of 2023. The remaining expense will be incurred primarily during the second quarter of 2023. Summary and Comparison of Operating Results Three months ended March 31, 2023 2022 Additional information Net interest income $ 1,037 43 Increase in 2023 compared with 2022 was due to higher interest rates. Loan servicing and systems revenue 139,227 136,368 See table below for additional information. Intersegment servicing revenue 7,790 8,480 Represents revenue earned by LSS from servicing loans for AGM and Nelnet Bank. Decrease in 2023 compared with 2022 was due to the continued amortization of AGM's FFELP portfolio. FFELP intersegment servicing revenue will continue to decrease as AGM's FFELP portfolio pays off. Other income 608 740 Represents revenue earned from providing administrative support and marketing services. Total other income 147,625 145,588 Salaries and benefits 84,560 91,972 Decrease in 2023 compared with 2022 was due to the Company being fully staffed with contact center operations and support associates in 2022 in preparation for the resumption of federal student loan payments and other activities after the CARES Act suspension. See “Government Loan Servicing - The CARES Act” above for additional details. In addition, the Company reduced staff in January and March 2023. See "Reduction in Staff" above for additional details. Depreciation and amortization 4,513 4,954 39 Other expenses 13,313 16,213 Decrease in 2023 compared with 2022 was due to a decrease in professional fees and facility costs. Over the last year, the Company has reduced its office space as a large number of employees continue to work from home. Intersegment expenses 21,057 20,398 Represent costs for certain corporate activities and services that are allocated to each operating segment based on estimated use of such activities and services. Total operating expenses 123,443 133,537 Income before income taxes 25,219 12,094 Income tax expense (6,053) (2,903) Represents income tax expense at an effective tax rate of 24%. Net income $ 19,166 9,191 Before tax operating margin 17.1 % 8.3 % Before tax operating margin represents before tax operating profitability as a percentage of revenue, and for LSS is calculated as income before income taxes divided by the total of loan servicing and systems revenue, intersegment servicing revenue, and other income revenue. The Company uses this metric to monitor and assess the segment’s performance, manage operating costs, identify and evaluate business trends affecting the segment, and make strategic decisions, and believes that it provides additional information to facilitate an understanding of the operating performance of the segment and provides a meaningful comparison of the results of operations between periods. Before tax operating margin increased in 2023 compared with 2022 due to a decrease in operating expenses as described above. Loan servicing and systems revenue Three months ended March 31, 2023 2022 Additional information Government loan servicing $ 108,880 109,125 Represents revenue from the Company's Department servicing contracts. Decrease in 2023 compared with 2022 was due to (i) the recognition of $6.7 million of revenue in the first quarter of 2022 for incremental work related primarily to CARES Act forbearance exit outreach activities to borrowers; and (ii) the recognition of $10.5 million of revenue in the first quarter of 2022 related to the discharge of borrowers under the Total and Permanent Disability (TPD) discharge program (the Company earns revenue per each borrower that satisfies the requirements for their loan to be discharged under the TPD discharge program). These decreases were partially offset by (i) an increase in the number of PHEAA borrowers serviced on the Company's servicing platform; (ii) a per borrower CARES Act forbearance rate increase on May 1, 2022; and (iii) a per borrower rate increase on September 1, 2022 (5.0%) to reflect the increase in the cost of labor (Employment Cost Index) per the provisions of the contracts. Effective April 1, 2023, the monthly fee earned per borrower on certain borrower statuses will be reduced by $0.19. See “Government Loan Servicing - Contract Modifications and Award" above for additional details. Private education and consumer loan servicing 12,164 12,873 Decrease in 2023 compared with 2022 was due to a decrease in servicing volume and client requested enhanced delinquency services. FFELP loan servicing 3,368 4,248 Decrease in 2023 compared with 2022 was due to a decrease in the number of borrowers serviced. Over time, FFELP servicing revenue will continue to decrease as third-party customers' FFELP portfolios pay off. Since late 2021, the Company has experienced accelerated run-off of its FFELP servicing portfolio due to FFELP borrowers consolidating their loans into Federal Direct Loan Program loans as a result of the continued extension of borrower relief under the CARES Act and 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. Software services 9,697 7,400 Increase in 2023 compared with 2022 was due to an increase in remote hosted borrowers and an increase in rates. Software services revenue from Department remote hosted servicing customers will be adversely impacted in future periods. See “Government Loan Servicing - Loan Volume Transfers” above for additional details. Outsourced services 5,118 2,722 Represents primarily revenue to provide contact center and back office operational outsourcing services. Increase in 2023 compared with 2022 was due to additional outsourced opportunities, including assisting existing Department servicers as operations transition from exiting servicers. Loan servicing and systems revenue $ 139,227 136,368 40 EDUCATION TECHNOLOGY, SERVICES, AND PAYMENT PROCESSING OPERATING SEGMENT – RESULTS OF OPERATIONS As discussed further in the Company's 2022 Annual Report, this segment of the Company’s business is subject to seasonal fluctuations which correspond, or are related to, the traditional school year. Based on the timing of revenue recognition and when expenses are incurred, revenue and before tax operating margin are higher in the first quarter compared with the remainder of the year. Summary and Comparison of Operating Results Three months ended March 31, 2023 2022 Additional information Net interest income $ 6,036 339 Represents interest income on tuition funds held in custody for schools. Increase in 2023 compared with 2022 was due to higher interest rates. Education technology, services, and payment processing revenue 133,603 112,286 See table below for additional information. Intersegment revenue 56 3 Total other income 133,659 112,289 Cost of services 47,704 35,545 See table below for additional information. Salaries and benefits 37,913 31,286 Increase in 2023 compared with 2022 was due to an increase in headcount to support the growth of the customer base and the investment in the development of new technologies. Depreciation and amortization 2,578 2,315 Represents primarily amortization of intangible assets from prior business acquisitions. Other expenses 8,063 5,764 Increase in 2023 compared with 2022 was due to higher costs for consulting, professional fees, and technology services resulting from investments in new technologies. Increase was also due to an increase in costs for travel and in-person hosted conferences that previously subsided due to the COVID pandemic. Intersegment expenses, net 5,800 4,605 Represents costs for certain corporate activities and services that are allocated to each operating segment based on estimated use of such activities and services. Total operating expenses 54,354 43,970 Income before income taxes 37,637 33,113 Income tax expense (9,066) (7,947) Represents income tax expense at an effective tax rate of 24%. Net income 28,571 25,166 Net loss attributable to noncontrolling interests 138 — Amounts for noncontrolling interests reflect the net loss attributable to the holders of minority membership interests in NextGen, of which the Company became the majority owner on April 30, 2022. Net income $ 28,709 25,166 41 Education technology, services, and payment processing revenue The following table provides disaggregated revenue by service offering and before tax operating margin for each reporting period. Three months ended March 31, 2023 2022 Additional information Tuition payment plan services $ 34,187 30,716 Increase in 2023 compared with 2022 was due to a higher number of payment plans in the K-12 and higher education market. Payment processing 44,041 38,071 Increase in 2023 compared with 2022 was due to increase in payment volumes for both the K-12 and higher education markets due to new customers and an increase in volume from existing customers. Education technology and services 54,787 43,251 Increase in 2023 compared with 2022 was due to an increase in revenue from the Company’s school information system software, enrollment and communication services, the NextGen acquisition completed in April 2022, and FACTS Education Solutions instructional and professional development services. FACTS Education Solutions instructional services revenue was the largest component of this increase, driven by the Emergency Assistance to Non-Public Schools (EANS) program which provides funds to non-public schools through September 2024 to address the impact COVID-19 has had or continues to have on students and teachers. Other 588 248 Education technology, services, and payment processing revenue 133,603 112,286 Cost of services 47,704 35,545 Represents costs relating to payment processing revenue and such costs decrease/increase in relationship to payment volumes. Costs to provide instructional services are also a component of this expense and were the primary driver of the increase in 2023 compared with 2022 due to the increase in instructional services resulting from the EANS program as noted above. Net revenue $ 85,899 76,741 GAAP before tax operating margin 43.8 % 43.1 % Before tax operating margin, excluding net interest income, is a non-GAAP measure of before tax operating profitability as a percentage of revenue, and for the ETS&PP segment is calculated as income before income taxes less interest income divided by net revenue. The Company uses this metric to monitor and assess the segment’s performance, manage operating costs, identify and evaluate business trends affecting the segment, and make strategic decisions, and believes that it facilitates an understanding of the operating performance of the segment and provides a meaningful comparison of the results of operations between periods. Before tax operating margin, excluding net interest income, decreased in 2023 compared with 2022 due to investments in (i) the development of new services and technologies; and (ii) superior customer experiences to align with the Company’s strategies to grow, retain, and diversify revenues. The Company anticipates before tax operating margin, excluding net interest income, will be impacted over the next several years as it continues to invest in these areas. Net interest income (7.0) (0.4) Non-GAAP before tax operating margin, excluding net interest income 36.8 % 42.7 % 42 ASSET GENERATION AND MANAGEMENT OPERATING SEGMENT – RESULTS OF OPERATIONS Loan Portfolio As of March 31, 2023, the AGM operating segment had a $13.5 billion loan portfolio, consisting primarily of federally insured loans. For a summary of the Company’s loan portfolio as of March 31, 2023 and December 31, 2022, see note 2 of the notes to consolidated financial statements included under Part I, Item 1 of this report. Loan Activity The following table sets forth the activity of loans in the AGM operating segment: Three months ended March 31, 2023 2022 Beginning balance $ 14,169,771 17,441,790 Loan acquisitions: Federally insured student loans 2,980 10,202 Private education loans — 1,026 Consumer and other loans 250,706 18,522 Total loan acquisitions 253,686 29,750 Repayments, claims, capitalized interest, participations, and other, net (410,239) (447,140) Loans lost to external parties (268,696) (387,648) Loans sold (261,902) (18,125) Ending balance $ 13,482,620 16,618,627 The Company has also purchased partial ownership in certain consumer, private education, and federally insured student loan securitizations that are accounted for as held-to-maturity beneficial interest investments and included in "investments and notes receivable" in the Company's consolidated financial statements. As of the latest remittance reports filed by the various trusts prior to or as of March 31, 2023, the Company’s ownership correlates to approximately $585 million, $590 million, and $370 million of consumer, private education, and federally insured student loans, respectively, included in these securitizations. The loans held in these securitizations are not included in the above table. Since late 2021, the Company has experienced accelerated run-off of its 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. Allowance for Loan Losses, Loan Delinquencies, and Loan Charge-offs For a summary of the allowance as a percentage of the ending balance and loan status and delinquency amounts for each of AGM's loan portfolios as of March 31, 2023 and December 31, 2022; and the activity in AGM's allowance for loan losses and net charge-offs as a percentage of average loans for the three months ended March 31, 2023 and 2022, see note 2 of the notes to consolidated financial statements included under Part I, Item 1 of this report. 43 Loan Spread Analysis The following table analyzes the loan spread on AGM’s portfolio of loans, which represents the spread between the yield earned on loan assets and the costs of the liabilities and derivative instruments used to fund the assets. The spread amounts included in the following table are calculated by using the notional dollar values found in the table under the caption "Net interest income after provision for loan losses, net of settlements on derivatives" below, divided by the average balance of loans or debt outstanding. Three months ended March 31, 2023 2022 Variable loan yield, gross 7.12 % 2.75 % Consolidation rebate fees (0.81) (0.85) Discount accretion, net of premium and deferred origination costs amortization 0.05 0.03 Variable loan yield, net 6.36 1.93 Loan cost of funds - interest expense (5.53) (1.09) Loan cost of funds - derivative settlements (a) (b) 0.03 0.01 Variable loan spread 0.86 0.85 Fixed rate floor income, gross 0.03 0.68 Fixed rate floor income - derivative settlements (a) (c) 0.68 (0.08) Fixed rate floor income, net of settlements on derivatives 0.71 0.60 Core loan spread 1.57 % 1.45 % Average balance of AGM's loans $ 13,991,241 17,208,909 Average balance of AGM's debt outstanding 13,364,876 16,773,698 (a) Derivative settlements represent the cash paid or received during the current period to settle with derivative instrument counterparties the economic effect of the Company's derivative instruments based on their contractual terms. Derivative accounting requires that net settlements with respect to derivatives that do not qualify for "hedge treatment" under GAAP be recorded in a separate income statement line item below net interest income. The Company maintains an overall risk management strategy that incorporates the use of derivative instruments to reduce the economic effect of interest rate volatility. As such, management believes derivative settlements for each applicable period should be evaluated with the Company’s net interest income (loan spread) as presented in this table. The Company reports this non-GAAP information because the Company believes that it provides additional information regarding operational and performance indicators that are closely assessed by management. There is no comprehensive, authoritative guidance for the presentation of such non-GAAP information, which is only meant to supplement GAAP results by providing additional information that management utilizes to assess performance. 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 instruments, including the net settlement activity recognized by the Company for each type of derivative for the 2023 and 2022 periods presented in the table under the caption "Consolidated Financial Statement Impact Related to Derivatives - Statements of Income" in note 4 and in this table. A reconciliation of core loan spread, which includes the impact of derivative settlements on loan spread, to loan spread without derivative settlements follows. Three months ended March 31, 2023 2022 Core loan spread 1.57 % 1.45 % Derivative settlements (1:3 basis swaps) (0.03) (0.01) Derivative settlements (fixed rate floor income) (0.68) 0.08 Loan spread 0.86 % 1.52 % (b) Derivative settlements consist of net settlements received related to the Company’s 1:3 basis swaps. (c) Derivative settlements consist of net settlements received (paid) related to the Company’s floor income interest rate swaps. 44 A trend analysis of AGM's core and variable loan spreads is summarized below. The interest earned on a large portion of AGM's FFELP student loan assets is indexed to the one-month LIBOR rate. AGM funds a portion of its assets with three-month LIBOR indexed floating rate securities. The relationship between the indices in which AGM earns interest on its loans and funds such loans has a significant impact on loan spread. The table above (the right axis) shows the difference between AGM's liability base rate and the one-month LIBOR rate by quarter. Variable loan spread increased during the three months ended March 31, 2023 compared with the same period in 2022 due to a narrowing of the basis between the asset and debt indices in which the Company earns interest on its loans and funds such loans (as reflected in the table above). In an increasing interest rate environment, student loan spread on FFELP loans increases due to the timing of interest rate resets on the Company's assets occurring daily in contrast to the timing of the interest resets on the Company's debt that occurs either monthly or quarterly. See Item 3, “Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk - AGM Operating Segment,” which provides additional detail on AGM’s FFELP student loan assets and related funding for those assets. The difference between variable loan spread and core loan spread is fixed rate floor income earned on a portion of AGM's federally insured student loan portfolio. A summary of fixed rate floor income and its contribution to core loan spread follows: Three months ended March 31, 2023 2022 Fixed rate floor income, gross $ 1,110 28,993 Derivative settlements (a) 22,478 (3,205) Fixed rate floor income, net $ 23,588 25,788 Fixed rate floor income contribution to spread, net 0.71 % 0.60 % (a) Derivative settlements consist of net settlements received (paid) related to the Company's derivatives used to hedge student loans earning fixed rate floor income. The decrease in gross fixed rate floor income for the three months ended March 31, 2023 compared with the same period in 2022 was due to higher interest rates in 2023 compared with 2022. 45 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. 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, the Company terminated its entire derivative portfolio hedging loans earning fixed rate floor income. As a result of the Company terminating these derivatives, there will be no derivative settlements on these derivatives in future periods. 46 Summary and Comparison of Operating Results Three months ended March 31, 2023 2022 Additional information Net interest income after provision for loan losses $ 13,663 73,459 See table below for additional analysis. Other income, net 2,845 6,511 Represents primarily borrower late fees, income from providing administration activities for third parties, and income from AGM's investment in a joint venture. Decrease in 2023 compared with 2022 was primarily due to the recognition of a $0.1 million loss in the first quarter of 2023 compared with $1.9 million of income for the same period in 2022 related to its investment in the joint venture. Gain on sale of loans, net 11,812 2,989 The Company sold $261.9 million (par value) and $18.1 million (par value) of loans to unrelated third parties in 2023 and 2022, respectively, and recognized net gains from such sales. Derivative settlements, net 23,337 (2,809) The Company maintains an overall risk management strategy that incorporates the use of derivative instruments to reduce the economic effect of interest rate volatility. Derivative settlements for each applicable period should be evaluated with the Company's net interest income as reflected in the table below. The majority of derivative settlements received in 2023 was from the Company's derivatives used to hedge loans earning fixed rate floor income. This entire derivative portfolio was terminated on March 15, 2023 to minimize the Company's exposure to market volatility. As such, there will be no derivative settlements received on these derivatives in future periods. Derivative market value adjustments, net (37,411) 145,734 Includes the realized and unrealized gains and losses that are caused by changes in fair values of derivatives which do not qualify for "hedge treatment" under GAAP. The majority of the derivative market value adjustments during 2023 and 2022 related to the changes in fair value of the Company's floor income interest rate swaps. Such changes reflect that a decrease in the forward yield curve during a reporting period results in a decrease in the fair value of the Company's floor income interest rate swaps, and an increase in the forward yield curve during a reporting period results in an increase in the fair value of such swaps. The entire portfolio of floor income interest rate swaps was terminated on March 15, 2023 to minimize the Company's exposure to market volatility. As such, the Company expects the derivative market value adjustments in future periods will be less substantial. Total other income (expense) 583 152,425 Salaries and benefits 755 591 Other expenses 5,016 3,033 Represents primarily servicing fees paid to third parties. Also includes certain professional and legal fees. Increase in 2023 compared with 2022 was due to incurring additional professional fees as the Company actively expands into new asset loan classes. Intersegment expenses 8,696 8,831 Represents fees paid to LSS for the servicing of AGM’s loan portfolio. These amounts exceed the actual cost of servicing the loans. Intersegment expenses also includes costs for certain corporate activities and services that are allocated to each operating segment based on estimated use of such activities and services. Total operating expenses 14,467 12,455 Total operating expenses were 41 basis points and 29 basis points of the average balance of loans for the three months ended March 31, 2023 and 2022, respectively. The increase in operating expenses as a percent of the average balance of loans in 2023 compared with 2022 was due to an increase in certain professional costs as discussed above. (Loss) income before income taxes (221) 213,429 Income tax benefit (expense) 53 (51,223) Represents income tax expense at an effective tax rate of 24%. Net (loss) income $ (168) 162,206 Additional information: Net (loss) income $ (168) 162,206 See "Overview - GAAP Net Income and Non-GAAP Net Income, Excluding Adjustments" above for additional details about non-GAAP net income, excluding derivative market value adjustments. Derivative market value adjustments, net 37,411 (145,734) Tax effect (8,979) 34,976 Net income, excluding derivative market value adjustments $ 28,264 51,448 47 Net interest income after provision for loan losses, net of settlements on derivatives The following table summarizes the components of "net interest income after provision for loan losses" and "derivative settlements, net." Three months ended March 31, 2023 2022 Additional information Variable interest income, gross $ 246,594 115,753 Increase in 2023 compared with 2022 was due to an increase in the gross yield earned on loans, partially offset by a decrease in the average balance of loans. Consolidation rebate fees (28,399) (36,771) Decrease in 2023 compared with 2022 was due to a decrease in the average consolidation loan balance. Discount accretion, net of premium and deferred origination costs amortization 1,607 1,459 Net discount accretion is due to the Company's purchases of loans at a net discount over the last several years. Variable interest income, net 219,802 80,441 Interest on bonds and notes payable (182,063) (45,209) Increase in 2023 compared with 2022 was due to an increase in cost of funds, partially offset by a decrease in the average balance of debt outstanding. Derivative settlements, net (a) 859 396 Derivative settlements include the net settlements received related to the Company’s 1:3 basis swaps. Variable loan interest margin, net of settlements on derivatives 38,598 35,628 Fixed rate floor income, gross 1,110 28,993 Decrease in 2023 compared with 2022 was due to higher interest rates. Derivative settlements, net (a) 22,478 (3,205) Derivative settlements include the settlements received (paid) related to the Company's floor income interest rate swaps. The increase in net derivative settlements received by the Company during 2023, compared with net derivative settlements paid during 2022, was due to an increase in interest rates, partially offset by a decrease in the notional amount of derivatives outstanding. The entire portfolio of floor income interest rate swaps was terminated on March 15, 2023 to minimize the Company's exposure to market volatility. As such, there will be no derivative settlements received on these derivatives in future periods. Fixed rate floor income, net of settlements on derivatives 23,588 25,788 Core loan interest income (a) 62,186 61,416 Investment interest 13,807 9,164 Increase in 2023 compared with 2022 was due to an increase of interest earned on restricted cash due to higher rates. Intercompany interest (7,135) (794) Increase in 2023 compared with 2022 was due to an increase in the balance of borrowings and higher rates. (Provision) negative provision for loan losses - federally insured loans (2,411) 2,748 The Company has recognized provision for loan losses during the three months ended March 31, 2023 due to management's estimate of declining economic conditions, as well as establishing an initial allowance for loans acquired during the period. For additional information, see note 2 of the notes to consolidated financial statements included under Part I, Item 1 of this report. (Provision) negative provision for loan losses - private education loans (240) 400 (Provision) for loan losses - consumer and other loans (29,207) (2,284) Net interest income after provision for loan losses (net of settlements on derivatives) (a) $ 37,000 70,650 Decrease in 2023 compared with 2022 was due to (i) a decrease in the average balance of loans; and (ii) an increase in provision for loan losses. These items were partially offset by (i) an increase in core loan spread; and (ii) an increase in investment interest income. (a) Core loan interest income and net interest income after provision for loan losses (net of settlements on derivatives) are non-GAAP financial measures. For an explanation of GAAP accounting for derivative settlements and the reasons why the Company reports these non-GAAP measures (and the limitations thereof), see footnote (a) to the table immediately under the caption “Loan Spread Analysis” above. 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 instruments, including the net settlement activity recognized by the Company for each type of derivative referred to in the "Additional information" column of this table, for the 2023 and 2022 periods presented in the table under the caption "Consolidated Financial Statement Impact Related to Derivatives - Statements of Income" in note 4 and in this table. Subsequent Event Subsequent to the end of the first quarter, in April 2023, the Company redeemed $188.6 million of FFELP loan asset-backed securities (bonds and notes payable) prior to their legal maturity. The remaining unamortized debt discount associated with these bonds at the time of redemption was written-off, resulting in a $25.9 million non-cash expense recognized in April 2023. 48 NELNET BANK OPERATING SEGMENT – RESULTS OF OPERATIONS Loan Portfolio As of March 31, 2023, Nelnet Bank had a $439.0 million loan portfolio, consisting of $355.7 million of private education loans, $63.4 million of FFELP loans, and $19.9 million of consumer and other loans. For a summary of the allowance as a percentage of the ending balance and loan status, delinquency amounts, and other key credit quality indicators of each of Nelnet Bank's loan portfolios as of March 31, 2023 and December 31, 2022; and the activity in Nelnet Bank's allowance for loan losses and net charge-offs as a percentage of average loans for the three months ended March 31, 2023 and 2022, see note 2 of the notes to consolidated financial statements included under Part I, Item 1 of this report. The following table sets forth the activity in Nelnet Bank's loan portfolio: Three months ended March 31, 2023 2022 Beginning balance $ 419,795 257,901 Loan originations: Private education loans 14,226 130,342 Consumer and other loans 19,632 — Total loan originations 33,858 130,342 Repayments (14,529) (18,394) Sales to AGM (117) (1,592) Ending balance $ 439,007 368,257 Deposits As of March 31, 2023, Nelnet Bank had $869.8 million of deposits. All of Nelnet Bank’s deposits are interest-bearing deposits and consist of brokered certificates of deposit (CDs) and retail and other savings deposits and CDs. Retail and other saving deposits include deposits from Educational 529 College Savings and Health Savings plans, Short Term Federal Investment Trust (STFIT), and commercial and institutional CDs. Union Bank, a related party, is the program manager for the Educational 529 College Savings plans and trustee for the STFIT. Nelnet Bank’s deposits include $194.0 million from Nelnet, Inc. (the parent company) and its subsidiaries (intercompany), and thus eliminated for consolidated financial reporting purposes. The intercompany deposits include a pledged deposit of $40.0 million from Nelnet, Inc. as required under the Capital and Liquidity Maintenance Agreement with the FDIC, deposits required for intercompany transactions, operating and savings deposits, and NBS custodial deposits consisting of collected tuition payments which are subsequently remitted to the appropriate school. 49 Average Balance Sheet The following table reflects the rates earned on interest-earning assets and paid on interest-bearing liabilities. Three months ended March 31, (a) 2023 2022 Balance Rate Balance Rate Average assets Federally insured student loans $ 64,655 5.93 % $ 85,266 1.42 % Private education loans 355,698 3.61 228,934 2.91 Consumer and other loans 7,308 12.30 — — Cash and investments 540,513 5.95 265,101 1.66 Total interest-earning assets 968,174 5.14 % 579,301 2.12 % Non-interest-earning assets 9,323 15,275 Total assets $ 977,497 $ 594,576 Average liabilities and equity Brokered deposits $ 205,411 1.39 % $ 144,527 1.20 % Intercompany deposits 187,872 4.96 70,576 0.20 Retail and other deposits 452,008 3.78 269,027 0.59 Total interest-bearing liabilities 845,291 3.46 % 484,130 0.72 % Non-interest-bearing liabilities 5,608 6,427 Equity 126,598 104,019 Total liabilities and equity $ 977,497 $ 594,576 (a) Calculated using average daily balances. Summary and Comparison of Operating Results Three months ended March 31, 2023 2022 Additional information Total interest income $ 12,259 3,030 Represents interest earned on loans, cash, and investments. Increase in 2023 compared with 2022 was due to an increase of these balances and interest rates. Interest expense 7,214 856 Represents interest expense on deposits. Increase in 2023 compared with 2022 was due to an increase of deposits and interest rates. Net interest income 5,045 2,174 Provision for loan losses 2,417 429 Increase in provision for loan losses was due to the mix of loans, including the mix of loans originated in 2023 compared with 2022, and management's estimate of declining economic conditions. For additional information, see note 2 of the notes to consolidated financial statements included under Part I, Item 1 of this report. Net interest income after provision for loan losses 2,628 1,745 Other income 210 1,500 Represents primarily income and net gains from investments. Salaries and benefits 2,064 1,554 Represents salaries and benefits of Nelnet Bank associates and third-party contract labor. Increase in 2023 compared with 2022 was due to the overall growth of Nelnet Bank activities. Depreciation 5 3 Other expenses 782 682 Intersegment expenses 80 45 Represents primarily servicing costs paid to LSS. Certain shared service and support costs incurred by the Company to support Nelnet Bank are not and will not be reflected as part of Nelnet Bank through 2023 (when the bank’s de novo period will end). The shared service and support costs incurred by the Company related to Nelnet Bank and not reflected in the bank’s operating segment were $1.7 million and $1.3 million for the three months ended March 31, 2023 and 2022, respectively. Total operating expenses 2,931 2,284 (Loss) income before income taxes (93) 961 Income tax benefit (expense) 35 (223) Represents income tax benefit (expense) at an effective tax rate of 37.4% and 23.2% for the three months ended March 31, 2023 and 2022, respectively. Net (loss) income $ (58) 738 50 CORPORATE AND OTHER ACTIVITIES – RESULTS OF OPERATIONS Other business activities and operating segments that are not reportable are combined and included in Corporate and Other Activities (“Corporate”). The following table summarizes the operating results of these activities. Income taxes are allocated based on 24% of income (loss) before taxes for each activity. The difference between the Corporate income tax expense and the sum of taxes calculated for each activity is included in income taxes in “other” in the table below. Summary and Comparison of Operating Results Nelnet Renewable Energy (c) Shared services (a) WRCM (b) Tax equity investments / syndication / administration GRNE Solar ALLO investment (d) Real estate investments (e) Venture capital investments (f) Interest income/expense, net (g) Other Total Three months ended March 31, 2023 Interest income $ — 2 — 41 — 141 670 20,237 108 21,199 Interest expense — — — (273) — — — (11,977) (68) (12,318) Net interest income — 2 — (232) — 141 670 8,260 40 8,881 Solar construction revenue — — — 8,651 — — — — — 8,651 Other, net 626 1,612 (1,948) 44 (17,864) 800 67 (3,941) 2,870 (17,734) Cost to provide solar construction services — — — (8,299) — — — — — (8,299) Salaries and benefits (23,384) (56) (1,007) (1,196) (30) (81) (177) — (1,488) (27,419) Depreciation and amortization (8,830) — — (617) — (6) — — (78) (9,531) Other expenses (10,566) (81) (821) (948) 12 (16) (165) (2,218) 1,192 (13,611) Intersegment expenses, net 29,165 (3) 15 (513) — (95) (10) (97) (675) 27,787 Income (loss) before income taxes (12,989) 1,474 (3,761) (3,110) (17,882) 743 385 2,004 1,861 (31,275) Income tax (expense) benefit 3,117 (319) 206 610 4,292 (180) (92) (481) (372) 6,781 Net (income) loss attributable to noncontrolling interests — (146) 2,903 569 — 6 — — — 3,332 Net income (loss) $ (9,872) 1,009 (652) (1,931) (13,590) 569 293 1,523 1,489 (21,162) Three months ended March 31, 2022 Interest income $ — — — — — 289 — 3,603 100 3,992 Interest expense — — — — — — — (1,745) (281) (2,026) Net interest income — — — — — 289 — 1,858 (181) 1,966 Solar construction revenue — — — — — — — — — — Other, net 689 1,281 (869) — (11,014) 4,472 4,902 (864) 2,528 1,125 Cost to provide solar construction services — — — — — — — — — — Salaries and benefits (21,868) (55) (258) — (84) (110) (239) — (1,398) (24,012) Depreciation and amortization (9,615) — — — — — — — (69) (9,684) Other expenses (12,261) (100) (102) — (24) (2) (23) (449) (843) (13,804) Intersegment expenses, net 25,755 (3) (3) — — (95) — (56) (202) 25,396 Income (loss) before income taxes (17,300) 1,123 (1,232) — (11,122) 4,554 4,640 489 (165) (19,013) Income tax (expense) benefit 4,152 (243) (153) — 2,669 (1,092) (1,114) (117) 2,496 6,598 Net (income) loss attributable to noncontrolling interests — (112) 1,869 — — (6) — — 10 1,761 Net income (loss) $ (13,148) 768 484 — (8,453) 3,456 3,526 372 2,341 (10,654) 51 (a) Includes corporate activities related to internal audit, human resources, accounting, legal, enterprise risk management, information technology, occupancy, and marketing. These costs are allocated to each operating segment based on estimated use of such activities and services. Certain shared service costs incurred to support Nelnet Bank will not be allocated to Nelnet Bank until the end of the Bank’s de novo period (November 2023). The amount allocated to operating segments is reflected as “intersegment expenses, net” in the table above. Also includes corporate costs and overhead functions not allocated to operating segments, including executive management, investments in innovation, and other holding company organizational costs. (b) The Company provides investment advisory services through Whitetail Rock Capital Management, LLC (WRCM), the Company's SEC-registered investment advisor subsidiary, under various arrangements. During the three months ended March 31, 2023 and 2022, WRCM earned $1.6 million and $1.3 million in management fees, respectively. Fees earned by WRCM are included in "other, net" in the table above. (c) Nelnet Renewable Energy, which includes solar tax equity investments made by the Company, administrative and management services provided by the Company on tax equity investments made by third parties, and solar development. As of March 31, 2023, the Company has invested a total of $294.4 million (which includes $115.9 million syndicated to third-party investors) in solar tax equity investments. Due to the management and control of each of these investment partnerships, the tax equity investments are consolidated on the Company’s consolidated financial statements, with the co-investor’s portion being presented as non-controlling interests. Included in tax equity investments is the Company's share of income or loss from solar investments under the Hypothetical Liquidation at Book Value (HLBV) method of accounting. For the majority of the Company's solar investments, the HLBV method of accounting results in accelerated losses in the initial years of investment. During the three months ended March 31, 2023 and 2022, Nelnet Renewable Energy recognized losses of $1.9 million and $1.0 million, respectively, on its tax equity investments. These losses, which include losses attributable to third-party noncontrolling interest investors, are included in “other, net” in the table above. Solar losses attributable to third-party noncontrolling interest investors was $2.7 million and $1.8 million for the three months ended March 31, 2023 and 2022, respectively, and are reflected in “net (income) loss attributable to noncontrolling interests” in the table above. Nelnet Renewable Energy syndicates tax equity investments to third parties and earns management and performance fees. Management fee income recognized by Nelnet Renewable Energy was $0.3 million and $0.2 million for the three months ended March 31, 2023 and 2022, respectively, which is included in "other, net" in the table above. In addition to solar tax equity investments, the Company has a strategy to own solar energy project assets. Accordingly, the Company has begun to execute a multi-faceted approach to originate, acquire, finance, own, and manage these assets. As part of this strategy, on July 1, 2022, the Company acquired 80% of the ownership interest in two subsidiaries of GRNE Solutions, LLC named GRNE-Nelnet, LLC (GRNE) and ENRG-Nelnet, LLC (ENRG) (collectively referred to as “GRNE Solar”). (d) Represents primarily the Company's share of loss on its voting membership interests and income on its preferred membership interest in ALLO. The Company accounts for its approximately 45% voting membership interests in ALLO Holdings LLC, a holding company for ALLO Communications LLC (collectively referred to as "ALLO") under the HLBV method of accounting. During the three months ended March 31, 2023 and 2022, the Company recognized losses of $20.2 million and $13.1 million, respectively, under the HLBV method of accounting on its ALLO voting membership interests investment. These amounts are reflected in “other, net” in the table above. As of March 31, 2023, the outstanding preferred membership interests and accrued and unpaid preferred return of ALLO held by the Company was $145.9 million and $2.2 million, respectively. The preferred membership interests of ALLO held by the Company earn a preferred annual return of 6.25%. During the three months ended March 31, 2023 and 2022, the Company recognized income on its ALLO preferred membership interests of $2.2 million and $2.1 million, respectively. These amounts are reflected in “other, net” in the table above. (e) Represents the operating results of the Company’s real estate investments and the administrative costs to manage this portfolio. During the three months ended March 31, 2023 and 2022, the Company recognized $0.8 million and $4.4 million, respectively, in net income and gains from its real estate investments, which is included in “other, net” in the table above. (f) Represents the operating results of the Company’s venture capital investments and the administrative costs to manage this portfolio. During the three months ended March 31, 2022, the Company recognized $4.9 million in net income and gains on venture capital investments, which is included in “other, net” in the table above. (g) Represents interest income earned on cash and investment debt securities (primarily student loan and other asset-backed securities), interest expense incurred on unsecured and certain other corporate related debt transactions, unrealized gains/losses on marketable equity securities, realized gains/losses on marketable equity securities and investment debt securities, and other costs to manage these investments and facilities. During the three months ended March 31, 2023 and 2022, the Company recognized losses of $4.1 million and $0.8 million, respectively, on its marketable equity and investment debt securities, which are included in “other, net” in the table above. During the three months ended March 31, 2023, the Company recognized $1.8 million in fees owed on collateral deposits with its derivative third-party clearinghouse as the result of an increase in collateral deposit balances and interest rates, which is included in “other expenses” in the table above. Fees owed on collateral deposits with its derivative third-party clearinghouse were insignificant for the three months ended March 31, 2022. 52 LIQUIDITY AND CAPITAL RESOURCES The Company’s Loan Servicing and Systems, and Education Technology, Services, and Payment Processing operating segments are non-capital intensive and both produce positive operating cash flows. As such, a minimal amount of debt and equity capital is allocated to these segments and any liquidity or capital needs are satisfied using cash flow from operations. Nelnet Bank launched operations in November 2020. Nelnet Bank was funded by the Company with an initial capital contribution of $100.0 million and the Company contributed an additional $30.0 million to Nelnet Bank during 2022. Based on Nelnet Bank's business plan for growth and current financial condition, the Company believes it will make additional capital contributions to the bank in future periods. Cash and investments held at Nelnet Bank are generally not available for Company activities outside of Nelnet Bank. See “Liquidity Impact Related to Nelnet Bank” included below for additional information. Therefore, the Liquidity and Capital Resources discussion is concentrated on the Company’s liquidity and capital needs to meet existing debt obligations in the Asset Generation and Management operating segment and the Company's other initiatives to pursue additional strategic investments. Sources of Liquidity As of March 31, 2023, the Company's sources of liquidity included: Cash and cash equivalents $ 187,574 Less: Cash and cash equivalents held at Nelnet Bank (1) (7,721) Net cash and cash equivalents 179,853 Available-for-sale (AFS) debt securities (investments) - at fair value 1,070,703 Less: AFS debt securities held at Nelnet Bank - at fair value (1) (388,233) AFS debt securities serving as collateral on participation agreement - at fair value (2) (289,086) AFS debt securities serving as collateral on repurchase agreements - at fair value (3) (294,590) AFS restricted debt securities - at fair value (15,910) Unencumbered AFS debt securities (investments) - at fair value 82,884 Unencumbered private, consumer, and other loans (Non-Nelnet Bank) - at par 285,401 Repurchased Nelnet issued asset-backed debt securities - at par (not included on consolidated financial statements) (4) 397,826 Less: Repurchased Nelnet issued asset-backed debt securities serving as collateral on repurchase agreements - at par (197,500) Unencumbered repurchased Nelnet issued asset-backed debt securities - at par 200,326 Unused capacity on unsecured line of credit (5) 495,000 Sources of liquidity as of March 31, 2023 $ 1,243,464 (1) Cash and investments held at Nelnet Bank are generally not available for Company activities outside of Nelnet Bank. (2) See the caption "Other Debt Facilities" below. (3) See the caption "Repurchase Agreements" below. (4) The Company has repurchased certain of its own 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. Certain of these securities serve as collateral on amounts outstanding under the Company's repurchase agreements as reflected in the table above. (5) The Company has a $495.0 million unsecured line of credit that matures on September 22, 2026. As of March 31, 2023, there was no amount outstanding on the unsecured line of credit and $495.0 million was available for future use. The line of credit 53 agreement contains certain financial covenants, including limitations on recourse indebtedness to adjusted EBITDA (over the last four rolling quarters). Of the $495.0 million availability, approximately $260 million was available for purposes other than reducing existing recourse debt due to the limitations on recourse indebtedness to adjusted EBITDA financial covenant. The Company intends to use its liquidity position to capitalize on market opportunities, including FFELP, private education, consumer, and other loan acquisitions (or investment interests therein); strategic acquisitions and investments; and capital management initiatives, including stock repurchases, debt repurchases, and dividend distributions. The timing and size of these opportunities will vary and will have a direct impact on the Company's cash and investment balances. Cash Flows The Company has historically generated positive cash flow from operations. During the three months ended March 31, 2023 and 2022, the Company generated $122.8 million and $275.3 million, respectively, in cash from operating activities. The decrease in 2023 compared with 2022 was due to: • A decrease in net income; • Payments to the Company's clearinghouse for margin payments on derivatives for the three months ended March 31, 2023 compared with proceeds received in 2022; and • Adjustments to net income for the impact of the non-cash change in deferred income taxes. These factors were partially offset by: • Proceeds from termination of derivative instruments in 2023; • Adjustments to net income for derivative market value adjustments, the impact of provision for loan losses, and loss on investments; and • The impact of changes to accounts receivable during the three months ended March 31, 2023 compared with the same period in 2022. The primary items included in the statement of cash flows for investing activities are the purchase, origination, and repayment of loans and the purchase and sale of available-for-sale securities. The primary items included in financing activities are the proceeds from the issuance of and payments on bonds and notes payable and Nelnet Bank deposits used to fund loans. Cash provided by investing activities and used in financing activities for the three months ended March 31, 2023 was $723.9 million and $1,306.3 million, respectively. Cash provided by investing activities and used in financing activities for the three months ended March 31, 2022 was $603.1 million and $895.1 million, respectively. Investing and financing activities are further addressed in the discussion that follows. Liquidity Needs and Sources of Liquidity Available to Satisfy Debt Obligations Secured by Loan Assets and Related Collateral The following table shows AGM's debt obligations outstanding that are secured by loan assets and related collateral. As of March 31, 2023 Carrying amount Final maturity Bonds and notes issued in asset-backed securitizations $ 11,774,925 8/26/30 - 9/25/69 FFELP, private education, and consumer loan warehouse facilities 1,049,679 12/31/23 - 11/14/25 $ 12,824,604 Bonds and Notes Issued in Asset-backed Securitizations The majority of AGM’s portfolio of student loans is funded in asset-backed securitizations that are structured to substantially match the maturity of the funded assets, thereby minimizing liquidity risk. Cash generated from student loans funded in asset-backed securitizations provide the sources of liquidity to satisfy all obligations related to the outstanding bonds and notes issued in such securitizations. In addition, due to (i) the difference between the yield AGM receives on the loans and cost of financing within these transactions, and (ii) the servicing and administration fees AGM earns from these transactions, AGM has created a portfolio that will generate earnings and significant cash flow over the life of these transactions. As of March 31, 2023, based on cash flow models developed to reflect management’s current estimate of, among other factors, prepayments, defaults, deferment, forbearance, and interest rates, AGM currently expects future undiscounted cash flows from its portfolio to be approximately $1.43 billion as detailed below. 54 The forecasted cash flow presented below includes all loans, the majority of which are federally insured student loans, funded in asset-backed securitizations as of March 31, 2023. As of March 31, 2023, AGM had $12.1 billion of loans included in asset-backed securitizations, which represented 89.5% of its total loan portfolio. The forecasted cash flow does not include cash flows that the Company expects to receive related to loans funded in its warehouse facilities, unencumbered private education, consumer, and other loans funded with operating cash, loans acquired subsequent to March 31, 2023, loans owned by Nelnet Bank, and cash flows relating to the Company's ownership of beneficial interest in loan securitizations (such beneficial interest investments are classified as "investments and notes receivable" on the Company's consolidated balance sheets). Asset-backed Securitization Cash Flow Forecast $1.43 billion (dollars in millions) The forecasted future undiscounted cash flows of approximately $1.43 billion include approximately $0.89 billion (as of March 31, 2023) of overcollateralization included in the asset-backed securitizations. These excess net asset positions are included in the consolidated balance sheets and included in the balances of "loans and accrued interest receivable" and "restricted cash." The difference between the total estimated future undiscounted cash flows and the overcollateralization of approximately $0.54 billion, or approximately $0.41 billion after income taxes based on the estimated effective tax rate, represents estimated future net interest income (earnings) from the portfolio and is expected to be accretive to the Company's March 31, 2023 balance of consolidated shareholders' equity. The Company uses various assumptions, including prepayments and future interest rates, when preparing its cash flow forecast. These assumptions are further discussed below. Prepayments : The primary variable in establishing a life of loan estimate is the level and timing of prepayments. Prepayment rates equal the amount of loans that prepay annually as a percentage of the beginning of period balance, net of scheduled principal payments. A number of factors can affect estimated prepayment rates, including the level of consolidation activity, borrower default rates, and utilization of debt management options such as income-based repayment, deferments, and forbearance. Should any of these factors change, management may revise its assumptions, which in turn would impact the projected future cash flow. The Company’s cash flow forecast above assumes prepayment rates of 5% for consolidation loans and 6% for all other loan types. 55 Since late 2021, the Company has experienced accelerated run-off of its 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. 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 significantly increase prepayments. See Part I, Item 1A, "Risk Factors - Loan Portfolio - Prepayments risk" in the Company's 2022 Annual Report for additional information related to risks associated with loan prepayments. The following table summarizes the estimated impact to the above forecasted cash flows if prepayments were greater than the prepayment rate assumptions used to calculate the forecasted cash flows. Increase in prepayment rate Reduction in forecasted cash flow from table above Forecasted cash flow using increased prepayment rate 2x $0.11 billion $1.32 billion 4x $0.25 billion $1.18 billion 10x $0.48 billion $0.95 billion If the entire AGM student loan portfolio prepaid, the Company would receive the full amount of overcollateralization included in the asset-backed securitizations of approximately $0.89 billion (as of March 31, 2023); however, the Company would not receive the $0.54 billion ($0.41 billion after tax) of estimated future earnings from the portfolio. Interest rates : The Company funds a large portion of its student loans with three-month LIBOR indexed floating rate securities. Meanwhile, the interest earned on the Company’s student loan assets is indexed primarily to a one-month LIBOR rate. The different interest rate characteristics of the Company’s loan assets and liabilities funding these assets result in basis risk. The Company’s cash flow forecast assumes three-month LIBOR will exceed one-month LIBOR by 12 basis points for the life of the portfolio, which approximates the historical relationship between these indices. If the forecast is computed assuming a spread of 24 basis points between three-month and one-month LIBOR for the life of the portfolio, the cash flow forecast would be reduced by approximately $45 million to $70 million. As the percentage of the Company's outstanding debt financed by three-month LIBOR declines, the Company's basis risk will be reduced. In addition, the Company attempts to mitigate the impact of this basis risk by entering into certain derivative instruments. The Company uses the current forward interest rate yield curve to forecast cash flows. A change in the forward interest rate curve would impact the future cash flows generated from the portfolio. An increase in future interest rates will reduce the amount of fixed rate floor income the Company is currently receiving. See Item 3, "Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk - AGM Operating Segment" for additional information about various interest rate risks which may impact future cash flows from AGM's loan assets. In addition, 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 forecasted cash flows from the Company's asset-backed securitizations. See Item 1A, "Risk Factors - Loan Portfolio - Interest rate risk - replacement of LIBOR as a benchmark rate" in the Company's 2022 Annual Report. Warehouse Facilities Warehousing allows the Company to buy and manage loans prior to transferring them into more permanent financing arrangements. The Company has a FFELP warehouse facility that, as of March 31, 2023, had an aggregate maximum financing amount available of $1.25 billion, of which $919.3 million was outstanding and $330.7 million was available for additional funding. The warehouse facility has a static advance rate until the expiration date of the liquidity provisions (May 22, 2023). In the event the liquidity provisions are not extended, the valuation agent has the right to perform a one-time mark to market on the underlying loans funded in this facility, subject to a floor. The loans would then be funded at this new advance rate until the final maturity date of the facility (May 22, 2024). As of March 31, 2023, the Company had $62.8 million advanced as equity support on this facility. On April 3, 2023, the Company obtained an additional FFELP warehouse facility that has an aggregate maximum financing amount available of $250.0 million. This warehouse facility's liquidity provisions expire on April 2, 2024 and has a final maturity date of April 2, 2025. 56 As of March 31, 2023, the Company's private education warehouse facility had an outstanding balance of $47.9 million, liquidity provisions through June 30, 2023, a final maturity of December 31, 2023, and $19.4 million was advanced as equity support. No additional amounts can be borrowed under this facility. The Company also has a consumer loan warehouse facility that, as of March 31, 2023, had an aggregate maximum financing amount available of $250.0 million, an advance rate of 70%, liquidity provisions through November 14, 2024, and a final maturity date of November 14, 2025. As of March 31, 2023, $82.4 million was outstanding under this facility, $167.6 million was available for future funding, and the Company had $35.2 million advanced as equity support. Upon termination or expiration of the warehouse facilities, the Company would expect to access the securitization market, obtain replacement warehouse facilities, use operating cash, consider the sale of assets, or transfer collateral to satisfy any remaining obligations. Other Uses of Liquidity The Company no longer originates FFELP loans, but continues to acquire FFELP loan portfolios from third parties and believes additional loan purchase opportunities exist, including opportunities to purchase private education, consumer, and other loans (or investment interests therein). The Company plans to fund additional loan acquisitions and related investments using current cash; proceeds from the sale of certain investments; its unsecured line of credit, its Union Bank student loan participation agreement, its Union Bank student loan asset-backed securities participation agreement, and third-party repurchase agreements (each as described below), and/or establishing similar secured and unsecured borrowing facilities; using its existing warehouse facilities (as described above); increasing the capacity under existing and/or establishing new warehouse facilities; and continuing to access the asset-backed securities market. Repurchase Agreements In December 2020, Wells Fargo announced the sale of its approximately $10.0 billion portfolio of private education loans representing approximately 445,000 borrowers. The Company entered into a joint venture with other investors to acquire the loans, and under the joint venture, the Company had an approximately 8% interest in the loans and has a corresponding 8% interest in residual interests in the 2021 securitizations of the loans discussed below. The joint venture established a limited partnership that purchased the private education loans and funded such loans with a temporary warehouse facility. During 2021, the Company sponsored four asset-backed securitization transactions to permanently finance a total of $8.7 billion of private education loans sold by Wells Fargo (which represented the total remaining loans originally purchased from Wells Fargo, factoring in borrower payments from the date of purchase). As sponsor, the Company is required to provide a certain level of risk retention, and has purchased bonds issued in such securitizations to satisfy this requirement. The bonds purchased to satisfy the risk retention requirement are reflected on the Company's consolidated balance sheet as "investments and notes receivable" and as of March 31, 2023, the fair value of these bonds was $294.6 million. The Company must retain these investment securities until the latest of (i) two years from the closing date of the securitization, (ii) the date the aggregate outstanding principal balance of the loans in the securitization is 33% or less of the initial loan balance, and (iii) the date the aggregate outstanding principal balance of the bonds is 33% or less of the aggregate initial outstanding principal balance of the bonds, at which time the Company can sell its investment securities (bonds) to a third party. The Company entered into repurchase agreements with third parties, of which a portion of the proceeds from such agreements were used to purchase the asset-backed investments, and such investments serve as collateral on the repurchase obligations. In addition, as discussed above, the Company has repurchased certain of its own asset-backed securities in the secondary market that serve as collateral on amounts outstanding under the Company's repurchase agreements. As of March 31, 2023, $433.0 million was outstanding on the Company's repurchase agreements, of which $274.0 million was borrowed to fund private education loan securitization bonds subject to the Company’s risk retention requirement and $159.0 million was borrowed to fund repurchased FFELP loan asset-backed securities. The repurchase agreements have various maturity dates (as of March 31, 2023) from April 6, 2023 through November 27, 2024, but one of the agreements is subject to early termination upon required notice provided by the Company or the applicable counterparty prior to the maturity dates. Subsequent to March 31, 2023, the maturities on these agreements were extended, and as of May 8, 2023, the maturity dates vary from May 26, 2023 through November 27, 2024. The Company is required to pay additional cash in the event the fair value of the securities subject to a repurchase agreement becomes less than the original purchase price of such securities. 57 Upon termination or expiration of the repurchase agreements, the Company would use cash and/or cash proceeds from its unsecured line of credit, consider the sale of assets (subject to any restrictions described above), or transfer collateral to satisfy any outstanding obligations subject to the repurchase agreements. Union Bank Participation Agreement The Company maintains an agreement with Union Bank, a related party, as trustee for various grantor trusts, under which Union Bank has agreed to purchase from the Company participation interests in student loans. As of March 31, 2023, $684.4 million of loans were subject to outstanding participation interests held by Union Bank, as trustee, under this agreement. The agreement automatically renews annually and is terminable by either party upon five business days' notice. This agreement provides beneficiaries of Union Bank’s grantor trusts with access to investments in interests in student loans, while providing liquidity to the Company. The Company can participate loans to Union Bank to the extent of availability under the grantor trusts, up to $900.0 million or an amount in excess of $900.0 million if mutually agreed to by both parties. Loans participated under this agreement have been accounted for by the Company as loan sales. Accordingly, the participation interests sold are not included on the Company’s consolidated balance sheets. Asset-backed Securities Transactions The Company, through its subsidiaries, has historically funded student loans by completing asset-backed securitizations. Depending on market conditions, the Company anticipates continuing to access the asset-backed securitization market. Such asset-backed securitization transactions would be used to refinance student loans included in its warehouse facilities, loans purchased from third parties, and/or student loans in its existing asset-backed securitizations. There were no asset-backed securitization transactions completed during the three months ended March 31, 2023. Liquidity Impact Related to Nelnet Bank Nelnet Bank launched operations in November 2020. Nelnet Bank was funded by the Company with an initial capital contribution of $100.0 million and the Company contributed an additional $30.0 million to Nelnet Bank during 2022. In addition, the Company made a pledged deposit of $40.0 million with Nelnet Bank, as required under an agreement with the FDIC discussed below. Prior to Nelnet Bank’s launch of operations, Nelnet Bank, Nelnet, Inc. (the parent), and Michael S. Dunlap (Nelnet, Inc.’s controlling shareholder) entered into a Capital and Liquidity Maintenance Agreement and a Parent Company Agreement with the FDIC in connection with Nelnet, Inc.’s role as a source of financial strength for Nelnet Bank. As part of the Capital and Liquidity Maintenance Agreement, Nelnet, Inc. is obligated to (i) contribute capital to Nelnet Bank for it to maintain capital levels that meet FDIC requirements for a “well capitalized” bank, including a leverage ratio of capital to total assets of at least 12%; (ii) provide and maintain an irrevocable asset liquidity takeout commitment for the benefit of Nelnet Bank in an amount equal to the greater of either 10% of Nelnet Bank’s total assets or such additional amount as agreed to by Nelnet Bank and Nelnet, Inc.; (iii) provide additional liquidity to Nelnet Bank in such amount and duration as may be necessary for Nelnet Bank to meet its ongoing liquidity obligations; and (iv) establish and maintain a pledged deposit of $40.0 million with Nelnet Bank. Under the regulatory framework for prompt corrective action, Nelnet Bank is subject to various regulatory capital requirements administered by the FDIC and the UDFI and must meet specific capital standards. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on Nelnet Bank’s business, results of operations, or financial condition. On January 1, 2020, the Community Bank Leverage Ratio (CBLR) framework, as issued jointly by the Office of the Comptroller of the Currency, the Federal Reserve Board, and the FDIC, became effective. Any banking organization with total consolidated assets of less than $10 billion, limited amounts of certain types of assets and off-balance sheet exposures, and a community bank leverage ratio greater than 9% may opt into the CBLR framework quarterly. The CBLR framework allows banks to satisfy capital standards and be considered "well capitalized" under the prompt corrective action framework if their leverage ratio is greater than 9%, unless the banking organization's federal banking agency determines that the banking organization's risk profile warrants a more stringent leverage ratio. The FDIC has ordered Nelnet Bank to maintain at least a 12% leverage ratio. Nelnet Bank has opted into the CBLR framework for the quarter ended March 31, 2023 with a leverage ratio of 12.6%. Nelnet Bank intends to maintain at all times regulatory capital levels that meet both the minimum level necessary to be considered “well capitalized” under the FDIC’s prompt corrective action framework and the minimum level required by the FDIC. Nelnet Bank has a portfolio of asset-backed securities investments that were accounted for and classified as available-for-sale. Accordingly, these securities were carried at fair value, with the changes in fair value, net of taxes, carried as a separate component of equity. To reduce Nelnet Bank's market exposure related to decreases in fair value on these investments, on March 31, 2023, securities at Nelnet Bank with a fair value of $149.2 million were transferred from available for sale to held to 58 maturity. The securities were reclassified at fair value at the time of the transfer, and such transfer represented a non-cash transaction. Accumulated other comprehensive income as of March 31, 2023 includes pre-tax unrealized losses of $3.7 million related to the transfer. These unrealized losses will be amortized, consistent with the amortization of any discounts on such securities, over the remaining lives of the respective securities as an adjustment of yield. Based on Nelnet Bank's business plan for growth and current financial condition, the Company believes it will make additional capital contributions to the bank in future periods. Liquidity Impact Related to Nelnet Renewable Energy The Company’s Nelnet Renewable Energy business makes solar tax equity investments. Through March 31, 2023, the Company has invested a total of $294.4 million (which includes $115.9 million syndicated to third-party investors) in tax equity investments in renewable energy solar partnerships. These investments provide a federal income tax credit under the Internal Revenue Code, equaling either 26% or 30% of the eligible project costs, with the tax credit available when the project is placed-in-service. The Company is allowed to reduce its tax estimates paid to the U.S. Treasury based on the credits earned. Based on the timing of when the Company funds a project and decreases its tax estimate to the U.S. Treasury due to earning of the tax credit, the amount of capital committed to solar tax equity investments at any point in time is not significant and has a minimal impact on the Company’s liquidity. As of March 31, 2023, the Company is committed to fund an additional $220.3 million on tax equity investments, of which $141.4 million is expected to be provided by syndication partners. In addition to solar tax equity investments, the Company has a strategy to own solar energy project assets. These assets provide long-term, predictable, and recurring cash flows. Accordingly, the Company has begun to execute a multi-faceted approach to originate, acquire, finance, own, and manage these assets. The Company plans to fund a large portion of its current growth plans in owning solar energy projects using third-party debt and third-party tax equity. The collateral on any third-party debt would be limited to the assets of the specific solar projects. Any capital requirements for the origination or purchase of solar projects not funded by third-party debt and third-party tax equity would be provided by the Company using operating cash, borrowings on its unsecured line of credit, and/or the sale of investments. Liquidity Impact Related to ALLO Upon the deconsolidation of ALLO on December 21, 2020, the Company recorded its 45% voting membership interests in ALLO at fair value, and accounts for such investment under the HLBV method of accounting. In addition, the Company recorded its remaining non-voting preferred membership units of ALLO at fair value, and accounts for such investment as a separate equity investment. As of March 31, 2023, the outstanding preferred membership interests of ALLO held by the Company was $145.9 million that earns a preferred annual return of 6.25%. Agreements among the Company, SDC (a third-party global digital infrastructure investor), and ALLO provide that they will use commercially reasonable efforts (which excludes requiring ALLO to raise any additional equity financing or sell any assets) to cause the redemption, on or before April 2024, the non-voting preferred membership interests in ALLO held by the Company, plus the amount of accrued and unpaid preferred return on such interests. However, if the non-voting preferred membership interests are not redeemed on or before April 2024, the preferred annual return is increased from 6.25% to 10.00%. As part of the ALLO recapitalization transaction, the Company and SDC entered into an agreement, in which the Company has a contingent payment obligation to pay SDC a contingent payment amount of $25.0 million to $35.0 million in the event the Company disposes of its voting membership interests of ALLO that it holds and realizes from such disposition certain targeted return levels. As of March 31, 2023 the estimated fair value of the contingent payment is $7.6 million. If ALLO needs additional capital to support its growth in existing or new markets, the Company has the option to contribute additional capital to maintain its voting equity interest. Although ALLO has obtained third-party debt financing to fund a large portion of its current growth plans, the Company contributed $8.4 million of additional equity to ALLO in the first quarter of 2023. As a result of this equity contribution, the Company’s voting membership interests percentage did not materially change. Based on ALLO's business plan for growth and current financial condition, the Company believes it will make additional capital contributions to ALLO in future periods. Liquidity Impact Related to Hedging Activities The Company utilizes derivative instruments to manage interest rate sensitivity. By using derivative instruments, the Company is exposed to market risk which could impact its liquidity. All over-the-counter derivative contracts executed by the Company 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 59 Company had received cash or had a receivable from the clearinghouse related to variation margin equal to the fair value as of March 15, 2023 of the derivatives used to hedge loans earning fixed rate floor income of $183.2 million, which included $19.1 million related to current period settlements. To minimize the Company's exposure to market volatility, the Company terminated its entire derivative portfolio hedging loans earning fixed rate floor income ($2.8 billion in notional amount of derivatives). Based on the remaining derivative portfolio outstanding as of March 31, 2023, the Company does not anticipate any movement in interest rates having a material impact on its capital or liquidity profile, nor does the Company expect that any movement in interest rates would have a material impact on its ability to make variation margin payments to its third-party clearinghouse. Other Debt Facilities As discussed above, the Company has a $495.0 million unsecured line of credit with a maturity date of September 22, 2026. As of March 31, 2023, the unsecured line of credit had no amount outstanding and $495.0 million was available for future use. The line of credit agreement contains certain financial covenants, including limitations on recourse indebtedness to adjusted EBITDA (over the last four rolling quarters). Of the $495.0 million availability, approximately $260 million was available for purposes other than reducing existing recourse debt due to the limitations on recourse indebtedness to adjusted EBITDA financial covenant. Upon the maturity date of this facility, there can be no assurance that the Company will be able to maintain this line of credit, increase or maintain the amount outstanding under the line, or find alternative funding if necessary. During 2020, the Company entered into an agreement with Union Bank, as trustee for various grantor trusts, under which Union Bank has agreed to purchase from the Company participation interests in federally insured student loan asset-backed securities. As of March 31, 2023, $311.8 million (par value) of student loan asset-backed securities were subject to outstanding participation interests held by Union Bank, as trustee, under this agreement. This participation agreement has been accounted for by the Company as a secured borrowing. Upon termination or expiration of this agreement, the Company would expect to use operating cash, consider the sale of assets, or transfer collateral to satisfy any remaining obligations. Stock Repurchases The Board of Directors has authorized a stock repurchase program to repurchase up to a total of five million shares of the Company's Class A common stock during the three-year period ending May 8, 2025. No shares were repurchased under this program during the first quarter of 2023. As of March 31, 2023, 4,467,021 shares remained authorized for repurchase under the Company's stock repurchase program. Shares may be repurchased from time to time on the open market, in private transactions (including with related parties), or otherwise, depending on various factors, including share prices and other potential uses of liquidity. During the first quarter of 2023, the Company repurchased 36,513 shares owned and tendered by employees to satisfy tax withholding obligations upon the vesting of restricted shares. These repurchased shares are excluded from the Company's repurchase program. See "Stock Repurchases" under Part II, Item 2 of this report. Dividends On March 15, 2023, the Company paid a first quarter 2023 cash dividend on the Company's Class A and Class B common stock of $0.26 per share. In addition, the Company's Board of Directors has declared a second quarter 2023 cash dividend on the Company's outstanding shares of Class A and Class B common stock of $0.26 per share. The second quarter cash dividend will be paid on June 15, 2023 to shareholders of record at the close of business on June 1, 2023. The Company plans to continue making regular quarterly dividend payments, subject to future earnings, capital requirements, financial condition, and other factors. CRITICAL ACCOUNTING POLICIES AND ESTIMATES This Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of income and expenses during the reporting periods. The Company bases its estimates and judgments on historical experience and on various other factors that the Company believes are reasonable under the circumstances. Actual results may differ from these estimates under varying assumptions or conditions. Note 3 of the notes to consolidated financial statements included in the Company’s 2022 Annual Report includes a summary of the significant accounting policies and methods used in the preparation of the consolidated financial statements. 60 On an on-going basis, management evaluates its estimates and judgments, particularly as they relate to accounting policies that management believes are most “critical” - that is, they are most important to the portrayal of the Company’s financial condition and results of operations and they require management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Management has identified the allowance for loan losses as a critical accounting policy and estimate, as discussed further under Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates – Allowance for Loan Losses” in the Company’s 2022 Annual Report. For additional information regarding changes in the Company’s allowance for loan losses for the three months ended March 31, 2023 and 2022, see the caption “Activity in the Allowance for Loan Losses” in note 2 of the notes to consolidated financial statements included under Part I, Item 1 of this report. There have been no material changes to the Company’s critical accounting policy and estimate since December 31, 2022.