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Item 3. Quantitative and Qualitative Disclosures About Market Risk

2023-08-07 compared with 2023-05-08 · 99 added, 47 removed, 95 unchanged (61% of the section changed)

1 unchanged sentence

(All dollars are in thousands, except share amounts, unless otherwise noted)

LIBOR Transition

On June 30, 2023, the LIBOR administrator ceased publication (on a representative basis) of all USD LIBOR rates.

When possible, the Company relied on fallback provisions or negotiated with counterparties to transition financial contracts from LIBOR to SOFR.

Due to certain noteholder consent requirements, it was not practicable to modify certain of the Company's asset-backed securities transactions.

The SAP formula for the Company's FFELP loans, the majority of which were indexed to one-month LIBOR, were not able to be modified without legislative action.

On March 15, 2022, the Adjustable Interest Rate (LIBOR) Act (the LIBOR Act) was signed into law.

The LIBOR Act provides that for contracts that contain no fallback provision or contain fallback provisions that do not identify a specific USD LIBOR benchmark replacement (including the SAP formula for FFELP loans), a benchmark replacement based on SOFR will automatically replace the USD LIBOR benchmark in the contract after June 30, 2023.

Following the enactment and implementation of the LIBOR Act, all of the Company's financial instruments which are currently indexed to USD LIBOR have transitioned, or will transition, to SOFR after June 30, 2023.

Specifically, after June 30, 2023, the SAP formula for FFELP loans will transition to 30-day Average SOFR and the Company's LIBOR-indexed FFELP asset-backed securities will also transition to a short-term SOFR index.

The Company does not expect the transition from LIBOR to SOFR to significantly impact its asset-backed securitization cash flow forecast as discussed under Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Liquidity Needs and Sources of Liquidity Available to Satisfy Debt Obligations Secured by Loan Assets and Related Collateral - Bonds and Notes Issued in Asset-backed Securitizations." The Company's LIBOR-indexed derivatives will transition to the fallback rate (SOFR) as defined in the individual agreements and/or published industry guidelines, as applicable.

For a discussion of the risks related to the LIBOR transition, see Item 1A, "Risk Factors - Loan Portfolio - Interest rate risk - replacement of LIBOR as a benchmark rate" in the Company's 2022 Annual Report for additional information.

Interest Rate Risk - AGM Operating Segment

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

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

As of June 30, 2023 As of December 31, 2022

Dollars Percent Dollars Percent

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

Three months ended March 31,

Three months ended June 30, Six months ended June 30,

2023 2022 2023 2022

Fixed rate floor income, gross $ 456 18,292 1,567 47,285

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Fixed rate floor income, net $ 503 21,984 24,092 47,772

(a) Derivative settlements consist of settlements received (paid) related to the Company's derivatives used to hedge student loans earning fixed rate floor income.

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

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

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

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

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

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

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

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

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

The following graph depicts fixed rate floor income for a borrower with a fixed rate of 6.75% and a SAP rate of 2.64%:

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

(a) Derivative settlements consist of settlements received related to the Company's derivatives used to hedge student loans earning fixed rate floor income.

Gross fixed rate floor income decreased for the three and six months ended June 30, 2023 compared with the same periods in 2022 due to higher interest rates in 2023 compared with 2022.

The Company had a significant 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.

On March 15, 2023, 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).

Through March 15, 2023, the Company had received cash or had a receivable from its clearinghouse related to variation margin equal to the fair value of the $2.8 billion notional amount of fixed rate floor derivatives as of March 15, 2023 of $183.2 million, which included $19.1 million related to current period settlements.

The decrease in net derivative settlements received by the Company during the three months ended June 30, 2023, compared with the same period in 2022, was due to the termination of the fixed rate floor derivatives in March 2023.

The increase in net derivative settlements received by the Company during the six months ended June 30, 2023, compared with the same period in 2022, was due to an increase in settlements on the Company's derivatives outstanding during this period as a result of an increase in interest rates.

The following table shows AGM’s federally insured student loan assets that were earning fixed rate floor income as of June 30, 2023.

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

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9.05% 6.41% 130,844

9.05% 6.41% 131,116

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

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

As of June 30, 2023, the weighted average estimated variable conversion rate was 5.80% and the short-term interest rate was 518 basis points.

In June 2023, the Company entered into a derivative with a notional amount of $50.0 million and a maturity date in 2030 to hedge a portion of loans remaining that earn fixed rate floor income.

Based on the terms of this derivative, the Company pays a weighted average fixed rate of 3.44% and receives payments based on SOFR that resets quarterly.

AGM is also exposed to interest rate risk in the form of basis risk and repricing risk because the interest rate characteristics of AGM’s assets do not match the interest rate characteristics of the funding for those assets.

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

The following table presents AGM’s FFELP student loan assets and related funding for those assets arranged by underlying indices as of June 30, 2023.

Index Frequency of variable resets Assets Funding of student loan assets

1 month LIBOR (a) Daily $ 12,099,443 —

1 month LIBOR (a) (b) Daily $ 12,002,100 —

3 month H15 financial commercial paper Daily 414,602 —

3 month Treasury bill Daily 403,040 —

1 month LIBOR Monthly — 7,612,093

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

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

1 month LIBOR (a) Monthly — 7,239,176

3 month LIBOR (a) (b) Quarterly — 3,255,282

Asset-backed commercial paper (c) Varies — 1,530,429

Fixed rate — — 519,156

Auction-rate (c) Varies — 142,385

Other (d) — 1,315,962 1,593,212

Auction-rate (d) Varies — 91,335

Other (e) — 1,248,304 1,432,668

$ 14,068,046 14,068,046

(a) The Company has certain basis swaps outstanding in which the Company receives three-month LIBOR and pays one-month LIBOR plus or minus a spread as defined in the agreements (the "1:3 Basis Swaps").

(a) Have transitioned, or will transition, to SOFR after June 30, 2023.

See "LIBOR Transition" above.

(b) The Company has certain basis swaps outstanding in which the Company receives three-month LIBOR and pays one-month LIBOR plus or minus a spread as defined in the agreements (the "1:3 Basis Swaps").

The Company entered into these derivative instruments to better match the interest rate characteristics on its student loan assets and the debt funding such assets.

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

The following table summarizes the 1:3 Basis Swaps outstanding as of June 30, 2023.

Maturity Notional amount (i)

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2026 1,150,000

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

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

(c) As of March 31, 2023, the Company was sponsor for $142.4 million of outstanding asset-backed securities that were set and provide for interest rates to be periodically reset via a "dutch auction" (the “Auction Rate Securities”).

(i) The weighted average rate paid by the Company on the 1:3 Basis Swaps as of June 30, 2023 was one-month LIBOR plus 10.1 basis points.

(d) As of June 30, 2023, the Company was sponsor for $91.3 million of outstanding asset-backed securities that were set and provide for interest rates to be periodically reset via a "dutch auction" (the “Auction Rate Securities”).

Since the auction feature has essentially been inoperable for substantially all auction rate securities since 2008, the Auction Rate Securities generally pay interest to the holder at a maximum rate as defined by the indenture.

While these rates will vary, they will generally be based on a spread to LIBOR or Treasury Securities, or the Net Loan Rate as defined in the financing documents.

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

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

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

LIBOR is in the process of being discontinued as a benchmark rate, and the market transition away from the current LIBOR framework could result in significant changes to the interest rate characteristics of the Company's LIBOR-indexed assets and funding for those assets.

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

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

Sensitivity Analysis

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Dollars Percent Dollars Percent Dollars Percent Dollars Percent

Three months ended March 31, 2023

Three months ended June 30, 2023

Effect on earnings:

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

Increase (decrease) in pre-tax net income before impact of derivative settlements $ 712 2.4 % $ 3,029 10.2 % $ 314 1.1 % $ 3,762 12.7 %

Impact of derivative settlements (a) 33 0.1 99 0.3 (33) (0.1) (99) (0.3)

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

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

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

Increase (decrease) in net income before taxes $ 745 2.5 % $ 3,128 10.5 % $ 281 1.0 % $ 3,663 12.4 %

Increase (decrease) in basic and diluted earnings per share $ 0.02 $ 0.06 $ 0.01 $ 0.07

Three months ended June 30, 2022

Effect on earnings:

Increase (decrease) in pre-tax net income before impact of derivative settlements $ (5,927) (5.4) % $ (10,505) (9.7) %

Impact of derivative settlements 7,729 7.1 23,187 21.4

Increase (decrease) in net income before taxes $ 1,802 1.7 % $ 12,682 11.7 %

Increase (decrease) in basic and diluted earnings per share $ 0.04 $ 0.26

Six months ended June 30, 2023

Effect on earnings:

Increase (decrease) in pre-tax net income before impact of derivative settlements $ 1,484 2.4 % $ 7,432 12.2 % $ 390 0.6 % $ 7,412 12.2 %

Impact of derivative settlements (a) 33 0.1 99 0.2 (33) (0.1) (99) (0.2)

Increase (decrease) in net income

before taxes $ 1,517 2.5 % $ 7,531 12.4 % $ 357 0.5 % $ 7,313 12.0 %

Increase (decrease) in basic and

diluted earnings per share $ 0.03 $ 0.15 $ 0.01 $ 0.15

Six months ended June 30, 2022

Effect on earnings:

Increase (decrease) in pre-tax net income before impact of derivative settlements $ (16,068) (4.6) % $ (28,152) (8.1) %

Impact of derivative settlements 18,455 5.3 55,365 15.9

Increase (decrease) in net income

before taxes $ 2,387 0.7 % $ 27,213 7.8 %

Increase (decrease) in basic and

diluted earnings per share $ 0.05 $ 0.55

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

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

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10 basis points Increase of

30 basis points Increase of

10 basis points Increase of

30 basis points

Dollars Percent Dollars Percent

Three months ended March 31, 2023

Dollars Percent Dollars Percent Dollars Percent Dollars Percent

Three months ended June 30, 2023 Three months ended June 30, 2022

Effect on earnings:

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

Increase (decrease) in pre-tax net income before impact of derivative settlements $ (1,182) (4.0) % $ (3,547) (12.0) % $ (1,199) (1.1) % $ (3,597) (3.3) %

Impact of derivative settlements 785 2.7 2,356 8.0 1,222 1.1 3,664 3.4

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

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

Increase (decrease) in net income before taxes $ (397) (1.3) % $ (1,191) (4.0) % $ 23 0.0 % $ 67 0.1 %

Increase (decrease) in basic and diluted earnings per share $ (0.01) $ (0.02) $ 0.00 $ 0.00

Six months ended June 30, 2023 Six months ended June 30, 2022

Effect on earnings:

Increase (decrease) in pre-tax net income before impact of derivative settlements $ (2,295) (3.8) % $ (6,886) (11.3) % $ (2,461) (0.7) % $ (7,383) (2.1) %

Impact of derivative settlements 1,562 2.6 4,686 7.7 2,677 0.8 8,028 2.3

Increase (decrease) in net income

before taxes $ (733) (1.2) % $ (2,200) (3.6) % $ 216 0.1 % $ 645 0.2 %

Increase (decrease) in basic and

diluted earnings per share $ (0.01) $ (0.04) $ 0.00 $ 0.01

Interest Rate Risk - Nelnet Bank

To manage Nelnet Bank's risk from fluctuations in market interest rates, the Company actively monitors interest rates and other interest sensitive components to minimize the impact that changes in interest rates have on the fair value of assets, net income, and cash flow.

To achieve this objective, the Company manages and mitigates Nelnet Bank’s exposure to fluctuations in market interest rates through several techniques, including managing the maturity, repricing, and mix of fixed and variable rate assets and liabilities.

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

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

As of June 30, 2023 As of December 31, 2022

Dollars Percent Dollars Percent

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Fixed-rate deposits $ 281,583 32.3 % $ 336,040 42.6 %

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

Variable-rate deposits (a) 589,839 67.7 453,604 57.4

Total deposits $ 871,422 100.0 % $ 789,644 100.0 %

(a) Nelnet Bank uses derivative instruments to hedge exposure to variability in cash flows of variable rate deposits to minimize the exposure to volatility in cash flows from future changes in interest rates.

The derivatives are not reflected in the above table.

See note 4 of the notes to the consolidated financial statements included under Part I, Item 1 of this report for a summary of Nelnet Bank's derivatives outstanding as of June 30, 2023.

Interest Rate and Market Risk - Investments

1 unchanged sentence

The table below excludes securities (investments) held by Nelnet Bank.

Three months ended March 31,

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

Three months ended June 30,

Asset-backed securities available-for-sale (a) (b) $ 1,076,344 22,911 8.54 % $ 1,258,770 5,104 1.63 %

1 unchanged sentence

Participation agreement - variable rate (c) $ 76,966 1,094 5.70 % $ 352,804 1,384 1.57 %

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

Repurchase agreements - variable rate (d) 415,514 6,278 6.06 471,033 1,682 1.43

$ 492,480 7,372 6.00 $ 823,837 3,066 1.49

Six months ended June 30,

Asset-backed securities available-for-sale (a) (b) $ 1,194,475 41,699 7.04 % $ 1,165,545 8,367 1.45 %

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

Participation agreement - variable rate (c) $ 230,889 6,153 5.37 % $ 304,669 1,944 1.29 %

Repurchase agreements - variable rate (d) 463,637 13,046 5.67 437,537 2,713 1.25

$ 694,526 19,199 5.57 $ 742,206 4,657 1.27

(a) The Company has repurchased certain of its own FFELP loan asset-backed securities (bonds and notes payable) in the secondary market.

4 unchanged sentences

(b) The majority of the Company’s asset-backed securities earn floating rates with expected returns of approximately LIBOR + 100 to 350 basis points to maturity.

As of March 31, 2023, $259.4 million (par value) of the Company’s asset-backed securities earn a weighted average fixed rate of 3.23%.

As of June 30, 2023, $258.1 million (par value) of the Company’s asset-backed securities earn a weighted average fixed rate of 3.29%.

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

1 unchanged sentence

The Company’s portfolio of asset-backed investment securities has limited liquidity, and the Company could incur a significant loss if the investments were sold prior to maturity at an amount less than the original purchase price.

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

As of June 30, 2023, the gross unrealized loss on the Company’s available-for-sale debt securities was $37.1 million, and the aggregate fair value of available-for-sale debt securities with unrealized losses was $783.0 million.

The Company currently has the intent and ability to retain these investments, and none of the unrealized losses were due to credit losses.

1 unchanged sentence

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

What changed 10-Q

Item 3. Quantitative and Qualitative Disclosures About Market Risk