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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

2024-02-27 compared with 2023-02-28 · 86 added, 56 removed, 92 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.

The Company relied on fallback provisions to transition financial contracts from LIBOR to SOFR.

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 were indexed to USD LIBOR transitioned to SOFR after June 30, 2023.

Specifically, after June 30, 2023, the SAP formula for FFELP loans transitioned to 30-day average SOFR and the Company's LIBOR-indexed FFELP asset-backed securities also transitioned 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 Item 7, "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 transitioned to the fallback rate (SOFR) as defined in the individual agreements and/or published industry guidelines, as applicable.

The market transition away from the previous LIBOR framework could result in significant changes to the interest rate characteristics of the Company's prior LIBOR-indexed assets and funding for those assets.

The Company is still uncertain as to the long-term relationship between overnight SOFR and Term SOFR as they are new indices, and the Company's assumptions with respect to this relationship may evolve over time.

To the extent that the spread between these indices were to widen, it could adversely impact future interest income earned on the Company's FFELP student loan portfolio.

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" for additional information.

Interest Rate Risk - AGM Operating Segment

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Depending on the type of loan and when it was originated, the borrower rate is either fixed to term or is reset to an annual rate each July 1.

As a result, for loans where the borrower rate is fixed to term, the Company may earn floor income for an extended period of time, which the Company refers to as fixed rate floor income, and for those loans where the borrower rate is reset annually on July 1, the Company may earn floor income to the next reset date, which the Company refers to as variable rate floor income.

floor income.

All FFELP loans first originated on or after April 1, 2006 effectively earn at the SAP rate, since lenders are required to rebate fixed rate floor income and variable rate floor income for those loans to the Department.

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Year ended December 31,

2023 2022 2021

Fixed rate floor income, gross $ 2,169 57,380 142,606

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

Gross fixed rate floor income decreased in 2022 compared with 2021 due to higher interest rates in 2022 compared with 2021.

Gross fixed rate floor income decreased each year compared with the preceding year due to higher interest rates each year compared with the preceding year.

Absent the use of derivative instruments, a rise in interest rates will reduce the amount of floor income received and has an impact on earnings due to interest margin compression caused by increasing financing costs, until such time as the federally insured loans earn interest at a variable rate in accordance with their SAP formulas.

In higher interest rate environments, where the interest rate rises above the borrower rate and fixed rate loans effectively become variable rate loans, the impact of the rate fluctuations is reduced.

The Company enters into derivative instruments to hedge student loans earning fixed rate floor income.

The increase in net derivative settlements received by the Company during 2022 compared with net derivative settlements paid in 2021, was due to an increase in interest rates, partially offset by a decrease in the notional amount of derivatives outstanding.

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 and increase liquidity, 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 2023 compared with 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 2022 compared with the net derivative settlements paid in 2021, was due to an increase in interest rates, partially offset by a decrease in the notional amount of derivatives outstanding.

During 2022, the Company terminated $2.4 billion in notional amount of derivatives for net proceeds of $91.8 million.

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

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

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> 9.0% 9.05% 6.41% 122,649

7.5 - 7.99% 7.72% 5.08% 158,317

8.0 - 8.99% 8.18% 5.54% 363,579

> 9.0% 9.05% 6.41% 139,081

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

As of December 31, 2023, the weighted average estimated variable conversion rate was 8.57% and the short-term interest rate was 554 basis points.

The following table summarizes the outstanding derivative instruments as of December 31, 2022 used by AGM to economically hedge loans earning fixed rate floor income.

Maturity Notional amount Weighted average fixed rate paid by the Company (a)

2024 $ 2,000,000 0.35 %

2026 500,000 1.02

2031 100,000 1.53

2032 (b) 200,000 2.92

$ 2,800,000 0.70 %

(a) For the interest rate derivatives maturing in 2032, the Company receives payments based on Secured Overnight Financing Rate (SOFR) that resets quarterly.

For all other interest rate derivatives, the Company receives payments based on three-month LIBOR that resets quarterly.

(b) These derivatives have forward effective start dates in November 2024.

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.

During the last half of 2023, the Company entered into multiple derivatives with notional amounts totaling $400 million with maturity dates through 2030, to hedge a portion of loans remaining that earn fixed rate floor income and other loans and investments in which the Company receives a fixed rate.

Based on the terms of these derivatives, the Company pays a weighted average fixed rate of 3.71% and receives payments based on SOFR that resets quarterly.

For further details of the Company’s derivatives used to hedge fixed rate loans and investments, see note 5 of the notes to consolidated financial statements included in this report.

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

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

Index Frequency of variable resets Assets Funding of student loan assets

1 month LIBOR (a) Daily $ 12,688,933 —

30-day average SOFR (a) (b) Daily $ 10,941,576 —

3-month H15 financial commercial paper Daily 375,376 —

3-month Treasury bill Daily 369,255 —

1 month LIBOR Monthly — 8,113,302

3 month LIBOR (a) Quarterly — 3,754,888

Asset-backed commercial paper (b) Varies — 978,956

30-day average SOFR / 1-month CME Term SOFR (a) Monthly — 6,780,300

90-day average SOFR / 3-month CME Term SOFR (a) (b) Quarterly — 2,772,367

Asset-backed commercial paper (c) Varies — 1,398,485

Fixed rate — — 471,427

Auction-rate (c) Varies — 178,960

Other (d) — 1,661,866 1,608,182

Auction-rate (d) Varies — 87,360

Other (e) — 1,193,097 1,369,365

$ 12,879,304 12,879,304

(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) Transitioned from LIBOR to SOFR after June 30, 2023.

See "LIBOR Transition" above.

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

Subsequent to the discontinuation of LIBOR on June 30, 2023, the Company now receives and pays the term adjusted SOFR rate on these derivatives (plus the tenor spread adjustment relating to LIBOR).

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.

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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 December 31, 2022 was one-month LIBOR plus 9.7 basis points.

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

(c) As of December 31, 2022, the Company was sponsor for $179.0 million of outstanding asset-backed securities that were set and provide for interest rates to be periodically reset via a "dutch auction" (the “Auction Rate Securities”).

(i) The weighted average rate paid by the Company on the 1:3 Basis Swaps as of December 31, 2023 was the term adjusted SOFR (plus the tenor spread adjustment relating to LIBOR) plus 10.1 basis points.

(d) As of December 31, 2023, the Company was sponsor for $87.4 million of outstanding asset-backed securities that were set and provide for interest rates to be periodically reset via a "dutch auction" (the “Auction Rate Securities”).

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

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

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

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

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

See Item 1A, "Risk Factors - Loan Portfolio - Interest rate risk - replacement of LIBOR as a benchmark rate."

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

(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 facilities.

Sensitivity Analysis

The following tables summarize the effect on the Company’s consolidated earnings, based upon a sensitivity analysis performed on AGM’s assets and liabilities assuming hypothetical increases in interest rates of 100 basis points and 300 basis points while funding spreads remain constant.

The following tables summarize the effect on the Company’s consolidated earnings, based upon a sensitivity analysis performed on AGM’s assets and liabilities assuming hypothetical increases and decreases in interest rates of 100 basis points and 300 basis points while funding spreads remain constant.

In addition, a sensitivity analysis was performed assuming the funding index increases 10 basis points and 30 basis points while holding the asset index constant, if the funding index is different than the asset index.

The sensitivity analysis was performed on AGM’s variable rate assets (including loans earning fixed rate floor income) and liabilities.

The analysis includes the effects of AGM’s derivative instruments in existence during these periods.

Interest rates Asset and funding index mismatches

Interest rates

Change from increase of

100 basis points Change from increase of

300 basis points Increase of

10 basis points Increase of

300 basis points Change from decrease of

100 basis points Change from decrease of

300 basis points

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Effect on earnings:

Decrease in pre-tax net income before impact of derivative settlements $ (19,344) (3.8) % $ (31,648) (6.2) % $ (4,773) (0.9) % $ (14,319) (2.8) %

Increase (decrease) in pre-tax net income before impact of derivative settlements $ 2,737 3.7 % $ 12,088 16.3 % $ 4,756 6.4 % $ 26,206 35.3 %

Impact of derivative settlements (a) 333 0.4 999 1.3 (333) (0.4) (999) (1.3)

Increase (decrease) in net income before taxes $ 3,070 4.1 % $ 13,087 17.6 % $ 4,423 6.0 % $ 25,207 34.0 %

Increase (decrease) in basic and diluted earnings per share $ 0.06 $ 0.27 $ 0.09 $ 0.51

Year ended December 31, 2022

Effect on earnings:

Increase (decrease) in pre-tax net income before impact of derivative settlements $ (19,344) (3.8) % $ (31,648) (6.2) % $ 35,420 7.0 % $ 142,587 28.0 %

Impact of derivative settlements 31,561 6.2 94,685 18.6 (31,561) (6.2) (94,684) (18.6)

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Effect on earnings:

Decrease in pre-tax net income before impact of derivative settlements $ (55,957) (11.1) % $ (103,742) (20.7) % $ (6,020) (1.2) % $ (18,063) (3.6) %

Increase (decrease) in pre-tax net income before impact of derivative settlements $ (55,957) (11.1) % $ (103,742) (20.7) % $ 87,060 17.3 % $ 263,398 52.4 %

Impact of derivative settlements 43,059 8.6 129,176 25.7 (43,059) (8.5) (129,176) (25.7)

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Increase (decrease) in basic and diluted earnings per share $ (0.25) $ 0.50 $ 0.87 $ 2.64

Financial Statement Impact – Derivatives

For a table summarizing the effect of derivative instruments in the consolidated statements of income, including the components of "derivative market value adjustments and derivative settlements, net" included in the consolidated statements of income, see note 6 of the notes to consolidated financial statements included in this report.

Based on AGM’s interest rate swaps outstanding as of December 31, 2022 used to hedge loans earning fixed rate floor income, if the forward interest rate curve was 50 basis points lower for the remaining duration of these derivatives, we would have been required to pay $29.3 million in additional variation margin.

In addition, if the forward basis curve between one-month and three-month LIBOR experienced a ten-basis point reduction in spread for the remaining duration of AGM’s 1:3 Basis Swaps (in which the Company pays one month LIBOR and receives three month LIBOR), we would have been required to pay $7.7 million in additional variation margin.

(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.

Asset and funding index mismatches

10 basis points Increase of

30 basis points Increase of

10 basis points Increase of

30 basis points Increase of

10 basis points Increase of

30 basis points

Dollars Percent Dollars Percent Dollars Percent Dollars Percent Dollars Percent Dollars Percent

Year ended December 31, 2023 Year ended December 31, 2022 Year ended December 31, 2021

Effect on earnings:

Increase (decrease) in pre-tax net income before impact of derivative settlements $ (4,564) (6.2) % $ (13,692) (18.4) % $ (4,773) (0.9) % $ (14,319) (2.8) % $ (6,020) (1.2) % $ (18,063) (3.6) %

Impact of derivative settlements 3,150 4.2 9,450 12.7 4,895 0.9 14,682 2.9 5,961 1.2 17,884 3.6

Increase (decrease) in net income before taxes $ (1,414) (2.0) % $ (4,242) (5.7) % $ 122 0.0 % $ 363 0.1 % $ (59) — % $ (179) — %

Increase (decrease) in basic and diluted earnings per share $ (0.03) $ (0.09) $ 0.00 $ 0.01 $ (0.00) $ (0.00)

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:

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Fixed-rate deposits $ 280,736 33.1 % $ 336,040 42.6 %

Variable-rate deposits 453,604 57.4 81,085 19.1

Variable-rate deposits (a) 566,828 66.9 453,604 57.4

Total deposits $ 847,564 100.0 % $ 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 5 of the notes to the consolidated financial statements included in this report for a summary of Nelnet Bank's derivatives outstanding as of December 31, 2023.

Interest Rate and Market Risk - Investments

The following table presents the rates earned on the Company’s available-for-sale debt securities (investments) and debt facilities used to fund a portion of such investments.

The table below excludes the available-for-sale debt securities (investments) held by Nelnet Bank.

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

Year ended December 31,

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

2023 2022 2021

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

Asset-backed securities available-for-sale (a) (b) $ 985,367 68,045 6.91 % $ 1,303,731 35,516 2.72 % $ 587,736 7,409 1.26 %

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

Participation agreement - variable rate $ 349,486 9,617 2.75 % $ 152,196 1,176 0.77 %

Repurchases agreements - variable rate 481,782 12,355 2.56 223,792 1,558 0.70

Participation agreement - variable rate (c) $ 115,420 6,207 5.38 % $ 349,486 9,617 2.75 % $ 152,196 1,176 0.77 %

Repurchases agreements - variable rate (d) 381,378 23,540 6.17 481,782 12,355 2.56 223,792 1,558 0.70

$ 496,798 29,747 5.99 $ 831,268 21,972 2.64 $ 375,988 2,734 0.73

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

(a) 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.

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The table above includes these repurchased bonds.

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

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

As of December 31, 2023, $226.7 million (par value) of the Company’s asset-backed securities earn a weighted average fixed rate of 3.24%.

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

As of December 31, 2022, the net unrealized losses on the Company’s available-for-sale debt securities was $52.6 million, and the aggregate fair value of available-for-sale debt securities with unrealized losses was $1.2 billion.

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

(d) Interest incurred by the Company on amounts borrowed under the repurchase agreements is at a variable rate of SOFR + 100 to 140 basis points.

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

As of December 31, 2023, the gross unrealized loss on the Company’s available-for-sale debt securities was $39.6 million, and the aggregate fair value of available-for-sale debt securities with unrealized losses was $616.7 million.

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

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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-K

Item 7A. Quantitative and Qualitative Disclosures About Market Risk