NELNET INC 10-Q

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (All dollars are in thousands, except share amounts, unless otherwise noted) Interest Rate Risk - AGM Operating Segment AGM’s primary market risk exposure arises from fluctuations in its borrowing and lending rates, the spread between which could impact AGM due to shifts in market interest rates. The following table sets forth AGM’s loan assets and debt instruments by rate characteristics: As of March 31, 2024 As of December 31, 2023 Dollars Percent Dollars Percent Fixed-rate loan assets $ 536,445 5.0 % $ 510,666 4.2 % Variable-rate loan assets 10,263,497 95.0 11,538,796 95.8 Total $ 10,799,942 100.0 % $ 12,049,462 100.0 % Fixed-rate debt instruments $ 509,294 4.8 % $ 561,557 4.8 % Variable-rate debt instruments 10,030,623 95.2 11,142,596 95.2 Total $ 10,539,917 100.0 % $ 11,704,153 100.0 % FFELP loans originated prior to April 1, 2006 generally earn interest at the higher of the borrower rate, which is fixed over a period of time, or a floating rate based on the special allowance payment (SAP) formula set by the Department. The SAP rate is based on an applicable index plus a fixed spread that depends on loan type, origination date, and repayment status. The Company generally finances its FFELP student loan portfolio with variable rate debt. In low and/or declining interest rate environments, when the fixed borrower rate is higher than the SAP rate, the Company’s FFELP student loans earn at a fixed rate while the interest on the variable rate debt typically continues to reflect the low and/or declining interest rates. In these interest rate environments, the Company may earn additional spread income that it refers to as floor income. Depending on the type of loan and when it was originated, the borrower rate is either fixed to term or is reset to an annual rate each July 1. As a result, for loans where the borrower rate is fixed to term, the Company may earn floor income for an extended period of time, which the Company refers to as fixed rate floor income, and for those loans where the borrower rate is reset annually on July 1, the Company may earn floor income to the next reset date, which the Company refers to as variable rate floor income. All FFELP loans first originated on or after April 1, 2006 effectively earn at the SAP rate, since lenders are required to rebate fixed rate floor income and variable rate floor income for those loans to the Department. 61 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. No variable-rate floor income was earned by the Company in 2024 or 2023. A summary of fixed rate floor income earned by the AGM operating segment follows. Three months ended March 31, 2024 2023 Fixed rate floor income, gross $ 180 1,110 Derivative settlements (a) 1,190 22,478 Fixed rate floor income, net $ 1,370 23,588 (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 months ended March 31, 2024 compared with the same period in 2023 due to higher interest rates in 2024 compared with 2023. 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. During the first quarter of 2023, to minimize the Company's exposure to market volatility and increase liquidity, the Company terminated its 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. Subsequent to terminating these derivatives, during the second and fourth quarters of 2023, the Company entered into a total of $400.0 million notional amount of derivatives to hedge loans earning fixed rate floor income and other loans and investments in which the Company receives a fixed rate. The decrease in net derivative settlements received by the Company during the three months ended March 31, 2024, compared with the same period in 2023, was due to a decrease in the notional amount of derivatives outstanding and less favorable terms on the $400.0 million of notional derivatives entered into in 2023 compared with the $2.8 billion notional derivatives that were terminated due to an increase in interest rates from when the terminated derivatives were initially executed. For further details of the Company’s derivatives used to hedge fixed rate loans, see note 4 of the notes to consolidated financial statements included in Part I, Item 1 of this report. The following table shows AGM’s federally insured student loan assets that were earning fixed rate floor income as of March 31, 2024. Fixed interest rate range Borrower/lender weighted average yield Estimated variable conversion rate (a) Loan balance 8.0 - 8.99% 8.25% 5.61% $ 161,073 > 9.0% 9.06% 6.42% 106,942 $ 268,015 (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, 2024, the weighted average estimated variable conversion rate was 5.93% and the short-term interest rate was 556 basis points. 62 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 March 31, 2024. Index Frequency of variable resets Assets Funding of student loan assets 30-day average SOFR (a) Daily $ 9,725,214 — 3-month H15 financial commercial paper Daily 336,128 — 3-month Treasury bill Daily 321,711 — 30-day average SOFR / 1-month CME Term SOFR Monthly — 6,198,559 90-day average SOFR / 3-month CME Term SOFR (a) Quarterly — 2,567,482 Asset-backed commercial paper (b) Varies — 1,066,197 Fixed rate — — 430,061 Auction-rate (c) Varies — 84,660 Other (d) — 1,250,367 1,286,461 $ 11,633,420 11,633,420 (a) The Company has certain basis swaps outstanding in which the Company receives and pays the term adjusted SOFR plus the tenor spread adjustment to LIBOR. Prior to the discontinuation of LIBOR on June 30, 2023, 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"). 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, 2024. Maturity Notional amount (i) 2024 $ 1,750,000 2026 1,150,000 2027 250,000 $ 3,150,000 (i) The weighted average rate paid by the Company on the 1:3 Basis Swaps as of March 31, 2024 was the term adjusted SOFR (plus the tenor spread adjustment relating to LIBOR) plus 10.1 basis points. (b) The interest rate on the Company's FFELP warehouse facilities is indexed to asset-backed commercial paper rates. (c) As of March 31, 2024, the Company was sponsor for $84.7 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 SOFR 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 loan asset-backed securitizations and warehouse facilities. 63 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 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. Interest rates Change from increase of 100 basis points Change from increase of 300 basis points Change from decrease of 100 basis points Change from decrease of 300 basis points Dollars Percent Dollars Percent Dollars Percent Dollars Percent Three months ended March 31, 2024 Effect on earnings: Increase in pre-tax net income before impact of derivative settlements $ 711 0.7 % $ 2,500 2.7 % $ 1,941 2.1 % $ 8,557 9.1 % Impact of derivative settlements 746 0.8 2,238 2.3 (746) (0.8) (2,238) (2.4) Increase in net income before taxes $ 1,457 1.5 % $ 4,738 5.0 % $ 1,195 1.3 % $ 6,319 6.7 % Increase in basic and diluted earnings per share $ 0.03 $ 0.10 $ 0.02 $ 0.13 Three months ended March 31, 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 % Impact of derivative settlements (a) — — — — — — — — Increase in net income before taxes $ 772 2.5 % $ 4,403 14.1 % $ 76 0.2 % $ 3,650 11.7 % Increase in basic and diluted earnings per share $ 0.02 $ 0.09 $ 0.00 $ 0.07 (a) On March 15, 2023, the Company terminated its 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 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 Three months ended March 31, 2024 Three months ended March 31, 2023 Effect on earnings: Decrease in pre-tax net income before impact of derivative settlements $ (1,017) (1.0) % $ (3,050) (3.2) % $ (1,113) (3.6) % $ (3,339) (10.7) % Impact of derivative settlements 783 0.8 2,349 2.5 777 2.5 2,330 7.5 Decrease in net income before taxes $ (234) (0.2) % $ (701) (0.7) % $ (336) (1.1) % $ (1,009) (3.2) % Decrease in basic and diluted earnings per share $ (0.00) $ (0.01) $ (0.01) $ (0.02) 64 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 and the use of derivative instruments. The following table presents Nelnet Bank's loan assets, asset-backed security investments, and deposits by rate characteristics: As of March 31, 2024 As of December 31, 2023 Dollars Percent Dollars Percent Fixed-rate loan assets $ 475,779 $ 424,284 Fixed-rate investments 70,743 34,644 Total fixed-rate assets 546,522 50.3 % 458,928 47.7 % Variable-rate loan assets 7,944 8,588 Variable-rate investments 531,063 495,004 Total variable rate assets 539,007 49.7 503,592 52.3 Total assets $ 1,085,529 100.0 % $ 962,520 100.0 % Fixed-rate deposits $ 279,331 29.1 % $ 280,736 33.1 % Variable-rate deposits (a) 681,302 70.9 566,828 66.9 Total deposits $ 960,633 100.0 % $ 847,564 100.0 % (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 March 31, 2024. Interest Rate and Market Risk - Investments The following table presents the rates earned on the Company’s available-for-sale debt securities (investments) and debt facilities used to fund a portion of such investments. The table below excludes securities (investments) held by Nelnet Bank. Three months ended March 31, 2024 2023 Average balance Interest income/ expense Average yields/ rates Average balance Interest income/ expense Average yields/ rates Investments: Asset-backed securities available-for-sale (a) (b) $ 863,634 14,012 6.51 % $ 1,309,752 17,486 5.41 % Debt funding asset-backed securities available-for-sale: Participation agreement - variable rate (c) $ 91 1 4.41 % $ 365,115 5,059 5.62 % Repurchase agreements - variable rate (d) 137,914 2,417 7.03 511,759 6,768 5.36 $ 138,005 2,418 7.03 $ 876,874 11,827 5.47 (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. However, these securities remain legally outstanding at the trust level and the Company could sell these notes to third parties or redeem the notes at par as cash is generated by the trust estate. Upon a sale of these notes to third parties, the Company would obtain cash proceeds equal to the market value of the notes on the date of such sale. The table above includes these repurchased bonds. (b) The majority of the Company’s asset-backed securities earn floating rates with expected returns of approximately SOFR + 100 to 350 basis points to maturity. As of March 31, 2024, $212.3 million (par value) of the Company’s asset-backed securities earn a weighted average fixed rate of 3.17%. (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 repurchase agreements is at a variable rate of SOFR + 100 to 140 basis points. 65 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, 2024, the gross unrealized loss on the Company’s available-for-sale debt securities was $27.8 million, and the aggregate fair value of available-for-sale debt securities with unrealized losses was $482.7 million. The Company currently has the intent and ability to retain these investments, and none of the unrealized losses were due to credit losses. See note 5 of the notes to consolidated financial statements included under Part I, Item 1 of this report for additional information.