- After hitting an all-time high late last year, Nelnet has sold off on political risks.
- Federal budget cuts and lower collection fees are hurting the company, but increased sales of loans by big banks help even if they fall short of a panacea.
- The stock offers significant value, but controversy and concerns about student loans will keep that value from being recognized by the market in the immediate future.
After hitting an all-time high around $45 a share in late 2013, student loan processor Nelnet (NNI) has fallen back to around $37 a share. While earnings are likely to struggle over the next few years, for reasons I will discuss in a moment, the company is still likely to earn ~$5.50-$5.80 per share this year and next. Further, tangible book value on the firm will probably hit $34 a share this year which should protect the firm from significant downside. Despite the inexpensive valuation, I think NNI could struggle to move higher in the short-run due to a lack of expected earnings growth, constant regulatory interference, and general headline risk in the student loan space. Given all this, NNI may be a good stock for the long-run, but investors should expect some stock price turbulence for a while.
The 15-20% sell-off in Nelnet is most likely due to Massachusetts' Senator Elizabeth Warren's plan to lower student loan interest rates. The plan remains basically an idea on the back of a napkin at this stage, but the most likely way for Sen. Warren to push her agenda is by advocating for the refinancing of third party student loans (many of which are serviced by NNI) to direct loans from the Federal government. The effect of this would be to lower Nelnet's earnings on these loans. Now this is far from the first time that a politician advocating on behalf of the indebted student masses has proposed this type of thing (Sen. Gillibrand of NY suggested something similar last year). Past proposals have come to little and I expect this one to follow the same route.
The simple truth is that student loans are a mess, and they are basically the worst type of mainstream loan from a default perspective (just read a news story about them - these things default at horrendous rates). Nelnet's own books show ~13% delinquency rate on Federally backed loans which is not out of line with peers or the overall asset class. Yet since the loans are mainly backed by the Federal government and they can't be escaped via bankruptcy, there is less concern among investors and the general public about cumulative problems within them than there has been about problems in other debt arenas like underwater mortgages.
Further, any legislative attempt to modify student loan rates will run into the buzz-saw of political infighting since Federal revenues include the current yield on student loans. This makes any reduction in these loans a direct deficit increase, and a very costly proposition for deficit hawks. In essence, student loans are a specialized form of "tax" on the segment of the population that borrowed money from the government to go to school. Any effort to reduce this tax, by Warren, Gillibrand, and like minded reformers runs the risk of hypocrisy as they call for higher taxes on other segments of the population. Between this hypocrisy, and the difficulty in finding offsetting spending cuts elsewhere, especially in an election year, I don't see this type of legislation having any legs whatsoever. This does not mean that investors won't fret about the political risk - they will. The issue will most likely get considerable airtime this election year as it plays well for cameras, but it's very hard to imagine a Congress as divided as the current one making a major change to a major government program like student lending.
The other major factor hurting Nelnet is the cuts in the Federal budget for student loan guarantor agencies. These agencies are passing along the pain of their budget cuts to NNI in the form of reduced revenues which will hurt NNI's earnings modestly going forward. Offsetting this is the possibility that large banks are likely to be more willing to sell student loan portfolios now than they have been in the past. This would benefit Nelnet (and peer Sallie Mae (SLM)), as the banks will likely end up selling perhaps ~$15B in FFELP (Federal Family Education Loan Program) loans. These loans could add 10-20% to NNI's earnings if it acquires a substantial portion of them. Such acquisitions would help NNI continue the recent string of positive earnings surprises the firm has seen over the last six quarters. This is something Nelnet really needs as the lower government payout from collecting for defaulted FFELP loans will lower EPS back by 5-7% going forward. This revenue hit is a key reason why I see NNI earning only $5.70.share this year vs. $5.75 for CY 2013.
Nelnet has enjoyed significant revenue and EPS growth for years now, but with the new found-frugality in Federal agency budgets and the excessive student loan debt likely to remain a hot button issue through November, NNI is going to face some headline risk for a while. Longer-term investors can use the sell-off to their benefit, but only if you don't buy the view that student loan burdens are unsustainable. If the student loan market were to implode or major changes were made like principle forgiveness, this would have a catastrophic effect on NNI. That risk probably explains the persistent single digit P/E multiple that Nelnet has faced for a while, and it's hard to see the risk going away anytime soon. Investors are getting value in the stock at today's prices, it's just hard to say when that value will be realized.