Nelnet Offers $55M to Settle Case - Analyst Blog

Nelnet Inc. (NNI) agreed to pay $55 million as part of its efforts to settle a lawsuit filed by Jon H. Oberg, the former Department of Education researcher, on behalf of the federal government. It was alleged the company, along with some other organizations such as SLM Corporation (SLM), of receiving improper subsidies from the government.

 

Nelnet would pay this amount with its existing cash and this would be reflected in the company’s third quarter 2010 results. While Nelnet didn’t admit any wrong doing, the company said it was alleged to have received about $407 million in improper 9.5% special allowance payments.

 

Student lenders have been subsidized for several years in order to encourage them to offer low interest rate loans to students. Not only did the Department of Education (DOE) guarantee those loans against defaults, the lenders also got a fixed 9.5% return on those loans, under one program. However, this program was designed to limit government subsidies to the lenders in an environment when interest rates were in double digits.

 

However, the Congress tried to stop the program in 1993, as it was discovered that with a drop in interest rates, the government was paying more in subsidies. While the students paid less than 4%, the government had to provide the remainder to ensure that the lenders were getting the fixed 9.5% return on their money.

 

This payment imbalance led many lenders to practice fraudulent modes, using several financial methods and provisions to not only maintain but increase the loan volume eligible under the program. This resulted in significant overpayments. Nelnet was one of those implicated.

 

Nelnet’s settlement pre-empts the trial that was scheduled to begin this Tuesday. According to the company, the settlement was only made to remove any uncertainties. The settlement is, however, subject to the Department of Justice’s approval and the finalization of a formal settlement agreement.

 

Earlier this month, Nelnet reported second quarter 2010 earnings of $1.17 per share, compared with 60 cents in the year-ago quarter. Results were ahead of the Zacks Consensus Estimate of 96 cents. Quarterly results reflect a decrease in interest expenses (payable on bonds and notes) and benefits of diversification of revenue through fee-based businesses. The company expects its earnings to benefit in the future quarters as well, if interest rates remain low.

 

However, effective July 1, private lenders such as Nelnet and Sallie Mae stopped originating federal student loans under the Federal Family Education Loan Program. This is due to the signing of the student loan reform act by the President in March, which forbids private sector companies from making new federal student loans after June 30, 2010.

 

Nelnet is experiencing an increase in profitability from its student lending business and is reaping the positives of its recent efforts to diversify. The company continues to shift to a more fee-based business model and is currently servicing the DOE's Direct Lending Program. While Nelnet is expected to strategically expand its fee-based business, the transition from its traditional role of a lender to a provider of fee-based services will take some time.

 

Nelnet currently carries a Zacks #1 Rank ('Strong Buy'), implying significant potential for upward pressure on the stocks over the next one to three months. The stock also has an Outperform recommendation in the long term.