Credit crisis calls on Lincoln; Nelnet debt downgraded

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The international credit crisis made a visit to Lincoln this week.

Nelnet, the student loan company based in Lincoln, expressed disagreement and disappointment with Moody’s Investor’s Service, one of the world’s big debt rating agencies, for downgrading Nelnet’s unsecured debt to “junk” status.

Moody’s downgraded the ratings of Nelnet’s senior unsecured debt to Ba1 from Baa2 and placed the ratings on review for possible further downgrade.

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Ba1 is considered a “junk” or high-risk rating, and as such, makes the debt security ineligible for purchase by some institutions.   It would be considered by some to be a purely speculative investment and at risk of default.

The downgrade will have a minor impact on Nelnet, said spokesman Ben Kiser, because the company is no longer issuing unsecured debt, hasn’t since 2005 and 2006 and has no plans to do so.    The company has $475 million in outstanding unsecured debt owned by investors. 

If they did try to issue new unsecured debt, under these circumstances, they’d have to pay higher interest rates to get it sold. 

The downgrading calls attention to Moody’s belief that Nelnet’s “financial flexibility has  become constrained.”

“We are concerned that, given the distressed state of the capital markets and the elevated balance of the company’s unsecured revolving credit facility, the company may not be able to generate sufficient cash flow to repay unsecured debt, absent significant refinancing and/or external capital raising actions,” said Moody’s senior analyst Curt Beaudouin.

“We are disappointed with Moody’s decision, however, we look forward to continuing our discussions with the rating agencies to demonstrate the fundamental strengths of our company,” Nelnet responded in a news release. “Despite the unprecedented global credit crisis, Nelnet remains a profitable education services company. We reported strong earnings for the third quarter of 2008, which underscores the success of our diversification strategy into stable, fee-based businesses that have significant growth opportunities and operating margins.”

In fact, Nelnet stock was up substantially on the New York Stock Exchange Thursday after the company reported late Wednesday that it swung to a profit in the third quarter, surpassing Wall Street's expectations.

For the period ended Sept. 30, excluding discontinued operations and legislative and restructuring charges, Nelnet earned $23.4 million, or 47 cents per share, compared with $22.2 million, or 45 cents per share, in the same period last year.

Analysts polled by Thomson Reuters, on average, expected earnings of 33 cents per share.

Reinforcing its objection to Moody’s action, Nelnet said it has focused on government-guaranteed student loan assets that carry virtually no risk of default. In fact, 99 percent of the company’s student loan assets are guaranteed by the federal government,  said company spokesman Ben Kiser.

But the sharp deterioration of the capital markets has caused a dramatic reduction in the value of all types of financial assets and securities, including, as Moody’s pointed out,  government-guaranteed student loans carried in Nelnet’s “warehouse” and financed for a short term, until they are bundled as securities and sold.

As the value of student loans has dropped, Nelnet has had to put up more money as collateral to its lenders to make up for the lower value of those loans.

Nelnet said in its earnings report that it drew from a line of credit in order to post additional collateral against its $2.5 billion federal student loan “warehouse facility,” which represents 10 percent of its loans.

Nelnet said it has increased the equity support to a total of $374.6 million.

"Due to this unprecedented period of market disruption, the mark-to-market formula specified under the terms of the (warehouse) facility produces an unreasonably low value for these federally guaranteed student loans," said Mike Dunlap, chief executive, in a statement.

Mark-to-market means that Nelnet must account every month for the loans in the warehouse as if they were worth no more than what someone is willing to pay at that time, regardless of what they may be worth in the future.  

This has become a huge issue, perhaps the biggest issue of the world’s credit crisis, and the cause of enormous losses among a broad array of financial companies that have had to reduce the value of securities backed by loans, including student loans and mortgages, or the loans themselves.

"These (student) loans are guaranteed by the federal government and have almost no default risk,” Dunlap continued. “However, we appreciate that we are truly in unprecedented times, and we are engaged in discussions with our lenders to reach amicable terms on these financings."

As Moody’s pointed out, however, the associated margin calls, or demands on Nelnet from lenders for more collateral, can be substantial.

Nelnet now has little remaining capacity under the revolving credit lines from which it borrows, Moody’s said.  Nelnet presently has an outstanding balance of $691.5 million borrowed from a line of revolving credit worth $750 million, while cash balances of $80 million provide only modest cushion, according to Moody’s.

In addition to the $80 million in cash, Nelnet has approximately $90 million of unencumbered private loans funded by cash of Nelnet that could be pledged as collateral, Kiser said.

Moody’s continued: “Nelnet’s exposure to market risk could result in additional margin calls that further deplete the firm’s cash resources.”

Richard Piersol is at 473-7241 or dpiersol@journalstar.com