摩根大通 (JPM) 2004 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the third quarter 2004 Collegiate Funding Services earnings conference call. My name is Anne Marie and I'll be your coordinator for today.

[OPERATOR INSTRUCTIONS].

I would now like to turn the presentation over to Mr. Kevin Landgraver, Chief Financial Officer. Please proceed.

Kevin Landgraver - Collegiate Funding Services - CFO

Good morning and thank you for joining us on the Collegiate Funding Services, Inc. third quarter conference call. I am Kevin Landgraver, the Chief Financial Officer of Collegiate Funding Services. Before we hear from Barry Morrow, our Chief Executive Officer, I'd like to summarize the Safe Harbor notice, a complete version of which is included in today's news release.

This conference call includes forward-looking statements as defined by the Federal Securities Laws. For a description of the risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements, please refer to our periodic filings with the Securities and Exchange Commission including quarterly reports on form 10Q and the registration statement on form S1.

We undertake no obligation to update or revise forward-looking statements unless otherwise required. The company claims the protection of the Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Now, Barry Morrow will highlight Collegiate Funding Services performance for the 2004 third quarter and then I will review the financial results. And then, finally, we'll respond to your questions. Barry.

Thanks Kevin and good morning everyone. As you know, this is our first quarter as a publicly traded company, but the strategies that are driving our growth have been in place for some time and are well established. I'd like to touch on key elements of those strategies which, I'm happy to report, led to solid performance for the third quarter of 2004.

Collegiate Funding Services is a leader in applying a direct to consumer marketing approach to the education loan business. We have supplemented this strategy by expanding our partnership network with universities, alumni organizations and professional associations organically as well as through our acquisition of Y2M earlier this year. This network now numbers over 1,000 relationships, providing a growing source for loan volume.

The past few years we have followed the strategy of retaining a significant portion of the federally guaranteed loans that we originate in order to build an asset base that will generate long term revenue. At the same time we are dramatically growing our private loan origination volume, and we have diversified our business to become a vertically integrated company allowing us to produce multiple income streams by marketing, financing and servicing the loans we originate.

By employing these strategies we produced increasing loan volume and strong revenue and earnings growth for the third quarter of 2004. Loan originations were 1.2 billion dollars for 2004 third quarter, up seven percent from one year ago. Our loan portfolio was 4.1 billion dollars at the end of September, up from two billion dollars last year. The servicing portfolio grew to 10.3 billion, up from 7.9 billion a year ago.

Net revenue increased to 59.1 million, from 29.3 million. This was due to the strong origination volume, increasing fee income and the expanding student loan portfolio that I mentioned earlier which provided close to 16 million dollars of net revenue this quarter alone.

I want to spend a couple of minutes on expenses, which were 45.5 million dollars the recent quarter, up from 27.9 million dollars last year.

Part of the increase was due to non-recurring items. First we had a one time non-cash charge from termination of the lease on our former headquarters and other relocation expenses. Secondly, as noted in our S1, we had one time compensation charges related to the granting of restricted stock to management upon a completion of our IPO. Expenses would have been about 2.5 million dollars lower without these one time items, or roughly five cents per share after tax.

The expense increase also reflects intensified marketing activities including our private loan business, which did a record 198.3 million dollars in volume this past quarter. Industry experience shows the substantial percentage of the customers we generate now will come back to us for future financing needs as they continue their education. Our investment and marketing to these customers today should generate additional volume going forward at a lower cost.

Marketing expenses also increased as a result of the two Department of Education policy changes made earlier this year, which they ultimately reversed in late August reopening that segment of the market to us. As a result of that reversal we reinitiated our campaigns to that segment in the third quarter of 2004. We also invested additional marketing dollars through Y2M and eGrad, our partnership channel, which provided approximately 90 million dollars in volume this past quarter.

And we took advantage of an opportunity to purchase some volume from one of our partners at reasonable prices. Of the year over year increase in marketing expenses, roughly 70% is attributable to our diversification of both products and distribution channels. These expenses are entirely variable and will be more in line with the second quarter of this year as we go through the fourth quarter of 2004.

As a result of our revenue growth offset by these expenses, we have GAAP earnings per share of 25 cents after the one time adjustments of five cents in third quarter versus a loss of two cents for the same quarter last year. Year to date diluted GAAP earnings per share was 43 cents compared with a loss of 61 cents for the first nine months of 2003.

I'm very pleased with these results which reflect our ability to execute on our strategies. Now I'll turn the call back over to Kevin to talk more in detail about our financial results. Kevin?

Kevin Landgraver - Collegiate Funding Services - CFO

Thanks Barry and thanks to all of your for joining us today. I'd now like to provide more detail behind the results that Barry briefly outlined, including more information on our origination volume, loan portfolio, incoming expenses and financing issues.

First let's look at loan volume in more detail. As Barry noted, our loan originations were 1.2 billion dollars for the 2004 third quarter, which is up seven percent from 1.1 billion a year ago. Year to date volume was 2.9 billion dollars, up 10% from 2.7 billion dollars for the first nine months of 2003. Significantly, private loan originations for Q3 2004 were 198.3 million dollars, up 117% from 91.6 million dollars for the same quarter last year. Year to date private loan volume was 298 million dollars, rising 94% from 154 million dollars.

The volume of FFELP loan originations declined a bit in the third quarter to 990 million dollars from one billion dollars a year earlier. This was largely due to two changes in regulatory interpretation by the Department of Education. As a result of these changes, some borrowers who normally would have been eligible for consolidation loans instead were ruled to be ineligible.

When it became clear that Congress was not going to complete the higher education act reauthorization in 2004, the Department decided in August to reverse its interpretations and return to the status quo pending Congressional action as part of the HEA reauthorization. But in the meantime this had the effect of reducing the universe of eligible consolidation customers in the third quarter.

On a year to date basis, FFELP volume was up five percent. We sold a total of 572.3 million dollars in FFELP loan applications this past quarter as well as all of our 198.3 million dollars in private loan originations. We retained 42% of our federally guaranteed originations in Q3 and sold 58%. As you may know, our target for retaining versus selling failed originations is about 50/50, although we vary that ratio based on market conditions and the characteristics of loans as we did this quarter. For 2004 year to date we have retained 51%, sold 49%. So we're right on target.

The servicing portfolio was 10.3 billion dollars at September 30, 2004, up 30% from a year ago. And as for our government guaranteed loan portfolio, which is a primary source of future revenue growth, we ended Q3 with 4.1 billion dollars, more than double the level of two billion dollars a year earlier.

Let me talk about income.

Net revenue for the 2004 third quarter was 59.1 million dollars, up 102% from 29.3 million dollars last year. Increases in both net interest income and fee income lead to the higher revenues. I'll talk about net interest income first. Net interest income after provision for loan losses was 15.8 million dollars, up 170% from 5.8 million dollars a year ago.

The major driver of the increase was the growth in our total average student loan portfolio, which more than doubled to 3.9 billion dollars from 1.8 billion dollars a year ago. I should point out that our net portfolio margin decreased to 1.67% for the 2004 third quarter compared with 1.87% in the third quarter of 2003. While our average cost of funds for financing student loans increased by 44 basis points quarter to quarter, this was partly offset by a 24 basis point rise in the yield on our student loan assets.

We provide a detailed reconciliation of net portfolio margins in the investor relations sections of our web site, which is www.csfloans.com. For the latest quarter provision for loan losses was 726,000 dollars, down from 904,000 dollars a year ago. Also, fixed rate floor income was five million dollars in the latest quarter and that compares to 4.7 million dollars in the third quarter of 2003.

I'll talk about fee income next. Fee income was 43.3 million dollars, up 85% from 23.5 million dollars a year ago. The growth in fee income largely reflected a 91% increase in fee income on originations sold to 38.9 million dollars. Servicing fees totaled 3.2 million dollars n the latest quarter. Fee income also included 1.2 million dollars in advertising income.

Now I'm going to turn to expenses. Total operating expenses, which includes salaries, marketing and other SG&A, were 45.4 million dollars in the 2004 third quarter compared with 27.9 million dollars last year.

The primary causes of this increase were as follows. Salaries and benefits expenses increased to 17.4 million dollars from 13.7 million dollars. This was due primarily to a full quarter of the Y2M organization and as Barry noted, we also paid one time bonuses of 1.4 million dollars in restrictive stock and cash. Excluding the bonuses, salary and benefits expense were about even with the 2004 second quarter level of 16.2 million dollars.

Marketing and mailing expenses were 17.5 million dollars, up from 6.8 million dollars a year ago. As Barry noted earlier, part of this increase was due to our marketing initiatives for private loans. Our numbers also reflect the addition of Y2M's marketing expenses. And, finally, compared with last year we increased the use of direct mailings and the internet, in response to the implementation of the national do not call registry in September of 2003.

In addition to these operating expenses I just mentioned, our hedging strategy influenced total expenses for the quarter. Since 2003 we've deployed hedges against rapid rises in interest rates. We recorded swap interest expense of 643,000 dollars and a non-cash mark to market expense of 245,000 dollars in Q3 of 2004.

By contrast, during the third quarter of 2003 we recorded swap interest expense of just over one million dollars and non-cash mark to market income of 948,000 dollars. Finally, we recorded an expense of 507,000 dollars for the accretion of dividend on preferred shares in Q3 2004, down from 1.6 million dollars a year ago. As you know, the preferred shares were redeemed with our IPO proceeds in July.

These factors produced net income of 7.6 million dollars or 25 cents per share on roughly 30.7 million diluted weighted average shares for the third quarter of 2004. In the third quarter of 2003 we recorded a loss of 386,000 dollars or two cents per share on roughly 15.5 million diluted weighted average shares.

I'll briefly review our 2004 nine month highlights, as most of the factors that drove the Q3 comparisons apply for the year to date. Net interest income was 45.8 million dollars after provisions, up sharply from 10.7 million dollars in the first nine months of last year. This reflected our decision to retain a greater portion of our government's loan volume, along with the effect of the loan loss provision of our exceptional performance status.

Year to date fee income rose to 86.1 million dollars from 66.5 million dollars in the same period of 2003. The 2004 figure included income from sold loan applications of 74.7 million dollars, servicing fees of 9.6 million dollars and advertising income of 1.8 million dollars. Given the above, net revenue increased 71% to 131.8 million dollars from 77.1 million dollars.

Total expenses increased 105.8 million dollars from 82.2 million dollars, reflecting the factors that I noted earlier.

That brings us to net income for the nine months of 2004 of 10.9 million dollars or 43 cents per share on roughly 25.5 million diluted weighted average shares. Last year we had a loss of 8.7 million dollars or 61 cents per share on roughly 14.1 million shares.

To summarize, we are continuing to produce strong loan volume and to retain a significant percentage of our originations. Our vertically integrated model means that we are generating multiple revenue streams: net interest income, fees from loan sales and servicing revenue. While expenses have risen, we believe this is justified given the change in our origination mix and our expansion into additional activities such as servicing.

With that, I'm going to turn it back to Barry.

Thanks Kevin. It's clear from our results for the quarter and year to date that our strategies are working. Collegiate Funding today has: • A successful direct to consumer and partnership approach that is generating solid loan origination volume with particularly robust growth in private loans. • A growing portfolio of high quality assets with virtually no credit risk, that will generate recurring interest income and • A vertically integrated business model that allows us to diversify our sources of growth and profitability and remain flexible as market conditions change.

We continue to be extremely optimistic about our position within the growing education market. We think our strategy will allow us to take advantage of the entire spectrum of products and services within this dynamic industry, leading to continued growth for the future. As always, I want to thank the dedicated and talented team of CFS for ongoing efforts that have enabled us to produce these strong results. Again, thank you for joining us on the call and now we'll be happy to respond to any questions you might have.

[OPERATOR INSTRUCTIONS].

And your first question comes from Patricia McInerney of JP Morgan. Please proceed.

Hi guys. I was wondering if you could talk a little bit more detail about the decision to sell versus hold loans, and how interest rates might impact that. And then also correspondingly if sort of the 50% level is still kind of what you think you'll be at for 2004.

Yes. For 2004, Patty, how you doing? We do look to be at 50/50 as we talked since earlier in this year. In terms of the optimization that we talked about in the past, again, each quarter, actually every day as loans come through we put them through our optimization model which is a combination of different attributes, balances, interest rates, term and deciding upon whether or not that particular loan is of more value to us to retain or to sell. We make that decision.

Now in the past quarter we did sell a little more, perhaps, than we wanted to but we wanted to invest some dollars in the marketing things that I talked about earlier. But I think in the fourth quarter we'll be back to 50%, for the year we'll be about on that 50 to 51% number.

OK. And then just one other question, on the consolidation loans that were held over from sort of second quarter I think you said last quarter that it was like 375 million. How does that compare to sort of the amount that was held over a year ago?

I believe that number was pretty flat.

OK.

And we did fund more in the second quarter this year than last because more people did decide to go ahead and fund in the second quarter because the rates were not up that much. I think we were up, if I'm not mistaken, a 100 and some odd million before the quarter.

Roughly, yes.

So there was less holdover second to third quarter this year than there was last year?

Right.

OK.

A lot of people - 50 basis points wasn't enough to make people wait.

OK. Great. Thank you.

Yes.

Thanks Patty.

And your next question comes from Douglas Harter of Credit Suisse First Boston. Please proceed.

Yes. I was wondering if you could talk about the opportunity for volume from the marketing effort that you put back into the two programs that were reinstated by the Department of Education. How much volume you think you could see from those.

It's a little difficult to tell. We do anticipate recapturing some of that volume. Unfortunately because of the timing a lot of the great eligible population that last year was eligible was not eligible and might have decided to consolidate elsewhere. Which makes them unavailable to us going forward.

We've kicked those campaigns off in the latter part of, mid-September I'd say, we kicked those campaigns off and we're starting to see some of it. So we do anticipate getting that volume back, at least a portion of it, in the fourth quarter and some might actually drag out in the first quarter of next year. But meantime, we'll discontinue some of the things we were doing to plug that hole and put more of the resources back into those two segments.

Which could prove, over the last four years, to be pretty effective segment. I can't give you a real good number right now, though, Doug.

All right. Thanks. There was just one other question on the provision. If you could just sort of talk about your provisioning for the coming quarters.

Yes. Our approach to the loan loss provision is to take into consideration expected losses as of the balance sheet date. What we look at there is the number of defaults, the timing and then you multiply that against an expected severity rate. Although we do have the exception performer designation, when we calculate loan loss provisions we don't assume that we will have that forever.

The reasons for that are two fold. When you have exceptional performer, you've got renewal risks. One obviously is the company risk, which we can control. The other one, quite frankly, is reauthorization risk. I believe now more than half of all loans serviced are serviced under exceptional performer status. One has to wonder in a budget deficient environment whether that's going to continue on.

We don't assume that that will. We account for some form of non-renewal risk and that's why we continue to add to loan loss provisions in conjunction with the aging of our portfolio.

Thanks.

You're welcome.

[OPERATOR INSTRUCTIONS].

Your next question comes from Beth Rosen of Merrill Lynch. Please proceed.

Good morning guys. Two questions. I wanted to know on the sell or hold, if you could follow that up with you're going to be the 50/50 in 2005. And also if there's any seasonality besides what you sort of told us as you look at each individual loan, but from quarter to quarter are there certain quarters where the consolidations are more or less attractive that you would sell more, I think, going forward?

Yes. Hi Beth. How you doing. This is Barry. There is some seasonality, particularly when you look at the grace period, which is that six month period when they leave school. They tend to have higher balances offset somewhat by lower rates, because they get a 60 basis point discount if they consolidate in the grace period.

So we do see, but overall we see the fourth quarter kind of as more attractive volume typically, which is why we sold more in third quarter so we could hold more this quarter is some of the thinking behind that. In terms of 2005, I think the question was are we going to retain the 50/50. Is that ...

Yes. That's the question.

You know, we continue to study that and look at that, analyze that and see what the impact is on the company and obviously on our shareholders. You know, as we go into our 2005 planning session, I don't want to single that we might change that, but we're certainly studying that very hard. It wouldn't be less than 50%.

OK. Great Barry. And just of all, any of the originations, were they in the PLUS or Stafford segment or was it all private in totality?

We had a little bit of volume in Stafford. Again, the PLUS from Stafford business is a little different. The Stafford business in particular is more of the business to business relationship building, you know, goes through financial aid office. We do have a number of schools that we're on the preferred lending list.

What we do in this quarter, third and fourth quarter of this year, is really positioning us for 2005 and 2006 academic year. We'll see some fruits of our labor. Unfortunately it takes that much time to see the results of that.

On the PLUS side, it must also go through a school channel that is also available through the direct to consumer. We have been doing some testing both in mail and on the internet and the preliminary results are very attractive. The cycle for plus lending will be in the April, May, June, July period of next year as people go on to their fall semester of school next year. So we're seeing some very solid results in our past and we look forward to some volume in that category next year.

OK. Great. Thank you.

[OPERATOR INSTRUCTIONS].

And your next question comes from Joseph Halpern of Halpern Capital. Please proceed.

Hi guys.

Hey Joe.

Could you just give me - I kind of missed the other number. On the floor income this quarter you had five million dollars. What was it last quarter?

Last quarter, Q2 of '04?

Yes.

It was 6.4 million dollars

OK. Yes. Because I think you only gave a year ago, so I got a little confused. So did it go down with the increase in rates?

That's correct.

When did, I think you mentioned you still have a hedge expense. When do those start kicking in where, you know, I guess you kind of have floor income kind of going down a bit as rates go up and then the hedge kind of covers you for a bit. What level is that?

Yes. Right now we have a little over two billion dollars in hedges. And actually the third quarter was a good laboratory for that because rates rose, we gave up floor income, 6.4 to five million. But on the other hand swap interest expense declined. So those performed the way that we had hoped they would.

OK. Great. Thanks guys. Good job.

[OPERATOR INSTRUCTIONS].

And there are no further questions at this time. I'd like to turn the call back to Mr. Morrow for closing remarks.

OK. Well thanks everybody. I appreciate you taking time out this morning to listen to us. Again, I think the third quarter was a great quarter for us. We did have some tests to learn and some challenges to go through, particularly with the Department of Education. We were successful in getting that reversed and we think going forward that we're well positioned to continue to grow in the education business.

So, again, thank you for your time and we'll be talking to you next quarter.

Thank you for your participation in today's conference. This does conclude the presentation. You may now disconnect.