摩根大通 (JPM) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Collegiate Funding Services second quarter 2005 earnings conference call. My name is Steven, and I'll be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question and answer session toward the end of this conference. For assistance during the call, please press star-zero and the coordinator will be happy to assist you.

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Kevin Landgraver, Chief Financial Officer. Please proceed, sir.

Great, thank you, Steven. Good morning, and thank you for joining us on the Collegiate Funding Services 2005 second quarter conference call. I am Kevin Landgraver, Chief Financial Officer of Collegiate Funding Services. Before we hear from Barry Morrow, our CEO, I'd like to summarize the Safe Harbor notice, which is included in today's news release. This conference call includes forward-looking statements as defined by 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 the annual report on Form 10-K and the quarterly reports on Form 10-Q. 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 will highlight Collegiate Funding Services' performance for the 2005 second quarter, and then I will review the financial results, and finally, we'll respond to your questions. Barry?

Thanks, Kevin, and good morning, everybody, and thank you for joining us today. In the second quarter of 2005, Collegiate Funding Services once again achieved solid results. In addition to loan-production, we also executed on two initiatives designed to drive our continued diversification and growth, the introduction of a private loan product that we can retain on our balance sheet, and a small but strategic acquisition that puts us in the attractive international education-lending market. Also, after the end of the quarter, we closed an offer of $1.3 billion in floating-rate asset-backed notes, with a favorable impact on stability and cost of our funding.

I'll briefly recap some of our financial highlights and I'll comment further on some of the other initiatives. We increased loan-originations 46% over last year's second quarter, bringing total volume for the first half of 2005 to 2.05 billion, or up 19% over last year's first half. Originations were driven by high consumer demand prior to the July 1st reset of interest rates and included incremental volumes in this year's market for in-school consolidations, as well as grace period volume. Our pipeline of applications pending funding in Q3 and Q4 has significantly increased, in large part due to our continue focus on recent graduates.

There was continued strong growth in private loans, where total originations rose 57% over the second quarter of last year, to $84.3 million. I also want to note that our loan originations for in-school products, which include private loans, as well as PLUS and Stafford loans, grew 98% in the second quarter of 2005, to total more than $75 million.

As of the end of the quarter, our student loan portfolio was up 16% since year-end, and the servicing portfolio was up 9% over the same time period. We continue to expand our distribution channels by forming additional relationships with schools, alumni associations and other partners. At the end of the quarter, we had 1,130 affinity relationships, an increase of 82 during the last six months.

As a result of our loan production and resulting fee income, netincome for the 2005 second quarter was $6.6 million, or 20 cents per diluted share. This compares with $2.1 million, or 9 cents per diluted share for the second quarter of last year.

We also had some other developments during the quarter, and I would like to briefly comment on those. As you know, we announced that the Department of Education withdrew the exceptional performer designation from our servicing subsidiary as a result of a certain processing error that we self-corrected and self-reported to the Department of Education. We do plan to reapply for the exceptional performer status and are anticipating being redesignated in the fourth quarter of this year. In addition, we reported that the Student Loan Corporation had decided to terminate its agreement to purchase consolidation loans from CFS, and to not renew its servicing agreement. These agreements may terminate in the fourth quarter of 2005. We are in discussions with the Student Loan Corporation and others, and expect to be able to provide clearer direction once these discussions are concluded.

We do, however, have other liquidity outlets currently in place. We anticipate, given the potential shift in our liquidity outlets, as well as a possible shift in our loan retention strategy, that we may see a reduction in the margins for loans sold.

Coming back to the initiatives I mentioned earlier, in June, we began marketing a private loan product that we can retain on our balance sheet. As we noted when we announced this program, this offers a compelling opportunity for us. This is a rapidly growing part of the education credit market and the potential returns retaining these loans on our balance sheet are significant.

In addition, the ability to market these loans gives us the opportunity to build relationships with customers early on, with the possibility of continuing to service their future needs, as they make multiple borrowing decisions over the course of their academic careers.

We also acquired the International Education Finance Corporation, which specializes in education loans, both for U.S. students who study abroad and international students attending U.S. schools. IEFC originated more than $180 million in 2004, and has an excellent network of relationships with school financial aid officers, lenders, and guarantors. This is a great niche that strengthens our campus channel programs, and we look forward to building on IEFC’s strengths to take advantage of the international and campus channel.

Our recent $1.3 billion asset-backed offering is significant, as it allowed us to refinance about $900 million in auction-rate certificates from an earlier master trust, and provides about $400 million to finance loans in our warehouse facility. Kevin will go into more detail on that later in the call.

To sum up, we enjoyed a strong quarter, and put in place important growth platforms for the future. Now I'll turn the call over to Kevin to review the financial results in more detail.

All right. Thanks, Barry, and good morning, again. I'd now like to provide more detail behind the results that Barry briefly outlined, including more information on our origination volume, loan portfolio, income and expense, and other finance topics.

Turning first to loan volume, our total on originations for the 2005 second quarter were just over $1 billion, an increase of 46% percent from a year ago. As Barry noted, our private loan volume continued to climb. We sold $82.9 million of third-party private loan applications and added $1.4 million of our own product to our balance sheet. Government-guaranteed loan volume totaled $942.8 million for the second quarter of 2005, or about 45% higher than the same period last year. We've been focusing on generating more in-school volume, and our second quarter originations included $75 million of in-school loans, up from $37.8 million a year earlier. This growth was achieved in what is traditionally considered a slow quarter for in-school lending.

The interest rate reset in July drove significant volume during the last quarter. Fortunately, we were able to process and fund many of the applications that came in during the quarter. However, a number of applications that were received at the end of the quarter did not fund, or were recent graduates that requested their loans not be funded until the end of their six-month grace period. As a result, we ended the quarter with a healthy pipeline of applications that will fund in the third and fourth quarters. While we like to see a healthy pipeline, we also recognize that the surge in demand prior to the rate reset will decrease the supply of repayment borrowers that may apply in the third and fourth quarters.

On a retention basis, we retained approximately 43% of our self-originations last quarter and sold 57%. Year-to-date, we're at 50% sold and 50% retained.

In terms of our managed assets, the government-guaranteed loan portfolio is $5.4 billion at June 30th, up 16% during the past six months, and our servicing portfolio is $11.9 billion, up 9% since the end of the year.

Now let me talk about income. Net revenue for the second quarter of 2005 was $53.6 million, up 41% from 38.1 million last year. We had an 85% increase in fee income that offset a decrease in net interest income after provisions, due to the change in our exceptional performer designation. Looking first at that interest income, that interest income before provision for loan losses was $17.1 million, compared with $15.7 million a year ago. This reflected growth in earning assets offset by a narrowing of the net interest margin as floor income decreased. It is worth noting that we derived only $759,000 from floor income in the second quarter of 2005.

The change in our exceptional performer status led to a $2.2 million loan loss provision in Q2 2005. This contrasts with a reversal of loan loss provision of $1.5 million in the same period last year, when we added the exceptional performer benefit to our calculations.

Fee income was $38.7 million for the 2005 second quarter, up 85% from $21 million a year ago. The majority of our fees -- $34.2 million - resulted from loan application sales. Application fee income was 99% higher than the same quarter last year. To provide further insight into our fee application income, $30.5 million was associated with the sale of federal volume, and $3.7 million was from the sale of private volume to various outlets. The balance of the fee-income increase came from servicing fees and the advertising income from Y2M's publishing activities.

Turning now to expenses. Total operation expenses before swap and derivative activities were $42.2 million in the 2005 second quarter, compared to $35 million last year. The primary causes of this increase were as follows. Salary and benefits expenses increased to $17.3 million, up 7% from a year ago. The main reasons for this increase were the expansion of our loan-origination operations, as well as higher benefit and incentive costs. Marketing and mailing expenses were $14.1 million, an increase of 30% from a year ago. This increase reflects our expanding marketing activity in anticipation of the July 1st rate increase, the efforts to reach in-school borrowers that could benefit from early consolidation, and private loans. We also saw increases in our other SG&A expenses, including a reserve of $1.6 million related to the change in exceptional performer status. We also had higher professional fees associated with IT projects and public company expenses such as Sarbanes-Oxley consultants.

As for the impact of hedging activities, we recorded cash swap interest income of $290,000 and non-cash mark-to-market expense of $819,000 in Q2 2005. During the second quarter of 2004, we recorded cash swap interest expense of $2 million and non-cash marked-to-market income of $5.9 million. In other words, our net-hedging impact was an expense of $529,000 this year versus a $3.9 million gain last year. As we have had less floor income, we have reduced our hedging activities.

Finally, there was no accretion of dividends on preferred shares in the second quarter of 2005 versus $2.2 million in the year-ago period. That brings us to net income, which was $6.6 million or 20 cents per share on roughly 32.4 million diluted weighted average shares for Q2 2005. For the same period of 2004, net income was 2.1 million or 9 cents per share on approximated 22.9 million diluted weighted average shares. Although we provide year-to-date information in the press release, most of the factors I discussed influencing Q2 results are the main points for the year-to-date comparisons, with the exception of noting that we did not acquire Y2M until April of last year.

I do want to give a little bit more color on a topic that Barry mentioned. Specifically, we recently announced the execution of our 2005B asset-backed securitization. $900 million of the $1.3 billion was used to pay off our first two securitizations. These older securitizations were 100% auction-rate debt. Over the past two years, we have experienced volatility in the auction-rate market. Moreover, this type of debt has a 25 basis point broker-dealer fee associated with it. At the same time, we've been able to issue new ABS transactions that are 100% LIBOR floating debt at much better rates. Consequently, we decided to extinguish the $900 million in auction-rate debt and finance the student loan assets, plus $400 million from our $1 billion warehouse facility, into a new instrument. The effect on our financial statements will be twofold. First, we'll take a one-time non-cash charge of $4.3 million in the third quarter, representing the unamortized cost associated with the extinguished debt, and then, second, our lower cost of funds from the 2005B should result in a pay-back of the one-time charge in under three years.

Now, before I turn the call back to Barry, I just want to summarize by saying that Collegiate Funding Services has continued to increase origination volume and our loan portfolio while constantly seeking to further diversify our revenue streams. We have posted strong-financial performance in spite of some challenging period-to-period comparisons. Setting aside some of the tough comparisons related to floor income, the impact of exceptional performer, and the effects of hedging, the basic financial performance of the company has been solid and in line with expectations. With that, I'll turn the call back to Barry.

Thanks, Kevin. I, too, am pleased with our progress thus far in 2005, despite some of the challenges that we've discussed here today. We continue to be a major force in the market for post-graduate education finance products, and are increasing our presence in the in-school segment. We are better positioned today and have a strong commitment to continuing to build our private education loan business, and we continue to expand our distribution networks to affinity partnerships and a growing school channel. With that, I'll conclude my prepared remarks and open the call up for questions.

Ladies and gentlemen, if you wish to ask a question, please press star-one on your touchtone telephone. If your question is answered or you would like to withdraw your question, please press star-two. Again, that is star-one if you would like to ask a question. Our first question comes from Stephen Schultz of KBW.

Hi. Thanks, guys. Good quarter. Just had a question on the repayment pipeline. You had mentioned that you expect, in the second half of the year, less volume from the repayment pipeline. What portion of the consolidation volume in the second quarter, or even just from the first half of the year, is coming from the grace pipeline, which is what you guys are focusing on more, going forward, if I understand correctly, versus that repayment pipeline.

I'm sorry, Stephen, you said grace pipeline?

What percentage - what's roughly the breakout in the mix between the grace pipeline and the repayment pipeline this year-to-date?

It's very little on the grace pipeline. Typically, those - the grace pipeline refers to those in graduate school who get out in May and June and have a six-month grace until the fourth quarter before they start repayment. So very little of the first quarter - first half of the year volume - is from the grace pipeline. There's probably a few in there - I don't have the number, Stephen - from the nontraditional graduates who might get out in December or January. But typically grace pipeline is a second half of the year, and really a fourth quarter, funding issue.

Okay. And can I just have one follow-up? I guess you had mentioned in the press release that in the fourth quarter, you may have some difference in terms of your retention mix following kind of the potential pressure on the margin. Can you just kind of talk about how you look on the decision whether to hold or retain loans and what's really the driver behind that decision and maybe compare how you look at that on the consolidation side now going forward versus what was the driver behind the decisions to retain private loans?

Yes. Yes, again, the way we look at whether we sell or retain is a combination of factors as we look at our liquidity contracts, the value of loans that we're selling versus the value of the loans on the balance sheet. A simple way to put it is basically a net-present value kind of analysis that we do in addition to the contractual commitments that we've got in place, and based on those factors we make that decision. As I mentioned, we're in conversations with a number of liquidity potential partners, and based on those discussions being concluded, we may offer our retention strategy to either sell more or sell less based on the value of those contracts once they're renegotiated.

But the decision of whether to sell or retain is driven more just based on the net-present value that you can get holding members versus the net-present value or the value you achieve selling them, right?

Thank you very much, guys.

Sure thing.

Our next question comes from Dan Weldon of Jeffries and Co.

Good morning.

Hi, Dan.

It seems like - I'm calculating the core margin with about 120 for the quarter, so it's holding up a little better than expected. Could you discuss some of the factors driving that?

Yes. Dan, this is Kevin. Some of the factors that are driving it is we've been a little bit more efficient on the use of restricted cash and, of course, short-term interest rates have increased. We've received a lift on that component of our net portfolio margin. I also think it's premature to call it a trend, but the number of people using direct debit hasn't been increasing the way we may have thought about it earlier, and perhaps some of the modeling that's been done. So a combination of slightly less usage of that borrower-benefit, as well as the impact of restricted cash, I think, are the two variables, plus some of the optimizing that we do in deciding to retain loans - i.e., if there's a high fixed-rate loan, we factor that into the net-present value and we may be more inclined to retain that.

On a standalone basis, what kind of efficiencies do you think the new securitization will create, kind of excluding the incentive fees blending into the portfolio?

The kind of contribution that the 2005B will make?

Exactly.

Yes, the background on that, I guess, or to kind of cut to the chase, is that that one priced at a weighted average spread of 13 basis points over a three-month LIBOR, which is a significant savings. We were pleased with it. Again, we're very close to the benchmark issuers in this space, so that lower cost of funds are not only the refinanced portion, but as well as pulling loans out of the warehouse, which had a slightly high cost. We're starting to see the benefits of that immediately, in July.

Okay, thanks.

The only other comment is it frees up capacity in our warehouse to handle the third and fourth quarter volumes.

Okay.

Thanks, Dan.

Our next question comes from Beth Rosen of Merrill Lynch.

Hi, guys. I have a couple numbers questions and then some general questions. First off, of the - I'm a little confused as the holdover of the third quarter and the fourth quarter. I understand the fourth quarter are the grace pipeline, but what exactly is hitting the third quarter? Is that just loans that weren't able to be funded but already processed and locked in that low rate? And then, if you could just give us an update on the authorization, especially given the change and proposal of a fixed and floating rate consolidation loan, how you think about handling that from a marketing standpoint, if that were to pass. And lastly, if you can give us some sense of that $30.5 million fee income, what percentage that comes from your new contract? That would be very helpful.

Hi, Beth, this is Barry. Let me start with the application pending. Yes, the third quarter application pending pipeline, you're right, is basically people who waited until, literally, the last minute to get an application in, prior to the July 1st reset. What's happened, across the industry, are processing backlogs because of the huge demand created in the second quarter, and, as consumers are typical procrastinators, a lot of it came in the second half of June. So the third quarter pipeline consists of those people who got the application in prior to the cutoff but were going through the processing to get the loan ultimately funded. So that's primarily what's the third quarter. The fourth quarter pipeline is your more typical new graduate, the grace pipeline that we talked about earlier, who won't go into repayment until October or November timeframe. We save the application to fund to let them take advantage of that six months. That's the pipeline. What was the second question? I'm sorry, Beth.

Well, just a follow up on that. Is there anyway you could let us know, if everything had funded this quarter, what your origination volume would have been?

The total pipeline for Q3 and 4 is about $1 billion in total funding. We're still going through breaking out what piece is grace versus more Q3. With the processing backlogs, it's been a bit of a challenge. But it's about $1 billion split between the two quarters, and I can't give a good number right now on Q3 versus Q4.

That's very helpful. My second question was on reauthorization and the fixed-floating.

Yes, on the reauthorization front there is a bill, a reauthorization version that the House has put out. Again, let me caveat this by saying - it still has a long way to go. It's got to get through the entire process, including the Senate, so we're not very hopeful this gets done this year, but it does give us a clear indication of where Congress is going. On the fixed variable, we were happy that the Congress agreed that giving consumers a choice was important and kind of mimicking what's done in the mortgage business in terms of a consumer being able to pick between a variable rate loan or a fixed rate loan. We're not real happy with the additional 50 basis point origination fee, and that's still under discretion with both the House and the Senate.

In terms of how we market this, it will really be dependent on how it ultimately gets passed, but without the marketing guys, my view is, again, that's a consumer choice issue, and we will talk with customers on the options and the benefits of one over the other. Some folks will be very interested in locking in a rate and having that certainty, and other folks will be more interested in playing the variable rate game - again these loans are capped at eight and a quarter, so a real high rate environment like we saw back in the '80s and '90s - these are capped to the consumers, so it's still a pretty good deal. So we're happy with where that came out. Again, some of the details need to be negotiated as it goes through the process.

I think the third question was how much of student loan sale fees come from federal consolidation loans.

I think we're about 90% of it.

Thank you.

Our next question comes from Michael Cohen of Susquehanna.

Hi. Can you talk about, sort of, the competitive environment in terms of response rates in the consolidation sector and how those are holding up, and then I have a follow up.

Yes, we've been seeing, as I've indicated, a maturing market, particularly for the repayment segment of this. We're seeing pretty good response rates, still, in our - very good response rates - in our in-school efforts. The flip side of what's happened with the repayment is we've gotten much more focused and our conversion rates are actually increasing, even though our initial response rates have kind of flattened out. So net-net, we ended up - once we talk to a consumer, they're more likely to go ahead and fund. We've seen that coming, now, for the last couple year and have been kind of targeting better through our segmentation that segment which we think is more likely to respond and more likely ultimately to fund.

So that's been kind of what we've been seeing the last couple of years now, quite frankly, in the segment.

Great, and then shifting gears to the private side, some commentary on what you're seeing on response rates there, and then if you could talk a little bit about your plans for securitization and the discussions that you've had with the rating agencies, since your announcement. I'm sure you had some ...

That's right.

Or what you think, sort of - if you could sort of map out the timeline of how you think that's going to play out with further discussions of rating agencies and when you ultimately plan to execute the first securitization transaction.

Right, right. Well, on our response rates in private, it's a little early. If you're talking about our product. The overall response rates for private education products have been very robust. We're not seeing the same kind of issue there we're seeing on the more mature federal consolidation side. So we're very pleased with our response rates.

Early indications for our product are very positive, but again, this was kicked off in the early part of June and time will be the true tale of the tape on that one. But we're pleased, and we're actually in line with our expectations on how we felt this product would work.

And as it relates to the ability to securitize, prior to our launching our private loan product, we did have extensive conversations with both rating agencies as well as surety providers to explore and confirm that we would be able to take a product with our unique underwriting characteristics and be able to turn to the ABS market as a financing solution. So we think we were prudent in doing our background checking and our homework prior to committing to this program, so we're confident that when it comes time, so that when we have sufficient size, we're still confident that we'll be able to turn that into the ABS market.

And that will be a first half of '06 event.

Does that answer your question, Michael?

That answers it very well. Thank you so much.

Our next question comes from Joe Halpern of Halpern Capital.

Hey, guys.

Hi, Joe.

Hi, Joe.

Can you give an idea of maybe what the fee differential is between I guess what you get on the open market versus what STU pays?

Again, Joe, I can't get into specifics about our liquidity providers for obvious reasons with liquidity contracts and confidentiality issues, so it's a little tough to answer that question. And the fact that we're in negotiations with not only the Student Loan Corp but a few others, I don't want to go down that path on a public call. It would put me at somewhat of a disadvantage, as you could understand.

Okay, so I understand.

That's kind of where we're at, Joe.

Okay, that's all I've got. Thanks, guys.

Thank you.

Our next question is from Dan Weldon of Jefferies and Company.

Hi, a couple of quick follow-ups. Do you have the number for the IEFC contribution in the second quarter, to total production?

Yes, the transaction closed at the end of the quarter, or late May. I think it was the legal closing date. And obviously May and June is a tough period. All in, they generated close to $10 million in both private and federal loans. So I wouldn't - I'm just trying to qualify that as I wouldn't extrapolate June's volume to get an annual run rate.

The peak will be in Q3 as the academic session for '05, '06 starts. They're an in-school lending group, so you'll see the volume in Q3 of this year.

And the debt extinguishment expense, that was 4.5 million in the third quarter?

Four-point-three million.

All right, thanks.

As a reminder, please press star, one, if you wish to ask a question.

And our next question comes from Michael Cohen.

Yes, I'm sorry, just a quick follow-up. What were the FFELP loan sale fees?

In the quarter, it was $30.5 million from selling FFELP loans.

And the $1 billion pipeline that you noted, that's for kind of both quarters of the back half of the year, but that also doesn't necessarily include what you're going to produce in that time period, obviously.

No, that's correct. Those are applications that we have in house, have been totally or partially completed, so it does not include the new production for Q3 and four.

How does that billion compare to where you were a year ago?

It's a 140% increase over a year ago.

That's nice. Thank you.

And our next question comes from Stephen Schultz.

Hi, it's just a follow-up on the gain on the sale on the FFELP side related to the STU contract. Is there any indication that you can give as to what you view as the net present value of the loans versus what you guys are getting in the secondary market for the sold FFELP currently, on a relative basis? In other words, are you getting 90% of the value from selling them, or are you getting 110% of the value.

No, I wish we were getting 110%, Steve. I think when you look at it, to put a percent is kind of tough, but the rule of thumb is we're getting probably 85, maybe 95, and kind of depends again on a loan by loan basis. If we can get that by selling them, then perhaps the best thing to do. If we're not getting that, then perhaps the best thing to do is to retain it.

Okay, so essentially you're not getting 100% of the value from selling it even under current conditions.

We don't believe so.

Okay, thank you.

And our next question comes from Beth Rosen.

Hi, guys, I had one follow up also. In the total managed portfolio, can you give us the PLUS and Stafford balances at the end of the quarter?

Hang on, Beth.

Kevin, if you can't find them, I can follow up with you online.

Let me come back, I'll answer it by the end of this call.

Thanks.

Beth, I'm sorry, I did find out the answer to Beth Rosen's question. We had about $35 million in Stanford and Plus on our balance sheet at the end of June.

Okay.

It appears there are no further questions, sir.

Okay, well thank everybody for joining us. Again, I think we had a great quarter, particularly given some of the challenges that we faced, but I think it shows the ability of CFS to respond and to adapt and I'm very optimistic about not only the balance of 2005, but way beyond that. So thank you for joining us, and I hope you have a good day.

Ladies and gentlemen, this concludes the conference. You may now disconnect, have a good day.