Nelnet, Inc. (NNI) 2005 Q3 法說會逐字稿

Good day, everyone, and welcome to the Nelnet Third Quarter 2005 Conference Call. Today's call is being recorded and broadcast live over the Internet. At this time, for opening remarks and introductions, I would like to turn the call over to Ms. Cheryl Watson, Nelnet's Chief Communications Officer. Please go ahead, ma'am.

Thank you, Operator. And thank you, everyone, for joining us today. If you do not have a copy of Nelnet's third quarter earnings release, it has been posted to the IR website at www.nelnet.net.

On today's call, Steve Butterfield, Co-Chief Executive Officer and Vice Chairman, will provide an overview of our financial and operational results. Mike Dunlap, Co-Chief Executive Officer and Chairman, will discuss operational results, and Terry Heimes, our Chief Financial Officer, will report on our 2005 financial results.

Before they begin their formal remarks, I would like to read the Safe Harbor Statement. We would like to remind you that there will be forward-looking statements made during today's call. The forward-looking statements may differ materially from actual results, and are subject to certain risks and uncertainties that are detailed in the earnings release and in our filings with the SEC. The Company does not intend to update any forward-looking statements made during today's call

During the course of this call, we will refer to a non-GAAP measure, which the Company defines as base net income. Please refer to our earnings release or to our website for the reconciliation of GAAP net income to base income.

After Steve, Mike, and Terry have concluded their formal remarks, we will open up the call for questions. I would now like to turn the call over to Steve Butterfield.

Thank you, Cheryl. We had a busy third quarter, and quite honestly, we've had a busy week already. As I'm sure you've seen, based on press releases over the last two days, we have closed on a couple of transactions we announced less than a month ago. We are very excited about the acquisition of the student loan portfolio, related servicing assets, and the rights to the Chela brand from Chela Education Finance, Inc., as well as the acquisition of LoanSTAR Funding Group, and related servicing assets of LoanSTAR Systems. We are proud to be associated with both of these well-respected student loan partners. These acquisitions expand our market scope and operational scale, as well as leverage our capital position.

While we are very excited about these two transactions, I don't want them to overshadow a very successful third quarter and how we have positioned Nelnet to move forward. As a growth company in a growth industry, we continue to focus on creating long-term sustainable value through asset growth, diversification, and providing a quality, vertically integrated approach to solving our customers' needs. Funding the student loan asset is critical to creating and managing customer relationships to drive the economic engine of Nelnet.

With that in mind, I am pleased to report that year-over-year student loan assets are up $3.6 billion, or 28%, to $16.4 billion at the end of the third quarter. For the nine-month period ending September 30, 2005, student loan assets are up $2.9 billion, or 22%, since December 31, 2004. From an earnings perspective, our focus continues to be on generating consistent, sustainable growth in that interest income, as well as diversification of our fee-based revenue. As such, as we continue to focus on base net income, exclusive of certain special allowance yield adjustments associated with our portfolio currently earning at a rate of 9.5%, and the impact of net settlements or derivatives used to hedge that portfolio.

For the nine months ended September 30, 2005, our base net income, excluding the impact of special allowance yield adjustment and related derivatives, was $1.07, compared to $0.69 per share a year ago. For the nine months ending September 30, 2005, base net income was $95.3 million, or $1.77 per share, as compared to $130.1 million, or $2.43 per share for the same period last year.

Focusing on asset growth and diversification, asset growth and the efficiencies in funding will drive future net interest margins. We continue to be pleased with the organic growth in our school channel, especially by the growth of our internal brands, as well as the continued success of our direct to consumer and consolidation activities. The consolidation activity associated with the July 1 interest rate reset carried a significant impact into the third quarter, resulting in $1.1 billion in gross consolidation loan originations. For the quarter, we experienced $538 million in net new loans, which are those loans [indiscernible] from other loan holders. However, we had $240 million [indiscernible] by third parties. Terry will cover the continued impact of this increase in activity later in this call.

Looking forward to the fourth quarter, we estimate that another $1.2 billion of loans currently reside in our consolidation pipeline. Despite the personnel costs and the resources related to processing the extension consolidation and loan volume, operation expenses increased less than 3% compared to the first and second quarters when we removed the impact of recent acquisitions.

Our asset growth also allowed us to achieve significant efficiencies in scale through our capital and funding arrangements. During the third quarter, Nelnet issued a $1.3 billion asset-backed securitization, bringing our total securitizations to $4.6 billion for the year. During the third quarter, we also established a $500 million unsecured line of credit to be used for acquisitions and general corporate purposes. We also increased our warehouse capacity from $4.4 billion to $6.5 billion to asset in the funding of student loan assets acquired from Chela.

While not directly related diversification revenue, the Chela and LoanSTAR acquisitions will also provide additional leverage points for our fee-based service products as well. Nelnet's loan and guaranty servicing income has increased nearly $36 million to the first three quarters of 2005, as compared to the same period in 2004, driven primarily by the acquisition of EDULINX in the fourth quarter of last year. With the addition of SMG and FACTS earlier this year, continued growth and diversification of our fee-based revenues will be a focus for 2006 and beyond, capitalizing on the success that we've been able to achieve this year.

We are also proud to highlight that GuaranTec, our guaranty servicing division, recently renewed its servicing contract with the Tennessee Student Assistance Corporation for another five years. Through this agreement, Nelnet provide guaranty servicing for TSAC's $5 billion portfolio.

Earlier this week, we also had the pleasure of announcing that Becky Stilling and Wendie Doyle have joined our guaranty servicing leadership team. Together, these talented individuals represent some 35 years of education finance experience, and we're truly excited to welcome them to the Nelnet family.

On the legislative front, momentum continues to build on the complete reauthorization of the Higher Education Act. The House Education and Work Force Committee and the Senate Health, Education, Labor, and Pension Committees have both completed action on their proposals, and those bills are expected to be sent for consideration by the full membership of their respective bodies in the near future. Many of the changes in the Higher Education Act may come through the budget reconciliation process if Congress is successful in completing that this year. We continue to work to assure that the progression of reauthorization can result in a more viable student loan program.

Finally, Nelnet was pleased to assist in hurricane relief efforts, donating approximately $400,000 to assist students and families in their recovery process. And now, I'll turn the call over to Mike to discuss our future strategic focus in greater detail.

Thank you, Steve. During our second quarter call, I focused on a discussion of Nelnet's growth strategy based on service delivery through a vertically integrated business model. By focusing on widening and deepening our touch points in the education market, we've maximized our opportunity for organic growth, continued the strength in our economies of scale, and further diversified our revenue base. Diversification of revenues and fee-for-service products allowed us to leverage our relationship in return as margins continued to narrow on the [indiscernible] themselves. This strategy applies to both our ongoing operations as well as our acquisition opportunities.

As we have previously indicated, as it relates to acquisitions, we look for opportunities that will allow one plus one to equal more than two. This means that we were able to capture existing revenue or assets of acquisition and strengthen our market presence, boost our economies of scale, and allow for cross-selling opportunities in order to generate even greater revenue. The acquisitions of the Chela portfolio and servicing operations and the LoanSTAR organization offers the opportunity to leverage our capital position, maximize our economies of scale, and also important, to focus on the future asset generation through organic growth and diversification.

The acquisition of Chela's $2.2 billion student loan portfolio further increases our asset base, while the Chela brand will expand our market presence in the West Coast region. As an asset purchase, the vast majority of the purchase price will be assigned to the student loan portfolio and recognized accordingly. We believe this transaction was an excellent opportunity to deploy our existing capital, focusing on portfolio value and servicing economies of scale. This also jumpstarted the investment we intended to make to expand our sales and marketing efforts in this growing market.

LoanSTAR also has a strong market reputation and adds an additional $864 million immediately to our asset base. We further expect the LoanSTAR origination channels to produce volume in excess of $200 million annually. More importantly, it expands existing and opens new market opportunities for Nelnet's loan origination in Texas and California, two of the larger loan origination states in the nation.

LoanSTAR was not structured as an asset purchase. It is an enterprise acquisition involved in more extensive operating units, access to future flow contracts, as well as an assumption of outstanding bonds and notes. Accordingly, the purchase price reflects the existing tangible book value of the organization that we acquired, plus the value related to the existing portfolio, fee-based revenue contracts, future flow contracts, and brand names. The portfolio also includes approximately $412 million of loans earning a floor of 9.5%.

Furthermore, intellectual capital that stems from the experience and successful leaders of these organizations provides a significant complement to Nelnet's overall growth strategy and market vision. The addition of the Chela and LoanSTAR brand representatives located in the South and Western regions provides a substantial increase in Nelnet's campus solution providers, expanding our origination opportunities due to the continuance of these brands.

We expect these acquisitions to be accretive to our 2006 base earnings through the net spread earned on the portfolio and integration of certain servicing operations and functions. We consider the deployment of capital and earnings that these acquisitions provide as an important part of our growth targets and objectives, those being high teens to low 20s growth in assets and base net income, excluding the impact of excess special allowance payments.

As hard leverage, our capital ratio at quarter end was 3.3%, and given consideration to these new transactions, will be approximately 2.8%. These acquisitions are also intended to supplement and help grow, not overshadow or replace, our continued focus on organic growth, both in our school-based channels and our direct to consumer channels. We expect that our existing technology, college planning solutions and related services, as well as those currently provided through Chela and LoanSTAR, to continue to strengthen not only our internal Nelnet brand, but also, our external branding, and forge [indiscernible] lending partners.

We will continue to focus resources on developing our sales force as well as the products, services, and infrastructure that we use to deliver to our customers. We believe our service quality as well as the comprehensive products offerings are among the key drivers behind the success and increase in our Nelnet brand origination to the school channel and our direct to consumer efforts that Steve mentioned earlier.

We will also continue developing our fee-based revenue streams, as evidenced through our acquisitions of EDULINX, Student Marketing Group, and FACTS. All three of these organizations continue to have positive growth. With FACTS, specifically, experiencing more than a 20% increase in tuition payment plan sales over the last year. Our message and long-term focus remains the same - customer-focused quality service and products, one. Number two, employees doing what they do best everyday. And number three, diversification of revenue streams, which lead to long-term sustainable, high quality asset and earnings growth.

Now I'd like to turn the call over to Terry to discuss our year-to-date and quarterly financial in more detail.

Thanks, Mike. I'll cover the financial information and operating results for the nine months ended September 30, 2005, as well as the third quarter, focusing on the more significant items that affected this quarter.

First off, I'd like to point out a slight modification that we have made to our earnings supplement, specifically, in the section describing base net income. We have added a line for the earnings per share impact of certain 9.5% floor loans and what base income per share would be, excluding the impact of that portfolio. For reference purposes, that calculates to $0.39 per share for the current quarter, as compared to $0.32 per share for the same period a year ago, or an increase of 22%.

For the nine months ended September 30, 2005, our base net income, excluding the impact of certain special allowance yield adjustments and related derivatives, was $1.07 per share, compared to $0.69 per share a year ago. For the nine months ended September 30, base net income, or net income excluding the impact of derivative mark-to-market adjustments, amortization of intangibles, and variable rate floor income, was $95.3 million, or $1.77 per share.

For the quarter ended September 30, 2005, base net income was $32.8 million, or $0.61 per share, compared to $33.7 million, or $0.63 per share for the same period last year. GAAP net income for the nine months ended September 30, 2005 was $138.4 million, or $2.58 per share, compared to $102 million, or $1.90 per share for the same period last year. Third quarter GAAP net income was $72.1 million, or $1.34 per share, compared to $7.6 million, or $0.14 per share, a year ago.

As we've discussed in the past, our derivatives are not structured to quality for hedge accounting under FAS-D133. As such, the change in fair value of our derivative instruments is recorded in our statement of operations. During the third quarter, the change in the forward yield curve resulted in a mark-to-market gain of $65.4 million, which is reflected in our GAAP net income. However, consistent with how we have treated this in the past and how we look at and manage our business, this gain is removed from our calculation of base net income. Comparatively, the same quarter a year ago included a $39.8 million loss, thus accounting for the significant difference in GAAP net income for the two periods.

Steve referenced our solid growth in our loan assets. We are pleased with the performance of our school channel, as well as our direct to consumer channel, which combine for a nearly $3.6 billion increase in student loan assets since third quarter of last year. As of September 30, 2005, consolidation loans make up more than 62% of our total portfolio.

We do expect to see significant growth percentage-wise in our private loan portfolio in the fourth quarter of 2005 and first quarter of 2006 as we acquire loans disbursed by our origination partners for the 2005 and 2006 academic year. We would expect to see a $30 to $50 million in private loans added to our books as the loans become fully disbursed. Although a nominal increase in terms of total amount, this would be 30 to 50% increase in our private loan portfolio. Because of the nominal increase in dollar amount, the addition of these loans would not be expected to impact our spread, but will impact our provision for losses.

Turning to some of the operations detail, net interest income, excluding a special allowance yield adjustment of $77.4 million for the nine months ended September 30, 2005, and $167.9 million for the same period last year, increased $30.3 million, or 22%. For the current quarter, net interest income, excluding the impact of special allowance yield adjustments, increased $11.4 million, or 25%, compared to the same period a year ago. Our core student loan spread was 1.54% for the nine months ended September 30, 2005, and 1.46% for the current quarter, holding relatively stable compared to last quarter, which was 1.5%. The compression during the current quarter was largely attributable to an increase in premium amortization of seven basis points, tied closely to the significantly consolidation activity.

The amortization of our existing portfolio, combined with the increase in short-term interest rates, continues to reduce those loans in our portfolio which are earning at a fixed or floor rate. At September 30, 2005, this portfolio was $4.74 billion, compared to approximately $5.9 billion a year ago. Historically, we have used derivatives to hedge this portfolio, taking into consideration the expected amortization of the loans as well as the yield curve at the time the spots were entered into. To date, we have maintained a hedge position of 80 to 90% of our portfolio that we feel could be economically hedged. As such, we have layered in derivatives which will roll off over time.

Additionally, through the Chela and LoanSTAR acquisitions, our portfolio of loans earning at rates above 6.5% will increase by about $690 million. Our Asset and Liability Committee will be evaluating the feasibility of adding additional derivatives in the near future.

As we noted in the second quarter call, as certain shorter duration interest rate swaps rolled off in the third quarter and will roll off in the fourth quarter, we added additional long-term derivatives to hedge the majority of our fixed rate portfolio. Specifically, the portfolio of loans earning at rates 9.5--above 9.5% through 2013, slightly increasing the weighted average rate of our derivative portfolio.

Loan and guaranty servicing income increased by about $35.9 million for the nine months ended September 30, 2005, as compared to the same period a year ago, and $12.9 million in the quarter, as compared to last year, with the acquisition of EDULINX in the fourth quarter of 2004. Our other fee-based revenue increased substantially with the acquisition of Student Marketing Group and National Honor Roll in the first quarter, and the most recent acquisition of FACTS Management Company in June of this year.

Total operating expenses increased $43.9 million for the nine months ended September 30, 2005, and $27.4 million in the current quarter, compared to last year. However, when excluding the impact of FACTS, which closed in the late second quarter, our operating expenses for the third quarter increased less than 3% when compared to the first and second quarters. We are very pleased with these results when considering the cost incurred by the Company due to the significant increase in consolidation loan activity.

As I mentioned on our last call, we incurred about $1.8 million of additional operating costs related to our fulfillment activities in the second quarter and a similar run rate in the third quarter. As we continue to focus on our direct to consumer activities, we would expect a continued resource allocation, though it may shift from fulfillment to generation of marketing.

Mike talked a little bit about our recent Chela and LoanSTAR acquisitions. For reference purposes, we do anticipate these acquisitions to be accretive to base income in 2006, driven by the additional net interest income of the various portfolios. For 2005, we would expect the additional yield to be offset by integration costs, making the impact of the fourth quarter relatively flat. Given the portfolio composition, we would expect a similar to slightly lower net spread when compared to our existing portfolio, given consideration of the amortization of cost acquisition assigned to the portfolio.

The net interest income will, however, be offset by some increase in servicing costs and operational expenses as a portion of the portfolio will be serviced by third parties, and some will be integrated into our existing services. Overall, we would expect to be able to achieve an overall expense ratio at least equal to our existing operations by the end of 2006.

I would also like to add some detail as to the value of these acquisitions, specifically, the LoanSTAR transaction, and reiterate that we look not only at the value of the portfolio, but what it brings to us in terms of future value, some of which may be intangible in nature. We looked at this acquisition similar to how we have looked at acquisitions of companies in the past in that we believe it will be very beneficial to us creating long-term value. As we indicated, the purchase was a stock purchase, and accordingly, a portion of the acquisition price would be assigned to its tangible net asset base.

While the final allocation is unknown at this time, it will likely be in the range of $70 to $75 million. The loans will be valued similar to how we have--would value [inaudible].

Please go ahead.

Thank you. Sorry for the inconvenience. I believe we were disconnected there. So we'll go back to--we'll start over at the beginning. No, just kidding. I think I was talking about the LoanSTAR acquisition and how we would look at that acquisition in terms of value.

As we indicated, the purchase--or the stock purchase, and accordingly, a purchase--a portion of the purchase price would be assigned to its tangible net asset base. While we don't know what the final allocation will be at this time, it will be in the range of $70 to $75 million. The loans will be valued similar to how we would look at other portfolios on a net present value basis. And portfolios in the market would range from 2 to 5%.

It's also important to note that a portion--about $412 million of the portfolio was earning at a floor rate of 9.5%, or an excess yield of 2 to 2.5% given the current interest rate environment. This would generate roughly $8 to $10 million annually, which was included in the value paid for the company. The balance will be applied to intangible assets and goodwill, which will be determined in the near future.

As Mike mentioned earlier, as an asset purchase, the vast majority of the Chela purchase price will be assigned to the student loan portfolio and recognized accordingly. Again, for reference, operating expenses, excluding the impact of acquisitions which would impact comparability, were flat for the nine months ended September 30, as compared to the same period last year, and increased less than 3%, as compared to the second quarter. We would expect operating expenses to grow in the low to mid-single digits as we move into 2006, especially as we integrate the new portfolio acquisitions.

We continue to focus our efforts on organic growth, diversification of revenue, efficiencies developed through scale, and taking advantage of acquisition opportunities as they present themselves. We believe this focus on long-term sustainable growth will continue to translate into long-term asset growth percentages in the high teens to low 20s, giving obvious consideration to the fact that the large acquisitions we just made will have an impact on percentage growth numbers in the near term. We believe we can leverage existing--our existing business platform and operations to generate continued growth in our base net income, excluding the impact of special allowance yield adjustments in the high teens to low 20s as well.

With that, I'll turn it over to Steve for closing comments.

Thanks, Terry. I'd just like to close by reiterating the key highlights of the third quarter. We are very excited to expand our market scope and operational scale through the acquisition of the student loan portfolio, related servicing assets, and a right to the Chela brands and the Chela Education Financing, Inc., as well as the acquisition of LoanSTAR Funding Group and relating servicing assets of LoanSTAR systems.

For the nine-month period ending September 30, 2005, student loan assets were up $2.9 billion, or 22% since December 31, 2004. For the nine months ended September 30,2005, our base net income, excluding the impact of special allowance yield adjustment and related derivatives, was $1.07, compared to $0.69 per share a year ago. We experienced significant growth in fee revenue, highlighted by our focus on--highlighting our focus on diversification. And operating expenses increased less than 3% compared to the first and second quarters when we removed the impact of recent acquisitions.

And now, we'd like to open up the call to any questions that you may have about our quarter. Operator?

Thank you. (Caller Instructions.) We'll take our first question from Ken Posner with Morgan Stanley.

Hi. Good afternoon, or good morning, I guess. Two questions. One on the derivatives adjustment, which is a fairly significant gain. And, of course, we're excluding that from base earnings as you do. But it occurs to me, if it weren't for the complexity of FAS 133, the real effect of that gain is to offset some of the rise in funding costs. So I'm wondering, is there a way to think about what time period that gain ought to be amortized over, or if you were going to go back to old-fashioned cost-based accounting?

Ken, this is Terry. In terms of the gain, that's really a change based on the value from quarter to quarter. So as opposed to amortizing it over a given period, it's really the change in the yield curve and what would happen to the value of those derivatives. And that's why we've really eliminated it from our calculation of base net income, because it can vary so--it can vary so much from quarter to quarter. So I don't think it's necessarily an amortization purpose--consideration as much as it is the change in value given the forward yield curve at the measurement date.

Right. Is it fair to say that the gain in the derivatives is offsetting the increase in funding costs resulting from the--from rising interest rates?

I think the gain in the derivatives that is offsetting the change in the future forward yield curve, not necessarily the current period funding cost. Because the current period funding cost, the offset there, is reflected in our net settlements line. And you can actually see the change in the net settlements that our net settlements are continuing to go down as interest rates rise. But the mark-to-market, or the derivative adjustment in terms of the mark-to-market, is based on the future evaluation of our existing portfolio as of the measurement date. So that's why we actually separate out both of those items in our statement of operations.

Okay, that's helpful. Thank you. And then, the second question I wanted to ask is, with respect to your cost structure as you grown organically--the question is how much do expenses need to grow - at the same rate or faster or slower? And can you shed some light on that question by talking about what percentage of your cost structure is fixed and what percentage is variable?

Hey, Ken. This is Mike. If we can continue to grow our portfolio in the high teens to low 20s, we've kind of got a target that we would like to grow our expenses at less than 4% during that timeframe. So if we can grow one at 20 and the other at 4, we should be okay over time. That's kind of what our target is. Some quarters it may be higher. Some years it may be higher, depending on the opportunity. Sometimes it might be less. But the majority of that growth is going to happen in the marketing and sales area.

And--well, that's a huge--I mean, if you are able to do that, that would be a huge source of operating leverage. What's the reason for the--such a big difference in the growth rates? Do you have excess capacity, or is there really not very much variable cost in this business?

Well, when you look at our servicing platform, as an example, the marginal cost to add alone to our servicing platform is substantially less than if we were starting with [indiscernible] and one. And the same thing is true with marginal acquisition opportunities. When we can add additional volume on, the leverage ratio we get there is significant--is fairly significant.

And so, even with having to hire more salespeople over time--or is that--I guess that's not really a function of--but it--how much--how big of a driver to the cost structure is the sales force?

I don't have that number off the top of my head. I can tell you inside of our campus solutions sales organization we have roughly 100 people. Inside of our direct consumer organization we have roughly 500 people involved in that equation. So out of 3,000 employees, we have--I'm just giving rough numbers, Ken--roughly 600 employees.

Okay. Thank you.

Thank you. Moving on to Neil Abromavage with Deutsche Bank. I do apologize. Douglas Harter with CS First Boston has our next question.

Thanks. I was wondering if you guys could talk about both your ability to make further acquisitions, and sort of the opportunities out there in the market right now?

Basically, there is always going to be somewhere in the neighborhood of a half dozen opportunities. There has been in the past. I will tell you the last two acquisitions that we just made, our initial discussions started seven and eight years ago with these companies. And it was just an eerie coincidence that they both closed within a week of each other, and actually, a day of each other, on the final closing.

So I think we've created relationships over a long period of time. We continue to talk to different opportunistic opportunities on the acquisition front. Going forward, acquisitions aren't necessarily a part of our strategy, other than being opportunistic. Our focus in on organic growth and trying to grow the Company organically. But when we get opportunities to make acquisitions that can be accretive to our earnings, we take advantage of those. And like I said, these two acquisitions, our initial discussions with these companies actually started seven and eight years ago. And it just happened to both close within a day of each other.

And then, I guess, along the lines of with these acquisitions, how--what are the origination capabilities of the two platforms? And sort of, how do you see that going forward, a sort of Nelnet branded loan origination as a percentage of your total originations?

Doug, as you can--this is Terry. I think as you can see, we've continued to expand and grow our internal brand originations, and with the acquisition of Chela, that will come an internal brand and we'll focus on growth that as we move forward. And in the Texas originate--or in the Texas market, we anticipate that will be upwards of $200 million, but that will all be part of our future organic growth targets. I mean, that's part of what we look at this acquisitions is how they would contribute to our organic growth, and that's where we're going to focus our efforts.

Thanks.

Thank you. Moving on to Neil Ambrovitch with Deutsche Bank. And your line is open. Please go ahead. Your line is open. Please check your mute function. Hearing no response, we'll move on to Joel Halpern with Halpern Capital.

Hi, guys. Nice quarter. I guess, nice quarter. On the Chela, could you--are you able to give the--I know it was just asked, but are you able to give kind of a rough range on where originations are going to be annually?

I think in the--when we were going over the text, we mentioned that LoanSTAR is going to be $200+ million, and Chela is going to be in the $100 to $309 million range as far as new loan originations going forward. We're not quite sure where that's going to end up at the end of the day. But between the two of them, it could be anywhere from $300 to $500 million.

Thank you. And then, also, just on consolidation find. Could you give us some insight in what's going on currently, I guess, in the current academic year in terms of volumes? Have they dropped off considerably after July 1, or would--I guess just what you're seeing.

The month of October is actually going to be the largest month we've had ever. We're going to consolidate growth over $500 million a month in October. Most of those applications that we're consolidating are applications that were done prior to July 1. But they--for grace period purposes, they are funding in the October timeframe. So the actual volume that we're seeing in the consolidation loan are that we thought we start to come down a little bit has basically peaked in October. It will come down in November and December. But a number of the kids that consolidated back before July 1. The way it's set up, they--six months later from their grace period when the loan actually funds. So from that perspective, that's [indiscernible] on that volume.

As far as new volume goes, when we look at the month of October and what's being generated as new applications that will fund in the future, that volume is probably off somewhere in the neighborhood of anywhere from 20 to 30% from what would have been an average month say last November, December, January, February, March, before we got into this crunch with respect to the July 1 interest date. So we have seen a drop-off in volume, because of the rush to consolidate loans before July 1 last year.

Okay . Thank you very much.

Thank you. Moving on Matt Snowling with Friedman, Billings, Ramsey.

Hi, guys. I have a follow-up question on the Chela and LoanSTAR acquisitions. As I calculate it, it looks like you should earn about $14 or $15 million on the fixed rate portfolios. Just wanting your plans to hedge that out.

[Indiscernible.]

It's not currently hedged right now, I guess.

I want to answer that question in two parts. First, I want Terry to comment on the $14 to $15 million calculation, because I think that's a little bit high. And then, I want to comment on the hedging.

And Matt, I don't have the calculation directly related to that. But as it goes out, we're going to continue to look at the excess yield on that portfolio and what we can do with it. So I don't have the actual calculation of the $14 to $15 million, but it's a lot--it sounds a little high.

Yes. I mean, just to give you some quick math on that, if the loan is earning 9.5% and you subtract off 264 basis points off of that, you're at the fixed rate of 686. And then if you look at the current yield curve on what can be hedged today, and you're looking somewhere in the 450 to say 4.75 area. Your net spread is going to be between 2 and 250 if you were going to hedge that out on the yield curve. So take that 200 basis points or 250 times the $400 million portfolio, and you're looking at $8 to $10 million in additional spread income on the portfolio if we had it hedged today.

And that's actually on the LoanSTAR. On the Chela, it's--it only added, I believe, Matt, about 250 to 290 that would be in that range. So you got 2 to 250 that is going to be earning at fixed rates, and those are actually at lower fixed rate, not necessarily 9.5 and above. So that's why I don't think you've got--you haven't got that much excess yield in that [inaudible] come available.

[Inaudible.] But assuming you're--you do hedge that out, is that built into your accretion function?

Just one last comment on the Chela portfolio. On the Chela portfolio, some of the loans are fixed at 7 and 8 percent. There aren't a lot of loans that are much higher than that. And so, the spread there, again, is 50 to 150 basis points versus 200 to 250 on the LoanSTAR acquisition, just to look at the--what the total value of that spread is going to be. As far as the accretion goes--Terry?

I mean, it would depend on when and how we layer in the hedges associated with that math. So the anticipation is that we would be able to layer in some of those hedges or look at it as combined with our overall portfolio.

Okay. All right. Just switching gears here. As I calculated, maybe about 40% of the loans from the combined acquisitions are Stafford. Just wondering--that seems like a fairly high number? Or where does that go with all the consolidation in the pipeline now?

One of the things that we're going to do is we're going to work with both portfolios to try to consolidate the ones that make sense to be consolidated. With respect to the Chela acquisition, if the loans are consolidated in the next 90 days, then we have a provision where the premiums that we paid for those loans is going to come back to us.

Oh, if it does consolidate?

If it consolidates away from us.

Away from you? Okay.

We don't get the loan.

Right. Okay. I'll get back in the queue.

Thank you. Moving on to Jordan Himowitz with Philadelphia Financial.

Hey guys. Good quarter. A couple quick questions. The $0.40 run rate, or $0.39 run rate you guys show, that's assuming that the current hedges are replaced with the marginal priced hedges or that's just you're under in the quarter with the lower cost hedges?

I mean, the current run rate was--we put the higher hedges in place at the beginning of the quarter, and we were running at 39%--or $0.39. The vast majority of our hedges relate to our portfolio of loans that are earning at the 9.5% rate.

Okay. So the majority though relates to that, so the--?

--Yes, the mass majority of--yes.

Okay. And then, you said the growth rate going forward on an EBITDA basis was--I apologize.

Our goal on our net income going forward is to grow it in the high teens to low 20% area year-over-year. That's--is that your question?

Yes. Thank you very much.

Thank you. We'll now hear from David Chamberlain with Timco.

Hi. Just a quick question on the private loan business. I mean, it seems like previously that this was not as much a priority for you. Is this primarily internal branding, direct to consumer--could you just of characterize? And then, what's the decision to build this portfolio?

To be competitive with the schools, we'd have all the products and services that they want. And one of the products and services we've had for a long time is the private loan product. I'm not so sure that it's that much of a differentiation in focus on our point to provide those products as it is that private loan market is growing fairly considerably, and we're just a beneficiary of that market growing faster on the school channel.

On the direct to consumer side of the equation, we do direct to consumer private consolidation loans. And that is a really minor part of what we do. I think year-to-date we've done around $10 million in direct to consumer private loans. Just to give you a feel for it, overall this year we may end up doing somewhere in the neighborhood of $35 to $55 million in private loans. So it's an increase from last year where I think we were around $20 million. But if you look at our total portfolio, which is going to be close--over $19 billion, we still are going to have less than $200 million in private loans.

As this market continues to grow, we'll continue to develop and provide products to the market. Our comments in the past have been that as our private loan market grows, we think over the next three to five years on the high side, it could end up being 3 to 5% of our portfolio. But at this point in time, it's really a minor piece of what we do, although we continue to develop and add products to help our schools and students attain a college education.

Just on the core spread, I'm curious, when you think about the consolidation loans that are left in the portfolio and where interest rates are going, what's your assumption--just tell me what do you think the core [indiscernible] will bottom out at? And do you think that kind of one--low 1 to 4% range is probably where is troughs out?

As far as our margin goes?

Yes.

Well, if you look at our portfolio today, it's roughly 60% consolidation loans--or 62% consolidation loans and 38% Stafford. And we think that if you were going to look at kids that were graduating today, somewhere between 70 and 80% of those kids would consolidate their loans, primarily because their debt is over $15,000. And for most kids, it's really hard to pay back their loan in 10 years when their debt gets over $15,000. So if you increased our percentage of our portfolio from say 62% consolidation loans to 70 to 80, that's probably going to drive our margin down lower.

I don't have those numbers off the top of my head. But I'm just going to give you a guess. It could be anywhere from 5 to 50 to 20 basis points, looking at the mad run over time. So if our whole portfolio was 80% consolidation loans, our margin over time as that evolved could drive our margin down that much further.

Got it. Thank you.

(Caller Instructions.) There are no further questions. At this time, I'll turn it back over to our speaker, Steve Butterfield, for any additional or closing comments.

Thank you very much. And we also on this--we'd like to thank the LoanSTAR and Chela people for the receptions that we've had this week. A very exciting week for--as Mike said, for us to knock on their door some many--7 or 8 years ago, to finally succeed in accomplishing an objective. Very exciting on both sides of the transaction, and it was a great week for Nelnet. So we thank you and thank all of you that took the time to join us on the call today. Thank you.

Thank you. That does conclude today's conference call. We thank you for your participation. You may now disconnect at this time.