Nelnet, Inc. (NNI) 2006 Q3 法說會逐字稿

Good day, everyone, welcome to the Nelnet third quarter 2006 conference call. Today's call is being recorded and broadcast live over the Internet. At this time, Miss Cheryl Watson, Nelnet's Chief Communications Officer will begin with opening remarks. Go ahead, ma'am.

Thank you, operator and thanks for joining us today. Nelnet's third quarter release and financial supplement have been posted on the investor relations website at www.Nelnet.net. On today's call, Mike Dunlap, Co-Chief Executive Officer and Chairman will provide an update on Nelnet's results of operations and Terry Heimes, Chief Financial Officer, will report on our financial results. Also with us today are Steve Butterfield, co-Chief Executive Officer and Vice Chairman and Jeff Noordhoek, President, who will be available for the Q&A session.

Before we begin the 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 made 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 the call.

During the course of this call, we will refer to two non-GAAP financial measures, which the Company defines as base net income and adjusted base net income. Please refer to our earnings release, or to the website for the reconciliation of GAAP net income, base, and adjusted base net income. After Mike and Terry have concluded their formal remarks, we will open the call up for questions. We'd now like to turn the call over to Mike Dunlap.

Thank you, Cheryl and good morning, everyone. Thanks for joining us today. We're very pleased with this quarter. We are particularly encouraged by the three following factors--First, fee-based revenue, which increased 68% over last year. Second, the continuing diversification of our earnings stream with fee income representing 54% of total revenue this quarter. And third, very strong growth in Student Loan assets, which grew 40% year-over-year and 13% year to day.

Revenues from Nelnet business solutions tripled, increasing $20.7 million to $31.2 million for the same quarter last year. We formed this division earlier this year to pull together strategic businesses that offer additional products and services to the life cycle of the student. While at the same time, adding diversification and fee income to Nelnet. These businesses include Enrollment Management, tuition payment plans, payment processing, list management and Direct Marketing, which are not dependent upon the government-sponsored programs and, therefore, do not expose the Company to political or credit risk.

As we build fee income through Nelnet business solutions, these products are going to be instrumental in Nelnet's long-term strategic vision and ability to continue to increase our fee-based revenue and achieving our goal of leveraging fee income into assets and assets into income. Total fee-based revenues increased $34.2 million to $84.1 million, an increase of 68% from last year. Continuing to diversify our earnings stream. Fee income was 54% of total revenue for the quarter and 47% of total revenue for the first nine months.

This compares with 39% for last year's third quarter and 36% for the first nine months of 2005. Almost all the net income associated with our fee-based businesses came from organic growth. As you all know, there's a long-term trend towards margin compression and our government-guaranteed Student Loan business.

Margins continue to compress this quarter because of a large increase in consolidation loans and the leveling off of interest rates which Terry will discuss further. Nelnet's strategy has been to diversify our earnings to a fee-based revenue while growing our asset base to counter this margin compression.

Over the last three years, as margins have compressed, we've been able to grow assets and fee-based revenues to counteract this effect. Student Loan assets grew by 6.6 billion or 40% year-over-year and by 2.7 billion or 13% from the end of 2005. This is in line with our expected Student Loan asset growth in the low double digits to high teens for the year. Our asset growth was fueled by outstanding performance in our direct consumer consolidation and school channels.

Let me start with our consolidation channel. Although we had some runoff attributable to the super 2 stuff and the repeal of the single holder rule, we did extremely well compared to our competition and are very pleased with the results at the end of this quarter. The two most important numbers to us are net new loans added for the quarter and the year. Net new consolidation loans were 425 million for the quarter and 912 million for the first nine months.

During the first nine months of 2006, we originated nearly 3.6 billion of consolidation loans, up from 2.6 billion in 2005. During the current quarter, we originate approximately 1.5 billion of consolidation loans that resulted in 767 million of new or additional loans in our books. After the rush to consolidate before interest rates increased on July 1, we anticipate consolidation volume this academic year to be between 55 and 65% of the volume from last year.

Since the end of the second quarter, new applications have decreased to approximately 60% of the volume from the beginning of this year as expected. We are working diligently to increase our net new market share and although the market is to increase our net new market share and although the market is expected to be down 35 to 45%, we anticipate our net new volume and value created for the full academic year to only be down slightly over the next 12 months in the direct-to-consumer and consolidation channel. Within our school channel, we had an excellent quarter, resulting in total originations from all of our channels of 817 million, up from 544 million in 2005.

For the calendar year, our originations, excluding spot purchases, totaled 2.95 billion, up from roughly 2 billion or 50% from September 30, 2005. The acquisition of the Chela and LoanSTAR brands were significant contributors to this growth. As we've said numerous times in the past, our focus is on generating long-term, sustainable value and cash flow.

We have experienced significant growth despite our strategic decision, unlike some of our competitors to not chase unprofitable loan volume. So far this year, we've turned down more than 0.5 billion in future annual forward-flow volume. Periodically, we may sell loans that we feel have higher risks of being consolidated away. This quarter, we sold roughly 350 million, which resulted in approximately an additional $0.10 per share net impact on the quarter. These loans were externally serviced and had an unusually high risk of consolidation. We expect these kind of sales to be part of our ongoing portfolio management strategy.

Briefly turning to the OIG audit, we received an extension to reply to the Department of Education by November 19. We believe the OIG is incorrect in their findings and we continue to work with the department for a timely resolution. Whatever the outcome of this issue it will not affect our strategy going forward or our confidence in the long-term prospects of Nelnet. Now I will turn the call over to Terry.

Thanks, Mike. I'll cover the financial information and operating results for the first nine months of 2006 as well as the third quarter. Before I discuss the detailed numbers, I wanted to highlight some events and information that should be considered in conjunction with my commentary and when reviewing our earnings supplement. Number one, diversification remains strong with fee revenues increasing 68% to $84.1 million for the quarter. And 56% year-to-date.

Fee-based revenues represented 54% of our total revenues for the quarter and 47% year-to-date. Number two, our loan assets are up 40% year-over-year and 13% since the beginning of the year. Number three, for the nine months ended September 30, 2006, adjusted base net income is up 20% to $68.8 million or $1.28 per share, compared to the same period a year ago. And finally, we deferred recognition of the excess SAP for the current quarter as we continue our discussions with the Department of Education, which we announced earlier this month.

For the quarter ended September 30, 2006, our adjusted base net income was $28 million or $0.52 per share, compared to $20.9 million or $0.39 per share a year ago, an increase of 33%. Year to date, our adjusted base net income increased 20% from $1.07 a year ago to $1.28 per share this year. Our operating results do include some unique and some nonrecurring items which should be considered when looking at the numbers. First, a large sale of loans previously referenced in our filings.

Second, nonrecurring expenses related to a derivative settlement tied to our hybrid capital issuance and legal and professional fees tied to our review of the OIG audit. And third, as we discussed in the past, our first quarter included a charge to establish a loan loss reserve, related to the increased risk sharing of approximately $6.9 million or $0.08 per share after tax. We have also charged an additional $900,000 in loan loss provision during the second and third quarters this year.

Last year, there was no provision for risk sharing related to the exceptional performer designation. The gain on sales of loans, net of additional compensation charges and the impact of not holding the loans for the quarter had a net positive impact on our results of about $0.10 per share. And the nonrecurring expenses amounted to $0.03 per share. Taking into account everything I just mentioned, our adjusted base net income is up over 20% year-to-date. I do want to emphasize one point, though.

We will continue to evaluate the merits of holding certain loans versus selling them. We would anticipate having periodic loan sales as part of our ongoing portfolio management practices, which will be included in our adjusted base net income. Base net income was $96.2 million or $1.78 per share for the nine months ended September 30, 2006. And $32.9 million or $0.62 per share for the current quarter. GAAP net income for the nine months ended September 30, 2006, was $75.5 million or $1.40 per share. Compared to $138.4 million or $2.58 per share for the same period a year ago.

For the current quarter, we had a GAAP loss of $22.4 million or $0.42 per share as compared to net income of $72.1 million or $1.34 per share a year ago. The change in GAAP earnings was driven by the change in our derivative market value of about $145 million comparing this quarter to the same quarter last year. Our channel growth was solid this quarter, growing 46% quarter-over-quarter and 32% for the nine-month period.

At September 30, our net Student Loan assets have increased $6.6 billion since last year. Our student loans increased 2.7 billion or 13% since the beginning of the year. And is expected to be in the mid to high teens for the year, in line with our expectations. At September 30, 2006, consolidation loans made up 68% of our total portfolio, compared to 64% at June 30, 2006.

Year-to-date, our internal school and our branding partner channels looked roughly flat at $1.7 billion for the period. It's important to note that last year's branding partner channel included the then-current portfolio of Union Bank and Trust when we acquired the brand in the first and second quarter of last year. Accordingly, those numbers include about 600 million of the then-existing portfolio that we acquired from Union Bank and Trust. After adjusting last year's numbers for the then-existing portfolio, our new loan volume generated through these channels was up more than 58%.

The increase in loan volume should drive an increase in our net interest income. However, contracting margins and the deferral of the current quarter excess special allowance that we previously discussed has caused our net interest income to remain relatively flat. Excluding the special allowance of $24.5 million for the nine months ended September 30, 2006 and the $77.4 million in 2005, our net interest income increased $50 million or 29%. For the current quarter, net interest income, excluding the special allowance yield adjustment increased about 26%.

Our core Student Loan spread contracted 15 basis points to 1.34% for the three months ended September 30, 2006. While we anticipated some contraction, it was accelerated more than anticipated due to the mismatch of the reset frequency between the floating rate assets and our floating rate liabilities as well as an increase in the percentage of consolidation loans held in our portfolio. When the Fed raised rates over the last few years, we benefited because our cost of funds was reset quarterly on a discreet basis while our earning asset kept increasing in yield on an average daily basis. Since the Fed stopped raising rates, we have not had this benefit.

We do anticipate continued compression as we move forward due to changes in the loan mix and the recognition of an increased cost of acquisition. We would anticipate spreads in the 120 to 130 basis point range as we move into 2007. Nelnet's strategy has been to diversify our earnings through fee-based revenue while growing our asset base to counter margin compression. Our fee-based revenues have increased $34.2 million to $84.1 or 68% compared to the third quarter of 2005. Year-to-date, our fee-based revenues have increased $77.9 million to $216.9 million or 56%.

Our other fee-based revenues through Nelnet business solutions were up $42.6 million or 186% since last year. Our fee-based revenues made up 47% of our total revenue during the first nine months of 2006 versus 36% for the nine months ended September 30, 2005. Our other fee-based revenues represent 14% of the total revenue, up from 6% last year. These percentages also approximately represent their contribution to net income. The majority of our fee-based revenues have variable cost models but do have significant operating leverage.

Operating expenses increased $49.9 million or 63% compared to the third quarter of last year. But acquisitions accounted for roughly $44 million of that increase. Excluding the impact of acquisitions, for comparability purposes, our operating expenses increased between 6 and 7% compared to last year and 2 to 3% compared to the second quarter. Our shareholders equity topped $680 million at quarter-end. At quarter-end, we had approximately 52.5 million shares outstanding.

Weighted average shares outstanding decreased from 53.7 million shares a year ago and 54.3 million shares last quarter to 53.3 million shares during the current quarter, driven by the acquisition of 1.6 million shares this quarter and 1.9 million shares year-to-date at an average cost of approximately $32 a share, under our previously-announced share repurchase program. Going forward, we will continue to evaluate when repurchasing shares of our stock make sense. With that, I will turn it over to Mike for closing comments.

Thanks, Terry. This quarter we issued 200 million in hybrid capital at a rate of 7.65%, which we think is incredibly favorable. We locked in this rate with a short-term hedge the week before we closed the transaction. Rates proceeded to go down 20 basis points, which led to a one-time charge of roughly 2 million, which is included in our results of operations.

Additional capital gives us the flexibility to deploy capital opportunistically for acquisitions or additional stock buybacks. As we look forward to the fourth quarter and into next year, we will be focusing on growing our fee-based revenues, integrating our sales approach to leverage our fee-based services and to potential asset generation activities and visa versa. Expanding our campus-based asset generation channels to grow our market share and leveraging our direct-to-consumer activities to retain our assets and continue to grow our portfolio through consolidation.

The slowdown of the consolidation market and the decision to not chase volume that's unprofitable may put some short-term pressure on our asset growth. But we expect to finish this year hitting our goals and increasing earnings over 20% for the third year in a row, continued margin compression will also put some pressure on our fourth quarter. Possibly pushing us to the mid to high-teens growth in our adjusted base net earnings for 2007. We anticipate providing further clarification during our fourth quarter call. As Terry mentioned, we bought back roughly 1.6 million shares this quarter. So far this year, we've bought back nearly 2 million shares or about 3.5% of our outstanding shares year-to-date at an approximate cost of $32 per share.

Here are our key points. One, we continue to diversify our revenue and grow our fee income. Our fee income represented 54% of our revenue this quarter. Number two, asset generation was outstanding this quarter and our ability to leverage fee income into assets and assets into fee income will continue to be instrumental to our future success. And three, over the long-term, we remain very confident in our ability to deliver superior returns to our shareholders. That concludes our prepared remarks. We're now happy to take your questions.

Thank you. [ OPERATOR INSTRUCTIONS ] We will go first to Ken Posner at Morgan Stanley.

Hi, Mike. Can you talk a little bit about your private loan strategy? Just remind us what you're doing in that space?

It continues to complement our guaranteed Student Loan product and I think last academic year we originated somewhere in the neighborhood of $100 million in private loans. This year we think we'll be in the 150 to $200 million range. But it's part of our strategy to provide the families the ability to afford to go to school. So, definitely a product -- one of our products in our product mix. It's not one of the primary products, but it's a definite complement to what we offer.

And are you making investments in technology or people or are you outsourcing that business? What's your execution plan right now?

On the origination side, we've made significant investments to originate the -- originate -- originate the private loans. With respect to the long-term financing of the loans, we are looking at probably outsourcing that or selling those loans in 2007.

Okay. Thank you.

And we'll go next to Matt Snowling at Friedman, Billings, Ramsey.

Hi, good morning.

Hello.

I have a couple of quick questions here. First, can you just explain a little bit your thought process as to why you're selling these loans? It just seems to me that some of the incremental loans that you put on your books today are at lower spreads than your existing portfolio. So, please help me think about the thought process.

If you look at the risk profile of this company, our goal is to get the highest return with the lowest amount of risk and as we -- as we continue to grow our -- grow our fee income and grow our asset base, we think the best risk return for the shareholder is to stay in things that we know well and that we're good at and that we're great at and in the private loan business, we're good at originating the loans, but we don't have some of the same expertise as some of the larger players in this market and, therefore, we think that it makes sense for us to look at a way to maximize the value, maximize our long-term cash flow to create those superior returns for our shareholders by focusing on what we're great at.

I understand. I just thought I heard you say you thought you were continuing on planning to sell portfolios of loans going forward. Is that just private loans? Or FFELP loans?

It's a combination of both. On private loan side, we just address that issue. On the guaranteed side of the equation, we're going to look at loans that we think have a high risk of consolidation. Primarily those are going to be loans that are not serviced on our portfolio -- on our platform. We think the better way to maximize long-term cash flow for the shareholder is to sell the loans. That's what we're going to do to create those superior returns.

Okay. And can you walk me through the actual gain on the portfolio that you just sold? Now, in your release, you say $11.7 million gain, by my math that works out to be a $0.14 gain, not a $0.10-gain. I know you're offsetting some compensation charges, but maybe explain what those compensation--?

Sure. Sure, Matt. This is Terry. That was between $0.13 and $0.14 and in accordance with our incentive package, we actually would accrue about 15% on that -- that component of the income so that would come off of that because we would have incurred that because of the sale and there was about $0.01 difference in terms of not holding the loans for the period, which we would have earned. But net-net, it comes down to about $0.10 per share.

Okay. And I guess my last question here being on your hedges. 250 million of additional hedges expiring 2006. Seems like the cost of those hedges went up. Was that related to that hybrid capital that -- the hybrid capital that you issued? And the relating hedges?

Matt, I'm not sure I understand completely your question.

Well, if I looked at, I think, last quarter's release, you were paying, I think, just over 2% on the 250 million of notional hedges maturing in 2006. And that rate has gone up. If I've got everything correct here.

I may take this offline with you.

That's fine. I can circle back.

To be sure we're looking at the same thing. Because the $250 million that's rolling off, that's about a 3.16%. Now, we did layer in the hedges each year. I don't know if we're looking at the same numbers.

Okay. I will follow-up later.

Okay.

We will go next to Carl Drake at SunTrust Robinson Humphrey.

Good morning. I wondered if you could provide more color on the fee businesses, which ones were the strongest performers in there? And then also what type of contribution they had on a pretax income basis after expenses? It looked like your expenses grew in lock step, not 100%, but grew significantly in the quarter. Was wondering if that's primarily due to the growth in the fee businesses?

If you look at Nelnet business solutions and look at their -- at that fee business, we were able to grow the revenues from 6% of revenue to roughly 14% of revenue from last year and that income contribution is right in at that 14% area. So, that's been one of our strongest areas of growth over the last 12 months. Terry, do you want to address the other issue?

Yes, as it relates to some of the other ones, if you look at Peterson and CUnet, the revenue for Peterson's and CUnet combined was about 17 million and that did have, right in that same neighborhood of expenses associated with it. However, all of our fee-based businesses have very positive operating leverage. So as we go forward, the key will be as we continue to integrate those and leverage the fees into assets and assets into fees, we will also benefit from the positive -- positive operating leverage that we get from those businesses.

So, the -- contribution of about 14% pretax is what you're saying for the fee businesses for the quarter?

That's for the Nelnet business solutions, piece of the fee businesses. On the -- on the other fee businesses, like our servicing and guaranteed servicing.

Yes.

It's not going to have the same contribution as the amount of revenue that it provides, but it's still a very significant provider to income for the quarter.

On the guarantee side it seems like your average servicing portfolio is declining yet the loan servicing guarantee income is going up. Is that because of can -- that you're having a greater contribution from the guarantee side?

Yes, it is. And as we continue to diversify and expand that relationship -- although our -- maybe our third party -- our third party portfolio is going down, we can continue to leverage and expand and grow other fee-based businesses to complement our business strategy.

Okay. And then the next question on the margin compression, I believe I heard you say it was going -- as we move into '07, 120 to 130 basis points, a couple of questions there. Could you provide a little bit more, -- guidance on margin compression out maybe 12 months? And second, what can you do from an asset liability management standpoint to stem the compression, possibly locking into shorter term contracts at the beginning of the quarter or matching the assets and the liabilities are better?

As it relates to -- if you look at the loans we're adding, those are still consistent with what we've disclosed in our Q that we would be adding in school loans, in the 100 to 110 basis point range, that we'd be adding repay loans in the 150 basis point range and consolidation at the 120 to 130 basis point range. But the key is that's why we continue to diversify our revenue into fee-based businesses and continue to focus on growing our assets to really counteract that margin compression. As it relates to the derivatives, we periodically will look at our hedging strategy, to see if we can economically hedge those risks and we will continue to do so. That's not something we've done in the past.

Okay, looking out, 12 months, do you have any guidance on to -- was that correct, it's 120 to 130 is really kind of heading in -- like the first quarter of '07, is that what we're talking about? Or the fourth quarter of '06?

As we get into the fourth quarter of '07, we're going to be in that range. And in the fourth quarter of '06, we will be in that range. And we go into '07, we are also going to be in that same range. One of the biggest drivers to our margin is how many consolidation loans we have on the books and the consolidation market has slowed down to some degree in '07 versus '06. So, there's a range in there.

If we are very, very successful in originating a lot of net new consolidation loans, that margin might be slightly smaller, but on a much larger asset base, which will lead to more net income for the shareholder. On the other side of the occasion, if we originate less consolidation loans that margin might be a little bit higher in '07. That's why we have the range of 120 to 130.

If you're looking at the forward LIBOR curve that shows flat rates between now and the end of the year and a 30 basis point drop to the end of '07, you're factoring all of that in? Yes.

Okay. Thank you.

We'll go next to Sameer Gokhale with Bear Stearns.

Hi, thanks for taking my questions. Not to parse this too much, but in terms of, again, that gain from the sale of the portfolio, now, how does it work out again? Is it $0.13 to $0.14 from the gain on the sale? And then 15% of that was really compensation-related expenses, that would be about $0.02. Does that mean the additional $0.02 that you're factoring in to get to the $0.10 net is really viewed as the opportunity costs of not having any income from that portfolio? Is that the way you're thinking about it?

That's the way -- I mean there's -- I think it's just about $0.135, a little over $0.02 and the balance would be the earnings. I think the key component there is that we felt we could maximize the long-term value or the most long-term value through that sale and it's something that will become part of our ongoing portfolio management strategy and as we go forward, we will continue to look to maximize the long-term value of our portfolio.

That's helpful. And then the other thing I just wanted to clarify was, if we add up your -- I think you had mentioned this in your comments, but the Stafford and Plus loan originations and the branding partner channel -- I know there was some mix between the two channels for some loan portfolios or volumes that switch from one to the other. If you add those up they're still -- they're flat to down slightly for the nine months ended September 30, '06. Can you go over the reasons for that again? I just missed that.

Sure. In the first part of -- in the first and second quarter of 2005, we acquired the then-existing portfolio of Union Bank and Trust. That was the portfolio that was on their books. It almost represents a -- almost like a spot purchase. So, if you back that out of the 2005 numbers, our loan growth in terms of new volume generation is really up over 58%.

Okay, but then there is volume in your branding partner channel from the Union Bank relationship in the nine-months ended September 30, '06 also, right?

That all became part of our internal branding partner channel.

Okay. Okay. So, on a quarter basis, we just have to strip out whatever you bought, almost like the spot purchase last year. Then we get to that core growth, that number that you were talking about.

Correct.

Okay. Okay. Great. Thank you.

We will take our next question from Moshe Orenbuch with Credit Suisse.

I was wondering how much more of those types of loans, similar to what you sold, might be in the portfolio, as we think about the magnitude of the sales going forward?

Moshe, this is Terry. We service in excess of 90% of the loans that we own ourselves. And so in terms of the loans that would be -- that we would be looking at -- making sure we maximize the long-term value, either by holding them or selling them, would be something less than 10% of our total portfolio.

And this was a $300 million and change portfolio?

That's correct.

Correct.

So, you've got a fairly hefty premium?

Yes.

Okay, thanks.

We will go next to Sanjay Sakhrani with Calyon Securities.

Thanks for taking my questions. A couple of questions. One was, Terry, you mentioned the $17 million associated with Peterson's and CUnet, in terms of revenues.

Yes.

Was that all in the other fee-based income line?

Yes.

Okay. Great. And those costs associated with Peterson's, that's part of the dilution you guys were anticipating associated with the acquisition?

Correct.

Okay. That's the net impact. Okay and on the Canadian servicing portfolio, I guess there was a sharp increase. That's nonrelated to the government contract, right?

Correct.

So, you guys -- I guess what portion of the Canadian subs business was that government contract, as of the end of the third quarter?

Can you -- I want to -- I want to make sure we understood your first question to make sure that we answer it properly. Did you -- were you talking about the increase in the Canadian servicing portfolio? We do service that under the Canadian servicing program, but it's not related to the Federal Family Education Loan program.

Okay. Yes, I mean I guess -- I was looking at the $8 billion going up to 9. Right? That's -- that difference was in addition to, right -- separate from the government guarantee.

Correct.

Right. Right. Just wanted to make sure that was the case. I guess going back to the other fee-based income, it went from 16 to 31 and 17 of it was related to just the acquisition. So, what portion of it was Nelnet business solutions?

Can you repeat that one more time? I'm sorry.

What was the contribution by Nelnet business solutions in the quarter? Is I guess what I'm getting at.

Roughly 14% before tax.

Okay. All right, great. Thank you. That's it.

We will go next to Mark Sproule with Thomas Weisel Partners.

I just wanted to -- one quick question, I guess. On the consolidation side, with the single holder rule, what are you doing, acting more aggressively to sort of protect your portfolio or are you not willing to sort of key on the pricing side there with some of the marketing groups that are coming after portfolios like yourselves.

Well, we're aggressively marketing to our own students, to consolidate their loans with us. We've got a number of different things that create brand value with that student and helping them plan for their education and not just pay for it. So, when they get to consolidation, we've built up a relationship with the student in the family. So, they want to consolidate with us. But we aggressively defend our portfolio. We also aggressively are originating loans that are not part of our portfolio. So we have a two-tiered approach, both an offensive and a defensive approach to the consolidation business. If you look at the last year, we are extremely pleased with our net position there, compared to some of our competitors. We're in a net positive position of over $900 million in net new consolidation loans after losses.

How much of that 727 million in the quarter is the single holder for runoff or versus two-step impact?

I do not have that broken out. I think the majority of it would not be related to the single holder rule. Because that just changed on July 1. That's going to be a piece of it. It's going to be from -- from the super two step and just the aggressive consolidation that happened before the July 1, interest rate change.

Okay, great, thanks.

We'll go next to [Mike Tejano] at UBS.

Hi, guys. Question on the spread. The 120 to 130 basis point guidance for next year, does that include the 200 million dead issuance that you had at the end of this quarter? And then also does it assume that the Fed, stays stagnant -- or if the Fed does ease next year, would you have sort of that opposite effect in that your debt will reprice, faster than your -- or your assets will reprice faster than your funding?

It does not -- it does not include the 200 million. It does take into -- it takes into account that as we move into the first part, that rates have been -- are anticipated to stay relatively flat. If there is a significant change in terms of how fast or how quickly they drop, that would have an impact toward the lower end of that range.

With respect to the 200 million that was issued, that money was not issued to fund student loans on a long-term basis, either. That's equity capital and is going to be invested either in organic growth opportunities, additional opportunistic acquisitions or potential stock buybacks.

Right. Right. But would it still be calculated as part of the margin, though? Or would it be separated out somehow?

When we look at our margin, we're looking at our cost to fund those assets.

Okay, got you.

Asset backed security.

Okay. And then on the -- I don't know if you want to disclose this, but did you tell us like what portion of the growth contribution in your internal brands came from Chela and LoanSTAR?

We didn't break that out. We're not going to break that out for competitive reasons.

Okay, I understand. And then lastly on operating expenses, the 6 to 7% increase in the core expense -- I guess that's trending a little bit higher than what you've had in previous periods. I think it was closer to 3 or 4. Is that largely just due to higher market expenses with consolidation in graduate plus? Or is there -- or something else that's driving that?

The big increase in those costs happened -- as we ramped up on to July 1, and as we continued to process those applications and those loans the last three months and throughout the end of this year. So, the biggest percentage of that was related to the consolidation loan ramp up.

Okay. Great, thanks.

We will go next to [Greg Rogan at Avenue Capital].

Thanks for taking the question. Actually, I have a quick question on guidance and what your baseline on adjusted EPS really is? Earlier in the year you talked about 40 to 45% of earnings coming in the first half. And I'm curious what number you're actually using on the first half number? If you're excluding the one-time catch-up on the provision so your -- you're using $0.82 from the first half or you're actually including that and using $0.74? And also if that guidance still holds? And the $0.52 this quarter, is that a clean number you're using for the full-year impact?

And we will start with the reverse, yes, that $0.52 is what we're using. In terms of -- the split, we're going to be very close to that split. The only -- the two things that have changed with regard to that has been the deferral of the excess SAP and the accelerated margin compression. With regard to the split, we're going to be right in -- right in that same neighborhood, regardless of the $0.70 -- $0.76 or $0.84. It will be in that same vein.

Okay, so you're saying -- what -- what gets that -- I mean if you're using the $0.40 to $0.45, and you're using--?

We will be in that range using the $0.84.

Using the $0.84. Okay. And then your -- you're backing out the deferred SAP and -- I'm sorry, could you repeat that -- you're backing out the deferred SAP from that?

The deferral of the SAP income, depending on what happens in the fourth quarter, could have an impact on that.

Right. Okay. All right, thank you.

Thank you.

Next, [Chad Caskarilla at Cedar Hill Capital].

Hi, guys. I was just trying to get a better sense of what maybe you'd call recurring earnings power in the quarter. So, we talked about how there is maybe $0.10 from the sale and $0.02 or $0.03 from nonrecurring items. But I also remembered last quarter you talked a little bit about Peterson's being dilutive for the third and fourth quarter to the tune of about $0.05 to $0.07 -- I didn't know if you could give us a sense of how much that affected this quarter? How much you think it will affect next quarter still? And you had talked a little bit about how expenses were somewhat artificially ramped for this quarter and next quarter because of the consolidation opportunities and the cents effect that was -- I think you mentioned a couple of cents last quarter as what the run rate effect was in this quarter or next quarter? I was just hoping you could maybe give us a sense of where all of those things shake out.

Sure, let me start with Peterson's. For the current quarter, we had about just over $5 million in terms of revenue. That represented roughly about 2 months of the quarter. And we had expenses that would have been close to about $5.6 million so we had, a slight loss in terms of dilution. However, it was very accretive to our product set and added significant value to our overall product set and it also adds significant positive operating leverage going forward and has been accretive to cash flow. As we go forward into the fourth quarter, I think you will also see similar to maybe slightly higher -- or slightly lower income contribution but it -- as we continue to integrate and capitalize on the operating leverage and use the cash flow, it will be an extremely valuable acquisition to our product set.

Bottom line, integration is going faster and better than we had anticipated and the amount of dilution that we talked about in the last earnings call, we think is going to be significantly less this year than we originally anticipated.

I got you. And do you have any sense of how much the ramp in expenses sort of is for the increased, I guess, call-up center people for the consolidation opportunity?

Well, we ramped, and I think we discussed that that was somewhere in the neighborhood of about $2 million last quarter. As we continue to ramp down and as Mike indicated as that volume runs through, the other thing to consider is this is also a very important quarter from our school channel acquisition and so we've also made investments in that channel to focus on the long-term, as well. So, I think the run rate of expenses will be similar as we go into the fourth quarter. I think the key component there is, again, to emphasize that Peterson's was about 2 out of the 3 months.

Just going back on the -- we were $2 million over in the second quarter, the expenses are probably going to decrease close to $1 million this quarter and we expect that to decrease again in the fourth quarter by about same amount.

Okay. Great. I got you. And so when we think about, again, just going back to Greg's question, a little bit about the guidance for the year, did the number that we -- we sort of backing out a lot of different things for the year for provisions and sales and one-time expenses and so on, but the bottom line, -- we looked at -- call it the adjusted base EPS progression, -- there is nothing that we should be backing out of there when we think about what it applies for total back half earnings out of this quarter. The $0.54 is part of the entire, call it 60 -- 55 to 60% of earnings as you come in the back half.

Our adjusted base income through the first nine months is up 20% and we think we're in line with our goals to hit that for the full calendar year.

Okay, great. Thanks a lot. I appreciate you taking my call.

[ OPERATOR INSTRUCTIONS ] We will go next to Jordan Hymowitz at Philadelphia Financial.

Hey, guys. A couple of questions, on the margin guidance that you gave, is that net of borrower benefits?

Yes.

Okay. So the 120 to 130, does that also include the hedge benefit from the derivative hedge gains that you've given?

No, we backed -- the derivatives, especially hedging our 9.5% portfolio is removed from that calculation.

No, not the 9.5, the 7.5 and the 8.5.

Yes. It would be in there.

Okay. So, the marginal spread without that would be closer to, what, 1, 1.7?

We -- our current spread at 134, last quarter we had about 15 basis points of lower income in there. It's going to be slightly less. It will be in the 14 basis point range this quarter. The key component there is as we continue, we anticipate that spread going down and that is why we're focused on continuing to diversify our fee income and continuing to grow our assets to offset that compression.

And second topic. You guys have made a number of acquisitions that you sold -- or offered stock for that's at a higher price than where the stock's at today. The Infinite acquisition, the Facts acquisition, how is that accounted for as the stock goes down in value? Does that run through the derivative? Or which line item does it run through?

Yes. It runs through the derivative market to market values. The current period was about $3.5 million loss, that's included in that derivative mark-to-market value.

So, out of the 79 million, 3.5 was the mark-to-market in the quarter as a result of the acquisitions where there's a for Chella agreement?

Yes.

Okay, thank you.

We'll take a follow-up from Carl Drake from SunTrust Robinson Humphrey.

Yes, Mike, on -- just one question on that guidance again. You had mentioned that it's a 20% guidance on adjusted-base EPS. That's off of $1.46 last year, which would imply $1.75 this year. The question is -- is the third quarter number you're using -- is it the $0.52 or is it the $0.45 for adjusted-base EPS? Because one has implication for the fourth quarter being either $0.41 or $0.47.

$0.52.

Okay, so, you are using the $0.52, which would imply basically $1.34 year-to-date on adjusted basis EPS. You take the 82 and the 52?

Terry?

Carl, can you go over that again?

You have $0.82 of adjusted base EPS for the first six months. And if you're using $0.52 for the third quarter, that would be $1.34? Not the $1.28?

Right.

So, if you're using $1.34, does that imply essentially a $0.41 for the fourth quarter?

To be in it that 45 to -- to be in that 45 to 55% range, yes.

And also to be in the 20% growth over the $1.46?

Correct.

Okay. All right. Thank you.

[OPERATOR INSTRUCTIONS] And there are no further questions at this time. I'd like to turn the conference back over for any additional or closing remarks.

Thank you very much, operator. And on behalf of Terry and Mike and Jeff, we just wanted to say how pleased we were with the quarter, in particular the fee-based revenue and the diversification of that revenue earnings stream. Which we are focused very -- very much on, pleases us. In addition, the asset growth and our focus on -- on continuing to drive those assets and diversifying our revenue stream will continue to be the focus that we have. So, on behalf of all of us here from Lincoln, we really appreciate the time that you all took to join us today and we remain confident in our ability to deliver returns to you, the shareholder, that you will be pleased with. So, thank you very much and have a great weekend.

That does conclude today's conference, ladies and gentlemen. Again, thank you for your participation and you may now disconnect.