Nelnet, Inc. (NNI) 2007 Q2 法說會逐字稿

Good day, everyone, and welcome to Nelnet's Second Quarter 2007 Conference Call.

(OPERATOR INSTRUCTIONS)

Cheryl Watson, Nelnet's Chief Communications Officer will begin with opening remarks. Please go ahead.

Thank you, Operator, and thank you everyone for joining us today. Nelnet's second quarter earnings release and financial supplement have been posted to the investor relations website at www.nelnet.com.

On today's call, Mike Dunlap, Chief Executive Officer and Chairman will provide an update on Nelnet's results of operations. Jerry Heimes, Chief Financial Officer, will report on our financial results and Jeff Noordhoek, President, will discuss the current political environment and impact to our business model.

Before we begin with 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 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 the 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 website for the reconciliation of GAAP net income to base net income. After Mike, Terry and Jeff have concluded their formal remarks, we will open up the call for questions.

I would now like to turn the call over to Mike Dunlap.

Thank you, Cheryl, and good morning, everyone. Thank you for joining us today to talk about the events of the second quarter. Despite a difficult political environment, we had a very strong quarter. We'll focus the call this morning on three key topics, our strong performance, the impact of the political changes and our approach in this new environment.

Our second quarter performance is highlighted by the following key results. Base net income for the quarter, excluding the loss and disposition of EDULINX was $0.50 per share. Our base net income, excluding all discontinued operations, increased more than 20% compared to last year, after consideration of excess special allowance interest. It was $0.04 per share versus $0.34 per share last year.

Our total student loan assets topped 26 billion, an increase of 17% year-over-year and 10% since the beginning of the year. And finally, our fee-based revenues, excluding discontinued operations, were $75.7 million, which represented 53% of our total revenue in the second quarter, compared to 36% for the same period last year.

Our continuing fee-based operations contributed roughly 40% of our base net income in the second quarter, compared to approximately 27% for the same period last year. As we consider the pending legislative changes, the strength of our business plan becomes particularly evident. Although the anticipated final legislational required changes for both Nelnet and the education finance industry, we remain committed to the Federal Family Education Loan Program.

Our business model has been developed specifically to reduce political risk, adapt to these kind of changes and to deliver long-term sustainable value to our shareholders. With change comes opportunity. And we are all well positioned to capitalize on those opportunities with the decision we made more than three years ago to modify our business plan.

As stated in previous calls, there are four key elements to our business plan. Originate high quality student loan assets, diversify our revenue streams, increase our fee-based income and deploy our capital efficiently. Diversifying our revenue streams and increasing fee-based income have the important benefits of lowering our exposure to key risks, political risk, interest rate risk and credit risk.

As demonstrated by the earlier highlights of results, I am pleased to say that we delivered on each of these four elements in the second quarter of 2007. At this time, I'd like to turn the call over to Terry to discuss in more detail the performance and the associated numbers.

Thanks, Mike. I'll cover the financial information and operating results for the second quarter of 2007. But before I discuss the detailed numbers, I want to highlight some events and information that should be considered in conjunction with my commentary and when reviewing our earnings supplement.

During the second quarter, we sold EDULINX, our Canadian servicing operation. Following this transaction, results of operations for EDULINX are recorded as discontinued operations. As previously disclosed, we did record a loss on the disposition of EDULINX of $0.18 per share. Excluding this loss, our base net income for the quarter would have been $0.50 per share.

Also during the second quarter, we acquired Packers Service Group, primarily to increase the transparency in Nelnet stock ownership. Packers is a holding company, whose principal asset was approximately 11.1 million shares of Nelnet stock. Nelnet acquired Packers in exchange for approximately 10.6 million shares of Nelnet and assumption of debt.

The transaction resulted in a decrease of approximately 474,000 shares outstanding. It's also important to note that we will issue approximately 522,000 shares of restricted stock in the third quarter to certain associates as part of our incentive, retention and employee ownership programs. This stock will vest over a ten-year period.

Finally, our 2007 second quarter operations do not include any 9.5% [SAP] earnings. The second quarter of 2006 included approximately $11.3 million, or $0.21 per share, of excess SAP related to the 9.5% yield and related to derivative impact. Turning to the traditional earnings measures, our GAAP net income for the second quarter was $14.8 million or $0.30 per share, versus [$45.8 million] or $0.84 per share for the same period in 2006.

Base net income for the period was $15.6 million or $0.32 per share. Base net income excluding the loss on disposition on EDULINX, was $0.50 per share, and base net income excluding all discontinued operations was $21.7 million, or $0.44 per share, for the second quarter. This compares to $0.34 per share for the same period a year ago, excluding the impact of the 9.5% floor earnings in 2006, an increase of 29.4%.

Turning the balance sheet and loan asset growth, our overall growth was very solid for the second quarter at 4.6% and at 10% since the beginning of the year. Our loan assets are up 17% year-over-year. Consolidation loans now make up 70% of our total portfolio, reducing the risk of loss to third parties and also reducing the risk that loans reprice at lower margins post legislation.

As expected, our total consolidation loans for the second quarter were lower than the same period last year. However, our net new consolidations for the quarter increased to $210 million, compared to $167 million for the same period in the prior year, an increase of 26% and $561 million year-to-date in 2007, compared to 488 million for the same period in 2006, an increase of 15%.

Our campus channels were down slightly year-over-year, reflecting the loss of certain key school customers as previously disclosed, and the timing of certain loan acquisition transactions with various branding and forward flow partners.

As expected, our core student loan spread remained stable during the quarter, at 128 basis points, compared to 129 basis points during the previous quarter. Excluding the impact of fixed rate floor earnings, the spread was roughly 123 basis points for both periods. Nelnet's strategy has been and will continue to be to diversify our earnings through fee-based revenue.

Our fee-based revenues from continuing operations amounted to $75.7 million for the second quarter of 2007, up nearly $27 million year-over-year, an increase of 54%. For the second quarter, these fee-based revenues made up 53% of our total revenues, as compared to 36% for the second quarter of last year.

We continue to see strong performance from our tuition payment plan and campus commerce segments, as well as certain areas of our enrollment services division. We will continue to integrate these operations to drive future revenue growth, control expenses and increase operating leverage.

Our fee-based business lines all provide the opportunity to generate and increase operating leverage. For the second quarter, total operating expenses from continuing operations were approximately $121 million, an increase of just over $19 million from the same period in the prior year, primarily due to the acquisition of Peterson's and CUnet.

Operating expenses were effectively flat, compared to the first quarter of this year and the same period last year, excluding acquisitions. Accordingly, we saw an improvement in operating margins in our fee-based businesses, allowing us to capitalize on the positive operating leverage.

Our shareholders' equity was $611 million at quarter-end, with approximately 49.2 million shares outstanding. Our capital ratio was 2.12% . I am also pleased to announce that on July 27th, our Board of Directors approved our third quarterly dividend of $0.07 per share, payable on September 15th to shareholders of record on September 1st.

Finally, during the third quarter, we chose to unwind all of our fixed rate derivative transaction. As a result, we will receive approximately $50 million in cash proceeds. The results of this transaction will reduce net settlements for the remainder of 2007 by about $0.09 per share, and will reduce 2008 and 2009 by approximately $0.23 per share and $0.15 per share respectively.

Future periods are also impacted, but by much lesser amounts. This will accelerate the cash flows related to these products. Because of the mark-to-market adjustments, it will have minimal impact on our GAAP net income, but the transaction will result in a shift from an unrealized gain on the mark-to-market of these derivative instruments, to a realized gain on the unwinding of those positions.

With that, I'll turn it over to Jeff to discuss the current political climate and the changes to our business model.

Thanks, Terry. I wanted to discuss the status of the pending legislative changes, the impact of those changes on Nelnet and the entire student loan industry and our approach for the new environment. As we go through this discussion, remember one of the basic business philosophies by which we have always operated, with change comes opportunity.

Although the legislation's not final, and there could be modifications along the path to implementation of the legislation, we now have enough information to begin estimating the timing and the effect of the changes. We believe that the changes in the student loan programs will be effective on October 1st, the beginning of the new federal fiscal year.

Several provisions in the legislation will have an economic impact on Nelnet, including the reduction to SAP, the increase in lender risk share and the elimination of Exceptional Performer. We expect that annual yield on all loans originated after the effective date to be reduced by 65 to 75 basis points.

With the reduction in annual yield of future loans, at the time the legislation becomes final, we are anticipating a one-time non-cash charge for impairment to loan origination rates, and other intangible assets related to prior acquisitions. We currently have approximately $47 million recorded on the balance sheet for those assets and will review the value in accordance with generally accepted accounting principles.

Also at the time the legislation becomes final, we will need to take a one-time charge related to the increase in risk share due to the elimination of Exceptional Performer. If we had incurred this charge at the end of the second quarter, the one-time non-cash charge would have been just over $17 million. As we consider additional immediate impacts of the legislation to Nelnet, there are important factors to keep in mind.

Given the high percentage of our portfolio already consolidated, the expected repayment rates, our volume of new originations and the estimated rate of borrowers moving into repayment status, we anticipate that approximately 15% to 20% of our total portfolio will be subject to the new rates in the first year. Accordingly, with the expected change in value of new consolidation loans, we expect both offensive and defensive originations will decrease.

As a result, the full impact on our portfolio spread will be phased in over a five to ten-year time frame. Our business model was developed to reduce our exposure to this type of political risk, and to mitigate the effects of current legislation. Our continued growth of fee income services and associate revenue provides a solid and growing economic base that is isolated from the pending legislative cuts.

However, even with the phase in effect of the yield reductions and the strength provided by our business model, we will need to consider additional changes. We are currently analyzing many options to change our student loan business, including reduction or elimination of borrower benefits, reducing the cost of asset acquisition and operating expenses, and continuing to maximize the long-term cash flow of the business.

Additionally, as the loan businesses evolved through legislative action, we may look at alternative structures securing all the loans on our balance sheet. Regardless of the balance sheet structure, the origination of loans will continue to be an important segment of our business.

Beyond the impact of legislation on our internal operating structure, as you might expect, we believe the pending legislative changes will strongly influence the look and feel of the student loan industry for the coming years. One expected outcome is a decrease in the number of FFELP program lender participants.

In an environment of steeply decreased lender yields, size, economies of scale and efficient operating models will be increasingly necessary for successful participation in [a] program. Even with lenders taking action, such as decreasing borrower benefits and other operating measures, margin will most likely not provide the required return for certain participants.

We believe that lenders with less scale than Nelnet, and lenders of less efficient operating platforms than Nelnet will be under increased pressure to exit from participation in the program. The end result will be fewer and larger FFELP program participants.

The proposed legislation does include a 15 basis point advantage for non-profit lenders. That advantage will help those participants remain in the program, at least for the short term. However, even with the yield advantage, the other cuts will put pressure on all entities to leverage scale and increase efficiencies.

The increasing pressure to create efficiencies and a decreasing number of participants present greater opportunities for Nelnet to provide services to lenders in order to leverage our existing scale. We anticipate opportunities to provide loan servicing and loan administration services to other program participants, generating additional fee income.

Also the decreasing number of participants creates opportunities for us to increase our market share. Although the most recent legislative debate has centered on the allocation of budget dollars and the yield to lenders, the undercurrent has been a debate about the federally sponsored student loan programs.

As we stated in our previous earnings call, in our opinion, the focus should be on the topics of choice, access, competition and cost to the taxpayer. Unfortunately, the pending legislation has a detrimental impact on all four of those areas, and could ultimately increase the cost of education to most families and taxpayers.

In addition to the impact of choice, access, competition and taxpayer costs, the pending legislation and other political activities are combining to restrict our ability to provide two valued services in the future. We have assisted alumni associations with providing their members access to competitive loan consolidation services, and in the process of doing so, generated revenue for the associations to use in support of their important mission.

We recently announced those associations that we will no longer be able to provide this service to college graduates and schools. Also, we have been building a business line that provides phone call outsourcing services to financial aid offices, and we are actively seeking a partner to take over that business to ensure no disruption in service.

While neither of these services have had a significant financial impact for Nelnet, the services were valued by our customers. In addition, we have reached an agreement this morning with the New York Attorney General. We are pleased to put this inquiry behind us and move forward, including the tough decisions we've already made regarding our alumni and outsourcing programs.

The code of conduct that we have adopted is nearly identical to the Nelnet student loan code of conduct that we agreed to follow back in April. Despite the challenges created by the current political environment, the strength of our business model provides the necessary foundation for us to continue our central mission of serving schools and education seeking families well into the future.

Schools are continuing to seek out ways to lower their administrative burden, and students are looking for services to assist with the confusing and difficult process of planning and paying for their education. We have the services to meet those needs now and into the future.

Now, I'll turn the discussion back to Mike for closing thoughts.

Thanks, Jeff. Let me conclude with a few thoughts. First, we are very pleased and proud of our accomplishments of the second quarter, which include growth in our base net income, excluding discontinued operations, in excess of 20% year-over-year. 17% growth in assets, with our student loan portfolio now in excess of 26 billion. 53% of our revenue came from fee-based revenues.

Second, although the political environment certainly creates challenges and impacts how Nelnet and the education industry operate in the future, we have developed a successful business model that prepares and positions us to adapt to the new environment. We'll continue to invest in our organic growth.

We'll continue to look for acquisitions that are accretive to our product and service offerings and our long-term sustainable cash flow, and we'll do these things with a discipline of returning value to our shareholders over the long term, which includes dividends and continuing our stock buyback program when prudent.

Additionally, we'll continue to focus on growing our fee-based revenues, growing our market share in the campus-based channel, leveraging our direct-to-consumer activities to retain our assets, generating positive operating leverage as we realize the benefits of synergies from our recent acquisitions.

And finally, as it relates to our expectations and outlook for the remainder of 2007 and beyond. Despite the recent political developments, we maintained a very positive outlook toward the education industry. We continue to expect mid-teen to high-teens growth in our student loan assets, and we continue to focus on growing our base net income.

Through the first six months, we have earned $1.04 in base net income, excluding the loss on the disposition of EDULINX. Terry mentioned we'll accelerate the cash flow on our match-funded derivative products in the third quarter, which will reduce net settlement income by $0.09 during the last half of the year.

And obviously, there are going to be some significant one-time non-cash financial impacts upon passage of the legislation. Adjusting for these, we expect to end the year with a mid to high-teens growth in our base net income for 2007. We will provide more color on 2008 in our third or fourth quarter earnings call as the impact of legislation continues to develop.

Let me leave with you with a closing thought that cuts through a lot of the noise you've been hearing. The demographics for our business are excellent. We estimate the 2008 high school graduating class will be 3.3 million graduates, the largest in history. We also expect that the graduating class of 2009 will be even larger.

So, we believe the demand for our products and services is greater now than ever before and will increase. That combined with our flexible and successful business model makes us feel very good about the future.

We'll now take your questions.

Thank you sir.

(OPERATOR INSTRUCTIONS)

And we'll go first to Carl Drake with SunTrust Robinson Humphrey.

Good morning. I wanted to ask you about the [New York] AG settlement, maybe you could go over that just a little bit, on what the details of that? You said it's very similar to the one you reached with the Nebraska AG. Was there anything -- could you maybe provide a little more color there?

Sure, Carl, it's Jeff. We signed it this morning. And the dollar amount of the settlement was $2 million, and the -- and we signed onto his code of conduct, which was nearly the exact same as we signed on before, except that we added on that we would no longer do the affinity alumni associations and the financial aid outsourcing, which we decided to terminate prior to this anyway.

Okay. So those are the two main things that were really related to the New York AG that were not incorporated into the Nebraska AG settlement?

Correct. And we had already decided -- disclosed that we were going to discontinue the operations.

And what type of a revenue and earnings impact did those two items have?

Carl, this is Terry. The impact of the affinity and/or financial aid outsourcing was minimal in terms of financial impact to either earnings or operations of the company. They were primarily a value-add service that we felt our customers benefited from, so they won't have a substantial impact from a standpoint of operations going forward.

Okay. Terry, could you provide some color between the $0.50 and the $0.44 of adjusted base net income for the quarter that excludes, [I'm] a little confused on those two numbers?

Sure. The $0.50 is the add back of the $0.18 loss on dispositions. The difference between the $0.50 and the $0.44 is that we did earn $0.06 per share on EDULINX operations during the quarter. So if you exclude all discontinued operations, which would include the normal operating income from EDULINX, its $0.44 per share. That will be what we focus on operating from on a go-forward basis.

So they're really -- the recurring number for the quarter is $0.44?

That's correct, yes.

Okay. And so the guidance, based on mid to high-teens, does that use the $0.44 or, the $0.50?

That includes the $0.50.

Okay. Includes the $0.50. Okay. Okay.

And $1.04 through the six months as Mike mentioned.

Okay. And the -- I think you mentioned the 15% to 20% of the portfolio impact, it's -- I think you said, 65 to 75 basis points. That's a little greater than what I would have expected. What -- besides the -- could you break that down in terms of the SAP, the SAP decline, the origination fees, et cetera, how that kind of breaks down?

Sure, Carl, it's Jeff again. You have differences in the House and the Senate bill, that's the 50 to 55 basis points cut to the SAP margins. Then you have to weigh in the elimination of Exceptional Performer, and then take that as a result of the amount of defaults that a lender might have, so you have to make an assumption on that which makes it slightly variable. And you also have to consider the increase in origination fees from 50 basis points (inaudible).

Okay. So you're including the Exceptional Performer defaults in there?

Right.

So, Carl, if you took the 50 basis points and you could add seven to ten basis points for the impact of increased risk sharing, and seven to eight basis points for the increase in origination fees depending on your amortization periods.

I see. And, Mike, in terms of loan return growth, you've commented in the past that you believe that you could grow the Company even with the legislative environment into the mid-teens. Is that something you feel comfortable with, with the elimination of borrower benefits or reducing borrower benefits? Some of the capital allocation initiatives you can take, the operating leverage on fee-based businesses?

We like our business model, and I think the key to our success long term is going to be our ability to adapt to the paradigm shift and the change that we're facing in our industry. As we go forward, we think we're in one of the better positions from a leverage and scale standpoint to adapt to that change and go forward on a very positive basis with our company.

Okay. One last question before I get out. In terms of other income, it looked like it dropped pretty significantly quarter-over-quarter. Was there anything in -- any rationale behind that? Is that something that would continue to be at these levels for this quarter?

Yes, Carl, I think the first quarter included the gain on sale of some loans and that was the primary difference there. I think we disclosed that gain on sale in the first quarter.

It was a couple of million, and so that was really it -- so portfolio sales are going to be lumpy going forward?

Yes.

Okay. That was the difference. Okay. Thank you.

We'll go next to Sameer Gokhale with KBW.

Hi. Good morning. I just wanted to -- I just have a couple of follow-up questions about the expected impact of the legislation, the 65 to 75 basis points. Can you please quantify for us the -- how much room you have there potentially to cut back the borrower benefits? Like how many basis points of that 65 to 75 basis points could be offset by the -- let's say you reduced borrower benefits to zero?

And then also, currently I think you buy a certain percentage of your loans from partners and you're paying them premiums. How much room do you have there? I mean in your view, would those begin to come down? And could you disclose what those premiums are so that we could estimate potentially how much of additional benefit you could have if those premiums were to go down?

Sure, Sameer, this is Terry, I'll try to add some color to that. As Jeff mentioned, we're assuming about 65 basis point cut. We believe we can mitigate that, some of those reductions through the reduction of cost of acquisition. If you look at 2006, I believe the amount of additional premiums that we added was somewhere in the neighborhood of 3.1% to 3.25% and we would be looking to reduce that.

As you look at our operating margins, we're going to continue to focus on capitalizing our scale, as well as diversifying our business into our further -- into our fee-based models. When we looked at our goal, our goal is to achieve mid to high-teens return on our committed equity, and our focus will be on developing our business model to achieve those goals.

Okay. I'm sorry. So those -- the cost of acquisition, I think you expressed those as premiums, is that correct? The 3.1 to 3.5%?

Yes. We would either have that up front cost of acquisition, it would either be in the form of premium that we would pay to a lender, or other buy downs or up front costs that we would incur as an originator.

Okay. So would you be able to try and fit that into some sort of annualized impact on the spread perhaps?

Well you -- if you assume a five to seven-year life, and I think you can look at -- we actually recorded amortization of those costs in our core student loan spread. Let me get that number for you, Sameer. Right at about 37 basis points for the current quarter, and that would be the impact of that current 3% to 3.75% cost of acquisition.

Okay. And just to clarify, that includes also in there borrower benefits in that 37 basis points?

That would include the up front borrower benefits that we would pay as a originator.

Okay. Okay. That's helpful. Thank you.

(OPERATOR INSTRUCTIONS)

We'll go next to Mike Taiano with Sandler O'Neill.

Hi. Good morning. Could you just walk me through what happened in the other acquisition channel this quarter? Were those just portfolios that you bought in the open market or is it something else in that line?

No, those are portfolios that we bought in the open market, either by -- from people who we third-party service for that liquidated or other portfolios that we acquired.

Okay. And those would be lower margin than your typical originations, right? Your branded and internal branded originations?

Generally, slightly, yes because we'd have to have a slightly higher premium or cost of acquisition associated with those.

Okay. And just, not to beat a dead horse, but on the 65 to 75 basis point reduction, I mean, do you guys have any sense right now as to how much or sort of ball park what you can do to offset that in terms of basis points? I mean, would you -- do you have 35, 40 basis points of offset? Is there any way to put a sort of a box around it?

We continue to look at ways that we can reduce our cost of acquisition, continue to look at ways that we can evaluate the competition and how it will impact borrower benefits, and we continue to look for ways that we can capitalize our scale, efficiency and operating margins.

We will also continue to look at ways that we can diversify our revenue and capitalize on our business model, and as we go forward we will be looking at all of those things to achieve our goals going forward.

Okay. So is the message here though that you think that on new loans going forward that you can meet your hurdle rate of return? Is that fair to say? Or, is it uncertain at this point?

At this point, until the legislation is final, it's uncertain.

Okay. And it -- just going -- if you were to say let's say, just looking at where your stock's at today. Just trying to get a gauge for what the -- what the stock's trading at now, relative to what it would be let's say in just a liquidation, I mean, in the past portfolios have been purchased in this business for somewhere around 4% to 6%, is that fair?

Yes, we have seen bids out there at those levels.

Okay. Great. Thanks a lot.

We'll go next to [Carl Robert] with [Kinekos].

Yes, just on the loan acquisition, the total channel acquisitions and origination of loans. It was down about 11% year-over-year. How much of that decrease is from a loan on schools, versus a lower percentage of volume from the existing schools?

We've got -- we had one large school that was about 200 million to 300 million that is starting to roll off. The other piece that is primarily impacting the channels is timing of loan sales. We actually accelerated some of the loan sales in 2006 with the change in -- or implementation of some of the front-end origination fee buy downs. So a lot of that is timing related to the impact of 2006 acquisitions.

Okay. And then could you give us the kind of the operating income for the tuition enrollment in the software services line? In terms of on the segment breakout, what it was prior year?

We generally don't break those entirely out. We have about 40% contribution from our fee-based businesses in terms of during the second quarter in terms of contribution to our base margin. Historically in terms of our enrollment management and tuition payment plan, those have made up somewhere in the 12% to 15% range. For the second quarter, those are -- didn't have quite that impact in terms of the contribution, but we continue to expect solid performance out of that tuition payment --.

Well I mean you -- I mean what I'm getting at in the March 10-Q, you broke it out?

And we will break it out in the Q.

And that's to indicate that in total it was actually down 7%. Is that what -- if we lump those three together, it was down 7% year-over-year, is that kind of a comparable? I mean, I guess my question is should I expect that -- when that Q comes out, is that going to be up or are you still going to be down or --?

Can you repeat your question?

Well if we took, in the March 10-Q, your tuition was up 21%, enrollment was down 52% and software's up 20%. And in the aggregate, those three lines together, there's actually down 7% year-over-year.

In terms of operating margins?

In terms of pre-tax, I'm talking about pre-tax income. Not margins. Pre-tax income on a segment basis. I'm just trying to get a feel for what the growth -- I'm trying to figure out if you're making progress in growing the other lines, I'm trying to figure out.

What I can do is, I can take that offline to make sure that I'm looking at the same information as you are to make sure that we focus on that. But in terms of -- we have experienced solid growth in terms of our tuition payment and campus commerce.

In terms of our software, 5280 is one of our software companies, which we acquired in the last year, and it is now contributing to our software services line item. And with the acquisition of Peterson's and CUnet, as we disclosed, Peterson's is not and has not been a significant contributor to net income.

It is going to be a significant contributor to our product and service offering going forward. And as we continue to integrate the operations, we will capitalize on the operating leverage going forward.

Okay.

One side comment on 5280 is, before it was a wholly owned subsidiary. Some of that income came in as software income. And after it was a wholly owned subsidiary, those numbers get somewhat convoluted, so that's why I think you have to take it offline with Terry and go through the numbers in detail so that you can get the exact information.

Okay. And then one last question, in terms of the legislation, this -- you're saying the legislation -- the cut in the yield will be -- if the cut in the yield will be 65 to 75 BIPS, or that would be the yield after the cut?

That would be cut if we were to take the impact of all of the different items, including the cut to the margins, the increased risk sharing and increased origination [sharing].

Okay. And so if we were to just take -- if that cut were involved with your P&L, today for this quarter, I want to make sure I'm understanding the impact on this, but if I go through the numbers, that would indicate a -- like what, an 80% cut to your pre-tax income? Is that correct, or am I looking at that incorrectly?

That would be related solely to our -- to the new loans that would be acquired. It would not have an impact -- that big an impact, because it would only impact 15% of our portfolio as it rolls on over a year.

Got you. Got you.

That is not accurate.

And remember, we are going to mitigate those cuts, reducing borrower benefits, costs of acquisitions and operating expenses. Those are the items that we're looking at to mitigate those [in effect].

Okay. Thank you very much.

And we have a follow-up from Mike Taiano from Sandler O'Neill.

Hey guys, sorry. Just wanted to clarify, the 15% to 20%, the portfolio you said, subject to new rates. Now what new rates are you referring to? I just want to make sure I'm clear on that. Is that the cut in half of the 6.8% down to 3.4%? What rates are you referring to there?

What we're talking about is, if the legislation goes into effect on October 1st, then we'll be operating -- creating new loans under the new rules, which include these changes, so lower SAP earnings and increased risk sharing, increase retention fees. After October 1st, then it will take a period of time to roll into our portfolio and it's about 15% to 20% in the first year after that.

Oh, I see. So that's just the phase in of a portion of --?

Yes.

Okay. I see. And then just a quick follow-up, on the -- how many shares did you buy back in the quarter?

Because of the Packers transaction, Mike, this is Terry. As a result of the Packers transaction we reduced shares outstanding by about 474,000 shares. As we go forward in the third quarter, I think it's important to note that we'll issue about 522,000 shares as result of our -- associate incentive, retention and ownership programs. But in addition, in the third quarter, we will buy back about 324,000 shares that we would have bought back in July so far.

Okay. And also just one other thing on that -- the [fax] option or redemption that you guys did, I guess, in July. Was that something that was -- just curious as to why you did it now. Is that something that was part of the contract, or why, I guess, now is the question?

It was a way to -- just focusing on the clean-up of our balance sheet and the opportunity to reduce the shares outstanding, because of the removal of the put, it will actually move through a mark-to-market positive or gain on the mark-to-market of that put of about 1.9 million.

Okay. Great. Thanks.

We'll go next to James Fotheringham of Goldman Sachs.

Thanks. Just a few questions about changes in the costs and fees, incremental to the effect of EDULINX. The second quarter operating expenses fell much more than the 7.7 million attributable to EDULINX. So could you please detail the various sources of the rest of this decline? And similarly, loan servicing and other fees fell more than the 12.5 million from EDULINX and what's specifically accounts for the rest of that fall? Thanks.

On the operating expenses, the decline was due to the reduction -- partially due to the reduction and asset generation costs, specifically in our consolidation area, our overall consolidation loans were down. In addition, we continue to achieve operating leverage from integration activities.

In terms of the revenue side, a large portion of that was due to the overall drop of our third-party servicing volume. Our third-party servicing volume was down about 10% year-over-year, and so that is the other contributing factor to the drop in loan and guarantee servicing income, or the reduction overall.

That answered my question. Thank you very much.

And gentlemen, there appear to be no further questions. I'd like to turn the call back to Ms. -- to our speakers for any additional or closing comments.

Thanks, everybody.

Again that does conclude today's conference call. Thank you for your participation. You may disconnect at this time.