Nelnet, Inc. (NNI) 2007 Q3 法說會逐字稿

Good day, everyone, and welcome to Nelnet's Third Quarter 2007 Conference Call. Today's call is being recorded and broadcast live over the Internet. At this time, Ms. 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 third quarter earnings release and financial supplement have been posted to the Investor Relations website at www.nelnet.com.

On today's call we will have Mike Dunlap, our Chief Executive Officer and Chairman; Jerry Heimes, Chief Financial Officer; and Jeff Noordhoek, President. 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 financial 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. Good morning, everyone. Thank you for joining us today. You all know about the new legislation and its impact on the higher education finance industry, and you've been asking, how does this affect our strategy? I want to offer you three thoughts.

First, more than half our revenues are fee-for-service. We provide valuable services to the world of education. This market has been growing. It's going to stay on an upward trend and continue to generate attractive returns.

Second, the new legislation is already forcing many lenders out of the business. We also see many lenders maintaining the same business model, which we believe will not work for them in the long term. Some of them try to survive through borrower discounts to maintain volume. We are not going to play that game. We believe our relationship with borrowers and institutions based on service will enable us to maintain a good flow of loan volume, but we're not going to compromise margins in order to stimulate greater volume than good economics dictate.

Third, the number of participants in our industry is contracting rapidly. We are well capitalized and expect to grow our loan assets and third-party servicing with this opportunity. We believe that the emerging buyer's market will provide selective opportunities to substantially grow our franchise.

Before discussing the third quarter, I want to remind you that Nelnet is a diversified educational services company serving the dynamic and growing needs of the education-seeking public. Today there are some 73 million people enrolled in K through 12 and post-secondary institutions across the U.S. This year, Nelnet's helping nearly 5 million students and families reach their educational goals, and I'm excited about the opportunities that are before us.

As you listen to our review of the past quarter, I want you to keep in mind that the market for our broad group of services has never been larger, and there are projections for growth in our market well into the next decade.

Our third quarter included strong bottom line performance when considering the impact of the new legislation, continued growth of our diversified revenue stream, and increased bottom-line contributions from fee-for-service operations. Base net income for the quarter, excluding charges related to new legislation and related restructuring, was $0.45 per share. Fee-based revenues reached $76.5 million, which represented 54% of our total revenue in the third quarter, compared with 48% for the same period last year.

More importantly, our fee-based operations contributed 49% of our base net income in the third quarter compared to 31% for the same period last year. Our total student loan assets were $26.6 billion, an increase of 16% year over year and 12% since the beginning of the year.

In the midst of challenges of the new legislation and the disruption of the credit market, the strength of our business plan becomes increasingly evident. Diversifying our revenue stream and increasing fee-based income is one of the major factors of our business model and will be a key contributor to our future growth and profitability. We remain committed to our mission of helping families plan, prepare, and pay for their education. Historically, the Federal Family Education Loan Program has been a key component of our strategy, and we intend to remain the leader in this program. These businesses of origination, acquisition, financing, and servicing of government-guaranteed assets remain a key component of our vertical integration and service we provide to families. However, we will only generate loan assets in the manner that adds to our long-term value creation.

The new legislation has created significant challenges in our FFELP business line for Nelnet and our industry. We've proactively made the tough decisions necessary to right-size our business with a new lower economics of the FFELP program. Many in the industry are choosing to delay this vision. They are handcuffed by outside constraints, or perhaps they're ill equipped to adapt to the new reality. Some are choosing to effectively lose money on every loan they originate after October 1.

We've already responded, and we're moving forward. At the same time, many of our thinly capitalized competitors are rapidly leaving the business. Others are scrambling to recreate themselves in this new environment. This is already creating new opportunities for Nelnet. In some circumstances, some of our larger competitors are making what we believe are irrational decisions. In the short term, we could lose some FFELP loans going to others who are not as quick to react to the legislative changes and the disrupted credit market. But their failure to recognize and respond to these market dynamics will create opportunities for us to purchase loan portfolios at reasonable prices and to increase our servicing base.

We have said in past calls, "With change comes opportunity," and we are as well positioned to capitalize on those changes as those opportunities emerge. In fact, we currently have opportunities to increase our third-party servicing by over $1 billion.

Let me be clear. We will not grow for growth's sake, and we will not create unprofitable loan assets and sacrifice value creation for short-term volume or some mythical market share benefit.

Consider the following. We have a $26.6 billion existing loan portfolio that will serve as annuity-type revenue stream for many years. We have highly efficient servicing and financing capabilities and significant scale and capacity to grow. We have a very strong capital base along with the operating capacity and financial liquidity to grow and seize new opportunities such as purchasing loan portfolios. We have a diversified product offering and revenue stream. And finally, our existing business operations are generating strong cash flow for future investment.

At this time I'd like to turn the call over to Terry to discuss the details of our performance.

Thanks, Mike. I'll cover the financial information and operating results for the third quarter of 2007. I also want to highlight some events and information that should be considered in conjunction with my remarks and which will be in our earnings supplement.

First, our third quarter results include charges associated with passage of the new legislation and restructuring of our asset generation activities. These charges total $43.5 million after tax, or $0.89 per share. Excluding these charges, our base net income for the quarter was $0.45 per share.

Second, the disruption in the credit markets impacted our operations and our student loan net spread. We were able to add or replace nearly $5 billion in short-term warehouse capacity, but the rate volatilities reduced our core student loan spread by 15 to 20 basis points.

And finally, we continue to focus on growing sustainable, recurrent, fee-based revenues that fulfill our mission of helping families plan, prepare, and pay for their education.

During the third quarter, we sold our 50% ownership with Premier Credit for a gain of $3.9 million, which is recorded as "Other Income" in our statement of operations. The volatility of the collection business does not fit the suite of fee-based businesses that we want to invest in. Because of the one-time charges related to restructuring and the legislative changes, we reported a GAAP net loss for the third quarter of $15.7 million, or $0.32 per share compared with last year's net loss of $22.4 million or $0.42 per share.

The third quarter of 2006 included a market-to-market loss of derivatives of nearly $80 million. Also due to the one-time charges, our base net loss for the period was $20.4 million, or $0.42 per share.

Base net income, excluding the one-time charges related to the passage of new legislation and restructuring of our asset generation business, was $22.2 million or $0.45 per share. This compares to $26.7 million, or $0.49 per share, for the same period a year ago, which did include $0.14 per share due to the one-time sale of loan assets.

Nelnet's strategy has been and will continue to be to diversify our earnings through the fee-based revenues. Our fee-based revenues from continuing operations amounted to $76.5 million for the third quarter, up nearly $8.7 million year over year, an increase of 13%. For the third quarter, these fee-based revenues made up 54% of our total revenue compared to 48% for the same period last year.

Our loan and guaranteed servicing revenue increased approximately $800,000, or 3% year over year. Fifty-five percent of this revenue is from loan servicing, and 45% is from our guaranteed outsourcing (inaudible). While our third-party loan servicing activities have declined in recent years, this has been offset by the growth of our guaranteed outsourcing activity. The new legislation and proposed regulatory changes will reduce the revenue earned by guarantee agencies and therefore the revenue that we can earn under our contract. In this segment, the new legislation will likely reduce 2008 guarantee servicing revenue by $8 million to $12 million. However, we also believe that lenders in particular with less scale and less efficient operating platforms than Nelnet will create significant opportunities for us to expand our FFELP loan servicing business.

Our other fee-based revenues includes our tuition payment plan, campus commerce, and enrollment service areas. We continue to see strong performance from our tuition payment plan and campus commerce segments, which had revenues of $10.5 million for the third quarter, an 18% increase over last year. We will continue to integrate these operations and drive future revenue growth, control expenses, and increase operating leverage.

Our enrollment services area is primarily focused on lead generation for institutions and is supported by strong content management and test preparation services for students and families. Our growth here has been driven through the acquisition of Peterson's and CUnet. During 2008, we will continue to integrate our lead generation activity and gain operating leverage.

We also continue to leverage out internal technology infrastructure as well as products and services we provide to third parties. Our external (inaudible) software revenues totaled $5.4 million for the quarter compared to $4.4 million a year ago, an increase of more than 23%.

As you are all aware, as a result of restructuring announced September 6, we will incur certain one-time severance and contract termination charges. Approximately $5 million was recognized this quarter, and an additional $5.4 million will be recognized in the fourth quarter. Excluding these items, our operating expenses are stable, demonstrating our ability to capitalize on the operating leverage of our business structure and strategy. Excluding the one-time items, our operating expenses are flat compared to last year and down about $6 million, or 4% sequentially, for the second quarter. As we previously disclosed, we expect our restructuring activity will result in expense savings of as much as $25 million annually beginning in 2008.

Turning to the balance sheet, our loan assets totaled $26.6 billion, an increase of 16% year over year, and 12% since the beginning of the year. Consolidation loans currently make up 71% of our total portfolio, reducing the risk of loss to third parties and also reducing the risk that Stafford loans will consolidate at post-October 1 margins.

It's also important to note that our credit exposure is very low. The composition of our portfolios concentrated in loans from high-quality, low-default educational institutions. Ninety-nine percent of our portfolio is government-guaranteed assets. Our private loan portfolio continues to grow and perform very well. Despite the performance issues in the subprime mortgage and consumer credit products, we continue to see very solid performance with extremely low default and delinquency activity.

Our total campus channels are down year over year, and we have pared back our offensive consolidation originations substantially, so we are very pleased with the continued growth of our internal campus originations. In addition, our net new consolidation activity remained relatively strong in the third quarter, allowing us to grow our portfolio despite the difficult market. With the change in economics of new consolidation loans and the large disruption in the capital markets, which significantly impacted the costs and availability of debt to finance these loans, we expect to significantly curtail our consolidation efforts. We also expect to see some continued short-term deterioration in our campus channel origination volume and market share as some industry participants are slow to respond to the new economic reality. We will evaluate our position and growth opportunities over the next 18 months, including origination, acquisition of existing portfolios, and serving as a flow partner for our servicing clients.

As expected, the credit market disruption impacted our core student loan spread. The widening of credit market spreads, the increasing cost of warehousing capacity, and the increasing cost of liquidity caused our core student loan spread, including fixed rate floor income, to drop from about 123 basis points to approximately 104 basis points. To be specific, in the quarter we experienced an unprecedented and near simultaneous widening of the CP LIBOR spread by as much as 20 basis points, asset-backed commercial paper by as much as 60 basis points, auction rates by as much as 50 to 100 basis points, and the test spread of nearly 140 basis points.

You might say a perfect storm occurred in the credit markets in reaction to the unfolding subprime mortgage prices. We have seen some improvement in the credit markets in the last few weeks but believe that there is still substantial risk and volatility despite the strength of our assets. Because of this, we do not expect any significant improvement in our funding costs, and we'd expect spreads on our existing portfolio to remain around 100 basis points through the end of the year.

The new legislation effectively cut 70 to 80 basis points out of spread on new loans. We believe we can mitigate some of those reduction through our restructuring activities, modifying borrower benefits, and reducing our cost of acquisition. Accordingly, we believe we can achieve an acceptable return on our capital. It's important to note that the new spread will only affect loans originated after October 1, 2007, and only to the extent these new loans remain on our books. We expect our existing portfolio to turn over over a period of five to 10 years.

Despite the restructuring charges and the charges related to legislative changes, our shareholders' equity was nearly $600 million at quarter end, with approximately 49.5 million shares outstanding. Our capital ratio was slightly above 2%. During the third quarter, we added or replaced short-term funding capacity of nearly $5 billion, primarily in the form of asset-backed commercial paper conduit programs. We have nearly $600 million in capacity in our unsecured bank loans and more than $160 million in cash through our unrestricted student loan asset.

I'm also pleased to announce that on October 31, our Board of Directors approved our fourth quarter dividend of $0.07 per share payable on December 15 to shareholders of record on December 1.

There are a few points I'd like to highlight. First, our capital and liquidity position remains very strong. Second, our plan for diversification is working and our fee-based revenue contribution to net income continues to increase. And finally, we have taken a proactive leadership position in dealing with the economics of the new legislation and have taken steps we believe are necessary to create long-term value through our asset generation activities going forward.

With that, I'll turn it over to Jeff to discuss what lies ahead for Nelnet.

Thanks, Jerry. First, let me reiterate that these recent events will not change our mission of helping families plan, prepare, and pay for education. Our core values, which include our customer focus and commitment to associates, remain unchanged as to the core underpinnings of our business model. We remain committed to diversifying and increasing our fee-based revenue streams, deploying capital efficiently, utilizing our scale and capacity to create efficiency, and generating high-quality assets.

So what does lie ahead for Nelnet? Additional growth in the education space outside of FFELP will reduce our political credit and interest rate risk. Revenue diversification will continue to make us stronger, and the new products and services we add will create value to our customers. To achieve this, we will continue to pursue opportunities to make acquisitions that add to our product and service offerings, creating sustainable, long-term cash flows.

Here's a clear example of change bringing opportunity. We are seeing multiple opportunities for asset acquisitions and portfolio purchases as our more thinly capitalized competitors look to exit the student loan business. These opportunities will allow us to deploy capital efficiently and increase scale. Asset generation will be intently focused on high-quality, low-default FFELP and private loan assets and maximizing their value by either portfolioing new loans that meet our return targets or forward-flowing them to strategic third parties.

Maintaining our relationships with our existing school customers is also critically important. Because we have led the market in adjusting our borrowed benefits and realigning our business, we anticipate we will likely suffer some short-term market setbacks and volume loss. However, we are confident in our ability to deliver superior products and services, which will be the key to our success in the long run.

There is an opportunity to expand market shares, not only through our campus sales force, but also by responding to the substantial increase in RFPs from colleges and universities as they react to the new regulatory environment. This should allow us to increase market share as well as increase potential partnership opportunities by capitalizing on our economies of scale and diversified product offerings. We see the opportunity to expand our third-party servicing as other market participants look to piggyback on our scale, efficiency, and world-class servicing operation.

Finally, as we move into 2008, we want to focus on innovation and organic growth opportunities with our fee-based businesses. We will leverage our knowledge of products and services as we continue to look at ways we can help schools deliver the value of education in an efficient manner.

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

Thanks, Jeff. Although the profitability of the asset generation segment has been negatively impacted by the legislation, I believe we are better positioned than anyone to deal with the changes because of the value of our existing portfolio; our size, scale and efficiencies; our strong capital base; and, most importantly, our diversified business operation and revenue stream. I'm proud of our associates, who are dedicated and have delivered top-quality service to our customers in an extremely challenging environment.

Let me repeat some of the numbers Terry shared. Base net income of $0.45 per share excluding the impacts of the new legislation and our restructuring and continued diversification of our revenues for fee-based income now making up 54% of our total revenues and 49% of our net income. We will continue to focus on what has and will make us successful in the future. This includes investing in our organic growth and looking for business opportunities that are accretive for our product and service offerings and our long-term sustainable cash flow. We will do these things with the discipline of returning value to our shareholders over the long term, which includes dividends and continuing our stock buyback program when accretive. And finally, as it relates to our expectations and outlook for the remainder of 2007 and beyond, we are in a time of great transition in the FFELP industry. We think this period could last a few years. It will include a lot of volatility as industry participants adapt, restructure, realign, and exit the business. Accordingly, we will not provide specific earnings guidance going forward.

But let me take a longer view and talk to you about how we see our Company after this transition phase. Nelnet will continue to deliver attractive value to its shareholders. The way we derive this value will be different, however. Our existing portfolio of loans will continue to generate an annuity-type revenue stream. It will be a meaningful contributor to our bottom line during the transition, but its contribution will naturally decline over time. We will continue to generate new student loan assets, but because they will be lower yielding, the overall contribution to our bottom line will be significantly less than it is today. The vast majority of these assets will be FFELP-related as we continue to see this as a valuable platform.

So how will we fill that void? Growing and diversifying fee-based businesses will be the major driver of future shareholder value creation. These businesses will represent a substantially larger piece of our income stream and the majority of our bottom line. We believe they will more than fill the void created by the lower contribution from the loan assets over the long term. As we've told you in the past, we have anticipated change and have laid down a solid foundation for the future. In addition to investing in our existing non-asset-based businesses, we believe there will be considerable business opportunities to expand and grow fee-based businesses as we move through the transition phase.

Underpinning all of this, our very solid education industry demographics. College enrollment is expected to increase every year through 2015, growing to more than 20 million students. The cost of education will continue to grow at twice the rate of inflation, and families will need more and more help affording that education.

Our vision and mission have not changed. We make educational dreams possible by helping families plan, prepare, and pay for their education. We will continue to focus on our customers, our associates, diversification of revenues, and giving back to the communities we work with and live in. This will translate into earnings and long-term value. That has been and will continue to be our focus as a management team. I'm proud that we've been able to deliver on these themes in the past, and I'm confident that our long-term opportunities will allow us to continue to generate long-term, sustainable value.

Before taking your questions, I'd to welcome two new Board members--Kathleen Farrell, Associate Professor of Finance at the University of Nebraska-Lincoln, and Kimberly Rath, Managing Director and President of Talent Plus. We are fortunate to have them join our Board and look forward to their contributions.

We'll now take your questions.

Thank you. (Operator Instructions.) We'll take the first question from Matt Snowling with FBR Capital Markets.

Yes, hi. A couple of quick questions. You mentioned that you're not, or you're cutting your borrower benefits more aggressively than some of your competitors, and I'm just wondering, can you give us a little bit more detail on how much you've cut that back relative to some of the competition?

Hi, Matt. This is Terry. The primary thing that we have addressed in terms of our borrower benefits is we've eliminated our front-end discounts, which have ranged from 2% to as much as 3%. And so those we would recognize over the life of the loan asset, similar to a premium or cost of acquisition.

But it's primarily, that's the upfront piece?

That's the primary piece. We've also reduced the back end of our benefits, which has a much less impact on the overall value that we have for these loans as well.

Okay. I think I heard you guys say that you expect the spread on the existing portfolio to remain around 100 basis points, but then with the new loans coming in well below that, does that imply that you expect the blended spread to drop below 100 basis points?

Yes.

Okay. And then one other quick question. You sold, I think, $3.2 billion of derivatives during the quarter. Can you tell how much benefit you received in terms of net interest income?

In terms of, it was a minimal impact in terms of net interest income. Most of that was in cash. We received about $50 million in terms of the cash unwind. That was all reported on the balance sheet as the mark to market, so there was no impact in the income statement with regard to that, and it had a minimal impact in terms of our spread. It probably had about a three- to five-basis point impact on the spread.

That won't be there next quarter, right?

Correct.

Okay, thank you.

Thank you. And we'll take our next question from Carl Drake with SunTrust Robinson Humphrey.

Yes, good afternoon. A couple of questions on, I guess, I know you're not providing specific earnings guidance, but maybe, in the past you had talked about the legislative impact on core spread going forward, and perhaps if it's, I think you said it was 70 to 80 basis points lower margins on new loans going forward. Should we think about that as, that coming into play over, gradually over a five-year period?

Carl, it will come into play as the loan portfolio turns over. The 70 to 80 basis points is before any of the measures that we've taken to mitigate some of that, and we will analyze how much of that we can mitigate over time going forward.

So the borrower benefit that you've cut back might offset 10 basis points of that, or something in that--10 to 15?

In terms of the upfront borrower benefits, which was the main thing that we, was impacted, was the 2% to 3% upfront cost, which would be amortized over the life of the loan. We're also looking to reduce our cost of acquisition, so all of those things will come into play over the life of the loan as we look to mitigate that cost.

Okay. In terms of asset growth, in the past you all have grown mid-teens, and I know the consolidation market is a lot trickier today. You didn't touch on Grad Plus either. Maybe you could talk about, maybe broadly, what you'd expect it to grow your assets over time in the new legislative environment.

Hey, Carl, it's Jeff. Give that there have been so many significant changes occurring in our industry due to the new legislation, and you couple that with the ongoing disruption in the credit market, and then you also along with the unprecedented opportunities we're seeing in the market due to these events, make it very difficult and not prudent for us to derive any speculative forward-looking asset growth guidance.

Okay.

However, we will update you in future calls as we see changes, opportunities, and the drivers in the business lines change.

It seems like here in the short term, you're taking the view that you're going to have some market share deterioration because of the, you're leaving the market in borrower benefits, so we should expect some pretty near-term impacts on growth?

We expect that, as we talked about in first the part of the call, that that could be possible. It's just too early, truthfully, to tell exactly what that impact's going to be.

And do you, on the fee-based side, you've been growing in--outside of enrollment management, I believe you mentioned, you've been growing in the high teens to 20%. Is that a growth rate that we should expect going forward?

Carl, as we continue to look to focus on the organic growth and investment in the organic growth of our fee-based businesses, we're going to look to continue to grow the revenue side as well as capitalize on the operating leverage that we can get, and so we'll continue to look at ways we can grow not only our tuition payment plan and our enrollment services but also our software revenues.

But is it, would there be any chance--you know, losing market share in the school channel, would that impact fee-based businesses, perhaps, on the growth rate?

We don't see a significant impact of the change in our asset generation activities having significant impact on our fee-based businesses.

Okay. All right. Thanks. I'll jump back in the queue.

Thank you. And I'll take our next question from Moshe Orenbuch with Credit Suisse.

Thanks. Could you talk a little bit about--I know you're not giving specific guidance on the margin--but the issues that came up in the third quarter and persist in the fourth, what could cause them to reverse, and over what time frame? How many of them are permanent, if any? Could you talk about that a little bit?

Sure, Moshe. This is Terry. I think the, some of the things that impacted the third quarter as it relates to the credit markets, we saw an increase in the asset-backed commercial paper spreads, which we use for warehousing. We have about $6 billion to $7 billion of our portfolio is actually financed in our warehousing line, and so we saw an increase in terms of the asset-backed commercial paper spread. Also, as we looked to swap out some of our capacity in terms of using our extendable commercial paper program with asset-backed commercial paper programs, we incurred some upfront costs as it related to adding capacity to those conduits, and the widening of the CP LIBOR spread also contributed to that.

In addition, we had some of our portfolio at a services auction rate. We saw a widening in that area, which all contributed to the 15- to 20-basis-point widening. We would expect that that would come back over time, though we think there will be some long-term carryover because of the efficiencies that we've been able to achieve as a market over the last few years. So we think it will take some time to get back down to those levels long-term.

I'm just going to add a little clarity to that also. If we look at what happened in 1998, the capital markets were pretty much back online by February or March. This seems to be a little bit different. It's not an exact copy of what happened in '98, and we think it could take essentially a longer period of time for the capital markets to come back to where they were at on the short end. Maybe it's three to nine months is our best guess, but if you look into your crystal ball.

So on some of the longer-term traunches that were used to finance consolidation loans or private loans or some of the subprime mortgages, it appears to us that those investors that were buying the long-term traunches in Europe and in other places don't exist anymore. And it could take a lot longer time frame for those traunches to come back into line, if they come back into line at all. We're talking about years. So from a financing standpoint, we're very confident that we're going to be able to do, say, the one-, three-, five-, or seven-year type traunches that we'd get at. For the longer traunches, we think those buyers are gone for the indefinite future.

Thank you. And we'll take our next question from Mark Sproule with Thomas Weisel.

Thanks. A quick one on the, I guess on the loan loss provision that you took this quarter for $15.5 million. What kind of a more normalized rate as you look forward given the loss of exceptional performance issues?

Well, we've seen--this is Terry--we've seen our default rates continue to come down, so it would be based on the performance of our portfolio. And then the amount of risk sharing that's related to the underlying loans. And the amount of risk sharing will range from as little as 1%, depending on when the loan was originated, to as much as 3%. So it will be, I think you could look at the total provision that we took this quarter less that $16 billion one-time charge as more reflective of a run rate.

Gotcha. And then you talked a little bit about opportunities for asset purchases given sort of consolidation of the market. What kind of pricing are you looking at? Has that dropped down significantly, given some of the legislative overhang?

Yes, as we look at the, some different portfolios have become available in the market. We think there are some real opportunities to buy some portfolios at prices that we haven't seen for a number of years.

Gotcha. And within that, you referenced that many of your competitors have been slow to react. Is there, aside from your just functional belief that they will react at some point--it's just a matter of time before they get their act together--is there sort of a difference in perspective as to how they're trying to counteract the legislative effects, or are they looking at it maybe as pushing FFELP as a loss leader over to the private loans, and how do you balance that against that kind of activity?

I think it's difficult to speculate on what the competition's doing in that front. However, we believe that for us, our strategy is the right strategy, and that is to diversify through fee-based revenues and position ourselves to grow in those manners.

Okay, and then lastly, on the fee-based side, how do you, are you starting to see some of the initiatives as far as leveraging from a margin perspective to get the incremental benefit from things like Peterson's and CUnet as you build out going forward? Thanks.

Okay, this is Terry. We will continue to focus on gaining that operating leverage. We saw an increase in the operating margins on all of our fee-based businesses this quarter, so that is something that we're very pleased about, and we will continue to look at focusing on the organic growth opportunities within the fee-based businesses and gaining the operating leverage that we believe is there going forward.

Thank you. And we'll move next to Mike Taiano with Sandler O'Neill.

Hi, good morning. Just a point of clarity. So essentially the decline in loan origination growth year over year, I guess it was like 30%. Are you saying that's almost entirely really attributable to competitors not being as aggressive in cutting the borrower benefits as you guys have been?

Mike, I think the other piece that you need to look at is the drop in the consolidation market that we saw. We expected to see a decline in the consolidation market moving into this year, and we did see that decline. So the combination of the drop in the consolidation market, and then some of the impact that we will see resulting from market dynamics post-legislation will drive that.

Yes, the market dynamics in the post-legislation will happen after October 1. The big difference year to year for this quarter is that the consolidation market is significantly smaller than it has been in the past. And our view of the future of the consolidation market is it's going to be non-existent.

Okay. And now has that, I mean, correct me if I'm wrong, but didn't you guys say, I guess at the beginning of the year, that you thought you would probably be flat in terms of the consolidation volume growth worsens and with the industry dropping perhaps 40% to 50%?

For the first core legislation changes, I would have said that and agreed with it. But the legislation changes, there really isn't a way to make a consolidation loan right now in a profitable way, and so you're not going to see us doing a lot in the consolidation market. I mentioned earlier about the long traunches, the buyers that buy for the 10- or 12-year traunch in a LIBOR-loaded piece of paper. That's what funded the consolidation loans. In the capital markets, there's nobody to buy those right now, and that's one side of the cost of funding is up. The second side is the legislative changes that happened with the cut in the consolidation market took it down to a level where we don't see how you can do consolidation loans, or a very, very small percentage of consolidation loans in a profitable way. So without the legislation changes, I think we could have potentially remained flat. With the legislation changes, we're seeing a significant decrease. And we started that, we started to pull back on that business in a big way in the third quarter because any loan originated after October 1 would have had the lower economics. It's basically been a wash for every one we made.

Oh, okay. And just in terms of from a competitive standpoint, could you maybe elaborate a little bit more on, in terms of competition, who it is that's really being slow to the change here? Is it more the not-for-profit agencies versus the for-profit companies that you're seeing? Any additional color you could give us on that?

Right now I would say that it's a pretty wide group of people that were waiting until the legislation actually passed before they made a decision, and now they're in the process of looking at the economics and making those decisions. And so the legislation didn't pass until the last week of September, so we've seen probably half a dozen competitors make similar changes to us. But there's a wide spattering of money center banks, large competitors, and tax-exempt secondary markets that still haven't come out and said what they're going to do. We think these changes will happen as people go through the budget cycle for 2008 and the finance people review the numbers. And as we go forward into the 2008, to the next academic year, which is July 1, it could take potentially a year for all the competitors to make the changes. It's going to happen. I mean, the numbers are the numbers.

All right. And just a last question. It doesn't look like your guys bought back any stock this quarter. Should we read into that that you're sort of stockpiling a little bit just to potentially acquire portfolios? Or is there some other reason?

I will tell you that. If you look at the, the potential uses of our capital, they would be to invest in organic growth, make strategic acquisitions, pay dividends, and then repurchase stock. At this time, we believe that prudence dictates that we enter into a capital preservation mode, as we are seeing multiple opportunities to acquire asset portfolios. We also believe that it's prudent to preserve capital in light of disrupted capital markets. So with both of these, both of those events and with our capital position that will actually allow us to take advantage or capitalize on the misfortunes of our more thinly capitalized competition at this time.

Thanks a lot.

Thank you.

Thank you. We'll move next to Sameer Gokhale with KBW.

Thanks. I just had a question on the, I think you mentioned in your commentary that there were some, an increase of the schools requesting the RFPs, and I was wondering if you could quantify that in a certain sense, just to give us a sense of our, how many schools have actually decided to increase the number of sort of vendors in their schools and potentially what the incremental opportunities could be there.

I'll tell you that. The new legislation affecting the creation of lender lists has dramatically changed the landscape of the market. In fact, it's changed the way we market our business. So as colleges and universities are now, we believe, primarily choosing lenders for their lender list due to RFP process, so you have to ask yourself, then, who is going to benefit from this process? And we believe it is the players with large scale, with long-term experience in the industry, and the financial strength in the form of real capital and capacity. So we think that leads right, this plays right into our business model. So the bottom line is we are seeing a significant increase in RFPs that we are receiving.

Okay, and then underlying this question is the pricing of borrower benefits that it seems like what you're saying is a couple of your larger competitors don't seem to have cut back on borrower benefits. Is that a fair statement? Are you saying that there seem to be smaller banks and the like also who aren't cutting their borrower benefits. But more specifically, if you look at the larger players, have they been doing the same, or in your view, have they not cut borrower benefits?

Some have and some haven't, but we have definitely seen some that said they're going to leave their borrower benefits the same until July 1 next year. Others have changed them. So it's a combination. Some have changed, some haven't.

Okay, and then in your commentary, I thought--and maybe I misheard--but I thought that you were saying that on the newer loans, given the change in economics, you might change the way you handle that the new loan origination, and I took that to mean maybe you'll go into more of kind of an originate and sell model? Did I hear that correctly? Am I interpreting it correctly? Can you just go right to the commentary on that?

Yes, this is Terry. I think we're going to look at all of our options as we continue to evaluate how we generate long-term, sustainable value, and part of that might be working in conjunction with our servicing clients. It might be the originate to sell of loans, or it might be, as Jeff mentioned, the portfolio of loans. So it will be a combination of all of those.

I'm just curious as far as selling the loans. Who would be buying the loans if the economics for scale players such as yourself would be, I guess it would make it less attractive where you get the portfolios loans and were attracted to sell them. Given that you have the scale, who would be the likely buyers of those loans?

In some geographic regions, you have tax-exempt secondary markets that can issue tax-exempt debt on the one side. On the other side, the way the legislation came out, they get a little bit more yield, I think an extra 15 basis points. On the other side of that equation, though, I think the gross amount of tax-exempt debt that can be issued annually is around $5 billion, and we're talking about a student loan market that's well in excess of $50 billion. So the amount of loans that those tax-exempt secondary markets are going to be able to provide liquidity on is going to be just a small percentage of the total market. So there are going to be some potential opportunities in different geographic regions where we'll work some of our servicing clients and make them leverage off of our scale and efficiencies in servicing. We can leverage off of their efficiencies with their ability to issue tax-exempt debt and get that extra 15 basis points in yield.

Okay. That's really helpful, fellows. Just my last question is this idea of paying, paying dividends and I think you expect to continue to pay dividends, but referencing in some of these changes, the legislative and comparative standpoint, does it make sense to suspend the dividends in the future, at least until some of those things clear up? And how do you think about that?

Well, we have a very, very strong capital position, and we think there are a lot of opportunities. If we sense that there are some opportunities that are bigger, that we can currently handle with our cash flow, it's something we might consider. But I can tell you right now, whereas I look at the future and the strong cash flow we have, I don't anticipate any situation where we would suspend the dividend at this point.

Thank you. And we'll move next to Eugene Fox with Cardinal Capital Management.

Thanks. Mike, with respect to the strategies that you've articulated, I sense you haven't acted yet aggressively to acquire portfolios or make acquisitions. From your comments, it appears that growth outside of the FFELP program in terms of these fee-based businesses are priority one. Are you all sort of waiting to see how the landscape ferrets out over the next several months before you decide how to allocate your capital in terms of taking advantage of some of the opportunities that you articulated (inaudible)? Thanks.

We are actively bidding on portfolios as they come to the market. We've seen a few portfolios that we've bid on. We were not the winning bidder. The buyer that won the bid failed on the purchase, didn't have the liquidity to buy the loan. Now we're seeing some of those portfolios come back around and we're bidding on them again. So we are actively bidding on these portfolios and looking for the opportunities to buy them at attractive prices. You are correct--we haven't had a lot of success in that in the third quarter. We think our strong capital position and strong liquidity position has us well positioned to take advantage of this going forward in the future, the next three to six months. So time will tell whether we get some of those portfolios bought or not, but we have a, I have a pretty high confidence that we're going to get some portfolios purchased.

With respect to the investment in our fee-based businesses, we're going to continue to invest significantly in our R&D and grow those businesses as we go forward in the future irrespective of what happens with our ability to either add to our servicing portfolio or buy additional student loan assets as people liquidate their portfolios.

We should assume that the prices or levels you find reasonably attractive won't necessarily be the low bidder, so you would be aggressive?

We are putting in what we think are fair price, fair bids to purchase these portfolios. We're not, as we look at all of our different businesses, I think we've been really consistent in this over time and will continue to be consistent in the future. We're not going to probably be the top, the highest bidder in all situations, but we are going to get a fair return. We're not going to take it down to the nub and try to get a minimized return. We like, we're not, I've said this like a number of times. We don't want to grow for growth's sake. We want to grow in a profitable way. And that's how we determine what our bid's going to be.

Thanks.

Thank you. We'll move to next to [Rohan Handas] with JPMorgan.

Hi. I just wanted to ask you that, I understand that your plan going forward is to diversify revenues and grow your fee-based business to offset the lower margin in the FFELP product. Now, have you thought about any higher-margin products such as increasing your private loan portfolio or consumer credit cards that can be sold across your existing customer base?

Private loans is one piece of our diversification along with a half dozen other things that we're doing in the fee-based businesses to diversify our business. In the past, our risk tolerance has served us well in the private loan business. We're comfortable with the delinquency and default rates that we've had in that business. And we really want to stay inside of our circle of confidence when it comes to private loans. There are some other players out there that have been more aggressive in the private loan business, and honestly, it's outside of our circle of confidence, and it's one of our diversification plays. It's only one of a half dozen different things we're doing. It's not the only thing that we're doing.

Okay. And now just a follow-up question. You mentioned that there are two new Board members. Did they replace any existing Board members, or are these incremental to the company, that they increased the size of the Board?

We had two vacancies as of the May annual meeting, and we have filled those vacancies with these two new people. We are very excited about the new Board members that are coming on.

Thank you. And we'll move next to Robert Tracy with Kynikos.

Yes. You mentioned that the price of loan portfolios seems to have come down a little bit. Could you maybe quantify that a little bit? And is that, how much of that is a function of the credit market and how much of that is a function of legislative regulatory changes?

I think primarily the portfolios we're looking at were originated prior to the legislative changes. But that being said, a certain percentage of loans are going to consolidate, and so if you have a loan that was originated prior to 10/1, and it consolidates after 10/1, it's going to lose its value, so that has had a, put a pressure point on what the price was on portfolios that originated prior to 10/1 because of that consolidation risk after 10/1.

As far as putting a number on it, I feel uncomfortable sharing what the numbers, what we think the numbers are at this point in time, because it's a competitive situation. We're bidding on different portfolios. I think you can probably go back and look in the past on what different portfolios have bought and sold for. But we think that given the legislative change, the consolidation risk, and the credit market, as I mentioned, having an impact on people's liquidity, it also can have an impact on their long-term cost of funds to fund certain types of assets like private loans or consolidation loans.

Okay. But, okay, that's very helpful. And then in terms of the enrollment services, it looks like the revenue there was up like 19% or 20%. You indicated that part of that is Peterson's and CUnet. I know those acquisitions happened, probably, I think at the beginning part of the third quarter last year. How, I guess I'm trying to understand. Is there, what's the organic revenue growth?

Yes, this is Terry. That is largely all organic growth. When I said that was driven by Peterson's and CUnet, that was largely on the year to date. So we're very pleased with the performance of that segment. We continue to look at ways that we can increase the operating margins and drive efficiencies through both our lead generation and other planning and prep activities. So we're very pleased with that.

So the, like I see it's a 20% growth rate on the revenue line. Could you talk a little bit in terms of how much of that is from pricing versus how much of that's just more flow?

We haven't done anything in our business model to, as an example of significantly reduced pricing to increase flow. Our consistent focus is to grow our revenue and grow our value in whatever business we do, whether it's a fee-based business or asset generation business.

So, no, I guess I (inaudible). My question is how much of that was from pricing, like you've increased prices versus how much of it was being able just to profit from more flow, in answer to my question?

Yes, and our focus has been on the organic growth rather than to try and drive revenue through price. I think our price has been consistent, to answer your question.

Okay. And so then, so then in terms of the enrollment services, it seems like it's going very well. Is there, could you explain the impairment charge, the $11.4 million on the assets in the services?

Sure. The impairment charge related to when we acquired Peterson's, part of our objective was to be able to leverage that activity into asset growth. With the change in legislation and the value of new assets going forward, we felt it prudent at this point in time to take the charge and reduce the goodwill that was recorded as part of that acquisition.

I'm sorry, but that's on all the services, right?

Right, because Peterson's is part of that segment, and so the charge against the goodwill when we acquired Peterson's was taken in that segment, although it was taken at the time because of the reduction in future loan value that we thought we might be able to leverage that acquisition.

I see. And so that's all a goodwill charge, then?

Yes, it is.

All right. Thank you very much.

Thank you. And we'll go next to [Lance Eddes] with [Motor Rock Cassell].

Hi. I have, I have a suggestion, actually, and a question. My suggestion is that, you know, we looked at your business going forward, and we feel very comfortable that you will be able to meet that mid-teen ROE. And, but I just think that, judging by the tone of this call, that you haven't laid it out. I mean, why not just lay out what the old costs were on the old spread and lay out what the new changes going forward are, and you can easily see that the spread's probably going to be about, maybe even up to 50 basis points. And you can come out with a very attractive ROE even at much lower levels.

And my question is, is that you guys talked about that you're seeing potentially very attractive opportunities out there and that that's the reason why you're really not actually buying stock back. To me, with your stock this low and really under liquidation value, those opportunities, I imagine, must be incredibly attractive. And so my question is one, have you measured those against your current stock price, and two, what are the, are there any other options you would have besides buying sort of loan assets?

Well, as we look at the market that we're in right now, there's a lot of transition going on, and there's a lot of volatility, and that's both true in specifically the asset generation market. It's also true in the capital market. There are a number of opportunities that we're looking at, and we think it's prudent to preserve our capital for that. There's also a major disruption in the capital market, and we think it's prudent to keep our capital for that. And we do, on an ongoing basis, compare those different opportunities between the opportunity of buying back our stock when it's prudent. And for the last quarter, we thought that given the disruption in the capital market and given the transition and volatility that our market's going through, it wasn't prudent to buy back our stock in the last quarter.

Thank you. We have no further questions. I would like to turn the conference back over for any additional or closing remarks.

I want to thank everybody for joining the call today. We're very, very excited about helping families and students meet their educational goals, and we're going to continue to focus on our customers, our associates, diversifying our revenue streams, and giving back to the communities we work with and live in. And in doing so, we're very, very confident that we're going to see long-term value being created by focusing on those goals. Everybody have a great day. Thank you.

Thanks. Ladies and gentlemen, that will conclude today's conference. We do thank you for your participation, and you may disconnect at this time.