Nelnet, Inc. (NNI) 2008 Q3 法說會逐字稿

Good day everyone and welcome to Nelnet's third quarter 2008 conference call. Today's call is being recorded and broadcast live over the internet. At this time for opening remarks and introductions, I would like to turn the conference over to Mr. Phil Morgan. Please go ahead.

Thank you, Dustin. Good afternoon and welcome to Nelnet's 2008 third quarter conference call. On today's call, Jeff Norrdhoe, President and Jim Krueger, Controller, will be making formal remarks and Mike Dunlap, Chief Executive Officer will be joining us for the question and answer session.

Please note during the conference call, we may discuss predictions and expectations that may make -- and may make other forward-looking statements. Actual results may differ from those discussed here, based on a variety of factors. These factors are discussed in the Company's Form 10-K and other filings with the SEC. The Company does not intend to update any forward-looking statements made during the call.

During the course of the call, we will refer to a non-GAAP financial measure which the Company defines as base net income. A description of base net income and a reconciliation of GAAP net income to base net income is included in our Third Quarter 2008 supplemental earnings disclosure, which is posted at our Investor Relations website at www.NelnetInvestors.Com.

After Jeff and Jim have concluded their formal remarks, we will open up the call for questions. Thank you, and now I'll turn the call over to Jeff.

Thanks, Phil and good afternoon, everyone. As Phil mentioned, joining me on the call is Jim Krueger, our Controller. Jim is filling in for Terry Heimes who had surgery for a knee injury making him unavailable to join us on the call. One of the things we've worked on over the years is developing a strong bench in our associate base and most of you know, Jim works alongside Terry in the preparation and analysis of the financial statements.

In short, we are quite pleased with our results for the third quarter. While operating in an unprecedented period of market disruption, our performance this year demonstrates the strong fundamentals of our Company, including our diversification into fee based businesses which have significant growth opportunities and operating margins. On today's call, we plan to discuss three items that have impacted operating results of the Company: Strong revenue generated from our fee based businesses and better than expected student loan spread, lower operating expenses and an update on our liquidity. Before I discuss our liquidity, Jim will address our operating results. Jim?

Thanks, Jeff. As Jeff indicated, we reported very strong earnings for the third quarter. Our earnings performance was driven by increased revenue from our fee based businesses, better than anticipated core student loan spread, and reduced operating expenses.

Let's start by reviewing the high level financial results. Our GAAP net income for the quarter was $0.48 per share. Our base net income was $0.47 per share for the third quarter compared to $0.54 in the second quarter and $0.45 per share last year. We continue to be pleased with our revenue growth and significant operating margins from our fee based businesses. During the third quarter, our total fee based revenues was $76.7 million an increase of $4.6 million from last year. Our enrollment services, tuition payment and campus commerce businesses continue to perform well. Total revenue for these businesses was $39.4 million an increase of 27% from last year. It is important to remember these businesses are not related to the federal student loan program and there for have little legislative risk.

Not only do we continue to focus on growing our fee based revenues, but also in making sure we allocate appropriate corporate overhead to our various business units for improved transparency and analysis. Operating margins for our fee based businesses for the third quarter remained healthy at 20% and excluding the allocation of corporate overhead the margin was 28%. We continue to focus on decreasing the operating costs related to corporate activities. Core student loan spread remains strong at 102 basis points for the quarter compared to 107 basis points during the Second Quarter. The compression and spread was due to a reduction in fixed rate floor income and the full impact of AVS transactions completed during the Second Quarter. Spread benefited in the third quarter due to the relationship between CP and LIBOR indices. We would expect the core student loan spread to remain relatively stable in the 90 to 100 basis point range in the Fourth Quarter and in the First Quarter of 2009.

In October, we did see an unprecedented divergence in the CP LIBOR spread when the world's major banks ceased lending to each other; however, because of the timing and limited duration of this event it is not expected to have a significant impact on our Fourth Quarter results. However, our spread could be impacted if there was a prolonged spike or divergence in the CP LIBOR indices. Operating expenses for the quarter decreased more than $15 million or 13% compared with last year and $56 million or 16% year-to-date. The decreases would have been greater but operating expenses for the third quarter include a $2.8 million of severance and retention costs related to strategic operating decisions. There will be continued focus on operating efficiency throughout the enterprise with particular attention on information technology, operating systems, and loan origination and servicing platforms. Those are the highlights of our earnings for the quarter.

I will now turn the call over to Jeff to address our liquidity.

Our short-term liquidity is primarily affected by two items. New loan originations and the mark-to-market provision included in our $2.1 billion [FELP] warehouse facility. We have originated more than $400 million of federal student loans this quarter, all new loan originations are being funded through the government participation facility. In addition we are encouraged that Congress extended the ensuring continued access to student loans act for a second academic year. In the spirit of this legislation, we are committed to making federal loans for all students attending all eligible school through the 2009-2010 academic year.

The main pressure we are receiving on our liquidity is coming from the mark-to-market formula used to value loans included in our [FELP] warehouse facility. This has resulted in a significant equity contributions to support the federally guaranteed loans in this facility. This mark-to-market valuation formula is mostly driven by current spreads in the asset backed securities market. As you know, ABS spreads have continued to widen as these security liquidated in an unprecedented manner. Without an active market for these securities, we believe the mark-to-market formula is broken and unreasonable. As of today, the mark-to-market formula has required us to post $375 million as equity funding support including $165 million in October. This level of equity support implies a value on the loans of approximately $0.83 on the dollar. This seems irrational given these loans are guaranteed by the Federal Government, are available rate assets and can be pledged by the banks to the Federal Reserve at a 90% advance rate.

Another example of the irrational amount -- of the rational amount of equity support for these assets is the fact that are thousands of banks in America that could own these loans on their balance sheet and earn a return on equity in excess of 25%. We have utilized our $750 million unsecured line of credit to fund the equity advances and have $51 million available for future use on this facility. In addition, as of last week, we had over $100 million in cash, approximately $90 million of unincumbered private loan assets and approximately $80 million of our own unincumbered subordinated bonds. To reduce our exposure to the mark to market advance rate provision, including our warehouse facility, we have signed a letter of agreement engaging Banc of America Securities to a range an amendment certain of our credit facilities including but not limited an amendment to place a floor on the valuation of collateral in our FELP warehouse conduit for which Banc of America acts as administrative agent. Banc of America Securities has commenced the a commendment process and together with us, is seeking approval of our lenders of a proposed amendment of such credit facilities on mutually agreeable terms.

In addition, the Department of Education has announced a new funding facility for government guaranteed student loans awarded after October 1, 2003. We believe approximately $900 million of loans in our warehouse will be eligible for this program. We are also encouraged by Secretary Paulson's remarks today in which he said, " With the Federal Reserve, we are exploring development, the potential liquidity facility for highly rated triple A asset backed securities. We are looking at ways to possibly use the TARP to encourage private investors to come back to the troubled market by providing them access to federal financing while protecting taxpayers investment. Addressing the needs of the securitization sector will help get lending going again, helping consumers in supporting the US economy". He also indicated the goal for the program is increase the supply of consumer credit including student loans. We believe this type of program would reduce ABS spreads and improve mark to market valuation in our warehouse facility.

Finally we continue to look at various alternatives to remove loans from the warehouse including other financing arrangements and/or selling loans. We are encouraged by these recent events and announcements and believe they have the potential to alleviate the liquidity pressure the Company is facing related to the mark-to-market positions in our FELP warehouse facility. With that I'd like to now open the call to your questions.

Thank you, sir. (OPERATOR INSTRUCTIONS). We'll take our first question from Sameer Gokhale with KBW.

Hi, thank you and good afternoon. I guess my first question is it would be helpful to get a sense for what kinds of discussions you've been having with B of A or the other lenders in your warehouse facility. Clearly you've pointed out the low credit risk associated with these loans and it doesn't seem rational for these loans to be valued at $0.83 on the dollar. Have you put it point blank to the lenders saying you've gotten TARP funding from the Federal Government, if you aren't going to lend against these zones, what other loans will you lend against, just would be helpful to get a sense for how those discussions are going and what pushback you might be getting from your warehouse lenders.

Sure, it's Jeff. We have engaged Banc of America and we have addressed all the issues around what we believe is the in rationality on the mark. I would tell you that in general, almost all of the banks agree that it is irrational in the given market. So we are in the process of negotiating with then as a whole to alleviate that and we'll give you a further update as we go through the process but right now, we're right in the middle of it.

Okay, thanks, Jeff and then the other question I had was Moody's recently downgraded your debt because of concerns over liquidity. Now, if and when the BOEs plan to fund older loans as finalized and that would free up say a third of the cash and equity trapped in your warehouse for the support you're providing, would that result in an upgrade of your debtor how will the rating agencies perceive that? Have you had those discussions with them?

Well to start obviously we disagree with the Moody's ratings action. That said, you are correct with the government program, there would be a significant reduction in the warehouse line and significant freeing of capital and so we will, we are and will be continuing to make those same arguments to the rating agencies and we can't tell you how it's going to turn out but we obviously believe strongly in those arguments you just laid out.

And actually I just had one last question which was on a different topic. Looking at your lender partner originations, I think they were up year-over-year and if I recall correctly there was some timing issue between Q2 and Q3, but it would seem at least from what we are hearing that other banks are less interested making FELP loans so should we be expecting to see the lender partner originations decrease over time or how should we think about that?

We see our primary originations in the future coming through our own channels. We have seen decreases in the lender partners channel. That said we saw some timing differences where we accelerate some purchases in the last quarter and that's how we see it in a go forward basis.

Okay, thank you.

(OPERATOR INSTRUCTIONS). We'll go next to Matt Snowling with FBR Capital Markets.

Hi, guys, how you doing? Just maybe a follow-up on the last question, with the announcement of the TARP and the new conduit shouldn't that return the market to a more rational pricing level in terms of the mark-to-markets?

I mean the short answer is we absolutely believe it should. We have to wait to see if that happens in the market but we believe it should.

Yeah, I know it's a little irrational out there but just if they're buying loans through the conduit at somewhere around par, one would believe that it would return the market almost immediately, right?

We'll wait and see but we are very hopeful.

Okay, can you give us any specifics in terms of the announced conduit, in terms of will they be buying loans at par or probably more importantly, do you have any sense as to what level that conduit could issue commercial paper at?

Sure. Well, generally let me give you an update on where that is. So the government has announced that it will provide liquidity support to the conduit. It has essentially delegated the creation of that conduit over to the student loan industry which is great news because obviously ourselves and our competitors are highly motivated to get that up and running and in place and in a workable manner, so we expect something near a 100% or par advance rate. We don't know what the exact number is. We haven't released it yet but we set something close to par.

And will there be a fee paid to the government to sponsor the conduit?

We have not seen any details on that yet if there's going to be a fee.

Okay. All right, I guess we'll wait and see. Thanks.

We'll go next to Moshe Orenbuch with Credit Suisse.

Yeah, Jeff, I'm just wondering if you could kind of look out a little while, kind of think about what's the prospect kind of post these government programs? How does the FELP program look whenever the government decides to end this or do you think that they kind of sustain this over the kind of intermediate term beyond 2009 year?

It's a great question. Let me tell you how we see it which is right now, we've got funding for new loan originations through the 2009-2010 season, that's been passed through Congress and has been approved the Department of Education on what they are going to do. That handles all new loan originations. We also have this funding facility that's coming up in place to handle all the Stafford and Plus loans that have been originated since 2003 that are trapped out there so that's great news in creating liquidity so ultimately what does that mean? What we believe is that two programs operating make sense in today's environment into the sense that the FELP industry is providing $50 billion plus annually of new loans to the student market, and so it's a highly needed.

I would also tell you as it relates to all of this that throughout time in the FELP program, so over the last 30 plus years, the industry has always had a government back stop in place in case the capital markets disrupted, up until recent times, that back stop was Sally Mae which was a GSE, and that was borrowed from the federal financing bank to fund the rest of the industry if there was a disruption and that had happened every time there was always a back stop. This is the first capital markets disruption or large capital market disruption we've seen since the GSE status going away so once again the government has had to step into provide liquidity like it always has in this market since the beginning of the FELP program. So, again, to summarize we expect the two programs to compete from everything we're hearing on a go forward basis.

All right, just to follow-up on that, the interesting thing about that observation is that when that was happening, Sally Mae was funding cheaply and even more recently you and Sally Mae were funding cheaply so you were cost competitive with the direct program. As you kind of look out two years from now, it will be harder to make that statement I guess, right?

I think the other thing, this is Mike Dunlap. The other thing that you need to take a look at is how much debt does the government want to put on their balance sheet and if there's a way to have a public/private partnership to keep some of that debt off the Federal Balance Sheet, we think that this is a great program that can do that and if you look at the number of loans being originated over the next 10 years, it could be a trillion dollars of guaranteed student loans and if there's a we for that to not show up on the government's balance sheet we think that's another real valuable argument, more so now than ever, given all of the other things that are going on to add to the federal deficit.

Gotcha, thanks.

And gentlemen, with no further questions in the queue, I'd like to turn things back to Mr. Noordhoek for additional or closing comments.

In closing, it's important to remember the fundamentals of our business remain strong. Approximately 90% of our portfolio is financed to term for the life of the loan at rates which will create a significant and valuable cash flow stream for the Company of $1.4 billion. We have capital and liquidity for new loan originations with the government participation and [PUT] programs and it's the opportunities for growth in the loan generation area. We have maintained the value of our service and delivery platforms while reducing our operating costs in excess of $56 million for the first nine months of the year. We have developed a broad, diversified offering of fee based businesses with significant growth opportunities and operating margins and we have a strong capital base with which to create long term value for our shareholders. We are encouraged by recent events and announcements that can improve our liquidity concerns relating to the mark-to-market provisions included in our FELP warehouse facility. Thank you all very much for your participation in the call this afternoon. Have a great day.

Again that does conclude today's conference call. We would like to thank you for your participation and you may disconnect at this time.