Nelnet, Inc. (NNI) 2008 Q4 法說會逐字稿

Good day, everyone, and welcome to Nelnet's fourth 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'd now like to turn the call over to Mr. Phil Morgan. Please go ahead, sir.

Alright. Thank you, Jay. Good afternoon, and welcome to Nelnet's 2008 fourth quarter earnings conference call. On today's call we have Jeff Noordhoek, President, and Terry Heimes, Chief Financial Officer.

Please note that during the conference call, we may discuss predictions and expectations, and may make other forward-looking statements. Actual results may differ from those discussed here, and 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 our 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 in our fourth quarter 2008 Supplemental Earnings Disclosure, which is posted on our Investor Relations website at www.nelnet investors.com.

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

Thanks Phil, and good afternoon, everyone. Given the global credit crisis, we are pleased with our 2008 results. The strength of our diversified business model helped us achieve positive operating results, despite the unprecedented reduction in liquidity for consumer loan assets.

Since we have received so many questions regarding the President's budget proposal, I will hit the issue head on before I discuss our evolving business model and our annual results. While we appreciate the proposal's focus on making college accessible, we obviously disagree with the recommendation to go to 100% direct lending, and believe Congress should go in a different direction as it considers what is in the best interest of American students and taxpayers. We are confident the budget proposal will receive a full public debate before it's completed by Congress. We look forward to being a part of this conversation to help shape the Federal Student Loan Programs for the future.

As we have stated many times, we strongly support keeping both loan programs in order for the nations's students to maintain benefits of choice, competition, and stable access to loans, while retaining the infrastructure in place for private capital to fund loans when the capital markets do stabilize. The FFEL Program has provided efficient uninterrupted access to student loans for over 40 years, and today serves students at more than 4,000 colleges and universities. Students and schools have overwhelmingly selected the FFEL Program because it provides students with the benefits of consumer choice, competition between lenders, and superior customer service.

In the midst of the credit crisis, we are continuing to provide loans to any student attending any school in the country. Through the government-provided participation facility, we have liquidity to fund all new loan originations, capitalizing on our infrastructure and delivery systems. Of the all of the credit programs that failed in the credit crisis, the one that continued to function through it all has been the Public-Private Partnership for Guaranteed Student Loans.

Shifting to a 100% government lending monopoly will drastically increase the federal deficit by up to an estimated $1 trillion in ten years, which seems illogical, given the current proposed growth in the national debt. This proposal also seems to be inconsistent with other new government proposals for public-private programs to help get capital flowing, such as to have, TALF, TARP and the CPFF, to name a few. The FFEL Program is a shining example of how a public-private partnership has generated hundreds of billions of dollars of private investment in consumer loans, even in the midst of the credit crisis.

With all of that said, regardless of the outcome of the budget proposal, earnings and revenue diversification continues to be our number one priority, and our business model has us well-positioned for significant changes in our industry. In 2008 we earned approximately $300 million in fee-based revenue. Consider that, even if you would have monetized the entire value of new loan originations in 2008, it would have represented less than 15% of our normal operating income. In addition, we have submitted a very competitive bid to service direct loans. We have been a leading student loan servicer for more than 30 years, earning a reputation for quality.

We are confident our pricing is competitive, and our service levels are high, and importantly, we have a market differentiator of keeping our jobs right here in the USA. We feel this is important, as we participate in a federally sponsored education program. For these reasons we feel we have a good shot at serving students under this contract, which provides another opportunity for fee business growth.

In 2009 we will continue to transform our business model to focus on education, fee generating businesses, that are not capital or balance sheet intensive, have operating margins, and generate significant cash flow. We have felt for some time that our business model and the cash flows it generates are being significantly undervalued, especially in light of the market reaction to the budget proposal last week. We believe that at some point, our earnings will start to drive our market valuation. We have no doubt that growth and diversification of our revenues, combined with the value generated by our existing portfolio, has positioned us well for future success.

Now I will turn the call over to Terry to discuss our operating results. Terry?

Thanks, Jeff. First off, let me apologize for any convenience caused by our decision to delay our earnings release until this morning. While we employ relatively [vanilla] derivative products, the need for KPMG to independently model and review the recorded market value caused the delay. There was no disagreement between management and the auditors, no issues of internal control or numbers in the financial statements. We just needed to allow enough time for everyone to do their job and reach the appropriate comfort level prior to the release. KPMG has also apologized to the Company for the unexpected delay.

Turning to our results, we reported strong performance for the quarter and for the year. In the midst of one of the most challenging economic times in our country's history, we were profitable, had strong cash flow from operations, and our financial position improved, not something everyone can say in this environment. Our GAAP net income for the year was $0.58 per share. For the quarter it was $0.63 per share.

Our adjusted base net income, or our base net income excluding the unusual items that won't impact run rate, was $1.72 per share for all of 2008 and $0.32 per share for the fourth quarter. Our tangible equity to tangible assets increased to 1.96%, compared to 1.67% at the end of 2007. Our 2008 results reflect our focus on liquidity, diversification, operating expenses, and the legislative developments related to the Student Loan Program.

We dramatically improved our liquidity position during 2008, reducing the amount of loans in our warehouse facility by more than $5 billion. During 2008, we issued more than $4 billion in asset-backed securitizations in a very difficult market. We were also able to execute whole loan sales totaling $1.8 billion. Through these activities, we created liquidity and reduced our risk to mark-to-market valuations.

The loan sales resulted in a $4 million loss recognized in the fourth quarter. Also during the fourth quarter, the Company incurred $13.5 million in non-recurring expenses related to contingent liquidity planning activities. We have excluded these fees and the loss in the sale of loans from our base net income for comparison purposes.

We continue to be pleased with the growth of our non-student loan-related fee-based revenues, specifically our enrollment services, tuition payment plan, and campus commerce businesses. During 2008, revenue from these businesses was $153 million, an increase of $25 million or 20%. We believe these businesses will continue to provide significant growth opportunities for us in the future.

While continuing to focus on growing and diversifying our revenue streams, we also took a very aggressive and proactive approach to managing and reducing our operating costs. Excluding restructuring, impairment and other charges operating expenses decreased more than $18 million or 16% for the quarter, and $75 million or 16% for the year. Creating efficiencies and reducing expenses will remain a priority for the Company as we move into 2009.

So from a financial performance perspective in 2008, we reduced our liquidity risk, we continued to grow and diversify our fee-based revenues, and we've reduced our operating costs, given the change in the economics of the Student Loan Program and economy in general. We also continued to benefit from our existing portfolio, which will serve as an annuity for us over the next several years.

Related to our existing portfolio, core spread for the period was 90 basis points, stabilized by the temporary solution implemented by the Department of Education to deal with the dislocation of the 90-day, H.15 CP and LIBOR rates. In mid to late fourth quarter, we saw the beginning of a sustained and unprecedented divergence in the CP LIBOR spread. While mitigated by the Department's actions and clarification for the fourth quarter of 2008, this issue remains at the forefront of the industry.

Again, given the challenges and the market volatility during 2008, we are pleased with our performance. We believe we have taken and will continue to take the proactive prudent steps to position the Company for continued success. I'll now turn the call back over to our operator for questions.

(Operator Instructions). Sameer Gokhale with KBW. Thank you, I just had a few questions.

First one was, Terry, you were talking about the $13.5 million dollars pretax for the liquidity contingency planning charges. Can you tell me exactly, can you explain what that is exactly?

Hi, Sameer. It's Jeff. In the fourth quarter as the ABS market continued to widen out and people started to become concerned about the mark-to-market on the warehouse line, we took numerous measures to protect the Company, and way I describe it is we put in a liquidity plan, and we put in a back-up to a liquidity plan, and then we put in a back-up to the back-up plan. All of those things came with an expense, but they were one-time in nature. So we would not expect to incur those charges in the future, as the Company's liquidity has dramatically improved and the market has dramatically improved since that time.

So can you explain it another way when you say had you a back-up and a back-up to a back-up, what does that essentially mean? Does that mean that you have no funding issues whatsoever, because I know you still have some loans on the warehouse, and you have I guess $1 billion or so of loans that you expect to fund either through the TALF or the conduit facility, but is this a contingency in the event that you can't access either one of those two, how should we think about these back-ups and the back-ups to the back-ups?

The way I would look at it is, we arranged for alternative financing if something came up in [this facility]. So we created liquidity contingency plans that would have been in place if there had been an issue, although there was not. It was just essentially back-up liquidity planning.

Okay. In terms of, I think you mentioned that you bid on the contract for servicing Federal Direct Loans. Have you also bid on the contract of service FFELP loans that could be put to the government. Is that the same thing or are you thinking of those two thing separately?

It is all in the same bid. So it could be for either or.

Okay, and when do you expect the results of the bid to come out? Wasn't there supposed to be an initial round of who is going to be going to the final round, are there some things to be announced this week perhaps, maybe as early as this week?

We don't have any definitive timing on when we expect to hear back on that bid, so it is up in the air at this point in time.

Okay. Then just my last question, I don't know if you had a chance to review the latest terms of the TALF that were released today, but I think effectively what that does is it reduces some of the funding cost from, say, LIBOR plus 100 to LIBOR plus 50 basis points, and then also reduces some of the haircuts. I was wondering if you had a chance to go through those changes, and how one would think about where the pricing for FFELP securities would eventually end up in the TALF? I don't know how you might have thought about this, or how you think about it from the perspective of an investor, and returns that they may get, relative to other securities? So, would love to get your thoughts on that if had you a chance to look at the document.

Sure, we did see that the TALF was launched today. We did see that the haircut was lowered, or the advance rate was increased for guaranteed student loans and cost of funds was lowered to LIBOR plus 50, so we were extremely encouraged by those developments. So the way we look at it is, that investor can fund itself at LIBOR plus 50, plus whatever return it needs to achieve to finance assets. So again, we think these are all positive developments, and think it will really open up the opportunity for student loans to be financed under TALF.

But do you have a sense at this point, I know I'm putting you on the spot a little bit here because it's still a little too early in the process, but relative to agency [MBS] or treasuries, or other types of alternative securities, which are also considered to be effectively either explicitly the full (inaudible) credit of the U.S. Government or with the guarantee, like you have in the case of student loans, where would you envision your funding costs going for those securities, based on where the markets are on the relative basis for the other kind of securities?

Sameer, I think it is too early to tell. The market is absorbing all this information today. I think in the next few weeks we will see transactions come to market, and we will have a better idea what have it looks like.

Okay, that's great, thanks, Jeff.

We will go next to Mike Taiano, with Sandler O'Neill. Hey, good afternoon guys.

Just a question on the President's budget proposal. And you mentioned that you are going to work with Congress in coming and helping to form a solution. I was wondering if would you mind just sharing with us how you are thinking about or how you will approach Congress on this front, in terms of coming up with an alternative solution? Could it potentially be this A-plus funding conduit vehicle? Is that sort of what you envision as maybe being the longer term solution for FFELP?

It's a really good question. The way we will approach the situation and we have been approaching as always, is to enter into the public debate to let our views be known. The key, as we see it, is that the program has to, number one, serve students. So how do we best deliver loan funds to students, while preserving the capital markets that can do that while, creating choice and competition to deliver that. Again, I think that the program will evolve, clearly that the market is disrupted, we do not have a clear view exactly how it will evolve or what the outcome of the debate will be.

That said, regardless of how it comes out for us, we feel as though we are positioned well to capitalize on the situation, no matter what happens. And that again as it stated in the script, that our income from new loan originations last year, if we'd monetized them, would only represent less than 15% of our total operating income. So, again, I think regardless of the outcome, we will be well-positioned to capitalized on the opportunity.

Thanks, and on the topic of the A-plus funding vehicle, I know the initial intent was to get that going by the end of February. What's the hold up there? I had heard that you are still waiting for Moody's to sign off on it? Is there any feedback from investors in terms of their appetite for that paper at this point?

I would tell you that with all new large multi-seller, multi-participant programs the process moves slower than we would hope. And so I don't have a clear incite of when it will be completed, but we are optimistic that in the coming weeks, months, that will be up and running and it will create additional liquidity for the industry.

Okay. And I just separately, I know you gave the operating margin for each of your respective segments. I apologize if this is somewhere in the queue, but do you have the operating margin for the Enrollment Services business "x" the List Marketing Services component, which I assume is weighing down the margin in that business overall?

It is. That would be right around 9%.

9%. Okay. And Terry, do you also, can you maybe give us a sense for just looking into 2009 where you expect the core spread to trend? Should it be relatively close to the 90 basis points and would you say your expense run rate going forward on a quarterly basis should be somewhere south of 100 million per quarter?

Depending on what happens with the CB LIBOR first quarter fix, that 90 basis point is where we would, assuming a similar treatment in the first quarter as the fourth quarter, we would expect the first quarter rate to be right in that 90 basis point area as well. In terms of the run rate, the fourth quarter run rate adjusted for kind of the unusual activity, specifically the 13.5 million, is a pretty good run rate.

Okay. Thanks a lot, guys.

We will go next to May-Kin Ho with Goldman Sachs.

Good afternoon, just two questions. The first question was on the GIC investment that was mentioned in the K. Can you explain what that is? It looks large having a large exposure to one financial institution that's rated A. Can you frame that institution?

Sure. It's a guaranteed investment contract that holds reserve funds in one of our outstanding bond issues. The counter party is very highly rated, but it does have a trigger upon the reduction. It's a triple-A rated counter party. We have the ability to exit or terminate that in the event of downgrade below single-A - - downgrade below double-A. So we have the ability to get out of that. We feel very strong about the security there, but we wanted to make sure we had full disclosure.

The next question then, in terms of when you are drawing down the warehouse, I know obviously $1 billion of loans can go through the FFELP warehouse. What happens to the remaining $400 million in the portfolio? Can you explain reason where and how you will refinance those loans?

Sure, it's Jeff. There are three different ways, or more, actually four, to refinance loans out of the warehouse lines. Let me go through them. We can sell loans into the new triple-A funding or super conduit is one option. We can issue new securitization under the TALF. We could sell loans to a third party, or we can actually issue a no-TALF eligible securitization. Also, I would point out that one of those has been done in the student loan market in the last month, which we find encouraging. So there are four different ways that we can use to clear that out to zero in the type time period we have left.

All right. Thank you.

(Operator Instructions). We'll go next to [Lance Edis] with [EOS Mortar Rock].

Hi, I just want to clarify some math. If you have 1.6 billion in your warehouse, and of that I believe that a total of [1.1101] billion can either be put in the TALF program or the super conduit, and then I believe you have the right to put another 250 million, that would leave, I believe, 499 million left. And then after that, you actually have the right to put 250 million of those bonds back, and that would leave you with 249 x-ing out, you would also have some pay down over time until the warehouse expires and some [hedge-some] defaults, which would actually be accretive for you, ironically, because you get $0.99 on the dollar for them versus what they are currently being valued at. And then you have 200 million worth of equity, so it would seem to be that you would only be short about $49 million, and much likely a lot less, after the rundown on any defaults, so it seems like you have almost no really true unfunded loans x-ing out the TALF program, the super conduits, and that put option you have.

We agree with your math. It's pretty close.

Thank you very much, then.

(Operator Instructions). And if there are no further questions, I'd like to turn the call back over to Jeff Noordhoek for any closing or additional remarks.

In closing, it is important to remember the fundamentals of our business remain strong. Approximately 90% of our portfolio is financed to term to the life of (the loan) rates, at rates which will create a significant and viable cash flow stream of approximately $1.4 billion. We have capital and liquidity for new loan originations through the government participation and put programs. If we would have montaged the entire value of the new loan originations in 2008, it would have represented less than 15% of our normal operating income. We have maintained the value of our service and delivery platforms while reducing our operating costs by $75 million. 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. I want to thank you for your participation in the call and want you to have a great day.

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation. Have a wonderful day. You may now disconnect.