Nelnet Inc. Q4 2008 Earnings Call Transcript

Mar. 3.09 | About: Nelnet, Inc. (NNI)

Nelnet Inc. (NYSE:NNI)

Q4 2008 Earnings Call

March 3, 2009 3:00 pm ET


Phil Morgan – Investor Relations

Jeffrey R. Noordhoek – President

Terry J. Heimes – Chief Financial Officer


Sameer Gokhale – Keefe, Bruyette & Woods

Michael Taiano – Sandler O'Neill & Partners

[Mark Kehoe] – Goldman Sachs

Lance Ettus – Eos Mortar Rock Capital Management


Good day everyone and welcome to Nelnet's fourth quarter 2008 conference call. (Operator Instructions). At this time I would now like to turn it over to Mr. Phil Morgan. Please go ahead, sir.

Phil Morgan

Good afternoon and welcome to Nelnet's 2008 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 our fourth quarter 2008 supplemental earnings disclosure, which is posted on our Investor Relations website at

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.

Jeffery Noordhoek

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're received so many questions in regards to 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 proposals 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 nation's students to maintain the benefits of choice, competition and stabile 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 programs 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 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 an estimated $1 trillion in 10 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 TALF, TARP and the CPFF to name a few. The FFEL program is a shinning 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 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 programs. For these reasons we feel we have a good shot at serving students under this contract which provides another option in [perceived] 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 healthy 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 under valued, especially in light of market reaction to the budget proposal last week. We believe at some point our earnings will start to drive our market valuation. We have no doubt the 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.

Terry J. Heimes

First off let me apologize for any inconvenience 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 a 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 countries 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 nonrecurring 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 reduced our operating costs given the change in the economics of the student loan program and the 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 H15, CB and LIBOR rates.

In mid to late fourth quarter we saw the beginning of a sustained and unprecedented divergence in the CB 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're pleased with our performance. We believe we have taken, and will continue to take the proactive prudent steps to position the company for its continued success. I'll now turn the call back over to our operator for questions.

Question-and-Answer Session


Your first question comes from Sameer Gokhale – Keefe, Bruyette & Woods.

Sameer Gokhale – Keefe, Bruyette & Woods

I just had a few questions. First one was Terry you were talking about the $13.5 million pre-tax for the liquidity contingency planning charges. Can you explain to me what that is exactly?

Jeffrey R. Noordhoek

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 the way I describe it is we put in a liquidity plan and we put in a backup to the liquidity plan and then we put in a backup to the backup 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’s dramatically improved since that time.

Sameer Gokhale – Keefe, Bruyette & Woods

So can explain in another way, when you say you have a backup and a backup to a backup, what does that essentially mean? Does that mean like you have no funding issues whatsoever? 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 backups and backups to the backups?

Jeffrey R. Noordhoek

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 is just essentially backup liquidity planning.

Sameer Gokhale – Keefe, Bruyette & Woods

And then in terms of, I think you mentioned that you had bid on the contract for servicing federal direct loans; have you also bid on the contract to service FFELP loans that could be put to the government? Is that the same thing or are you thinking of those two things separately?

Jeffrey R. Noordhoek

It is all in the same bid, so it can be for either or.

Sameer Gokhale – Keefe, Bruyette & Woods

And when do you expect the results of the bid to come out? Wasn’t there supposed to be an initial kind of round of who is going to be going to the final round? Is something to be announced this week, perhaps, maybe as early as this week?

Jeffrey R. Noordhoek

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.

Sameer Gokhale – Keefe, Bruyette & Woods

And 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 reduces some of the funding costs from say LIBOR plus a hundred 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 securities, for FFELP securities would eventually end up in the TALF. I don’t know how you might maybe 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 you’ve had a chance to look at the document.

Jeffrey R. Noordhoek

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 the cost of funds was lowered to LIBOR plus 50. So we were extremely encouraged by those developments. 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 positive developments and think it will really open up the opportunity for student loans to be financed under TALF.

Sameer Gokhale – Keefe, Bruyette & Woods

But do you have a sense at this point and 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 faith and credit of the U.S. government or with a guarantee like you have in a case of student loans, I mean where would you envision your funding costs going for those securities based on where the markets are and a relative basis for the other kinds of securities?

Jeffrey R. Noordhoek

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’ll have a better idea of what it looks like.


Your next question comes from Mike Taiano – Sandler O’Neill

Michael Taiano – Sandler O’Neill & Partners

Just a question on the President’s budget proposal and you mentioned that you’re going to work with Congress in coming and helping to form a solution. Was wondering if you mind just sharing with us sort of how you’re 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 maybe envision as maybe being the longer term solution for FFELP?

Jeffrey R. Noordhoek

It’s a really good question. The way we will approach the situation, 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.

So, again, I think that the program will evolve. Clearly the market’s disrupted and we do not have a clear view of 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’re positioned well to capitalize on the situation no matter what happens. And that, again, as I stated in the script, that our income from new loan originations last year, if we monetize them, only represent less than 15% of our total operating income. So, again, I think regardless of the outcome, we will be well positioned to capitalize on the opportunity.

Michael Taiano – Sandler O’Neill & Partners

And on the top 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’d heard that you were 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?

Jeffrey R. Noordhoek

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 insight of when it will be completed, but we are optimistic that in the coming weeks, months that we’ll be up and running and it will create additional liquidity for the industry.

Michael Taiano – Sandler O’Neill & Partners

I guess separately, I know you gave the operating margins for each of your respective segments. Could you, I apologize if this is somewhere in the queue, but do you have the operating margin for the enrollment services business minus the list marketing services component, which I assume is weighing down the margin in that business overall.

Terry J. Heimes

It is. That would be right around 9%.

Michael Taiano – Sandler O’Neill & Partners

And Terry, 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?

Terry J. Heimes

Depending on what happens with happens with the CB LIBOR first quarter fixed, 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.


Your next question comes from [Mark Kehoe] – Goldman Sachs

[Mark Kehoe] – Goldman Sachs

Just two questions. The first question was on the GIC facility --- or the GIC investment that was mentioned in the K. Can you explain what that is? It looks a large exposure to one of the institutions that’s rated A; can you frame that institution?

Terry J. Heimes

Sure. It’s a guaranteed investment contract that holds reserve funds in one of our outstanding bond issues. The counterparty is very highly rated, but it does have a trigger upon the reduction. It’s a AAA rated counterparty. It does have the ability – we have the ability to exit or terminate that in the event of down grade below single A, down grade below AA and 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.

[Mark Kehoe] – Goldman Sachs

The next question, then, in terms of when you’re drawing down the warehouse I know obviously $1 billion in loans can go to the [SEP] warehouse; what happens to remaining $400 million in the portfolio? Can you explain where and how you will refinance those loans?

Jeffrey R. Noordhoek

Sure, Jeff. There are three different or more, actually four to refinance loans out of the warehouse lines, when it gets room. We can sell loans into the new AAA funding or Superconduit is one option. We can issue a new securitization under the TALF. We can sell loans to a third party or we could actually issue a non-TALF eligible securitization also, and 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 time period that we have left.


(Operator Instructions). We'll go next to Lance Ettus – Eos Mortar Rock.

Lance Ettus – Eos Mortar Rock Capital Management

Hi. I just wanted to kind of clarify some math, and that's that if you have $1.6 billion in your warehouse, and of that I believe that a total of $1.101 billion can either be put in the TALF program or the Superconduit, 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 million.

You would also, I guess, have some pay down over time until the warehouse expires and some [inaudible] defaults would actually be accretive for you, ironically, so that you'd get $0.99 on the dollar for them versus. what they're currently being valued at.

And then you have $200 million worth of equity, so it would seem to me that you would only be short about $49 million, and much likely a lot less after the rundown and any defaults. So it seems like you have almost no really, truly unfunded liabilities crossing out the TALF program or the Superconduits on that put option you have.

Terry J. Heimes

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

Lance Ettus – Eos Mortar Rock Capital Management

Okay. Thank you very much then.


(Operator Instructions). I'd like to turn the call back over to Jeff Noordhoek for any closing or additional remarks.

Jeffrey R. Noordhoek

In closing, it is 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 rates, at rates which will create a significant and valuable cash flow stream of approximately $1.4 billion. We have capital and liquidity for new loan originations due to 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 I 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.

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