Nelnet Inc. Q4 2007 Earnings Call Transcript

Mar. 4.08 | About: Nelnet, Inc. (NNI)

Nelnet Inc. (NYSE:NNI)

Q4 2007 Earnings Call

March 04, 2008 11:00 am ET


Michael S. Dunlap – Chairman, Co-Chief Executive Officer, Member of Executive Committee

Jeffrey Noordhoek – President

Terry Heimes – Chief Financial Officer, Principal Accounting Officer, Executive Director of Finance

Phil Morgan – Investor Relations


Sameer Gokhale – Keefe, Bruyette & Woods

Cyral Buckeeny – Credit Suisse

Robert Kirkpatrick – Cardinal Capital

Shane Wilson – QBC Financial

Charles Kesstria – Cedar Hill

Lance Eddis – Warner, Rock Capital Management


Good day everyone and welcome to Nelnet’s fourth quarter 2007 conference call. Today’s call if being recorded and broadcast live over the internet. At this time, Mr. Phil Morgan of Nelnet’s Investor Relations Office will begin with opening remarks, please go ahead sir.

Phil Morgan

Thank you Lisa and thank you everyone for joining us today. Nelnet’s fourth quarter earning’s release and financial supplement have been posted to the Investor Relations website at On today’s call we will have Jeff Noordhoek, President, and Terry Heimes, Chief Financial Officer providing the formal remarks and Mike Dunlap, Chief Executive Officer and Chairman joining for the question and answer session.

Before we begin the formal remarks, I would like to read the Safe Harbor Statement. We would like to remind you that there will be forward looking statement 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 our earnings release and with 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 Jeff and Terry have concluded their formal remarks, we will open up the call for further questions. I would like to now turn the call over to Jeff.

Jeff Noordhoek

Thank you Phil and good morning everyone, thank you for joining us today.

Today we will discuss our operating results for 2007 but more importantly let’s talk about the success of our strategy to diversify revenue and net income. I will take some time to talk about the impact of recent legislation and the global liquidity crisis has had on the student loan origination and acquisition components of our business. Finally, I will briefly touch upon the outstanding fundamentals and the macro economic dynamics that impact education services industries as a whole.

First, let me remind you that Nelnet is a diversified education services Company serving the growing needs of the education seeking public. As you listen to our revue of 2007 and consider our opportunities for 2008, we want you to keep in mind that we have been highly successful in reducing our reliance on student loan at interest margin. In addition, the demand for our broad group of lower risk, fee-based services in education market is extremely encouraging.

The results for 2007 include continued growth of our diversified revenue stream, increased bottom line contribution from fee for service operation, active management of operating expenses and strong bottom line performance when considering the impact of the 2007 legislation and the ongoing global credit crisis.

Base net income excluding charges related to the new legislation and related structuring was $0.34 per share for the fourth quarter and 1.72 per share for the year. Fee based revenues reached $83 million for the quarter and $312 million for the year, which represented 65% of our total revenue for the fourth quarter and 56% for the year.

Importantly and as a reflection of where more and more of our revenues will be coming from in the future, our fee based operations give it 43% of our base net income for 2007 compared with 33% for 2006. Terry will provide a more in-depth analysis of numbers in a few minutes.

Even though it represents an ever-decreasing portion of our revenue in net income, I will spend time discussing the current status of student loan industry as it is in such state of flux. We remain committed to our mission of helping families plan, prepare and pay for education; however, the manner in which we fulfill our mission is continuing to evolve as legislation enacted in September coupled with the global credit crisis is putting extreme pressure on the student loan advance market.

New legislation alone created significant challenges in the FFELP industry. Last fall, we proactively made the tough decisions necessary to right size our business with a new lower economics of the FFELP Program.

As we predicted, many of our thinly capitalized competitors who did not respond quickly are being forced to exit the business in an abrupt manner. However, what we did not predict was the ever increasing severity of the global credit crisis and its far reaching impact on the entire student loan finance industry.

The ability to attract capital to funds FFELP for private loans becomes increasingly difficult and increasingly more expensive. We secured liquidity in the fall as the credit market was tightening and we currently maintain a $8.9 billion warehouse line of credit with nine banks with approximately 1.7 billion available capacity as of today. The credit slowly matures in May 2010 but the liquidity line backing facility has an annual renewing new of this coming May. We expect relatively significant pricing pressure on liquid renewal given the current credit contraption going on worldwide. Ultimately, if we cannot come to acceptable pricing terms with our warehouse lenders, we do maintain the ability to term out facility for two years, with a minimal step up in cost.

The buyer base has contracted dramatically within near complete disappearance of the structure investment vehicles, which drove the pricing along into the market. That said, FFELP ABS transactions are still being done for well capitalized finance companies that can fund the subordinate tranche on balance sheet. This means that significant portion of our more thinly capitalized competitors are currently unable to access the ABS market and are also more likely unable to renew warehouse lines of credit due to the need for tangible equity capital.

In contrast, we fully intend to continue to use our financial strength to secure ties and our self-belt loan assets to free of capacity in our warehouse line of credit.

The ABS market for private student loans has essentially disappeared and accordingly we will look to significantly reduce and potentially eliminate the private loans we fund on our own balance sheet and shift our efforts to working with others in their origination activity to create fee income from our private one business.

Spurred by the stress in ABS commercial paper markets, the auction rate and variable rate demand no markets have also experienced an unprecedented disruption. Many auction brokers on Wall Street have decided to let auctions of all asset classes fail. We currently have two billion of OEX rate and 900 million of variable rate demand notes outstanding which when combined is only 10% of our debt capital structure. Even though our OEX rate VRD in debt predominately rated AAA and are generally over 100% collateralized by federally guaranteed student loans, investors or broker dealers spooked by loss in the sub prime mortgage market have created an irrational and unprecedented environment of fail auctions in these highly credit worthy assets. Interest rates charged on the failed auctions are slightly different depending on the notes but are generally in the T-bill plus 125 to Y or plus 150 bases point range. We are actively working to restructure the option and VRD in debt at more favorable rates.

This crisis in the capital markets led us to announce a second restructuring in January. We gradually took steps to reduce operating expenses relating to our student loan origination related business further. Since we cannot determine nor control the length or depth of the capital market disruption, we plan to actively manage direct and indirect costs related to our asset generation activities and be more selective in pursuing loan originations in both the school and direct consumer channels. Accordingly, we have suspended consolidation on originations and will continue to review various origination decisions going forward. As a result of these items, we will experience a near term decrease in origination volume compared to historical periods.

Where does all this leave the Company in particular the student loan finance industry?

First, consider a few critical points about our Company. We have a $26.7 billion existing loan portfolio that will serve as annuity type revenue stream for many years. We have the flexibility to dial up and dial down our FFELP loan originations based on our strong orientation platform and liquidity position. We have highly efficient loan surfacing capabilities with significant scale and capacity to grow, do our own internal originations or to seize new third party servicing opportunities. We have a very strong capital base along with operating capacity. We have a diversified product offering and revenue stream. Fee based revenues are growing both as a percentage of total revenue and in absolute dollars a trend we expect will continue.

We have been very proactive in right sizing our expense structure in response to two unprecedented events affecting our student loan business.

Let me repeat our statement from our last call. We will not grow for growth sake and will not create unprofitable loan assets and sacrifice value creations for short term volume or some mythical market share benefit. We will continue to monitor the market and be proactive in keeping the Company financially strong.

Before I turn the call over to Terry to discuss the details of our financial performance, I would like to highlight some of the dynamics that we look to as we chart the course for Nelnet in 2008 and beyond.

2008 will provide the largest class of graduation high school seniors in the history of the United States. The cost of education continues to rise at twice the rate of inflation. The finance related process continually increasing in complexity given the ever increasing government regulation. We have seen the suspension or dramatic reduction in new loan originations from approximately 15 industry participants including two top ten participants. Capital to fund loans is becoming scarce and accordingly more and more expensive to obtain and banks are more reluctant to put new loan assets on their balance sheet given the increase capital commitments from all consumer commercial financial assets.

What does all this mean? There are definite challenges for some participants in the student lending business. These are potentially insurmountable challenges for Nelnet. However, the industry dynamics are providing opportunities in the education services area in general. We believe our strategy has positioned us for success in this growing but complex space.

Let me highlight the 65% of our revenues came from fee-based businesses in the fourth quarter.

At this time, I would like to turn the call over to Terry Heimes to discuss the details of our financial performance.

Terry Heimes

Thanks Jeff, today I want to talk to you about our operating results for 2007 and provide some color on our business strategy and performance of our various operating segments.

Given the current market conditions, I will spend some time talking about our liquidity and funding capacity and finally talk about our strategy and performance objectives given the business environment for 2008 and moving forward.

First, the more traditional measures of performance and results. Our GAAP net income from continuing operations was $19.2 million or $0.34 per share for the fourth quarter of 2007 and $35.4 million or $0.71 per share for the year. This compares to a loss of $5.9 million in the fourth quarter of last year and GAAP net income of $65.9 million or $1.23 per share for all of 2006.

Base net income was $13.4 million or $0.27 per share for the fourth quarter of 2007 and $38.5 million or $0.78 per share for the year, which compares to $0.22 and $1.42 per share for the fourth quarter of 2006 and the 2006 fiscal year.

Obviously, it’s a substantial amount of unusual activity occurred during all period and moving the discussion to review comparable operations can be complicated. Consider the fall line, the fourth quarter of 2007 included restructuring charges of $3.3 million after tax or $0.07 per share.

The fourth quarter of 2006 includes impairment charges related to our settlement with the Department of Education totaling about 22% per share after tax. Thus excluding the legislative changes, impairment charges and other one-time items based net income is $0.34 per share for the fourth quarter of 2007 versus $0.44 per share for the fourth quarter of 2006.

From a full year perspective, the year ended December 31, 2007, included approximately $46.8 million in after tax restructuring or other charges related changes in legislation for a total of $0.94 per share. Excluding legislative changes, impairment charges and other one-time items, base net income was $1.72 per share for 2007 versus $1.64 per share for 2006.

Our student loan assets were $26.7 billion an increase of $2.9 million or 12% year over year and our shareholders equity topped $608 million at year end.

As we look back at 2007, Nelnet has been very successful in their execution of our key business strategies and diversification revenues but is also facing significant challenges in terms of market and industry conditions.

As we look forward to 2008 with the change in legislation, disruption in the capital markets and reduced economics related to new FFELP loans. Asset generation and asset growth will no longer be key drivers or measures of our success.

Before we get to funding, liquidity and the prospects for 2008, let’s talk about the performance of our fee-based businesses and operating segments.

Our fee-based revenues totaled $83.2 million for the quarter. An increase of $12.1 million or 17% compared to the same period a year ago. For the year, fee-based revenues totaled nearly $312 million, an increase of $72 million or 30%. Fee-based revenues made up 65% of our total revenues for the fourth quarter and 56% of our total revenues for the year a substantial increase from the 53% and 44% a year ago.

Importantly, our fee-based business segments contributed nearly 43% of our base net income during 2007 compared to 33% in 2006.

For the year, ended December 31, 2007, loan and guarantee servicing revenues from third parties totaled $128.1 million for an increase of $6.5 million or 5.3% compared to 2006.

We saw a substantial increase in our guarantee out sourcing revenue in 2007 as compared to 2006, which offset a decline or run off in our third party FFELP loan servicing revenues.

The changes in legislation and capital markets will provide some challenges as well as opportunities in this segment as we move into 2008. A repeal of the VFA Agreements between the Department of Education and certain guarantee agencies could reduce our revenues by nearly $9 million in 2008. We believe there will be some significant opportunities to increase our third party loan servicing revenues as some indiscreet participants look to take advantage of our origination and servicing platforms allowing us to capitalize on our significant economy to scale in this area.

Our other fee-based revenues are generated from our tuition payment plan and campus commerce segment as well as in our enrollment services segment. These revenues increased $58.6 million during 2007 to nearly $161 million an increase of more than 57%. Our tuition payment plan and campus commerce revenue totaled $42.7 million for 2007 an increase of $7.6 million or 21.6% compared to 2006.

We continue to seek positive leverage in growth opportunities here. After tax operating margins have improved each of the last three years and although this is a relatively mature market, we believe we have growth opportunities not only through new school clients but also growth in revenue opportunities from our existing client base.

Nelnet Enrollment Services includes our College Preparation and Planning Services as well as our league generation activities. Revenues increased $48 million or 86% during 2007. The acquisitions of Peterson’s and CUNet have significantly expanded our product offering. We believe we have some excellent opportunities to capture value here. Not only through integration, economy scale and operating leverage but also through our school touch points services provided and administrative capabilities allowing us to create value for our school clients.

Excluding a one-time charge for impairment of intangible assets incurred during the third quarter base net income contribution was roughly flat for 2007. Although operating margins have contracted here over the last couple of years as we’ve built the business, we believe we have opportunities take advantage of revenue growth and expenses control in 2008 and beyond.

Our software and technical services revenue increased $6.6 million during 2007 or 43% totaled $22.1 million for the year. During 2007, we were able to increase our after tax-operating margin by capitalizing on our operating leverage. While we expect some potential softening of revenues in this area should lenders exit the student loan business, we also see opportunity to work with lenders and school clients, outsource their develop and maintenance activities.

In addition to our traditional education focus, we also see diversification opportunities outside the education financial services areas with some new product development activities.

With the changes in legislation and capital market activities, we have proactively taken steps toward operating cost reduction specifically focused in the asset generation and related support areas. Operating expenses excluding the restructuring charges are flat compared to third quarter and compared to the fourth quarter of last year. We are very pleased with our operating cost performance given the growth in our fee-based revenues.

Through our restructuring efforts, we have reduced the cost related to our asset generating activities to a level that can be supported by the economics of new loans provided we get some relief in stability related to our funding costs.

This brings us to a discussion of our lending activities, the related funding costs and funding capacity. As you are all aware, the legislation passed last year significantly reduced the yield of loans originated after October 1, 2007. At year-end, we had less than $500 million of these loans on our balance sheet less than 2% of our total assets.

The capital market disruption has put additional pressure on the economic liability of new loan originations but before I talk about new loan originations, I want to spend some time talking about the portfolio of existing loans on our balance sheet.

We currently have $26.3 billion in par value of student loans on our balance sheet at a curing cost of 1.7% of unadvertised premium. Roughly 18 billion or 70% of those loans are financed to term or matched to maturity with term ABF securities at very attractive fixed spreads of three month LIBOR and since we don’t use gain on sale accounting, we have a significant amount of unrealized value in these loans. We estimate the future earnings and cash from this portfolio over its life will be in excess of $1.2 billion assuming normalized historical spread between LIBOR and commercial paper.

Our highest priority is to term financing or refinancing of loans in our short-term warehouse vehicle. The facility included provisions requiring us to roll or refinance a portion of the loans annually. It also includes provisions that if we are unable to agree on renewal terms of the liquidity support, we can term the facility through 2010 at a minimal step up in cost. The facility also includes an advanced rate provision subject to evaluation formula based on current term, ABS market criteria. As ABS spreads have widened, advance rates have been reduced for acquiring equity support for the funding portfolio.

So our focus on refinancing is twofold. One, reduce the maturity mismatch of this portfolio and two; reduce the volatility related to the equity support of our portfolio to the appropriate level for government guaranteed assets.

We will be working to refinance or term out this portfolio over the very near term as well as continuing discussions related to the extension or renewal of the liquidity provisions. The refinancing and/or renewal will come at a price. Our current cost related to the warehouse is less than 30 bases points over LIBOR. Historically, we have been able to achieve financing efficiency in the term market refinancing the portfolio to achieve a reduction in funding cost.

Going forward, we know that will not be the case with this $7 billion portfolio. Costs are likely to increase 40 to 60 bases points either as a result of renewal or as a result of refinancing and the term ABS market.

The next obvious question relates to the future loans and the availability of capacity and liquidity. Jeff indicated we are committed to our mission of helping families plan, prepare, and pay for their education.

We’ve made significant investments in loan origination and delivery platforms and we’ve developed broad array of services to help our school loan student customers. We have 600 million in equity capital and access to a $750 million unsecured credit line. Today more than $400 million of that credit line remains undrawn and 200 million of the amount drawn is providing funding support for our warehouse portfolio of high quality government guaranteed assets.

We are positioning the Company for the 2008, 2009 lending year. However, Jeff also indicated we would not generate volume for volumes sake. If we cannot secure economically viable capacity for new loan, we will shift our efforts to other product and service lines including our fee-based origination of servicing activities to help our school and lender clients.

It is also important to note that because of our economy’s scale and efficient operations, we have a greater ability to achieve those economically viable risk adjusted returns necessary for us to remain in the asset generation acquisition business long term as compared to other industry participants.

In summary, what are we doing related to our funding and capacity in 2008? We are going to refinance a significant portion of our warehouse portfolio at wider spreads relative to historically ABS levels and our warehouse funding cost if down under the curve marked conditions. We will look to renew or renegotiate in a new warehouse facility and extend the liquidity provisions on our existing facility. The cost will be substantially higher than historical levels but likely limited to a one-year agreement giving the term ABS markets time to settle and recover. We will use our equity and capital to support our warehouse in term ABS issuance in the short term to retain the accumulated value in our portfolio and we will continue to monitor the viability of new loan generation and acquisitions given the developing market conditions.

It is also important to note that we are in a seasonally driven slower origination period. If we do not see the appropriate signs of market correction prior to certain peak origination periods, we will take prudent steps to keep the Company financially strong.

We have already taken the steps to reduce our operating costs and we maintain the flux ability to dial up or dial down on loan production.

That brings us to our overall strategy, plan and performance objectives for 2008 and beyond. We will continue to execute our business plan focused on diversification. We will continue to deploy our capital and resources to retain and generate value and we will be proactive in dealing with the very challenging and dynamic business in capital market environment related to the education finance portion of our business.

As we look specifically to 2008, it will be a year of volatility, continued transition, continued diversification and positioning. Accordingly, we are not going to provide definitive earnings guidance. We can tell you where we will focus our efforts in terms of business dynamics and some of the areas that are sure to impact our performance. Mainly, we will not focus on funding assets on our balance sheet in 2008.

At this point in time, we anticipate being active in the asset generation and acquisition area but it is dependent on our ability to fund the asset profitably over the long term and secure reasonable risk adjusted returns. We expect our spread to contract specifically as it relates to the roughly $7 billion of our portfolio currently funded in our short-term warehouse vehicle. The extent and the impact is dependent on the amount of loans we refinance, the stability of the term ABS markets and our ability to renew liquidity for our warehouse program.

We expect opportunities to grow our third party service in revenues and profit contribution; however, we expect new legislation to reduce guarantee-outsourcing revenues by as much as $9 million in 2008.

We expect continued growth and strong performance in our tuition payment and campus commerce segment.

We expect continued opportunity for revenue growth in our enrollment services segments and we expect to improve our operating margins here taking advantage of integration and scale.

Finally, we have under taken steps to aggressively control our costs and will continue to do so while balancing the need for innovation and investment in technological developments.

With that, I will turn it back over to Jeff for closing comments and discuss what lies ahead for Nelnet.

Jeff Noordhoek

Thank you, Terry. I am going to take a few minutes to describe what we feel could be in store of the entire student loan market and particularly students and their families as to what really matters in these large public call for aids.

We believe the combined effect of the college cost reduction act, passed in September coupled with the global credit crisis is already starting to affect students and will only worsen through 2008 if something does not change.

As all lenders are choosing where to invest their shrinking pool of available funds, the first to feel this effect will be the students attending higher default/low graduation rate schools. You have heard us and each of our public competitors’ state that we are pulling away from this market.

As capital flowing into the broader student loan market continues to wither, our fear is that this could quickly roll into the for-profit education sector in the community cause market where smaller loan balances and higher delinquencies and default equate to higher servicing costs and lower margins and this would be a needles failure for our country. As thousands of people who have had the option to gain the most from education are served by these colleges.

Ultimately, if something does not change, four-year College and graduate students will also start to feel the pinch as most banks and finance companies would be constrained in their ability to fund this growing amount of low margin assets on their balance sheets.

There are some people publicly saying that the direct loan program will simply pick up the volume left by the FFELP Program lenders. We think this strategy is very risky and it’s our opinion the direct loan program does not have the infrastructure in place to more than double or triple in a short period of time that of massive disruption service to schools and students.

In addition, normal self-volume is expected to exceed over $500 billion in the next five years, which if funded under the direct loan program would be added directly to our national debt. September 2007 was designed to channel more grant aid to students which we all agree makes sense. What will not change is the reality that the growing cost of higher education will mean that most students will also need the extended needs loans.

Grants and loans go hand in hand; if the loan market is disrupted, it will not be students in place to benefit from grants. The good news is that this is not too late to head off this gathering storm and the industry is actively discussing ideas with multiple constituencies on how to infuse liquidity into the student loan market to insure that no interruption of access occurs as it never has in over 40 year old history of the FFELP Program.

I am going to almost exactly quote my closing statements from our last quarterly call and they are so import to understanding our Company.

First, let me reiterate these recent events will not change our mission helping families plan, prepare and pay for their education. Our core values which include our customer focus are a commitment to associates remain unchanged after the core underpinnings of our business model, which we remain committed to diversifying and increasing our fee-based revenue streams, deploying capital efficiency, efficiently utilizing our scale and past to recreate efficiencies and generating high quality assets for a prompt return on investment can be achieved.

What does lie ahead for Nelnet? Growing in diversified fee-based businesses will be the major drive for future shareholder value creation. These businesses will represent substantially larger piece of our income stream and the majority of our bottom line.

We believe they will ultimately fill the void created by the lower contribution from loan assets over the long term.

Additional growth in education space outside the field to reduce political credit industry risk, revenue diversification will continue to make us stronger and a new product and services we add will create value for our customers while creating sustainable long-term cash flows for our Company. We see ever-increasing opportunity to expand our third party servicing and other market participants look to piggyback on our scale of efficiency and world class servicing operations.

Maintaining our relationships with our existing school customers in our target market is critically important; however, the market and how we approach the market has changed significantly. A weighted example, in a typical year we were likely to receive approximately 40 lender lists RPs from college and universities. Since last September, we have received response over 500 RPs. Asset generation will be intently focused on high quality, low default FFELP assets and maximizing their value by either balance sheeting new loans that meet our return targets or flow within. Work flowing in strategic third parties.

Finally, before we take your questions, I want to practically address what we plan to do in terms of regulatory filings, earnings release and investor outreach during 2008.

We believe our public files contain the information necessary to evaluate our performance and understand our business operation. This is where we focus our public disclosure and transparency. We believe it is important information for investors and should be reviewed and considered in conjunction with our comments and discussion.

Going forward, our quarterly calls will be scheduled after we have filed our 10K or 10Q.

Mike, Terry and I will now take your questions.

Question-and-Answer Session


Thank you, sir. The question and answer session will be conducted electronically. (Operator Instructions.)

Our first question comes from Sameer Gokhale of CBW.

Sameer Gokhale – CBW

Hi, good morning, I think you have mentioned that you were currently in discussions with the third constituency about perhaps thinking of ways of which to inject liquidity into the funding markets for student loans. Would you be willing to discuss any specific proposals you have submitted and perhaps who you might have spoken to or approached so far. I know Hank Paulsen, the Treasury Secretary has been approached, some lawmakers on this issue and I was wondering if you had pursued that line as well. Just would love to get your thoughts on this issue.

Jeff Noordhoek

What I would say is that the industry as a whole, many participants and industry trade groups have approached multiple levels of government that would be local, state and federal levels and all different types of agencies have discussions about what is going on in the student loan market, what is going on in the capital markets and what it means for students and families in the United States. I’ll tell you that there have been multiple discussions at multiple levels across government on this issue.

Sameer Gokhale – CBW

Is there anything more specific you can give us as far as proposals. Perhaps to have the government provide some sort of backstop liquidity support to the extent that ABS investors or kind of hesitating to invest in even government guaranteed ABS and maybe by providing back up liquidity you get more of these investors into the market. Is there along those lines or would you discuss specifically what kinds of ideas you’ve been thinking about?

Mike Dunlap

Some of the discussion, this is Mike, has gone down the line of you look at some of the other market assessments like housing, you’ve got the federal home loan bank and the federal farm credit system for the agricultural area Fanny Mae, Freddie Mac in the mortgage sector. Student loan sector did have direct access when Sally Mae was a GSC to the federal financing bank. Some of the discussion that we’ve had is should the Federal Home Loan Bank of the Federal Financing Bank be allowed to provide liquidity directly into student loan assets or aftermath securities with a number of different players in government. That is some of the different ideas what we’ve talked about.

Sameer Gokhale – CBW

That’s perfect, that is very helpful for color. The other thing I was wondering about is I think this warehouse facility that I think is due for renewal in May of this year, I think you mentioned that if it weren’t renewed it would become a term facility and you had mentioned a modest step up in cost. Would you be able to share with us what the incremental step up in cost on that facility would be if you were to just leave the assets in there and kind of term it out?

Mike Dunlap

Ten bases points.

Sameer Gokhale – CBW

Ten bases points as compared to what you are doing now, okay. The last thing I was curious about was on your fee-based income, I know there is some commentary given but in Q4 in your other fee-based income there is a big sequential increase and was that pretty much all due to seasonality or was there one business in particular that was performing better than the others?

Mike Dunlap

It was primarily seasonality. We’ve seen really solid growth in terms of our tuition payment campus commerce segment as well as with the CU Net and Peterson’s, our enrollment services had a good quarter as well as our lead generation activity.

Sameer Gokhale – CBW

Ok, great, thank you.


Your next call is from the line of Robert Kirkpatrick of Cardinal Capital.

Robert Kirkpatrick – Cardinal Capital

Good morning, could you talk a little bit about where you are in your restructuring process with the one that was announced in January or are you all the way through that at this point and can you give us some guidance as to where your cost structure is relative to that which you reported in the fourth quarter, please.

Terry Heimes

Sure Robert, this is Terry. We are largely through our restructuring process. We do have as we exit some associates they will be carry over severance and other costs that will flow into the second quarter but we are largely through that. In terms of our cost structure and run rate, we expect in as we announced previously with restructurings, we would expect a cost savings in the $25 to $50 million range from a standpoint of our 2007 run rate perspective. We would start to expect to see that in 2008 starting to take effect in the first quarter; however, with some of our carryover, we will see the main impact in the third quarter 2008.

Robert Kirkpatrick – Cardinal Capital

First of all, what’s the 2007 run rate? Is that the rate at which you exited the year or is that the rates of the whole year?

Terry Heimes

That we exited.

Robert Kirkpatrick – Cardinal Capital

What contributes to a variation of 25 to 50 million or nearly 100% swing in your assessment of the cost being safe?

Terry Heimes

It would somewhat depend upon the level of asset generation activities that we actually undertake in 2008.

Robert Kirkpatrick – Cardinal Capital

Okay and could you go back to the point that you made during your prepared remarks about the loan portfolio having $1.2 billion of future value and explain that a little bit greater detail for us.

Terry Heimes

Sure, this is Terry. We’ve got of our $26 billion portfolio, we have $17.5 to 18 billion that is funded using the term market with fixed spread to three month LIBOR. When we run that out to the life of the portfolio, the cash flow and earnings generated on that portfolio over its life is in excess of $1.2 billion, which would include the excess spread, the servicing revenue that we would largely generate for ourselves because we are servicing it via administration releases from the trust estate. That assumes a historical level or spread between commercial paper and LIBOR as well as certain repayment rates et cetera. The point that we wanted to make though is that we have that portfolio financed to term with very attractive spreads and we’ve locked in the value on that portfolio. Since we don’t use gain on sale accounting, we are going to recognize that value over the life of that portfolio.

Robert Kirkpatrick – Cardinal Capital

What is the term that you have locked in? What’s the average term of that 1.2 billion?

Terry Heimes

They vary by asset type or substantial portion of those are consolidation loans. They are going to have a very long life, probably in the neighborhood of ten to twenty years in terms of an average useful life.

Robert Kirkpatrick – Cardinal Capital

Okay and your equity market value today is a little less than that?

Terry Heimes


Robert Kirkpatrick – Cardinal Capital

Great, thanks so much gentlemen, I appreciate your time.


(Operator Instructions)

We have a call from Cyral Buckeeny with Credit Suisse.

Cyral Buckeeny – Credit Suisse

Good morning, my question has to deal with your funding to a college, could you just maybe discuss what is coming due in 2008. I think you’ve talked about the 6.6 billion warehouse facility which you plan to term out and then I think there are 2.9 billion auction rate loans, how do you plan on refunding that given the current situation?

Terry Heimes

Sure, you are correct. We have about $6.9 or 7 billion warehouse line, which although it has a final maturity of May 2010, the liquidity is renewed annually and so with that renewing in May this year, we got that as coming due this year. In addition, the auction rate is reset annually, those we are experiencing dislocation in the rates; however, I think it is also important to note that some of those loans in those financing have lower floor character affixed to them so those are still economically viable trust estates. We are going to look to refinance those into an alternative source to reduce our funding costs there for our first priority is to refinance our short-term warehouse portfolio.

Cyral Buckeeny – Credit Suisse

Are you referring to the 6.6 billion?

Terry Heimes


Cyral Buckeeny – Credit Suisse

This you can always term it out to 2010, right? If it can’t be refinanced.

Terry Heimes

We do have that option and yes, we are trying to make sure that we put ourselves in the best, most flexible position as we move into 2008 and beyond.

Cyral Buckeeny – Credit Suisse

The 2.9 billion in auction rates funding and what’s plan B if you can’t refinance that?

Terry Heimes

As I said, those have the ability to…those are not coming due. They are just (inaudible) periodically and we have the ability to leave those in the auction rate or variable rate demand mode. It is just going to be more efficient to refinance those to the extent they can because they are currently earning at the max rate. They’ve gone to the max rate.

We want to refinance those to gain efficiency.

Cyral Buckeeny – Credit Suisse

Okay so when are they coming due?

Terry Heimes

They have varying maturities most of them are probably going to be anywhere from 12 to 30 years.

Cyral Buckeeny – Credit Suisse

Okay, great, thank you.


We will take our next question from Shane Wilson with QBC Financial.

Shane Wilson - QBC Financial

Hi, I was wondering when you speak about increasing revenue from third party servicing, you know that service basing general assessment of the state of our now or if you had very specific conversations with specific other initial participants?

Terry Heimes

There are all different kinds of opportunities that are popping up as people are looking at ways to become more efficient. They are looking at companies like ours that have the scale and efficiency to help them do things more efficiently. We always have had a sales pipeline in our servicing area that’s increased significantly in the last three to six months as term wells kind of rocked the market.

Shane Wilson - QBC Financial

Okay, thanks.


Our next question comes from Charles Kesstria with Cedar Hill.

Charles Kesstria - Cedar Hill

Hey guys, I was wondering if you could just aluminates just a little better for me or us the derivatives you added in the quarter like you did have some activity there and what has hedged and what’s not hedged and what the exposures are?

Terry Heimes

Sure, this is Terry. Let me start with some of the exposures that we were trying to hedge. As you may recall, our assets are set off the average daily rate of the 90-day commercial paper so our assets set daily. The majority of our debt will reset every three months based off LIBOR. In a rising rate environment, we benefit from our assets resetting daily and our debt resetting discreetly every 90 days. When rates leveled out, we recognized that volatility and wanted to hedge against that in a declining rate environment and so we added a total of about $24 billion in terms of hedges that are outlined in our K that come on in varying points in time which hedge that average versus discreet difference in the reset provisions of our assets and our debts. That’s one of the risks that we’ve hedged and that we have benefitted from in terms of the recent substantial decrease in rates.

Charles Kesstria - Cedar Hill

Those are bases hedges?

Terry Heimes

The other area that we have undertaken hedging activity is we have a portion of our loans that about $3.5 billion that have the ability to earn variable rate flooring income if rates drop substantially because they were reset last July. Rates have dropped substantially; we actually earn variable rate floor income to the extent that commercial paper would drop below about 4.9%. We have hedged or put on about $2 billion in hedges against that $3.5 billion portfolio, which lock in a rate of 4.18. We have effectively locked in or hedged about 72 bases points of variable rate floor income on $2 billion of our portfolio that could be eligible.

We have an additional billion five to 2.4 billion that could be eligible for additional variable rate floor income because of T bill and T bill rates or commercial paper rates that we will earn a spread on as rates drop and we will earn variable rate flooring income between the difference of about 4.8 to 4.9% and the commercial paper rate, which currently is running probably around three. We have the ability to earn an additional 1.75 to 2.0% on that additional billion five of loans that are reset based on commercial paper. We also have about 800 million of loans that have the ability to earn variable rate floor income that are reset off the T bill; however, because we don’t have really any debt that is matched or based off the treasury bill while we earn variable rate flooring, we really don’t receive the economic benefit of that because of the wide tent spread. That’s the variable rate floor income component of it. Then on the fixed rate income, our fixed rate floors, we have about $2 billion that is earning at the fixed borrower rate of about 7.5% and we will have locked in because of hedges, we have locked in about 120 bases points of fixed rated floor income on that $2 billion portfolio. One billion of it was earning at fixed rates at year-end and a billion dollars was added after year end or an additional billion dollars converted to fixed rate after year end because of the continued decline in interest rates.

Charles Kesstria - Cedar Hill

I got you that’s great, I appreciate it.


Your next call is from the line of Lance Eddis with Warner, Rock Capital Management.

Lance Eddis – Warner, Rock Capital Management

I actually have a few questions. First, I know you said you are locked in part of your portfolio with 1.2 billion, I was wondering if you would comment on from what you are seeing out there, whether the part that’s is now locked in if it still sell those loans. I think you could still sell those loans at a slight premium to book value. In other words, you could sell them at 1.005 or 50 bases points above.

Mike Dunlap

Obviously there is a substantial amount of destruction in the capital markets and the availability of capacity and liquidity has become challenging and I think it has become irrational in terms of the impact on the what assets would be sold for. We still believe that significant value and we are looking to retain that value by terming out some of them out of our warehouse but we will continue to look for ways we can capture that value including potential sale.

Lance Eddis – Warner, Rock Capital Management

Okay and I just also comment one on your servicing business what’s been the growth there on the part that is not your assets and two; you mentioned diversification efforts before diversifying outside the payment arena. So, if you could comment on what kind of products we should expect coming in the pipeline.

Terry Heimes

This is Terry, let me first address this servicing. As we grew our portfolio historically, we have been able to grow our assets on balance sheet so through consolidation we actually saw a run off in our third party servicing portfolio. That has actually been declining over recent years because of the consolidation as well as our focus on growth of assets on our balance sheet. With the reduced consolidation impact and the reduced economics and people looking for efficiencies as Mike indicated, we see some opportunities to add some additional lenders and also grow for lenders to grow our third party servicing going forward. While that has historically seen a decline or run off, we see some opportunity to grow that going forward.

Then, you other question on diversification, can you repeat that?

Lance Eddis – Warner, Rock Capital Management

Just you commented before that you are looking to diversify sort of outside the core sort of payment products and your other fee businesses, would you just comment on that, be more specific on that if you could?

Terry Heimes

One of the4 areas that we’ve seen opportunity here has been in our software, technical services area and we’ve been able to develop products that really have appealed to constituencies outside of schools and students and we’ve been able to start to develop a market in that area. Right now, it’s really immaterial in terms of the overall contribution but we see opportunities to continue to diversify specifically in the software and technical areas outside.

In addition, we also see opportunities to continue to diversify the product and service offered under our enrollment services area by example. Where traditionally that has been focused on planning and preparation as well as lead generation with lead generation taking the lion’s share of the activity there. We see opportunities to expand the product service offering to schools and students outside of that as we move forward.

Lance Eddis – Warner, Rock Capital Management

Okay, thank you.


We have a follow up question from Sameer Gokhale with KBW.

Sameer Gokhale – KBW

Just a couple of quick follow ups, on that warehouse facility and $6.6 billion of loans in there, assuming that facility isn’t renewed, as those loans paying down does that create additional capacity back up to the 6.6 billion or is that just basically fully amortizing at that point in time? I just wanted to kind of get some more detail on that.

Mike Dunlap

If we were to term the facility with the providers, it would just amortize down.

Sameer Gokhale – KBW

Okay and then, the other question I had was on that portfolio, where you talked about the future cash flows. I am assuming that doesn’t take into account any of the operating costs associated with servicing that portfolio. If one were to try to do an MPV on that piece of the portfolio, what would you envision your fallbacks would be if you were to just do a minimal amount of servicing on that and you cut out all the infrastructure related to the origination part of the business. How should we think about it from an MPV perspective if we were thinking of valuing that whole earning stream?

Terry Heimes

Well on that earning stream, the largest portion is going to be the net spread and the servicing is provided out of the cash flows that’s there. Our servicing is done, one of the developments or one of the things that we have been able to develop is a significant amount of scale or our cost is very efficient in that regard as it relates to…there is a lot of different factors that can come into the present value. Our focus was to make sure that we provided guidance on the amount that would flow off that portfolio to demonstrate the value that’s there.

Sameer Gokhale – KBW

Let me try again and ask the question another way. If I was just trying to value within run off so you don’t leverage off of the scale of new loans that you might add on there and service those if you were just going to run the portfolio off. Your OFFEX ratio right now for the current quarter just if that business if it was 80 bases points or so I don’t know if that sounds reasonable but if your were just doing a minimal amount of servicing on that portfolio cut out all the origination costs, et cetera. Perhaps that could be 40 bases points of expense you are left with in a burned down scenario where you just are running the portfolio off. Is that the way I should be thinking about it and not take into account, not assuming growth in the business, just assuming a burned down run off analysis from an MPV perspective does those numbers makes sense?

Terry Heimes

You are still high in terms of the true cost associated with a run off scenario. Again, substantial portion of those are high balanced consolidation loans, so our servicing costs true marginal incremental servicing cost is going to be very low substantially less than the 40 bases points that you referenced.

Sameer Gokhale – KBW

How about the all in costs of that portfolio, would it be lower than 40 bases points? Not looking at marginal again just assuming a run off the portfolio so servicing that existing portfolio with the cost, I assume, would that be 40 bases points or all including your fixed costs infrastructure, et cetera?

Terry Heimes

No, it will be less than that. The key is our ability to manage our fixed cost infrastructure is how we continue to grow our fee based businesses, the opportunities that are provided to continue to focus on the growth of our servicing business, the ability to expand our enrollment services areas, the ability to continue to grow our tuition payment campus commerce, so all of those play into our ability to manage our fixed cost infrastructure.

Sameer Gokhale – KBW

Okay, thank Terry.


There are no further questions at this time. I would like to turn the conference back over to our speakers for any additional or closing remarks.

Mike Dunlap

We have diversified our revenues and reduced our reliance on that interest margin and government fund program. We have established valid entry points in school and lender customers. We have developed significant accomplish scale on our loan servicing and our tuition payment plan operations and are developing similar consensus scale in our enrollment services areas. We have accessed the necessary capital to expand our business in profitable areas. We have the management experience and expertise to take advantage of business opportunities. We have demonstrated the ability to execute our business plan and challenging times.

We want to thank you for participating in our call. Have a great day.


That concludes today’s teleconference. Thank you for your participation. Have a good day.

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