NELNET INC - Quarter Report: 2008 September (Form 10-Q)
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2008
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to .
COMMISSION FILE NUMBER 001-31924
NELNET, INC.
(Exact name of registrant as specified in its charter)
NEBRASKA | 84-0748903 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
121 SOUTH 13TH STREET, SUITE 201 | 68508 | |
LINCOLN, NEBRASKA | (Zip Code) | |
(Address of principal executive offices) |
(402) 458-2370
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See the
definitions of large accelerated filer, accelerated filer and smaller reporting
company in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No þ
As of October 31, 2008, there were 37,998,182 and 11,495,377 shares of Class A Common
Stock and Class B Common Stock, par value $0.01 per share, outstanding, respectively
(excluding 11,058,604 shares of Class A Common Stock held by a wholly owned subsidiary).
NELNET, INC.
FORM 10-Q
INDEX
September 30, 2008
FORM 10-Q
INDEX
September 30, 2008
2 | ||||||||
29 | ||||||||
66 | ||||||||
72 | ||||||||
72 | ||||||||
74 | ||||||||
77 | ||||||||
79 | ||||||||
80 | ||||||||
Exhibit 10.1 | ||||||||
Exhibit 10.2 | ||||||||
Exhibit 10.3 | ||||||||
Exhibit 10.4 | ||||||||
Exhibit 10.5 | ||||||||
Exhibit 10.6 | ||||||||
Exhibit 31.1 | ||||||||
Exhibit 31.2 | ||||||||
Exhibit 32 |
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
As of | As of | |||||||
September 30, 2008 | December 31, 2007 | |||||||
(unaudited) | ||||||||
Assets: |
||||||||
Student loans receivable (net of allowance for loan losses of
$49,070 and $45,592, respectively) |
$ | 26,376,269 | 26,736,122 | |||||
Cash and cash equivalents: |
||||||||
Cash and cash equivalents not held at a related party |
16,062 | 38,305 | ||||||
Cash and cash equivalents held at a related party |
308,945 | 73,441 | ||||||
Total cash and cash equivalents |
325,007 | 111,746 | ||||||
Restricted cash and investments |
1,082,015 | 927,247 | ||||||
Restricted cash due to customers |
47,859 | 81,845 | ||||||
Accrued interest receivable |
530,102 | 593,322 | ||||||
Accounts receivable, net |
49,204 | 49,084 | ||||||
Goodwill |
175,178 | 164,695 | ||||||
Intangible assets, net |
83,565 | 112,830 | ||||||
Property and equipment, net |
43,629 | 55,797 | ||||||
Other assets |
102,446 | 107,624 | ||||||
Fair value of derivative instruments |
154,741 | 222,471 | ||||||
Total assets |
$ | 28,970,015 | 29,162,783 | |||||
Liabilities: |
||||||||
Bonds and notes payable |
$ | 28,004,835 | 28,115,829 | |||||
Accrued interest payable |
92,112 | 129,446 | ||||||
Other liabilities |
192,550 | 220,899 | ||||||
Due to customers |
47,859 | 81,845 | ||||||
Fair value of derivative instruments |
22,929 | 5,885 | ||||||
Total liabilities |
28,360,285 | 28,553,904 | ||||||
Shareholders equity: |
||||||||
Preferred stock, $0.01 par value. Authorized 50,000,000 shares;
no shares issued or outstanding |
| | ||||||
Common stock: |
||||||||
Class A, $0.01 par value. Authorized 600,000,000 shares;
issued and outstanding 37,994,332 shares as of September 30,
2008 and 37,980,617 shares as of December 31, 2007 |
380 | 380 | ||||||
Class B, convertible, $0.01 par value. Authorized 60,000,000 shares;
issued and outstanding 11,495,377 shares as of September 30,
2008 and December 31, 2007 |
115 | 115 | ||||||
Additional paid-in capital |
101,757 | 96,185 | ||||||
Retained earnings |
509,524 | 515,317 | ||||||
Employee notes receivable |
(2,046 | ) | (3,118 | ) | ||||
Total shareholders equity |
609,730 | 608,879 | ||||||
Commitments and contingencies |
||||||||
Total liabilities and shareholders equity |
$ | 28,970,015 | 29,162,783 | |||||
See accompanying notes to consolidated financial statements.
2
Table of Contents
NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share data)
(unaudited)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share data)
(unaudited)
Three months | Nine months | |||||||||||||||
ended September 30, | ended September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Interest income: |
||||||||||||||||
Loan interest |
$ | 284,468 | 437,251 | 911,140 | 1,251,391 | |||||||||||
Investment interest |
9,118 | 21,023 | 29,914 | 61,231 | ||||||||||||
Total interest income |
293,586 | 458,274 | 941,054 | 1,312,622 | ||||||||||||
Interest expense: |
||||||||||||||||
Interest on bonds and notes payable |
234,016 | 393,875 | 791,621 | 1,112,263 | ||||||||||||
Net interest income |
59,570 | 64,399 | 149,433 | 200,359 | ||||||||||||
Less provision for loan losses |
7,000 | 18,340 | 18,000 | 23,628 | ||||||||||||
Net interest income after provision for loan losses |
52,570 | 46,059 | 131,433 | 176,731 | ||||||||||||
Other income (expense): |
||||||||||||||||
Loan and guaranty servicing income |
30,633 | 33,040 | 81,650 | 95,116 | ||||||||||||
Other fee-based income |
45,887 | 38,025 | 132,617 | 116,316 | ||||||||||||
Software services income |
4,217 | 5,426 | 15,865 | 17,022 | ||||||||||||
Other income |
1,242 | 7,028 | 4,298 | 14,048 | ||||||||||||
Gain (loss) on sale of loans |
| 492 | (47,426 | ) | 3,288 | |||||||||||
Derivative market value, foreign currency,
and put option adjustments and derivative
settlements, net |
6,874 | 16,113 | 10,468 | 18,966 | ||||||||||||
Total other income |
88,853 | 100,124 | 197,472 | 264,756 | ||||||||||||
Operating expenses: |
||||||||||||||||
Salaries and benefits |
44,739 | 60,545 | 142,131 | 182,010 | ||||||||||||
Other operating expenses: |
||||||||||||||||
Impairment expense |
| 49,504 | 18,834 | 49,504 | ||||||||||||
Advertising and marketing |
18,388 | 14,141 | 50,734 | 43,590 | ||||||||||||
Depreciation and amortization |
10,781 | 15,084 | 32,218 | 36,741 | ||||||||||||
Professional and other services |
10,963 | 9,336 | 27,548 | 28,219 | ||||||||||||
Occupancy and communications |
4,194 | 5,931 | 14,949 | 16,182 | ||||||||||||
Postage and distribution |
3,026 | 4,123 | 9,586 | 14,266 | ||||||||||||
Trustee and other debt related fees |
2,423 | 3,337 | 7,277 | 8,965 | ||||||||||||
Other |
9,155 | 11,444 | 27,151 | 35,843 | ||||||||||||
Total other operating expenses |
58,930 | 112,900 | 188,297 | 233,310 | ||||||||||||
Total operating expenses |
103,669 | 173,445 | 330,428 | 415,320 | ||||||||||||
Income (loss) before income taxes |
37,754 | (27,262 | ) | (1,523 | ) | 26,167 | ||||||||||
Income tax expense (benefit) |
13,969 | (10,664 | ) | 1,793 | 9,906 | |||||||||||
Income (loss) from continuing operations |
23,785 | (16,598 | ) | (3,316 | ) | 16,261 | ||||||||||
Income (loss) from discontinued operations, net of tax |
| 909 | 981 | (2,416 | ) | |||||||||||
Net income (loss) |
$ | 23,785 | (15,689 | ) | (2,335 | ) | 13,845 | |||||||||
Earnings (loss) per share, basic and diluted: |
||||||||||||||||
Income (loss) from continuing operations |
0.48 | (0.34 | ) | (0.07 | ) | 0.32 | ||||||||||
Income (loss) from discontinued
operations |
| 0.02 | 0.02 | (0.04 | ) | |||||||||||
Net income (loss) |
$ | 0.48 | (0.32 | ) | (0.05 | ) | 0.28 | |||||||||
See accompanying notes to consolidated financial statements.
3
Table of Contents
NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands, except share data)
(unaudited)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands, except share data)
(unaudited)
Accumulated | ||||||||||||||||||||||||||||||||||||||||||||
Preferred | Class A | Class B | Additional | Employee | other | Total | ||||||||||||||||||||||||||||||||||||||
stock | Common stock shares | Preferred | common | common | paid-in | Retained | notes | comprehensive | shareholders | |||||||||||||||||||||||||||||||||||
shares | Class A | Class B | stock | stock | stock | capital | earnings | receivable | income | equity | ||||||||||||||||||||||||||||||||||
Balance as of June 30, 2007 |
| 37,661,381 | 11,495,377 | $ | | 377 | 115 | 94,473 | 518,910 | (2,697 | ) | | 611,178 | |||||||||||||||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||||||||||||||||
Net loss |
| | | | | | | (15,689 | ) | | | (15,689 | ) | |||||||||||||||||||||||||||||||
Total comprehensive income (loss) |
(15,689 | ) | ||||||||||||||||||||||||||||||||||||||||||
Cash
dividend on Class A and Class B common stock $0.07 per share |
| | | | | | | (3,453 | ) | | | (3,453 | ) | |||||||||||||||||||||||||||||||
Reserve for uncertain income tax provisions |
| | | | | | 2,519 | | | | 2,519 | |||||||||||||||||||||||||||||||||
Issuance of common stock, net of forfeitures |
| 514,782 | | | 5 | | 1,408 | | (225 | ) | | 1,188 | ||||||||||||||||||||||||||||||||
Compensation expense for stock-based awards |
| | | | | | 1,575 | | | | 1,575 | |||||||||||||||||||||||||||||||||
Repurchase of common stock |
| (239,124 | ) | | | (3 | ) | | (5,422 | ) | | | | (5,425 | ) | |||||||||||||||||||||||||||||
Balance as of September 30, 2007 |
| 37,937,039 | 11,495,377 | $ | | 379 | 115 | 94,553 | 499,768 | (2,922 | ) | | 591,893 | |||||||||||||||||||||||||||||||
Balance as of June 30, 2008 |
| 37,952,246 | 11,495,377 | $ | | 380 | 115 | 99,854 | 485,739 | (2,046 | ) | | 584,042 | |||||||||||||||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||||||||||||||||
Net income |
| | | | | | | 23,785 | | | 23,785 | |||||||||||||||||||||||||||||||||
Total comprehensive income |
23,785 | |||||||||||||||||||||||||||||||||||||||||||
Issuance of common stock, net of forfeitures |
| 49,650 | | | 1 | | 960 | | | | 961 | |||||||||||||||||||||||||||||||||
Compensation expense for stock based awards |
| | | | | | 1,045 | | | | 1,045 | |||||||||||||||||||||||||||||||||
Repurchase of common stock |
| (7,564 | ) | | | (1 | ) | | (102 | ) | | | | (103 | ) | |||||||||||||||||||||||||||||
Balance as of September 30, 2008 |
| 37,994,332 | 11,495,377 | $ | | 380 | 115 | 101,757 | 509,524 | (2,046 | ) | | 609,730 | |||||||||||||||||||||||||||||||
Balance as of December 31, 2006 |
| 39,035,169 | 13,505,812 | $ | | 390 | 135 | 177,678 | 496,341 | (2,825 | ) | 131 | 671,850 | |||||||||||||||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||||||||||||||||
Net income |
| | | | | | | 13,845 | | | 13,845 | |||||||||||||||||||||||||||||||||
Other comprehensive income: |
||||||||||||||||||||||||||||||||||||||||||||
Foreign currency translation |
| | | | | | | | | (322 | ) | (322 | ) | |||||||||||||||||||||||||||||||
Non-pension postretirement
benefit plan |
| | | | | | | | | 191 | 191 | |||||||||||||||||||||||||||||||||
Total comprehensive income |
13,714 | |||||||||||||||||||||||||||||||||||||||||||
Cash
dividend on Class A and Class B common stock $0.21 per share |
| | | | | | | (10,357 | ) | | | (10,357 | ) | |||||||||||||||||||||||||||||||
Adjustment
to adopt provisions of FASB Interpretation No. 48 |
| | | | | | | (61 | ) | | | (61 | ) | |||||||||||||||||||||||||||||||
Reserve for uncertain income tax provisions |
| | | | | | 2,519 | | | | 2,519 | |||||||||||||||||||||||||||||||||
Issuance of common stock, net of forfeitures |
| 667,055 | | | 7 | | 4,627 | | (225 | ) | | 4,409 | ||||||||||||||||||||||||||||||||
Compensation expense for stock based awards |
| | | | | | 3,105 | | | | 3,105 | |||||||||||||||||||||||||||||||||
Repurchase of common stock |
| (3,301,194 | ) | | | (33 | ) | | (80,874 | ) | | | | (80,907 | ) | |||||||||||||||||||||||||||||
Conversion of common stock |
| 2,010,435 | (2,010,435 | ) | | 20 | (20 | ) | | | | | | |||||||||||||||||||||||||||||||
Acquisition of enterprise under common control |
| (474,426 | ) | | | (5 | ) | | (12,502 | ) | | | | (12,507 | ) | |||||||||||||||||||||||||||||
Reduction of employee stock notes receivable |
| | | | | | | | 128 | | 128 | |||||||||||||||||||||||||||||||||
Balance as of September 30, 2007 |
| 37,937,039 | 11,495,377 | $ | | 379 | 115 | 94,553 | 499,768 | (2,922 | ) | | 591,893 | |||||||||||||||||||||||||||||||
Balance as of December 31, 2007 |
| 37,980,617 | 11,495,377 | $ | | 380 | 115 | 96,185 | 515,317 | (3,118 | ) | | 608,879 | |||||||||||||||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||||||||||||||||
Net loss |
| | | | | | | (2,335 | ) | | | (2,335 | ) | |||||||||||||||||||||||||||||||
Total comprehensive income (loss) |
(2,335 | ) | ||||||||||||||||||||||||||||||||||||||||||
Cash
dividend on Class A and Class B common stock $0.07 per share |
| | | | | | | (3,458 | ) | | | (3,458 | ) | |||||||||||||||||||||||||||||||
Issuance of common stock, net of forfeitures |
| 83,337 | | | 1 | | 2,033 | | | | 2,034 | |||||||||||||||||||||||||||||||||
Compensation expense for stock based awards |
| | | | | | 4,308 | | | | 4,308 | |||||||||||||||||||||||||||||||||
Repurchase of common stock |
| (69,622 | ) | | | (1 | ) | | (769 | ) | | | | (770 | ) | |||||||||||||||||||||||||||||
Reduction of employee stock notes receivable |
| | | | | | | | 1,072 | | 1,072 | |||||||||||||||||||||||||||||||||
Balance as of September 30, 2008 |
| 37,994,332 | 11,495,377 | $ | | 380 | 115 | 101,757 | 509,524 | (2,046 | ) | | 609,730 | |||||||||||||||||||||||||||||||
See accompanying notes to consolidated financial statements.
4
Table of Contents
NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)
Nine months ended September 30, |
||||||||
2008 | 2007 | |||||||
Net income (loss) |
$ | (2,335 | ) | 13,845 | ||||
Income (loss) from discontinued operations |
981 | (2,416 | ) | |||||
Income (loss) from continuing operations |
(3,316 | ) | 16,261 | |||||
Adjustments to reconcile income (loss) from continuing operations to net cash provided
by operating activities, net of business acquisitions: |
||||||||
Depreciation and amortization, including loan premiums and deferred origination costs |
107,944 | 223,552 | ||||||
Derivative market value adjustment |
72,399 | (93,031 | ) | |||||
Foreign currency transaction adjustment |
(40,360 | ) | 79,020 | |||||
Change in value of put options issued in business acquisitions |
3,483 | 2,145 | ||||||
Proceeds from termination of derivative instruments |
15,403 | 50,843 | ||||||
Payments to terminate derivative instruments |
(3,679 | ) | (8,100 | ) | ||||
Impairment expense |
18,834 | 49,504 | ||||||
Loss on sale of business |
| 8,132 | ||||||
Gain on sale of equity method investment |
| (3,942 | ) | |||||
Loss (gain) on sale of student loans |
47,426 | (3,288 | ) | |||||
Non-cash compensation expense |
5,670 | 4,595 | ||||||
Deferred income tax benefit |
(23,979 | ) | (30,374 | ) | ||||
Provision for loan losses |
18,000 | 23,628 | ||||||
Other non-cash items |
1,258 | (2,900 | ) | |||||
Decrease (increase) in accrued interest receivable |
63,220 | (125,929 | ) | |||||
Decrease (increase) in accounts receivable |
445 | (7,045 | ) | |||||
Decrease in other assets |
13,928 | 7,450 | ||||||
(Decrease) increase in accrued interest payable |
(37,334 | ) | 64,812 | |||||
(Decrease) increase in other liabilities |
(1,765 | ) | 19,785 | |||||
Net cash flows from operating activities continuing operations |
257,577 | 275,118 | ||||||
Net cash flows from operating activities discontinued operations |
| (3,558 | ) | |||||
Net cash provided by operating activities |
257,577 | 271,560 | ||||||
Cash flows from investing activities, net of business acquisitions: |
||||||||
Originations, purchases, and consolidations of student loans, including loan premiums
and deferred origination costs |
(2,368,229 | ) | (4,509,308 | ) | ||||
Purchases of student loans, including loan premiums, from a related party |
(212,888 | ) | (232,769 | ) | ||||
Net proceeds from student loan repayments, claims, capitalized interest, participations, and other |
1,538,134 | 1,740,351 | ||||||
Proceeds from sale of student loans |
1,267,826 | 107,673 | ||||||
Purchases of property and equipment, net |
(5,094 | ) | (18,375 | ) | ||||
(Increase)
decrease in restricted cash and investments, net |
(154,768 | ) | 316,415 | |||||
Purchases of equity method investments |
(2,988 | ) | | |||||
Distributions from equity method investments |
| 747 | ||||||
Sale of business, net of cash sold |
| 7,551 | ||||||
Business acquisitions, net of cash acquired |
(18,000 | ) | 2,211 | |||||
Proceeds from sale of equity method investment |
| 10,000 | ||||||
Net cash flows from investing activities continuing operations |
43,993 | (2,575,504 | ) | |||||
Net cash flows from investing activities discontinued operations |
| (294 | ) | |||||
Net cash provided by (used in) investing activities |
43,993 | (2,575,798 | ) | |||||
Cash flows from financing activities: |
||||||||
Payments on bonds and notes payable |
(5,328,782 | ) | (4,496,077 | ) | ||||
Proceeds from issuance of bonds and notes payable |
5,225,548 | 7,022,018 | ||||||
Proceeds (payments) from issuance of notes payable due to a related party, net |
32,790 | (56,917 | ) | |||||
Payments of debt issuance costs |
(14,778 | ) | (13,951 | ) | ||||
Dividends paid |
(3,458 | ) | (10,357 | ) | ||||
Payment on settlement of put option |
| (15,875 | ) | |||||
Proceeds from issuance of common stock |
566 | 1,231 | ||||||
Repurchases of common stock |
(770 | ) | (75,504 | ) | ||||
Payments received on employee stock notes receivable |
575 | 128 | ||||||
Net cash flows (used in) provided by financing activities continuing operations |
(88,309 | ) | 2,354,696 | |||||
Net cash flows from financing activities discontinued operations |
| | ||||||
Net cash (used in) provided by financing activities |
(88,309 | ) | 2,354,696 | |||||
Effect of exchange rate fluctuations on cash |
| 548 | ||||||
Net increase in cash and cash equivalents |
213,261 | 51,006 | ||||||
Cash and cash equivalents, beginning of period |
111,746 | 106,086 | ||||||
Cash and cash equivalents, end of period |
$ | 325,007 | 157,092 | |||||
Supplemental disclosures of cash flow information: |
||||||||
Interest paid |
$ | 814,469 | 920,966 | |||||
Income taxes paid, net of refunds |
$ | 24,302 | 20,908 | |||||
See accompanying notes to consolidated financial statements.
5
Table of Contents
NELNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information as of September 30, 2008 and for the three months and nine months ended
September 30, 2008 and 2007 is unaudited)
(Dollars in thousands, except per share amounts, unless otherwise noted)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information as of September 30, 2008 and for the three months and nine months ended
September 30, 2008 and 2007 is unaudited)
(Dollars in thousands, except per share amounts, unless otherwise noted)
1. Basis of Financial Reporting
The accompanying unaudited consolidated financial statements of Nelnet, Inc. and subsidiaries (the
Company) as of September 30, 2008 and for the three and nine months ended September 30, 2008 and
2007 have been prepared on the same basis as the audited consolidated financial statements for the
year ended December 31, 2007 and, in the opinion of the Companys management, the unaudited
consolidated financial statements reflect all adjustments, consisting of normal recurring
adjustments, necessary for a fair presentation of results of operations for the interim periods
presented. The preparation of financial statements in conformity with U.S. generally accepted
accounting principles requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes. Actual results could
differ from those estimates. Operating results for the three and nine months ended September 30,
2008 are not necessarily indicative of the results for the year ending December 31, 2008. The
unaudited consolidated financial statements should be read in conjunction with the Companys Annual
Report on Form 10-K for the year ended December 31, 2007. Certain amounts from 2007 have been
reclassified to conform to the current period presentation.
2. Discontinued Operations
On May 25, 2007, the Company sold EDULINX Canada Corporation (EDULINX), a Canadian student loan
service provider and a subsidiary of the Company, for initial proceeds of $19.0 million. The
Company recognized an initial net loss of $9.0 million related to this transaction. During the
three months ended June 30, 2008, the Company earned $2.0 million ($1.0 million net of tax) in
additional consideration as a result of the sale of EDULINX. This payment represented contingent
consideration earned by the Company based on EDULINX meeting certain performance measures. As a
result of the sale of EDULINX, the results of operations for EDULINX, including the contingent
payment earned in 2008, are reported as discontinued operations in the accompanying consolidated
statements of operations.
The components of income (loss) from discontinued operations are presented below.
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Operating income of discontinued operations |
$ | | | | 9,278 | |||||||||||
Income tax on operations |
| | | (3,562 | ) | |||||||||||
Gain (loss) on disposal |
| (6 | ) | 1,966 | (8,157 | ) | ||||||||||
Income tax on disposal |
| 915 | (985 | ) | 25 | |||||||||||
Income (loss) from discontinued
operations, net of tax |
$ | | 909 | 981 | (2,416 | ) | ||||||||||
The following operations of EDULINX have been segregated from continuing operations and reported as
discontinued operations through the date of disposition. Interest expense was not allocated to
EDULINX and, therefore, all of the Companys interest expense is included within continuing
operations.
Nine months ended | ||||
September 30, 2007 | ||||
Net interest income |
$ | 124 | ||
Other income |
31,511 | |||
Operating expenses |
(22,357 | ) | ||
Income before income taxes |
9,278 | |||
Income tax expense |
3,562 | |||
Operating income of discontinued
operations, net of tax |
$ | 5,716 | ||
6
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As a result of the contingent consideration received during the second quarter 2008, the Company
earned $0.8 million of foreign tax credits available to offset future U.S. federal income taxes.
Under current tax law, these tax credits expire in 2018. The Company established a valuation
allowance for these tax credits due to the Companys assessment that this deferred tax asset did
not meet the more-likely-than-not recognition criteria of Statement of Financial Accounting
Standards (SFAS) No. 109, Accounting for Income Taxes.
3. Restructuring Charges
Legislative Impact
On September 6, 2007, the Company announced a strategic initiative to create efficiencies and lower
costs in advance of the enactment of the College Cost Reduction and Access Act of 2007, which
impacted the Federal Family Education Loan Program (the FFEL Program or FFELP) in which the
Company participates. In anticipation of the federally driven cuts to the student loan programs,
management initiated a variety of strategies to modify the Companys student loan business model,
including lowering the cost of student loan acquisition, creating efficiencies in the Companys
asset generation business, and decreasing operating expenses through a reduction in workforce and
realignment of operating facilities. Implementation of the plan began immediately and was
completed as of December 31, 2007. As a result of these strategic decisions, the Company recorded
restructuring charges of $15.0 million and $5.3 million in the third and fourth quarters of 2007,
respectively, and income of $0.2 million in the first quarter of 2008 to recognize adjustments from
initial estimates.
Information related to the remaining restructuring accrual, which is included in other
liabilities on the consolidated balance sheet, follows:
Employee | ||||||||||||
termination | Lease | |||||||||||
benefits | terminations | Total | ||||||||||
Restructuring accrual as of December 31, 2007 |
$ | 1,193 | 3,682 | 4,875 | ||||||||
Adjustment from initial estimated charges |
(191 | ) | | (191 | ) | |||||||
Cash payments |
(868 | ) | (358 | ) | (1,226 | ) | ||||||
Restructuring accrual as of March 31, 2008 |
134 | 3,324 | 3,458 | |||||||||
Cash payments |
(134 | ) | (45 | ) | (179 | ) | ||||||
Restructuring accrual as of June 30, 2008 |
| 3,279 | 3,279 | |||||||||
Cash payments |
| (259 | ) | (259 | ) | |||||||
Restructuring accrual as of September 30, 2008 |
$ | | 3,020 | 3,020 | ||||||||
Capital Markets Impact
On January 23, 2008, the Company announced a plan to further reduce operating expenses related to
its student loan origination and related businesses as a result of ongoing disruptions in the
credit markets. Management developed a restructuring plan related to its asset generation and
supporting businesses which reduced marketing, sales, service, and related support costs through a
reduction in workforce and realignment of operating facilities. Implementation of the plan began
immediately and was completed as of June 30, 2008. As a result of these strategic decisions, the
Company recorded restructuring charges of $26.5 million in the first quarter of 2008 and income of
$0.4 million in the second quarter of 2008 to recognize adjustments from initial estimates.
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Selected information relating to the restructuring charge follows:
Employee | ||||||||||||||||
termination | Lease | Write-down | ||||||||||||||
benefits | terminations | of assets | Total | |||||||||||||
Restructuring costs recognized during the
three month period ended March 31, 2008 |
$ | 6,095 | (a) | 1,573 | (b) | 18,834 | (c) | 26,502 | ||||||||
Write-down of assets to net realizable value |
| | (18,834 | ) | (18,834 | ) | ||||||||||
Cash payments |
(4,952 | ) | | | (4,952 | ) | ||||||||||
Restructuring accrual as of March 31, 2008 |
1,143 | 1,573 | | 2,716 | ||||||||||||
Adjustment from initial estimated charges |
(190 | )(a) | (175 | )(b) | (365 | ) | ||||||||||
Cash payments |
(792 | ) | (369 | ) | (1,161 | ) | ||||||||||
Restructuring accrual as of June 30, 2008 |
161 | 1,029 | | 1,190 | ||||||||||||
Cash payments |
(121 | ) | (265 | ) | | (386 | ) | |||||||||
Restructuring accrual as of September 30, 2008 |
$ | 40 | 764 | | 804 | |||||||||||
(a) | Employee termination benefits are included in salaries and
benefits in the consolidated statements of operations. |
|
(b) | Lease termination costs are included in occupancy and
communications in the consolidated statements of operations. |
|
(c) | Costs related to the write-down of assets are included in
impairment expense in the consolidated statements of operations. |
Selected information relating to the restructuring charge by operating segment and Corporate
Activity and Overhead follows:
Restructuring costs | ||||||||||||||||||||||||||||
recognized during | Adjustment | |||||||||||||||||||||||||||
the three month | Write-down of | Restructuring | from initial | Restructuring | ||||||||||||||||||||||||
period ended | assets to net | Cash | accrual as of | estimated | Cash | accrual as of | ||||||||||||||||||||||
Operating segment | March 31, 2008 | realizable value | payments | March 31, 2008 | charges | payments | June 30, 2008 | |||||||||||||||||||||
Student Loan and Guaranty Servicing |
$ | 6,010 | (5,074 | ) | (430 | ) | 506 | (104 | ) | (352 | ) | 50 | ||||||||||||||||
Tuition Payment Processing and
Campus Commerce |
| | | | | | | |||||||||||||||||||||
Enrollment Services and List
Management |
312 | | (291 | ) | 21 | (15 | ) | (19 | ) | (13 | ) | |||||||||||||||||
Software and Technical Services |
518 | | (472 | ) | 46 | (8 | ) | | 38 | |||||||||||||||||||
Asset Generation and Management |
11,287 | (9,351 | ) | (1,806 | ) | 130 | (52 | ) | (72 | ) | 6 | |||||||||||||||||
Corporate Activity and Overhead |
8,375 | (4,409 | ) | (1,953 | ) | 2,013 | (186 | ) | (718 | ) | 1,109 | |||||||||||||||||
$ | 26,502 | (18,834 | ) | (4,952 | ) | 2,716 | (365 | ) | (1,161 | ) | 1,190 | |||||||||||||||||
4. Legal, Industry, and Legislative Developments
Legal Proceedings
General
The Company is subject to various claims, lawsuits, and proceedings that arise in the normal course
of business. These matters principally consist of claims by student loan borrowers disputing the
manner in which their student loans have been processed and disputes with other business entities.
On the basis of present information, anticipated insurance coverage, and advice received from
counsel, it is the opinion of the Companys management that the disposition or ultimate
determination of these claims, lawsuits, and proceedings will not have a material adverse effect on
the Companys business, financial position, or results of operations.
8
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Municipal Derivative Bid Practices Investigation
As previously disclosed, on February 8, 2008, Shockley Financial Corp. (SFC), an indirect,
wholly-owned subsidiary of the Company that provides investment advisory services for the
investment of proceeds from the issuance of municipal and corporate bonds, received a grand jury
subpoena issued by the U.S. District Court for the Southern District of New York upon application
of the Antitrust Division of the U.S. Department of Justice. The subpoena seeks certain
information and documents from SFC in connection with the Department of Justices ongoing criminal
investigation of the bond industry with respect to possible anti-competitive practices related to
awards of guaranteed investment contracts (GICs) and other products for the investment of
proceeds from bond issuances. SFC currently has one employee. The Company and SFC are cooperating
with the investigation.
On March 5, 2008, SFC received a subpoena from the Securities and Exchange Commission (the SEC)
related to an ongoing industry-wide investigation concerning the bidding of municipal GICs. In
addition, on or about June 6, 2008 and June 12, 2008, SFC received a subpoena from both the New York
Attorney General (the NYAG) and the Florida Attorney General, respectively, relating to their
investigations concerning the bidding of municipal GICs and possible violations of various state
and federal laws. The subpoenas seek certain information and documents from SFC relating to its
GIC business. The Company and SFC are cooperating with these investigations.
SFC has also been named as a defendant in a number of substantially identical purported class
action lawsuits. In each of the lawsuits, a large number of financial institutions and financial
service providers, including SFC, are named as defendants. The complaints allege that the
defendants engaged in a conspiracy not to compete and to fix prices and rig bids for municipal
derivatives (including GICs) sold to issuers of municipal bonds. All the complaints assert claims
for violations of Section 1 of the Sherman Act and fraudulent concealment, and three complaints
also assert claims for unfair competition and violation of the California Cartwright Act. On
June 16, 2008, the United States Judicial Panel on Multidistrict Litigation issued an order
transferring the cases then before it to the U.S. District Court for the Southern District of New
York which consolidated several cases under the caption Hinds County, Mississippi v. Wachovia Bank,
N.A. et al. SFC intends to vigorously contest these purported class action lawsuits.
SFC, the Company, or other subsidiaries of the Company may receive subpoenas from other regulatory
agencies. Due to the preliminary nature of these matters as to SFC, the Company is unable to
predict the ultimate outcome of the investigations or the class action lawsuits.
Industry Inquiries and Investigations
On January 11, 2007, the Company received a letter from the NYAG requesting certain information and
documents from the Company in connection with the NYAGs investigation into preferred lender list
activities. Since January 2007, a number of state attorneys general, including the NYAG, and the
U.S. Senate Committee on Health, Education, Labor, and Pensions also announced or are reportedly
conducting broad inquiries or investigations of the activities of various participants in the
student loan industry, including activities which may involve perceived conflicts of interest. A
focus of the inquiries or investigations has been on any financial arrangements among student loan
lenders and other industry participants which may facilitate increased volumes of student loans for
particular lenders. Like many other student loan lenders, the Company received requests for
information from certain state attorneys general and the Chairman of the U.S. Senate Committee on
Health, Education, Labor, and Pensions in connection with their inquiries or investigations. In
addition, the Company received subpoenas for information from the NYAG, the New Jersey Attorney
General, and the Ohio Attorney General. In each case the Company is cooperating with the requests
and subpoenas for information that it has received.
On July 31, 2007, the Company announced that it had agreed with the NYAG to adopt the NYAGs Code
of Conduct, which is substantially similar to the Companys previously adopted Nelnet Student Loan
Code of Conduct. As part of the agreement, the Company agreed to contribute $2.0 million to a
national fund for educating high school students and their parents regarding the financial aid
process (the NYAG Fund).
On October 10, 2007, the Company received a subpoena from the NYAG requesting certain information
and documents from the Company in connection with the NYAGs investigation into direct-to-consumer
marketing practices of student lenders. On September 9, 2008, the Company announced that it agreed
to adopt the NYAGs Student Loan Direct Marketing Code of Conduct. As part of the agreement, the
Company agreed to contribute $200,000 to the NYAG Fund.
While the Company cannot predict the ultimate outcome of any inquiry or investigation, the Company
believes its activities have materially complied with applicable law, including the Higher
Education Act of 1965 (the Higher Education Act), the rules and regulations adopted by the
Department of Education (the Department) thereunder, and the Departments guidance regarding
those rules and regulations.
Department of Education Review
The Department of Education periodically reviews participants in the FFEL Program for compliance
with program provisions. On June 28, 2007, the Department notified the Company that it would be
conducting a review of the Companys administration of the FFEL Program under the Higher Education
Act. The Company understands that the Department has selected several schools and lenders for
review. Specifically, the Department is reviewing the Companys practices in connection with the
prohibited inducement provisions of the Higher Education Act
and the provisions of the Higher Education Act and the associated regulations which allow borrowers
to have a choice of lenders. The Company has responded to the Departments requests for
information and documentation and is cooperating with their review.
9
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While the Company cannot predict the ultimate outcome of the review, the Company believes its
activities have materially complied with the Higher Education Act, the rules and regulations
adopted by the Department thereunder, and the Departments guidance regarding those rules and
regulations.
Department of Justice
In connection with the Companys settlement with the Department of Education in January 2007 to
resolve the Office of Inspector General of the Department of Education (the OIG) audit report
with respect to the Companys student loan portfolio receiving special allowance payments at a
minimum 9.5% interest rate, the Company was informed by the Department of Education that a civil
attorney with the Department of Justice had opened a file regarding the issues set forth in the OIG
report, which the Company understands is common procedure following an OIG audit report. The
Company has engaged in discussions with and provided information to the Department of Justice in
connection with the review.
While the Company is unable to predict the ultimate outcome of the review, the Company believes its
practices complied with applicable law, including the provisions of the Higher Education Act, the
rules and regulations adopted by the Department of Education thereunder, and the Departments
guidance regarding those rules and regulations.
Internal Revenue Service
In October 2007, the Company received a letter from the Internal Revenue Service (IRS) revoking a
previously issued Private Letter Ruling retroactive to September 30, 2003 concerning the Companys
arbitrage and excess interest calculations on certain of its tax-exempt bonds. The IRS letter
provided procedures for the Company to follow to appeal the retroactive application of the
revocation. The Company responded to the IRS in November 2007 requesting relief from
retroactivity. In March 2008, the IRS responded with a final determination that the revocation of
the Private Letter Ruling would apply prospectively beginning on July 1, 2008. Management believes
that the July 1, 2008 prospective application of the Private Letter Ruling revocation will not have
a significant impact on the Companys operating results.
Legislative Developments
On May 7, 2008, the President signed into law the Ensuring Continued Access to Student Loans Act of
2008 (the Ensuring Continued Access to Student Loans Act). This legislation contains provisions
that expand the federal governments support of financing the cost of higher education. Among
other things, the Ensuring Continued Access to Student Loans Act:
| Increases statutory limits on annual and aggregate borrowing for FFELP loans; and |
||
| Allows the Department to act as a secondary market and enter into agreements with
lenders to purchase certain FFELP loans or participation interests in those loans. |
As a result of this legislation, the Departments of Education and Treasury developed a plan to
implement the Ensuring Continued Access to Student Loans Act. Among other things, this plan:
| Allows the Department to purchase certain loans from lenders for the 2008-2009
academic year and offers lenders access to short-term liquidity; and |
||
| Commits to continue working with the FFELP community to explore programs to reengage
the capital markets in the long-run. |
On May 22, 2008, the Company announced that, as a result of the above plan, it would continue
originating new federal student loans for the 2008-2009 academic year to all students regardless of
the school they attend.
On July 1, 2008, pursuant to the Ensuring Continued Access to Student Loans Act, the Department of
Education announced terms under which it will offer to purchase FFELP student loans and loan
participations from lenders. See note 7 for information related to the Departments programs.
On August 14, 2008, the President signed into law the Higher Education Opportunity Act, which
amends the Higher Education Act to revise and reauthorize the Higher Education Act programs. Among
other items, this legislation:
| Contains school code of conduct requirements applicable to FFELP and
private education lenders; |
| Contains additional provisions and reporting requirements for lenders and schools
participating in preferred lender arrangements; and |
| Contains additional disclosures that FFELP lenders must make to borrowers as well as
added FFELP loan servicing requirements for lenders. |
10
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On October 7, 2008, legislation was enacted to extend the Departments authority to address FFELP
student loans made for the 2009-2010 academic year. See note 7 for additional information related
to this extension.
5. Student Loans Receivable and Allowance for Loan Losses
Student loans receivable consisted of the following:
As of | As of | |||||||
September 30, 2008 | December 31, 2007 | |||||||
Federally insured loans |
$ | 25,725,893 | 26,054,398 | |||||
Non-federally insured loans |
275,520 | 274,815 | ||||||
26,001,413 | 26,329,213 | |||||||
Unamortized loan premiums and deferred origination costs |
423,926 | 452,501 | ||||||
Allowance for loan losses federally insured loans |
(24,366 | ) | (24,534 | ) | ||||
Allowance for loan losses non-federally insured loans |
(24,704 | ) | (21,058 | ) | ||||
$ | 26,376,269 | 26,736,122 | ||||||
Federally insured allowance as a percentage of ending balance of federally insured loans |
0.09 | % | 0.09 | % | ||||
Non-federally insured allowance as a percentage of ending balance of non-federally insured loans |
8.97 | % | 7.66 | % | ||||
Total allowance as a percentage of ending balance of total loans |
0.19 | % | 0.17 | % |
Loan Sales
On March 31, 2008, the Company sold $857.8 million (par value) of federally insured student loans
resulting in the recognition of a loss of $30.4 million. In addition, on April 8, 2008, the
Company sold $428.6 million (par value) of federally insured student loans. The portfolio of
student loans sold on April 8, 2008 was presented as held for sale on the March 31, 2008
consolidated balance sheet and was valued at the lower of cost or fair value. The Company
recognized a loss of $17.1 million during the three month period ended March 31, 2008 as a result
of marking these loans to fair value. Combined, the portfolios sold on March 31, 2008 and April 8,
2008 were sold for a purchase price of approximately 98% of the par value of such loans. As a
result of the disruptions in the debt and secondary markets, the Company sold these loan portfolios
in order to reduce the amount of student loans remaining under the Companys multi-year committed
financing facility for FFELP loans, which reduced the Companys exposure related to certain equity
support provisions included in this facility (see note 7 for additional information related to
these equity support provisions).
As part of the Companys asset management strategy, the Company periodically sells student loan
portfolios to third parties. During the three and nine months ended September 30, 2007, the
Company sold $17.7 million (par value) and $103.7 million (par value), respectively, of federally
insured student loans resulting in the recognition of gains of $0.5 million and $3.3 million,
respectively.
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6. Intangible Assets and Goodwill
Intangible assets consist of the following:
Weighted | ||||||||||||
average | ||||||||||||
remaining | ||||||||||||
useful life as of | As of | As of | ||||||||||
September 30, | September 30, | December 31, | ||||||||||
2008 | 2008 | 2007 | ||||||||||
Amortizable intangible assets: |
||||||||||||
Customer relationships (net of accumulated amortization of $27,393
and $20,299, respectively) |
109 | $ | 52,967 | 60,061 | ||||||||
Trade names (net of accumulated amortization of $4,431 and
$1,258, respectively) |
45 | 12,628 | 1,609 | |||||||||
Covenants not to compete (net of accumulated amortization of
$13,451 and $11,815, respectively) |
22 | 10,171 | 15,425 | |||||||||
Database and content (net of accumulated amortization of $4,883
and $3,193, respectively) |
25 | 4,597 | 6,287 | |||||||||
Computer software (net of accumulated amortization of $6,839
and $4,898, respectively) |
12 | 2,163 | 4,189 | |||||||||
Student lists (net of accumulated amortization of $7,343 and
$5,806, respectively) |
5 | 854 | 2,391 | |||||||||
Other (net of accumulated amortization of $89 and $71, respectively) |
89 | 185 | 203 | |||||||||
Loan origination rights (net of accumulated amortization of $8,180) |
| | 8,473 | |||||||||
Total amortizable intangible assets |
81 months | 83,565 | 98,638 | |||||||||
Unamortizable intangible assets trade names |
| 14,192 | ||||||||||
$ | 83,565 | 112,830 | ||||||||||
As disclosed in note 3, as a result of the disruptions in the debt and secondary markets and the
student loan business model modifications the Company implemented due to the disruptions, the
Company recorded an impairment charge of $18.8 million during the first quarter of 2008. This
charge is included in impairment expense in the Companys consolidated statements of operations.
Information related to the impairment charge follows:
Operating | Impairment | |||||||
Asset | segment | charge | ||||||
Amortizable intangible assets: |
||||||||
Covenants not to compete |
Student Loan and Guaranty Servicing | $ | 4,689 | |||||
Covenants not to compete |
Asset Generation and Management | 336 | ||||||
Loan origination rights |
Asset Generation and Management | 8,336 | ||||||
Computer software |
Asset Generation and Management | 12 | ||||||
Goodwill |
Asset Generation and Management | 667 | ||||||
Property and equipment |
Student Loan and Guaranty Servicing | 385 | ||||||
Property and equipment |
Corporate activities | 4,409 | ||||||
Total impairment charge |
$ | 18,834 | ||||||
The fair value of the intangible assets and reporting unit within the Asset Generation and
Management operating segment were estimated using the expected present value of future cash flows.
During the first quarter of 2008, management determined that the trade names not subject to
amortization have a finite useful life. As such, these assets will be amortized prospectively over
their estimated remaining useful lives.
12
Table of Contents
The Company recorded amortization expense on its intangible assets of $6.6 million and $10.9
million for the three months ended September 30, 2008 and 2007, respectively, and $19.7 million and
$24.0 million for the nine months ended September 30, 2008 and 2007, respectively. The Company
will continue to amortize intangible assets over their remaining useful lives. As of September 30,
2008, the Company estimates it will record amortization expense as follows:
2008 |
$ | 6,511 | ||
2009 |
22,319 | |||
2010 |
15,985 | |||
2011 |
10,031 | |||
2012 |
9,029 | |||
2013 and thereafter |
19,690 | |||
$ | 83,565 | |||
The change in the carrying amount of goodwill by operating segment was as follows:
Tuition | ||||||||||||||||||||||||
Payment | Enrollment | Software | Asset | |||||||||||||||||||||
Student Loan | Processing | Services | and | Generation | ||||||||||||||||||||
and Guaranty | and Campus | and List | Technical | and | ||||||||||||||||||||
Servicing | Commerce | Management | Services | Management | Total | |||||||||||||||||||
Balance as of December 31, 2007 |
$ | | 58,086 | 55,463 | 8,596 | 42,550 | 164,695 | |||||||||||||||||
Additional
contingent
consideration paid
(a) |
| | 11,150 | | | 11,150 | ||||||||||||||||||
Impairment charge |
| | | | (667 | ) | (667 | ) | ||||||||||||||||
Balance as of March 31, 2008 (b) |
$ | | 58,086 | 66,613 | 8,596 | 41,883 | 175,178 | |||||||||||||||||
(a) | In January 2008, the Company paid $18.0 million (of which $6.8 million was
accrued as of December 31, 2007) of additional consideration related to its 2005
acquisitions of Student Marketing Group, Inc. and National Honor Roll, L.L.C. This
payment satisfies all of the Companys obligations related to the contingencies per the
terms of the purchase agreement. |
|
(b) | During the quarters ended June 30, 2008 and September 30, 2008, there was no
change in goodwill. |
13
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7. Bonds and Notes Payable
The following tables summarize outstanding bonds and notes payable by type of instrument:
As of September 30, 2008 | ||||||||||||
Carrying | Interest rate | |||||||||||
amount | range | Final maturity | ||||||||||
Variable-rate bonds and notes (a): |
||||||||||||
Bonds and notes based on indices |
$ | 20,891,535 | 2.79% - 5.07% | 09/25/13 - 06/25/41 | ||||||||
Bonds and notes based on auction or remarketing (b) |
2,771,445 | 0.00% - 9.01% | 11/01/09 - 07/01/43 | |||||||||
Total variable-rate bonds
and notes |
23,662,980 | |||||||||||
Commercial paper FFELP facility (c) |
2,525,410 | 2.54% - 3.94% | 05/09/10 | |||||||||
Commercial paper private loan facility (c) |
132,020 | 3.14% | 03/14/09 | |||||||||
Fixed-rate bonds and notes (a) |
205,435 | 5.30% - 6.68% | 11/01/09 - 05/01/29 | |||||||||
Unsecured fixed rate debt |
475,000 | 5.13% and 7.40% | 06/01/10 and 09/15/61 | |||||||||
Unsecured line of credit |
645,000 | 2.90% - 3.65% | 05/08/12 | |||||||||
Department of Education Participation |
263,920 | 3.25% | 09/30/09 | |||||||||
Other borrowings |
95,070 | 4.09% - 5.10% | 05/22/09 - 11/01/15 | |||||||||
$ | 28,004,835 | |||||||||||
As of December 31, 2007 | ||||||||||||
Carrying | Interest rate | |||||||||||
amount | range | Final maturity | ||||||||||
Variable-rate bonds and notes (a): |
||||||||||||
Bonds and notes based on indices |
$ | 17,508,810 | 4.73% - 5.78% | 09/25/12 - 06/25/41 | ||||||||
Bonds and notes based on auction or remarketing |
2,905,295 | 2.96% - 7.25% | 11/01/09 - 07/01/43 | |||||||||
Total variable-rate bonds and notes |
20,414,105 | |||||||||||
Commercial paper FFELP facility (c) |
6,629,109 | 5.22% - 5.98% | 05/09/10 | |||||||||
Commercial paper private loan facility (c) |
226,250 | 5.58% | 03/14/09 | |||||||||
Fixed-rate bonds and notes (a) |
214,476 | 5.20% - 6.68% | 11/01/09 - 05/01/29 | |||||||||
Unsecured fixed rate debt |
475,000 | 5.13% and 7.40% | 06/01/10 and 09/15/61 | |||||||||
Unsecured line of credit |
80,000 | 5.40% - 5.53% | 05/08/12 | |||||||||
Other borrowings |
76,889 | 4.65% - 5.20% | 09/28/08 - 11/01/15 | |||||||||
$ | 28,115,829 | |||||||||||
(a) | Issued in asset-backed securitizations. |
|
(b) | As of September 30, 2008, the Company had $165 million of
bonds based on an auction rate of 0%, due to the Maximum Rate auction
provisions in the underlying documents for such financings. The Maximum
Rate provisions include multiple components, one of which is based on
T-bill rates. The T-bill component calculation for these bonds produced
negative rates, which resulted in auction rates of zero percent for the
applicable period. |
|
(c) | Loan warehouse facilities. |
Secured Financing Transactions
The Company has historically relied upon secured financing vehicles as its most significant source
of funding for student loans. The net cash flow the Company receives from the securitized student
loans generally represents the excess amounts, if any, generated by the underlying student loans
over the amounts required to be paid to the bondholders, after deducting servicing fees and any
other expenses relating to the securitizations. The Companys rights to cash flow from securitized
student loans are subordinate to bondholder interests and may fail to generate any cash flow beyond
what is due to bondholders. The Companys secured financing vehicles are loan warehouse facilities
and asset-backed securitizations.
In August 2008, the Company began to fund FFELP student loan originations for the 2008-2009
academic year pursuant to the Department of Educations Loan Participation Program (Participation
Program) and an existing participation agreement with Union Bank and Trust Company (Union Bank),
an entity under common control with the Company.
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Loan warehouse facilities
Student loan warehousing has historically allowed the Company to buy and manage student loans prior
to transferring them into more permanent financing arrangements. The Company has historically
relied upon three conduit warehouse loan financing vehicles to support its funding needs on a
short-term basis: a multi-year committed facility for FFELP loans, a $250.0 million private loan
warehouse for non-federally insured student loans, and a single-seller extendible commercial paper
conduit for FFELP loans.
FFELP Warehouse facility
The Companys multi-year committed facility for FFELP loans terminates in May 2010 and was
supported by 364-day liquidity which was up for renewal on May 9, 2008. The Company obtained an
extension on this renewal until July 31, 2008. On July 31, 2008, the Company did not renew the
liquidity provisions of this facility. Accordingly, as of July 31, 2008, the facility became a
term facility with a final maturity date of May 9, 2010. Pursuant to the terms of the agreement,
since liquidity was not renewed, the Companys cost of financing under this facility increased 10
basis points. The agreement also includes provisions which allow the banks to charge a rate equal
to LIBOR plus 128.5 basis points if they choose to finance their portion of the facility with
sources of funds other than their commercial paper conduit. In addition, the FFELP warehouse
facility has a provision requiring the Company to refinance or remove 75% of the pledged collateral
on an annual basis. The Company believes it has met this requirement for the annual period ending
in May 2009. Under the current terms of the facility, the remaining collateral will need to be
refinanced or removed by May 9, 2010. As of September 30, 2008 and November 7, 2008, $2.5 billion and $2.1 billion, respectively, was outstanding under
this facility.
The terms and conditions of the Companys warehouse facility for FFELP loans provide for
mark-to-market advance rates. On October 22, 2008, the Company posted $165.5 million in additional
funds to the facility based on this mark-to-market provision. While the Company does not believe
that the loan valuation formula is reflective of the actual fair value of its loans, it is subject
to compliance with such mark-to-market provisions of the warehouse facility agreement. As of
September 30, 2008 and November 7, 2008, the Company had a cumulative amount of $209.1 million and
$374.6 million, respectively, posted as equity funding support for this facility.
The Company has utilized its $750.0 million unsecured line of credit to fund equity advances on its
warehouse facility. As of November 7, 2008, the Company has $691.5 million outstanding under this
line of credit. The line of credit terminates in May 2012.
Continued dislocations in the credit markets may cause additional volatility in the loan valuation
formula. Should a significant change in the valuation of loans result in additional required
equity funding support for the warehouse facility greater than what the Company can provide and the Company has not amended the facility as discussed below, the
warehouse facility could be subject to an event of default resulting in a termination of the
facility and an acceleration of the repayment provisions. A default on the FFELP warehouse facility would
result in an event of default on the Companys unsecured line of credit that would result in the
outstanding balance on the line of credit becoming immediately due and payable.
To reduce the Companys exposure from the mark-to-market advance rate provision included in the
FFELP warehouse facility, the Company has signed a letter agreement engaging Banc of America Securities LLC to arrange an amendment of
certain of the Companys credit facilities, including but not limited to an amendment to place a
floor on the valuation of collateral in the Companys FFELP loan warehouse line of credit for
which Bank of America, N.A. acts as administrative agent. Banc of America Securities LLC has
commenced the amendment process and together with the Company is seeking the approval of the
Companys lenders of a proposed amendment of such credit facilities on mutually agreeable terms. In addition, the Company continues to look at various
alternatives to remove loans from the warehouse facility including other financing arrangements
and/or selling loans to third parties.
In addition, on November 8, 2008, the Department announced they intend to provide liquidity support
to one or more conforming asset backed commercial paper conduits to purchase and provide
longer-term financing for FFELP loans. While details of this conduit are forthcoming, it is
intended that all fully-disbursed non-consolidation FFELP loans awarded between October 1, 2003 and
July 1, 2009 will be eligible for inclusion. As of November 7, 2008, the Company had approximately
$900 million of loans included in its warehouse facility that would be eligible for this proposed
conduit program.
Private Loan Warehouse Facility
The private loan warehouse facility, which terminates on March 14, 2009, is an uncommitted facility
that is offered to the Company by a banking partner. As of September 30, 2008 and November 7, 2008,
$132.0 million was outstanding under this facility. New advances are also subject to approval by
the sponsor bank, and the Company believes it is unlikely such approval would be granted in the
future. The Company guarantees the performance of the assets in the private loan warehouse
facility. This facility provides for advance rates on subject collateral which require certain
levels of equity enhancement support. As of September 30, 2008 and November 7, 2008, the Company
had $50.5 million utilized as equity funding support based on provisions of this agreement. There
can be no assurance that the Company will be able to maintain this conduit facility, find
alternative funding, or make adequate equity contributions, if necessary. While the Companys bank
supported facilities have historically been renewed for successive terms, there can be no assurance
that this will continue in the future. In January 2008, the Company suspended originating private
loans.
Commercial Paper Warehouse Program
In August 2006, the Company established a $5.0 billion extendable commercial paper warehouse
program for FFELP loans, under which it can issue one or more short-term extendable secured
liquidity notes. As of September 30, 2008, no notes were outstanding under this warehouse program.
As a result of the disruption of the credit markets, there is no market for the issuance of notes
under this facility. Management believes it is currently unlikely a market will exist in the
foreseeable future.
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Department of Educations Loan Participation and Purchase Commitment Programs
On July 1, 2008, pursuant to the Ensuring Continued Access to Student Loans Act, the Department of
Education announced terms under which it will offer to purchase certain FFELP student loans and
participation interests in certain FFELP student loans from FFELP lenders. Under the Departments
Loan Purchase Commitment Program (Purchase Program), the Department will purchase loans at a
price equal to the sum of (i) par value, (ii) accrued interest, (iii) the one percent origination
fee paid to the Department, and (iv) a fixed amount of $75 per loan. Under the Participation
Program, the Department provides interim short-term liquidity to FFELP lenders by purchasing
participation interests in pools of FFELP loans. FFELP lenders are charged a rate of commercial
paper plus 50 basis points on the principal amount of participation interests outstanding. Loans
funded under the Participation Program must be either refinanced by the lender or sold to the
Department pursuant to the Purchase Program prior to its expiration on September 30, 2009. To be
eligible for purchase or participation under the Departments programs, loans must be FFELP
Stafford or PLUS loans made for the academic year 2008-2009, first disbursed between May 1, 2008
and July 1, 2009, with eligible borrower benefits.
On October 7, 2008, legislation was enacted to extend the Departments authority to address FFELP
student loans made for the 2009-2010 academic year and allowing for the extension of the
Participation Program and Purchase Program from September 30, 2009 to September 30, 2010. The
Department has provided preliminary guidance relating to the extension and has indicated that
programs similar to the Participation Program and Purchase Program will be implemented for the
2009-2010 academic year along with providing liquidity support for one or more asset backed
commercial paper conduits for FFELP Stafford and PLUS loans awarded between October 1, 2003 and
July 1, 2009. The Department has indicated that loans for the 2008-2009 academic year
which are funded under the Departments Participation Program will need to be refinanced or sold to
the Department prior to September 30, 2009. Management understands that such loans will not be
eligible for participation under the Departments 2009-2010 Participation Program, but should be
eligible for refinancing through the Departments commercial paper conduit program. Management of
the Company is encouraged by these developments; however, until the Department provides additional
details regarding the programs, the Company is unable to determine the full impact these programs
will have on the Company.
The Company has completed and filed all relevant documents to participate in the Department of
Educations Participation Program and began to utilize the Participation Program in the third
quarter of 2008 to fund a significant portion of its loan originations for the 2008-2009 academic
year. As of September 30, 2008 and November 7, 2008, $263.9 million and $504.4 million of loans,
respectively, were funded using the Participation Program.
Union Bank Participation Agreement
The Company maintains an agreement with Union Bank, as trustee for various grantor trusts, under
which Union Bank has agreed to purchase from the Company participation interests in student loans
(the FFELP Participation Agreement). The Company has the option to purchase the participation
interests from the grantor trusts at the end of a 364-day term upon termination of the
participation certificate. As of September 30, 2008 and November 7, 2008, $221.6 million and
$335.3 million, respectively, of loans were subject to outstanding participation interests held by
Union Bank, as trustee, under this agreement. The agreement automatically renews annually and is
terminable by either party upon five business days notice. This agreement provides beneficiaries of
Union Banks grantor trusts with access to investments in interests in student loans, while
providing liquidity to the Company on a short-term basis. The Company can participate loans to
Union Bank to the extent of availability under the grantor trusts, up to $750 million. Loans
participated under this agreement qualify as a sale pursuant to the provisions of SFAS No. 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
(SFAS No. 140). Accordingly, the participation interests sold are not included on the Companys
consolidated balance sheet.
Asset-backed Securitizations
On March 7, 2008, April 2, 2008, April 22, 2008, and May 19, 2008, the Company completed
asset-backed securities transactions of $1.2 billion, $0.5 billion, $1.5 billion, and $1.3 billion,
respectively. Notes issued in these transactions carry interest rates based on a spread to LIBOR.
As part of the Companys issuance of asset-backed securitizations in March 2008 and May 2008, due
to credit market conditions when these notes were issued, the Company purchased the Class B
subordinated notes of $36 million (par value) and $41 million (par value), respectively. These
notes are not included on the Companys consolidated balance sheet. If the credit market
conditions improve, the Company anticipates selling these notes to third parties. Upon a sale to
third parties, the Company would obtain cash proceeds equal to the market value of the notes on the
date of such sale. Upon sale, these notes would be shown as bonds and notes payable on the
Companys consolidated balance sheet. Unless there is a significant market improvement, the
Company believes the market value of such notes will be less than par value. The difference
between the par value and market value would be recognized by the Company as interest expense over
the life of the bonds.
Notes issued during 2006 included 773.2 million (950 million in U.S. dollars) with variable
interest rates initially based on a spread to EURIBOR (the Euro Notes). As of September 30, 2008
and December 31, 2007, the Euro Notes were recorded on the Companys balance sheet at $1.1 billion.
The changes in the principal amount of Euro Notes as a result of the fluctuation of the foreign
currency exchange rate were decreases of $128.9 million and $40.4 million for the three and nine
months ended September 30, 2008, respectively, and increases of $54.0 million and $79.0 million for
the three and nine months ended September 30, 2007, respectively, and are included in the
derivative market value, foreign currency, and put option adjustments and derivative settlements, net in the
consolidated statements of operations. Concurrently with the issuance of the Euro Notes, the
Company entered into cross-currency interest rate swaps which are further discussed in note 8.
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The interest rates on certain of the Companys asset-backed securities are set and periodically
reset via a dutch auction (Auction Rate Securities) or through a remarketing utilizing
broker-dealers and remarketing agents (Variable Rate Demand Notes). The Company is currently
sponsor on approximately $1.9 billion of Auction Rate Securities and $0.8 billion of Variable Rate
Demand Notes.
For Auction Rate Securities, investors and potential investors submit orders through a
broker-dealer as to the principal amount of notes they wish to buy, hold, or sell at various
interest rates. The broker-dealers submit their clients orders to the auction agent, who then
determines the clearing interest rate for the upcoming period. Interest rates on these Auction Rate
Securities are reset periodically, generally every 7 to 35 days, by the auction agent or agents.
During the first quarter of 2008, as part of the credit market crisis, several auction rate
securities from various issuers failed to receive sufficient order interest from potential
investors to clear successfully, resulting in failed auction status. Since February 8, 2008, the
Companys Auction Rate Securities have failed in this manner. Under normal conditions, banks have
historically stepped in when investor demand is weak. However, banks have been allowing these
auctions to fail.
As a result of a failed auction, the Auction Rate Securities will generally pay interest to the
holder at a maximum rate as defined by the commercial paper, governing documents, or indenture.
While these rates will vary by the trust structure the notes were issued from as well as the class
and rating of the security, they will generally be based on a spread to LIBOR, commercial paper, or
Treasury Securities. Based on the relative levels of these indices as of September 30, 2008, the
rates expected to be paid by the Company range from 91-day T-Bill plus 125 basis points, on the low
end, to LIBOR plus 250 basis points, on the high end.
During the three month period ended September 30, 2008, the Company paid favorable interest rates
on the majority of its Auction Rate Securities as a result of the application of certain of these
maximum rate auction provisions in the underlying documents for such financings.
The Company cannot predict whether future auctions related to its Auction Rate Securities will be
successful, but management believes it is likely auctions will continue to fail indefinitely. The
Company is currently seeking alternatives for reducing its exposure to the auction rate market, but
may not be able to achieve alternate financing for some or all of its Auction Rate Securities.
For Variable Rate Demand Notes, the remarketing agents set the price, which is then offered to
investors. If there are insufficient potential bid orders to purchase all of the notes offered for
sale, the Company could be subject to interest costs substantially above the anticipated and
historical rates paid on these types of securities. The maximum rate for Variable Rate Demand
Notes is based on a spread to certain indexes as defined in the underlying documents, with the
highest to the Company being Prime plus 200 basis points. Certain of the Variable Rate Demand
Notes are secured by financial guaranty insurance policies issued by MBIA Insurance Corporation.
These Variable Rate Demand Notes are currently experiencing reduced investor demand and certain of
these securities have been put to the liquidity provider, Lloyds TSB Bank, at a cost ranging from
Federal Funds plus 150 basis points to LIBOR plus 175 basis points.
Unsecured Lines of Credit
The Company has a $750.0 million unsecured line of credit that terminates in May 2012. As of
September 30, 2008, there was $645.0 million outstanding on this line and $105.0 million available
for future use. The weighted average interest rate on this line of credit was
3.44% as of
September 30, 2008. Upon termination in 2012, there can be no assurance that the Company will be
able to maintain this line of credit, find alternative funding, or increase the amount outstanding
under the line, if necessary. As discussed previously, the Company may need to fund certain loans
or provide additional equity funding support related to advance rates on its warehouse facilities.
As of November 7, 2008, the Company has contributed $425.1 million in equity funding support to these
facilities. The Company has funded these contributions primarily by advances on its operating line
of credit. As of November 7, 2008, the Company has $691.5 million outstanding under this line of
credit and $58.5 million available for future uses. The lending commitment on the Companys
unsecured line of credit is provided by multiple banks. Lehman Brothers Bank, FSB (Lehman Bank)
represents seven percent of the lending commitment under the line of credit. On September 15,
2008, Lehman Brothers Holdings Inc. filed a voluntary petition for relief under Chapter 11 of the
United States Bankruptcy Code. Since the bankruptcy filing, the Company has experienced funding
delays from Lehman Bank for its portion of the lending commitment under the line of credit. As of
November 7, 2008, excluding Lehman Banks lending commitment, the Company has $51.2 million
available for future use under its unsecured line of credit.
The line of credit agreement contains certain financial covenants that, if not met, lead to an
event of default under the agreement. The covenants include maintaining:
(i) | A minimum consolidated net worth; |
||
(ii) | A minimum adjusted EBITDA to corporate debt interest (over the last four rolling quarters); |
||
(iii) | A limitation on subsidiary indebtedness; and |
||
(iv) | A limitation on the percentage of non-guaranteed loans in the Companys portfolio. |
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As of September 30, 2008, the Company was in compliance with all of these requirements. Many of
these covenants are duplicated in the Companys other lending facilities, including its FFELP and
private loan warehouses.
As previously discussed, continued dislocations in the credit markets may cause additional
volatility in the loan valuation formula included in the Companys FFELP warehouse facility.
Should a significant change in the valuation of loans result in additional required equity funding
support for the warehouse facility greater than what the Company can provide, the warehouse
facility could be subject to an event of default resulting in a termination of the facility and an
acceleration of the repayment provisions. A default on the FFELP warehouse facility would result in
an event of default on the Companys unsecured line of credit that would result in the outstanding
balance on the line of credit becoming immediately due and payable.
The Companys operating line of credit does not have any covenants related to unsecured debt
ratings. However, changes in the Companys ratings (as well as the amounts the Company borrows)
have modest implications on the pricing level at which the Company obtains funding.
Other Borrowings
As of September 30, 2008 and December 31, 2007, bonds and notes payable includes $90.1 million and
$57.3 million, respectively, of notes due to Union Bank. The Company has used the proceeds from
these notes to invest in student loan assets via a participation agreement. This participation
agreement is in addition to the $750 million FFELP Participation Agreement, and participations
under this participation agreement do not qualify as sales pursuant to SFAS No. 140. On October
23, 2008, the Company paid Union Bank $89.5 million to pay off the remaining balance on these
notes.
8. Derivative Financial Instruments
The Company maintains an overall risk management strategy that incorporates the use of derivative
instruments to reduce the economic effect of interest rate volatility and fluctuations in foreign
currency exchange rates. Derivative instruments used as part of the Companys risk management
strategy include interest rate swaps, basis swaps, and cross-currency interest rate swaps.
Interest Rate Swaps
FFELP student loans generally earn interest at the higher of a floating rate based on the Special
Allowance Payment or SAP formula set by the Department and the borrower rate, which is fixed over a
period of time. The Company generally finances its student loan portfolio with variable-rate debt.
In low and/or declining interest rate environments, when the fixed borrower rate is higher than
the rate produced by the SAP formula, the Companys student loans earn at a fixed rate while the
interest on the variable-rate debt continues to decline. In these interest rate environments, the
Company earns additional spread income that it refers to as floor income.
Depending on the type of the student loan and when it was originated, the borrower rate is either
fixed to term or is reset to market rate each July 1. As a result, for loans where the borrower
rate is fixed to term, the Company earns floor income for an extended period of time, which the
Company refers to as fixed rate floor income, and for those loans where the borrower rate is reset
annually on July 1, the Company earns floor income to the next reset date, which the Company refers
to as variable-rate floor income. In accordance with legislation enacted in 2006, lenders are
required to rebate fixed-rate floor income and variable-rate floor income to the Department for all
FFELP loans originated on or after April 1, 2006.
Absent the use of derivative instruments, a rise in interest rates will have an adverse effect on
earnings due to interest margin compression caused by increasing financing costs, until such time
as the federally insured loans earn interest at a variable rate in accordance with the SAP formula.
In higher interest rate environments, where the interest rate rises above the borrower rate and
fixed-rate loans effectively become variable rate loans, the impact of the rate fluctuations is
reduced.
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Table of Contents
As of September 30, 2008, the Company held the following interest rate swaps to hedge student loan
assets earning fixed rate floor income.
Weighted | ||||||||
average fixed | ||||||||
Notional | rate paid by | |||||||
Maturity | Amount | the Company (a) | ||||||
2009 |
$ | 500,000 | 4.08 | % | ||||
2010 |
500,000 | 3.84 | ||||||
$ | 1,000,000 | 3.96 | % | |||||
(a) | For all interest rate derivatives for which the Company pays a fixed rate, the
Company receives discrete three-month LIBOR. |
During the third quarter of 2008, the Company terminated certain interest rate swaps with a total
notional amount of $1.4 billion and original maturity dates ranging from 2010 to 2012 for total net
proceeds of $5.6 million.
Basis Swaps
The Company has entered into basis swaps in which the Company receives three-month LIBOR set
discretely in advance and pays a daily weighted average three-month LIBOR less a spread as defined
in the individual agreements. The Company entered into these derivative instruments to better
match the interest rate characteristics on its student loan assets and the debt funding such
assets. The following table summarizes these derivatives as of September 30, 2008:
Notional | ||||
Maturity | Amounts | |||
2008 |
$ | 1,000,000 | ||
2009 |
1,000,000 | |||
2010 |
5,500,000 | |||
2011 |
2,700,000 | |||
2012 |
2,400,000 | |||
$ | 12,600,000 | |||
During the first and third quarters of 2008, the Company terminated certain basis swaps with total
notional amounts of $2.9 billion and $9.8 billion, respectively, with original maturity dates
ranging from 2009 to 2012 for total net proceeds of $7.1 million and total net payments of $1.5
million, respectively. In October 2008, the Company terminated a basis swap with a notional amount
of $1.0 billion and an original maturity date in 2010 for proceeds of $0.6 million. This
derivative is included in the above table.
Cross-Currency Interest Rate Swaps
The Company entered into derivative instruments in 2006 as a result of the issuance of the Euro
Notes as discussed in note 7. Under the terms of these derivative instrument agreements, the
Company receives from a counterparty a spread to the EURIBOR index based on a notional amount of
420.5 million and 352.7 million, respectively, and pays a spread to the LIBOR index based on a
notional amount of $500.0 million and $450.0 million, respectively. In addition, under the terms
of these agreements, all principal payments on the Euro Notes will effectively be paid at the
exchange rate in effect as of the issuance of these notes.
Accounting for Derivative Financial Instruments
The Company accounts for derivative instruments under SFAS No. 133, which requires that every
derivative instrument be recorded on the balance sheet as either an asset or liability measured at
its fair value. Management has structured all of the Companys derivative transactions with the
intent that each is economically effective; however, the Companys derivative instruments do not
qualify for hedge accounting under SFAS No. 133. As a result, the change in fair value of
derivative instruments is recorded in the consolidated statements of operations at each reporting
date. Upon termination of a derivative instrument, any proceeds received or payments made by the
Company are included in derivative market value, foreign currency, and put option adjustments and
derivative settlements, net on the consolidated statements of operations and is accounted for as a
change in fair value on such derivative.
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Table of Contents
The following table summarizes the net fair value of the Companys derivative portfolio:
As of | As of | |||||||
September 30, 2008 | December 31, 2007 | |||||||
Interest rate swaps |
$ | (5,579 | ) | (2,695 | ) | |||
Basis swaps |
(17,082 | ) | 27,525 | |||||
Cross-currency interest rate
swaps |
154,473 | 191,756 | ||||||
Net fair value |
$ | 131,812 | 216,586 | |||||
The change in the fair value of the Companys derivative portfolio included in derivative market
value, foreign currency, and put option adjustments and derivative settlements, net on the
Companys consolidated statements of operations resulted in a loss of $119.9 million and income of
$72.7 million for the three months ended September 30, 2008 and 2007, respectively, and a loss of
$72.4 million and income of $93.0 million for the nine months ended September 30, 2008 and 2007,
respectively.
The following table summarizes the net derivative settlements which are included in the derivative
market value, foreign currency, and put option adjustments and derivative settlements, net in the
consolidated statements of operations:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Interest rate swaps |
$ | (3,176 | ) | 1,729 | (14,194 | ) | 16,803 | |||||||||
Basis swaps |
(3,999 | ) | (2,608 | ) | 41,605 | (2,489 | ) | |||||||||
Cross-currency interest rate swaps |
7,963 | (1,457 | ) | 18,577 | (7,214 | ) | ||||||||||
Derivative settlements received (paid), net |
$ | 788 | (2,336 | ) | 45,988 | 7,100 | ||||||||||
By using derivative instruments, the Company is exposed to credit and market risk. When the fair
value of a derivative contract is positive, this generally indicates that the counterparty owes the
Company. If the counterparty fails to perform, credit risk is equal to the extent of the fair
value gain in a derivative. When the fair value of a derivative contract is negative, the Company
owes the counterparty and, therefore, it has no credit risk. The Company minimizes the credit (or
repayment) risk in derivative instruments by entering into transactions with high-quality
counterparties that are reviewed periodically by the Companys risk committee. The Company also
maintains a policy of requiring that all derivative contracts be governed by an International Swaps
and Derivatives Association, Inc. Master Agreement.
Market risk is the adverse effect that a change in interest rates, or implied volatility rates, has
on the value of a financial instrument. The Company manages market risk associated with interest
rates by establishing and monitoring limits as to the types and degree of risk that may be
undertaken.
9. Fair Value
On January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (SFAS No. 157).
SFAS No. 157 defines fair value, establishes a consistent framework for measuring fair value, and
expands disclosure requirements about fair value measurements. The Company elected to delay the
application of SFAS No. 157 to nonfinancial assets and nonfinancial liabilities, as allowed by FASB
Staff Position SFAS No. 157-2. SFAS No. 157 applies when other accounting pronouncements require
or permit fair value measurements; it does not require new fair value measurements.
Fair value under SFAS No. 157 is defined as the price to sell an asset or transfer a liability in
an orderly transaction between willing and able market participants. The Company determines fair
value using valuation techniques which are based upon observable and unobservable inputs.
Observable inputs reflect market data obtained from independent sources, while unobservable inputs
reflect the Companys market assumptions. Transaction costs are not included in the determination
of fair value. When possible, the Company seeks to validate the models output to market
transactions. Depending on the availability of observable inputs and prices, different valuation
models could produce materially different fair value estimates. The values presented may not
represent future fair values and may not be realizable. Additionally, there may be inherent
weaknesses in any calculation technique, and changes in the underlying assumptions used, including
discount rates and estimates of future cash flows, could significantly affect the results of
current or future values.
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Table of Contents
Under SFAS No. 157, the Company categorizes its fair value estimates based on a hierarchal
framework associated with three levels of price transparency utilized in measuring financial
instruments at fair value. Classification is based on the lowest level of input that is
significant to the fair value of the instrument. The three levels include:
| Level 1: Quoted prices for identical instruments in active markets. The types of
financial instruments included in Level 1 are highly liquid instruments with quoted prices. |
| Level 2: Quoted prices for similar instruments in active markets, quoted prices for
identical or similar instruments in markets that are not active; and model derived
valuations whose inputs are observable or whose primary value drivers are observable. |
| Level 3: Instruments whose primary value drivers are unobservable. Inputs are developed
based on the best information available; however, significant judgment is required by
management in developing the inputs. |
The following table presents the Companys financial assets and liabilities that are measured at
fair value on a recurring basis. All financial assets and liabilities that are measured at fair
value are categorized as Level 1 or 2 based on the above hierarchy.
As of September 30, 2008 | ||||||||||||
Level 1 | Level 2 | Total | ||||||||||
Assets: |
||||||||||||
Other assets (a) |
$ | 5,477 | 5,129 | 10,606 | ||||||||
Fair value of derivative instruments (b) |
| 154,741 | 154,741 | |||||||||
Total assets |
$ | 5,477 | 159,870 | 165,347 | ||||||||
Liabilities: |
||||||||||||
Fair value of derivative instruments (b) |
$ | | 22,929 | 22,929 | ||||||||
Other liabilities (c) |
| 9,600 | 9,600 | |||||||||
Total liabilities |
$ | | 32,529 | 32,529 | ||||||||
As of December 31, 2007 | ||||||||||||
Level 1 | Level 2 | Total | ||||||||||
Assets: |
||||||||||||
Fair value of derivative instruments (b) |
$ | | 222,471 | 222,471 | ||||||||
Total assets |
$ | | 222,471 | 222,471 | ||||||||
Liabilities: |
||||||||||||
Fair value of derivative instruments (b) |
$ | | 5,885 | 5,885 | ||||||||
Other liabilities (c) |
| 6,117 | 6,117 | |||||||||
Total liabilities |
$ | | 12,002 | 12,002 | ||||||||
(a) | Other assets includes investments recorded at fair value on a recurring basis.
Fair value measurement is based upon quoted prices. Level 1 investments include
investments traded on an active exchange, such as the New York Stock Exchange, and U.S.
Treasury securities that are traded by dealers or brokers in active over-the-counter
markets. Level 2 investments include corporate debt securities. |
|
(b) | All derivatives are accounted for at fair value in the financial statements. The
fair values of derivative financial instruments are determined by derivative pricing
models using the stated terms of the contracts and observable yield curves, forward
foreign currency exchange rates, and volatilities from active markets. It is the
Companys policy to compare its derivative fair values to those received by its
counterparties in order to validate the models outputs. Fair value of derivative
instruments is comprised of market value less accrued interest and excludes collateral. |
|
(c) | Other liabilities includes put options valued using a Black-Scholes pricing model
using the stated terms of the contracts and observable inputs including the Companys
common stock volatility and dividend yield and a risk-free interest rate over the
expected term of the option. |
10. Earnings per Common Share
Basic earnings per common share (basic EPS) is computed by dividing net income by the weighted
average number of shares of common stock outstanding during each period. SFAS No. 128, Earnings
Per Share (SFAS No. 128), requires that nonvested restricted stock that vests solely upon
continued service be excluded from basic EPS but reflected in diluted earnings per common share
(diluted EPS) by application of the treasury stock method.
21
Table of Contents
A reconciliation of weighted average shares outstanding follows:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Weighted average shares outstanding |
49,525,674 | 49,320,629 | 49,472,020 | 49,912,506 | ||||||||||||
Less: Nonvested restricted stock
vesting solely upon continued service |
349,238 | 302,538 | 362,680 | 101,954 | ||||||||||||
Weighted average shares outstanding used
to compute basic EPS |
49,176,436 | 49,018,091 | 49,109,340 | 49,810,552 | ||||||||||||
Dilutive effect of nonvested restricted stock |
21,366 | | | 500 | ||||||||||||
Weighted average shares used to compute diluted EPS |
49,197,802 | 49,018,091 | 49,109,340 | 49,811,052 | ||||||||||||
No dilutive effect of nonvested restricted stock is presented for the three months ended September
30, 2007 and the nine months ended September 30, 2008 as the Company reported a net loss and
including these shares would have been antidilutive for the period. The dilutive effect of these
shares if the Company had net income for the period was not significant.
11. Segment Reporting
The Company has five operating segments as defined in SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information, as follows: Student Loan and Guaranty Servicing, Tuition
Payment Processing and Campus Commerce, Enrollment Services and List Management, Software and
Technical Services, and Asset Generation and Management. The Companys operating segments are
defined by the products and services they offer or the types of customers they serve, and they
reflect the manner in which financial information is currently evaluated by management. The
accounting policies of the Companys operating segments are the same as those described in the
summary of significant accounting policies. Intersegment revenues are charged by a segment to
another segment that provides the product or service. Intersegment revenues and expenses are
included within each segment consistent with the income statement presentation provided to
management. Changes in management structure or allocation methodologies and procedures may result
in changes in reported segment financial information.
The management reporting process measures the performance of the Companys operating segments based
on the management structure of the Company as well as the methodology used by management to
evaluate performance and allocate resources. Management, including the Companys chief operating
decision maker, evaluates the performance of the Companys operating segments based on their
profitability. As discussed further below, management measures the profitability of the Companys
operating segments based on base net income. Accordingly, information regarding the Companys
operating segments is provided based on base net income. The Companys base net income is not
a defined term within GAAP and may not be comparable to similarly titled measures reported by other
companies. Unlike financial accounting, there is no comprehensive, authoritative guidance for
management reporting.
In May 2007, the Company sold EDULINX, a Canadian student loan service provider and subsidiary of
the Company. As a result of this transaction, the results of operations for EDULINX are reported
as discontinued operations for all periods presented. The operating results of EDULINX were
included in the Student Loan and Guaranty Servicing operating segment. The Company presents base
net income excluding discontinued operations since the operations and cash flows of EDULINX have
been eliminated from the ongoing operations of the Company. Therefore, the results of operations
for the Student Loan and Guaranty Servicing segment exclude the operating results of EDULINX for
all periods presented. See note 2 for additional information concerning EDULINXs detailed
operating results that have been segregated from continuing operations and reported as discontinued
operations.
Historically, the Company generated the majority of its revenue from net interest income earned in
its Asset Generation and Management operating segment. In recent years, the Company has made
several acquisitions that have expanded the Companys products and services and has diversified its
revenue primarily from fee-based businesses. The Company currently offers a broad range of
pre-college, in-college, and post-college products and services to students, families, schools, and
financial institutions. These products and services help students and families plan and pay for
their education and students plan their careers. The Companys products and services are designed
to simplify the education planning and financing process and are focused on providing value to
students, families, and schools throughout the education life cycle. The Company continues to
diversify its sources of revenue, including those generated from businesses that are not dependent
upon government programs, reducing legislative and political risk.
22
Table of Contents
Fee-Based Operating Segments
Student Loan and Guaranty Servicing
The Student Loan and Guaranty Servicing segment provides for the servicing of the Companys student
loan portfolios and the portfolios of third parties and servicing provided to guaranty agencies.
The servicing and business process outsourcing activities include loan origination activities,
application processing, borrower updates, payment processing, due diligence procedures, and claim
processing. These activities are performed internally for the Companys portfolio in addition to
generating fee revenue when performed for third-party clients. The guaranty servicing, servicing
support, and business process outsourcing activities include providing software and data center
services, borrower and loan updates, default aversion tracking services, claim processing services,
and post-default collection services to guaranty agencies. The following are the primary product
and service offerings the Company offers as part of its Student Loan and Guaranty Servicing
segment:
| Origination and servicing of FFELP loans; |
| Servicing of non-federally insured student loans; and |
| Servicing and support outsourcing for guaranty agencies. |
Tuition Payment Processing and Campus Commerce
The Tuition Payment Processing and Campus Commerce segment provides products and services to help
institutions and education seeking families manage the payment of education costs during the
pre-college and college stages of the education life cycle. The Company provides actively managed
tuition payment solutions, online payment processing, detailed information reporting, financial
needs analysis, and data integration services to K-12 and higher educational institutions,
families, and students. In addition, the Company provides customer-focused electronic
transactions, information sharing, and account and bill presentment to colleges and universities.
Enrollment Services and List Management
The Enrollment Services and List Management segment provides a wide range of direct marketing
products and services to help schools and businesses reach the middle school, high school, college
bound high school, college, and young adult market places. In addition, this segment offers
products and services that are focused on helping (i) students plan and prepare for life after high
school and (ii) colleges recruit and retain students.
Software and Technical Services
The Software and Technical Services segment provides information technology products and
full-service technical consulting, with core areas of business in educational loan software
solutions, business intelligence, technical consulting services, and Enterprise Content Management
(ECM) solutions.
Asset Generation and Management Operating Segment
The Asset Generation and Management segment includes the acquisition, management, and ownership of
the Companys student loan assets. Revenues are primarily generated from the Companys earnings
from the spread, referred to as the Companys student loan spread, between the yield received on
the student loan portfolio and the costs associated with originating, acquiring, financing,
servicing, and managing the student loan portfolio. The Company generates student loan assets
through direct origination or through acquisitions. The student loan assets are held in a series of
education lending subsidiaries designed specifically for this purpose. In addition to the student
loan portfolio, all costs and activity associated with the generation of assets, funding of those
assets, and maintenance of the debt transactions are included in this segment. This includes
derivative activity and the related derivative market value and foreign currency adjustments. The
Company is also able to leverage its capital market expertise by providing investment advisory
services and other related services to third parties through a licensed broker dealer subsidiary.
Revenues and expenses for those functions are also included in the Asset Generation and Management
segment.
Segment Operating Results Base Net Income
The tables below include the operating results of each of the Companys operating segments.
Management, including the chief operating decision maker, evaluates the Company on certain non-GAAP
performance measures that the Company refers to as base net income for each operating segment.
While base net income is not a substitute for reported results under GAAP, the Company relies on
base net income to manage each operating segment because it believes this measure provides
additional information regarding the operational and performance indicators that are most closely
assessed by management.
23
Table of Contents
Base net income is the primary financial performance measure used by management to develop the
Companys financial plans, track results, and establish corporate performance targets and incentive
compensation. Management believes this information provides additional insight into the financial
performance of the core business activities of the Companys operating segments. Accordingly, the
tables presented below
reflect base net income, which is the operating measure reviewed and utilized by management to
manage the business. Reconciliation of the segment totals to the Companys operating results in
accordance with GAAP are also included in the tables below.
Segment Results and Reconciliations to GAAP
Three months ended September 30, 2008 | ||||||||||||||||||||||||||||||||||||||||
Fee-Based | ||||||||||||||||||||||||||||||||||||||||
Student | Tuition | Enrollment | Base net | |||||||||||||||||||||||||||||||||||||
Loan | Payment | Services | Software | Asset | Corporate | income | ||||||||||||||||||||||||||||||||||
and | Processing | and | and | Total | Generation | Activity | Eliminations | Adjustments | GAAP | |||||||||||||||||||||||||||||||
Guaranty | and Campus | List | Technical | Fee- | and | and | and | to GAAP | Results of | |||||||||||||||||||||||||||||||
Servicing | Commerce | Management | Services | Based | Management | Overhead | Reclassifications | Results | Operations | |||||||||||||||||||||||||||||||
Total interest income |
$ | 304 | 396 | 6 | | 706 | 290,039 | 2,010 | (749 | ) | 1,580 | 293,586 | ||||||||||||||||||||||||||||
Interest expense |
| | 1 | | 1 | 224,272 | 10,492 | (749 | ) | | 234,016 | |||||||||||||||||||||||||||||
Net interest income (loss) |
304 | 396 | 5 | | 705 | 65,767 | (8,482 | ) | | 1,580 | 59,570 | |||||||||||||||||||||||||||||
Less provision for loan losses |
| | | | | 7,000 | | | | 7,000 | ||||||||||||||||||||||||||||||
Net interest income (loss) after provision
for loan losses |
304 | 396 | 5 | | 705 | 58,767 | (8,482 | ) | | 1,580 | 52,570 | |||||||||||||||||||||||||||||
Other income (expense): |
||||||||||||||||||||||||||||||||||||||||
Loan and guaranty servicing income |
30,769 | | | | 30,769 | (136 | ) | | | | 30,633 | |||||||||||||||||||||||||||||
Other fee-based income |
| 11,861 | 29,859 | | 41,720 | 4,167 | | | | 45,887 | ||||||||||||||||||||||||||||||
Software services income |
| | | 4,217 | 4,217 | | | | | 4,217 | ||||||||||||||||||||||||||||||
Other income |
6 | 1 | | | 7 | (88 | ) | 1,323 | | | 1,242 | |||||||||||||||||||||||||||||
Intersegment revenue |
18,402 | 58 | 2 | 1,660 | 20,122 | | 15,671 | (35,793 | ) | | | |||||||||||||||||||||||||||||
Derivative market value, foreign currency,
and put option adjustments |
| | | | | | | | 6,085 | 6,085 | ||||||||||||||||||||||||||||||
Derivative settlements, net |
| | | | | 789 | | | | 789 | ||||||||||||||||||||||||||||||
Total other income (expense) |
49,177 | 11,920 | 29,861 | 5,877 | 96,835 | 4,732 | 16,994 | (35,793 | ) | 6,085 | 88,853 | |||||||||||||||||||||||||||||
Operating expenses: |
||||||||||||||||||||||||||||||||||||||||
Salaries and benefits |
13,876 | 6,236 | 5,805 | 4,138 | 30,055 | 1,980 | 14,179 | (1,952 | ) | 477 | 44,739 | |||||||||||||||||||||||||||||
Other expenses |
10,632 | 2,132 | 20,416 | 568 | 33,748 | 5,354 | 13,477 | (247 | ) | 6,598 | 58,930 | |||||||||||||||||||||||||||||
Intersegment expenses |
11,940 | 288 | 1,509 | 826 | 14,563 | 18,200 | 831 | (33,594 | ) | | | |||||||||||||||||||||||||||||
Total operating expenses |
36,448 | 8,656 | 27,730 | 5,532 | 78,366 | 25,534 | 28,487 | (35,793 | ) | 7,075 | 103,669 | |||||||||||||||||||||||||||||
Income (loss) before income taxes |
13,033 | 3,660 | 2,136 | 345 | 19,174 | 37,965 | (19,975 | ) | | 590 | 37,754 | |||||||||||||||||||||||||||||
Income tax expense (benefit) (a) |
4,823 | 1,354 | 790 | 128 | 7,095 | 14,047 | (7,391 | ) | | 218 | 13,969 | |||||||||||||||||||||||||||||
Net income (loss) from
continuing operations |
8,210 | 2,306 | 1,346 | 217 | 12,079 | 23,918 | (12,584 | ) | | 372 | 23,785 | |||||||||||||||||||||||||||||
Income from discontinued operations, net of tax |
| | | | | | | | | | ||||||||||||||||||||||||||||||
Net income (loss) |
$ | 8,210 | 2,306 | 1,346 | 217 | 12,079 | 23,918 | (12,584 | ) | | 372 | 23,785 | ||||||||||||||||||||||||||||
(a) | Beginning in 2008, the consolidated effective tax rate for each applicable quarterly period is used to calculate income taxes for each operating segment. |
24
Table of Contents
Three months ended September 30, 2007 | ||||||||||||||||||||||||||||||||||||||||
Fee-Based | ||||||||||||||||||||||||||||||||||||||||
Student | Tuition | Enrollment | Base net | |||||||||||||||||||||||||||||||||||||
Loan | Payment | Services | Software | Asset | Corporate | income | ||||||||||||||||||||||||||||||||||
and | Processing | and | and | Total | Generation | Activity | Eliminations | Adjustments | GAAP | |||||||||||||||||||||||||||||||
Guaranty | and Campus | List | Technical | Fee- | and | and | and | to GAAP | Results of | |||||||||||||||||||||||||||||||
Servicing | Commerce | Management | Services | Based | Management | Overhead | Reclassifications | Results | Operations | |||||||||||||||||||||||||||||||
Total interest income |
$ | 1,182 | 990 | 110 | | 2,282 | 454,053 | 1,875 | (533 | ) | 597 | 458,274 | ||||||||||||||||||||||||||||
Interest expense |
| | 1 | | 1 | 384,793 | 9,614 | (533 | ) | | 393,875 | |||||||||||||||||||||||||||||
Net interest income (loss) |
1,182 | 990 | 109 | | 2,281 | 69,260 | (7,739 | ) | | 597 | 64,399 | |||||||||||||||||||||||||||||
Less provision for loan losses |
| | | | | 18,340 | | | | 18,340 | ||||||||||||||||||||||||||||||
Net interest income (loss) after provision
for loan losses |
1,182 | 990 | 109 | | 2,281 | 50,920 | (7,739 | ) | | 597 | 46,059 | |||||||||||||||||||||||||||||
Other income (expense): |
||||||||||||||||||||||||||||||||||||||||
Loan and guaranty servicing income |
32,870 | | | | 32,870 | 170 | | | | 33,040 | ||||||||||||||||||||||||||||||
Other fee-based income |
| 10,316 | 23,471 | | 33,787 | 3,526 | 712 | | | 38,025 | ||||||||||||||||||||||||||||||
Software services income |
| | 169 | 5,257 | 5,426 | | | | | 5,426 | ||||||||||||||||||||||||||||||
Other income |
| 31 | | | 31 | 1,181 | 5,816 | | | 7,028 | ||||||||||||||||||||||||||||||
Gain on sale of loans |
| | | | | 492 | | | | 492 | ||||||||||||||||||||||||||||||
Intersegment revenue |
22,237 | 168 | (37 | ) | 4,805 | 27,173 | | 1,492 | (28,665 | ) | | | ||||||||||||||||||||||||||||
Derivative market value, foreign currency,
and put option adjustments |
| | | | | | | | 18,449 | 18,449 | ||||||||||||||||||||||||||||||
Derivative settlements, net |
| | | | | (4,065 | ) | 1,729 | | | (2,336 | ) | ||||||||||||||||||||||||||||
Total other income (expense) |
55,107 | 10,515 | 23,603 | 10,062 | 99,287 | 1,304 | 9,749 | (28,665 | ) | 18,449 | 100,124 | |||||||||||||||||||||||||||||
Operating expenses: |
||||||||||||||||||||||||||||||||||||||||
Salaries and benefits |
21,961 | 5,312 | 8,095 | 6,537 | 41,905 | 6,154 | 9,691 | 2,292 | 503 | 60,545 | ||||||||||||||||||||||||||||||
Restructure expense- severance and contract
termination costs |
1,231 | | 737 | 58 | 2,026 | 1,921 | 1,009 | (4,956 | ) | | | |||||||||||||||||||||||||||||
Impairment expense |
| | 11,401 | | 11,401 | 28,291 | 9,812 | | | 49,504 | ||||||||||||||||||||||||||||||
Other expenses |
8,565 | 2,029 | 13,809 | 689 | 25,092 | 7,429 | 19,822 | 168 | 10,885 | 63,396 | ||||||||||||||||||||||||||||||
Intersegment expenses |
1,613 | (15 | ) | 67 | 147 | 1,812 | 20,924 | 3,433 | (26,169 | ) | | | ||||||||||||||||||||||||||||
Total operating expenses |
33,370 | 7,326 | 34,109 | 7,431 | 82,236 | 64,719 | 43,767 | (28,665 | ) | 11,388 | 173,445 | |||||||||||||||||||||||||||||
Income (loss) before income taxes |
22,919 | 4,179 | (10,397 | ) | 2,631 | 19,332 | (12,495 | ) | (41,757 | ) | | 7,658 | (27,262 | ) | ||||||||||||||||||||||||||
Income tax expense (benefit) (a) |
8,709 | 1,588 | (3,951 | ) | 1,000 | 7,346 | (4,748 | ) | (16,233 | ) | | 2,971 | (10,664 | ) | ||||||||||||||||||||||||||
Net income (loss) from
continuing operations |
14,210 | 2,591 | (6,446 | ) | 1,631 | 11,986 | (7,747 | ) | (25,524 | ) | | 4,687 | (16,598 | ) | ||||||||||||||||||||||||||
Loss from discontinued operations, net of tax |
| | | | | | | | 909 | 909 | ||||||||||||||||||||||||||||||
Net income (loss) |
$ | 14,210 | 2,591 | (6,446 | ) | 1,631 | 11,986 | (7,747 | ) | (25,524 | ) | | 5,596 | (15,689 | ) | |||||||||||||||||||||||||
(a) | Income taxes are based on 38% of net income (loss) before tax for the individual operating segment. |
25
Table of Contents
Nine months ended September 30, 2008 | ||||||||||||||||||||||||||||||||||||||||
Fee-Based | ||||||||||||||||||||||||||||||||||||||||
Student | Tuition | Enrollment | Base net | |||||||||||||||||||||||||||||||||||||
Loan | Payment | Services | Software | Asset | Corporate | income | ||||||||||||||||||||||||||||||||||
and | Processing | and | and | Total | Generation | Activity | Eliminations | Adjustments | GAAP | |||||||||||||||||||||||||||||||
Guaranty | and Campus | List | Technical | Fee- | and | and | and | to GAAP | Results of | |||||||||||||||||||||||||||||||
Servicing | Commerce | Management | Services | Based | Management | Overhead | Reclassifications | Results | Operations | |||||||||||||||||||||||||||||||
Total interest income |
$ | 1,160 | 1,471 | 16 | | 2,647 | 892,690 | 4,781 | (1,389 | ) | 42,325 | 941,054 | ||||||||||||||||||||||||||||
Interest expense |
| | 3 | | 3 | 762,689 | 30,318 | (1,389 | ) | | 791,621 | |||||||||||||||||||||||||||||
Net interest income (loss) |
1,160 | 1,471 | 13 | | 2,644 | 130,001 | (25,537 | ) | | 42,325 | 149,433 | |||||||||||||||||||||||||||||
Less provision for loan losses |
| | | | | 18,000 | | | | 18,000 | ||||||||||||||||||||||||||||||
Net interest income (loss) after provision
for loan losses |
1,160 | 1,471 | 13 | | 2,644 | 112,001 | (25,537 | ) | | 42,325 | 131,433 | |||||||||||||||||||||||||||||
Other income (expense): |
||||||||||||||||||||||||||||||||||||||||
Loan and guaranty servicing income |
81,624 | | | | 81,624 | 26 | | | | 81,650 | ||||||||||||||||||||||||||||||
Other fee-based income |
| 35,975 | 83,148 | | 119,123 | 13,494 | | | | 132,617 | ||||||||||||||||||||||||||||||
Software services income |
| | 37 | 15,828 | 15,865 | | | | | 15,865 | ||||||||||||||||||||||||||||||
Other income |
44 | 5 | | | 49 | 293 | 3,956 | | | 4,298 | ||||||||||||||||||||||||||||||
Loss on sale of loans |
| | | | | (47,426 | ) | | | | (47,426 | ) | ||||||||||||||||||||||||||||
Intersegment revenue |
57,008 | 242 | 2 | 4,993 | 62,245 | | 46,844 | (109,089 | ) | | | |||||||||||||||||||||||||||||
Derivative market value, foreign currency,
and put option adjustments |
| | | | | 466 | | | (35,987 | ) | (35,521 | ) | ||||||||||||||||||||||||||||
Derivative settlements, net |
| | | | | 55,954 | | | (9,965 | ) | 45,989 | |||||||||||||||||||||||||||||
Total other income (expense) |
138,676 | 36,222 | 83,187 | 20,821 | 278,906 | 22,807 | 50,800 | (109,089 | ) | (45,952 | ) | 197,472 | ||||||||||||||||||||||||||||
Operating expenses: |
||||||||||||||||||||||||||||||||||||||||
Salaries and benefits |
40,365 | 17,450 | 18,701 | 14,031 | 90,547 | 6,157 | 41,581 | 1,323 | 2,523 | 142,131 | ||||||||||||||||||||||||||||||
Restructure expense severance and contract
termination costs |
747 | | 282 | 487 | 1,516 | 1,845 | 3,746 | (7,107 | ) | | | |||||||||||||||||||||||||||||
Impairment expense |
5,074 | | | | 5,074 | 9,351 | 4,409 | | | 18,834 | ||||||||||||||||||||||||||||||
Other expenses |
27,130 | 6,743 | 55,863 | 1,901 | 91,637 | 15,793 | 42,263 | 51 | 19,719 | 169,463 | ||||||||||||||||||||||||||||||
Intersegment expenses |
35,040 | 1,045 | 4,936 | 1,562 | 42,583 | 57,754 | 3,019 | (103,356 | ) | | | |||||||||||||||||||||||||||||
Total operating expenses |
108,356 | 25,238 | 79,782 | 17,981 | 231,357 | 90,900 | 95,018 | (109,089 | ) | 22,242 | 330,428 | |||||||||||||||||||||||||||||
Income (loss) before income taxes |
31,480 | 12,455 | 3,418 | 2,840 | 50,193 | 43,908 | (69,755 | ) | | (25,869 | ) | (1,523 | ) | |||||||||||||||||||||||||||
Income tax expense (benefit) (a) |
10,542 | 4,081 | 1,187 | 902 | 16,712 | 15,889 | (22,824 | ) | | (7,984 | ) | 1,793 | ||||||||||||||||||||||||||||
Net income (loss) from
continuing operations |
20,938 | 8,374 | 2,231 | 1,938 | 33,481 | 28,019 | (46,931 | ) | | (17,885 | ) | (3,316 | ) | |||||||||||||||||||||||||||
Income from discontinued operations, net of tax |
| | | | | | | | 981 | 981 | ||||||||||||||||||||||||||||||
Net income (loss) |
$ | 20,938 | 8,374 | 2,231 | 1,938 | 33,481 | 28,019 | (46,931 | ) | | (16,904 | ) | (2,335 | ) | ||||||||||||||||||||||||||
(a) | Beginning in 2008, the consolidated effective tax rate for each applicable quarterly period is used to calculate income taxes for each operating segment. |
26
Table of Contents
Nine months ended September 30, 2007 | ||||||||||||||||||||||||||||||||||||||||
Fee-Based | ||||||||||||||||||||||||||||||||||||||||
Student | Tuition | Enrollment | Base net | |||||||||||||||||||||||||||||||||||||
Loan | Payment | Services | Software | Asset | Corporate | income | ||||||||||||||||||||||||||||||||||
and | Processing | and | and | Total | Generation | Activity | Eliminations | Adjustments | GAAP | |||||||||||||||||||||||||||||||
Guaranty | and Campus | List | Technical | Fee- | and | and | and | to GAAP | Results of | |||||||||||||||||||||||||||||||
Servicing | Commerce | Management | Services | Based | Management | Overhead | Reclassifications | Results | Operations | |||||||||||||||||||||||||||||||
Total interest income |
$ | 4,607 | 2,670 | 290 | 18 | 7,585 | 1,301,947 | 6,230 | (3,737 | ) | 597 | 1,312,622 | ||||||||||||||||||||||||||||
Interest expense |
| 7 | 5 | | 12 | 1,084,792 | 31,196 | (3,737 | ) | | 1,112,263 | |||||||||||||||||||||||||||||
Net interest income (loss) |
4,607 | 2,663 | 285 | 18 | 7,573 | 217,155 | (24,966 | ) | | 597 | 200,359 | |||||||||||||||||||||||||||||
Less provision for loan losses |
| | | | | 23,628 | | | | 23,628 | ||||||||||||||||||||||||||||||
Net interest income (loss) after provision
for loan losses |
4,607 | 2,663 | 285 | 18 | 7,573 | 193,527 | (24,966 | ) | | 597 | 176,731 | |||||||||||||||||||||||||||||
Other income (expense): |
||||||||||||||||||||||||||||||||||||||||
Loan and guaranty servicing income |
94,828 | | | | 94,828 | 288 | | | | 95,116 | ||||||||||||||||||||||||||||||
Other fee-based income |
| 31,492 | 73,341 | | 104,833 | 10,511 | 972 | | | 116,316 | ||||||||||||||||||||||||||||||
Software services income |
| | 456 | 16,566 | 17,022 | | | | | 17,022 | ||||||||||||||||||||||||||||||
Other income |
11 | 59 | | | 70 | 4,329 | 9,649 | | | 14,048 | ||||||||||||||||||||||||||||||
Gain on sale of loans |
| | | | | 3,288 | | | | 3,288 | ||||||||||||||||||||||||||||||
Intersegment revenue |
58,821 | 508 | 891 | 13,026 | 73,246 | | 7,608 | (80,854 | ) | | | |||||||||||||||||||||||||||||
Derivative market value, foreign currency,
and put option adjustments |
| | | | | | | | 11,866 | 11,866 | ||||||||||||||||||||||||||||||
Derivative settlements, net |
| | | | | (4,950 | ) | 12,050 | | | 7,100 | |||||||||||||||||||||||||||||
Total other income (expense) |
153,660 | 32,059 | 74,688 | 29,592 | 289,999 | 13,466 | 30,279 | (80,854 | ) | 11,866 | 264,756 | |||||||||||||||||||||||||||||
Operating expenses: |
||||||||||||||||||||||||||||||||||||||||
Salaries and benefits |
66,988 | 15,312 | 26,486 | 18,869 | 127,655 | 20,600 | 34,669 | (2,370 | ) | 1,456 | 182,010 | |||||||||||||||||||||||||||||
Restructure expense- severance and contract
termination costs |
1,231 | | 737 | 58 | 2,026 | 1,921 | 1,009 | (4,956 | ) | | | |||||||||||||||||||||||||||||
Impairment expense |
| | 11,401 | | 11,401 | 28,291 | 9,812 | | | 49,504 | ||||||||||||||||||||||||||||||
Other expenses |
26,219 | 6,522 | 42,957 | 2,224 | 77,922 | 22,940 | 58,762 | 168 | 24,014 | 183,806 | ||||||||||||||||||||||||||||||
Intersegment expenses |
8,681 | 384 | 252 | 550 | 9,867 | 59,594 | 4,235 | (73,696 | ) | | | |||||||||||||||||||||||||||||
Total operating expenses |
103,119 | 22,218 | 81,833 | 21,701 | 228,871 | 133,346 | 108,487 | (80,854 | ) | 25,470 | 415,320 | |||||||||||||||||||||||||||||
Income (loss) before income taxes |
55,148 | 12,504 | (6,860 | ) | 7,909 | 68,701 | 73,647 | (103,174 | ) | | (13,007 | ) | 26,167 | |||||||||||||||||||||||||||
Income tax expense (benefit) (a) |
20,956 | 4,752 | (2,607 | ) | 3,006 | 26,107 | 27,986 | (40,059 | ) | | (4,128 | ) | 9,906 | |||||||||||||||||||||||||||
Net income (loss) from
continuing operations |
34,192 | 7,752 | (4,253 | ) | 4,903 | 42,594 | 45,661 | (63,115 | ) | | (8,879 | ) | 16,261 | |||||||||||||||||||||||||||
Loss from discontinued operations, net of tax |
| | | | | | | | (2,416 | ) | (2,416 | ) | ||||||||||||||||||||||||||||
Net income (loss) |
$ | 34,192 | 7,752 | (4,253 | ) | 4,903 | 42,594 | 45,661 | (63,115 | ) | | (11,295 | ) | 13,845 | ||||||||||||||||||||||||||
(a) | Income taxes are based on 38% of net income (loss) before tax for the individual operating segment. |
Corporate Activity and Overhead in the previous tables primarily includes the following items:
| Income earned on certain investment activities; |
| Interest expense incurred on unsecured debt transactions; |
| Other products and service offerings that are not considered operating segments; and |
| Corporate activities and overhead functions such as executive management, human
resources, accounting and finance, legal, marketing, and corporate technology support. |
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The adjustments required to reconcile from the Companys base net income measure to its GAAP
results of operations relate to differing treatments for derivatives, foreign currency transaction
adjustments, discontinued operations, and certain other items that management does not consider in
evaluating the Companys operating results. The following tables reflect adjustments associated
with these areas by operating segment and Corporate Activity and Overhead:
Student | Tuition | Enrollment | ||||||||||||||||||||||||||
Loan | Payment | Services | Software | Asset | Corporate | |||||||||||||||||||||||
and | Processing | and | and | Generation | Activity | |||||||||||||||||||||||
Guaranty | and Campus | List | Technical | and | and | |||||||||||||||||||||||
Servicing | Commerce | Management | Services | Management | Overhead | Total | ||||||||||||||||||||||
Three months ended September 30, 2008 | ||||||||||||||||||||||||||||
Derivative market value, foreign currency, and
put option adjustments (1) |
$ | | | | | (9,030 | ) | 2,945 | (6,085 | ) | ||||||||||||||||||
Amortization of intangible assets (2) |
1,165 | 1,889 | 3,258 | 286 | | | 6,598 | |||||||||||||||||||||
Compensation related to business combinations (3) |
| | | | | 477 | 477 | |||||||||||||||||||||
Variable-rate floor income, net of settlements on derivatives (4) |
| | | | (1,580 | ) | | (1,580 | ) | |||||||||||||||||||
Income (loss) from discontinued operations, net of tax (5) |
| | | | | | | |||||||||||||||||||||
Net tax effect (6) |
(432 | ) | (699 | ) | (1,205 | ) | (106 | ) | 3,926 | (1,266 | ) | 218 | ||||||||||||||||
Total adjustments to GAAP |
$ | 733 | 1,190 | 2,053 | 180 | (6,684 | ) | 2,156 | (372 | ) | ||||||||||||||||||
Three months ended September 30, 2007 |
||||||||||||||||||||||||||||
Derivative market value, foreign currency, and
put option adjustments (1) |
$ | | | | | (20,017 | ) | 1,568 | (18,449 | ) | ||||||||||||||||||
Amortization of intangible assets (2) |
1,350 | 1,434 | 6,442 | 287 | 1,372 | | 10,885 | |||||||||||||||||||||
Compensation related to business combinations (3) |
| | | | | 503 | 503 | |||||||||||||||||||||
Variable-rate floor income, net of settlements on derivatives (4) |
| | | | (597 | ) | | (597 | ) | |||||||||||||||||||
Income (loss) from discontinued operations, net of tax (5) |
(909 | ) | | | | | | (909 | ) | |||||||||||||||||||
Net tax effect (6) |
(513 | ) | (545 | ) | (2,448 | ) | (109 | ) | 7,312 | (726 | ) | 2,971 | ||||||||||||||||
Total adjustments to GAAP |
$ | (72 | ) | 889 | 3,994 | 178 | (11,930 | ) | 1,345 | (5,596 | ) | |||||||||||||||||
Nine months ended September 30, 2008 |
||||||||||||||||||||||||||||
Derivative market value, foreign currency, and
put option adjustments (1) |
$ | | | | | 32,504 | 3,483 | 35,987 | ||||||||||||||||||||
Amortization of intangible assets (2) |
3,586 | 5,937 | 9,193 | 858 | 145 | | 19,719 | |||||||||||||||||||||
Compensation related to business combinations (3) |
| | | | | 2,523 | 2,523 | |||||||||||||||||||||
Variable-rate floor income, net of settlements on derivatives (4) |
| | | | (32,360 | ) | | (32,360 | ) | |||||||||||||||||||
Income (loss) from discontinued operations, net of tax (5) |
(981 | ) | | | | | | (981 | ) | |||||||||||||||||||
Net tax effect (6) |
(1,182 | ) | (1,954 | ) | (3,045 | ) | (284 | ) | 548 | (2,067 | ) | (7,984 | ) | |||||||||||||||
Total adjustments to GAAP |
$ | 1,423 | 3,983 | 6,148 | 574 | 837 | 3,939 | 16,904 | ||||||||||||||||||||
Nine months ended September 30, 2007 |
||||||||||||||||||||||||||||
Derivative market value, foreign currency, and
put option adjustments (1) |
$ | | | | | (7,801 | ) | (4,065 | ) | (11,866 | ) | |||||||||||||||||
Amortization of intangible assets (2) |
3,744 | 4,372 | 9,797 | 904 | 5,197 | | 24,014 | |||||||||||||||||||||
Compensation related to business combinations (3) |
| | | | | 1,456 | 1,456 | |||||||||||||||||||||
Variable-rate floor income, net of settlements on derivatives (4) |
| | | | (597 | ) | | (597 | ) | |||||||||||||||||||
Income (loss) from discontinued operations, net of tax (5) |
2,416 | | | | | | 2,416 | |||||||||||||||||||||
Net tax effect (6) |
(1,423 | ) | (1,661 | ) | (3,723 | ) | (343 | ) | 1,216 | 1,806 | (4,128 | ) | ||||||||||||||||
Total adjustments to GAAP |
$ | 4,737 | 2,711 | 6,074 | 561 | (1,985 | ) | (803 | ) | 11,295 | ||||||||||||||||||
(1) | Derivative market value, foreign currency, and put option adjustments: Base net
income excludes the periodic unrealized gains and losses that are caused by the change
in fair value on derivatives used in the Companys risk management strategy in which the
Company does not qualify for hedge treatment under GAAP. Included in base net
income are the economic effects of the Companys derivative instruments, which includes
any cash paid or received being recognized as an expense or revenue upon actual
derivative settlements. Base net income also excludes the foreign currency
transaction gains or losses caused by the re-measurement of the Companys
Euro-denominated bonds to U.S. dollars and the change in fair value of put options
issued by the Company for certain business acquisitions. |
|
(2) | Amortization of intangible assets: Base net income excludes the amortization
of acquired intangibles. |
|
(3) | Compensation related to business combinations: The Company has structured
certain business combinations in which the consideration paid has been dependent on the
sellers continued employment with the Company. As such, the value of the consideration
paid is recognized as compensation expense by the Company over the term of the
applicable employment agreement. Base net income excludes this expense. |
|
(4) | Variable-rate floor income: Loans that reset annually on July 1 can generate
excess spread income compared with the rate based on the special allowance payment
formula in declining interest rate environments. The Company refers to this additional
income as variable-rate floor income. The Company excludes variable-rate floor income,
net of settlements paid on derivatives used to hedge student loan assets earning
variable-rate floor income, from its base net income since the timing and amount of
variable-rate floor income (if any) is uncertain, it has been eliminated by legislation
for all loans originated on and after April 1, 2006, and it is in excess of expected
spreads. In addition, because variable-rate floor income is subject to the underlying
rate for the subject loans being reset annually on July 1, it is a factor beyond the
Companys control which can affect the period-to-period comparability of results of
operations. |
|
(5) | Discontinued operations: In May 2007, the Company sold EDULINX. As a result of
this transaction, the results of operations for EDULINX are reported as discontinued
operations for all periods presented. The Company presents base net income excluding
discontinued operations since the operations and cash flows of EDULINX have been
eliminated from the ongoing operations of the Company. |
|
(6) | Beginning in 2008, tax effect is computed using the Companys consolidated
effective tax rate for each applicable quarterly period. In prior periods, tax effect
was computed at 38%. The change in the value of the put options for prior periods
(included in Corporate Activities and Overhead) was not tax effected as this is not
deductible for income tax purposes. |
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Table of Contents
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OPERATIONS
(Managements Discussion and Analysis of Financial Condition and Results of Operations is for the
three and nine months ended September 30, 2008 and 2007. All dollars are in thousands, except per
share amounts, unless otherwise noted).
The following discussion and analysis provides information that the Companys management believes
is relevant to an assessment and understanding of the consolidated results of operations and
financial condition of the Company. The discussion should be read in conjunction with the
Companys consolidated financial statements included in the Companys Annual Report on Form 10-K
for the year ended December 31, 2007.
Forward-looking and cautionary statements
This report contains forward-looking statements and information based on managements current
expectations as of the date of this document. When used in this report, the words anticipate,
believe, estimate, expect, and intend and similar expressions are intended to identify
forward-looking statements. These forward-looking statements are subject to risks, uncertainties,
assumptions, and other factors that may cause the actual results to be materially different from
those reflected in such forward-looking statements. These factors include, among others, the risks
and uncertainties set forth in Risk Factors and elsewhere in this Quarterly Report on Form 10-Q,
prior quarterly reports filed by the Company, and the Companys Annual Report on Form 10-K for the
year ended December 31, 2007, and changes in the terms of student loans and the educational credit
marketplace arising from the implementation of, or changes in, applicable laws and regulations,
which may reduce the volume, average term, special allowance payments, and costs of yields on
student loans under the FFEL Program or result in loans being originated or refinanced under
non-FFEL programs or may affect the terms upon which banks and others agree to sell FFELP loans to
the Company. In addition, a larger than expected increase in third party consolidations of the
Companys FFELP loans could materially adversely affect the Companys results of operations. The
Company could also be affected by changes in the demand for educational financing or in financing
preferences of lenders, educational institutions, students, and their families; the Companys
ability to maintain its credit facilities or obtain new facilities; the ability of lenders under
the Companys credit facilities to fulfill their lending commitments under those facilities;
changes to the terms and conditions of the liquidity programs offered by the Department of
Education; changes in the general interest rate environment and in the securitization markets for
education loans, which may increase the costs or limit the availability of financings necessary to
initiate, purchase, or carry education loans; losses from loan defaults; changes in prepayment
rates, guaranty rates, loan floor rates, and credit spreads; the financial strength of contract
counterparties; the uncertain nature of the expected benefits from acquisitions and the ability to
successfully integrate operations; and the uncertain nature of estimated expenses that may be
incurred and cost savings that may result from the Companys strategic restructuring initiatives.
The reader should not place undue reliance on forward-looking statements, which speak only as of
the date of this Quarterly Report on Form 10-Q. Additionally, financial projections may not prove
to be accurate and may vary materially. The Company is not obligated to publicly release any
revisions to forward-looking statements to reflect events after the date of this Quarterly Report
on Form 10-Q or unforeseen events. Although the Company may from time to time voluntarily update
its prior forward-looking statements, it disclaims any commitment to do so except as required by
securities laws.
Overview
The Company is an education planning and financing company focused on providing quality products
and services to students, families, and schools nationwide. The Company is a vertically-integrated
organization that offers a broad range of products and services to its customers throughout the
education life cycle.
Built through a focus on long-term organic growth and further enhanced by strategic acquisitions,
the Company earns its revenues from fee-based revenues related to its diversified education finance
and service operations and from net interest income on its portfolio of student loans.
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Table of Contents
The following provides certain events and operating activities that have impacted the
financial condition and operating results of the Company. These items include:
| Liquidity developments related to the Companys FFELP warehouse and unsecured line of
credit facilities and legislative developments regarding funding new loan originations; |
| Strong student loan spread earned on the Companys loan portfolio; |
| Increased revenue and operating margins from the Companys fee-based businesses; and |
| Continued decreases in operating expenses. |
Liquidity and Legislative Developments
FFELP Warehouse Facility and Unsecured Line of Credit
On July 31, 2008, the Company did not renew its liquidity provisions on its FFELP loan warehouse
facility. Accordingly, the facility became a term facility and no new loan originations can be
funded with this facility. As of November 7, 2008, $2.1 billion was outstanding under this
facility. The terms and conditions of this facility provides for mark-to-market advance rates. On
October 22, 2008, the Company posted $165.5 million in additional funds to the facility based on
this mark-to-market formula. As of November 7, 2008, the Company has a cumulative amount of $374.6
million posted as equity funding support for the facility.
The Company has utilized its $750.0 million unsecured line of credit to fund equity advances on its
warehouse facility. As of November 7, 2008, the Company has $691.5 million outstanding under this
line of credit. The line of credit terminates in May 2012.
Continued dislocations in the credit markets may cause additional volatility in the loan valuation
formula. Should a significant change in the valuation of loans result in additional required
equity funding support for the warehouse facility greater than what the Company can provide and the Company has not amended the facility as discussed below, the
warehouse facility could be subject to an event of default resulting in a termination of the
facility and an acceleration of the repayment provisions. A default on the FFELP warehouse facility would
result in an event of default on the Companys unsecured line of credit that would result in the
outstanding balance on the line of credit becoming immediately due and payable.
To reduce the Companys exposure from the mark-to-market advance rate provision included in the
FFELP warehouse facility, the Company has signed a letter agreement engaging Banc of America Securities LLC to arrange an amendment of
certain of the Companys credit facilities, including but not limited to an amendment to place a
floor on the valuation of collateral in the Companys FFELP loan warehouse line of credit for
which Bank of America, N.A. acts as administrative agent. Banc of America Securities LLC has
commenced the amendment process and together with the Company is seeking the approval of the
Companys lenders of a proposed amendment of such credit facilities on mutually agreeable terms. In addition, the Company continues to look at various
alternatives to remove loans from the warehouse facility including other financing arrangements
and/or selling loans to third parties.
In addition, on November 8, 2008, the Department announced they intend to provide liquidity support
to one or more conforming asset backed commercial paper conduits to purchase and provide
longer-term financing for FFELP loans. While details of this conduit are forthcoming, it is
intended that all fully-disbursed non-consolidation FFELP loans awarded between October 1, 2003 and
July 1, 2009 will be eligible for inclusion. As of November 7, 2008, the Company had approximately
$900 million of loans included in its warehouse facility that would be eligible for this proposed
conduit program.
Funding New Loan Originations
In July 2008, pursuant to the Ensuring Continued Access to Student Loans Act, the Department of
Education announced terms under which it would offer to purchase FFELP student loans and loan
participations from lenders. Upon not renewing the liquidity provisions on the Companys FFELP
warehouse facility, in August 2008, the Company began to fund FFELP student loan originations for
the 2008-2009 academic year pursuant to the Departments Participation Program and an existing
participation agreement with Union Bank. As of September 30, 2008, the Company has funded $263.9
million of FFELP loans using the Departments Participation Program. The Company plans to continue
to use the Participation Program to fund the majority of loans originated for the 2008-2009
academic year.
On October 7, 2008, legislation was enacted to extend the Departments authority to address FFELP
student loans made for the 2009-2010 academic year and allowing for the extension of the
Participation Program and Purchase Program from September 30, 2009 to September 30, 2010. The
Department has provided preliminary guidance relating to the extension and has indicated that
programs similar to the Participation Program and the Purchase Program for the 2009-2010 academic
year along with providing liquidity support for one or more asset backed commercial paper conduits
for FFELP Stafford and PLUS loans awarded between October 1, 2003 and July 1, 2009. The
Department has indicated that loans for the 2008-2009 academic year which are funded under the
Departments Participation Program will need to be refinanced or sold to the Department prior to
September 30, 2009. Management understands that such loans will not be eligible for participation
under the Departments 2009-2010 Participation Program, but should be eligible for refinancing
through the Departments commercial paper conduit program. Management of the Company is encouraged
by these developments; however, until the Department provides additional details regarding the
programs, the Company is unable to determine the full impact these programs will have on the
Company.
Student Loan Spread
The Companys core student loan spread for the three months ended September 30, 2008 was 102 basis
points. Excluding fixed-rate floor income, core student loan spread for both the three months
ended September 30, 2008 and June 30, 2008 was 92 basis points.
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Table of Contents
Fee-based businesses
Revenue
from the Companys fee-based businesses increased $4.6 million,
or 6.4%, to $76.7 million
for the three months ended September 30, 2008 compared to $72.1 million for the three months ended
September 30, 2007. Excluding list marketing services, revenue from the Companys Tuition Payment
Processing and Campus Commerce and Enrollment Services and List Management operating segments
increased $8.3 million, or 26.5%, to $39.4 million for the three months ended September 30, 2008
compared to $31.1 million for the three months ended September 30, 2007. These operating segments
are less impacted by legislation and the student loan industry.
Operating margins for the Companys fee based businesses, excluding the expenses associated with the variation in allocation methodologies and
restructuring and impairment charges, were 27.7% and 27.8% for the three and nine months ended
September 30, 2008, respectively, compared to 32.3% and 27.6% for the same periods in 2007.
Operating Expenses
As a result of the restructuring plans implemented in September 2007 and January 2008, as well as
the Companys continued focus on capitalizing on the operating leverage of the Companys business
structure and strategies, operating expenses continued to decrease during the quarter. Excluding
restructuring and impairment charges, operating expenses decreased $15.3 million, or 12.9%, and
$56.4 million, or 15.6%, for the three and nine months ended September 30, 2008 compared to the
same periods in 2007, respectively.
RESULTS OF OPERATIONS
The Companys operating results are primarily driven by the performance of its existing portfolio,
the cost necessary to generate new assets, the revenues generated by its fee based businesses, and
the cost to provide those services. The performance of the Companys portfolio is driven by net
interest income and losses related to credit quality of the assets along with the cost to
administer and service the assets and related debt.
Net Interest Income
The Company generates a significant portion of its earnings from the spread, referred to as its
student loan spread, between the yield the Company receives on its student loan portfolio and the
cost of funding these loans. This spread income is reported on the Companys consolidated
statements of operations as net interest income. The amortization of loan premiums, including
capitalized costs of origination, the 1.05% per year consolidation loan rebate fee paid to the
Department, and yield adjustments from borrower benefit programs, are netted against loan interest
income on the Companys statements of operations. The amortization of debt issuance costs is
included in interest expense on the Companys statements of operations.
The Companys portfolio of FFELP loans originated prior to April 1, 2006 earns interest at the
higher of a variable rate based on the special allowance payment (SAP) formula set by the
Department of Education and the borrower rate. The SAP formula is based on an applicable index
plus a fixed spread that is dependent upon when the loan was originated, the loans repayment
status, and funding sources for the loan. As a result of one of the provisions of the Higher
Education Reconciliation Act of 2005 (HERA), the Companys portfolio of FFELP loans originated on
or after April 1, 2006 earns interest at a variable rate based on the SAP formula. For the
portfolio of loans originated on or after April 1, 2006, when the borrower rate exceeds the
variable rate based on the SAP formula, the Company must return the excess to the Department.
On September 27, 2007, the President signed into law the College Cost Reduction and Access Act of
2007. This legislation has and will continue to have a significant impact on the Companys net
interest income and should be considered when reviewing the Companys results of operations. Among
other things, this legislation:
| Reduced special allowance payments to for-profit lenders and not-for-profit lenders
by 0.55 percentage points and 0.40 percentage points, respectively, for both Stafford
and Consolidation loans disbursed on or after October 1, 2007; |
| Reduced special allowance payments to for-profit lenders and not-for-profit lenders
by 0.85 percentage points and 0.70 percentage points, respectively, for PLUS loans
disbursed on or after October 1, 2007; |
| Increased origination fees paid by lenders on all FFELP loan types, from 0.5 percent
to 1.0 percent, for all loans first disbursed on or after October 1, 2007; |
| Eliminated all provisions relating to Exceptional Performer status, and the monetary
benefit associated with it, effective October 1, 2007; and |
| Reduces default insurance to 95 percent of the unpaid principal of such loans, for
loans first disbursed on or after October 1, 2012. |
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Management estimates the impact of this legislation will reduce the annual yield on FFELP loans
originated after October 1, 2007 by 70 to 80 basis points. The Company believes it can mitigate
some of the reduction in annual yield by creating efficiencies and lowering costs, modifying
borrower benefits, and reducing loan acquisition costs.
Because the Company generates a significant portion of its earnings from its student loan spread,
the interest rate sensitivity of the Companys balance sheet is very important to its operations.
The current and future interest rate environment can and will affect the Companys interest
earnings, net interest income, and net income. The effects of changing interest rate environments
are further outlined in Item 3, Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk.
Investment interest income, which is a component of net interest income, includes income from
unrestricted interest-earning deposits and funds in the Companys special purpose entities which
are utilized for its asset-backed securitizations.
Net interest income also includes interest expense on unsecured debt offerings. The proceeds from
these unsecured debt offerings were and have been used by the Company to fund general business
operations, certain asset and business acquisitions, and the repurchase of stock under the
Companys stock repurchase plan.
Provision for Loan Losses
Management estimates and establishes an allowance for loan losses through a provision charged to
expense. Losses are charged against the allowance when management believes the collectibility of
the loan principal is unlikely. Recovery of amounts previously charged off is credited to the
allowance for loan losses. Management maintains the allowance for federally insured and
non-federally insured loans at a level believed to be adequate to provide for estimated probable
credit losses inherent in the loan portfolio. This evaluation is inherently subjective because it
requires estimates that may be susceptible to significant changes. The Company analyzes the
allowance separately for its federally insured loans and its non-federally insured loans.
Management bases the allowance for the federally insured loan portfolio on periodic evaluations of
the Companys loan portfolios, considering past experience, trends in student loan claims rejected
for payment by guarantors, changes to federal student loan programs, current economic conditions,
and other relevant factors. One of the changes to the Higher Education Act as a result of HERAs
enactment in February 2006, was to lower the guaranty rates on FFELP loans, including a decrease in
insurance and reinsurance on portfolios receiving the benefit of the Exceptional Performance
designation by 1%, from 100% to 99% of principal and accrued interest (effective July 1, 2006), and
a decrease in insurance and reinsurance on portfolios not subject to the Exceptional Performance
designation by 1%, from 98% to 97% of principal and accrued interest (effective for all loans first
disbursed on and after July 1, 2006).
In September 2005, the Company was re-designated as an Exceptional Performer by the Department in
recognition of its exceptional level of performance in servicing FFELP loans. As a result of this
designation, the Company received 99% reimbursement (100% reimbursement prior to July 1, 2006) on
all eligible FFELP default claims submitted for reimbursement during the applicable period. Only
FFELP loans that were serviced by the Company, as well as loans owned by the Company and serviced
by other service providers designated as Exceptional Performers by the Department, were eligible
for the 99% reimbursement.
On September 27, 2007, the President signed into law the College Cost Reduction and Access Act of
2007. Among other things, this legislation eliminated all provisions relating to Exceptional
Performer status, and the monetary benefit associated with it, effective October 1, 2007.
Accordingly, the majority of claims submitted on or after October 1, 2007 are subject to
reimbursement at 97% or 98% of principal and accrued interest depending on the disbursement date of
the loan. During the three month period ended September 30, 2007, the Company recorded an expense
of $15.7 million to increase the Companys allowance for loan losses related to the increase in
risk share as a result of the elimination of the Exceptional Performer program.
In determining the adequacy of the allowance for loan losses on the non-federally insured loans,
the Company considers several factors including: loans in repayment versus those in a nonpaying
status, months in repayment, delinquency status, type of program, and trends in defaults in the
portfolio based on Company and industry data. The Company places a non-federally insured loan on
nonaccrual status and charges off the loan when the collection of principal and interest is 120
days past due.
Other Income
The Company also earns fees and generates income from other sources, including principally loan and
guaranty servicing income; fee-based income on borrower late fees, payment management activities,
and certain marketing and enrollment services; and fees from providing software services.
Loan and Guaranty Servicing Income Loan servicing fees are determined according to individual
agreements with customers and are calculated based on the dollar value of loans, number of loans,
or number of borrowers serviced for each customer. Guaranty servicing fees, generally, are
calculated based on the number of loans serviced or amounts collected. Revenue is recognized when
earned pursuant to applicable agreements, and when ultimate collection is assured.
32
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Other Fee-Based Income Other fee-based income includes borrower late fee income, payment
management fees, the sale of lists and print products, and subscription-based products and
services. Borrower late fee income earned by the Companys education lending subsidiaries is
recognized when payments are collected from the borrower. Fees for payment management services are
recognized over the period in which services are provided to customers. Revenue from the sale of
lists and printed products is generally earned and recognized, net of estimated returns, upon
shipment or delivery. Revenues from the sales of subscription-based products and services are
recognized ratably over the term of the subscription. Subscription revenue received or receivable
in advance of the delivery of services is included in deferred revenue.
Software Services Software services income is determined from individual agreements with
customers and includes license and maintenance fees associated with student loan software products.
Computer and software consulting services are recognized over the period in which services are
provided to customers.
Operating Expenses
Operating expenses includes indirect costs incurred to generate and acquire student loans, costs
incurred to manage and administer the Companys student loan portfolio and its financing
transactions, costs incurred to service the Companys student loan portfolio and the portfolios of
third parties, costs incurred to provide tuition payment processing, campus commerce, enrollment,
list management, software, and technical services to third parties, the depreciation and
amortization of capital assets and intangible assets, and other general and administrative
expenses. Operating expenses also includes employee termination benefits, lease termination costs,
and the write-down of certain assets related to the Companys September 2007 and January 2008
restructuring initiatives.
Three and nine months ended September 30, 2008 compared to the three and nine months ended
September 30, 2007
Net Interest Income
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||||||||||
2008 | 2007 | $ Change | 2008 | 2007 | $ Change | |||||||||||||||||||
Interest income: |
||||||||||||||||||||||||
Loan interest |
$ | 284,468 | 437,251 | (152,783 | ) | 911,140 | 1,251,391 | (340,251 | ) | |||||||||||||||
Investment interest |
9,118 | 21,023 | (11,905 | ) | 29,914 | 61,231 | (31,317 | ) | ||||||||||||||||
Total interest income |
293,586 | 458,274 | (164,688 | ) | 941,054 | 1,312,622 | (371,568 | ) | ||||||||||||||||
Interest expense: |
||||||||||||||||||||||||
Interest on bonds and notes payable |
234,016 | 393,875 | (159,859 | ) | 791,621 | 1,112,263 | (320,642 | ) | ||||||||||||||||
Net interest income |
59,570 | 64,399 | (4,829 | ) | 149,433 | 200,359 | (50,926 | ) | ||||||||||||||||
Provision for loan losses |
7,000 | 18,340 | (11,340 | ) | 18,000 | 23,628 | (5,628 | ) | ||||||||||||||||
Net interest income after
provision for loan losses |
$ | 52,570 | 46,059 | 6,511 | 131,433 | 176,731 | (45,298 | ) | ||||||||||||||||
| Net interest income decreased for the three and nine months ended September 30, 2008
compared to 2007 as a result of the compression in the core student loan spread as
discussed in this Item 2 under Asset Generation and Management Operating Segment Results
of Operations. Core student loan spread was 0.93% and 1.20% for the nine months ended
September 30, 2008 and 2007, respectively, and 1.02% and 1.05% for the three months ended
September 30, 2008 and 2007, respectively. The decrease was also due to an overall
decrease in cash held in 2008 compared to 2007 and lower interest rates in 2008. The
decreases to net interest income were offset by the amount of variable-rate floor income
the Company earned during these periods. During the three and nine months ended September
30, 2008, the Company earned $1.6 million and $41.7 million, respectively, of variable-rate
floor income, as compared to $0.6 million of variable-rate floor income earned during both
the three and nine months ended September 30, 2007. |
| Excluding an expense of $15.7 million in September 2007 to increase the Companys
allowance for loan losses related to the increase in risk share as a result of the
elimination of the Exceptional Performer program in the third quarter of 2007, the
provision for loan losses increased for the three and nine months ended September 30, 2008
compared to 2007. The provision for loan losses for federally insured loans increased as a
result of the increase in risk share as a result of the loss of Exceptional Performer in
September 2007. The provision for loan
losses for non-federally insured loans increased primarily due to increases in
delinquencies as a result of the continued weakening of the U.S. economy. |
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Table of Contents
Other Income
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||||||||||
2008 | 2007 | $ Change | 2008 | 2007 | $ Change | |||||||||||||||||||
Loan and guaranty servicing income |
$ | 30,633 | 33,040 | (2,407 | ) | 81,650 | 95,116 | (13,466 | ) | |||||||||||||||
Other fee-based income |
45,887 | 38,025 | 7,862 | 132,617 | 116,316 | 16,301 | ||||||||||||||||||
Software services income |
4,217 | 5,426 | (1,209 | ) | 15,865 | 17,022 | (1,157 | ) | ||||||||||||||||
Other income |
1,242 | 7,028 | (5,786 | ) | 4,298 | 14,048 | (9,750 | ) | ||||||||||||||||
Gain (loss) on sale of loans |
| 492 | (492 | ) | (47,426 | ) | 3,288 | (50,714 | ) | |||||||||||||||
Derivative market value, foreign currency,
and put option adjustments |
6,085 | 18,449 | (12,364 | ) | (35,521 | ) | 11,866 | (47,387 | ) | |||||||||||||||
Derivative settlements, net |
789 | (2,336 | ) | 3,125 | 45,989 | 7,100 | 38,889 | |||||||||||||||||
Total other income |
$ | 88,853 | 100,124 | (11,271 | ) | 197,472 | 264,756 | (67,284 | ) | |||||||||||||||
| Loan and guaranty servicing income decreased due to decreases in FFELP loan servicing
income, non-federally insured loan servicing income, and guaranty servicing income as
further discussed in this Item 2 under Student Loan and Guaranty Servicing Operating
Segment Results of Operations. |
| Other fee-based income increased due to an increase in the number of managed tuition
payment plans and an increase in campus commerce and related clients in the Tuition Payment
Processing and Campus Commerce Operating Segment, as well as an increase in lead generation
sales volume in the Enrollment Services and List Management Operating Segment. |
| Software services income decreased as the result of a reduction in the number of
projects for existing customers and the loss of customers due to the legislative
developments in the student loan industry throughout 2008 in the Software and Technical
Services Operating Segment. |
| Other income decreased for the three and nine months ended September 30, 2008 compared
to 2007 due to a gain of $3.9 million from the sale of an entity accounted for under the
equity method in September 2007. In addition, an agreement with
a third party ended during the third quarter of 2007 under which the Company provided administrative services to the third party for
a fee. The remaining change is a result of a decrease in income earned on certain
investment activities. |
| The Company recognized a loss of $47.5 million during the first quarter of 2008 as a
result of the sale of $1.3 billion of student loans as further discussed in this Item 2
under Asset Generation and Management Operating Segment Results of Operations. |
| The change in derivative market value, foreign currency, and put option adjustments
was caused by the change in the fair value of the Companys derivative portfolio and
foreign currency rate fluctuations which are further discussed in Item 3, Quantitative and
Qualitative Disclosures about Market Risk. |
| Further detail of the components of derivative settlements is included in Item 3,
Quantitative and Qualitative Disclosures about Market Risk. The Company maintains an
overall risk management strategy that incorporates the use of derivative instruments to
reduce the economic effect of interest rate volatility. Management has structured all of
the Companys derivative transactions with the intent that each is economically effective;
however, the Companys derivative instruments do not qualify for hedge accounting under
SFAS No. 133. Derivative settlements for each applicable period
should be evaluated with the Companys net interest income. |
Operating Expenses
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||||||||||
2008 | 2007 | $ Change | 2008 | 2007 | $ Change | |||||||||||||||||||
Salaries and benefits |
$ | 44,739 | 55,757 | (11,018 | ) | 136,422 | 177,222 | (40,800 | ) | |||||||||||||||
Other expenses |
58,930 | 63,228 | (4,298 | ) | 168,065 | 183,638 | (15,573 | ) | ||||||||||||||||
Operating expenses, excluding
impairment and restructure charges |
103,669 | 118,985 | $ | (15,316 | ) | 304,487 | 360,860 | $ | (56,373 | ) | ||||||||||||||
Impairment expense |
| 39,444 | 18,834 | 39,444 | ||||||||||||||||||||
Restructure expense |
| 15,016 | 7,107 | 15,016 | ||||||||||||||||||||
Total operating expenses |
$ | 103,669 | 173,445 | 330,428 | 415,320 | |||||||||||||||||||
Excluding restructuring and impairment charges, operating expenses decreased $15.3 million and
$56.4 million for the three and nine months ended September 30, 2008 compared to the same periods
in 2007, respectively. The decreases are the result of cost savings from the September 2007 and
January 2008 restructuring plans implemented by the Company. These plans resulted in the net
reduction of approximately 700 positions in the Companys overall workforce, leading to decreases
in salaries and benefits and other expenses. The decrease is also a result of the Company
capitalizing on the operating leverage of its business structure and strategies.
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Table of Contents
Operating expenses for the three and nine months ended September 30, 2008 includes $2.8 million of
certain severance and retention costs associated with additional strategic decisions made in the
third quarter of 2008. These costs are not included in restructure expense in the above table.
Income Taxes
The Companys effective tax rate was 37.0% and 117.7% for the three and nine months ended September
30, 2008, compared to 39.1% and 37.9% for the same periods in 2007.
The 2008 year-to-date tax
expense and effective tax rate is the result of the year-to-date pre-tax loss and the various state
gross receipts taxes and other items which are not deductible for tax purposes.
Additional information on the Companys results of operations is included with the discussion of
the Companys operating segments in this Item 2 under Operating Segments.
Financial Condition as of September 30, 2008 compared to December 31, 2007
As of | As of | |||||||||||||||
September 30, | December 31, | Change | ||||||||||||||
2008 | 2007 | Dollars | Percent | |||||||||||||
Assets: |
||||||||||||||||
Student loans receivable, net |
$ | 26,376,269 | 26,736,122 | (359,853 | ) | (1.3 | )% | |||||||||
Cash, cash equivalents, and investments |
1,454,881 | 1,120,838 | 334,043 | 29.8 | ||||||||||||
Goodwill |
175,178 | 164,695 | 10,483 | 6.4 | ||||||||||||
Intangible assets, net |
83,565 | 112,830 | (29,265 | ) | (25.9 | ) | ||||||||||
Fair value of derivative instruments |
154,741 | 222,471 | (67,730 | ) | (30.4 | ) | ||||||||||
Other assets |
725,381 | 805,827 | (80,446 | ) | (10.0 | ) | ||||||||||
Total assets |
$ | 28,970,015 | 29,162,783 | (192,768 | ) | (0.7 | )% | |||||||||
Liabilities: |
||||||||||||||||
Bonds and notes payable |
$ | 28,004,835 | 28,115,829 | (110,994 | ) | (0.4 | )% | |||||||||
Fair value of derivative instruments |
22,929 | 5,885 | 17,044 | 289.6 | ||||||||||||
Other liabilities |
332,521 | 432,190 | (99,669 | ) | (23.1 | ) | ||||||||||
Total liabilities |
28,360,285 | 28,553,904 | (193,619 | ) | (0.7 | ) | ||||||||||
Shareholders equity |
609,730 | 608,879 | 851 | 0.1 | ||||||||||||
Total liabilities and shareholders equity |
$ | 28,970,015 | 29,162,783 | (192,768 | ) | (0.7 | )% | |||||||||
The Companys total assets decreased during 2008 primarily due to a decrease in student loans
receivable as a result of a sale of $1.3 billion of student loans in 2008 as further discussed in
this Item 2 under Asset Generation and Management Operating Segment Results of Operations
offset by loan originations and acquisitions, net of repayments and participations. Total
liabilities decreased primarily due to a decrease in bonds and notes payable. This decrease is a
result of the decrease in student loan funding obligations due to a decrease in the Companys
student loan portfolio offset by increased borrowings on the unsecured line of credit to provide
equity funding support related to advances on the Companys warehouse facilities.
OPERATING SEGMENTS
The Company has five operating segments as defined in SFAS No. 131 as follows: Student Loan and
Guaranty Servicing, Tuition Payment Processing and Campus Commerce, Enrollment Services and List
Management, Software and Technical Services, and Asset Generation and Management. The Companys
operating segments are defined by the products and services they offer or the types of customers
they serve, and they reflect the manner in which financial information is currently evaluated by
management. The accounting policies of the Companys operating segments are the same as those
described in the summary of significant accounting policies included in the Companys consolidated
financial statements included in the Companys Annual Report on Form 10-K for the year ended
December 31, 2007. Intersegment revenues are charged by a segment to another segment that provides
the product or service. Intersegment revenues and expenses are included within each segment
consistent with the income statement presentation provided to management. Changes in management
structure or allocation methodologies and procedures may result in changes in reported segment
financial information.
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Table of Contents
The management reporting process measures the performance of the Companys operating segments based
on the management structure of the Company as well as the methodology used by management to
evaluate performance and allocate resources. Management, including the Companys chief operating
decision maker, evaluates the performance of the Companys operating segments based on their
profitability. As discussed further below, management measures the profitability of the Companys
operating segments on the basis of base net income. Accordingly, information regarding the
Companys operating segments is provided based on base net income. The Companys base net
income is not a defined term within GAAP and may not be comparable to similarly titled measures
reported by other companies. Unlike financial accounting, there is no comprehensive, authoritative
guidance for management reporting.
In May 2007, the Company sold EDULINX, a Canadian student loan service provider and subsidiary of
the Company. As a result of this transaction, the results of operations for EDULINX are reported
as discontinued operations for all periods presented. The operating results of EDULINX were
included in the Student Loan and Guaranty Servicing operating segment. The Company presents base
net income excluding discontinued operations since the operations and cash flows of EDULINX have
been eliminated from the ongoing operations of the Company. Therefore, the results of operations
for the Student Loan and Guaranty Servicing segment exclude the operating results of EDULINX for
all periods presented. See note 2 in the notes to the consolidated financial statements included
in this Report for additional information concerning EDULINXs detailed operating results that have
been segregated from continuing operations and reported as discontinued operations.
Historically, the Company generated the majority of its revenue from net interest income earned in
its Asset Generation and Management operating segment. In recent years, the Company has made
several acquisitions that have expanded the Companys products and services and has diversified its
revenue primarily from fee-based businesses. The Company currently offers a broad range of
pre-college, in-college, and post-college products and services to students, families, schools, and
financial institutions. These products and services help students and families plan and pay for
their education and students plan their careers. The Companys products and services are designed
to simplify the education planning and financing process and are focused on providing value to
students, families, and schools throughout the education life cycle. The Company continues to look
for ways to diversify its sources of revenue, including those generated from businesses that are
not dependent upon government programs, reducing legislative and political risk.
Base net income is the primary financial performance measure used by management to develop the
Companys financial plans, track results, and establish corporate performance targets and incentive
compensation. While base net income is not a substitute for reported results under GAAP, the
Company relies on base net income in operating its business because base net income permits
management to make meaningful period-to-period comparisons of the operational and performance
indicators that are most closely assessed by management. Management believes this information
provides additional insight into the financial performance of the core business activities of the
Companys operating segments.
Accordingly, the tables presented below reflect base net income which is reviewed and utilized by
management to manage the business for each of the Companys operating segments. Reconciliation of
the segment totals to the Companys consolidated operating results in accordance with GAAP are also
included in the tables below. Included below under Non-GAAP Performance Measures is further
discussion regarding base net income and its limitations, including a table that details the
differences between base net income and GAAP net income by operating segment.
36
Table of Contents
Segment Results and Reconciliations to GAAP
Three months ended September 30, 2008 | ||||||||||||||||||||||||||||||||||||||||
Fee-Based | ||||||||||||||||||||||||||||||||||||||||
Student | Tuition | Enrollment | Base net | |||||||||||||||||||||||||||||||||||||
Loan | Payment | Services | Software | Asset | Corporate | income | ||||||||||||||||||||||||||||||||||
and | Processing | and | and | Total | Generation | Activity | Eliminations | Adjustments | GAAP | |||||||||||||||||||||||||||||||
Guaranty | and Campus | List | Technical | Fee- | and | and | and | to GAAP | Results of | |||||||||||||||||||||||||||||||
Servicing | Commerce | Management | Services | Based | Management | Overhead | Reclassifications | Results | Operations | |||||||||||||||||||||||||||||||
Total interest income |
$ | 304 | 396 | 6 | | 706 | 290,039 | 2,010 | (749 | ) | 1,580 | 293,586 | ||||||||||||||||||||||||||||
Interest expense |
| | 1 | | 1 | 224,272 | 10,492 | (749 | ) | | 234,016 | |||||||||||||||||||||||||||||
Net interest income (loss) |
304 | 396 | 5 | | 705 | 65,767 | (8,482 | ) | | 1,580 | 59,570 | |||||||||||||||||||||||||||||
Less provision for loan losses |
| | | | | 7,000 | | | | 7,000 | ||||||||||||||||||||||||||||||
Net interest income (loss) after provision
for loan losses |
304 | 396 | 5 | | 705 | 58,767 | (8,482 | ) | | 1,580 | 52,570 | |||||||||||||||||||||||||||||
Other income (expense): |
||||||||||||||||||||||||||||||||||||||||
Loan and guaranty servicing income |
30,769 | | | | 30,769 | (136 | ) | | | | 30,633 | |||||||||||||||||||||||||||||
Other fee-based income |
| 11,861 | 29,859 | | 41,720 | 4,167 | | | | 45,887 | ||||||||||||||||||||||||||||||
Software services income |
| | | 4,217 | 4,217 | | | | | 4,217 | ||||||||||||||||||||||||||||||
Other income |
6 | 1 | | | 7 | (88 | ) | 1,323 | | | 1,242 | |||||||||||||||||||||||||||||
Intersegment revenue |
18,402 | 58 | 2 | 1,660 | 20,122 | | 15,671 | (35,793 | ) | | | |||||||||||||||||||||||||||||
Derivative market value, foreign currency,
and put option adjustments |
| | | | | | | | 6,085 | 6,085 | ||||||||||||||||||||||||||||||
Derivative settlements, net |
| | | | | 789 | | | | 789 | ||||||||||||||||||||||||||||||
Total other income (expense) |
49,177 | 11,920 | 29,861 | 5,877 | 96,835 | 4,732 | 16,994 | (35,793 | ) | 6,085 | 88,853 | |||||||||||||||||||||||||||||
Operating expenses: |
||||||||||||||||||||||||||||||||||||||||
Salaries and benefits |
13,876 | 6,236 | 5,805 | 4,138 | 30,055 | 1,980 | 14,179 | (1,952 | ) | 477 | 44,739 | |||||||||||||||||||||||||||||
Other expenses |
10,632 | 2,132 | 20,416 | 568 | 33,748 | 5,354 | 13,477 | (247 | ) | 6,598 | 58,930 | |||||||||||||||||||||||||||||
Intersegment expenses |
11,940 | 288 | 1,509 | 826 | 14,563 | 18,200 | 831 | (33,594 | ) | | | |||||||||||||||||||||||||||||
Total operating expenses |
36,448 | 8,656 | 27,730 | 5,532 | 78,366 | 25,534 | 28,487 | (35,793 | ) | 7,075 | 103,669 | |||||||||||||||||||||||||||||
Income (loss) before income taxes |
13,033 | 3,660 | 2,136 | 345 | 19,174 | 37,965 | (19,975 | ) | | 590 | 37,754 | |||||||||||||||||||||||||||||
Income tax expense (benefit) (a) |
4,823 | 1,354 | 790 | 128 | 7,095 | 14,047 | (7,391 | ) | | 218 | 13,969 | |||||||||||||||||||||||||||||
Net income (loss) from continuing
operations |
8,210 | 2,306 | 1,346 | 217 | 12,079 | 23,918 | (12,584 | ) | | 372 | 23,785 | |||||||||||||||||||||||||||||
Income from discontinued operations, net of tax |
| | | | | | | | | | ||||||||||||||||||||||||||||||
Net income (loss) |
$ | 8,210 | 2,306 | 1,346 | 217 | 12,079 | 23,918 | (12,584 | ) | | 372 | 23,785 | ||||||||||||||||||||||||||||
(a) Beginning in 2008, the consolidated effective tax rate for each applicable quarterly period is used to calculate income taxes for each operating segment. |
||||||||||||||||||||||||||||||||||||||||
Three months ended September 30, 2008: |
||||||||||||||||||||||||||||||||||||||||
Before Tax Operating Margin |
26.3 | % | 29.7 | % | 7.2 | % | 5.9 | % | 19.7 | % | 59.8 | % | ||||||||||||||||||||||||||||
Three months ended September 30, 2007: |
||||||||||||||||||||||||||||||||||||||||
Before Tax Operating Margin
excluding restructure expense,
impairment expense, and provision
for loan losses related to the loss
of Exceptional Performer |
42.9 | % | 36.3 | % | 7.3 | % | 26.7 | % | 32.3 | % | 49.2 | % |
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Table of Contents
Three months ended September 30, 2007 | ||||||||||||||||||||||||||||||||||||||||
Fee-Based | ||||||||||||||||||||||||||||||||||||||||
Student | Tuition | Enrollment | Base net | |||||||||||||||||||||||||||||||||||||
Loan | Payment | Services | Software | Asset | Corporate | income | ||||||||||||||||||||||||||||||||||
and | Processing | and | and | Total | Generation | Activity | Eliminations | Adjustments | GAAP | |||||||||||||||||||||||||||||||
Guaranty | and Campus | List | Technical | Fee- | and | and | and | to GAAP | Results of | |||||||||||||||||||||||||||||||
Servicing | Commerce | Management | Services | Based | Management | Overhead | Reclassifications | Results | Operations | |||||||||||||||||||||||||||||||
Total interest income |
$ | 1,182 | 990 | 110 | | 2,282 | 454,053 | 1,875 | (533 | ) | 597 | 458,274 | ||||||||||||||||||||||||||||
Interest expense |
| | 1 | | 1 | 384,793 | 9,614 | (533 | ) | | 393,875 | |||||||||||||||||||||||||||||
Net interest income (loss) |
1,182 | 990 | 109 | | 2,281 | 69,260 | (7,739 | ) | | 597 | 64,399 | |||||||||||||||||||||||||||||
Less provision for loan losses |
| | | | | 18,340 | | | | 18,340 | ||||||||||||||||||||||||||||||
Net interest income (loss) after provision
for loan losses |
1,182 | 990 | 109 | | 2,281 | 50,920 | (7,739 | ) | | 597 | 46,059 | |||||||||||||||||||||||||||||
Other income (expense): |
||||||||||||||||||||||||||||||||||||||||
Loan and guaranty servicing income |
32,870 | | | | 32,870 | 170 | | | | 33,040 | ||||||||||||||||||||||||||||||
Other fee-based income |
| 10,316 | 23,471 | | 33,787 | 3,526 | 712 | | | 38,025 | ||||||||||||||||||||||||||||||
Software services income |
| | 169 | 5,257 | 5,426 | | | | | 5,426 | ||||||||||||||||||||||||||||||
Other income |
| 31 | | | 31 | 1,181 | 5,816 | | | 7,028 | ||||||||||||||||||||||||||||||
Gain on sale of loans |
| | | | | 492 | | | | 492 | ||||||||||||||||||||||||||||||
Intersegment revenue |
22,237 | 168 | (37 | ) | 4,805 | 27,173 | | 1,492 | (28,665 | ) | | | ||||||||||||||||||||||||||||
Derivative market value, foreign currency,
and put option adjustments |
| | | | | | | | 18,449 | 18,449 | ||||||||||||||||||||||||||||||
Derivative settlements, net |
| | | | | (4,065 | ) | 1,729 | | | (2,336 | ) | ||||||||||||||||||||||||||||
Total other income (expense) |
55,107 | 10,515 | 23,603 | 10,062 | 99,287 | 1,304 | 9,749 | (28,665 | ) | 18,449 | 100,124 | |||||||||||||||||||||||||||||
Operating expenses: |
||||||||||||||||||||||||||||||||||||||||
Salaries and benefits |
21,961 | 5,312 | 8,095 | 6,537 | 41,905 | 6,154 | 9,691 | 2,292 | 503 | 60,545 | ||||||||||||||||||||||||||||||
Restructure expense- severance and contract
termination costs |
1,231 | | 737 | 58 | 2,026 | 1,921 | 1,009 | (4,956 | ) | | | |||||||||||||||||||||||||||||
Impairment expense |
| | 11,401 | | 11,401 | 28,291 | 9,812 | | | 49,504 | ||||||||||||||||||||||||||||||
Other expenses |
8,565 | 2,029 | 13,809 | 689 | 25,092 | 7,429 | 19,822 | 168 | 10,885 | 63,396 | ||||||||||||||||||||||||||||||
Intersegment expenses |
1,613 | (15 | ) | 67 | 147 | 1,812 | 20,924 | 3,433 | (26,169 | ) | | | ||||||||||||||||||||||||||||
Total operating expenses |
33,370 | 7,326 | 34,109 | 7,431 | 82,236 | 64,719 | 43,767 | (28,665 | ) | 11,388 | 173,445 | |||||||||||||||||||||||||||||
Income (loss) before income taxes |
22,919 | 4,179 | (10,397 | ) | 2,631 | 19,332 | (12,495 | ) | (41,757 | ) | | 7,658 | (27,262 | ) | ||||||||||||||||||||||||||
Income tax expense (benefit) (a) |
8,709 | 1,588 | (3,951 | ) | 1,000 | 7,346 | (4,748 | ) | (16,233 | ) | | 2,971 | (10,664 | ) | ||||||||||||||||||||||||||
Net income (loss) from
continuing operations |
14,210 | 2,591 | (6,446 | ) | 1,631 | 11,986 | (7,747 | ) | (25,524 | ) | | 4,687 | (16,598 | ) | ||||||||||||||||||||||||||
Income (loss) from discontinued operations, net of tax |
| | | | | | | | 909 | 909 | ||||||||||||||||||||||||||||||
Net income (loss) |
$ | 14,210 | 2,591 | (6,446 | ) | 1,631 | 11,986 | (7,747 | ) | (25,524 | ) | | 5,596 | (15,689 | ) | |||||||||||||||||||||||||
(a) | Income taxes are based on 38% of net income (loss) before tax for the individual operating segment. |
38
Table of Contents
Nine months ended September 30, 2008 | ||||||||||||||||||||||||||||||||||||||||
Fee-Based | ||||||||||||||||||||||||||||||||||||||||
Student | Tuition | Enrollment | Base net | |||||||||||||||||||||||||||||||||||||
Loan | Payment | Services | Software | Asset | Corporate | income | ||||||||||||||||||||||||||||||||||
and | Processing | and | and | Total | Generation | Activity | Eliminations | Adjustments | GAAP | |||||||||||||||||||||||||||||||
Guaranty | and Campus | List | Technical | Fee- | and | and | and | to GAAP | Results of | |||||||||||||||||||||||||||||||
Servicing | Commerce | Management | Services | Based | Management | Overhead | Reclassifications | Results | Operations | |||||||||||||||||||||||||||||||
Total interest income |
$ | 1,160 | 1,471 | 16 | | 2,647 | 892,690 | 4,781 | (1,389 | ) | 42,325 | 941,054 | ||||||||||||||||||||||||||||
Interest expense |
| | 3 | | 3 | 762,689 | 30,318 | (1,389 | ) | | 791,621 | |||||||||||||||||||||||||||||
Net interest income (loss) |
1,160 | 1,471 | 13 | | 2,644 | 130,001 | (25,537 | ) | | 42,325 | 149,433 | |||||||||||||||||||||||||||||
Less provision for loan losses |
| | | | | 18,000 | | | | 18,000 | ||||||||||||||||||||||||||||||
Net interest income (loss) after provision
for loan losses |
1,160 | 1,471 | 13 | | 2,644 | 112,001 | (25,537 | ) | | 42,325 | 131,433 | |||||||||||||||||||||||||||||
Other income (expense): |
||||||||||||||||||||||||||||||||||||||||
Loan and guaranty servicing income |
81,624 | | | | 81,624 | 26 | | | | 81,650 | ||||||||||||||||||||||||||||||
Other fee-based income |
| 35,975 | 83,148 | | 119,123 | 13,494 | | | | 132,617 | ||||||||||||||||||||||||||||||
Software services income |
| | 37 | 15,828 | 15,865 | | | | | 15,865 | ||||||||||||||||||||||||||||||
Other income |
44 | 5 | | | 49 | 293 | 3,956 | | | 4,298 | ||||||||||||||||||||||||||||||
Loss on sale of loans |
| | | | | (47,426 | ) | | | | (47,426 | ) | ||||||||||||||||||||||||||||
Intersegment revenue |
57,008 | 242 | 2 | 4,993 | 62,245 | | 46,844 | (109,089 | ) | | | |||||||||||||||||||||||||||||
Derivative market value, foreign currency,
and put option adjustments |
| | | | | 466 | | | (35,987 | ) | (35,521 | ) | ||||||||||||||||||||||||||||
Derivative settlements, net |
| | | | | 55,954 | | | (9,965 | ) | 45,989 | |||||||||||||||||||||||||||||
Total other income (expense) |
138,676 | 36,222 | 83,187 | 20,821 | 278,906 | 22,807 | 50,800 | (109,089 | ) | (45,952 | ) | 197,472 | ||||||||||||||||||||||||||||
Operating expenses: |
||||||||||||||||||||||||||||||||||||||||
Salaries and benefits |
40,365 | 17,450 | 18,701 | 14,031 | 90,547 | 6,157 | 41,581 | 1,323 | 2,523 | 142,131 | ||||||||||||||||||||||||||||||
Restructure expense severance and contract
termination costs |
747 | | 282 | 487 | 1,516 | 1,845 | 3,746 | (7,107 | ) | | | |||||||||||||||||||||||||||||
Impairment expense |
5,074 | | | | 5,074 | 9,351 | 4,409 | | | 18,834 | ||||||||||||||||||||||||||||||
Other expenses |
27,130 | 6,743 | 55,863 | 1,901 | 91,637 | 15,793 | 42,263 | 51 | 19,719 | 169,463 | ||||||||||||||||||||||||||||||
Intersegment expenses |
35,040 | 1,045 | 4,936 | 1,562 | 42,583 | 57,754 | 3,019 | (103,356 | ) | | | |||||||||||||||||||||||||||||
Total operating expenses |
108,356 | 25,238 | 79,782 | 17,981 | 231,357 | 90,900 | 95,018 | (109,089 | ) | 22,242 | 330,428 | |||||||||||||||||||||||||||||
Income (loss) before income taxes |
31,480 | 12,455 | 3,418 | 2,840 | 50,193 | 43,908 | (69,755 | ) | | (25,869 | ) | (1,523 | ) | |||||||||||||||||||||||||||
Income tax expense (benefit) (a) |
10,542 | 4,081 | 1,187 | 902 | 16,712 | 15,889 | (22,824 | ) | | (7,984 | ) | 1,793 | ||||||||||||||||||||||||||||
Net income (loss) from continuing operations |
20,938 | 8,374 | 2,231 | 1,938 | 33,481 | 28,019 | (46,931 | ) | | (17,885 | ) | (3,316 | ) | |||||||||||||||||||||||||||
Income from discontinued operations, net of tax |
| | | | | | | | 981 | 981 | ||||||||||||||||||||||||||||||
Net income (loss) |
$ | 20,938 | 8,374 | 2,231 | 1,938 | 33,481 | 28,019 | (46,931 | ) | | (16,904 | ) | (2,335 | ) | ||||||||||||||||||||||||||
(a) Beginning in 2008, the consolidated effective tax rate
for each applicable quarterly period is used to calculate
income taxes for each operating segment. |
||||||||||||||||||||||||||||||||||||||||
Nine months ended September 30, 2008: |
||||||||||||||||||||||||||||||||||||||||
Before Tax Operating Margin
excluding restructure expense,
impairment expense, and the loss on sale
of loans during the first quarter of 2008 |
26.7 | % | 33.0 | % | 4.4 | % | 16.0 | % | 20.2 | % | 56.3 | % | ||||||||||||||||||||||||||||
Nine months ended September, 2007: |
||||||||||||||||||||||||||||||||||||||||
Before Tax Operating Margin
excluding restructure expense,
impairment expense, and provision
for loan losses related to the loss
of Exceptional Performer |
35.6 | % | 36.0 | % | 7.0 | % | 26.9 | % | 27.6 | % | 53.7 | % |
39
Table of Contents
Nine months ended September 30, 2007 | ||||||||||||||||||||||||||||||||||||||||
Fee-Based | ||||||||||||||||||||||||||||||||||||||||
Student | Tuition | Enrollment | Base net | |||||||||||||||||||||||||||||||||||||
Loan | Payment | Services | Software | Asset | Corporate | income | ||||||||||||||||||||||||||||||||||
and | Processing | and | and | Total | Generation | Activity | Eliminations | Adjustments | GAAP | |||||||||||||||||||||||||||||||
Guaranty | and Campus | List | Technical | Fee- | and | and | and | to GAAP | Results of | |||||||||||||||||||||||||||||||
Servicing | Commerce | Management | Services | Based | Management | Overhead | Reclassifications | Results | Operations | |||||||||||||||||||||||||||||||
Total interest income |
$ | 4,607 | 2,670 | 290 | 18 | 7,585 | 1,301,947 | 6,230 | (3,737 | ) | 597 | 1,312,622 | ||||||||||||||||||||||||||||
Interest expense |
| 7 | 5 | | 12 | 1,084,792 | 31,196 | (3,737 | ) | | 1,112,263 | |||||||||||||||||||||||||||||
Net interest income (loss) |
4,607 | 2,663 | 285 | 18 | 7,573 | 217,155 | (24,966 | ) | | 597 | 200,359 | |||||||||||||||||||||||||||||
Less provision for loan losses |
| | | | | 23,628 | | | | 23,628 | ||||||||||||||||||||||||||||||
Net interest income (loss) after provision
for loan losses |
4,607 | 2,663 | 285 | 18 | 7,573 | 193,527 | (24,966 | ) | | 597 | 176,731 | |||||||||||||||||||||||||||||
Other income (expense): |
||||||||||||||||||||||||||||||||||||||||
Loan and guaranty servicing income |
94,828 | | | | 94,828 | 288 | | | | 95,116 | ||||||||||||||||||||||||||||||
Other fee-based income |
| 31,492 | 73,341 | | 104,833 | 10,511 | 972 | | | 116,316 | ||||||||||||||||||||||||||||||
Software services income |
| | 456 | 16,566 | 17,022 | | | | | 17,022 | ||||||||||||||||||||||||||||||
Other income |
11 | 59 | | | 70 | 4,329 | 9,649 | | | 14,048 | ||||||||||||||||||||||||||||||
Gain on sale of loans |
| | | | | 3,288 | | | | 3,288 | ||||||||||||||||||||||||||||||
Intersegment revenue |
58,821 | 508 | 891 | 13,026 | 73,246 | | 7,608 | (80,854 | ) | | | |||||||||||||||||||||||||||||
Derivative market value, foreign currency,
and put option adjustments |
| | | | | | | | 11,866 | 11,866 | ||||||||||||||||||||||||||||||
Derivative settlements, net |
| | | | | (4,950 | ) | 12,050 | | | 7,100 | |||||||||||||||||||||||||||||
Total other income (expense) |
153,660 | 32,059 | 74,688 | 29,592 | 289,999 | 13,466 | 30,279 | (80,854 | ) | 11,866 | 264,756 | |||||||||||||||||||||||||||||
Operating expenses: |
||||||||||||||||||||||||||||||||||||||||
Salaries and benefits |
66,988 | 15,312 | 26,486 | 18,869 | 127,655 | 20,600 | 34,669 | (2,370 | ) | 1,456 | 182,010 | |||||||||||||||||||||||||||||
Restructure expense- severance an dcontract
termination costs |
1,231 | | 737 | 58 | 2,026 | 1,921 | 1,009 | (4,956 | ) | | ||||||||||||||||||||||||||||||
Impairment expense |
| | 11,401 | | 11,401 | 28,291 | 9,812 | | | 49,504 | ||||||||||||||||||||||||||||||
Other expenses |
26,219 | 6,522 | 42,957 | 2,224 | 77,922 | 22,940 | 58,762 | 168 | 24,014 | 183,806 | ||||||||||||||||||||||||||||||
Intersegment expenses |
8,681 | 384 | 252 | 550 | 9,867 | 59,594 | 4,235 | (73,696 | ) | | | |||||||||||||||||||||||||||||
Total operating expenses |
103,119 | 22,218 | 81,833 | 21,701 | 228,871 | 133,346 | 108,487 | (80,854 | ) | 25,470 | 415,320 | |||||||||||||||||||||||||||||
Income (loss) before income taxes |
55,148 | 12,504 | (6,860 | ) | 7,909 | 68,701 | 73,647 | (103,174 | ) | | (13,007 | ) | 26,167 | |||||||||||||||||||||||||||
Income tax expense (benefit) (a) |
20,956 | 4,752 | (2,607 | ) | 3,006 | 26,107 | 27,986 | (40,059 | ) | | (4,128 | ) | 9,906 | |||||||||||||||||||||||||||
Net income (loss) from continuing operations |
34,192 | 7,752 | (4,253 | ) | 4,903 | 42,594 | 45,661 | (63,115 | ) | | (8,879 | ) | 16,261 | |||||||||||||||||||||||||||
Income (loss) from discontinued operations, net of tax |
| | | | | | | | (2,416 | ) | (2,416 | ) | ||||||||||||||||||||||||||||
Net income (loss) |
$ | 34,192 | 7,752 | (4,253 | ) | 4,903 | 42,594 | 45,661 | (63,115 | ) | | (11,295 | ) | 13,845 | ||||||||||||||||||||||||||
(a) | Income taxes are based on 38% of net income before tax for the individual operating segment. |
Non-GAAP Performance Measures
In accordance with the rules and regulations of the Securities and Exchange Commission (SEC), the
Company prepares financial statements in accordance with generally accepted accounting principles
(GAAP). In addition to evaluating the Companys GAAP-based financial information, management
also evaluates the Companys operating segments on a non-GAAP performance measure referred to as
base net income for each operating segment. While base net income is not a substitute for
reported results under GAAP, the Company relies on base net income to manage each operating
segment because management believes these measures provide additional information regarding the
operational and performance indicators that are most closely assessed by management.
40
Table of Contents
Base net income is the primary financial performance measure used by management to develop
financial plans, allocate resources, track results, evaluate performance, establish corporate
performance targets, and determine incentive compensation. Accordingly, financial information is
reported to management on a base net income basis by operating segment, as these are the measures
used regularly by the Companys chief operating decision maker. The Companys board of directors
utilizes base net income to set performance targets and evaluate managements performance. The
Company also believes analysts, rating agencies, and creditors use base net income in their
evaluation of the Companys results of operations. While base net income is not a substitute for
reported results under GAAP, the Company utilizes base net income in operating its business
because base net income permits management to make meaningful period-to-period comparisons by
eliminating the temporary volatility in the Companys performance that arises from certain items
that are primarily affected by factors beyond the control of management. Management believes base
net income provides additional insight into the financial performance of the core business
activities of the Companys operations.
Limitations of Base Net Income
While GAAP provides a uniform, comprehensive basis of accounting, for the reasons discussed above,
management believes that base net income is an important additional tool for providing a more
complete understanding of the Companys results of operations. Nevertheless, base net income is
subject to certain general and specific limitations that investors should carefully consider. For
example, as stated above, unlike financial accounting, there is no comprehensive, authoritative
guidance for management reporting. The Companys base net income is not a defined term within
GAAP and may not be comparable to similarly titled measures reported by other companies.
Investors, therefore, may not be able to compare the Companys performance with that of other
companies based upon base net income. Base net income results are only meant to supplement
GAAP results by providing additional information regarding the operational and performance
indicators that are most closely monitored and used by the Companys management and board of
directors to assess performance and information which the Company believes is important to
analysts, rating agencies, and creditors.
Other limitations of base net income arise from the specific adjustments that management makes to
GAAP results to derive base net income results. These differences are described below.
41
Table of Contents
The adjustments required to reconcile from the Companys base net income measure to its GAAP
results of operations relate to differing treatments for derivatives, foreign currency transaction
adjustments, discontinued operations, and certain other items that management does not consider in
evaluating the Companys operating results. The following table reflects adjustments associated
with these areas by operating segment and Corporate Activity and Overhead:
Student | Tuition | Enrollment | ||||||||||||||||||||||||||
Loan | Payment | Services | Software | Asset | Corporate | |||||||||||||||||||||||
and | Processing | and | and | Generation | Activity | |||||||||||||||||||||||
Guaranty | and Campus | List | Technical | and | and | |||||||||||||||||||||||
Servicing | Commerce | Management | Services | Management | Overhead | Total | ||||||||||||||||||||||
Three months ended September 30, 2008 | ||||||||||||||||||||||||||||
Derivative market value, foreign currency, and
put option adjustments |
$ | | | | | (9,030 | ) | 2,945 | (6,085 | ) | ||||||||||||||||||
Amortization of intangible assets |
1,165 | 1,889 | 3,258 | 286 | | | 6,598 | |||||||||||||||||||||
Compensation related to business combinations |
| | | | | 477 | 477 | |||||||||||||||||||||
Variable-rate floor income, net of settlements on derivatives |
| | | | (1,580 | ) | | (1,580 | ) | |||||||||||||||||||
Income (loss) from discontinued operations, net of tax |
| | | | | | | |||||||||||||||||||||
Net tax effect (a) |
(432 | ) | (699 | ) | (1,205 | ) | (106 | ) | 3,926 | (1,266 | ) | 218 | ||||||||||||||||
Total adjustments to GAAP |
$ | 733 | 1,190 | 2,053 | 180 | (6,684 | ) | 2,156 | (372 | ) | ||||||||||||||||||
Three months ended September 30, 2007 |
||||||||||||||||||||||||||||
Derivative market value, foreign currency, and
put option adjustments |
$ | | | | | (20,017 | ) | 1,568 | (18,449 | ) | ||||||||||||||||||
Amortization of intangible assets |
1,350 | 1,434 | 6,442 | 287 | 1,372 | | 10,885 | |||||||||||||||||||||
Compensation related to business combinations |
| | | | | 503 | 503 | |||||||||||||||||||||
Variable-rate floor income, net of settlements on derivatives |
| | | | (597 | ) | | (597 | ) | |||||||||||||||||||
Income (loss) from discontinued operations, net of tax |
(909 | ) | | | | | | (909 | ) | |||||||||||||||||||
Net tax effect (a) |
(513 | ) | (545 | ) | (2,448 | ) | (109 | ) | 7,312 | (726 | ) | 2,971 | ||||||||||||||||
Total adjustments to GAAP |
$ | (72 | ) | 889 | 3,994 | 178 | (11,930 | ) | 1,345 | (5,596 | ) | |||||||||||||||||
Nine months ended September 30, 2008 |
||||||||||||||||||||||||||||
Derivative market value, foreign currency, and
put option adjustments |
$ | | | | | 32,504 | 3,483 | 35,987 | ||||||||||||||||||||
Amortization of intangible assets |
3,586 | 5,937 | 9,193 | 858 | 145 | | 19,719 | |||||||||||||||||||||
Compensation related to business combinations |
| | | | | 2,523 | 2,523 | |||||||||||||||||||||
Variable-rate floor income, net of settlements on derivatives |
| | | | (32,360 | ) | | (32,360 | ) | |||||||||||||||||||
Income (loss) from discontinued operations, net of tax |
(981 | ) | | | | | | (981 | ) | |||||||||||||||||||
Net tax effect (a) |
(1,182 | ) | (1,954 | ) | (3,045 | ) | (284 | ) | 548 | (2,067 | ) | (7,984 | ) | |||||||||||||||
Total adjustments to GAAP |
$ | 1,423 | 3,983 | 6,148 | 574 | 837 | 3,939 | 16,904 | ||||||||||||||||||||
Nine months ended September 30, 2007 |
||||||||||||||||||||||||||||
Derivative market value, foreign currency, and
put option adjustments |
$ | | | | | (7,801 | ) | (4,065 | ) | (11,866 | ) | |||||||||||||||||
Amortization of intangible assets |
3,744 | 4,372 | 9,797 | 904 | 5,197 | | 24,014 | |||||||||||||||||||||
Compensation related to business combinations |
| | | | | 1,456 | 1,456 | |||||||||||||||||||||
Variable-rate floor income, net of settlements on derivatives |
| | | | (597 | ) | | (597 | ) | |||||||||||||||||||
Income (loss) from discontinued operations, net of tax |
2,416 | | | | | | 2,416 | |||||||||||||||||||||
Net tax effect (a) |
(1,423 | ) | (1,661 | ) | (3,723 | ) | (343 | ) | 1,216 | 1,806 | (4,128 | ) | ||||||||||||||||
Total adjustments to GAAP |
$ | 4,737 | 2,711 | 6,074 | 561 | (1,985 | ) | (803 | ) | 11,295 | ||||||||||||||||||
(a) | Beginning in 2008, tax effect is computed using the Companys consolidated
effective tax rate for each applicable quarterly period. In prior periods, tax effect
was computed at 38%. The change in the value of the put options for prior periods
(included in Corporate Activity and Overhead) was not tax effected as this is not
deductible for income tax purposes. |
Differences between GAAP and Base Net Income
Managements financial planning and evaluation of operating results does not take into account the
following items because their volatility and/or inherent uncertainty affect the period-to-period
comparability of the Companys results of operations. A more detailed discussion of the
differences between GAAP and base net income follows.
42
Table of Contents
Derivative market value, foreign currency, and put option adjustments: Base net income excludes
the periodic unrealized gains and losses that are caused by the change in fair value on derivatives
used in the Companys risk management strategy in which the Company does not qualify for hedge
treatment under GAAP. Statement of Financial Accounting Standards No. 133, Accounting for
Derivative Instruments and Hedging Activities (SFAS No. 133), requires that changes in fair value
of derivative instruments be recognized currently in earnings unless specific hedge accounting
criteria, as specified by SFAS No. 133, are met. The Company maintains an overall interest rate
risk management strategy that incorporates the use of derivative instruments to reduce the economic
effect of interest rate volatility. Derivative instruments primarily used by the Company include
interest rate swaps, basis swaps, and cross-currency interest rate swaps. Management has
structured all of the Companys derivative transactions with the intent that each is economically
effective. However, the Company does not qualify its
derivatives for hedge treatment as defined
by SFAS No. 133, and the stand-alone derivative must be marked-to-market in the income statement
with no consideration for the corresponding change in fair value of the hedged item. The Company
believes these point-in-time estimates of asset and liability values that are subject to interest
rate fluctuations make it difficult to evaluate the ongoing results of operations against its
business plan and affect the period-to-period comparability of the results of operations. Included
in base net income are the economic effects of the Companys derivative instruments, which
includes any cash paid or received being recognized as an expense or revenue upon actual derivative
settlements. These settlements are included in Derivative market value, foreign currency, and put
option adjustments and derivative settlements, net on the Companys consolidated statements of
operations.
Base net income excludes the foreign currency transaction gains or losses caused by the
re-measurement of the Companys Euro-denominated bonds to U.S. dollars. In connection with the
issuance of the Euro-denominated bonds, the Company has entered into cross-currency interest rate
swaps. Under the terms of these agreements, the principal payments on the Euro-denominated notes
will effectively be paid at the exchange rate in effect at the issuance date of the bonds. The
cross-currency interest rate swaps also convert the floating rate paid on the Euro-denominated
bonds (EURIBOR index) to an index based on LIBOR. Included in base net income are the economic
effects of any cash paid or received being recognized as an expense or revenue upon actual
settlements of the cross-currency interest rate swaps. These settlements are included in
Derivative market value, foreign currency, and put option adjustments and derivative settlements,
net on the Companys consolidated statements of operations. However, the gains or losses caused
by the re-measurement of the Euro-denominated bonds to U.S. dollars and the change in market value
of the cross-currency interest rate swaps are excluded from base net income as the Company
believes the point-in-time estimates of value that are subject to currency rate fluctuations
related to these financial instruments make it difficult to evaluate the ongoing results of
operations against the Companys business plan and affect the period-to-period comparability of the
results of operations. The re-measurement of the Euro-denominated bonds correlates with the change
in fair value of the cross-currency interest rate swaps. However, the Company will experience
unrealized gains or losses related to the cross-currency interest rate swaps if the two underlying
indices (and related forward curve) do not move in parallel.
Base net income also excludes the change in fair value of put options issued by the Company for
certain business acquisitions. The put options are valued by the Company each reporting period
using a Black-Scholes pricing model. Therefore, the fair value of these options is primarily
affected by the strike price and term of the underlying option, the Companys current stock price,
and the dividend yield and volatility of the Companys stock. The Company believes these
point-in-time estimates of value that are subject to fluctuations make it difficult to evaluate the
ongoing results of operations against the Companys business plans and affects the period-to-period
comparability of the results of operations.
The gains and/or losses included in Derivative market value, foreign currency, and put option
adjustments and derivative settlements, net on the Companys consolidated statements of operations
are primarily caused by interest rate and currency volatility, changes in the value of put options
based on the inputs used in the Black-Scholes pricing model, as well as the volume and terms of put
options and of derivatives not
receiving hedge treatment. Base net income excludes these unrealized gains and losses and
isolates the effect of interest rate, currency, and put option volatility on the fair value of such
instruments during the period. Under GAAP, the effects of these factors on the fair value of the
put options and the derivative instruments (but not the underlying hedged item) tend to show more
volatility in the short term.
Amortization of intangible assets: Base net income excludes the amortization of acquired
intangibles, which arises primarily from the acquisition of definite life intangible assets in
connection with the Companys acquisitions, since the Company feels that such charges do not drive
the Companys operating performance on a long-term basis and can affect the period-to-period
comparability of the results of operations.
Compensation related to business combinations: The Company has structured certain business
combinations in which the consideration paid has been dependent on the sellers continued
employment with the Company. As such, the value of the consideration paid is recognized as
compensation expense by the Company over the term of the applicable employment agreement. Base
net income excludes this expense because the Company believes such charges do not drive its
operating performance on a long-term basis and can affect the period-to-period comparability of the
results of operations. If the Company did not enter into the employment agreements in connection
with the acquisition, the amount paid to these former shareholders of the acquired entity would
have been recorded by the Company as additional consideration of the acquired entity, thus, not
having an effect on the Companys results of operations.
Variable-rate floor income, net of settlements on derivatives: Loans that reset annually on July 1
can generate excess spread income compared with the rate based on the special allowance payment
formula in declining interest rate environments. The Company refers to this additional income as
variable-rate floor income. The Company excludes variable-rate floor income, net of settlements
paid on derivatives used to hedge student loan assets earning variable-rate floor income, from its
base net income since the timing and amount of variable-rate floor income (if any) is uncertain,
it has been eliminated by legislation for all loans originated on and after April 1, 2006, and it
is in excess of expected spreads. In addition, because variable-rate floor income is subject to
the underlying rate for the subject loans being reset annually on July 1, it is a factor beyond the
Companys control which can affect the period-to-period comparability of results of operations.
Discontinued operations: In May 2007, the Company sold EDULINX. As a result of this transaction,
the results of operations for EDULINX are reported as discontinued operations for all periods
presented. The Company presents base net income excluding discontinued operations since the
operations and cash flows of EDULINX have been eliminated from the ongoing operations of the
Company.
43
Table of Contents
STUDENT LOAN AND GUARANTY SERVICING OPERATING SEGMENT RESULTS OF OPERATIONS
The Student Loan and Guaranty Servicing segment provides for the servicing of the Companys student
loan portfolios and the portfolios of third parties and servicing provided to guaranty agencies.
The servicing and business process outsourcing activities include loan origination activities,
application processing, borrower updates, payment processing, due diligence procedures, and claim
processing. These activities are performed internally for the Companys portfolio in addition to
generating fee revenue when performed for third-party clients. The guaranty servicing, servicing
support, and business process outsourcing activities include providing software and data center
services, borrower and loan updates, default aversion tracking services, claim processing services,
and post-default collection services to guaranty agencies.
Student Loan Servicing Volumes
As of | As of | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2008 | 2007 | |||||||||||||||
Dollar | Percent | Dollar | Percent | |||||||||||||
(dollars in millions) | ||||||||||||||||
Company |
$ | 25,248 | (a) | 70.3 | % | $ | 25,491 | 76.1 | % | |||||||
Third Party |
10,661 | (b) | 29.7 | 8,026 | 23.9 | |||||||||||
$ | 35,909 | 100.0 | % | $ | 33,517 | 100.0 | % | |||||||||
(a) | Approximately $410
million of these loans were disbursed on or after
May 1, 2008 and are eligible to be sold to the
Department of Education pursuant to its Purchase
Commitment Program. The Department obtains all
rights to service loans which it purchases as part
of this program. |
|
(b) | Approximately $671
million of these loans were disbursed on or after
May 1, 2008 and may be eligible to be sold to the
Department of Education pursuant to its Purchase
Commitment Program. The Department obtains all
rights to service loans which it purchases as part
of this program. |
Three and nine months ended September 30, 2008 compared to the three and nine months ended
September 30, 2007
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||||||||||
2008 | 2007 | $ Change | 2008 | 2007 | $ Change | |||||||||||||||||||
Net interest income after the provision
for loan losses |
$ | 304 | 1,182 | (878 | ) | 1,160 | 4,607 | (3,447 | ) | |||||||||||||||
Loan and guaranty servicing income |
30,769 | 32,870 | (2,101 | ) | 81,624 | 94,828 | (13,204 | ) | ||||||||||||||||
Other income |
6 | | 6 | 44 | 11 | 33 | ||||||||||||||||||
Intersegment revenue |
18,402 | 22,237 | (3,835 | ) | 57,008 | 58,821 | (1,813 | ) | ||||||||||||||||
Total other income |
49,177 | 55,107 | (5,930 | ) | 138,676 | 153,660 | (14,984 | ) | ||||||||||||||||
Salaries and benefits |
13,876 | 21,961 | (8,085 | ) | 40,365 | 66,988 | (26,623 | ) | ||||||||||||||||
Restructure expense severance and contract
termination costs |
| 1,231 | (1,231 | ) | 747 | 1,231 | (484 | ) | ||||||||||||||||
Impairment expense |
| | | 5,074 | | 5,074 | ||||||||||||||||||
Other expenses |
10,632 | 8,565 | 2,067 | 27,130 | 26,219 | 911 | ||||||||||||||||||
Intersegment expenses |
11,940 | 1,613 | 10,327 | 35,040 | 8,681 | 26,359 | ||||||||||||||||||
Total operating expenses |
36,448 | 33,370 | 3,078 | 108,356 | 103,119 | 5,237 | ||||||||||||||||||
Base net income before
income taxes |
13,033 | 22,919 | (9,886 | ) | 31,480 | 55,148 | (23,668 | ) | ||||||||||||||||
Income tax expense |
4,823 | 8,709 | (3,886 | ) | 10,542 | 20,956 | (10,414 | ) | ||||||||||||||||
Base net income |
$ | 8,210 | 14,210 | (6,000 | ) | 20,938 | 34,192 | (13,254 | ) | |||||||||||||||
Before Tax Operating Margin |
26.3 | % | 40.7 | % | 22.5 | % | 34.8 | % | ||||||||||||||||
Before Tax
Operating Margin
excluding restructure expense
and impairment expense |
26.3 | % | 42.9 | % | 26.7 | % | 35.6 | % |
Net interest income after the provision for loan losses. Investment income decreased as a
result of an overall decrease in cash held in 2008 compared to 2007, as well as lower interest
rates.
44
Table of Contents
Loan and guaranty servicing income. Loan and guaranty servicing income for the three and
nine months ended September 30, 2008 decreased from the same periods in 2007 as follows:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||||||||||||||||||
2008 | 2007 | $ Change | % Change | 2008 | 2007 | $ Change | % Change | |||||||||||||||||||||||||
Origination and servicing of
FFEL Program loans |
$ | 14,041 | 14,785 | (744 | ) | (5.0 | )% | $ | 38,854 | 42,689 | (3,835 | ) | (9.0 | )% | ||||||||||||||||||
Origination and servicing of
non-federally insured student loans |
2,016 | 3,173 | (1,157 | ) | (36.5 | ) | 6,159 | 7,830 | (1,671 | ) | (21.3 | ) | ||||||||||||||||||||
Servicing and support outsourcing for
guaranty agencies |
14,712 | 14,912 | (200 | ) | (1.3 | ) | 36,611 | 44,309 | (7,698 | ) | (17.4 | ) | ||||||||||||||||||||
Loan and guaranty servicing income
to external parties |
$ | 30,769 | 32,870 | (2,101 | ) | (6.4 | )% | $ | 81,624 | 94,828 | (13,204 | ) | (13.9 | )% | ||||||||||||||||||
| FFELP loan servicing income decreased due to new servicing contracts being priced at
lower rates and the loss of clients following the legislative developments in September
2007. This decrease is partially offset by an increase in loan servicing volume due to
entering into new servicing contracts. |
||
| Non-federally insured loan servicing income decreased due to a significant customer
ceasing to originate non-federally insured loans. |
||
| Servicing and support outsourcing for guaranty agencies decreased due to the termination
of the Voluntary Flexible Agreement between the Department of Education and College Assist
offset by an increase in the volume of guaranteed loans serviced and an increase in
collections revenue. For the three months ended September 30, 2008, the change remained
relatively flat due to an increase in collections revenue from rehabilitated loans. |
Intersegment revenue. The decrease in intersegment revenue for the three and nine months
ended September 30, 2008 compared to the same periods in 2007 was the result of a decrease in
internal call center revenue due to the Companys reduction in direct-to-consumer marketing offset
by an increase in servicing volume and rates for internal customers.
Operating expenses. Operating expenses increased $3.1 million and $5.2 million for the
three and nine months ended September 30, 2008 compared to the same period in 2007 as a result of
the allocation of additional corporate overhead expenses, which were included in Corporate Activity
and Overhead for the three and nine months ended September 30, 2007. Excluding restructuring and impairment charges and the increase in
expenses associated with the variation in allocation methodologies,
operating expenses decreased $1.7 million and
$15.4 million for the three and nine months ended September 30, 2008 compared to the same period in
2007 as a result of cost savings from the Companys September 2007 and January 2008 restructuring
plans. Operating margins, excluding restructuring and impairment
charges and the expenses associated with the variation in allocation
methodologies, were 38.4% and 38.5% for the three and nine months ended September 30, 2008.
45
Table of Contents
TUITION PAYMENT PROCESSING AND CAMPUS COMMERCE OPERATING SEGMENT RESULTS OF OPERATIONS
The Companys Tuition Payment Processing and Campus Commerce operating segment provides products
and services to help institutions and education seeking families manage the payment of education
costs during the pre-college and college stages of the education life cycle. The Company provides
actively managed tuition payment solutions, online payment processing, detailed information
reporting, financial needs analysis, and data integration services to K-12 and higher educational
institutions, families, and students. In addition, the Company provides customer-focused
electronic transactions, information sharing, and account and bill presentment to colleges and
universities.
Three and nine months ended September 30, 2008 compared to the three and nine months ended
September 30, 2007
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||||||||||
2008 | 2007 | $ Change | 2008 | 2007 | $ Change | |||||||||||||||||||
Net interest income after the provision
for loan losses |
$ | 396 | 990 | (594 | ) | 1,471 | 2,663 | (1,192 | ) | |||||||||||||||
Other fee-based income |
11,861 | 10,316 | 1,545 | 35,975 | 31,492 | 4,483 | ||||||||||||||||||
Other income |
1 | 31 | (30 | ) | 5 | 59 | (54 | ) | ||||||||||||||||
Intersegment revenue |
58 | 168 | (110 | ) | 242 | 508 | (266 | ) | ||||||||||||||||
Total other income |
11,920 | 10,515 | 1,405 | 36,222 | 32,059 | 4,163 | ||||||||||||||||||
Salaries and benefits |
6,236 | 5,312 | 924 | 17,450 | 15,312 | 2,138 | ||||||||||||||||||
Other expenses |
2,132 | 2,029 | 103 | 6,743 | 6,522 | 221 | ||||||||||||||||||
Intersegment expenses |
288 | (15 | ) | 303 | 1,045 | 384 | 661 | |||||||||||||||||
Total operating expenses |
8,656 | 7,326 | 1,330 | 25,238 | 22,218 | 3,020 | ||||||||||||||||||
Base net income
before income taxes |
3,660 | 4,179 | (519 | ) | 12,455 | 12,504 | (49 | ) | ||||||||||||||||
Income tax expense |
1,354 | 1,588 | (234 | ) | 4,081 | 4,752 | (671 | ) | ||||||||||||||||
Base net income |
$ | 2,306 | 2,591 | (285 | ) | 8,374 | 7,752 | 622 | ||||||||||||||||
Before Tax Operating Margin |
29.7 | % | 36.3 | % | 33.0 | % | 36.0 | % |
Net interest income after the provision for loan losses. Investment income decreased as a
result of decreases in interest rates on cash held in 2008 compared to 2007.
Other fee-based income. Other fee-based income increased for the three and nine months
ended September 30, 2008 compared to the same period in 2007 as a result of an increase in the
number of managed tuition payment plans as well as an increase in campus commerce clients.
Operating expenses. Operating expenses increased for the three and nine months ended
September 30, 2008 compared to the same period in 2007 as a result of incurring additional costs
associated with salaries and benefits, as well as other expenses, to support the increase in the
number of managed tuition payment plans and campus commerce clients. In addition, the Company
continues to invest in products, services, and technology to meet customer needs and support
continued revenue growth. These investments increased 2008 operating expenses compared to 2007.
46
Table of Contents
ENROLLMENT SERVICES AND LIST MANAGEMENT OPERATING SEGMENT RESULTS OF OPERATIONS
The Companys Enrollment Services and List Management segment provides a wide range of direct
marketing products and services to help schools and businesses reach the middle school, high
school, college bound high school, college, and young adult market places. In addition, this
segment offers products and services that are focused on helping (i) students plan and prepare for
life after high school and (ii) colleges recruit and retain students.
Three and nine months ended September 30, 2008 compared to the three and nine months ended
September 30, 2007
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||||||||||
2008 | 2007 | $ Change | 2008 | 2007 | $ Change | |||||||||||||||||||
Net interest income after the provision
for loan losses |
$ | 5 | 109 | (104 | ) | 13 | 285 | (272 | ) | |||||||||||||||
Other fee-based income |
29,859 | 23,471 | 6,388 | 83,148 | 73,341 | 9,807 | ||||||||||||||||||
Software services income |
| 169 | (169 | ) | 37 | 456 | (419 | ) | ||||||||||||||||
Intersegment revenue |
2 | (37 | ) | 39 | 2 | 891 | (889 | ) | ||||||||||||||||
Total other income |
29,861 | 23,603 | 6,258 | 83,187 | 74,688 | 8,499 | ||||||||||||||||||
Salaries and benefits |
5,805 | 8,095 | (2,290 | ) | 18,701 | 26,486 | (7,785 | ) | ||||||||||||||||
Restructure expense severance and contract
termination costs |
| 737 | (737 | ) | 282 | 737 | (455 | ) | ||||||||||||||||
Impairment expense |
| 11,401 | (11,401 | ) | | 11,401 | (11,401 | ) | ||||||||||||||||
Other expenses |
20,416 | 13,809 | 6,607 | 55,863 | 42,957 | 12,906 | ||||||||||||||||||
Intersegment expenses |
1,509 | 67 | 1,442 | 4,936 | 252 | 4,684 | ||||||||||||||||||
Total operating expenses |
27,730 | 34,109 | (6,379 | ) | 79,782 | 81,833 | (2,051 | ) | ||||||||||||||||
Base net income (loss)
before income taxes |
2,136 | (10,397 | ) | 12,533 | 3,418 | (6,860 | ) | 10,278 | ||||||||||||||||
Income tax expense (benefit) |
790 | (3,951 | ) | 4,741 | 1,187 | (2,607 | ) | 3,794 | ||||||||||||||||
Base net income (loss) |
$ | 1,346 | (6,446 | ) | 7,792 | 2,231 | (4,253 | ) | 6,484 | |||||||||||||||
Before Tax Operating Margin |
7.2 | % | (43.8 | %) | 4.1 | % | (9.1 | %) | ||||||||||||||||
Before Tax Operating Margin
excluding restructure and
impairment expense |
7.2 | % | 7.3 | % | 4.4 | % | 7.0 | % |
Other fee-based income. Other fee-based income increased as a result of an increase in
lead generation volume and an increase in other enrollment products and services, such as test
preparation study guides and online courses, admissions consulting, and essay and resume editing
services. This increase in income was offset by a decrease due to the impacts of the legislative
developments in the student loan industry on the list marketing services offered by this segment.
In addition, the Company reduced the number of student recognition publications it plans to offer.
Excluding the income associated with the list marketing services and student recognition
publications, other fee-based income increased approximately $6.7 million, or 32.3%, and $18.4
million, or 31.6%, for the three and nine months ended September 30, 2008 compared to the same
periods in 2007.
Operating expenses. Excluding restructure and impairment charges, operating expenses
increased $5.8 million, or 26.2%, and $9.8 million, or 14.1%, for the three and nine months ended
September 30, 2008 compared to the same periods in 2007 as a result of an increase in costs
associated with providing lead generation services and the allocation of additional corporate
overhead expenses, which were included in Corporate Activity and Overhead for the three and nine
months ended September 30, 2007. The increases in operating expenses were offset as a result of
cost savings from the September 2007 and January 2008 restructuring plans, resulting in the
decrease in salaries and benefits of $2.3 million and $7.8 million for the three and nine months
ended September 30, 2008 compared to the same periods in 2007. Excluding intersegment expenses and
restructure and impairment charges, the before tax operating margin was 12.2% and 10.4% for the
three and nine months ended September 30, 2008.
47
Table of Contents
SOFTWARE AND TECHNICAL SERVICES OPERATING SEGMENT RESULTS OF OPERATIONS
The Software and Technical Services segment provides information technology products and
full-service technical consulting, with core areas of business in educational loan software
solutions, business intelligence, technical consulting services, and Enterprise Content Management
(ECM) solutions.
Many of the Companys customers receiving services in this segment have been negatively impacted as
a result of the passage of the College Cost Reduction Act and the recent disruption in the capital
markets. This impact could decrease the demand for products and services and affect this segments
future revenue and profit margins.
Three and nine months ended September 30, 2008 compared to the three and nine months ended
September 30, 2007
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||||||||||
2008 | 2007 | $ Change | 2008 | 2007 | $ Change | |||||||||||||||||||
Net interest income after the provision
for loan losses |
$ | | | | | 18 | (18 | ) | ||||||||||||||||
Software services income |
4,217 | 5,257 | (1,040 | ) | 15,828 | 16,566 | (738 | ) | ||||||||||||||||
Intersegment revenue |
1,660 | 4,805 | (3,145 | ) | 4,993 | 13,026 | (8,033 | ) | ||||||||||||||||
Total other income |
5,877 | 10,062 | (4,185 | ) | 20,821 | 29,592 | (8,771 | ) | ||||||||||||||||
Salaries and benefits |
4,138 | 6,537 | (2,399 | ) | 14,031 | 18,869 | (4,838 | ) | ||||||||||||||||
Restructure expense severance and contract
termination costs |
| 58 | (58 | ) | 487 | 58 | 429 | |||||||||||||||||
Other expenses |
568 | 689 | (121 | ) | 1,901 | 2,224 | (323 | ) | ||||||||||||||||
Intersegment expenses |
826 | 147 | 679 | 1,562 | 550 | 1,012 | ||||||||||||||||||
Total operating expenses |
5,532 | 7,431 | (1,899 | ) | 17,981 | 21,701 | (3,720 | ) | ||||||||||||||||
Base net income before
income taxes |
345 | 2,631 | (2,286 | ) | 2,840 | 7,909 | (5,069 | ) | ||||||||||||||||
Income tax expense |
128 | 1,000 | (872 | ) | 902 | 3,006 | (2,104 | ) | ||||||||||||||||
Base net income |
$ | 217 | 1,631 | (1,414 | ) | 1,938 | 4,903 | (2,965 | ) | |||||||||||||||
Before Tax Operating Margin |
5.9 | % | 26.1 | % | 13.6 | % | 26.7 | % | ||||||||||||||||
Before Tax
Operating Margin
excluding restructure expense |
5.9 | % | 26.7 | % | 16.0 | % | 26.9 | % |
Software services income. Software services income decreased for the three and nine months
ended September 30, 2008 compared to the same period in 2007 as the result of a reduction in the
number of projects for existing customers and the loss of customers due to the legislative
developments in the student loan industry throughout 2008.
Intersegment revenue. Intersegment revenue decreased for the three and nine months ended
September 30, 2008 compared to the same periods in 2007 as a result of a decrease in projects for
internal customers.
Operating expenses. The decrease in operating expenses was driven by a decrease in costs
associated with salaries and benefits as a result of the decrease in projects for customers and the
loss of customers due to legislative developments in the student loan industry. These decreases
were partially offset by increases in operating expenses as a result of the allocation of
additional corporate overhead expenses, which were included in Corporate Activity and Overhead for
the three and nine months ended September 30, 2007. In addition, the Company continues to invest
in new products and services to meet customer needs and expand product and service offerings.
These investments increased 2008 operating expenses compared to 2007.
48
Table of Contents
ASSET GENERATION AND MANAGEMENT OPERATING SEGMENT RESULTS OF OPERATIONS
The Asset Generation and Management segment includes the acquisition, management, and ownership of
the Companys student loan assets. Revenues are primarily generated from the Companys earnings
from the spread, referred to as the Companys student loan spread, between the yield received on
the student loan portfolio and the costs associated with originating, acquiring, financing,
servicing, and managing the student loan portfolio. The Company generates student loan assets
through direct origination or through acquisitions. The student loan assets are held in a series of
education lending subsidiaries designed specifically for this purpose.
In addition to the student loan portfolio, all costs and activity associated with the generation of
assets, funding of those assets, and maintenance of the debt transactions are included in this
segment. This includes derivative activity and the related derivative market value and foreign
currency adjustments. The Company is also able to leverage its capital market expertise by
providing investment advisory services and other related services to third parties through a
licensed broker-dealer subsidiary. Revenues and expenses for those functions are also included in
the Asset Generation and Management segment.
Student Loan Portfolio
The table below outlines the components of the Companys student loan portfolio:
As of September 30, 2008 | As of December 31, 2007 | |||||||||||||||
Dollars | Percent | Dollars | Percent | |||||||||||||
Federally insured: (a) (b) |
||||||||||||||||
Stafford |
||||||||||||||||
Originated prior to 10/1/07 |
$ | 6,780,214 | 25.7 | % | $ | 6,624,009 | 24.8 | % | ||||||||
Originated on or after 10/1/07 |
689,097 | 2.6 | 101,901 | 0.4 | ||||||||||||
PLUS/SLS |
||||||||||||||||
Originated prior to 10/1/07 |
428,037 | 1.6 | 414,708 | 1.5 | ||||||||||||
Originated on or after 10/1/07 |
85,066 | 0.3 | 15,233 | 0.1 | ||||||||||||
Consolidation |
||||||||||||||||
Originated prior to 10/1/07 |
17,427,448 | 66.2 | 18,646,993 | 69.8 | ||||||||||||
Originated on or after 10/1/07 |
316,031 | 1.2 | 251,554 | 0.9 | ||||||||||||
Non-federally insured |
275,520 | 1.0 | 274,815 | 1.0 | ||||||||||||
Total |
26,001,413 | 98.6 | 26,329,213 | 98.5 | ||||||||||||
Unamortized
premiums and deferred origination costs |
423,926 | 1.6 | 452,501 | 1.7 | ||||||||||||
Allowance for loan losses: |
||||||||||||||||
Allowance federally insured |
(24,366 | ) | (0.1 | ) | (24,534 | ) | (0.1 | ) | ||||||||
Allowance non-federally insured |
(24,704 | ) | (0.1 | ) | (21,058 | ) | (0.1 | ) | ||||||||
$ | 26,376,269 | 100.0 | % | $ | 26,736,122 | 100.0 | % | |||||||||
(a) | The College Cost Reduction Act reduced the yield on federally insured
loans originated on or after October 1, 2007. As of September 30, 2008 and
December 31, 2007, $221.6 million and $278.9 million, respectively, of federally
insured student loans are excluded from the above table as these loans are
accounted for as participation interests sold under an agreement with Union Bank
which is further discussed in note 7 of the Companys consolidated financial
statements included in this Quarterly Report. As of September 30, 2008, $172.6
million of the loans accounted for as participation interests sold under this
agreement were originated on or after October 1, 2007. |
|
(b) | As of September 30, 2008, $429.2 million of federally insured student
loans were eligible to be sold or participated to the Department under the
Departments Loan Purchase Commitment and Participation Programs, of which $263.9
million were participated to the Department under the Participation Program. |
Origination and Acquisition
The Company originates and acquires loans through various methods and channels including: (i)
direct-to-consumer channel (in which the Company originates student loans directly with student and
parent borrowers), (ii) campus based origination channels, and (iii) spot purchases.
The Company will originate or acquire loans through its campus based channel either directly under
one of its brand names or through other originating lenders. In addition to its brands, the
Company acquires student loans from lenders to whom the Company provides marketing and/or
origination services established through various contracts. Branding partners are lenders for
which the Company acts as a marketing agent in specified geographic areas. A forward flow lender
is one for whom the Company provides origination services but provides no
marketing services or whom simply agrees to sell loans to the Company under forward sale
commitments.
49
Table of Contents
The following table sets forth the activity of loans originated or acquired through each of the
Companys channels:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Beginning balance |
$ | 25,612,126 | 25,746,000 | 26,329,213 | 23,414,468 | |||||||||||
Direct channel: |
||||||||||||||||
Consolidation loan originations |
44 | 914,842 | 69,073 | 2,815,791 | ||||||||||||
Less consolidation of existing portfolio |
(27 | ) | (537,539 | ) | (28,474 | ) | (1,450,326 | ) | ||||||||
Net consolidation loan originations |
17 | 377,303 | 40,599 | 1,365,465 | ||||||||||||
Stafford/PLUS loan originations |
416,721 | 426,740 | 952,050 | 923,450 | ||||||||||||
Branding partner channel |
334,685 | 125,220 | 935,992 | 583,213 | ||||||||||||
Forward flow channel |
114,488 | 178,226 | 517,548 | 946,342 | ||||||||||||
Other channels |
| 24,373 | 55,922 | 791,087 | ||||||||||||
Total channel acquisitions |
865,911 | 1,131,862 | 2,502,111 | 4,609,557 | ||||||||||||
Repayments, claims, capitalized interest, participations, and other |
(369,940 | ) | (479,512 | ) | (1,255,183 | ) | (1,112,878 | ) | ||||||||
Consolidation loans lost to external parties |
(106,684 | ) | (200,719 | ) | (282,951 | ) | (627,473 | ) | ||||||||
Loans sold |
| (17,661 | ) | (1,291,777 | ) | (103,704 | ) | |||||||||
Ending balance |
$ | 26,001,413 | 26,179,970 | 26,001,413 | 26,179,970 | |||||||||||
The Company has significant financing needs that it meets through the capital markets, including
the debt and secondary markets. Since August 2007, these markets have experienced unprecedented
disruptions, which has had an adverse impact on the Companys earnings and financial condition.
Since the Company could not determine nor control the length of time or extent to which the capital
markets would remain disrupted, it reduced its direct and indirect costs related to its asset
generation activities and was more selective in pursuing origination activity, in both the school
and direct to consumer channels. Accordingly, in January 2008, the Company suspended Consolidation
and private student loan originations and, during the second quarter of 2008, exercised contractual
rights to discontinue, suspend, or defer the acquisition of student loans in connection with
substantially all of its branding and forward flow relationships. Prior to and in conjunction with
exercising this right, during the first quarter of 2008, the Company accelerated the purchase of
loans from certain branding partner and forward flow lenders of approximately $511 million.
During July 2008, the Company purchased approximately $440 million of student loans from certain
branding partner and forward flow lenders of which such purchases were previously deferred. These
loans were financed in the Companys FFELP warehouse facility prior to the term-out of this
agreement.
On May 7, 2008, the President signed into law the Ensuring Continued Access to Student Loans Act.
This legislation contains provisions that expand the federal governments support of financing the
cost of higher education. Among other things, the Ensuring Continued Access to Student Loans Act :
| Increases statutory limits on annual and aggregate borrowing for FFELP loans; and |
||
| Allows the Department to act as a secondary market and enter into agreements with
lenders to purchase certain FFELP loans or participation interests in those loans. |
As a result of this legislation, the Departments of Education and Treasury developed a plan to
implement the Ensuring Continued Access to Student Loans Act. Among other things, this plan:
| Allows the Department to purchase certain loans from lenders for the 2008-2009
academic year and offers lenders access to short-term liquidity; and |
| Commits to continue working with the FFELP community to explore programs to reengage
the capital markets in the long-run. |
On May 22, 2008, the Company announced that, as a result of the above plan, it would continue
originating new federal student loans for the 2008-2009 academic year to all students regardless of
the school they attend. On October 7, 2008, legislation was enacted to extend the Departments
authority to address FFELP student loans made for the 2009-2010 academic year and allowing for the
extension of the
Departments Participation Program and Purchase Program from September 30, 2009 to September 30,
2010. Management of the Company is encouraged by these developments; however, until the Department
provides additional details regarding the programs, the Company is unable to determine the full
impact these programs will have on the Companys origination volume.
50
Table of Contents
Activity in the Allowance for Loan Losses
The provision for loan losses represents the periodic expense of maintaining an allowance
sufficient to absorb losses, net of recoveries, inherent in the portfolio of student loans. An
analysis of the Companys allowance for loan losses is presented in the following table:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Balance at beginning of period |
$ | 47,909 | 27,140 | 45,592 | 26,003 | |||||||||||
Provision for loan losses: |
||||||||||||||||
Federally insured loans |
4,500 | 17,040 | 12,000 | 20,158 | ||||||||||||
Non-federally insured loans |
2,500 | 1,300 | 6,000 | 3,470 | ||||||||||||
Total provision for loan losses |
7,000 | 18,340 | 18,000 | 23,628 | ||||||||||||
Charge-offs, net of recoveries: |
||||||||||||||||
Federally insured loans |
(4,218 | ) | (1,327 | ) | (11,418 | ) | (3,852 | ) | ||||||||
Non-federally insured loans |
(1,621 | ) | (139 | ) | (2,354 | ) | (594 | ) | ||||||||
Net charge-offs |
(5,839 | ) | (1,466 | ) | (13,772 | ) | (4,446 | ) | ||||||||
Sale of federally insured loans |
| | (750 | ) | | |||||||||||
Sale of non-federally insured loans |
| | | (1,171 | ) | |||||||||||
Balance at end of period |
$ | 49,070 | 44,014 | 49,070 | 44,014 | |||||||||||
Allocation of the allowance for loan losses: |
||||||||||||||||
Federally insured loans |
$ | 24,366 | 23,907 | 24,366 | 23,907 | |||||||||||
Non-federally insured loans |
24,704 | 20,107 | 24,704 | 20,107 | ||||||||||||
Total allowance for loan losses |
$ | 49,070 | 44,014 | 49,070 | 44,014 | |||||||||||
Net loan charge-offs as a percentage of average student loans |
0.090 | % | 0.023 | % | 0.070 | % | 0.024 | % | ||||||||
Total allowance as a percentage of average student loans |
0.188 | % | 0.170 | % | 0.187 | % | 0.177 | % | ||||||||
Total allowance as a percentage of ending balance of student loans |
0.189 | % | 0.168 | % | 0.189 | % | 0.168 | % | ||||||||
Non-federally insured allowance as a percentage of the ending
balance of non-federally insured loans |
8.966 | % | 7.995 | % | 8.966 | % | 7.995 | % | ||||||||
Average student loans |
$ | 26,035,006 | 25,866,660 | 26,220,486 | 24,799,585 | |||||||||||
Ending balance of student loans |
26,001,413 | 26,179,970 | 26,001,413 | 26,179,970 | ||||||||||||
Ending balance of non-federally insured loans |
275,520 | 251,503 | 275,520 | 251,503 |
The allowance for loan losses increased during the three and nine months ended September 30, 2008
compared to the same period in 2007 as a result of the elimination of the Exceptional Performer
program. Due to the elimination of this program, the Company recorded an expense of $15.7 million
in September 2007 to increase the Companys allowance for loan losses related to the increase in
risk share.
Delinquencies have the potential to adversely impact the Companys earnings through increased
servicing and collection costs and account charge-offs. The table below shows the Companys
student loan delinquency amounts:
As of September 30, 2008 | As of December 31, 2007 | |||||||||||||||
Dollars | Percent | Dollars | Percent | |||||||||||||
Federally Insured Loans: |
||||||||||||||||
Loans in-school/grace/deferment(1) |
$ | 8,250,265 | $ | 7,115,505 | ||||||||||||
Loans in forebearance(2) |
2,527,052 | 3,015,456 | ||||||||||||||
Loans in repayment status: |
||||||||||||||||
Loans current |
13,171,661 | 88.1 | % | 13,937,702 | 87.5 | % | ||||||||||
Loans delinquent 31-60 days(3) |
557,788 | 3.7 | 682,956 | 4.3 | ||||||||||||
Loans delinquent 61-90 days(3) |
267,665 | 1.8 | 353,303 | 2.2 | ||||||||||||
Loans delinquent 91 days or greater(4) |
951,462 | 6.4 | 949,476 | 6.0 | ||||||||||||
Total loans in repayment |
14,948,576 | 100.0 | % | 15,923,437 | 100.0 | % | ||||||||||
Total federally insured loans |
$ | 25,725,893 | $ | 26,054,398 | ||||||||||||
Non-Federally Insured Loans: |
||||||||||||||||
Loans in-school/grace/deferment(1) |
$ | 103,833 | $ | 111,946 | ||||||||||||
Loans in forebearance(2) |
8,921 | 12,895 | ||||||||||||||
Loans in repayment status: |
||||||||||||||||
Loans current |
154,130 | 94.7 | % | 142,851 | 95.3 | % | ||||||||||
Loans delinquent 31-60 days(3) |
3,005 | 1.9 | 3,450 | 2.3 | ||||||||||||
Loans delinquent 61-90 days(3) |
2,325 | 1.4 | 1,247 | 0.8 | ||||||||||||
Loans delinquent 91 days or greater(4) |
3,306 | 2.0 | 2,426 | 1.6 | ||||||||||||
Total loans in repayment |
162,766 | 100.0 | % | 149,974 | 100.0 | % | ||||||||||
Total non-federally insured loans |
$ | 275,520 | $ | 274,815 | ||||||||||||
51
Table of Contents
(1) | Loans for borrowers who still may be attending school or engaging in other permitted
educational activities and are not yet required to make payments on the loans, e.g., residency
periods for medical students or a grace period for bar exam preparation for law students. |
|
(2) | Loans for borrowers who have temporarily ceased making full payments due to hardship or other
factors, according to a schedule approved by the servicer consistent with the established loan
program servicing procedures and policies. |
|
(3) | The period of delinquency is based on the number of days scheduled payments are contractually
past due and relate to repayment loans, that is, receivables not charged off, and not in
school, grace, deferment, or forbearance. |
|
(4) | Loans delinquent 91 days or greater include loans in claim status, which are loans that have
gone into default and have been submitted to the guaranty agency for FFELP loans, or, if
applicable, the insurer for non-federally insured loans, to process the claim for payment. |
Student Loan Spread Analysis
The following table analyzes the student loan spread on the Companys portfolio of student loans
and represents the spread on assets earned in conjunction with the liabilities and derivative
instruments used to fund the assets:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Student loan yield |
5.38 | % | 7.83 | % | 5.69 | % | 7.87 | % | ||||||||
Consolidation rebate fees |
(0.72 | ) | (0.76 | ) | (0.74 | ) | (0.77 | ) | ||||||||
Premium and deferred origination
costs amortization |
(0.33 | ) | (0.36 | ) | (0.35 | ) | (0.36 | ) | ||||||||
Student loan net yield |
4.33 | 6.71 | 4.60 | 6.74 | ||||||||||||
Student loan cost of funds (a) |
(3.29 | ) | (5.65 | ) | (3.50 | ) | (5.54 | ) | ||||||||
Student loan spread |
1.04 | 1.06 | 1.10 | 1.20 | ||||||||||||
Variable-rate floor income,
net of settlements on derivatives (b) |
(0.02 | ) | (0.01 | ) | (0.17 | ) | | |||||||||
Core student loan spread |
1.02 | % | 1.05 | % | 0.93 | % | 1.20 | % | ||||||||
Average balance of student loans |
$ | 26,035,006 | 25,866,660 | 26,220,486 | 24,799,585 | |||||||||||
Average balance of debt outstanding |
26,769,955 | 27,321,874 | 27,120,342 | 26,293,342 |
(a) | The student loan cost of funds includes the effects of net settlement costs on the
Companys derivative instruments (excluding the net settlements of $1.7 million and $12.1
million, for the three and nine months ended September 30, 2007, respectively, on those
derivatives no longer hedging student loan assets). |
|
(b) | The Company entered into interest rate swaps with effective dates beginning in January
2008 to hedge a portion of the variable-rate floor income. Settlements on these
derivatives are presented as part of the Companys statutory calculation of variable-rate
floor income. The maturity date for these derivatives was June 30, 2008. |
As noted in Item 3, Quantitative and Qualitative Disclosures about Market Risk, the Company has a
portfolio of student loans that are earning interest at a fixed borrower rate which exceeds the
statutorily defined variable lender rate creating fixed rate floor income which is
included in its core student loan spread. The majority of these loans are consolidation loans that
earn the greater of the borrower rate or 2.64% above the average commercial paper rate during the
calendar quarter. When excluding fixed rate floor income, the Companys core student loan spread
was 0.92% and 0.80% for the three and nine months ended September 30, 2008, respectively, and 1.04%
and 1.16% for the three and nine months ended September 30, 2007, respectively.
52
Table of Contents
The compression of the Companys core student loan spread during the three and nine months ended
September 30, 2008 compared to 2007 was the result of the following items:
| Historically, the movement of the various interest rate indices received on the
Companys student loan assets and paid on the debt to fund such loans was highly
correlated. As shown in Item 3, Quantitative and Qualitative Disclosures about Market
Risk, the short-term movement of the indices was dislocated beginning in August 2007.
This dislocation has had a negative impact on the Companys student loan net interest
income. |
||
| The spread to LIBOR on asset-backed securities transactions has increased significantly
since August 2007. Since August 2007, the Company has issued $6.0 billion of notes in
asset-backed securities transactions ($1.5 billion in August 2007, $1.2 billion in March
2008, $1.9 billion in April 2008, and $1.3 billion in May 2008). The increase in costs on
these transactions from historical levels have had and will continue to have a negative
impact on the Companys student loan net interest income. The increased spread to LIBOR
on asset-backed securities transactions is shown in the below table: |
![(LINE GRAPH)](https://www.sec.gov/Archives/edgar/data/0001258602/000136231008007003/c76837c7683701.gif)
| As a result of the passage of the College Cost Reduction and Access Act of 2007,
the yield on FFELP loans originated after October 1, 2007 was reduced. As of
September 30, 2008, the Company had $1.1 billion of FFELP loans originated after
October 1, 2007. The core student loan spread on FFELP loans originated after
October 1, 2007 for both the three and nine months ended September 30, 2008 was
approximately 40 to 50 basis points. |
The decrease in the Companys core student loan spread was offset by a non-recurring benefit
related to the Companys cost of funds related to certain of its asset-backed securities. The
interest rates on approximately $2.0 billion of the Companys asset-backed securities are set and
periodically reset via a dutch auction (Auction
Rate Securities). As previously disclosed, the
auction process to establish the rates on the Auction Rate Securities has failed. As a result of a
failed auction, the Auction Rate Securities will generally pay interest to the holder at a maximum
rate as defined by the governing documents. During the three and nine month periods ended
September 30, 2008, the Company paid favorable interest rates on the majority of its Auction Rate
Securities as a result of the application of certain of these maximum rate auction provisions in
the underlying documents for such financings.
53
Table of Contents
Three and nine months ended September 30, 2008 compared to the three and nine months ended
September 30, 2007
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||||||||||
2008 | 2007 | $ Change | 2008 | 2007 | $ Change | |||||||||||||||||||
Net interest income after the provision
for loan losses |
$ | 58,767 | 50,920 | 7,847 | 112,001 | 193,527 | (81,526 | ) | ||||||||||||||||
Loan and guaranty servicing income |
(136 | ) | 170 | (306 | ) | 26 | 288 | (262 | ) | |||||||||||||||
Other fee-based income |
4,167 | 3,526 | 641 | 13,494 | 10,511 | 2,983 | ||||||||||||||||||
Other income |
(88 | ) | 1,181 | (1,269 | ) | 293 | 4,329 | (4,036 | ) | |||||||||||||||
Gain (loss) on sale of loans |
| 492 | (492 | ) | (47,426 | ) | 3,288 | (50,714 | ) | |||||||||||||||
Derivative market value, foreign currency,
and put option adjustments |
| | | 466 | | 466 | ||||||||||||||||||
Derivative settlements, net |
789 | (4,065 | ) | 4,854 | 55,954 | (4,950 | ) | 60,904 | ||||||||||||||||
Total other income |
4,732 | 1,304 | 3,428 | 22,807 | 13,466 | 9,341 | ||||||||||||||||||
Salaries and benefits |
1,980 | 6,154 | (4,174 | ) | 6,157 | 20,600 | (14,443 | ) | ||||||||||||||||
Restructure expense severance and contract
termination costs |
| 1,921 | (1,921 | ) | 1,845 | 1,921 | (76 | ) | ||||||||||||||||
Impairment expense |
| 28,291 | (28,291 | ) | 9,351 | 28,291 | (18,940 | ) | ||||||||||||||||
Other expenses |
5,354 | 7,429 | (2,075 | ) | 15,793 | 22,940 | (7,147 | ) | ||||||||||||||||
Intersegment expenses |
18,200 | 20,924 | (2,724 | ) | 57,754 | 59,594 | (1,840 | ) | ||||||||||||||||
Total operating expenses |
25,534 | 64,719 | (39,185 | ) | 90,900 | 133,346 | (42,446 | ) | ||||||||||||||||
Base net income (loss) before income taxes |
37,965 | (12,495 | ) | 50,460 | 43,908 | 73,647 | (29,739 | ) | ||||||||||||||||
Income tax expense (benefit) |
14,047 | (4,748 | ) | 18,795 | 15,889 | 27,986 | (12,097 | ) | ||||||||||||||||
Base net income (loss) |
$ | 23,918 | (7,747 | ) | 31,665 | 28,019 | 45,661 | (17,642 | ) | |||||||||||||||
Before Tax Operating Margin |
59.8 | % | (23.9 | %) | 32.6 | % | 35.6 | % | ||||||||||||||||
Before Tax Operating Margin
excluding restructure expense,
impairment expense, provision for loan
losses related to the loss of Exceptional
Performer, and the loss on sale of loans
during the first quarter 2008 |
59.8 | % | 49.2 | % | 56.3 | % | 53.7 | % |
Net interest income after the provision for loan losses
Three months ended September 30, | Change | |||||||||||||||
2008 | 2007 | Dollars | Percent | |||||||||||||
Loan interest |
$ | 351,331 | 509,596 | (158,265 | ) | (31.1 | )% | |||||||||
Consolidation rebate fees |
(47,105 | ) | (49,492 | ) | 2,387 | 4.8 | ||||||||||
Amortization of loan premiums and
deferred origination costs |
(21,338 | ) | (23,450 | ) | 2,112 | 9.0 | ||||||||||
Total loan interest |
282,888 | 436,654 | (153,766 | ) | (35.2 | ) | ||||||||||
Investment interest |
7,151 | 17,399 | (10,248 | ) | (58.9 | ) | ||||||||||
Total interest income |
290,039 | 454,053 | (164,014 | ) | (36.1 | ) | ||||||||||
Interest on bonds and notes payable |
223,523 | 384,793 | (161,270 | ) | (41.9 | ) | ||||||||||
Intercompany interest |
749 | | 749 | N/A | ||||||||||||
Provision for loan losses |
7,000 | 18,340 | (11,340 | ) | (61.8 | ) | ||||||||||
Net interest income after provision
for loan losses |
$ | 58,767 | 50,920 | 7,847 | 15.4 | % | ||||||||||
54
Table of Contents
| The average student loan portfolio increased $0.2 billion, or 0.7%, for the three months
ended September 30, 2008 compared to the same period in 2007. The increase in average
loans was offset by a decrease in the yield earned on student loans. Loan interest income
decreased $158.3 million as a result of these factors. |
||
| Consolidation rebate fees decreased due to the $0.9 billion, or 4.6%, decrease in the
average consolidation portfolio. |
||
| The amortization of loan premiums and deferred origination costs decreased as a result
of reduced costs to acquire or originate loans. |
||
| Investment income decreased as a result of an overall decrease in average cash held in
2008 as compared to 2007, as well as lower interest rates. |
||
| Interest expense decreased as a result of a decrease in interest rates on the Companys
variable rate debt which lowered the Companys cost of funds (excluding net derivative
settlements) to 3.32% for the three months ended September 30, 2008 compared to 5.59% for
the same period a year ago. In addition, average debt decreased by $0.6 billion, or 2.0%,
for the three months ended September 30, 2008 compared to the same period in 2007. |
||
| Excluding an expense of $15.7 million in September 2007 to increase the Companys
allowance for loan losses related to the increase in risk share as a result of the
elimination of the Exceptional Performer program in the third quarter of 2007, the
provision for loan losses increased for the three months ended September 30, 2008 compared
to 2007. The provision for loan losses for federally insured loans increased as a result
of the increase in risk share as a result of the loss of Exceptional Performer in September
2007. The provision for loan losses for
non-federally insured loans increased primarily due to increases in delinquencies as a
result of the continued weakening of the U.S. economy. |
Nine months ended September 30, | Change | |||||||||||||||
2008 | 2007 | Dollars | Percent | |||||||||||||
Loan interest |
$ | 1,083,078 | 1,461,594 | (378,516 | ) | (25.9 | )% | |||||||||
Consolidation rebate fees |
(144,680 | ) | (143,657 | ) | (1,023 | ) | (0.7 | ) | ||||||||
Amortization of loan premiums and
deferred origination costs |
(69,583 | ) | (67,143 | ) | (2,440 | ) | (3.6 | ) | ||||||||
Total loan interest |
868,815 | 1,250,794 | (381,979 | ) | (30.5 | ) | ||||||||||
Investment interest |
23,875 | 51,153 | (27,278 | ) | (53.3 | ) | ||||||||||
Total interest income |
892,690 | 1,301,947 | (409,257 | ) | (31.4 | ) | ||||||||||
Interest on bonds and notes payable |
761,300 | 1,081,588 | (320,288 | ) | (29.6 | ) | ||||||||||
Intercompany interest |
1,389 | 3,204 | (1,815 | ) | (56.6 | ) | ||||||||||
Provision for loan losses |
18,000 | 23,628 | (5,628 | ) | (23.8 | ) | ||||||||||
Net interest income after provision
for loan losses |
$ | 112,001 | 193,527 | (81,526 | ) | (42.1 | )% | |||||||||
| The average student loan portfolio increased $1.4 billion, or 5.7%, for the nine months
ended September 30, 2008 compared to the same period in 2007. The increase in average
loans was offset by a decrease in the yield earned on student loans. Loan interest income
decreased $378.5 million as a result of these factors. |
| Consolidation rebate fees increased due to the $0.5 billion, or 2.8%, increase in the
average consolidation loan portfolio. |
| The amortization of loan premiums and deferred origination costs increased as a result
of an increase in the average student loan portfolio offset as a result of reduced costs to
acquire or originate loans. |
| Investment income decreased as a result of an overall decrease in average cash held in
2008 as compared to 2007, as well as lower interest rates. |
| Interest expense decreased as a result of a decrease in interest rates on the Companys
variable rate debt which lowered the Companys cost of funds (excluding net derivative
settlements) to 3.75% for the nine months ended September 30, 2008 compared to 5.52% for
the same period a year ago. This was offset by a $0.8 billion, or 3.2%, increase in
average debt for the nine months ended September 30, 2008 compared to the same period in
2007. |
| Excluding an expense of $15.7 million in September 2007 to increase the Companys
allowance for loan losses related to the increase in risk share as a result of the
elimination of the Exceptional Performer program in the third quarter of 2007, the
provision for loan losses increased for the nine months ended September 30, 2008 compared
to 2007. The provision for loan losses for federally insured
loans increased as a result of the increase in risk share as a result of the loss of
Exceptional Performer in September 2007. The
provision for loan losses for non-federally insured loans increased primarily due to
increases in delinquencies as a result of the continued weakening of the U.S. economy. |
Other fee-based income. Borrower late fees increased $0.7 million and $2.5 million for the
three and nine months ended September 30, 2008 compared to the same periods in 2007.
55
Table of Contents
Other income. Other income decreased due to the elimination of an agreement with a third
party during the third quarter of 2007 under which the Company provided administrative services to the third party for
a fee.
Gain (loss) on sale of loans. The Company sold $857.8 million (par value) of federally
insured student loans resulting in the recognition of a loss of $30.4 million on March 31, 2008.
In addition, on April 8, 2008, the Company sold $428.6 million (par value) of federally insured
student loans. The Company recognized a loss of $17.1 million during the three month period ended
March 31, 2008 as a result of marking these loans to fair value. Combined, the portfolios sold on
March 31, 2008 and April 8, 2008 sold for a purchase price of approximately 98% of the par value of
such loans. As a result of the disruptions in the debt and secondary markets, the Company sold
these loan portfolios in order to reduce the amount of student loans remaining under the Companys
multi-year committed financing facility for FFELP loans which reduced the Companys exposure to
certain equity support provisions included in this facility.
Operating expenses. Excluding the restructure and impairment charges, operating expenses
decreased $9.0 million, or 26.0%, and $23.4 million, or 22.7%, for the three and nine months ended
September 30, 2008 compared to same periods in 2007. This decrease is a result of the September
2007 and January 2008 restructuring plans.
LIQUIDITY AND CAPITAL RESOURCES
The Companys fee-based businesses are not capital intensive businesses and all of these businesses
produce positive operating cash flows. As such, a minimal amount of debt and equity capital is
allocated to these segments. Therefore, the majority of the Liquidity and Capital Resources
discussion is concentrated on the Companys Asset Generation and Management operating segment. The
Company has historically utilized operating cash flow, secured financing transactions (which
include warehouse facilities and asset-backed securitizations), operating lines of credit, and
other borrowing arrangements to fund its Asset Generation and Management operations and student
loan acquisitions. In addition, the Company uses operating cash flow, borrowings on its unsecured
line of credit, and unsecured debt offerings to fund corporate activities, business acquisitions,
and repurchases of common stock. The Company has also used its common stock to partially fund
certain business acquisitions. The Company has a universal shelf registration statement with the
SEC which allows the Company to sell up to $750.0 million of securities that may consist of common
stock, preferred stock, unsecured debt securities, warrants, stock purchase contracts, and stock
purchase units. The terms of any securities are established at the time of the offering. This
shelf registration statement expires in December 2008.
The following table summarizes the Companys bonds and notes outstanding as of September 30, 2008:
As of September 30, 2008 | ||||||||||||
Carrying | Interest rate | |||||||||||
amount | range | Final maturity | ||||||||||
Variable-rate bonds and notes (a): |
||||||||||||
Bonds and notes based on indices |
$ | 20,891,535 | 2.79% - 5.07% | 09/25/13 - 06/25/41 | ||||||||
Bonds and notes based on auction or remarketing (b) |
2,771,445 | 0.00% - 9.01% | 11/01/09 - 07/01/43 | |||||||||
Total variable-rate bonds and notes |
23,662,980 | |||||||||||
Commercial paper FFELP facility (c) |
2,525,410 | 2.54% - 3.94% | 05/09/10 | |||||||||
Commercial paper private loan facility (c) |
132,020 | 3.14% | 03/14/09 | |||||||||
Fixed-rate bonds and notes (a) |
205,435 | 5.30% - 6.68% | 11/01/09 - 05/01/29 | |||||||||
Unsecured fixed rate debt |
475,000 | 5.13% and 7.40% | 06/01/10 and 09/15/61 | |||||||||
Unsecured line of credit |
645,000 | 2.90% - 3.65% | 05/08/12 | |||||||||
Department of Education Participation |
263,920 | 3.25% | 09/30/09 | |||||||||
Other borrowings |
95,070 | 4.09% - 5.10% | 05/22/09 - 11/01/15 | |||||||||
$ | 28,004,835 | |||||||||||
(a) | Issued in asset-backed
securitizations. |
|
(b) | As of September 30, 2008, the Company had $165 million of
bonds based on an auction rate of 0%, due to the Maximum Rate auction
provisions in the underlying documents for such financings. The Maximum
Rate provisions include multiple components, one of which is based on
T-bill rates. The T-bill component calculation for these bonds produced
negative rates, which resulted in auction rates of zero percent for the
applicable period. |
|
(c) | Loan warehouse facilities. |
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Secured Financing Transactions
The Company has historically relied upon secured financing vehicles as its most significant source
of funding for student loans. The net cash flow the Company receives from the securitized student
loans generally represents the excess amounts, if any, generated by the underlying student loans
over the amounts required to be paid to the bondholders, after deducting servicing fees and any
other expenses relating to the securitizations. The Companys rights to cash flow from securitized
student loans are subordinate to bondholder interests and may fail to generate any cash flow beyond
what is due to bondholders. The Companys secured financing vehicles are loan warehouse facilities
and asset-backed securitizations.
On July 31, 2008, the Company did not renew its liquidity provisions on its FFELP loan warehouse
facility. Accordingly, the facility became a term facility and no new loan originations could be
funded with this facility. In August 2008, the Company accessed alternative sources of funding to
originate new FFELP student loans, including the Department of Educations Loan Participation
Program (Participation Program), and an existing facility with Union Bank which are further
discussed below.
Loan warehouse facilities
Student loan warehousing has historically allowed the Company to buy and manage student loans prior
to transferring them into more permanent financing arrangements. The Company has historically
relied upon three conduit warehouse loan financing vehicles to support its funding needs on a
short-term basis: a multi-year committed facility for FFELP loans, a $250.0 million private loan
warehouse for non-federally insured student loans, and a single-seller extendible commercial paper
conduit for FFELP loans.
FFELP Warehouse Facility
The Companys multi-year committed facility for FFELP loans terminates in May 2010 and was
supported by 364-day liquidity which was up for renewal on May 9, 2008. The Company obtained an
extension on this renewal until July 31, 2008. On July 31, 2008, the Company did not renew the
liquidity provisions of this facility. Accordingly, as of July 31, 2008, the facility became a
term facility with a final maturity date of May 9, 2010. Pursuant to the terms of the agreement,
since liquidity was not renewed, the Companys cost of financing under this facility increased 10
basis points. The agreement also includes provisions which allow the banks to charge a rate equal
to LIBOR plus 128.5 basis points if they choose to finance their portion of the facility with
sources of funds other than their commercial paper conduit. In addition, the FFELP warehouse
facility has a provision requiring the Company to refinance or remove 75% of the pledged collateral
on an annual basis. The Company believes it has met this requirement for the annual period ending
in May 2009. However, the Company does have an obligation to remove approximately $30 million of
loans by December 31, 2008 because these loans were partially disbursed when the facility was
termed-out on July 31, 2008. Under the current terms of the facility, the
remaining collateral will need to be refinanced or removed by May 9, 2010. As of September 30,
2008 and November 7, 2008, $2.5 billion and $2.1 billion, respectively, was outstanding under this facility.
The terms and conditions of the Companys warehouse facility for FFELP loans provide for
mark-to-market advance rates. On October 22, 2008, the Company posted $165.5 million in additional
funds to the facility based on this mark-to-market provision. While the Company does not believe
that the loan valuation formula is reflective of the actual fair value of its loans, it is subject
to compliance with such mark-to-market provisions of the warehouse facility agreement. As of
September 30, 2008 and November 7, 2008, the Company had a cumulative amount of $209.1 million and
$374.6 million, respectively, posted as equity funding support for this facility.
The Company has utilized its $750.0 million unsecured line of credit to fund equity advances on its
warehouse facility. As of November 7, 2008, the Company has $691.5 million outstanding under this
line of credit. The line of credit terminates in May 2012.
Continued dislocations in the credit markets may cause additional volatility in the loan valuation
formula. Should a significant change in the valuation of loans result in additional required
equity funding support for the warehouse facility greater than what the Company can provide and the Company has not amended the facility as discussed below, the
warehouse facility could be subject to an event of default resulting in a termination of the
facility and an acceleration of the repayment provisions. A default on the FFELP warehouse facility would
result in an event of default on the Companys unsecured line of credit that would result in the
outstanding balance on the line of credit becoming immediately due and payable.
To reduce the Companys exposure from the mark-to-market advance rate provision included in the
FFELP warehouse facility, the Company has signed a letter agreement engaging Banc of America Securities LLC to arrange an amendment of
certain of the Companys credit facilities, including but not limited to an amendment to place a
floor on the valuation of collateral in the Companys FFELP loan warehouse line of credit for
which Bank of America, N.A. acts as administrative agent. Banc of America Securities LLC has
commenced the amendment process and together with the Company is seeking the approval of the
Companys lenders of a proposed amendment of such credit facilities on mutually agreeable terms. In addition, the Company continues to look at various
alternatives to remove loans from the warehouse facility including other financing arrangements
and/or selling loans to third parties.
In addition, on November 8, 2008, the Department announced they intend to provide liquidity support
to one or more conforming asset backed commercial paper conduits to purchase and provide
longer-term financing for FFELP loans. While details of this conduit are forthcoming, it is
intended that all fully-disbursed non-consolidation FFELP loans awarded between October 1, 2003 and
July 1, 2009 will be eligible for inclusion. As of November 7, 2008, the Company had approximately
$900 million of loans included in its warehouse facility that would be eligible for this proposed
conduit program.
Private Loan Warehouse Facility
The private loan warehouse facility, which terminates on March 14, 2009, is an uncommitted facility
that is offered to the Company by a banking partner. As of September 30, 2008 and November 7, 2008,
$132.0 million was outstanding under this facility. New advances are also subject to approval by
the sponsor bank, and the Company believes it is unlikely such approval would be granted in the
future. The Company guarantees the performance of the assets in the private loan warehouse
facility. This facility provides for advance rates on subject collateral
which require certain levels of equity enhancement support. As of September 30, 2008 and November
7, 2008, the Company had $50.5 million utilized as equity funding support based on provisions of
this agreement. There can be no assurance that the Company will be able to maintain this conduit
facility, find alternative funding, or make adequate equity contributions, if necessary. While the
Companys bank supported facilities have historically been renewed for successive terms, there can
be no assurance that this will continue in the future. In January 2008, the Company suspended
originating private loans.
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The Company has an obligation to reduce the amount outstanding in this facility approximately $30
million by December 15, 2008. The Company plans to sell loans in the facility and/or other
unencumbered private loan assets and/or use operating cash to satisfy
this obligation.
Commercial Paper Warehouse Program
In August 2006, the Company established a $5.0 billion extendable commercial paper warehouse
program for FFELP loans, under which it can issue one or more short-term extendable secured
liquidity notes. As of September 30, 2008, no notes were outstanding under this warehouse program.
As a result of the disruption of the credit markets, there is no market for the issuance of notes
under this facility. Management believes it is currently unlikely a market will exist in the
foreseeable future.
Asset-backed securitizations
Of the $28.0 billion of debt outstanding as of September 30, 2008, $23.9 billion was issued under
term asset-backed securitizations. Depending on market conditions, the Company anticipates
continuing to access the asset-backed securities market. As a result of the disruptions in the
credit markets, the Company may not be able to issue asset-backed financings at rates historically
achieved by the Company, at levels equal to or less than other financing agreements, or at levels
otherwise considered beneficial to the Company. Accordingly, the Companys operational and
financial results may be negatively impacted. Securities issued in the securitization transactions
are generally priced based upon a spread to LIBOR or set under an auction or remarketing procedure.
LIBOR based notes
As of
September 30, 2008, the Company had $20.9 billion of notes issued under asset-backed
securitizations that primarily reprice at a fixed spread to three month LIBOR and are structured to
substantially match the maturity of the funded assets. These notes fund FFELP student loans that
are predominantly set based on a spread to three month commercial paper. The three month LIBOR and
three month commercial paper indexes have been highly correlated historically. Based on cash flows
developed to reflect managements current estimate of, among other factors, prepayments, defaults,
deferment, forbearance, and interest rates, the Company currently expects future undiscounted cash
flows from these transactions will be approximately $1.4 billion. These cash flows consist of net
spread and servicing and administrative revenue in excess of estimated cost.
The Company has certain LIBOR-indexed notes that match the maturity of the funded assets, however,
must periodically be remarketed by the Company. Upon remarketing, the interest rates on the notes
are reset. The Company also has the option to repurchase the notes prior to a failed remarketing
and hold the notes as an investment until such time they can be remarketed. In the event the notes
cannot be remarketed and they are not repurchased by the Company, the interest rate steps up to and
remains at 3-month LIBOR plus 75 basis points until such time they can be successfully remarketed
or purchased by the Company. The Company has $130 million and $200 million of notes due to be
remarketed on November 25, 2008 and May 25, 2009,
respectively, and an additional $950 million and $115 million to
be remarketed in 2016 and 2018, respectively.
Auction or remarketing based notes
The interest rates on certain of the Companys asset-backed securities are set and periodically
reset via a dutch auction (Auction Rate Securities) or through a remarketing utilizing
broker-dealers and remarketing agents (Variable Rate Demand Notes). The Company is currently
sponsor on approximately $1.9 billion of Auction Rate Securities and $0.8 billion of Variable Rate
Demand Notes.
For Auction Rate Securities, investors and potential investors submit orders through a
broker-dealer as to the principal amount of notes they wish to buy, hold, or sell at various
interest rates. The broker-dealers submit their clients orders to the auction agent, who then
determines the clearing interest rate for the upcoming period. Interest rates on these Auction Rate
Securities are reset periodically, generally every 7 to 35 days, by the auction agent or agents.
During the first quarter of 2008, as part of the credit market crisis, several auction rate
securities from various issuers failed to receive sufficient order interest from potential
investors to clear successfully, resulting in failed auction status. Since February 8, 2008, the
Companys Auction Rate Securities have failed in this manner. Under normal conditions, banks have
historically stepped in when investor demand is weak. However, banks have been allowing these
auctions to fail.
As a result of a failed auction, the Auction Rate Securities will generally pay interest to the
holder at a maximum rate as defined by the commercial paper, governing documents, or indenture.
While these rates will vary by the trust structure the notes were issued from as well as the class
and rating of the security, they will generally be based on a spread to LIBOR, commercial paper, or
Treasury Securities. Based on the
relative levels of these indices as of September 30, 2008, the rates expected to be paid by the
Company range from 91-day T-Bill plus 125 basis points, on the low end, to LIBOR plus 250 basis
points, on the high end.
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During the three month period ended September 30, 2008, the Company paid favorable interest rates
on the majority of its Auction Rate Securities as a result of the application of certain of these
maximum rate auction provisions in the underlying documents for such financings.
The Company cannot predict whether future auctions related to its Auction Rate Securities will be
successful, but management believes it is likely auctions will continue to fail indefinitely. The
Company is currently seeking alternatives for reducing its exposure to the auction rate market, but
may not be able to achieve alternate financing for some or all of its Auction Rate Securities.
For Variable Rate Demand Notes, the remarketing agents set the price, which is then offered to
investors. If there are insufficient potential bid orders to purchase all of the notes offered for
sale, the Company could be subject to interest costs substantially above the anticipated and
historical rates paid on these types of securities. The maximum rate for Variable Rate Demand
Notes is based on a spread to certain indexes as defined in the underlying documents, with the
highest to the Company being Prime plus 200 basis points. Certain of the Variable Rate Demand
Notes are secured by financial guaranty insurance policies issued by MBIA Insurance Corporation.
These Variable Rate Demand Notes are currently experiencing reduced investor demand and certain of
these securities have been put to the liquidity provider, Lloyds TSB Bank, at a cost ranging from
Federal Funds plus 150 basis points to LIBOR plus 175 basis points.
Funding New FFELP Student Loan Originations
Department of Educations Loan Participation and Purchase Commitment Programs
On July 1, 2008, pursuant to the Ensuring Continued Access to Student Loans Act, the Department of
Education announced terms under which it will offer to purchase certain FFELP student loans and
participation interests in certain FFELP student loans from FFELP lenders. Under the Departments
Purchase Program, the Department will purchase loans at a price equal to the sum of (i) par value,
(ii) accrued interest, (iii) the one percent origination fee paid to the Department, and (iv) a
fixed amount of $75 per loan. Under the Participation Program, the Department provides interim
short-term liquidity to FFELP lenders by purchasing participation interests in pools of FFELP
loans. FFELP lenders are charged a rate of commercial paper plus 50 basis points on the principal
amount of participation interests outstanding. Loans funded under the Participation Program must
be either refinanced by the lender or sold to the Department pursuant to the Purchase Program prior
to its expiration on September 30, 2009. To be eligible for purchase or participation under the
Departments programs, loans must be FFELP Stafford or PLUS loans made for the academic year
2008-2009, first disbursed between May 1, 2008 and July 1, 2009, with eligible borrower benefits.
On October 7, 2008, legislation was enacted to extend the Departments authority to address FFELP
student loans made for the 2009-2010 academic year and allowing for the extension of the
Participation Program and Purchase Program from September 30, 2009 to September 30, 2010. The
Department has provided preliminary guidance relating to the extension and has indicated that
programs similar to the Participation Program and Purchase Program will be implemented for the
2009-2010 academic year along with providing liquidity support for one or more asset backed
commercial paper conduits for FFELP Stafford and PLUS loans awarded between October 1, 2003 and
July 1, 2009. The Department has indicated that loans for the 2008-2009 academic year
which are funded under the Departments Participation Program will need to be refinanced or sold to
the Department prior to September 30, 2009. Management understands that such loans will not be
eligible for participation under the Departments 2009-2010 Participation Program, but should be
eligible for refinancing through the Departments commercial paper conduit program. Management of
the Company is encouraged by these developments; however, until the Department provides additional
details regarding the programs, the Company is unable to determine the full impact these programs
will have on the Company.
The Company has completed and filed all relevant documents to participate in the Department of
Educations Participation Program and began to utilize the Participation Program in the third
quarter of 2008 to fund a significant portion of its loan originations for the 2008-2009 academic
year. As of September 30, 2008 and November 7, 2008, $263.9 million and $504.4 million of loans,
respectively, were funded using the Participation Program.
Union Bank Participation Agreement
The Company maintains an agreement with Union Bank, as trustee for various grantor trusts, under
which Union Bank has agreed to purchase from the Company participation interests in student loans
(the FFELP Participation Agreement). The Company has the option to purchase the participation
interests from the grantor trusts at the end of a 364-day term upon termination of the
participation certificate. As of September 30, 2008 and November 7, 2008, $221.6 million and
$335.3 million, respectively, of loans were subject to outstanding participation interests held by
Union Bank, as trustee, under this agreement. The agreement automatically renews annually and is
terminable by either party upon five business days notice. This agreement provides beneficiaries of
Union Banks grantor trusts with access to investments in interests in student loans, while
providing liquidity to the Company on a short-term basis. The Company can participate loans to
Union Bank to the extent of availability under the grantor trusts, up to $750 million. Loans
participated under this agreement qualify as a sale pursuant to the provisions of SFAS No. 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
(SFAS No. 140). Accordingly, the participation interests sold are not included on the Companys
consolidated balance sheet.
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Operating Lines of Credit
The Company has a $750.0 million unsecured line of credit that terminates in May 2012. As of
September 30, 2008, there was $645.0 million outstanding on this line and $105.0 million available
for future use. The weighted average interest rate on this line of
credit was 3.44% as of
September 30, 2008. Upon termination in 2012, there can be no assurance that the Company will be
able to maintain this line of credit, find alternative funding, or increase the amount outstanding
under the line, if necessary. As discussed previously, the Company may need to fund certain loans
or provide equity funding support related to advance rates on its warehouse facilities. As of
November 7, 2008, the Company has contributed $425.1 million in equity funding support to these
facilities. The Company has funded these contributions primarily by advances on its operating line
of credit. As of November 7, 2008, the Company has $691.5 million outstanding under this line of
credit and $58.5 million available for future uses. The lending commitment on the Companys
unsecured line of credit is provided by multiple banks. Lehman Brothers Bank, FSB (Lehman Bank)
represents seven percent of the lending commitment under the line of credit. On September 15,
2008, Lehman Brothers Holdings Inc. filed a voluntary petition for relief under Chapter 11 of the
United States Bankruptcy Code. Since the bankruptcy filing, Lehman Bank has experienced funding
delays for its portion of the lending commitment under the line of credit. As of November 7, 2008,
excluding Lehman Banks lending commitment, the Company has $51.2 million available for future use
under its unsecured line of credit.
The line of credit agreement contains certain financial covenants that, if not met, lead to an
event of default under the agreement. The covenants include maintaining:
(v) | A minimum consolidated net worth; |
||
(vi) | A minimum adjusted EBITDA to corporate debt interest (over the last four rolling quarters); |
||
(vii) | A limitation on subsidiary indebtedness; and |
||
(viii) | A limitation on the percentage of non-guaranteed loans in the Companys portfolio. |
As of September 30, 2008, the Company was in compliance with all of these requirements and believes
it has the ability to maintain the covenants in future periods. Many of these covenants are
duplicated in the Companys other lending facilities, including its FFELP and private loan
warehouses.
As previously discussed, continued dislocations in the credit markets may cause additional
volatility in the loan valuation formula included in the Companys FFELP warehouse facility.
Should a significant change in the valuation of loans result in additional required equity funding
support for the warehouse facility greater than what the Company can provide, the warehouse
facility could be subject to an event of default resulting in a termination of the facility and an
acceleration of the repayment provisions. A default on the FFELP warehouse facility would result in
an event of default on the Companys unsecured line of credit that would result in the outstanding
balance on the line of credit becoming immediately due and payable.
The Companys operating line of credit does not have any covenants related to unsecured debt
ratings. However, changes in the Companys ratings (as well as the amounts the Company borrows)
have modest implications on the pricing level at which the Company obtains funding.
Universal Shelf Offerings
In May 2005, the Company consummated a debt offering under its universal shelf consisting of $275.0
million in aggregate principal amount of Senior Notes due June 1, 2010 (the Notes). The Notes
are unsecured obligations of the Company. The interest rate on the Notes is 5.125%, payable
semiannually. At the Companys option, the Notes are redeemable in whole at any time or in part
from time to time at the redemption price described in the Companys prospectus supplement.
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In September 2006, the Company consummated a debt offering under its universal shelf consisting of
$200.0 million aggregate principal amount of Junior Subordinated Hybrid Securities (Hybrid
Securities). The Hybrid Securities are unsecured obligations of the Company. The interest rate on
the Hybrid Securities from the date they were issued through the optional redemption date,
September 28, 2011, is 7.40%, payable semi-annually. Beginning September 29, 2011 through September
29, 2036, the scheduled maturity date, the interest rate on the
Hybrid Securities will be equal to three-month LIBOR plus 3.375%, payable quarterly. The principal
amount of the Hybrid Securities will become due on the scheduled maturity date only to the extent
that the Company has received proceeds from the sale of certain qualifying capital securities prior
to such date (as defined in the Hybrid Securities prospectus). If any amount is not paid on the
scheduled maturity date, it will remain outstanding and bear interest at a floating rate as defined
in the prospectus, payable monthly. On September 15, 2061, the Company must pay any remaining
principal and interest on the Hybrid Securities in full whether or not the Company has sold
qualifying capital securities. At the Companys option, the Hybrid Securities are redeemable in
whole at any time or in part from time to time at the redemption price described in the prospectus
supplement.
The proceeds from these unsecured debt offerings were or will be used by the Company to fund
general business operations, certain asset and business acquisitions, and the repurchase of stock
under the Companys stock repurchase plan.
Contractual Obligations
The Company is committed under noncancelable operating leases for certain office and warehouse
space and equipment. The Companys contractual obligations as of September 30, 2008 were as
follows:
Less than | More than | |||||||||||||||||||
Total | 1 year | 1 to 3 years | 3 to 5 years | 5 years | ||||||||||||||||
Bonds and notes payable |
$ | 28,004,835 | 501,742 | 2,914,569 | 790,422 | 23,798,102 | ||||||||||||||
Operating lease obligations |
41,607 | 9,278 | 16,398 | 11,976 | 3,955 | |||||||||||||||
Other |
62,520 | 30,300 | 32,220 | | | |||||||||||||||
Total |
$ | 28,108,962 | 541,320 | 2,963,187 | 802,398 | 23,802,057 | ||||||||||||||
As of September 30, 2008, the Company had a reserve of $8.8 million for uncertain income tax
positions per the provisions of FIN 48. This obligation is not included in the above table as the
timing and resolution of the income tax positions cannot be reasonably estimated at this time.
The Company has an obligation to purchase $51.9 million of private loans from an unrelated
financial institution in eight quarterly installments beginning in the fourth quarter of 2008. The
first seven installments will equal approximately $5 million and the eighth and final installment
will include the remaining outstanding balance of loans to be purchased. This obligation is
included in other in the above table.
The Company has commitments with its branding partners and forward flow lenders which obligate the
Company to purchase loans originated under specific criteria, although the branding partners and
forward flow lenders are typically not obligated to provide the Company with a minimum amount of
loans. These commitments generally run for periods ranging from one to five years and are
generally renewable. The Company has significant financing needs that it meets through the capital
markets, including the debt and secondary markets. Since August 2007, these markets have
experienced unprecedented disruptions, which are having an adverse impact on the Companys earnings
and financial condition. The Company cannot determine nor control the length of time or extent to
which the capital markets will remain disrupted. Accordingly, the Company has the ability to
exercise contractual rights to discontinue, suspend, or defer the acquisition of student loans in
connection with its branding and forward flow relationships. Commitments to purchase loans under
these arrangements are not included in the table above.
As a result of the Companys recent acquisitions, the Company has certain contractual obligations
or commitments as follows:
| LoanSTAR Funding Group, Inc. (LoanSTAR) As part of the agreement for the acquisition
of the capital stock of LoanSTAR from the Greater Texas Foundation (Texas Foundation),
the Company agreed to sell student loans in an aggregate amount sufficient to permit the
Texas Foundation to maintain a portfolio of loans equal to no less than $200 million
through October 2010. The sales price for such loans is the fair value mutually agreed
upon between the Company and the Texas Foundation. To satisfy this obligation, the Company
is obligated to sell loans to the Texas Foundation on a quarterly basis; however, the
Foundation recently has chosen not to purchase such loans. |
||
| infiNET Integrated Solutions, Inc. (infiNET) Stock price guarantee of $104.8375 per
share on 95,380 shares of Class A Common Stock (less the greater of $41.9335 or the gross
sales price such seller obtains from a sale of the shares occurring prior to February 28,
2011 as defined in the agreement) issued as part of the original purchase price. The
obligation to pay this guaranteed stock price is due February 28, 2011 and is not included
in the table above. Based upon the closing sale price of the Companys Class A Common
Stock as of September 30, 2008 of $14.20 per share, the Companys obligation under this
stock price guarantee would have been $6.0 million (($104.8375 $41.9335) x 95,380
shares). Any cash paid by the Company in consideration of satisfying the guaranteed value
of stock issued for this acquisition would be recorded by the Company as a reduction to
additional paid-in capital. |
||
| 5280 Solutions, Inc. 258,760 shares of Class A Common Stock issued as part of the
original purchase price is subject to a put option arrangement whereby during the 30-day
period ending November 30, 2008, the holders may require the Company to repurchase all or
part of the shares at a price of $37.10 per share. The value of this put option as of
September 30, 2008 was $9.6 million and is included in other in the above table. The
Company paid $9.6 million on November 10, 2008 to satisfy its obligation related to these
agreements. |
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Sources of Liquidity
Sources of Liquidity Available for New FFELP Stafford and PLUS Loans
On July 31, 2008, the Company did not renew the liquidity provisions of its FFELP warehouse
facility. Accordingly, on July 31, 2008, the facility became a term facility with a final maturity
date of May 9, 2010. No new student loan originations can be funded under this program. In
addition, the Company has $5.0 billion authorized for future issuance under its FFELP Commercial
Paper Program. As a result of the disruption of the credit markets, there is no market for the
issuance of notes under this facility. Management believes it is unlikely a market will exist in
the future. However, the Company has unlimited sources of primary liquidity available for new
FFELP Stafford and PLUS loan originations for the 2008-2009 academic year under the Departments
Participation and Purchase Programs. In addition, the Company maintains an agreement with Union
Bank, as trustee for various grantor trusts, under which Union Bank has agreed to purchase from the
Company participation interests in student loans. See Union Bank Participation Agreement discussed earlier in this section.
Sources of Liquidity Available for General Corporate Purposes
The following table details the Companys primary sources of liquidity and the available capacity
at November 7, 2008 for general corporate purposes:
Sources of primary liquidity: (a) |
||||
Cash and cash equivalents (b) |
$ | 117,894 | ||
Unencumbered private student loan assets |
93,437 | |||
Unused unsecured line of credit (c) |
51,200 | |||
Total sources of primary liquidity |
$ | 262,531 | ||
(a) | The sources of primary liquidity table above does not include the following: |
| Asset-backed security investments As part of the Companys
issuance of asset-backed securitizations in March 2008 and May 2008, due to
credit market conditions when these notes were issued, the Company purchased
the Class B subordinated notes of $36 million (par value) and $41 million (par
value), respectively. These notes are not included on the Companys
consolidated balance sheet. If the credit market conditions improve, the
Company anticipates selling these notes to third parties. Upon a sale to third
parties, the Company would obtain cash proceeds equal to the market value of
the notes on the date of such sale. Upon sale, these notes would be shown as
bonds and notes payable on the Companys consolidated balance sheet. Unless
there is a significant market improvement, the Company believes the market
value of such notes will be less than par value. The difference between the
par value and market value would be recognized by the Company as interest
expense over the life of the bonds. |
(b) | The Company also has restricted cash and investments, however, the Company is
limited in the amounts of funds that can be transferred from its subsidiaries through
intercompany loans, advances, or cash dividends. These limitations result from the
restrictions contained in trust indentures under debt financing arrangements to which
the Companys education lending subsidiaries are parties. The Company does not
believe these limitations will significantly affect its operating cash needs. The
amounts of cash and investments restricted in the respective reserve accounts of the
education lending subsidiaries are shown on the balance sheets as restricted cash and
investments. |
|
(c) | As of November 7, 2008, the Company has $691.5 million outstanding under this
line of credit and $58.5 million available for future uses. The lending commitment on
the Companys unsecured line of credit is provided by multiple banks. Lehman Bank
represents seven percent of the lending commitment under the line of credit. On
September 15, 2008, Lehman Brothers Holdings Inc. filed a voluntary petition for
relief under Chapter 11 of the United States Bankruptcy Code. Since the bankruptcy
filing, the Company has experienced funding delays from Lehman Bank for its portion of
the lending commitment under the line of credit. As of November 7, 2008, excluding
Lehman Banks lending commitment, the Company has $51.2 million available for future
use under its unsecured line of credit. |
Dividends
In the first quarter of 2007, the Company began paying dividends of $0.07 per share on the
Companys Class A and Class B Common Stock which were paid quarterly through the first quarter of
2008. On May 21, 2008, the Company announced that it was temporarily suspending its
quarterly dividend program. The Company will continue to evaluate its dividend policy, which is
subject to future earnings, capital requirements, financial condition, and other factors.
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CRITICAL ACCOUNTING POLICIES
This Managements Discussion and Analysis of Financial Condition and Results of Operations
discusses the Companys consolidated financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United States. The preparation of these
financial statements requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the reported amounts of income and expenses during the
reporting periods. The Company bases its estimates and judgments on historical experience and on
various other factors that the Company believes are reasonable under the circumstances. Actual
results may differ from these estimates under varying assumptions or conditions. Note 3 of the
consolidated financial statements, which are included in the Companys Annual Report on Form 10-K
for the year ended December 31, 2007, includes a summary of the significant accounting policies and
methods used in the preparation of the consolidated financial statements.
On an on-going basis, management evaluates its estimates and judgments, particularly as they relate
to accounting policies that management believes are most critical that is, they are most
important to the portrayal of the Companys financial condition and results of operations and they
require managements most difficult, subjective, or complex judgments, often as a result of the
need to make estimates about the effect of matters that are inherently uncertain. Management has
identified the following critical accounting policies that are discussed in more detail below:
allowance for loan losses, revenue recognition, purchase price accounting related to business and
certain asset acquisitions, and income taxes.
Allowance for Loan Losses
The allowance for loan losses represents managements estimate of probable losses on student loans.
This evaluation process is subject to numerous estimates and judgments. The Company evaluates the
adequacy of the allowance for loan losses on its federally insured loan portfolio separately from
its non-federally insured loan portfolio.
The allowance for the federally insured loan portfolio is based on periodic evaluations of the
Companys loan portfolios considering past experience, trends in student loan claims rejected for
payment by guarantors, changes to federal student loan programs, current economic conditions, and
other relevant factors. Should any of these factors change, the estimates made by management would
also change, which in turn would impact the level of the Companys future provision for loan
losses.
In determining the adequacy of the allowance for loan losses on the non-federally insured loans,
the Company considers several factors including: loans in repayment versus those in a nonpaying
status, months in repayment, delinquency status, type of program, and trends in defaults in the
portfolio based on Company and industry data. Should any of these factors change, the estimates
made by management would also change, which in turn would impact the level of the Companys future
provision for loan losses. The Company places a non-federally insured loan on nonaccrual status
and charges off the loan when the collection of principal and interest is 120 days past due.
The allowance for federally insured and non-federally insured loans is maintained at a level
management believes is adequate to provide for estimated probable credit losses inherent in the
loan portfolio. This evaluation is inherently subjective because it requires estimates that may be
susceptible to significant changes.
Revenue Recognition
Student Loan Income The Company recognizes student loan income as earned, net of amortization of
loan premiums and deferred origination costs. Loan income is recognized based upon the expected
yield of the loan after giving effect to borrower utilization of incentives such as principal
reductions for timely payments (borrower benefits) and other yield adjustments. The estimate of
the borrower benefits discount is dependent on the estimate of the number of borrowers who will
eventually qualify for these benefits. For competitive purposes, the Company frequently changes
the borrower benefit programs in both amount and qualification factors. These programmatic changes
must be reflected in the estimate of the borrower benefit discount. Loan premiums, deferred
origination costs, and borrower benefits are included in the carrying value of the student loan on
the consolidated balance sheet and are amortized over the estimated life of the loan in accordance
with SFAS No. 91, Accounting for Non-Refundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases. The most sensitive estimate for loan premiums,
deferred origination costs, and borrower benefits is the estimate of the constant prepayment rate
(CPR). CPR is a variable in the life of loan estimate that measures the rate at which loans in a
portfolio pay before their stated maturity. The CPR is directly correlated to the average life of
the portfolio. CPR equals the percentage of loans that prepay annually as a percentage of the
beginning of period balance. A number of factors can affect the CPR estimate such as the rate of
consolidation activity and default rates. Should any of these factors change, the estimates made
by management would also change, which in turn would impact the amount of loan premium and deferred
origination cost amortization recognized by the Company in a particular period.
Other Fee-Based Income Other fee-based income is primarily attributable to fees for providing
services and the sale of lists and print products. Fees associated with services are recognized in
the period services are rendered and earned under service arrangements with clients
where service fees are fixed or determinable and collectibility is reasonably assured. The
Companys service fees are determined based on written price quotations or service agreements
having stipulated terms and conditions that do not require management to make any significant
judgments or assumptions regarding any potential uncertainties. Revenue from the sale of lists and
print products is generally earned and recognized, net of estimated returns, upon shipment or
delivery.
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The Company assesses collectibility of revenues and its allowance for doubtful accounts based on a
number of factors, including past transaction history with the customer and the credit-worthiness
of the customer. An allowance for doubtful accounts is established to record accounts receivable
at estimated net realizable value. If the Company determines that collection of revenues is not
reasonably assured at or prior to delivery of the Companys services, revenue is recognized upon
the receipt of cash.
Purchase Price Accounting Related to Business and Certain Asset Acquisitions
The Company has completed several business and asset acquisitions which have generated significant
amounts of goodwill and intangible assets and related amortization. The values assigned to
goodwill and intangibles, as well as their related useful lives, are subject to judgment and
estimation by the Company. Goodwill and intangibles related to acquisitions are determined and
based on purchase price allocations. Valuation of intangible assets is generally based on the
estimated cash flows related to those assets, while the initial value assigned to goodwill is the
residual of the purchase price over the fair value of all identifiable assets acquired and
liabilities assumed. Useful lives are determined based on the expected future period of the
benefit of the asset, the assessment of which considers various characteristics of the asset,
including historical cash flows. Due to the number of estimates involved related to the allocation
of purchase price and determining the appropriate useful lives of intangible assets, management has
identified purchase price accounting as a critical accounting policy.
Goodwill and Intangible Assets Impairment Assessments
The Company reviews goodwill for impairment annually and whenever triggering events or changes in
circumstances indicate its carrying value may not be recoverable in accordance with SFAS No. 142,
Goodwill and Other Intangible Assets (SFAS No. 142). The provisions of SFAS No. 142 require that
a two-step impairment test be performed on goodwill. In the first step, the Company compares the
fair value of each reporting unit to its carrying value. If the fair value of the reporting unit
exceeds the carrying value of the net assets assigned to that unit, goodwill is considered not
impaired and the Company is not required to perform further testing. If the carrying value of the
net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then the
Company must perform the second step of the impairment test in order to determine the implied fair
value of the reporting units goodwill. If the carrying value of a reporting units goodwill
exceeds its implied fair value, then the Company would record an impairment loss equal to the
difference.
Determining the fair value of a reporting unit involves the use of significant estimates and
assumptions. These estimates and assumptions include revenue growth rates and operating margins
used to calculate projected future cash flows, risk-adjusted discount rates, future economic and
market conditions, and determination of appropriate market comparables. Actual future results may
differ from those estimates.
The Company makes judgments about the recoverability of purchased intangible assets annually and
whenever triggering events or changes in circumstances indicate that an other than temporary
impairment may exist. Each quarter the Company evaluates the estimated remaining useful lives of
purchased intangible assets and whether events or changes in circumstances warrant a revision to
the remaining periods of amortization. In accordance with FASB Statement No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets, recoverability of these assets is measured by
comparison of the carrying amount of the asset to the future undiscounted cash flows the asset is
expected to generate. If the asset is considered to be impaired, the amount of any impairment is
measured as the difference between the carrying value and the fair value of the impaired asset.
Assumptions and estimates about future values and remaining useful lives of the Companys
intangible and other long-lived assets are complex and subjective. They can be affected by a
variety of factors, including external factors such as industry and economic trends, and internal
factors such as changes in the Companys business strategy and internal forecasts. Although the
Company believes the historical assumptions and estimates used are reasonable and appropriate,
different assumptions and estimates could materially impact the reported financial results.
Income Taxes
The Company is subject to the income tax laws of the U.S and its states and municipalities in which
the Company operates. These tax laws are complex and subject to different interpretations by the
taxpayer and the relevant government taxing authorities. In establishing a provision for income tax
expense, the Company must make judgments and interpretations about the application of these
inherently complex tax laws. The Company must also make estimates about when in the future certain
items will affect taxable income in the various tax jurisdictions. Disputes over interpretations
of the tax laws may be subject to review/adjudication by the court systems of the various tax
jurisdictions or may be settled with the taxing authority upon examination or audit. The Company
reviews these balances quarterly and as new information becomes available, the balances are
adjusted, as appropriate.
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RECENT ACCOUNTING PRONOUNCEMENTS
In December 2007, the FASB issued SFAS No. 141R, Business Combinations (SFAS No. 141R), which
changes the accounting for business acquisitions. SFAS No. 141R requires the acquiring entity in a
business combination to recognize all (and only) the assets acquired and liabilities assumed in the
transaction and establishes the acquisition-date fair value as the measurement objective for all
assets acquired and liabilities assumed in a business combination. Certain provisions of this
standard will, among other things, impact the determination of acquisition-date fair value of
consideration paid in a business combination (including contingent consideration); exclude
transaction costs from acquisition accounting; and change accounting practices for acquired
contingencies, acquisition-related restructuring costs, in-process research and development,
indemnification assets, and tax benefits. For the Company, SFAS No. 141R is effective for business
combinations and adjustments to an acquired entitys deferred tax asset and liability balances
occurring after December 31, 2008. The Company is currently evaluating the future impacts and
disclosures related to SFAS No. 141R.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No. 157). This
Statement defines fair value, establishes a framework for measuring fair value in generally
accepted accounting principles, and expands disclosures about fair value measurements. The
provisions of SFAS No. 157 are effective as of the beginning of the first fiscal year that begins
after November 15, 2007 (January 1, 2008 for the Company) and is to be applied prospectively. The
Company adopted SFAS No. 157 on January 1, 2008. The Company elected to delay the application of
SFAS No. 157 to nonfinancial assets and nonfinancial liabilities, as allowed by FASB Staff Position
SFAS No. 157-2. The Company is currently evaluating the impacts and disclosures related to SFAS
No. 157-2, but would not expect SFAS No. 157-2 to have a material impact on the Companys
consolidated results of operations or financial condition. In light of the recent economic turmoil
occurring in the United States, the FASB released FSP SFAS No. 157-3, Determining the Fair Value of
a Financial Asset When the Market for That Asset is Not Active (SFAS No. 157-3), on October 10,
2008. SFAS No. 157-3 clarified, among other things, that quotes and other market inputs need not
be solely used to determine fair value if they do not relate to an active market. SFAS No. 157-3
points out that when relevant observable market information is not available, an approach that
incorporates managements judgments about the assumptions that market participants would use in
pricing the asset in a current sale transaction would be acceptable (such as a discounted cash flow
analysis). Regardless of the valuation technique applied, entities must include appropriate risk
adjustments that market participants would make, including adjustments for nonperformance risk
(credit risk) and liquidity risk.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities Including an amendment of FASB Statement No. 115 (SFAS No. 159), which
permits an entity to choose, at specified election dates, to measure eligible financial instruments
and certain other items at fair value that are not currently required to be measured at fair value.
An entity shall report unrealized gains and losses on items for which the fair value option has
been elected in earnings at each subsequent reporting date. SFAS No. 159 allows entities to achieve
an offset accounting effect for certain changes in fair value of related assets and liabilities
without having to apply complex hedge accounting provisions, and is expected to expand the use of
fair value measurement consistent with the Boards long-term objectives for financial instruments.
SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate
comparisons between entities that choose different measurement attributes for similar types of
assets and liabilities. SFAS No. 159 is effective as of the beginning of an entitys first fiscal
year that begins after November 15, 2007 (January 1, 2008 for the Company). At the effective date,
an entity may elect the fair value option for eligible items that exist at that date. The entity
shall report the effect of the first remeasurement to fair value as a cumulative-effect adjustment
to the opening balance of retained earnings. Upon the effective date of SFAS No. 159, the Company
has elected not to measure any items at fair value that were not currently required to be measured
at fair value. Accordingly, the adoption of SFAS No. 159 had no impact on the Companys financial
statements.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial
Statements, an amendment of ARB No. 51 (SFAS No. 160), which establishes new standards governing
the accounting for and reporting of noncontrolling interests (NCIs) in partially owned
consolidated subsidiaries and the loss of control of subsidiaries. Certain provisions of this
standard indicate, among other things, that NCIs (previously referred to as minority interests) be
treated as a separate component of equity, not as a liability; that increases and decreases in the
parents ownership interest that leave control intact be treated as equity transactions, rather
than as step acquisitions or dilution gains or losses; and that losses of a partially owned
consolidated subsidiary be allocated to the NCI even when such allocation might result in a deficit
balance. This standard also requires changes to certain presentation and disclosure requirements.
For the Company, SFAS No. 160 is effective beginning January 1, 2009. The provisions of the
standard are to be applied to all NCIs prospectively, except for the presentation and disclosure
requirements, which are to be applied retrospectively to all periods presented. The Company is
currently evaluating the future impacts and disclosures related to SFAS No. 60.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging
Activities, which is intended to improve financial reporting about derivative instruments and
hedging activities by requiring enhanced disclosures to enable investors to better understand the
effects of derivative instruments and hedging activities on an entitys financial position,
financial performance, and cash flows. The new standard also improves transparency about the
location and amounts of derivative instruments in an entitys financial statements, how derivative
instruments and related hedged items are accounted for under SFAS No. 133, and how derivative
instruments and related hedged items affect its financial position, financial performance, and cash
flows. The standard is effective for financial statements issued for fiscal years and interim
periods beginning after November 15, 2008, with early application encouraged. The Company is
currently evaluating the future impacts and disclosures related to SFAS No. 161.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting
Principles (SFAS No. 162). This standard is intended to improve financial reporting by
identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in
preparing financial statements that are presented in conformity with generally accepted accounting
principles in the United States for non-governmental entities. SFAS No. 162 is effective 60 days
following approval by the U.S. Securities and Exchange Commission (SEC) of the Public Company
Accounting Oversight Boards amendments to AU Section 411, The Meaning of Present Fairly in
Conformity with Generally Accepted Accounting Principles. The Company does not expect SFAS No. 162
to have a material impact on the preparation of its consolidated financial statements.
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In December 2007, the FASB ratified the Emerging Issues Task Force consensus on EITF Issue
No. 07-1, Accounting for Collaborative Arrangements (EITF No. 07-1), that discusses how parties
to a collaborative arrangement (which does not establish a legal entity within such arrangement)
should account for various activities. The consensus indicates that costs incurred and revenues
generated from transactions with third parties (i.e. parties outside of the collaborative
arrangement) should be reported by the collaborators on the respective line items in their income
statements pursuant to EITF Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Net as
an Agent. Additionally, the consensus provides that income statement characterization of payments
between the participants in a collaborative arrangement should be based upon existing authoritative
pronouncements; analogy to such pronouncements if not within their scope; or a reasonable,
rational, and consistently applied accounting policy election. EITF No. 07-1 is effective for the
Company beginning January 1, 2009 and is to be applied retrospectively to all periods presented for
collaborative arrangements existing as of the date of adoption. The Company is currently evaluating
the impacts and disclosures related to EITF No. 07-1.
In April 2008, the FASB issued FSP SFAS 142-3, Determination of the Useful Life of Intangible
Assets (FSP 142-3). This guidance is intended to improve the consistency between the useful life
of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets (SFAS
142), and the period of expected cash flows used to measure the fair value of the asset under
SFAS 141R when the underlying arrangement includes renewal or extension of terms that would require
substantial costs or result in a material modification to the asset upon renewal or extension.
Companies estimating the useful life of a recognized intangible asset must now consider their
historical experience in renewing or extending similar arrangements or, in the absence of
historical experience, must consider assumptions that market participants would use about renewal
or extension as adjusted for SFAS 142s entity-specific factors. FSP 142-3 is effective for the
Company beginning January 1, 2009. The Company is currently evaluating the potential impact of the
adoption of FSP 142-3 on its consolidated financial position, results of operations, and cash
flows.
In September 2008, the FASB issued FSP SFAS 133-1 and FIN 45-4, Disclosures about Credit
Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation
No. 45, and Clarification of the Effective Date of FASB Statement No. 161 (FSP 133-1 and FIN
45-4), that require additional disclosures for sellers of credit derivative instruments and
certain guarantees. FSP 133-1 and FIN 45-4 amend FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities, and FASB Interpretation No. 45, Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, by
requiring additional disclosures for certain guarantees and credit derivatives sold including:
maximum potential amount of future payments, the related fair value, and the current status of the
payment/performance risk. The standard is effective for financial statements issued for fiscal
years and interim periods beginning after November 15, 2008, with early application encouraged.
The Company is currently evaluating the impacts and disclosures related to FSP 133-1 and FIN 45-4.
In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in
Share-Based Payment Transactions are Participating Securities (EITF 03-6-1). EITF 03-6-1 defines
participating securities as those that are expected to vest and are entitled to receive
nonforfeitable dividends or dividend equivalents. Unvested share-based payment awards that have a
right to receive dividends on common stock (restricted stock) will be considered participating
securities and included in earnings per share using the two-class method. The two-class method
requires net income to be reduced for dividends declared and paid in the period on such shares.
Remaining net income is then allocated to each class of stock (proportionately based on
unrestricted and restricted shares which pay dividends) for calculation of basic earnings per
share. Diluted earnings per share would then be calculated based on basic shares outstanding plus
any additional potentially dilutive shares, such as options and restricted stock that do not pay
dividends or are not expected to vest. This FSP is effective in the first quarter 2009. The
Company is currently evaluating the impacts and disclosures relating to EITF 03-6-1.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
The Companys primary market risk exposure arises from fluctuations in its borrowing and lending
rates, the spread between which could impact the Company due to shifts in market interest rates.
Because the Company generates a significant portion of its earnings from its student loan spread,
the interest sensitivity of the balance sheet is a key profitability driver.
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The following table sets forth the Companys loan assets and debt instruments by rate
characteristics:
As of September 30, 2008 | As of December 31, 2007 | |||||||||||||||
Dollars | Percent | Dollars | Percent | |||||||||||||
Fixed-rate loan assets |
$ | 2,240,539 | 8.6 | % | $ | 1,136,544 | 4.3 | % | ||||||||
Variable-rate loan assets |
23,760,874 | 91.4 | 25,192,669 | 95.7 | ||||||||||||
Total |
$ | 26,001,413 | 100.0 | % | $ | 26,329,213 | 100.0 | % | ||||||||
Fixed-rate debt instruments |
680,435 | 2.4 | % | 689,476 | 2.5 | % | ||||||||||
Variable-rate debt instruments |
27,324,400 | 97.6 | 27,426,353 | 97.5 | ||||||||||||
Total |
$ | 28,004,835 | 100.0 | % | $ | 28,115,829 | 100.0 | % | ||||||||
FFELP student loans generally earn interest at the higher of a floating rate based on the Special
Allowance Payment or SAP formula set by the Department and the borrower rate, which is fixed over a
period of time. The SAP formula is based on an applicable index plus a fixed spread that is
dependant upon when the loan was originated, the loans repayment status, and funding sources for
the loan. The Company generally finances its student loan portfolio with variable-rate debt. In
low and/or declining interest rate environments, when the fixed borrower rate is higher than the
rate produced by the SAP formula, the Companys student loans earn at a fixed rate while the
interest on the variable-rate debt continues to decline. In these interest rate environments, the
Company earns additional spread income that it refers to as floor income.
Depending on the type of the student loan and when it was originated, the borrower rate is either
fixed to term or is reset to market rate each July 1. As a result, for loans where the borrower
rate is fixed to term, the Company earns floor income for an extended period of time, which the
Company refers to as fixed rate floor income, and for those loans where the borrower rate is reset
annually on July 1, the Company earns floor income to the next reset date, which the Company refers
to as variable-rate floor income. In accordance with legislation enacted in 2006, lenders are
required to rebate floor income and variable-rate floor income to the Department for all FFELP
loans originated on or after April 1, 2006.
For the three and nine months ended September 30, 2008, loan interest income includes approximately
$6.8 million and $25.2 million of fixed rate floor income, respectively. For the three and nine
months ended September 30, 2007, loan interest income includes approximately $0.8 million and $7.0
million of fixed rate floor income, respectively. For the three and nine months ended September
30, 2008, loan interest income includes approximately $1.6 million and $42.3 million of
variable-rate floor income, respectively. The Company earned $0.6 million of variable-rate floor
income during both the three and nine months ended September 30, 2007.
Absent the use of derivative instruments, a rise in interest rates may reduce the amount of floor
income received and this may have an impact on earnings due to interest margin compression caused
by increasing financing costs, until such time as the federally insured loans earn interest at a
variable rate in accordance with the special allowance payment formula. In higher interest rate
environments, where the interest rate rises above the borrower rate and fixed-rate loans
effectively become variable rate loans, the impact of the rate fluctuations is reduced.
The following graph depicts fixed rate floor income for a borrower with a fixed rate of 6.75% and a
SAP rate of 2.64%:
![(LINE GRAPH)](https://www.sec.gov/Archives/edgar/data/0001258602/000136231008007003/c76837c7683702.gif)
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The following table shows the Companys student loan assets that are earning fixed rate floor
income as of September 30, 2008:
Borrower/ | Estimated | Balance of | ||||||||||
Fixed | lender | variable | assets earning fixed-rate | |||||||||
interest | weighted | conversion | floor income as of | |||||||||
rate range | average yield | rate (a) | September 30, 2008 (b) | |||||||||
4.5 - 4.99% |
4.84 | % | 2.20 | % | $ | 1,274 | ||||||
5.0 - 5.49% |
5.08 | % | 2.44 | % | 7,614 | |||||||
5.5 - 5.99% |
5.74 | % | 3.10 | % | 245,169 | |||||||
6.0 - 6.49% |
6.19 | % | 3.55 | % | 419,291 | |||||||
6.5 - 6.99% |
6.70 | % | 4.06 | % | 375,929 | |||||||
7.0 - 7.49% |
7.17 | % | 4.53 | % | 130,684 | |||||||
7.5 - 7.99% |
7.71 | % | 5.07 | % | 224,331 | |||||||
8.0 - 8.99% |
8.16 | % | 5.52 | % | 512,938 | |||||||
> 9.0% |
9.04 | % | 6.40 | % | 323,309 | |||||||
$ | 2,240,539 | |||||||||||
(a) | The estimated variable conversion rate is the estimated short-term interest rate at which
loans would convert to variable rate. |
|
(b) | As of September 30, 2008, the Company had $204.8 million of fixed rate debt that was used
by the Company to hedge fixed-rate student loan assets. The weighted average interest rate
paid by the Company on this debt as of September 30, 2008 was 6.17%. |
The following table summarizes the outstanding derivative instruments as of September 30, 2008 used
by the Company to hedge fixed-rate student loan assets.
Weighted | ||||||||
average fixed | ||||||||
Notional | rate paid by | |||||||
Maturity | Amount | the Company (a) | ||||||
2009 |
$ | 500,000 | 4.08 | % | ||||
2010 |
500,000 | 3.84 | ||||||
$ | 1,000,000 | 3.96 | % |
(a) | For all interest rate derivatives for which the Company pays a fixed rate, the Company
receives discrete three-month LIBOR. |
As of September 30, 2008, the Company had $3.8 billion of student loan assets that were eligible to earn
variable-rate floor income. As a result of the decrease in short-term interest rates subsequent to
September 30, 2008, the Company anticipates earning additional variable-rate floor income in the
fourth quarter.
The Company is exposed to interest rate risk in the form of basis risk and repricing risk because
the interest rate characteristics of the Companys assets do not match the interest rate
characteristics of the funding. The Company attempts to match the interest rate characteristics of
certain pools of loan assets with debt instruments of substantially similar characteristics. Due
to the variability in duration of the Companys assets and varying market conditions, the Company
does not attempt to perfectly match the interest rate characteristics of the entire loan portfolio
with the underlying debt instruments. The Company has adopted a policy of periodically reviewing
the mismatch related to the interest rate characteristics of its assets and liabilities together
with the Companys outlook as to current and future market conditions. Based on those factors, the
Company uses derivative instruments as part of its overall risk management strategy. Derivative
instruments used as part of the Companys interest rate risk management strategy currently include
interest rate swaps, basis swaps, and cross-currency swaps.
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The following table presents the Companys student loan assets and related funding arranged by
underlying indices as of September 30, 2008:
Debt | ||||||||||||
outstanding | ||||||||||||
that funded | ||||||||||||
Frequency of | student loan | |||||||||||
Index (e) | Variable Resets | Assets | assets (a) | |||||||||
3 month H15 financial commercial paper (b) |
Daily | $ | 24,422,798 | 354,003 | ||||||||
3 month Treasury bill |
Varies | 1,303,095 | | |||||||||
Private student loans |
275,520 | | ||||||||||
3 month LIBOR (c) |
Quarterly | | 20,891,535 | |||||||||
Auction-rate or remarketing |
Varies | | 2,771,445 | |||||||||
Asset-backed commercial paper |
Varies | | 2,657,430 | |||||||||
Fixed rate |
| 205,435 | ||||||||||
Other (d) |
878,435 | | ||||||||||
$ | 26,879,848 | 26,879,848 | ||||||||||
(a) | During 2007, the Company entered into basis swaps in which the Company receives
three-month LIBOR set discretely in advance and pays a daily weighted average three-month
LIBOR less a spread as defined in the individual agreements. The Company entered into these
derivative instruments to better match the interest rate characteristics on its student loan
assets and the debt funding such assets. The following table summarizes these derivatives
as of September 30, 2008: |
Notional | ||||
Maturity | Amount | |||
2008 |
$ | 1,000,000 | ||
2009 |
1,000,000 | |||
2010 (1) |
5,500,000 | |||
2011 |
2,700,000 | |||
2012 |
2,400,000 | |||
$ | 12,600,000 | |||
(1) | In October 2008, the Company terminated a basis swap with a notional
amount of $1.0 billion and an original maturity date in 2010 for
proceeds of $0.6 million. This derivative is included in the above
table. |
|
(b) | The Companys FFELP student loans earn interest based on the daily average H15 financial
commercial paper index calculated on a fiscal quarter. The Companys funding includes $90.1
million funding private student loans under a participation agreement with Union Bank and
$263.9 million funding FFELP student loans under the Departments Participation Program. |
|
(c) | The Company has Euro-denominated notes that reprice on the EURIBOR index. The Company has
entered into derivative instruments (cross-currency interest rate swaps) that convert the
EURIBOR index to 3 month LIBOR. As a result, these notes are reflected in the 3 month LIBOR
category in the above table. See Foreign Currency Exchange Risk. |
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(d) | Assets include restricted cash and investments and other assets. |
|
(e) | Historically, the movement of the various interest rate indices received on the Companys
student loan assets and paid on the debt to fund such loans was highly correlated. As shown
below, the short-term movement of the indices was dislocated beginning in August 2007. This
dislocation has had a negative impact on the Companys student loan net interest income. |
![(LINE GRAPH)](https://www.sec.gov/Archives/edgar/data/0001258602/000136231008007003/c76837c7683703.gif)
Financial Statement Impact of Derivative Instruments
The Company accounts for its derivative instruments in accordance with SFAS No. 133. SFAS No. 133
requires that changes in the fair value of derivative instruments be recognized currently in
earnings unless specific hedge accounting criteria as specified by SFAS No. 133 are met.
Management has structured all of the Companys derivative transactions with the intent that each is
economically effective. However, the Companys derivative instruments do not qualify for hedge
accounting under SFAS No. 133; consequently, the change in fair value of these derivative
instruments is included in the Companys operating results. Changes or shifts in the forward yield
curve and fluctuations in currency rates can significantly impact the valuation of the Companys
derivatives. Accordingly, changes or shifts to the forward yield curve and fluctuations in
currency rates will impact the financial position and results of operations of the Company. The
change in fair value of the Companys derivatives are included in derivative market value, foreign
currency, and put option adjustments and derivative settlements, net in the Companys consolidated
statements of operations and resulted in an expense of $119.9 million and $72.4 million for the
three and nine months ended September 30, 2008, respectively, and income of $72.7 million and $93.0
million for the three and nine months ended September 30, 2007, respectively.
The following summarizes the derivative settlements included in derivative market value, foreign
currency, and put option adjustments and derivative settlements, net on the consolidated
statements of operations:
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Interest rate swaps loan portfolio |
$ | (3,176 | ) | | (14,195 | ) | 4,753 | |||||||||
Basis swaps loan portfolio |
(3,999 | ) | (2,608 | ) | 41,606 | (2,489 | ) | |||||||||
Interest rate swaps other (a) |
| 1,729 | | 12,050 | ||||||||||||
Cross-currency interest rate swaps |
7,963 | (1,457 | ) | 18,577 | (7,214 | ) | ||||||||||
Derivative settlements received (paid), net |
$ | 788 | (2,336 | ) | 45,988 | 7,100 | ||||||||||
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(a) | During the fourth quarter 2006, in consideration of not receiving 9.5% special
allowance payments on a prospective basis, the Company entered into a series of off-setting
interest rate swaps that mirrored the $2.45 billion in pre-existing interest rate swaps
that the Company had utilized to hedge its loan portfolio receiving 9.5% special allowance
payments against increases in interest rates. |
|
During the second quarter 2007, the Company entered into a series of off-setting interest
rate swaps that mirrored the remaining interest rate swaps utilized to hedge the Companys
student loan portfolio against increases in interest rates. |
||
The net effect of the offsetting derivatives discussed above was to lock in a series of
future income streams on underlying trades through their respective maturity dates. The net
settlements on these derivatives are included in interest rate swaps other. In August
2007, the Company terminated these derivatives for net proceeds of $50.8 million. |
Sensitivity Analysis
The following tables summarize the effect on the Companys earnings, based upon a sensitivity
analysis performed by the Company assuming a hypothetical increase and decrease in interest rates
of 100 basis points and an increase in interest rates of 200 basis points while funding spreads
remain constant. The effect on earnings was performed on the Companys variable-rate assets and
liabilities. The analysis includes the effects of the Companys interest rate and basis swaps in
existence during these periods. As a result of the Companys interest rate management activities,
the Company expects such a change in pre-tax net income resulting from a 100 basis point increase
or decrease or a 200 basis point increase in interest rates would not result in a proportional
decrease in net income.
Three months ended September 30, 2008 | ||||||||||||||||||||||||
Change from decrease of 100 | Change from increase of 100 | Change from increase of 200 | ||||||||||||||||||||||
basis points | basis points | basis points | ||||||||||||||||||||||
Dollar | Percent | Dollar | Percent | Dollar | Percent | |||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
Effect on earnings: |
||||||||||||||||||||||||
Increase (decrease) in pre-tax net income before
impact of derivative settlements |
$ | 8,803 | 23.3 | % | (2,299 | ) | (6.1 | )% | (3,170 | ) | (8.4 | )% | ||||||||||||
Impact of derivative settlements |
(3,101 | ) | (8.2 | ) | 3,100 | 8.2 | 6,201 | 16.4 | ||||||||||||||||
Increase in net income before taxes |
$ | 5,702 | 15.1 | % | 801 | 2.1 | % | 3,031 | 8.0 | % | ||||||||||||||
Increase in basic and diluted
earning per share |
$ | 0.07 | 0.01 | 0.04 | ||||||||||||||||||||
Three months ended September 30, 2007 | ||||||||||||||||||||||||
Change from decrease of 100 | Change from increase of 100 | Change from increase of 200 | ||||||||||||||||||||||
basis points | basis points | basis points | ||||||||||||||||||||||
Dollar | Percent | Dollar | Percent | Dollar | Percent | |||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
Effect on earnings: |
||||||||||||||||||||||||
Increase in pre-tax net income before
impact of derivative settlements |
$ | 7,557 | 27.7 | % | 159 | 0.6 | % | 1,395 | 5.1 | % | ||||||||||||||
Impact of derivative settlements |
| | | | | | ||||||||||||||||||
Increase in net income before taxes |
$ | 7,557 | 27.7 | % | 159 | 0.6 | % | 1,395 | 5.1 | % | ||||||||||||||
Increase in basic and diluted
earning per share |
$ | 0.09 | | 0.02 | ||||||||||||||||||||
Nine months ended September 30, 2008 | ||||||||||||||||||||||||
Change from decrease of 100 | Change from increase of 100 | Change from increase of 200 | ||||||||||||||||||||||
basis points | basis points | basis points | ||||||||||||||||||||||
Dollar | Percent | Dollar | Percent | Dollar | Percent | |||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
Effect on earnings: |
||||||||||||||||||||||||
Increase (decrease) in pre-tax net income before impact of derivative settlements |
$ | 33,585 | 2,205.2 | % | (33,585 | ) | (2,205.2 | )% | (46,123 | ) | (3,028.4 | )% | ||||||||||||
Impact of derivative settlements |
(8,141 | ) | (534.5 | ) | 8,141 | 534.5 | 16,282 | 1,069.1 | ||||||||||||||||
Increase (decrease) in net income before taxes |
$ | 25,444 | 1,670.7 | % | (25,444 | ) | (1,670.7 | )% | (29,841 | ) | (1,959.3 | )% | ||||||||||||
Increase (decrease) in basic and diluted
earning per share |
$ | 0.33 | (0.33 | ) | (0.38 | ) | ||||||||||||||||||
Nine months ended September 30, 2007 | ||||||||||||||||||||||||
Change from decrease of 100 | Change from increase of 100 | Change from increase of 200 | ||||||||||||||||||||||
basis points | basis points | basis points | ||||||||||||||||||||||
Dollar | Percent | Dollar | Percent | Dollar | Percent | |||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
Effect on earnings: |
||||||||||||||||||||||||
Increase in pre-tax net income before
impact of derivative settlements |
$ | 15,170 | 58.0 | % | 8,858 | 33.9 | % | 20,980 | 80.2 | % | ||||||||||||||
Impact of derivative settlements |
| | | | | | ||||||||||||||||||
Increase in net income before taxes |
$ | 15,170 | 58.0 | % | 8,858 | 33.9 | % | 20,980 | 80.2 | % | ||||||||||||||
Increase in basic and diluted
earning per share |
$ | 0.20 | 0.12 | 0.27 | ||||||||||||||||||||
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Foreign Currency Exchange Risk
During 2006, the Company completed separate debt offerings of student loan asset-backed securities
that included 420.5 million and 352.7 million Euro-denominated notes with interest rates based on a
spread to the EURIBOR index. As a result of this transaction, the Company is exposed to market
risk related to fluctuations in foreign currency exchange rates between the U.S. and Euro dollars.
The principal and accrued interest on these notes is re-measured at each reporting period and
recorded on the Companys balance sheet in U.S. dollars based on the foreign currency exchange rate
on that date. Changes in the principal and accrued interest amounts as a result of foreign
currency exchange rate fluctuations are included in the derivative market value, foreign currency,
and put option adjustments and derivative settlements, net in the Companys consolidated
statements of operations.
The Company entered into cross-currency interest rate swaps in connection with the issuance of the
Euro Notes. Under the terms of these derivative instrument agreements, the Company receives from a
counterparty a spread to the EURIBOR index based on notional amounts of 420.5 million and 352.7
million and pays a spread to the LIBOR index based on notional amounts of $500.0 million and $450.0
million, respectively. In addition, under the terms of these agreements, all principal payments on
the Euro Notes will effectively be paid at the exchange rate in effect as of the issuance of the
notes. The Company did not qualify these derivative instruments as hedges under SFAS No. 133;
consequently, the change in fair value is included in the Companys operating results.
For the three and nine months ended September 30, 2008, the Company recorded income of $128.9
million and $40.4 million, respectively, as a result of re-measurement of the Euro Notes and losses
of $129.0 million and $37.3 million, respectively, for the change in the fair value of the related
derivative instrument. For the three and nine months ended September 30, 2007, the Company
recorded losses of $54.0 million and $79.0 million, respectively, as a result of the re-measurement
of the Euro Notes, and income of $58.8 million and $85.8 million, respectively, for the change in
the fair value of the related derivative instrument. Both of these amounts are included in
derivative market value, foreign currency, and put option adjustments and derivative settlements,
net on the Companys consolidated statements of operations.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Under supervision and with the participation of certain members of the Companys management,
including the chief executive and the chief financial officers, the Company completed an evaluation
of the effectiveness of the design and operation of its disclosure controls and procedures (as
defined in SEC Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on
this evaluation, the Companys chief executive and chief financial officers believe that the
disclosure controls and procedures were effective as of the end of the period covered by this
Quarterly Report on Form 10-Q with respect to timely communication to them and other members of
management responsible for preparing periodic reports and material information required to be
disclosed in this Quarterly Report on Form 10-Q as it relates to the Company and its consolidated
subsidiaries.
The effectiveness of the Companys or any system of disclosure controls and procedures is subject
to certain limitations, including the exercise of judgment in designing, implementing, and
evaluating the controls and procedures, the assumptions used in identifying the likelihood of
future events, and the inability to eliminate misconduct completely. As a result, there can be no
assurance that the Companys disclosure controls and procedures will prevent all errors or fraud or
ensure that all material information will be made known to appropriate management in a timely
fashion. By their nature, the Companys or any system of disclosure controls and procedures can
provide only reasonable assurance regarding managements control objectives.
Changes in Internal Control over Financial Reporting
There was no change in the Companys internal control over financial reporting during the Companys
last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
General
The Company is subject to various claims, lawsuits, and proceedings that arise in the normal course
of business. These matters principally consist of claims by student loan borrowers disputing the
manner in which their student loans have been processed and disputes with other business entities.
On the basis of present information, anticipated insurance coverage, and advice received from
counsel, it is the opinion of the Companys management that the disposition or ultimate
determination of these claims, lawsuits, and proceedings will not have a material adverse effect on
the Companys business, financial position, or results of operations.
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Municipal Derivative Bid Practices Investigation
As previously disclosed, on February 8, 2008, Shockley Financial Corp. (SFC), an indirect,
wholly-owned subsidiary of the Company that provides investment advisory services for the
investment of proceeds from the issuance of municipal and corporate bonds, received a grand jury
subpoena issued by the U.S. District Court for the Southern District of New York upon application
of the Antitrust Division of the U.S. Department of Justice. The subpoena seeks certain
information and documents from SFC in connection with the Department of Justices ongoing criminal
investigation of the bond industry with respect to possible anti-competitive practices related to
awards of guaranteed investment contracts (GICs) and other products for the investment of
proceeds from bond issuances. SFC currently has one employee. The Company and SFC are cooperating
with the investigation.
On March 5, 2008, SFC received a subpoena from the Securities and Exchange Commission (the SEC)
related to an ongoing industry-wide investigation concerning the bidding of municipal GICs. In
addition, on or about June 6, 2008 and June 12, 2008, SFC received a subpoena from both the New York
Attorney General (the NYAG) and the Florida Attorney General, respectively, relating to their
investigations concerning the bidding of municipal GICs and possible violations of various state
and federal laws. The subpoenas seek certain information and documents from SFC relating to its
GIC business. The Company and SFC are cooperating with these investigations.
SFC has also been named as a defendant in a number of substantially identical purported class
action lawsuits. In each of the lawsuits, a large number of financial institutions and financial
service providers, including SFC, are named as defendants. The complaints allege that the
defendants engaged in a conspiracy not to compete and to fix prices and rig bids for municipal
derivatives (including GICs) sold to issuers of municipal bonds. All the complaints assert claims
for violations of Section 1 of the Sherman Act and fraudulent concealment, and three complaints
also assert claims for unfair competition and violation of the California Cartwright Act. On
June 16, 2008, the United States Judicial Panel on Multidistrict Litigation issued an order
transferring the cases then before it to the U.S. District Court for the Southern District of New
York which consolidated several cases under the caption Hinds County, Mississippi v. Wachovia Bank,
N.A. et al. SFC intends to vigorously contest these purported class action lawsuits.
SFC, the Company, or other subsidiaries of the Company may receive subpoenas from other regulatory
agencies. Due to the preliminary nature of these matters as to SFC, the Company is unable to
predict the ultimate outcome of the investigations or the class action lawsuits.
Industry Investigations
On January 11, 2007, the Company received a letter from the NYAG requesting certain information and
documents from the Company in connection with the NYAGs investigation into preferred lender list
activities. Since January 2007, a number of state attorneys general, including the NYAG, and the
U.S. Senate Committee on Health, Education, Labor, and Pensions also announced or are reportedly
conducting broad inquiries or investigations of the activities of various participants in the
student loan industry, including activities which may involve perceived conflicts of interest. A
focus of the inquiries or investigations has been on any financial arrangements among student loan
lenders and other industry participants which may facilitate increased volumes of student loans for
particular lenders. Like many other student loan lenders, the Company received requests for
information from certain state attorneys general and the Chairman of the U.S. Senate Committee on
Health, Education, Labor, and Pensions in connection with their inquiries or investigations. In
addition, the Company received subpoenas for information from the NYAG, the New Jersey Attorney
General, and the Ohio Attorney General. In each case the Company is cooperating with the requests
and subpoenas for information that it has received.
On July 31, 2007, the Company announced that it had agreed with the NYAG to adopt the NYAGs Code
of Conduct, which is substantially similar to the Companys previously adopted Nelnet Student Loan
Code of Conduct. As part of the agreement, the Company agreed to contribute $2.0 million to a
national fund for educating high school students and their parents regarding the financial aid
process (the NYAG Fund).
On October 10, 2007, the Company received a subpoena from the NYAG requesting certain information
and documents from the Company in connection with the NYAGs investigation into direct-to-consumer
marketing practices of student lenders. On September 9, 2008, the Company announced that it agreed
to adopt the NYAGs Student Loan Direct Marketing Code of Conduct. As part of the agreement, the
Company agreed to contribute $200,000 to the NYAG Fund.
While the Company cannot predict the ultimate outcome of any inquiry or investigation, the Company
believes its activities have materially complied with applicable law, including the Higher
Education Act, the rules and regulations adopted by the Department of Education thereunder, and the
Departments guidance regarding those rules and regulations.
Department of Education Review
The Department of Education periodically reviews participants in the FFEL Program for compliance
with program provisions. On June 28, 2007, the Department notified the Company that it would be
conducting a review of the Companys administration of the FFEL Program under the Higher Education
Act. The Company understands that the Department has selected several schools and lenders for
review. Specifically, the Department is reviewing the Companys practices in connection with the
prohibited inducement provisions of the Higher Education Act
and the provisions of the Higher Education Act and the associated regulations which allow borrowers
to have a choice of lenders. The Company has responded to the Departments requests for
information and documentation and is cooperating with their review.
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While the Company cannot predict the ultimate outcome of the review, the Company believes its
activities have materially complied with the Higher Education Act, the rules and regulations
adopted by the Department of Education thereunder, and the Departments guidance regarding those
rules and regulations.
Department of Justice
In connection with the Companys settlement with the Department of Education in January 2007 to
resolve the Office of Inspector General of the Department of Education (the OIG) audit report
with respect to the Companys student loan portfolio receiving special allowance payments at a
minimum 9.5% interest rate, the Company was informed by the Department of Education that a civil
attorney with the Department of Justice had opened a file regarding the issues set forth in the OIG
report, which the Company understands is common procedure following an OIG audit report. The
Company has engaged in discussions with and provided information to the Department of Justice in
connection with the review.
While the Company is unable to predict the ultimate outcome of the review, the Company believes its
practices complied with applicable law, including the provisions of the Higher Education Act, the
rules and regulations adopted by the Department of Education thereunder, and the Departments
guidance regarding those rules and regulations.
ITEM 1A. RISK FACTORS
Except as set forth below and except as disclosed in the Companys Quarterly Reports on Form 10-Q
for the quarters ended March 31, 2008 and June 30, 2008, there have been no material changes from
the risk factors described in the Companys Annual Report on Form 10-K for the year ended December
31, 2007 in response to Item 1A of Part I of such Form 10-K.
The recent credit and financial market crisis has had an adverse effect on the Companys liquidity
and poses counterparty risks.
The recent unprecedented disruptions in the credit and financial markets, and the related crisis
affecting the banking system which resulted in the enactment of the Emergency Economic
Stabilization Act of 2008 in October 2008, have had and may continue to have an adverse effect on
the cost and availability of financing for the Companys student loan portfolios and, as a result,
have had and may continue to have an adverse effect on the Companys liquidity, results of
operations, and financial condition. Such adverse conditions may continue or worsen in the future.
The Company has historically relied on a multi-seller bank provided conduit warehouse facility to
fund the origination and acquisition of FFELP student loans. The facility for FFELP loans
terminates in May 2010 and was supported by 364-day liquidity which was up for renewal on May 9,
2008. The Company obtained an extension of the renewal until July 31, 2008. On July 31, 2008, the
Company did not renew the liquidity provisions of this facility. Accordingly, as of July 31, 2008,
the facility became a term facility with an outstanding balance of approximately $2.8 billion and a
final maturity of May 9, 2010. As of November 7, 2008, the outstanding balance under this facility
was $2.1 billion. Pursuant to the terms of the agreement, since liquidity was not renewed, the
Companys cost of financing under this facility increased 10 basis points. The agreement also
includes provisions which allow the banks to charge a rate equal to LIBOR plus 128.5 basis points
if they choose to finance their portion of the facility with sources of funds other than their
commercial paper conduit. In addition, the FFELP warehouse facility has a provision requiring the
Company to refinance or remove 75% of the pledged collateral on an annual basis. The Company
believes it has met this requirement for the annual period ending in May 2009. However, the
Company does have an obligation to remove approximately $30 million of loans by December 31, 2008
because these loans were partially disbursed when the facility was termed-out on July 31, 2008.
Under the current
terms of the facility, the remaining collateral will need to be refinanced or removed by May 9,
2010.
The warehouse facility for FFELP loans also currently provides for mark-to-market advance rates
related to the valuation of financed loans. On October 22, 2008, the Company posted $165.5 million
in additional funds to the facility based on this mark-to-market provision. While the Company does
not believe that the loan valuation formula is reflective of the actual fair value of its loans, it
is subject to compliance with the current mark-to-market provisions of the warehouse facility
agreement. As of November 7, 2008, the Company has a cumulative amount of $374.6 million posted as
equity funding support for the facility.
The Company has utilized its $750.0 million unsecured line of credit to fund equity advances on its
warehouse facility. As of November 7, 2008, the Company had $691.5 million outstanding under the
line of credit and $58.5 million available for future use. The lending commitment under the line
of credit is provided by a total of thirteen banks, with no individual bank representing more than
11% of the total lending commitment. The bank lending group includes Lehman Bank, which represents
approximately 7% of the lending commitment under the line of credit. On September 15, 2008, Lehman
Brothers Holdings Inc. filed a voluntary petition for relief under Chapter 11 of the United States
Bankruptcy Code. Since the bankruptcy filing, the Company has experienced funding delays from
Lehman Bank for its portion of the lending commitment under the line of credit.
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Continued disruptions in the credit and financial markets may cause additional volatility in the
mark-to-market loan valuation formula under the warehouse facility. Should a significant change in
the valuation of loans result in additional required equity funding support for the warehouse
facility greater than what the Company can provide and the Company has not amended the facility as discussed below, the warehouse facility could be subject to an
event of default resulting in a termination of the facility and an acceleration of the repayment
provisions. A default on the FFELP warehouse facility would result in an event of default on the Companys
unsecured line of credit that would result in the outstanding balance on the line of credit
becoming immediately due and payable.
To reduce the Companys exposure from the mark-to-market advance rate provision included in the
FFELP warehouse facility, the Company has signed a letter agreement engaging Banc of America Securities LLC to arrange an amendment of
certain of the Companys credit facilities, including but not limited to an amendment to place a
floor on the valuation of collateral in the Companys FFELP loan warehouse line of credit for
which Bank of America, N.A. acts as administrative agent. Banc of America Securities LLC has
commenced the amendment process and together with the Company is seeking the approval of the
Companys lenders of a proposed amendment of such credit facilities on mutually agreeable terms. In addition, the Company continues to look at various
alternatives to remove loans from the warehouse facility including other financing arrangements
and/or selling loans to third parties.
In addition, on November 8, 2008, the Department announced they intend to provide liquidity support
to one or more conforming asset backed commercial paper conduits to purchase and provide
longer-term financing for FFELP loans. While details of this conduit are forthcoming, it is
intended that all fully-disbursed non-consolidation FFELP loans awarded between October 1, 2003 and
July 1, 2009 will be eligible for inclusion. As of November 7, 2008, the Company had approximately
$900 million of loans included in its warehouse facility that would be eligible for this proposed
conduit program.
The Company has historically used its warehouse facility to pool student loans in order to maximize
loan portfolio characteristics for efficient financing and to properly time market conditions for
movement of the loans into an asset-backed securitization. In addition, the Company has
historically relied on asset-backed securitizations as a significant source of funding for student
loans on a long-term basis. Since late September 2008, the severe disruptions in the credit and
financial markets have made asset-backed securitization financing generally unavailable. The
Company is currently unable to predict when market conditions will allow for future asset-backed
securitization financing. If the Company were unable to continue to securitize student loans on
favorable terms, it could use alternative funding sources to meet liquidity needs, including (i)
the Department of Educations new financing programs as discussed below for loans disbursed after
April 30, 2008, (ii) an existing FFELP loan participation facility with Union Bank, an entity under
common control with the Company, and (iii) the Companys unsecured line of credit; however, such
alternatives may result in the sale of loans by the Company and a loss of the accompanying
servicing rights. If the Company is unable to obtain cost-effective and stable funding
alternatives, its funding capabilities and liquidity would be negatively impacted and its cost of
funds could increase, adversely affecting the Companys results of operations. In addition, the
Companys ability to originate and acquire student loans would be limited or could be eliminated.
With respect to the origination of new FFELP student loans, the Company currently expects to
utilize the Department of Educations new financing programs as discussed below, the participation
facility with Union Bank, and the Companys unsecured line of credit.
On July 1, 2008, pursuant to the Ensuring Continued Access to Student Loans Act, the Department of
Education announced terms under which it will offer to purchase certain FFELP student loans and
participation interests in certain FFELP student loans from FFELP lenders. Under the Departments
Purchase Program, the Department will purchase loans at a price equal to the sum of (i) par value,
(ii) accrued interest, (iii) the one percent origination fee paid to the Department, and (iv) a
fixed amount of $75 per loan. Lenders will have until September 30, 2009 to sell loans to the
Department. Under the Departments Participation Program, the Department will provide interim
short-term liquidity to FFELP lenders by purchasing participation interests in pools of FFELP
loans. FFELP lenders will be charged a rate of commercial paper plus 50 basis points on the
principal amount of participation interests outstanding. Loans funded under the Participation
Program must be either refinanced by the lender or sold to the Department pursuant to the Purchase
Program prior to its expiration on September 30, 2009. To be eligible for purchase or
participation under the Departments programs, loans must be FFELP Stafford or PLUS loans made for
the academic year 2008-2009, first disbursed between May 1, 2008 and July 1, 2009, with eligible
borrower benefits. On August 14, 2008, the Company received notification that the Department had
approved the Master Participation Agreement the Company submitted to enable the Company to begin
participating in the Participation Program. The Company expects to utilize the Participation
Program to fund a significant portion of its loan originations for the 2008-2009 academic year.
On October 7, 2008, legislation was enacted to extend the Departments authority to address FFELP
student loans made for the 2009-2010 academic year and allowing for the extension of the
Participation Program and Purchase Program from September 30, 2009 to September 30, 2010. The
Department has provided preliminary guidance relating to the extension and has indicated that
programs similar to the Participation Program and Purchase Program will be implemented for the
2009-2010 academic year along with providing liquidity support for one or more asset backed
commercial paper conduits for FFELP Stafford and PLUS loans awarded between October 1, 2003 and
July 1, 2009. The Department has indicated that loans for the 2008-2009 academic year
which are funded under the Departments Participation Program will need to be refinanced or sold to
the Department prior to September 30, 2009. Management understands that such loans will not be
eligible for participation under the Departments 2009-2010 Participation Program, but should be
eligible for refinancing through the Departments commercial paper conduit program. Management of
the Company is encouraged by these developments; however, until the Department provides additional
details regarding the programs, the Company is unable to determine the full impact these programs
will have on the Company.
There can be no assurance that the Departments Participation Program and Purchase Program, the
participation facility with Union Bank, or the Companys unsecured line of credit will be adequate
to fund the Companys student loan origination and acquisition obligations. As such, the Companys
ability to originate and acquire student loans could be limited or eliminated.
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The recent credit and financial market crisis has increased the risk that a lending, investment, or
derivative counterparty will not be able to meet its obligations to the Company. As discussed
above, since the bankruptcy filing of Lehman Brothers Holdings Inc. in September 2008, the
Company has experienced funding delays from Lehman Bank for its portion of the Companys borrowing
requests under its line of credit, and the Company anticipates that Lehman Bank may not fund future
borrowing requests by the Company. In addition, as of September 30, 2008, the Company had a total
of $658.4 million invested in guaranteed investment contracts (GICs), for which there is no
available or active market. Approximately $118.3 million of these GICs are with foreign banks,
which receive support from the governments. The remaining $540.1 million of these GICs are with a
total of three banks, all of which are currently AA rated, and with one such bank representing 88%
of this amount. A default by the counterparties under the GICs could lead to a loss of the
Companys investment and have a material adverse effect on the Companys results of operations and
financial condition.
The recent reductions in the Companys student loan purchases from branding and forward flow
partners could have an adverse impact on its business.
The Company has historically acquired student loans through forward flow commitments and branding
partner arrangements with other student loan lenders. The enactment of the College Cost Reduction
Act in September 2007 resulted in a reduction in the yields on student loans and, accordingly, a
reduction in the amount of the premium the Company could pay lenders under its forward flow
commitments and branding partner arrangements. In addition, the current capital market disruptions
have rendered origination or acquisition of student loans through these channels uneconomical.
Accordingly, the Company has recently reduced the acquisition of student loans through its branding
and forward flow relationships. As a result, the Company has and will continue to experience a
decrease in its forward flow and branding partner loan volume. The Company can give no assurance
that it will be successful in renegotiating or renewing, on economically reasonable terms, its
branding and forward flow agreements once those agreements expire. Loss of a strong branding or
forward flow partner, or relationships with schools from which a significant volume of student
loans is directly or indirectly acquired, could result in an adverse effect on the Companys
business.
Recent changes in legislation may affect the Companys business and profitability.
On August 14, 2008, the Higher Education Opportunity Act became law. The Higher Education
Opportunity Act amends the Higher Education Act to revise and reauthorize Higher Education Act
programs. In addition, among other items, this legislation:
| Contains lender and school code of conduct requirements applicable to FFELP and
private education lenders; |
||
| Contains additional provisions and reporting requirements for lenders and schools
participating in preferred lender arrangements; and |
||
| Contains additional disclosures that FFELP lenders must make to borrowers as well as
added FFELP loan servicing requirements for lenders. |
The Higher Education Opportunity Act may affect the Companys profitability by increasing costs as
a result of required changes to the Companys operations.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Stock Repurchases
The following table summarizes the repurchases of Class A common stock during the third quarter of
2008 by the Company or any affiliated purchaser of the Company, as defined in Rule 10b-18(a)(3)
under the Securities Exchange Act of 1934.
Total number of | Maximum number | |||||||||||||||
shares purchased | of shares that may | |||||||||||||||
Total number | Average | as part of publicly | yet be purchased | |||||||||||||
of shares | price paid | announced plans | under the plans | |||||||||||||
Period | purchased (1) | per share | or programs (2) (3) | or programs (4) | ||||||||||||
July 1 - July 31, 2008 |
843 | $ | 10.64 | 843 | 8,006,039 | |||||||||||
August 1 - August 31, 2008 |
4,581 | 13.22 | 4,581 | 6,938,898 | ||||||||||||
September 1 - September 30, 2008 |
2,140 | 15.67 | 2,140 | 7,184,957 | ||||||||||||
Total |
7,564 | $ | 13.63 | 7,564 | ||||||||||||
(1) | The total number of shares includes: (i) shares purchased pursuant to the 2006
Plan discussed in footnote (2) below; and (ii) shares purchased pursuant to the 2006
ESLP discussed in footnote (3) below, of which there were none for the months of July,
August, or September 2008. Shares of Class A common stock purchased pursuant to the
2006 Plan included (i) 843 shares, 363 shares, and 2,140 shares in July, August, and
September, respectively, that had been issued to the Companys 401(k) plan and allocated
to employee participant accounts pursuant to the plans provisions for Company matching
contributions in shares of Company stock, and were purchased by the Company from the
plan pursuant to employee participant instructions to dispose of such shares, and (ii)
4,218 shares purchased in August 2008 from employees upon cancellation of loans
associated with shares originally acquired pursuant to the 2006 ESLP. |
|
(2) | On May 25, 2006, the Company publicly announced that its Board of Directors had
authorized a stock repurchase program to repurchase up to a total of five million shares
of the Companys Class A common stock (the 2006 Plan). On February 7, 2007, the
Companys Board of Directors increased the total shares the Company is allowed to
repurchase to 10 million. The 2006 Plan had an initial expiration date of May 24, 2008,
which was extended until May 24, 2010 by the Companys Board of Directors on January 30,
2008. |
|
(3) | On May 25, 2006, the Company publicly announced that the shareholders of the
Company approved an Employee Stock Purchase Loan Plan (the 2006 ESLP) to allow the
Company to make loans to employees for the purchase of shares of the Companys Class A
common stock either in the open market or directly from the Company. A total of $40
million in loans may be made under the 2006 ESLP, and a total of one million shares of
Class A common stock are reserved for issuance under the 2006 ESLP. Shares may be
purchased directly from the Company or in the open market through a broker at prevailing
market prices at the time of purchase, subject to any conditions or restrictions on the
timing, volume, or prices of purchases as determined by the Compensation Committee of
the Board of Directors and set forth in the Stock Purchase Loan Agreement with the
participant. The 2006 ESLP shall terminate May 25, 2016. |
|
(4) | The maximum number of shares that may yet be purchased under the plans is
calculated below. There are no assurances that any additional shares will be
repurchased under either the 2006 Plan or the 2006 ESLP. Shares under the 2006 ESLP may
be issued by the Company rather than purchased in open market transactions. |
(B / C) | (A + D) | |||||||||||||||||||
Approximate dollar | Closing price on the | Approximate | Approximate | |||||||||||||||||
Maximum number of | value of shares that | last trading | number of shares | number of shares | ||||||||||||||||
shares that may yet be | may yet be | day of the | that may yet be | that may yet be | ||||||||||||||||
purchased under the | purchased under | Companys Class A | purchased under | purchased under | ||||||||||||||||
2006 Plan | the 2006 ESLP | Common Stock | the 2006 ESLP | the 2006 Plan and | ||||||||||||||||
As of | (A) | (B) | (C) | (D) | 2006 ESLP | |||||||||||||||
July 31, 2008 |
4,624,777 | 36,450,000 | 10.78 | 3,381,262 | 8,006,039 | |||||||||||||||
August 31, 2008 |
4,620,196 | 36,450,000 | 15.72 | 2,318,702 | 6,938,898 | |||||||||||||||
September 30, 2008 |
4,618,056 | 36,450,000 | 14.20 | 2,566,901 | 7,184,957 |
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Table of Contents
Working capital and dividend restrictions/limitations
The Companys credit facilities, including its revolving line of credit which is available through
May of 2012, impose restrictions on the Companys minimum consolidated net worth, the ratio of the
Companys Adjusted EBITDA to corporate debt interest, the indebtedness of the Companys
subsidiaries, and the ratio of Non-FFELP loans to all loans in the Companys portfolio. In
addition, trust indentures and other financing agreements governing debt issued by the Companys
education lending subsidiaries may have general limitations on the amounts of funds that can be
transferred to the Company by its subsidiaries through cash dividends.
On September 27, 2006 the Company consummated a debt offering of $200.0 million aggregate principal
amount of Junior Subordinated Hybrid Securities (Hybrid Securities). So long as any Hybrid
Securities remain outstanding, if the Company gives notice of its election to defer interest
payments but the related deferral period has not yet commenced or a deferral period is continuing,
then the Company will not, and will not permit any of its subsidiaries to:
| declare or pay any dividends or distributions on, or redeem, purchase, acquire or
make a liquidation payment regarding, any of the Companys capital stock; |
||
| except as required in connection with the repayment of principal, and except for any
partial payments of deferred interest that may be made through the alternative payment
mechanism described in the Hybrid Securities indenture, make any payment of principal
of, or interest or premium, if any, on, or repay, repurchase, or redeem any of the
Companys debt securities that rank pari passu with or junior to the Hybrid Securities;
or |
||
| make any guarantee payments regarding any guarantee by the Company of the
subordinated debt securities of any of the Companys subsidiaries if the guarantee ranks
pari passu with or junior in interest to the Hybrid Securities. |
In addition, if any deferral period lasts longer than one year, the limitation on the Companys
ability to redeem or repurchase any of its securities that rank pari passu with or junior in
interest to the Hybrid Securities will continue until the first anniversary of the date on which
all deferred interest has been paid or cancelled.
If the Company is involved in a business combination where immediately after its consummation more
than 50% of the surviving entitys voting stock is owned by the shareholders of the other party to
the business combination, then the immediately preceding sentence will not apply to any deferral
period that is terminated on the next interest payment date following the date of consummation of
the business combination.
However, at any time, including during a deferral period, the Company will be permitted to:
| pay dividends or distributions in additional shares of the Companys capital stock; |
||
| declare or pay a dividend in connection with the implementation of a shareholders
rights plan, or issue stock under such a plan, or redeem or repurchase any rights
distributed pursuant to such a plan; and |
||
| purchase common stock for issuance pursuant to any employee benefit plans. |
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Table of Contents
ITEM 6. EXHIBITS
10.1* | Fourth Amendment of Amended and Restated Participation Agreement, dated as of August 1, 2005,
by and between Union Bank and Trust Company and Nelnet, Inc. (f/k/a NELnet, Inc.) (subsequently
renamed National Education Loan Network, Inc.). |
|
10.2* | Fifth Amendment of Amended and Restated Participation Agreement, dated as of November 1, 2005,
by and between Union Bank and Trust Company and Nelnet, Inc. (f/k/a NELnet, Inc.) (subsequently
renamed National Education Loan Network, Inc.). |
|
10.3* | Sixth Amendment of Amended and Restated Participation Agreement, dated as of December 12, 2005,
by and between Union Bank and Trust Company and Nelnet, Inc. (f/k/a NELnet, Inc.) (subsequently
renamed National Education Loan Network, Inc.). |
|
10.4* | Master Participation Agreement, dated as of August 14, 2008, by and between the United States
Department of Education and Nelnet, Inc. |
|
10.5* | Master Loan Sale Agreement, dated as of August 14, 2008, by and between the United States
Department of Education and Nelnet, Inc. |
|
10.6*+ | Separation Agreement, dated as of July 21, 2008, by and between Matthew D. Hall and Nelnet, Inc. |
|
31.1* | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Chief Executive
Officer Michael S. Dunlap. |
|
31.2* | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Chief Financial
Officer Terry J. Heimes. |
|
32** | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. |
* | Filed herewith |
|
** | Furnished herewith |
|
+ | Indicates a compensatory plan or arrangement |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
NELNET, INC. |
||||
Date: November 10, 2008 | By: | /s/ MICHAEL S. DUNLAP | ||
Name: | Michael S. Dunlap | |||
Title: | Chairman and Chief Executive Officer | |||
By: | /s/ TERRY J. HEIMES | |||
Name: | Terry J. Heimes | |||
Title: | Chief Financial Officer |
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Table of Contents
EXHIBIT INDEX
10.1* | Fourth Amendment of Amended and Restated Participation Agreement, dated as of August 1, 2005,
by and between Union Bank and Trust Company and Nelnet, Inc. (f/k/a NELnet, Inc.) (subsequently
renamed National Education Loan Network, Inc.). |
|
10.2* | Fifth Amendment of Amended and Restated Participation Agreement, dated as of November 1, 2005,
by and between Union Bank and Trust Company and Nelnet, Inc. (f/k/a NELnet, Inc.) (subsequently
renamed National Education Loan Network, Inc.). |
|
10.3* | Sixth Amendment of Amended and Restated Participation Agreement, dated as of December 12, 2005,
by and between Union Bank and Trust Company and Nelnet, Inc. (f/k/a NELnet, Inc.) (subsequently
renamed National Education Loan Network, Inc.). |
|
10.4* | Master Participation Agreement, dated as of August 14, 2008, by and between the United States
Department of Education and Nelnet, Inc. |
|
10.5* | Master Loan Sale Agreement, dated as of August 14, 2008, by and between the United States
Department of Education and Nelnet, Inc. |
|
10.6*+ | Separation Agreement, dated as of July 21, 2008, by and between Matthew D. Hall and Nelnet, Inc. |
|
31.1* | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Chief Executive
Officer Michael S. Dunlap. |
|
31.2* | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Chief Financial
Officer Terry J. Heimes. |
|
32** | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. |
* | Filed herewith |
|
** | Furnished herewith |
|
+ | Indicates a compensatory plan or arrangement |
81