NELNET INC - Quarter Report: 2008 June (Form 10-Q)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
(Mark
One)
x
|
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF
1934
|
For
the quarterly period ended June 30, 2008
or
¨
|
|
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
LINCOLN,
NEBRASKA
|
68508
|
(Address
of principal executive offices)
|
(Zip
Code)
|
(402)
458-2370
(Registrant’s
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 x
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.
Large
accelerated filer x
|
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
x
As
of
July 31, 2008, there were 37,969,493
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
June
30, 2008
2
|
|||
29
|
|||
65
|
|||
71
|
|||
71
|
|||
73
|
|||
74
|
|||
76
|
|||
77
|
|||
78
|
NELNET,
INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(Dollars
in thousands, except share data)
As of
|
As of
|
||||||
June 30, 2008
|
December 31, 2007
|
||||||
(unaudited)
|
|||||||
Assets:
|
|||||||
Student
loans receivable (net of allowance for loan losses of $47,909 and
$45,592,
respectively)
|
$
|
25,993,307
|
26,736,122
|
||||
Cash
and cash equivalents:
|
|||||||
Cash
and cash equivalents - not held at a related party
|
15,629
|
38,305
|
|||||
Cash
and cash equivalents - held at a related party
|
122,825
|
73,441
|
|||||
Total
cash and cash equivalents
|
138,454
|
111,746
|
|||||
Restricted
cash
|
912,252
|
842,020
|
|||||
Restricted
investments
|
95,061
|
85,227
|
|||||
Restricted
cash - due to customers
|
29,543
|
81,845
|
|||||
Accrued
interest receivable
|
501,544
|
593,322
|
|||||
Accounts
receivable, net
|
45,986
|
49,084
|
|||||
Goodwill
|
175,178
|
164,695
|
|||||
Intangible
assets, net
|
90,163
|
112,830
|
|||||
Property
and equipment, net
|
46,429
|
55,797
|
|||||
Other
assets
|
108,662
|
107,624
|
|||||
Fair
value of derivative instruments
|
295,346
|
222,471
|
|||||
Total
assets
|
$
|
28,431,925
|
29,162,783
|
||||
Liabilities:
|
|||||||
Bonds
and notes payable
|
$
|
27,530,237
|
28,115,829
|
||||
Accrued
interest payable
|
86,496
|
129,446
|
|||||
Other
liabilities
|
162,761
|
220,899
|
|||||
Due
to customers
|
29,543
|
81,845
|
|||||
Fair
value of derivative instruments
|
38,846
|
5,885
|
|||||
Total
liabilities
|
27,847,883
|
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
37,952,246 shares as of June 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 June 30, 2008 and December 31,
2007
|
115
|
115
|
|||||
Additional
paid-in capital
|
99,854
|
96,185
|
|||||
Retained
earnings
|
485,739
|
515,317
|
|||||
Employee
notes receivable
|
(2,046
|
)
|
(3,118
|
)
|
|||
Total
shareholders' equity
|
584,042
|
608,879
|
|||||
Commitments
and contingencies
|
|||||||
Total
liabilities and shareholders' equity
|
$
|
28,431,925
|
29,162,783
|
See
accompanying notes to consolidated financial statements.
NELNET,
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
(Dollars
in thousands, except share data)
(unaudited)
Three
months
|
Six
months
|
||||||||||||
ended
June 30,
|
ended
June 30,
|
||||||||||||
2008
|
2007
|
2008
|
2007
|
||||||||||
Interest
income:
|
|||||||||||||
Loan
interest
|
$
|
296,686
|
417,086
|
626,672
|
814,140
|
||||||||
Investment
interest
|
9,116
|
18,783
|
20,796
|
40,208
|
|||||||||
Total
interest income
|
305,802
|
435,869
|
647,468
|
854,348
|
|||||||||
Interest
expense:
|
|||||||||||||
Interest
on bonds and notes payable
|
232,464
|
367,893
|
557,605
|
718,388
|
|||||||||
Net
interest income
|
73,338
|
67,976
|
89,863
|
135,960
|
|||||||||
Less
provision for loan losses
|
6,000
|
2,535
|
11,000
|
5,288
|
|||||||||
Net
interest income after provision for loan losses
|
67,338
|
65,441
|
78,863
|
130,672
|
|||||||||
Other
income (expense):
|
|||||||||||||
Loan
and guaranty servicing income
|
24,904
|
31,610
|
51,017
|
62,076
|
|||||||||
Other
fee-based income
|
40,817
|
38,262
|
86,730
|
78,291
|
|||||||||
Software
services income
|
4,896
|
5,848
|
11,648
|
11,596
|
|||||||||
Other
income
|
1,646
|
1,927
|
3,056
|
7,020
|
|||||||||
Gain
(loss) on sale of loans
|
48
|
1,010
|
(47,426
|
)
|
2,796
|
||||||||
Derivative
market value, foreign currency, and put option adjustments and derivative
settlements, net
|
20,192
|
10,743
|
3,594
|
2,853
|
|||||||||
Total
other income
|
92,503
|
89,400
|
108,619
|
164,632
|
|||||||||
Operating
expenses:
|
|||||||||||||
Salaries
and benefits
|
43,549
|
59,761
|
97,392
|
121,465
|
|||||||||
Other
operating expenses:
|
|||||||||||||
Impairment
expense
|
—
|
—
|
18,834
|
—
|
|||||||||
Advertising
and marketing
|
16,143
|
15,456
|
32,346
|
29,449
|
|||||||||
Depreciation
and amortization
|
10,603
|
10,647
|
21,437
|
21,657
|
|||||||||
Professional
and other services
|
8,478
|
10,514
|
16,585
|
18,883
|
|||||||||
Occupancy
and communications
|
4,914
|
5,032
|
10,755
|
10,251
|
|||||||||
Postage
and distribution
|
2,743
|
5,624
|
6,560
|
10,143
|
|||||||||
Trustee
and other debt related fees
|
2,464
|
2,785
|
4,854
|
5,628
|
|||||||||
Other
|
9,028
|
10,827
|
17,996
|
24,399
|
|||||||||
Total
other operating expenses
|
54,373
|
60,885
|
129,367
|
120,410
|
|||||||||
Total
operating expenses
|
97,922
|
120,646
|
226,759
|
241,875
|
|||||||||
Income
(loss) before income taxes
|
61,919
|
34,195
|
(39,277
|
)
|
53,429
|
||||||||
Income
tax expense (benefit)
|
19,195
|
13,306
|
(12,176
|
)
|
20,570
|
||||||||
Income
(loss) from continuing operations
|
42,724
|
20,889
|
(27,101
|
)
|
32,859
|
||||||||
Income
(loss) from discontinued operations, net of tax
|
981
|
(6,135
|
)
|
981
|
(3,325
|
)
|
|||||||
Net
income (loss)
|
$
|
43,705
|
14,754
|
(26,120
|
)
|
29,534
|
|||||||
Earnings
(loss) per share, basic and diluted:
|
|||||||||||||
Income
(loss) from continuing operations
|
0.87
|
0.42
|
(0.55
|
)
|
0.66
|
||||||||
Income
(loss) from discontinued operations
|
0.02
|
(0.12
|
)
|
0.02
|
(0.07
|
)
|
|||||||
Net
income (loss)
|
$
|
0.89
|
0.30
|
(0.53
|
)
|
0.59
|
See
accompanying notes to consolidated financial statements.
NELNET,
INC. AND SUBSIDIARIES
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 March 31, 2007
|
—
|
38,097,623
|
11,495,377
|
$
|
—
|
381
|
115
|
105,345
|
507,596
|
(2,701
|
)
|
382
|
611,118
|
|||||||||||||||||||||
Comprehensive
income:
|
||||||||||||||||||||||||||||||||||
Net
income
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
14,754
|
—
|
—
|
14,754
|
|||||||||||||||||||||||
Other
comprehensive income:
|
||||||||||||||||||||||||||||||||||
Foreign
currency translation
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
(574
|
)
|
(574
|
)
|
|||||||||||||||||||||
Non-pension
postretirement benefit plan
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
192
|
192
|
|||||||||||||||||||||||
Total
comprehensive income
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
14,372
|
|||||||||||||||||||||||
Cash
dividend on Class A and Class B common stock - $0.07 per
share
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
(3,440
|
)
|
—
|
—
|
(3,440
|
)
|
|||||||||||||||||||||
Issuance
of common stock, net of forfeitures
|
—
|
39,182
|
—
|
—
|
1
|
—
|
880
|
—
|
—
|
—
|
881
|
|||||||||||||||||||||||
Compensation
expense for stock based awards
|
—
|
—
|
—
|
—
|
—
|
—
|
772
|
—
|
—
|
—
|
772
|
|||||||||||||||||||||||
Repurchase
of common stock
|
—
|
(998
|
)
|
—
|
—
|
—
|
—
|
(22
|
)
|
—
|
—
|
—
|
(22
|
)
|
||||||||||||||||||||
Acquisition
of enterprise under common control
|
—
|
(474,426
|
)
|
—
|
—
|
(5
|
)
|
—
|
(12,502
|
)
|
—
|
—
|
—
|
(12,507
|
)
|
|||||||||||||||||||
Reduction
of employee stock notes receivable
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
4
|
—
|
4
|
|||||||||||||||||||||||
Balance
as of June 30, 2007
|
—
|
37,661,381
|
11,495,377
|
$
|
—
|
377
|
115
|
94,473
|
518,910
|
(2,697
|
)
|
—
|
611,178
|
|||||||||||||||||||||
Balance
as of March 31, 2008
|
—
|
37,912,773
|
11,495,377
|
$
|
—
|
379
|
115
|
97,875
|
442,034
|
(2,296
|
)
|
—
|
538,107
|
|||||||||||||||||||||
Comprehensive
income:
|
||||||||||||||||||||||||||||||||||
Net
income
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
43,705
|
—
|
—
|
43,705
|
|||||||||||||||||||||||
Total
comprehensive income
|
43,705
|
|||||||||||||||||||||||||||||||||
Issuance
of common stock, net of forfeitures
|
—
|
53,467
|
—
|
—
|
1
|
—
|
310
|
—
|
—
|
—
|
311
|
|||||||||||||||||||||||
Compensation
expense for stock based awards
|
—
|
—
|
—
|
—
|
—
|
—
|
1,848
|
—
|
—
|
—
|
1,848
|
|||||||||||||||||||||||
Repurchase
of common stock
|
—
|
(13,994
|
)
|
—
|
—
|
—
|
—
|
(179
|
)
|
—
|
—
|
—
|
(179
|
)
|
||||||||||||||||||||
Reduction
of employee stock notes receivable
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
250
|
—
|
250
|
|||||||||||||||||||||||
Balance
as of June 30, 2008
|
—
|
37,952,246
|
11,495,377
|
$
|
—
|
380
|
115
|
99,854
|
485,739
|
(2,046
|
)
|
—
|
584,042
|
|||||||||||||||||||||
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
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
29,534
|
—
|
—
|
29,534
|
|||||||||||||||||||||||
Other
comprehensive income:
|
||||||||||||||||||||||||||||||||||
Foreign
currency translation
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
(322
|
)
|
(322
|
)
|
|||||||||||||||||||||
Non-pension
postretirement benefit plan
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
191
|
191
|
|||||||||||||||||||||||
Total
comprehensive income
|
29,403
|
|||||||||||||||||||||||||||||||||
Cash
dividend on Class A and Class B common stock - $0.14 per
share
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
(6,904
|
)
|
—
|
—
|
(6,904
|
)
|
|||||||||||||||||||||
Adjustment
to adopt provisions of
|
||||||||||||||||||||||||||||||||||
FASB
Interpretation No. 48
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
(61
|
)
|
—
|
—
|
(61
|
)
|
|||||||||||||||||||||
Issuance
of common stock, net of forfeitures
|
—
|
152,273
|
—
|
—
|
2
|
—
|
3,219
|
—
|
—
|
—
|
3,221
|
|||||||||||||||||||||||
Compensation
expense for stock based awards
|
—
|
—
|
—
|
—
|
—
|
—
|
1,530
|
—
|
—
|
—
|
1,530
|
|||||||||||||||||||||||
Repurchase
of common stock
|
—
|
(3,062,070
|
)
|
—
|
—
|
(30
|
)
|
—
|
(75,452
|
)
|
—
|
—
|
—
|
(75,482
|
)
|
|||||||||||||||||||
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 June 30, 2007
|
—
|
37,661,381
|
11,495,377
|
$
|
—
|
377
|
115
|
94,473
|
518,910
|
(2,697
|
)
|
—
|
611,178
|
|||||||||||||||||||||
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
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
(26,120
|
)
|
—
|
—
|
(26,120
|
)
|
|||||||||||||||||||||
Total
comprehensive income (loss)
|
(26,120
|
)
|
||||||||||||||||||||||||||||||||
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
|
—
|
33,687
|
—
|
—
|
—
|
—
|
1,073
|
—
|
—
|
—
|
1,073
|
|||||||||||||||||||||||
Compensation
expense for stock based awards
|
—
|
—
|
—
|
—
|
—
|
—
|
3,263
|
—
|
—
|
—
|
3,263
|
|||||||||||||||||||||||
Repurchase
of common stock
|
—
|
(62,058
|
)
|
—
|
—
|
—
|
—
|
(667
|
)
|
—
|
—
|
—
|
(667
|
)
|
||||||||||||||||||||
Reduction
of employee stock notes receivable
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
1,072
|
—
|
1,072
|
|||||||||||||||||||||||
Balance
as of June 30, 2008
|
—
|
37,952,246
|
11,495,377
|
$
|
—
|
380
|
115
|
99,854
|
485,739
|
(2,046
|
)
|
—
|
584,042
|
See
accompanying notes to consolidated financial statements.
NELNET,
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(Dollars
in thousands)
(unaudited)
Six
months ended June 30,
|
|||||||
2008
|
2007
|
||||||
Net
income (loss)
|
$
|
(26,120
|
)
|
29,534
|
|||
Income
(loss) from discontinued operations
|
981
|
(3,325
|
)
|
||||
Income
(loss) from continuing operations
|
(27,101
|
)
|
32,859
|
||||
Adjustments
to reconcile income from continuing operations to net cash provided
by
operating activities, net of business acquisitions:
|
|||||||
Depreciation
and amortization, including loan premiums and deferred origination
costs
|
74,312
|
150,465
|
|||||
Derivative
market value adjustment
|
(47,462
|
)
|
(20,374
|
)
|
|||
Foreign
currency transaction adjustment
|
88,530
|
24,974
|
|||||
Change
in value of put options issued in business acquisitions
|
538
|
1,983
|
|||||
Proceeds
from termination of derivative instruments
|
7,547
|
—
|
|||||
Payments
to terminate floor contracts
|
—
|
(8,100
|
)
|
||||
Impairment
expense
|
18,834
|
—
|
|||||
Loss
on sale of business
|
—
|
9,041
|
|||||
Loss
(gain) on sale of student loans
|
47,426
|
(2,796
|
)
|
||||
Non-cash
compensation expense
|
4,372
|
2,591
|
|||||
Deferred
income tax benefit
|
(24,237
|
)
|
(921
|
)
|
|||
Provision
for loan losses
|
11,000
|
5,288
|
|||||
Other
non-cash items
|
344
|
(2,906
|
)
|
||||
Decrease
(increase) in accrued interest receivable
|
91,778
|
(81,421
|
)
|
||||
Decrease
(increase) in accounts receivable
|
3,098
|
(6,698
|
)
|
||||
Decrease
in other assets
|
9,419
|
6,491
|
|||||
Decrease
in accrued interest payable
|
(42,950
|
)
|
(1,545
|
)
|
|||
(Decrease)
increase in other liabilities
|
(28,351
|
)
|
5,667
|
||||
Net
cash flows from operating activities - continuing
operations
|
187,097
|
114,598
|
|||||
Net
cash flows from operating activities - discontinued
operations
|
—
|
(4,467
|
)
|
||||
Net
cash provided by operating activities
|
187,097
|
110,131
|
|||||
Cash
flows from investing activities, net of business
acquisitions:
|
|||||||
Originations,
purchases, and consolidations of student loans, including loan premiums
and deferred origination costs
|
(1,480,305
|
)
|
(3,390,016
|
)
|
|||
Purchases
of student loans, including loan premiums, from a related
party
|
(212,888
|
)
|
(191,003
|
)
|
|||
Net
proceeds from student loan repayments, claims, capitalized interest,
participations, and other
|
1,061,510
|
1,060,117
|
|||||
Proceeds
from sale of student loans
|
1,267,826
|
89,311
|
|||||
Purchases
of property and equipment, net
|
(3,721
|
)
|
(13,830
|
)
|
|||
(Increase)
decrease in restricted cash
|
(70,232
|
)
|
279,349
|
||||
Purchases
of restricted investments
|
(170,512
|
)
|
(239,691
|
)
|
|||
Proceeds
from maturities of restricted investments
|
160,678
|
261,597
|
|||||
Purchases
of equity method investments
|
(2,988
|
)
|
—
|
||||
Distributions
from equity method investments
|
—
|
434
|
|||||
Business
acquisitions, net of cash acquired
|
(18,000
|
)
|
2,211
|
||||
Proceeds
from sale of business, net of cash sold
|
—
|
7,551
|
|||||
Net
cash flows from investing activities - continuing
operations
|
531,368
|
(2,133,970
|
)
|
||||
Net
cash flows from investing activities - discontinued
operations
|
—
|
(294
|
)
|
||||
Net
cash provided by (used in) investing activities
|
531,368
|
(2,134,264
|
)
|
||||
Cash
flows from financing activities:
|
|||||||
Payments
on bonds and notes payable
|
(5,444,408
|
)
|
(1,435,054
|
)
|
|||
Proceeds
from issuance of bonds and notes payable
|
4,761,143
|
3,601,480
|
|||||
Proceeds
(payments) from issuance of notes payable due to a related party,
net
|
9,269
|
(55,715
|
)
|
||||
Payments
of debt issuance costs
|
(14,634
|
)
|
(5,899
|
)
|
|||
Dividends
paid
|
(3,458
|
)
|
(6,904
|
)
|
|||
Proceeds
from issuance of common stock
|
423
|
951
|
|||||
Repurchases
of common stock
|
(667
|
)
|
(75,482
|
)
|
|||
Payments
received on employee stock notes receivable
|
575
|
128
|
|||||
Net
cash flows from financing activities - continuing
operations
|
(691,757
|
)
|
2,023,505
|
||||
Net
cash flows from financing activities - discontinued
operations
|
—
|
—
|
|||||
Net
cash (used in) provided by financing activities
|
(691,757
|
)
|
2,023,505
|
||||
Effect
of exchange rate fluctuations on cash
|
—
|
548
|
|||||
Net
increase (decrease) in cash and cash equivalents
|
26,708
|
(80
|
)
|
||||
Cash
and cash equivalents, beginning of period
|
111,746
|
106,086
|
|||||
Cash
and cash equivalents, end of period
|
$
|
138,454
|
106,006
|
||||
Supplemental
disclosures of cash flow information:
|
|||||||
Interest
paid
|
$
|
589,578
|
630,175
|
||||
Income
taxes paid, net of refunds
|
$
|
14,126
|
12,130
|
See
accompanying notes to consolidated financial statements.
NELNET,
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Information
as of June 30, 2008 and for the three months and six months
ended
June
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 June 30, 2008 and for the three and six
months ended June 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 Company’s 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 six months ended June
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 Company’s 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 during the current period, 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 June 30,
|
Six
months ended June 30,
|
||||||||||||
2008
|
2007
|
2008
|
2007
|
||||||||||
Operating
income of discontinued operations
|
$
|
—
|
4,864
|
—
|
9,278
|
||||||||
Income
tax on operations
|
—
|
(1,958
|
)
|
—
|
(3,562
|
)
|
|||||||
Gain
(loss) on disposal
|
1,966
|
(8,151
|
)
|
1,966
|
(8,151
|
)
|
|||||||
Income
tax on disposal
|
(985
|
)
|
(890
|
)
|
(985
|
)
|
(890
|
)
|
|||||
Income
(loss) from discontinued operations, net of tax
|
$
|
981
|
(6,135
|
)
|
981
|
(3,325
|
)
|
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
Company’s interest expense is included within continuing
operations.
Three months ended
|
Six months ended
|
||||||
June 30, 2007
|
June 30, 2007
|
||||||
Net
interest income
|
$
|
53
|
124
|
||||
Other
income
|
12,480
|
31,511
|
|||||
Operating
expenses
|
(7,669
|
)
|
(22,357
|
)
|
|||
Income
before income taxes
|
4,864
|
9,278
|
|||||
Income
tax expense
|
1,958
|
3,562
|
|||||
Operating
income of discontinued operations, net of tax
|
$
|
2,906
|
5,716
|
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 Company’s 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 Act, 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 Company’s student loan business model,
including lowering the cost of student loan acquisition, creating efficiencies
in the Company’s 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.
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
|
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 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 of approximately 300 positions and realignment of certain
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
during
the three months ended March 31, 2008 and income of $0.4 million
during
the three months ended June 30, 2008 to recognize adjustments from initial
estimates.
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
|
(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
|
March 31, 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 Company’s management that the disposition or
ultimate determination of these claims, lawsuits, and proceedings will not
have
a material adverse effect on the Company’s business, financial position, or
results of operations.
Municipal
Derivative Bid Practices Investigation
On
February 8, 2008, Shockley Financial Corp. (“SFC”), an indirect wholly owned
subsidiary of the Company with two associates 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
Justice’s 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. The Company and SFC are cooperating with the investigation.
In
addition, 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. The subpoena seeks
certain information and documents from SFC relating to its GIC business. The
Company and SFC are cooperating with the investigation.
On
or
about June 6, 2008, SFC received a subpoena from the New York Attorney General
(the “NYAG”) relating to the NYAG’s investigation concerning the bidding of
municipal GICs and possible violations of various state and federal laws. The
subpoena seeks certain information and documents from SFC relating to its GIC
business. The Company and SFC are cooperating with the
investigation.
On
or
about June 12, 2008, SFC received a subpoena from the Florida Attorney General
(the “FLAG”) relating to the FLAG’s investigation concerning the bidding of
municipal GICs and possible violations of various state and federal laws. The
subpoena seeks certain information and documents from SFC relating to its GIC
business. The Company and SFC are cooperating with the investigation.
SFC has also been named as a defendant in a total of eight 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 has also been named as a defendant in a total of eight 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 NYAG’s
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 NYAG’s Code of Conduct, which is substantially similar to
the Company's 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 seniors and their parents regarding
the
financial aid process.
On
October 10, 2007, the Company received a subpoena from the NYAG requesting
certain information and documents from the Company in connection with the NYAG’s
investigation into direct-to-consumer marketing practices of student lenders.
The Company is cooperating with the subpoena.
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 Department’s 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 of
Education notified the Company that it would be conducting a review of the
Company’s administration of the FFEL Program under the Higher Education Act. The
Company understands that the Department of Education has selected several
schools and lenders for review. Specifically, the Department is reviewing the
Company’s 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 Department of Education’s requests for information
and documentation and is cooperating with their review.
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
Department’s guidance regarding those rules and regulations.
Department
of Justice
In
connection with the Company’s 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 Company’s 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 Department’s 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 Company’s 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 will apply
prospectively beginning on July 1, 2008. Management believes that a July 1,
2008
prospective application of the Private Letter Ruling will not have a significant
impact on the Company’s operating results.
Legislative
Developments
On
May 7,
2008, the President signed into law H.R. 5715, the Ensuring Continued Access
to
Student Loans Act of 2008 (“HR 5715”). This legislation contains provisions that
expand the federal government’s support of financing the cost of higher
education. Among other things, HR 5715:
·
|
Increases
statutory limits on annual and aggregate borrowing for FFELP loans;
and
|
·
|
Allows
the Department to act as a secondary market and enter into forward
purchasing agreements with lenders.
|
As
a
result of this legislation, the Departments of Education and Treasury developed
a plan. Among other things, this plan:
·
|
Offers
to purchase 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 will
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 HR 5715, 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 Department’s
programs.
On
August
6, 2008, having passed in identical form in both the House of Representatives
and the Senate, the Higher Education Opportunity Act was sent to the President.
Upon the President’s approval, this legislation will become law. The Higher
Education Opportunity Act amends the Higher Education Act of 1965 (“HEA”) to
revise and reauthorize HEA 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.
|
5.
Student Loans Receivable and Allowance for Loan Losses
Student
loans receivable consisted of the following:
As of
|
As of
|
||||||
June 30, 2008
|
December 31, 2007
|
||||||
Federally
insured loans
|
$
|
25,332,173
|
26,054,398
|
||||
Non-federally
insured loans
|
279,953
|
274,815
|
|||||
25,612,126
|
26,329,213
|
||||||
Unamortized
loan premiums and deferred origination costs
|
429,090
|
452,501
|
|||||
Allowance
for loan losses - federally insured loans
|
(24,084
|
)
|
(24,534
|
)
|
|||
Allowance
for loan losses - non-federally insured loans
|
(23,825
|
)
|
(21,058
|
)
|
|||
$
|
25,993,307
|
26,736,122
|
|||||
Federally
insured allowance as a percentage of ending balance of federally
insured
loans
|
0.10
|
%
|
0.09
|
%
|
|||
Non-federally
insured allowance as a percentage of ending balance of non-federally
insured loans
|
8.51
|
%
|
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 Company’s multi-year committed financing facility for
FFELP loans, which reduced the Company’s 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 Company’s asset
management
strategy, the Company periodically sells student loan portfolios to third
parties. During the three and six months ended June 30, 2007, the Company sold
$34.4 million
(par
value) and $86.0 million
(par
value), respectively, of federally insured student loans resulting in the
recognition of gains of $1.0 million
and $2.8
million,
respectively.
6. Intangible
Assets and Goodwill
Intangible
assets consist of the following:
Weighted
|
||||||||||
average
|
||||||||||
remaining
|
||||||||||
useful life as of
|
As of
|
As of
|
||||||||
June 30,
|
June 30,
|
December 31,
|
||||||||
2008
|
2008
|
2007
|
||||||||
Amortizable
intangible assets:
|
||||||||||
Customer
relationships (net of accumulated amortization of $25,048 and $20,299,
respectively)
|
112
|
$
|
55,312
|
60,061
|
||||||
Trade
names (net of accumulated amortization of $3,372 and $1,258,
respectively)
|
47
|
13,687
|
1,609
|
|||||||
Covenants
not to compete (net of accumulated amortization of $11,939 and $11,815,
respectively)
|
25
|
11,683
|
15,425
|
|||||||
Database
and content (net of accumulated amortization of $4,320 and $3,193,
respectively)
|
28
|
5,160
|
6,287
|
|||||||
Computer
software (net of accumulated amortization of $6,238 and $4,898,
respectively)
|
15
|
2,764
|
4,189
|
|||||||
Student
lists (net of accumulated amortization of $6,831 and $5,806,
respectively)
|
8
|
1,366
|
2,391
|
|||||||
Other
(net of accumulated amortization of $83 and $71,
respectively)
|
92
|
191
|
203
|
|||||||
Loan
origination rights (net of accumulated amortization of
$8,180)
|
—
|
—
|
8,473
|
|||||||
Total
- amortizable intangible assets
|
81
months
|
90,163
|
98,638
|
|||||||
Unamortizable
intangible assets - trade names
|
—
|
14,192
|
||||||||
|
$
|
90,163
|
112,830
|
As
disclosed in note 3,
as a
result of the disruption in the debt and secondary markets and the student
loan
business model modifications the Company implemented due to the disruption,
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 Company’s 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.
The
Company recorded amortization expense on its intangible assets of $6.6
million
and $6.5
million for the three months ended June 30, 2008 and 2007, respectively, and
$13.1 million
for the
six months ended June 30, 2008 and 2007, respectively. The Company will continue
to amortize intangible assets over their remaining useful lives. As of June
30,
2008, the Company estimates it will record amortization expense as
follows:
2008
|
$
|
13,109
|
||
2009
|
22,319
|
|||
2010
|
15,985
|
|||
2011
|
10,031
|
|||
2012
|
9,029
|
|||
2013
and thereafter
|
19,690
|
|||
$
|
90,163
|
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 Company’s obligations
related to the contingencies per the terms of the purchase
agreement.
|
(b)
|
During
the quarter ended June 30, 2008, there was no change in
goodwill.
|
7.
Bonds and Notes Payable
The
following tables summarize outstanding bonds and notes payable by type of
instrument:
As of June 30, 2008
|
||||||||||
Carrying
|
Interest rate
|
|||||||||
amount
|
range
|
Final maturity
|
||||||||
Variable-rate
bonds and notes (a):
|
||||||||||
Bonds
and notes based on indices
|
$
|
21,339,035
|
2.65%
- 4.97
|
%
|
09/25/13
- 06/25/41
|
|||||
Bonds
and notes based on auction or remarketing
|
2,841,245
|
0.67%
- 7.00
|
%
|
11/01/09
- 07/01/43
|
||||||
Total
variable-rate bonds and notes
|
24,180,280
|
|||||||||
Commercial
paper - FFELP facility (b)
|
1,986,212
|
2.08%
- 2.91
|
%
|
05/09/10
|
||||||
Commercial
paper - private loan facility (b)
|
159,800
|
3.08
|
%
|
03/14/09
|
||||||
Fixed-rate
bonds and notes (a)
|
207,376
|
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
|
450,000
|
2.90
|
%
|
05/08/12
|
||||||
Other
borrowings
|
71,569
|
3.19%
- 5.10
|
%
|
05/22/09
- 11/01/15
|
||||||
$
|
27,530,237
|
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 (b)
|
6,629,109
|
5.22%
- 5.98
|
%
|
05/09/10
|
||||||
Commercial
paper - private loan facility (b)
|
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) |
Loan
warehouse facilities
|
Secured
Financing Transactions
The
Company relies 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 Company’s 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 Company’s
secured financing vehicles are loan warehouse facilities and asset-backed
securitizations.
Loan
warehouse facilities
Student
loan warehousing allows 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 private loan warehouse for non-federally
insured student loans, and a single-seller extendible commercial paper conduit
for FFELP loans.
The
multi-year committed facility for FFELP loans, which terminates in May 2010,
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
an
outstanding balance of approximately $2.8 billion
and a final maturity date of May 9, 2010. 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 must refinance or remove
approximately $900 million of loans by May 2009 to satisfy this provision.
Pursuant to the terms of the agreement, since liquidity was not renewed, the
Company’s 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.
The
terms
and conditions of the Company’s warehouse facility for FFELP loans provide for
advance rates related to financed loans subject to a valuation formula based
on
current market conditions. Dislocation in the credit markets including
disruptions in the current capital markets can and will cause short-term
volatility in the loan valuation formulas. Severe volatility and dislocation
in
the credit markets, even if temporary, could cause the valuation assigned to
the
Company’s student loan portfolio financed by the applicable line to be
significantly less than par. Should a significant change in the valuation of
subject loans result in a reduction in advance rate and require equity support
greater than what the Company can or is willing to provide, the facility could
be subject to termination. While the Company does not believe the loan valuation
formula is reflective of the fair market value of its loans, it is subject
to
compliance with provisions of the warehouse documents. As of August 8, 2008,
the
Company has $135.3 million
utilized
as equity funding support based on provisions of this agreement.
The
private loan warehouse facility is an uncommitted facility that is offered
to
the Company by a banking partner, which terminates on March 14, 2009. As of
June
30, 2008, $159.8 million
was outstanding under this facility and $90.2 million
was available for future use. As of August 8, 2008, $132.0
million
was outstanding under this facility and $118.0
million
was available for future use. 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 August 8, 2008, the Company has $54.5
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 Company’s 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.
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
June
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 future.
The
Company expects to access alternative sources of funding to originate new FFELP
student loans, including the Department of Education’s Loan Participation
Program (“Participation Program”), an existing facility with Union Bank and
Trust Company (“Union Bank”), an entity under common control with the Company,
and its $750 million
unsecured operating line of credit.
On
July
1, 2008, pursuant to HR 5715, the Department of Education announced terms under
which it will offer to purchase FFELP student loans and loan participations
from
FFELP lenders. Under the Department’s 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. Lenders
will have until September 30, 2009, to sell loans to the Department. Under
the
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 Department’s
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. The Company is in the process of completing and filing all
relevant documents to participate in the Department of Education’s Participation
Program and expects to utilize the Participation Program to fund a significant
portion of its loan originations for the 2008-2009 academic
year.
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 June 30, 2008 and August 8, 2008, approximately
$228.7 million
and
$56.4
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 Bank’s 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
Company’s 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 Company’s 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 Company’s
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 Company’s 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 June 30, 2008 and December 31, 2007, the Euro Notes
were recorded on the Company’s balance sheet at $1.2 billion
and $1.1
billion,
respectively. The change in the principal amount of Euro Notes as a result
of
the fluctuation of the foreign currency exchange rate was a decrease of $4.4
million
and an
increase of $88.5 million
for the
three and six months ended June 30, 2008, respectively, and increases of $11.3
million
and
$25.0 million
for the
three and six months ended June 30, 2007, respectively, and is 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.
The
interest rates on certain of the Company's 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 $2.0
billion
of
Auction Rate Securities and $0.9 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 Company’s Auction Rate Securities
have failed in this manner. Under normal conditions, banks have historically
stepped in when investor demand is weak. However, recently 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
June
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 June 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 does not expect this funding benefit on its Auction Rate Securities
in future periods.
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 million
unsecured line of credit that terminates in May 2012. As of June 30, 2008,
there
was $450.0 million
outstanding on this line and $300.0 million
available for future use. The weighted average interest rate on this line of
credit was 2.90%
as of
June 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 August
8,
2008, the Company has contributed $189.8
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
August 8, 2008, the Company has $450.0
million outstanding under this line of credit and $300.0
million
available for future uses.
The
Company has a $725.0 million
unsecured commercial paper program in which the Company may issue commercial
paper for general corporate purposes. The maturities of the notes issued under
this program will vary, but may not exceed 397 days from the date of issue.
Notes issued under this program will bear interest at rates that will vary
based
on market conditions at the time of issuance. As of June 30, 2008, there were
no
borrowings outstanding on this line and $725.0 million
of
remaining authorization. The Company does not expect to be able to issue
unsecured commercial paper in the near or intermediate future at a cost
effective level relative to the Company’s unsecured line of credit.
Other
Borrowings
As
of
June 30, 2008 and December 31, 2007, bonds and notes payable includes $66.6
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.
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 Company’s 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 Company’s 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 new legislation enacted
in
2006, lenders are required to rebate floor income and variable-rate floor income
to the Department for all net 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.
As
of
June 30, 2008, the Company held the following interest rate derivatives to
hedge
fixed-rate student loan assets earning fixed rate floor income or variable-rate
floor income.
Weighted
|
|||||||
average fixed
|
|||||||
Notional
|
rate paid by
|
||||||
Maturity
|
Amount
|
the Company (a)
|
|||||
2008 (b)
|
$
|
2,000,000
|
4.18
|
%
|
|||
2009
|
500,000
|
4.08
|
|||||
2010
|
700,000
|
3.44
|
|||||
2011
|
500,000
|
3.57
|
|||||
2012
|
250,000
|
3.86
|
|||||
$
|
3,950,000
|
3.94
|
%
|
(a) |
For
all interest rate derivatives for which the Company pays a fixed
rate, the
Company receives discrete three-month
LIBOR.
|
(b)
|
The
maturity date on these derivatives is June 30, 2008. The Company
has
hedged a portion of its student loan portfolio in which the borrower
interest rate resets annually on July 1. These loans can generate
excess
spread income compared with the rate based on the special allowance
formula in declining interest rate environments. As discussed above,
the
Company refers to this additional income as variable-rate floor
income.
|
In
April
2008 and May 2008, the Company entered into interest rate swaps with notional
amounts of $200.0 million
and $250.0
million which had forward-start dates of July 25, 2008 and June 25, 2008,
respectively. The Company receives a fixed rate of 2.9805%
and
3.693%,
respectively, and pays discrete three-month LIBOR. These trades offset $450.0
million of fixed rate swaps previously entered into by the Company (included
in
the above table) and were executed in order to maintain the Company’s desired
hedge ratio.
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 June 30, 2008:
Notional
Amount (a)
|
||||||||||||||||
Maturity
|
Effective date in second
quarter 2007
|
Effective date in third
quarter 2007
|
Effective date in second
quarter 2008
|
Effective date in third
quarter 2008
|
Total
|
|||||||||||
2008
|
$
|
1,000,000
|
2,000,000
|
—
|
—
|
3,000,000
|
||||||||||
2009
|
2,000,000
|
4,000,000
|
—
|
3,000,000
|
(b)(f)
|
9,000,000
|
||||||||||
2010
|
500,000
|
2,000,000
|
(c)
|
2,000,000
|
1,000,000
|
5,500,000
|
||||||||||
2011
|
—
|
(d)
|
2,700,000
|
—
|
—
|
2,700,000
|
||||||||||
2012
|
—
|
(e)
|
1,000,000
|
(f)
|
800,000
|
1,600,000
|
3,400,000
|
|||||||||
$
|
3,500,000
|
11,700,000
|
2,800,000
|
5,600,000
|
23,600,000
|
(a)
|
All
basis swaps were executed by the Company during the second quarter
2007,
unless otherwise noted.
|
(b)
|
Executed
by the Company during the second quarter
2008.
|
(c)
|
In
March 2008, the Company terminated a basis swap with a notional amount
of
$1.0 billion, which is not included in the table
above.
|
(d)
|
In
March 2008, the Company terminated a basis swap with a notional amount
of
$1.35 billion, which is not included in the table
above.
|
(e)
|
In
March 2008, the Company terminated a basis swap with a notional amount
of
$0.5 billion, which is not included in the table
above.
|
(f)
|
In
July 2008, the Company terminated these basis
swaps.
|
During
the first quarter of 2008, the Company unwound three, 10 year basis swaps with
notional amounts of $500 million
each in
which the Company received three-month LIBOR and paid one-month LIBOR less
a
spread as defined in the individual agreements.
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 Company’s derivative transactions with the intent that each is economically
effective; however, the Company’s 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.
The
following table summarizes the net fair value of the Company’s derivative
portfolio:
As of
|
As of
|
||||||
June 30, 2008
|
December 31, 2007
|
||||||
Interest
rate swaps
|
$
|
1,403
|
(2,695
|
)
|
|||
Basis
swaps
|
(28,326
|
)
|
27,525
|
||||
Cross-currency
interest rate swaps
|
283,423
|
191,756
|
|||||
Net
fair value
|
$
|
256,500
|
216,586
|
The
change in the fair value of the Company’s derivative portfolio included in
“derivative market value, foreign currency, and put option adjustments and
derivative settlements, net” on the Company’s consolidated statements of
operations resulted in a gain of $11.5 million
and
$47.5 million
for the
three and six months ended June 30, 2008, respectively, and $16.7
million
and
$20.4 million
for the
three and six months ended June 30, 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 June 30,
|
Six months ended June 30,
|
||||||||||||
2008
|
2007
|
2008
|
2007
|
||||||||||
Interest
rate swaps
|
$
|
(7,842
|
)
|
7,576
|
(11,019
|
)
|
15,074
|
||||||
Basis
swaps
|
5,148
|
58
|
45,605
|
119
|
|||||||||
Cross-currency
interest rate swaps
|
7,131
|
(2,438
|
)
|
10,614
|
(5,757
|
)
|
|||||||
|
|||||||||||||
Derivative
settlements received, net
|
$
|
4,437
|
5,196
|
45,200
|
9,436
|
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 Company’s 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 Company’s market assumptions. Transaction costs are not included in the
determination of fair value. When possible, the Company seeks to validate the
model’s 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.
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 Company’s 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 June 30, 2008
|
||||||||||
Level
1
|
Level
2
|
Total
|
||||||||
Assets:
|
||||||||||
Other
assets (a)
|
$
|
4,185
|
5,540
|
9,725
|
||||||
Fair
value of derivative instruments (b)
|
—
|
295,346
|
295,346
|
|||||||
Total
assets
|
$
|
4,185
|
300,886
|
305,071
|
||||||
Liabilities:
|
||||||||||
Fair
value of derivative instruments (b)
|
$
|
—
|
38,846
|
38,846
|
||||||
Other
liabilities (c)
|
—
|
6,655
|
6,655
|
|||||||
Total
liabilities
|
$
|
—
|
45,501
|
45,501
|
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 Company’s policy to compare
its derivative fair values to those received by its counterparties
in
order to validate the model’s 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 Company’s 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.
A
reconciliation of weighted average shares outstanding follows:
Three months ended June 30,
|
Six months ended June 30,
|
||||||||||||
2008
|
2007
|
2008
|
2007
|
||||||||||
Weighted
average shares outstanding
|
49,442,435
|
49,452,960
|
49,443,425
|
50,213,349
|
|||||||||
Less:
Nonvested restricted stock - vesting solely upon continued
service
|
347,282
|
—
|
369,845
|
—
|
|||||||||
Weighted
average shares outstanding used to compute basic EPS
|
49,095,153
|
49,452,960
|
49,073,580
|
50,213,349
|
|||||||||
Dilutive
effect of nonvested restricted stock
|
9,488
|
—
|
—
|
—
|
|||||||||
Weighted
average shares used to compute diluted EPS
|
49,104,641
|
49,452,960
|
49,073,580
|
50,213,349
|
The
Company had no common stock equivalents and no potentially dilutive common
shares outstanding during the three and six months ended June 30, 2007.
No
dilutive effect of nonvested restricted stock is presented for the six months
ended June 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 Company’s 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 Company’s
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 Company’s 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 Company’s chief operating decision maker, evaluates
the performance of the Company’s operating segments based on their
profitability. As discussed further below, management measures the profitability
of the Company’s operating segments based on “base net income.” Accordingly,
information regarding the Company’s operating segments is provided based on
“base net income.” The Company’s “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 EDULINX’s 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
Company’s 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 Company’s 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.
Fee-Based
Operating Segments
Student
Loan and Guaranty Servicing
The
Student Loan and Guaranty Servicing segment provides for the servicing of the
Company’s 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 Company’s
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 Company’s student loan assets. Revenues are primarily generated
from the Company’s earnings from the spread, referred to as the Company’s
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 Company’s 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.
“Base
net
income” is the primary financial performance measure used by management to
develop the Company’s 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 Company’s 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 Company’s operating results in accordance with GAAP
are also included in the tables below.
Segment
Results and Reconciliations to GAAP
Three months ended June 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
|
$
|
243
|
310
|
1
|
—
|
554
|
282,293
|
1,574
|
(546
|
)
|
21,927
|
305,802
|
|||||||||||||||||||
Interest
expense
|
—
|
—
|
1
|
—
|
1
|
222,402
|
10,607
|
(546
|
)
|
—
|
232,464
|
||||||||||||||||||||
Net
interest income (loss)
|
243
|
310
|
—
|
—
|
553
|
59,891
|
(9,033
|
)
|
—
|
21,927
|
73,338
|
||||||||||||||||||||
Less
provision for loan losses
|
—
|
—
|
—
|
—
|
—
|
6,000
|
—
|
—
|
—
|
6,000
|
|||||||||||||||||||||
Net
interest income (loss) after provision for loan losses
|
243
|
310
|
—
|
—
|
553
|
53,891
|
(9,033
|
)
|
—
|
21,927
|
67,338
|
||||||||||||||||||||
Other
income (expense):
|
|||||||||||||||||||||||||||||||
Loan
and guaranty servicing income
|
24,747
|
—
|
—
|
—
|
24,747
|
157
|
—
|
—
|
—
|
24,904
|
|||||||||||||||||||||
Other
fee-based income
|
—
|
10,292
|
26,067
|
—
|
36,359
|
4,458
|
—
|
—
|
—
|
40,817
|
|||||||||||||||||||||
Software
services income
|
—
|
—
|
—
|
4,896
|
4,896
|
—
|
—
|
—
|
—
|
4,896
|
|||||||||||||||||||||
Other
income
|
6
|
(21
|
)
|
—
|
—
|
(15
|
)
|
393
|
1,268
|
—
|
—
|
1,646
|
|||||||||||||||||||
Gain
on sale of loans
|
—
|
—
|
—
|
—
|
—
|
48
|
—
|
—
|
—
|
48
|
|||||||||||||||||||||
Intersegment
revenue
|
18,382
|
(76
|
)
|
—
|
1,517
|
19,823
|
—
|
13,960
|
(33,783
|
)
|
—
|
—
|
|||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
15,755
|
15,755
|
|||||||||||||||||||||
Derivative
settlements, net
|
—
|
—
|
—
|
—
|
—
|
11,638
|
—
|
—
|
(7,201
|
)
|
4,437
|
||||||||||||||||||||
Total
other income (expense)
|
43,135
|
10,195
|
26,067
|
6,413
|
85,810
|
16,694
|
15,228
|
(33,783
|
)
|
8,554
|
92,503
|
||||||||||||||||||||
Operating
expenses:
|
|||||||||||||||||||||||||||||||
Salaries
and benefits
|
12,491
|
5,784
|
6,373
|
4,702
|
29,350
|
1,954
|
12,828
|
(1,333
|
)
|
750
|
43,549
|
||||||||||||||||||||
Restructure
expense - severance and contract termination costs
|
(104
|
)
|
—
|
(15
|
)
|
(8
|
)
|
(127
|
)
|
(52
|
)
|
(186
|
)
|
365
|
—
|
—
|
|||||||||||||||
Other
expenses
|
8,011
|
2,551
|
17,284
|
714
|
28,560
|
5,095
|
14,921
|
(764
|
)
|
6,561
|
54,373
|
||||||||||||||||||||
Intersegment
expenses
|
9,822
|
461
|
1,580
|
342
|
12,205
|
18,952
|
894
|
(32,051
|
)
|
—
|
—
|
||||||||||||||||||||
Total
operating expenses
|
30,220
|
8,796
|
25,222
|
5,750
|
69,988
|
25,949
|
28,457
|
(33,783
|
)
|
7,311
|
97,922
|
||||||||||||||||||||
Income
(loss) before income taxes
|
13,158
|
1,709
|
845
|
663
|
16,375
|
44,636
|
(22,262
|
)
|
—
|
23,170
|
61,919
|
||||||||||||||||||||
Income
tax expense (benefit) (a)
|
4,079
|
530
|
262
|
206
|
5,077
|
13,837
|
(6,902
|
)
|
—
|
7,183
|
19,195
|
||||||||||||||||||||
Net
income (loss) from continuing operations
|
9,079
|
1,179
|
583
|
457
|
11,298
|
30,799
|
(15,360
|
)
|
—
|
15,987
|
42,724
|
||||||||||||||||||||
Income
from discontinued operations, net of tax
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
981
|
981
|
|||||||||||||||||||||
Net
income (loss)
|
$
|
9,079
|
1,179
|
583
|
457
|
11,298
|
30,799
|
(15,360
|
)
|
—
|
16,968
|
43,705
|
(a)
Beginning in 2008, the consolidated effective tax rate is used to calculate
income taxes for each operating segment.
Three months ended June 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
|
$
|
1,181
|
670
|
93
|
—
|
1,944
|
433,404
|
554
|
(33
|
)
|
—
|
435,869
|
|||||||||||||||||||
Interest
expense
|
—
|
2
|
2
|
—
|
4
|
358,341
|
9,581
|
(33
|
)
|
—
|
367,893
|
||||||||||||||||||||
Net
interest income (loss)
|
1,181
|
668
|
91
|
—
|
1,940
|
75,063
|
(9,027
|
)
|
—
|
—
|
67,976
|
||||||||||||||||||||
Less
provision for loan losses
|
—
|
—
|
—
|
—
|
—
|
2,535
|
—
|
—
|
—
|
2,535
|
|||||||||||||||||||||
Net
interest income (loss) after provision for loan losses
|
1,181
|
668
|
91
|
—
|
1,940
|
72,528
|
(9,027
|
)
|
—
|
—
|
65,441
|
||||||||||||||||||||
Other
income (expense):
|
|||||||||||||||||||||||||||||||
Loan
and guaranty servicing income
|
31,492
|
—
|
—
|
—
|
31,492
|
118
|
—
|
—
|
—
|
31,610
|
|||||||||||||||||||||
Other
fee-based income
|
—
|
9,405
|
24,923
|
—
|
34,328
|
3,674
|
260
|
—
|
—
|
38,262
|
|||||||||||||||||||||
Software
services income
|
—
|
—
|
157
|
5,691
|
5,848
|
—
|
—
|
—
|
—
|
5,848
|
|||||||||||||||||||||
Other
income
|
5
|
25
|
—
|
—
|
30
|
105
|
1,792
|
—
|
—
|
1,927
|
|||||||||||||||||||||
Gain
on sale of loans
|
—
|
—
|
—
|
—
|
—
|
1,010
|
—
|
—
|
—
|
1,010
|
|||||||||||||||||||||
Intersegment
revenue
|
20,120
|
188
|
178
|
4,389
|
24,875
|
—
|
4,100
|
(28,975
|
)
|
—
|
—
|
||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
5,547
|
5,547
|
|||||||||||||||||||||
Derivative
settlements, net
|
—
|
—
|
—
|
—
|
—
|
(461
|
)
|
5,657
|
—
|
—
|
5,196
|
||||||||||||||||||||
Total
other income (expense)
|
51,617
|
9,618
|
25,258
|
10,080
|
96,573
|
4,446
|
11,809
|
(28,975
|
)
|
5,547
|
89,400
|
||||||||||||||||||||
Operating
expenses:
|
|||||||||||||||||||||||||||||||
Salaries
and benefits
|
22,023
|
5,082
|
9,022
|
5,857
|
41,984
|
7,167
|
12,272
|
(2,138
|
)
|
476
|
59,761
|
||||||||||||||||||||
Other
expenses
|
8,404
|
2,333
|
14,589
|
751
|
26,077
|
7,246
|
21,071
|
—
|
6,491
|
60,885
|
|||||||||||||||||||||
Intersegment
expenses
|
3,750
|
25
|
29
|
403
|
4,207
|
22,034
|
596
|
(26,837
|
)
|
—
|
—
|
||||||||||||||||||||
Total
operating expenses
|
34,177
|
7,440
|
23,640
|
7,011
|
72,268
|
36,447
|
33,939
|
(28,975
|
)
|
6,967
|
120,646
|
||||||||||||||||||||
Income
(loss) before income taxes
|
18,621
|
2,846
|
1,709
|
3,069
|
26,245
|
40,527
|
(31,157
|
)
|
—
|
(1,420
|
)
|
34,195
|
|||||||||||||||||||
Income
tax expense (benefit) (a)
|
7,076
|
1,082
|
649
|
1,167
|
9,974
|
15,400
|
(11,500
|
)
|
—
|
(568
|
)
|
13,306
|
|||||||||||||||||||
Net
income (loss) from continuing operations
|
11,545
|
1,764
|
1,060
|
1,902
|
16,271
|
25,127
|
(19,657
|
)
|
—
|
(852
|
)
|
20,889
|
|||||||||||||||||||
Loss
from discontinued operations, net of tax
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
(6,135
|
)
|
(6,135
|
)
|
|||||||||||||||||||
Net
income (loss)
|
$
|
11,545
|
1,764
|
1,060
|
1,902
|
16,271
|
25,127
|
(19,657
|
)
|
—
|
(6,987
|
)
|
14,754
|
(a)
Income taxes are based on 38% of net income (loss) before tax for the individual
operating segment.
Six months ended June 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
|
$
|
856
|
1,075
|
10
|
—
|
1,941
|
602,651
|
2,771
|
(640
|
)
|
40,745
|
647,468
|
|||||||||||||||||||
Interest
expense
|
—
|
—
|
2
|
—
|
2
|
538,417
|
19,826
|
(640
|
)
|
—
|
557,605
|
||||||||||||||||||||
Net
interest income (loss)
|
856
|
1,075
|
8
|
—
|
1,939
|
64,234
|
(17,055
|
)
|
—
|
40,745
|
89,863
|
||||||||||||||||||||
Less
provision for loan losses
|
—
|
—
|
—
|
—
|
—
|
11,000
|
—
|
—
|
—
|
11,000
|
|||||||||||||||||||||
Net
interest income (loss) after provision for loan losses
|
856
|
1,075
|
8
|
—
|
1,939
|
53,234
|
(17,055
|
)
|
—
|
40,745
|
78,863
|
||||||||||||||||||||
Other
income (expense):
|
|||||||||||||||||||||||||||||||
Loan
and guaranty servicing income
|
50,855
|
—
|
—
|
—
|
50,855
|
162
|
—
|
—
|
—
|
51,017
|
|||||||||||||||||||||
Other
fee-based income
|
—
|
24,114
|
53,289
|
—
|
77,403
|
9,327
|
—
|
—
|
—
|
86,730
|
|||||||||||||||||||||
Software
services income
|
—
|
—
|
37
|
11,611
|
11,648
|
—
|
—
|
—
|
—
|
11,648
|
|||||||||||||||||||||
Other
income
|
38
|
4
|
—
|
—
|
42
|
381
|
2,633
|
—
|
—
|
3,056
|
|||||||||||||||||||||
Loss
on sale of loans
|
—
|
—
|
—
|
—
|
—
|
(47,426
|
)
|
—
|
—
|
—
|
(47,426
|
)
|
|||||||||||||||||||
Intersegment
revenue
|
38,606
|
184
|
—
|
3,333
|
42,123
|
—
|
31,173
|
(73,296
|
)
|
—
|
—
|
||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
—
|
—
|
—
|
—
|
—
|
466
|
—
|
—
|
(42,072
|
)
|
(41,606
|
)
|
|||||||||||||||||||
Derivative
settlements, net
|
—
|
—
|
—
|
—
|
—
|
55,165
|
—
|
—
|
(9,965
|
)
|
45,200
|
||||||||||||||||||||
Total
other income (expense)
|
89,499
|
24,302
|
53,326
|
14,944
|
182,071
|
18,075
|
33,806
|
(73,296
|
)
|
(52,037
|
)
|
108,619
|
|||||||||||||||||||
Operating
expenses:
|
|||||||||||||||||||||||||||||||
Salaries
and benefits
|
26,489
|
11,214
|
12,896
|
9,870
|
60,469
|
4,178
|
27,419
|
3,280
|
2,046
|
97,392
|
|||||||||||||||||||||
Restructure
expense - severance and contract termination costs
|
747
|
—
|
282
|
510
|
1,539
|
1,844
|
3,729
|
(7,112
|
)
|
—
|
—
|
||||||||||||||||||||
Impairment
expense
|
5,074
|
—
|
—
|
—
|
5,074
|
9,351
|
4,409
|
—
|
—
|
18,834
|
|||||||||||||||||||||
Other
expenses
|
16,498
|
4,611
|
35,447
|
1,333
|
57,889
|
10,439
|
28,786
|
298
|
13,121
|
110,533
|
|||||||||||||||||||||
Intersegment
expenses
|
23,100
|
757
|
3,427
|
736
|
28,020
|
39,554
|
2,188
|
(69,762
|
)
|
—
|
—
|
||||||||||||||||||||
Total
operating expenses
|
71,908
|
16,582
|
52,052
|
12,449
|
152,991
|
65,366
|
66,531
|
(73,296
|
)
|
15,167
|
226,759
|
||||||||||||||||||||
Income
(loss) before income taxes
|
18,447
|
8,795
|
1,282
|
2,495
|
31,019
|
5,943
|
(49,780
|
)
|
—
|
(26,459
|
)
|
(39,277
|
)
|
||||||||||||||||||
Income
tax expense (benefit) (a)
|
5,719
|
2,727
|
397
|
774
|
9,617
|
1,842
|
(15,433
|
)
|
—
|
(8,202
|
)
|
(12,176
|
)
|
||||||||||||||||||
Net
income (loss) from continuing operations
|
12,728
|
6,068
|
885
|
1,721
|
21,402
|
4,101
|
(34,347
|
)
|
—
|
(18,257
|
)
|
(27,101
|
)
|
||||||||||||||||||
Income
from discontinued operations, net of tax
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
981
|
981
|
|||||||||||||||||||||
Net
income (loss)
|
$
|
12,728
|
6,068
|
885
|
1,721
|
21,402
|
4,101
|
(34,347
|
)
|
—
|
(17,276
|
)
|
(26,120
|
)
|
(a)
Beginning in 2008, the consolidated effective tax rate is used to calculate
income taxes for each operating segment.
Six months ended June 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
|
$
|
3,425
|
1,680
|
180
|
18
|
5,303
|
847,894
|
4,355
|
(3,204
|
)
|
—
|
854,348
|
|||||||||||||||||||
Interest
expense
|
—
|
7
|
4
|
—
|
11
|
699,999
|
21,582
|
(3,204
|
)
|
—
|
718,388
|
||||||||||||||||||||
Net
interest income (loss)
|
3,425
|
1,673
|
176
|
18
|
5,292
|
147,895
|
(17,227
|
)
|
—
|
—
|
135,960
|
||||||||||||||||||||
Less
provision for loan losses
|
—
|
—
|
—
|
—
|
—
|
5,288
|
—
|
—
|
—
|
5,288
|
|||||||||||||||||||||
Net
interest income (loss) after provision for loan losses
|
3,425
|
1,673
|
176
|
18
|
5,292
|
142,607
|
(17,227
|
)
|
—
|
—
|
130,672
|
||||||||||||||||||||
Other
income (expense):
|
|||||||||||||||||||||||||||||||
Loan
and guaranty servicing income
|
61,958
|
—
|
—
|
—
|
61,958
|
118
|
—
|
—
|
—
|
62,076
|
|||||||||||||||||||||
Other
fee-based income
|
—
|
21,176
|
49,870
|
—
|
71,046
|
6,985
|
260
|
—
|
—
|
78,291
|
|||||||||||||||||||||
Software
services income
|
—
|
—
|
287
|
11,309
|
11,596
|
—
|
—
|
—
|
—
|
11,596
|
|||||||||||||||||||||
Other
income
|
11
|
28
|
—
|
—
|
39
|
3,148
|
3,833
|
—
|
—
|
7,020
|
|||||||||||||||||||||
Gain
on sale of loans
|
—
|
—
|
—
|
—
|
—
|
2,796
|
—
|
—
|
—
|
2,796
|
|||||||||||||||||||||
Intersegment
revenue
|
36,584
|
340
|
928
|
8,221
|
46,073
|
—
|
6,116
|
(52,189
|
)
|
—
|
—
|
||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
(6,583
|
)
|
(6,583
|
)
|
|||||||||||||||||||
Derivative
settlements, net
|
—
|
—
|
—
|
—
|
—
|
(885
|
)
|
10,321
|
—
|
—
|
9,436
|
||||||||||||||||||||
Total
other income (expense)
|
98,553
|
21,544
|
51,085
|
19,530
|
190,712
|
12,162
|
20,530
|
(52,189
|
)
|
(6,583
|
)
|
164,632
|
|||||||||||||||||||
Operating
expenses:
|
|||||||||||||||||||||||||||||||
Salaries
and benefits
|
45,027
|
10,000
|
18,391
|
12,332
|
85,750
|
14,446
|
24,978
|
(4,662
|
)
|
953
|
121,465
|
||||||||||||||||||||
Other
expenses
|
17,654
|
4,493
|
29,148
|
1,535
|
52,830
|
15,511
|
38,940
|
—
|
13,129
|
120,410
|
|||||||||||||||||||||
Intersegment
expenses
|
7,068
|
399
|
185
|
403
|
8,055
|
38,670
|
802
|
(47,527
|
)
|
—
|
—
|
||||||||||||||||||||
Total
operating expenses
|
69,749
|
14,892
|
47,724
|
14,270
|
146,635
|
68,627
|
64,720
|
(52,189
|
)
|
14,082
|
241,875
|
||||||||||||||||||||
Income
(loss) before income taxes
|
32,229
|
8,325
|
3,537
|
5,278
|
49,369
|
86,142
|
(61,417
|
)
|
—
|
(20,665
|
)
|
53,429
|
|||||||||||||||||||
Income
tax expense (benefit) (a)
|
12,247
|
3,164
|
1,344
|
2,006
|
18,761
|
32,734
|
(23,826
|
)
|
—
|
(7,099
|
)
|
20,570
|
|||||||||||||||||||
Net
income (loss) from continuing operations
|
19,982
|
5,161
|
2,193
|
3,272
|
30,608
|
53,408
|
(37,591
|
)
|
—
|
(13,566
|
)
|
32,859
|
|||||||||||||||||||
Loss
from discontinued operations, net of tax
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
(3,325
|
)
|
(3,325
|
)
|
|||||||||||||||||||
Net
income (loss)
|
$
|
19,982
|
5,161
|
2,193
|
3,272
|
30,608
|
53,408
|
(37,591
|
)
|
—
|
(16,891
|
)
|
29,534
|
(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.
|
The
adjustments required to reconcile from the Company’s “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
Company’s 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 June 30, 2008
|
||||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
(1)
|
$
|
—
|
—
|
—
|
—
|
(15,866
|
)
|
111
|
(15,755
|
)
|
||||||||||||
Amortization
of intangible assets (2)
|
1,165
|
1,997
|
3,113
|
286
|
—
|
—
|
6,561
|
|||||||||||||||
Compensation
related to business combinations (3)
|
—
|
—
|
—
|
—
|
—
|
750
|
750
|
|||||||||||||||
Variable-rate
floor income, net of settlements on derivatives (4)
|
—
|
—
|
—
|
—
|
(14,726
|
)
|
—
|
(14,726
|
)
|
|||||||||||||
Income
from discontinued operations, net of tax (5)
|
(981
|
)
|
—
|
—
|
—
|
—
|
—
|
(981
|
)
|
|||||||||||||
Net
tax effect (6)
|
(361
|
)
|
(619
|
)
|
(965
|
)
|
(89
|
)
|
9,484
|
(267
|
)
|
7,183
|
||||||||||
Total
adjustments to GAAP
|
$
|
(177
|
)
|
1,378
|
2,148
|
197
|
(21,108
|
)
|
594
|
(16,968
|
)
|
|||||||||||
|
Three
months ended June 30, 2007
|
|||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
(1)
|
$
|
—
|
—
|
—
|
—
|
6,002
|
(11,549
|
)
|
(5,547
|
)
|
||||||||||||
Amortization
of intangible assets (2)
|
1,350
|
1,469
|
1,545
|
287
|
1,840
|
—
|
6,491
|
|||||||||||||||
Compensation
related to business combinations (3)
|
—
|
—
|
—
|
—
|
—
|
476
|
476
|
|||||||||||||||
Variable-rate
floor income, net of settlements on derivatives (4)
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
|||||||||||||||
Loss
from discontinued operations, net of tax (5)
|
6,135
|
—
|
—
|
—
|
—
|
—
|
6,135
|
|||||||||||||||
Net
tax effect (6)
|
(513
|
)
|
(558
|
)
|
(587
|
)
|
(109
|
)
|
(2,980
|
)
|
4,179
|
(568
|
)
|
|||||||||
Total
adjustments to GAAP
|
$
|
6,972
|
911
|
958
|
178
|
4,862
|
(6,894
|
)
|
6,987
|
|||||||||||||
|
Six
months ended June 30, 2008
|
|||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
(1)
|
$
|
—
|
—
|
—
|
—
|
41,534
|
538
|
42,072
|
||||||||||||||
Amortization
of intangible assets (2)
|
2,421
|
4,048
|
5,935
|
572
|
145
|
—
|
13,121
|
|||||||||||||||
Compensation
related to business combinations (3)
|
—
|
—
|
—
|
—
|
—
|
2,046
|
2,046
|
|||||||||||||||
Variable-rate
floor income, net of settlements on derivatives (4)
|
—
|
—
|
—
|
—
|
(30,780
|
)
|
—
|
(30,780
|
)
|
|||||||||||||
Income
from discontinued operations, net of tax (5)
|
(981
|
)
|
—
|
—
|
—
|
—
|
—
|
(981
|
)
|
|||||||||||||
Net
tax effect (6)
|
(750
|
)
|
(1,255
|
)
|
(1,840
|
)
|
(178
|
)
|
(3,378
|
)
|
(801
|
)
|
(8,202
|
)
|
||||||||
Total
adjustments to GAAP
|
$
|
690
|
2,793
|
4,095
|
394
|
7,521
|
1,783
|
17,276
|
||||||||||||||
|
Six
months ended June 30, 2007
|
|||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
(1)
|
$
|
—
|
—
|
—
|
—
|
12,216
|
(5,633
|
)
|
6,583
|
|||||||||||||
Amortization
of intangible assets (2)
|
2,394
|
2,938
|
3,355
|
617
|
3,825
|
—
|
13,129
|
|||||||||||||||
Compensation
related to business combinations (3)
|
—
|
—
|
—
|
—
|
—
|
953
|
953
|
|||||||||||||||
Variable-rate
floor income, net of settlements on derivatives (4)
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
|||||||||||||||
Loss
from discontinued operations, net of tax (5)
|
3,325
|
—
|
—
|
—
|
—
|
—
|
3,325
|
|||||||||||||||
Net
tax effect (6)
|
(910
|
)
|
(1,116
|
)
|
(1,275
|
)
|
(234
|
)
|
(6,096
|
)
|
2,532
|
(7,099
|
)
|
|||||||||
Total
adjustments to GAAP
|
$
|
4,809
|
1,822
|
2,080
|
383
|
9,945
|
(2,148
|
)
|
16,891
|
(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 Company’s 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 Company’s 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
Company’s 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 Company’s 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 Company’s consolidated effective
tax rate for each applicable 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.
|
(Management’s
Discussion and Analysis of Financial Condition and Results of Operations is
for
the three and six months ended June 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 Company’s
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 Company’s consolidated
financial statements included in the Company’s 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 management’s
current expectations as of the date of this document. When used in this report,
the words “anticipate,” “believe,” “estimate,” “intend,” and “expect” 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 Company’s Annual Report on Form 10-K for the year ended
December 31, 2007, 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 Company’s FFELP loans could materially adversely affect
the Company’s 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 Company’s
ability to maintain its credit facilities or obtain new 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 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 Company’s 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.
During
the three months ended June 30, 2008, significant events impacted the operating
results of the Company related to:
·
|
Legislative
developments;
|
· |
Student
loan spread;
|
· |
Operating
expenses; and
|
· |
Fee-based
businesses.
|
Legislative
Developments
On
May 7,
2008, the President signed into law H.R. 5715, the Ensuring Continued Access
to
Student Loans Act of 2008 (“HR 5715”). This legislation contains provisions that
expand the federal government’s support of financing the cost of higher
education. Among other things, HR 5715:
·
|
Increases
statutory limits on annual and aggregate borrowing for FFELP loans;
and
|
·
|
Allows
the Department to act as a secondary market and enter into forward
purchasing agreements with lenders.
|
As
a
result of this legislation, the Departments of Education and Treasury developed
a plan. Among other things, this plan:
·
|
Offers
to purchase 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 will
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 HR 5715, the Department of Education announced terms under
which it will offer to purchase FFELP student loans and loan participations
from
lenders. The Company is in the process of completing and filing all relevant
documents to participate in the Department of Education’s Participation Program
and expects to utilize the Participation Program to fund a significant portion
of its loan originations for the 2008-2009 academic year.
Student
Loan Spread
The
Company’s core student loan spread for the three months ended June 30, 2008
increased to 107 basis points
compared
to 73 basis points
for the
three months ended March 31, 2008. Excluding fixed-rate floor income, core
student loan spread for the three month period ended June 30, 2008 was 92 basis
points
compared
to 60 basis points
for the
prior quarter. The increase in core student loan spread was driven by the change
in relationship between the short-term interest rate indices in which the
Company earns on its loan assets and the rate the Company pays to fund such
assets, as well as a non-recurring reduction in rates paid on certain of its
auction rate securities. These increases were partially offset due to
asset-backed securitizations completed during 2008 in which the funding costs
were higher than prior funding costs. The Company believes 15 basis points
of
the improvement in core student loan spread during the second quarter of 2008
is
not sustainable and may not benefit future periods.
Excluded
from student loan spread was income recognized by the Company in the second
quarter of 2008 of $4.6 million related to a change in estimate on certain
liabilities initially established by the Company during its purchase price
allocation related to a 2005 business acquisition.
Operating
Expenses
As
a
result of the restructuring plans implemented in September 2007 and January
2008, as well as the Company’s continued focus on capitalizing on the operating
leverage of the Company’s business structure and strategies, operating expenses
continued to decrease. Excluding restructuring and impairment charges, operating
expenses decreased $22.4 million
and $41.1 million
for the three and six months ended June 30, 2008 compared to the same periods
in
2007, respectively.
Fee-based
businesses
During
the three month period ended June 30, 2008, certain of the Company’s fee based
businesses were negatively impacted by recent events in the student loan
industry. These items included a decrease to guaranty servicing revenue due
to
the loss of the Voluntary Flexible Agreement between the Department of Education
and College Assist and decreased demand for the Company’s software and technical
services and list marketing services. However, the Company also experienced
significant growth in other product and service offerings. In particular,
the
Company experienced significant growth in certain of its products and services
in its Enrollment Services and Tuition Payment Processing operating segments.
In
addition, during the second quarter of 2008, the Company made investments
in
products, services, and technology in the Tuition Payment Processing and
Campus
Commerce segment. These investments were made by the Company to meet customer
needs and support continued revenue growth. However, these investments increased
operating expenses and lowered operating margins in this segment compared
to
prior periods.
RESULTS
OF OPERATIONS
The
Company’s 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 Company’s 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 Company’s consolidated statements of operations as net
interest income. The amortization of loan premiums, including capitalized costs
of origination, the consolidation loan rebate fee, and yield adjustments from
borrower benefit programs, are netted against loan interest income on the
Company’s statements of operations. The amortization of debt issuance costs is
included in interest expense on the Company’s statements of
operations.
The
Company’s 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 U.S. Department of Education (the “Department”) 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 loan’s 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 Company’s
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
most
consolidation loans, the Company must pay a 1.05% per year rebate fee to the
Department. Those consolidation loans that have variable interest rates based
on
the SAP formula earn an annual yield less than that of a Stafford loan. Those
consolidation loans that have fixed interest rates less than the sum of 1.05%
and the variable rate based on the SAP formula also earn an annual yield less
than that of a Stafford loan.
On
September 27, 2007, the President signed into law the College Cost Reduction
Act. This legislation will have a significant impact on the Company’s net
interest income in future periods and should be considered when reviewing the
Company’s 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.
|
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 Company’s balance sheet is
very important to its operations. The current and future interest rate
environment can and will affect the Company’s 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 Company’s 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 Company’s 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 Company’s 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 HERA’s
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
Act. 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 Company’s 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 or number of loans serviced for
each customer. Guaranty servicing fees 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.
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 Company’s 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 Company’s student loan portfolio and
its financing transactions, costs incurred to service the Company’s 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
Company’s September 2007 and January 2008 restructuring plans.
Three
and six months ended June 30, 2008 compared to the three and six months ended
June 30, 2007
Net
Interest Income
Three months ended June 30,
|
Six months ended June 30,
|
||||||||||||||||||
2008
|
2007
|
$ Change
|
2008
|
2007
|
$ Change
|
||||||||||||||
Interest
income:
|
|||||||||||||||||||
Loan
interest
|
$
|
296,686
|
417,086
|
(120,400
|
)
|
626,672
|
814,140
|
(187,468
|
)
|
||||||||||
Investment
interest
|
9,116
|
18,783
|
(9,667
|
)
|
20,796
|
40,208
|
(19,412
|
)
|
|||||||||||
Total
interest income
|
305,802
|
435,869
|
(130,067
|
)
|
647,468
|
854,348
|
(206,880
|
)
|
|||||||||||
Interest
expense:
|
|||||||||||||||||||
Interest
on bonds and notes payable
|
232,464
|
367,893
|
(135,429
|
)
|
557,605
|
718,388
|
(160,783
|
)
|
|||||||||||
Net
interest income
|
73,338
|
67,976
|
5,362
|
89,863
|
135,960
|
(46,097
|
)
|
||||||||||||
Provision
for loan losses
|
6,000
|
2,535
|
3,465
|
11,000
|
5,288
|
5,712
|
|||||||||||||
Net
interest income after provision for loan losses
|
$
|
67,338
|
65,441
|
1,897
|
78,863
|
130,672
|
(51,809
|
)
|
·
|
Net
interest income decreased for the six months ended June 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.” The decrease in net interest income was
offset by $40.7 million of variable-rate floor income earned by
the
Company in 2008 and an increase in average student loans compared
to 2007.
Net interest income increased for the three months ended June 30,
2008
compared to the same period in 2007 as a result of an increase
in student
loan spread (including approximately $21.9 million of variable-rate
floor
income in 2008) and an increase in average student
loans.
|
·
|
The
provision for loan losses increased for the three and six months
ended
June 30, 2008 compared to 2007 due to an increase in risk share as
a
result of the elimination of the Exceptional Performer
program.
|
Other
Income
Three months ended June 30,
|
Six months ended June 30,
|
||||||||||||||||||
2008
|
2007
|
$ Change
|
2008
|
2007
|
$ Change
|
||||||||||||||
Loan and guaranty servicing
income
|
$
|
24,904
|
31,610
|
(6,706
|
)
|
51,017
|
62,076
|
(11,059
|
)
|
||||||||||
Other
fee-based income
|
40,817
|
38,262
|
2,555
|
86,730
|
78,291
|
8,439
|
|||||||||||||
Software
services income
|
4,896
|
5,848
|
(952
|
)
|
11,648
|
11,596
|
52
|
||||||||||||
Other
income
|
1,646
|
1,927
|
(281
|
)
|
3,056
|
7,020
|
(3,964
|
)
|
|||||||||||
Gain
(loss) on sale of loans
|
48
|
1,010
|
(962
|
)
|
(47,426
|
)
|
2,796
|
(50,222
|
)
|
||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
15,755
|
5,547
|
10,208
|
(41,606
|
)
|
(6,583
|
)
|
(35,023
|
)
|
||||||||||
Derivative
settlements, net
|
4,437
|
5,196
|
(759
|
)
|
45,200
|
9,436
|
35,764
|
||||||||||||
Total
other income
|
$
|
92,503
|
89,400
|
3,103
|
108,619
|
164,632
|
(56,013
|
)
|
·
|
“Loan
and guaranty servicing income” decreased due to decreases in both FFELP
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.
|
·
|
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 a change in the fair value of the Company’s
derivative portfolio and foreign currency rate fluctuations which
are
further discussed in Item 3, “Quantitative and Qualitative Disclosures
about Market Risk.”
|
·
|
The
change in derivative settlements is discussed in Item 3, “Quantitative and
Qualitative Disclosures about Market Risk.”
|
Operating
Expenses
Net change
|
|||||||||||||
after impact of
|
|||||||||||||
Three months ended
|
Impact of restructuring
|
restructuring and
|
Three months ended
|
||||||||||
June 30, 2007
|
and impairment charges
|
impairment charges
|
June 30, 2008
|
||||||||||
Salaries
and benefits
|
$
|
59,761
|
(190
|
)
|
(16,022
|
)
|
43,549
|
||||||
Other
expenses
|
60,885
|
(175
|
)
|
(6,337
|
)
|
54,373
|
|||||||
Total
operating expenses
|
$
|
120,646
|
(365
|
)
|
(22,359
|
)
|
97,922
|
Net change
|
|||||||||||||
after impact of
|
|||||||||||||
Six months ended
|
Impact of restructuring
|
restructuring and
|
Six months ended
|
||||||||||
June 30, 2007
|
and impairment charges
|
impairment charges
|
June 30, 2008
|
||||||||||
Salaries
and benefits
|
$
|
121,465
|
5,714
|
(29,787
|
)
|
97,392
|
|||||||
Other
expenses
|
120,410
|
20,232
|
(11,275
|
)
|
129,367
|
||||||||
Total
operating expenses
|
$
|
241,875
|
25,946
|
(41,062
|
)
|
226,759
|
Excluding
restructuring and impairment charges, operating expenses decreased $22.4
million
and $41.1 million
for the three and six months ended June 30, 2008 compared to the same periods
in
2007, respectively. The decrease is 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
Company’s 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.
Income
Taxes
The
Company’s effective tax rate was 31.0% for the three and six months ended June
30, 2008, compared to 38.9% and 38.5% for the same periods in 2007. The
effective tax rate decreased due to the year-to-date tax benefit reduced by
various state gross receipts taxes and other items which are not deductible
for
tax purposes. Management expects the Company’s effective income tax rate to
remain relatively stable for the remainder of 2008.
Additional
information on the Company’s results of operations is included with the
discussion of the Company’s operating segments in this Item 2 under “Operating
Segments”.
Financial
Condition as of June 30, 2008 compared to December 31,
2007
As of
|
As of
|
||||||||||||
June 30,
|
December 31,
|
Change
|
|||||||||||
2008
|
2007
|
Dollars
|
Percent
|
||||||||||
Assets:
|
|||||||||||||
Student
loans receivable, net
|
$
|
25,993,307
|
26,736,122
|
(742,815
|
)
|
(2.8
|
)%
|
||||||
Cash,
cash equivalents, and investments
|
1,175,310
|
1,120,838
|
54,472
|
4.9
|
|||||||||
Goodwill
|
175,178
|
164,695
|
10,483
|
6.4
|
|||||||||
Intangible
assets, net
|
90,163
|
112,830
|
(22,667
|
)
|
(20.1
|
)
|
|||||||
Fair
value of derivative instruments
|
295,346
|
222,471
|
72,875
|
32.8
|
|||||||||
Other
assets
|
702,621
|
805,827
|
(103,206
|
)
|
(12.8
|
)
|
|||||||
Total
assets
|
$
|
28,431,925
|
29,162,783
|
(730,858
|
)
|
(2.5
|
)%
|
||||||
Liabilities:
|
|||||||||||||
Bonds
and notes payable
|
$
|
27,530,237
|
28,115,829
|
(585,592
|
)
|
(2.1
|
)%
|
||||||
Fair
value of derivative instruments
|
38,846
|
5,885
|
32,961
|
560.1
|
|||||||||
Other
liabilities
|
278,800
|
432,190
|
(153,390
|
)
|
(35.5
|
)
|
|||||||
Total
liabilities
|
27,847,883
|
28,553,904
|
(706,021
|
)
|
(2.5
|
)
|
|||||||
Shareholders'
equity
|
584,042
|
608,879
|
(24,837
|
)
|
(4.1
|
)
|
|||||||
Total
liabilities and shareholders' equity
|
$
|
28,431,925
|
29,162,783
|
(730,858
|
)
|
(2.5
|
)%
|
The
Company’s 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.” 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 Company’s student loan portfolio. Total
equity decreased $24.8 million
as a result of a $26.1 million
net loss for the six months ended June 30, 2008. In addition, the Company paid
a
$0.07 per share dividend on its Class A and Class B common stock in the first
quarter of 2008, which reduced equity by $3.5 million.
These decreases to equity were offset by increases due to the issuance of common
stock, compensation expense for stock-based awards, and payments received on
employee stock notes receivable.
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 Company’s 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 Company’s
operating segments are the same as those described in the summary of significant
accounting policies included in the Company’s consolidated financial statements
included in the Company’s 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.
The
management reporting process measures the performance of the Company’s 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 Company’s chief operating decision maker, evaluates
the performance of the Company’s operating segments based on their
profitability. As discussed further below, management measures the profitability
of the Company’s operating segments on the basis of “base net income.”
Accordingly, information regarding the Company’s operating segments is provided
based on “base net income.” The Company’s “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 EDULINX’s 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
Company’s 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 Company’s 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.
“Base
net
income” is the primary financial performance measure used by management to
develop the Company’s 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 Company’s 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 Company’s
operating segments. Reconciliation of the segment totals to the Company’s
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.
Segment
Results and Reconciliations to GAAP
Three months ended June 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
|
$
|
243
|
310
|
1
|
—
|
554
|
282,293
|
1,574
|
(546
|
)
|
21,927
|
305,802
|
|||||||||||||||||||
Interest
expense
|
—
|
—
|
1
|
—
|
1
|
222,402
|
10,607
|
(546
|
)
|
—
|
232,464
|
||||||||||||||||||||
Net
interest income (loss)
|
243
|
310
|
—
|
—
|
553
|
59,891
|
(9,033
|
)
|
—
|
21,927
|
73,338
|
||||||||||||||||||||
Less
provision for loan losses
|
—
|
—
|
—
|
—
|
—
|
6,000
|
—
|
—
|
—
|
6,000
|
|||||||||||||||||||||
Net
interest income (loss) after provision for loan losses
|
243
|
310
|
—
|
—
|
553
|
53,891
|
(9,033
|
)
|
—
|
21,927
|
67,338
|
||||||||||||||||||||
Other
income (expense):
|
|||||||||||||||||||||||||||||||
Loan
and guaranty servicing income
|
24,747
|
—
|
—
|
—
|
24,747
|
157
|
—
|
—
|
—
|
24,904
|
|||||||||||||||||||||
Other
fee-based income
|
—
|
10,292
|
26,067
|
—
|
36,359
|
4,458
|
—
|
—
|
—
|
40,817
|
|||||||||||||||||||||
Software
services income
|
—
|
—
|
—
|
4,896
|
4,896
|
—
|
—
|
—
|
—
|
4,896
|
|||||||||||||||||||||
Other
income
|
6
|
(21
|
)
|
—
|
—
|
(15
|
)
|
393
|
1,268
|
—
|
—
|
1,646
|
|||||||||||||||||||
Gain
on sale of loans
|
—
|
—
|
—
|
—
|
—
|
48
|
—
|
—
|
—
|
48
|
|||||||||||||||||||||
Intersegment
revenue
|
18,382
|
(76
|
)
|
—
|
1,517
|
19,823
|
—
|
13,960
|
(33,783
|
)
|
—
|
—
|
|||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
15,755
|
15,755
|
|||||||||||||||||||||
Derivative
settlements, net
|
—
|
—
|
—
|
—
|
—
|
11,638
|
—
|
—
|
(7,201
|
)
|
4,437
|
||||||||||||||||||||
Total
other income (expense)
|
43,135
|
10,195
|
26,067
|
6,413
|
85,810
|
16,694
|
15,228
|
(33,783
|
)
|
8,554
|
92,503
|
||||||||||||||||||||
Operating
expenses:
|
|||||||||||||||||||||||||||||||
Salaries
and benefits
|
12,491
|
5,784
|
6,373
|
4,702
|
29,350
|
1,954
|
12,828
|
(1,333
|
)
|
750
|
43,549
|
||||||||||||||||||||
Restructure
expense - severance and contract termination costs
|
(104
|
)
|
—
|
(15
|
)
|
(8
|
)
|
(127
|
)
|
(52
|
)
|
(186
|
)
|
365
|
—
|
—
|
|||||||||||||||
Other
expenses
|
8,011
|
2,551
|
17,284
|
714
|
28,560
|
5,095
|
14,921
|
(764
|
)
|
6,561
|
54,373
|
||||||||||||||||||||
Intersegment
expenses
|
9,822
|
461
|
1,580
|
342
|
12,205
|
18,952
|
894
|
(32,051
|
)
|
—
|
—
|
||||||||||||||||||||
Total
operating expenses
|
30,220
|
8,796
|
25,222
|
5,750
|
69,988
|
25,949
|
28,457
|
(33,783
|
)
|
7,311
|
97,922
|
||||||||||||||||||||
Income
(loss) before income taxes
|
13,158
|
1,709
|
845
|
663
|
16,375
|
44,636
|
(22,262
|
)
|
—
|
23,170
|
61,919
|
||||||||||||||||||||
Income
tax expense (benefit) (a)
|
4,079
|
530
|
262
|
206
|
5,077
|
13,837
|
(6,902
|
)
|
—
|
7,183
|
19,195
|
||||||||||||||||||||
Net
income (loss) from continuing operations
|
9,079
|
1,179
|
583
|
457
|
11,298
|
30,799
|
(15,360
|
)
|
—
|
15,987
|
42,724
|
||||||||||||||||||||
Income
from discontinued operations, net of tax
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
981
|
981
|
|||||||||||||||||||||
Net
income (loss)
|
$
|
9,079
|
1,179
|
583
|
457
|
11,298
|
30,799
|
(15,360
|
)
|
—
|
16,968
|
43,705
|
|||||||||||||||||||
(a)
Beginning in 2008, the consolidated effective tax rate is used to
calculate income taxes for each operating segment.
|
|||||||||||||||||||||||||||||||
Three
months ended June 30, 2008:
|
|||||||||||||||||||||||||||||||
Before
Tax Operating Margin -excluding restructure expense
|
30.1
|
%
|
16.3
|
%
|
3.2
|
%
|
10.2
|
%
|
18.8
|
%
|
63.2
|
%
|
|||||||||||||||||||
Three
months ended June 30, 2007:
|
|||||||||||||||||||||||||||||||
Before
Tax Operating Margin
|
35.3
|
%
|
27.7
|
%
|
6.7
|
%
|
30.4
|
%
|
26.6
|
%
|
52.7
|
%
|
Three months ended June 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
|
$
|
1,181
|
670
|
93
|
—
|
1,944
|
433,404
|
554
|
(33
|
)
|
—
|
435,869
|
|||||||||||||||||||
Interest
expense
|
—
|
2
|
2
|
—
|
4
|
358,341
|
9,581
|
(33
|
)
|
—
|
367,893
|
||||||||||||||||||||
Net
interest income (loss)
|
1,181
|
668
|
91
|
—
|
1,940
|
75,063
|
(9,027
|
)
|
—
|
—
|
67,976
|
||||||||||||||||||||
Less
provision for loan losses
|
—
|
—
|
—
|
—
|
—
|
2,535
|
—
|
—
|
—
|
2,535
|
|||||||||||||||||||||
Net
interest income (loss) after provision for loan losses
|
1,181
|
668
|
91
|
—
|
1,940
|
72,528
|
(9,027
|
)
|
—
|
—
|
65,441
|
||||||||||||||||||||
Other
income (expense):
|
|||||||||||||||||||||||||||||||
Loan
and guaranty servicing income
|
31,492
|
—
|
—
|
—
|
31,492
|
118
|
—
|
—
|
—
|
31,610
|
|||||||||||||||||||||
Other
fee-based income
|
—
|
9,405
|
24,923
|
—
|
34,328
|
3,674
|
260
|
—
|
—
|
38,262
|
|||||||||||||||||||||
Software
services income
|
—
|
—
|
157
|
5,691
|
5,848
|
—
|
—
|
—
|
—
|
5,848
|
|||||||||||||||||||||
Other
income
|
5
|
25
|
—
|
—
|
30
|
105
|
1,792
|
—
|
—
|
1,927
|
|||||||||||||||||||||
Gain
on the sale of loans
|
—
|
—
|
—
|
—
|
—
|
1,010
|
—
|
—
|
—
|
1,010
|
|||||||||||||||||||||
Intersegment
revenue
|
20,120
|
188
|
178
|
4,389
|
24,875
|
—
|
4,100
|
(28,975
|
)
|
—
|
—
|
||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
5,547
|
5,547
|
|||||||||||||||||||||
Derivative
settlements, net
|
—
|
—
|
—
|
—
|
—
|
(461
|
)
|
5,657
|
—
|
—
|
5,196
|
||||||||||||||||||||
Total
other income (expense)
|
51,617
|
9,618
|
25,258
|
10,080
|
96,573
|
4,446
|
11,809
|
(28,975
|
)
|
5,547
|
89,400
|
||||||||||||||||||||
Operating
expenses:
|
|||||||||||||||||||||||||||||||
Salaries
and benefits
|
22,023
|
5,082
|
9,022
|
5,857
|
41,984
|
7,167
|
12,272
|
(2,138
|
)
|
476
|
59,761
|
||||||||||||||||||||
Other
expenses
|
8,404
|
2,333
|
14,589
|
751
|
26,077
|
7,246
|
21,071
|
—
|
6,491
|
60,885
|
|||||||||||||||||||||
Intersegment
expenses
|
3,750
|
25
|
29
|
403
|
4,207
|
22,034
|
596
|
(26,837
|
)
|
—
|
—
|
||||||||||||||||||||
Total
operating expenses
|
34,177
|
7,440
|
23,640
|
7,011
|
72,268
|
36,447
|
33,939
|
(28,975
|
)
|
6,967
|
120,646
|
||||||||||||||||||||
Income
(loss) before income taxes
|
18,621
|
2,846
|
1,709
|
3,069
|
26,245
|
40,527
|
(31,157
|
)
|
—
|
(1,420
|
)
|
34,195
|
|||||||||||||||||||
Income
tax expense (benefit) (a)
|
7,076
|
1,082
|
649
|
1,167
|
9,974
|
15,400
|
(11,500
|
)
|
—
|
(568
|
)
|
13,306
|
|||||||||||||||||||
Net
income (loss) from continuing operations
|
11,545
|
1,764
|
1,060
|
1,902
|
16,271
|
25,127
|
(19,657
|
)
|
—
|
(852
|
)
|
20,889
|
|||||||||||||||||||
Loss
from discontinued operations, net of tax
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
(6,135
|
)
|
(6,135
|
)
|
|||||||||||||||||||
Net
income (loss)
|
$
|
11,545
|
1,764
|
1,060
|
1,902
|
16,271
|
25,127
|
(19,657
|
)
|
—
|
(6,987
|
)
|
14,754
|
(a)
Income taxes are based on 38% of net income before tax for the individual
operating segment.
Six months ended June 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
|
$
|
856
|
1,075
|
10
|
—
|
1,941
|
602,651
|
2,771
|
(640
|
)
|
40,745
|
647,468
|
|||||||||||||||||||
Interest
expense
|
—
|
—
|
2
|
—
|
2
|
538,417
|
19,826
|
(640
|
)
|
—
|
557,605
|
||||||||||||||||||||
Net
interest income (loss)
|
856
|
1,075
|
8
|
—
|
1,939
|
64,234
|
(17,055
|
)
|
—
|
40,745
|
89,863
|
||||||||||||||||||||
Less
provision for loan losses
|
—
|
—
|
—
|
—
|
—
|
11,000
|
—
|
—
|
—
|
11,000
|
|||||||||||||||||||||
Net
interest income (loss) after provision for loan losses
|
856
|
1,075
|
8
|
—
|
1,939
|
53,234
|
(17,055
|
)
|
—
|
40,745
|
78,863
|
||||||||||||||||||||
Other
income (expense):
|
|||||||||||||||||||||||||||||||
Loan
and guaranty servicing income
|
50,855
|
—
|
—
|
—
|
50,855
|
162
|
—
|
—
|
—
|
51,017
|
|||||||||||||||||||||
Other
fee-based income
|
—
|
24,114
|
53,289
|
—
|
77,403
|
9,327
|
—
|
—
|
—
|
86,730
|
|||||||||||||||||||||
Software
services income
|
—
|
—
|
37
|
11,611
|
11,648
|
—
|
—
|
—
|
—
|
11,648
|
|||||||||||||||||||||
Other
income
|
38
|
4
|
—
|
—
|
42
|
381
|
2,633
|
—
|
—
|
3,056
|
|||||||||||||||||||||
Loss
on sale of loans
|
—
|
—
|
—
|
—
|
—
|
(47,426
|
)
|
—
|
—
|
—
|
(47,426
|
)
|
|||||||||||||||||||
Intersegment
revenue
|
38,606
|
184
|
—
|
3,333
|
42,123
|
—
|
31,173
|
(73,296
|
)
|
—
|
—
|
||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
—
|
—
|
—
|
—
|
—
|
466
|
—
|
—
|
(42,072
|
)
|
(41,606
|
)
|
|||||||||||||||||||
Derivative
settlements, net
|
—
|
—
|
—
|
—
|
—
|
55,165
|
—
|
—
|
(9,965
|
)
|
45,200
|
||||||||||||||||||||
Total
other income (expense)
|
89,499
|
24,302
|
53,326
|
14,944
|
182,071
|
18,075
|
33,806
|
(73,296
|
)
|
(52,037
|
)
|
108,619
|
|||||||||||||||||||
Operating
expenses:
|
|||||||||||||||||||||||||||||||
Salaries
and benefits
|
26,489
|
11,214
|
12,896
|
9,870
|
60,469
|
4,178
|
27,419
|
3,280
|
2,046
|
97,392
|
|||||||||||||||||||||
Restructure
expense - severance and contract termination costs
|
747
|
—
|
282
|
510
|
1,539
|
1,844
|
3,729
|
(7,112
|
)
|
—
|
—
|
||||||||||||||||||||
Impairment
expense
|
5,074
|
—
|
—
|
—
|
5,074
|
9,351
|
4,409
|
—
|
—
|
18,834
|
|||||||||||||||||||||
Other
expenses
|
16,498
|
4,611
|
35,447
|
1,333
|
57,889
|
10,439
|
28,786
|
298
|
13,121
|
110,533
|
|||||||||||||||||||||
Intersegment
expenses
|
23,100
|
757
|
3,427
|
736
|
28,020
|
39,554
|
2,188
|
(69,762
|
)
|
—
|
—
|
||||||||||||||||||||
Total
operating expenses
|
71,908
|
16,582
|
52,052
|
12,449
|
152,991
|
65,366
|
66,531
|
(73,296
|
)
|
15,167
|
226,759
|
||||||||||||||||||||
Income
(loss) before income taxes
|
18,447
|
8,795
|
1,282
|
2,495
|
31,019
|
5,943
|
(49,780
|
)
|
—
|
(26,459
|
)
|
(39,277
|
)
|
||||||||||||||||||
Income
tax expense (benefit) (a)
|
5,719
|
2,727
|
397
|
774
|
9,617
|
1,842
|
(15,433
|
)
|
—
|
(8,202
|
)
|
(12,176
|
)
|
||||||||||||||||||
Net
income (loss) from continuing operations
|
12,728
|
6,068
|
885
|
1,721
|
21,402
|
4,101
|
(34,347
|
)
|
—
|
(18,257
|
)
|
(27,101
|
)
|
||||||||||||||||||
Income
from discontinued operations, net of tax
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
981
|
981
|
|||||||||||||||||||||
Net
income (loss)
|
$
|
12,728
|
6,068
|
885
|
1,721
|
21,402
|
4,101
|
(34,347
|
)
|
—
|
(17,276
|
)
|
(26,120
|
)
|
|||||||||||||||||
(a)
Beginning in 2008, the consolidated effective tax rate is used to
calculate income taxes for each operating segment.
|
|||||||||||||||||||||||||||||||
Six
months ended June 30, 2008:
|
|||||||||||||||||||||||||||||||
Before
Tax Operating Margin - excluding restructure expense, impairment
expense,
and the loss on sale of loans during the first quarter of
2008
|
26.9
|
%
|
34.7
|
%
|
2.9
|
%
|
20.1
|
%
|
20.5
|
%
|
54.4
|
%
|
|||||||||||||||||||
Six
months ended June, 2007:
|
|||||||||||||||||||||||||||||||
Before
Tax Operating Margin
|
31.6
|
%
|
35.9
|
%
|
6.9
|
%
|
27.0
|
%
|
25.2
|
%
|
55.7
|
%
|
Six
months ended June 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
|
$
|
3,425
|
1,680
|
180
|
18
|
5,303
|
847,894
|
4,355
|
(3,204
|
)
|
—
|
854,348
|
|||||||||||||||||||
Interest
expense
|
—
|
7
|
4
|
—
|
11
|
699,999
|
21,582
|
(3,204
|
)
|
—
|
718,388
|
||||||||||||||||||||
Net
interest income (loss)
|
3,425
|
1,673
|
176
|
18
|
5,292
|
147,895
|
(17,227
|
)
|
—
|
—
|
135,960
|
||||||||||||||||||||
Less
provision for loan losses
|
—
|
—
|
—
|
—
|
—
|
5,288
|
—
|
—
|
—
|
5,288
|
|||||||||||||||||||||
Net
interest income (loss) after provision for loan losses
|
3,425
|
1,673
|
176
|
18
|
5,292
|
142,607
|
(17,227
|
)
|
—
|
—
|
130,672
|
||||||||||||||||||||
Other
income (expense):
|
|||||||||||||||||||||||||||||||
Loan
and guaranty servicing income
|
61,958
|
—
|
—
|
—
|
61,958
|
118
|
—
|
—
|
—
|
62,076
|
|||||||||||||||||||||
Other
fee-based income
|
—
|
21,176
|
49,870
|
—
|
71,046
|
6,985
|
260
|
—
|
—
|
78,291
|
|||||||||||||||||||||
Software
services income
|
—
|
—
|
287
|
11,309
|
11,596
|
—
|
—
|
—
|
—
|
11,596
|
|||||||||||||||||||||
Other
income
|
11
|
28
|
—
|
—
|
39
|
3,148
|
3,833
|
—
|
—
|
7,020
|
|||||||||||||||||||||
Gain
on the sale of loans
|
—
|
—
|
—
|
—
|
—
|
2,796
|
—
|
—
|
—
|
2,796
|
|||||||||||||||||||||
Intersegment
revenue
|
36,584
|
340
|
928
|
8,221
|
46,073
|
—
|
6,116
|
(52,189
|
)
|
—
|
—
|
||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
(6,583
|
)
|
(6,583
|
)
|
|||||||||||||||||||
Derivative
settlements, net
|
—
|
—
|
—
|
—
|
—
|
(885
|
)
|
10,321
|
—
|
—
|
9,436
|
||||||||||||||||||||
Total
other income (expense)
|
98,553
|
21,544
|
51,085
|
19,530
|
190,712
|
12,162
|
20,530
|
(52,189
|
)
|
(6,583
|
)
|
164,632
|
|||||||||||||||||||
Operating
expenses:
|
|||||||||||||||||||||||||||||||
Salaries
and benefits
|
45,027
|
10,000
|
18,391
|
12,332
|
85,750
|
14,446
|
24,978
|
(4,662
|
)
|
953
|
121,465
|
||||||||||||||||||||
Other
expenses
|
17,654
|
4,493
|
29,148
|
1,535
|
52,830
|
15,511
|
38,940
|
—
|
13,129
|
120,410
|
|||||||||||||||||||||
Intersegment
expenses
|
7,068
|
399
|
185
|
403
|
8,055
|
38,670
|
802
|
(47,527
|
)
|
—
|
—
|
||||||||||||||||||||
Total
operating expenses
|
69,749
|
14,892
|
47,724
|
14,270
|
146,635
|
68,627
|
64,720
|
(52,189
|
)
|
14,082
|
241,875
|
||||||||||||||||||||
Income
(loss) before income taxes
|
32,229
|
8,325
|
3,537
|
5,278
|
49,369
|
86,142
|
(61,417
|
)
|
—
|
(20,665
|
)
|
53,429
|
|||||||||||||||||||
Income
tax expense (benefit) (a)
|
12,247
|
3,164
|
1,344
|
2,006
|
18,761
|
32,734
|
(23,826
|
)
|
—
|
(7,099
|
)
|
20,570
|
|||||||||||||||||||
Net
income (loss) from continuing operations
|
19,982
|
5,161
|
2,193
|
3,272
|
30,608
|
53,408
|
(37,591
|
)
|
—
|
(13,566
|
)
|
32,859
|
|||||||||||||||||||
Loss
from discontinued operations, net of tax
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
(3,325
|
)
|
(3,325
|
)
|
|||||||||||||||||||
Net
income (loss)
|
$
|
19,982
|
5,161
|
2,193
|
3,272
|
30,608
|
53,408
|
(37,591
|
)
|
—
|
(16,891
|
)
|
29,534
|
(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
Company’s GAAP-based financial information, management also evaluates the
Company’s 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.
“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 Company’s chief operating decision maker. The Company’s board
of directors utilizes “base net income” to set performance targets and evaluate
management’s performance. The Company also believes analysts, rating agencies,
and creditors use “base net income” in their evaluation of the Company’s 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 Company’s 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
Company’s 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 Company’s
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 Company’s
“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 Company’s 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 Company’s 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.
The
adjustments required to reconcile from the Company’s “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
Company’s 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 June 30, 2008
|
||||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
$
|
—
|
—
|
—
|
—
|
(15,866
|
)
|
111
|
(15,755
|
)
|
||||||||||||
Amortization
of intangible assets
|
1,165
|
1,997
|
3,113
|
286
|
—
|
—
|
6,561
|
|||||||||||||||
Compensation
related to business combinations
|
—
|
—
|
—
|
—
|
—
|
750
|
750
|
|||||||||||||||
Variable-rate
floor income, net of settlements on derivatives
|
—
|
—
|
—
|
—
|
(14,726
|
)
|
—
|
(14,726
|
)
|
|||||||||||||
Income
from discontinued operations, net of tax
|
(981
|
)
|
—
|
—
|
—
|
—
|
—
|
(981
|
)
|
|||||||||||||
Net
tax effect (a)
|
(361
|
)
|
(619
|
)
|
(965
|
)
|
(89
|
)
|
9,484
|
(267
|
)
|
7,183
|
||||||||||
Total
adjustments to GAAP
|
$
|
(177
|
)
|
1,378
|
2,148
|
197
|
(21,108
|
)
|
594
|
(16,968
|
)
|
|||||||||||
|
Three
months ended June 30, 2007
|
|||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
$
|
—
|
—
|
—
|
—
|
6,002
|
(11,549
|
)
|
(5,547
|
)
|
||||||||||||
Amortization
of intangible assets
|
1,350
|
1,469
|
1,545
|
287
|
1,840
|
—
|
6,491
|
|||||||||||||||
Compensation
related to business combinations
|
—
|
—
|
—
|
—
|
—
|
476
|
476
|
|||||||||||||||
Variable-rate
floor income, net of settlements on derivatives
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
|||||||||||||||
Loss
from discontinued operations, net of tax
|
6,135
|
—
|
—
|
—
|
—
|
—
|
6,135
|
|||||||||||||||
Net
tax effect (a)
|
(513
|
)
|
(558
|
)
|
(587
|
)
|
(109
|
)
|
(2,980
|
)
|
4,179
|
(568
|
)
|
|||||||||
Total
adjustments to GAAP
|
$
|
6,972
|
911
|
958
|
178
|
4,862
|
(6,894
|
)
|
6,987
|
|||||||||||||
|
Six
months ended June 30, 2008
|
|||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
$
|
—
|
—
|
—
|
—
|
41,534
|
538
|
42,072
|
||||||||||||||
Amortization
of intangible assets
|
2,421
|
4,048
|
5,935
|
572
|
145
|
—
|
13,121
|
|||||||||||||||
Compensation
related to business combinations
|
—
|
—
|
—
|
—
|
—
|
2,046
|
2,046
|
|||||||||||||||
Variable-rate
floor income, net of settlements on derivatives
|
—
|
—
|
—
|
—
|
(30,780
|
)
|
—
|
(30,780
|
)
|
|||||||||||||
Income
from discontinued operations, net of tax
|
(981
|
)
|
—
|
—
|
—
|
—
|
—
|
(981
|
)
|
|||||||||||||
Net
tax effect (a)
|
(750
|
)
|
(1,255
|
)
|
(1,840
|
)
|
(178
|
)
|
(3,378
|
)
|
(801
|
)
|
(8,202
|
)
|
||||||||
Total
adjustments to GAAP
|
$
|
690
|
2,793
|
4,095
|
394
|
7,521
|
1,783
|
17,276
|
||||||||||||||
|
Six
months ended June 30, 2007
|
|||||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
$
|
—
|
—
|
—
|
—
|
12,216
|
(5,633
|
)
|
6,583
|
|||||||||||||
Amortization
of intangible assets
|
2,394
|
2,938
|
3,355
|
617
|
3,825
|
—
|
13,129
|
|||||||||||||||
Compensation
related to business combinations
|
—
|
—
|
—
|
—
|
—
|
953
|
953
|
|||||||||||||||
Variable-rate
floor income, net of settlements on derivatives
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
|||||||||||||||
Loss
from discontinued operations, net of tax
|
3,325
|
—
|
—
|
—
|
—
|
—
|
3,325
|
|||||||||||||||
Net
tax effect (a)
|
(910
|
)
|
(1,116
|
)
|
(1,275
|
)
|
(234
|
)
|
(6,096
|
)
|
2,532
|
(7,099
|
)
|
|||||||||
Total
adjustments to GAAP
|
$
|
4,809
|
1,822
|
2,080
|
383
|
9,945
|
(2,148
|
)
|
16,891
|
(a)
|
Beginning
in 2008, tax effect is computed using the Company’s consolidated effective
tax rate for each applicable 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”
Management’s
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 Company’s results of
operations. A more detailed discussion of the differences between GAAP and
“base
net income” follows.
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 Company’s 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 Company's 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 Company’s 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 Company’s consolidated statements of
operations.
“Base
net
income” excludes the foreign currency transaction gains or losses caused by the
re-measurement of the Company’s 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 Company’s 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 Company’s
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 Company’s current stock price, and the
dividend yield and volatility of the Company’s 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 Company’s
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 Company’s
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 Company’s acquisitions, since the Company feels that such charges do
not drive the Company’s 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 Company’s 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 Company’s control which can affect
the period-to-period comparability of results of operations.
Variable-rate
floor income is calculated by the Company on a statutory basis. As a result
of
the disruptions in the debt and secondary capital markets beginning in August
2007, the full benefit of variable-rate floor income has not been realized
by
the Company due to the widening of the spread between short term interest rate
indices and the Company’s actual cost of funds.
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.
STUDENT
LOAN AND GUARANTY SERVICING OPERATING SEGMENT - RESULTS OF
OPERATIONS
The
Student Loan and Guaranty Servicing segment provides for the servicing of the
Company’s 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 Company’s
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
|
||||||||||||
June 30,
|
June 30,
|
||||||||||||
2008
|
2007
|
||||||||||||
Dollar
|
Percent
|
Dollar
|
Percent
|
||||||||||
(dollars in millions)
|
|||||||||||||
Company
|
$
|
24,873
|
(a)
|
70.0
|
%
|
$
|
24,429
|
75.6
|
%
|
||||
Third
Party
|
10,680
|
(b)
|
30.0
|
7,884
|
24.4
|
||||||||
$
|
35,553
|
100.0
|
%
|
$
|
32,313
|
100.0
|
%
|
(a)
|
Approximately
$26 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
$145 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 six months ended June 30, 2008 compared to the three and six months ended
June 30, 2007
Three months
ended June 30,
|
Six
months ended June 30,
|
||||||||||||||||||
2008
|
2007
|
$
Change
|
2008
|
2007
|
$
Change
|
||||||||||||||
Net
interest income after the provision for loan losses
|
$
|
243
|
1,181
|
(938
|
)
|
856
|
3,425
|
(2,569
|
)
|
||||||||||
Loan
and guaranty servicing income
|
24,747
|
31,492
|
(6,745
|
)
|
50,855
|
61,958
|
(11,103
|
)
|
|||||||||||
Other
income
|
6
|
5
|
1
|
38
|
11
|
27
|
|||||||||||||
Intersegment
revenue
|
18,382
|
20,120
|
(1,738
|
)
|
38,606
|
36,584
|
2,022
|
||||||||||||
Total
other income
|
43,135
|
51,617
|
(8,482
|
)
|
89,499
|
98,553
|
(9,054
|
)
|
|||||||||||
Salaries
and benefits
|
12,491
|
22,023
|
(9,532
|
)
|
26,489
|
45,027
|
(18,538
|
)
|
|||||||||||
Restructure
expense - severance and contract termination costs
|
(104
|
)
|
—
|
(104
|
)
|
747
|
—
|
747
|
|||||||||||
Impairment
expense
|
—
|
—
|
—
|
5,074
|
—
|
5,074
|
|||||||||||||
Other
expenses
|
8,011
|
8,404
|
(393
|
)
|
16,498
|
17,654
|
(1,156
|
)
|
|||||||||||
Intersegment
expenses
|
9,822
|
3,750
|
6,072
|
23,100
|
7,068
|
16,032
|
|||||||||||||
Total
operating expenses
|
30,220
|
34,177
|
(3,957
|
)
|
71,908
|
69,749
|
2,159
|
||||||||||||
"Base
net income" before income taxes
|
13,158
|
18,621
|
(5,463
|
)
|
18,447
|
32,229
|
(13,782
|
)
|
|||||||||||
Income
tax expense
|
4,079
|
7,076
|
(2,997
|
)
|
5,719
|
12,247
|
(6,528
|
)
|
|||||||||||
"Base
net income"
|
$
|
9,079
|
11,545
|
(2,466
|
)
|
12,728
|
19,982
|
(7,254
|
)
|
||||||||||
Before
Tax Operating Margin
|
30.3
|
%
|
35.3
|
%
|
20.4
|
%
|
31.6
|
%
|
|||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Before
Tax Operating Margin - excluding restructure expense and impairment
expense
|
30.1
|
%
|
35.3
|
%
|
26.9
|
%
|
31.6
|
%
|
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.
Loan
and guaranty servicing income.
Loan
and guaranty servicing income for the three and six months ended June 30, 2008
decreased from the same periods in 2007 as follows:
Three
months ended June 30,
|
Six
months ended June 30,
|
||||||||||||||||||||||||
2008
|
2007
|
$
Change
|
%
Change
|
2008
|
2007
|
$
Change
|
%
Change
|
||||||||||||||||||
Origination
and servicing of FFEL Program loans
|
$
|
12,533
|
13,774
|
(1,241
|
)
|
(9.0
|
)%
|
$
|
24,812
|
27,904
|
(3,092
|
)
|
(11.1
|
)%
|
|||||||||||
Origination
and servicing of non-federally insured student loans
|
1,872
|
2,335
|
(463
|
)
|
(19.8
|
)
|
4,143
|
4,656
|
(513
|
)
|
(11.0
|
)
|
|||||||||||||
Servicing
and support outsourcing for guaranty agencies
|
10,342
|
15,383
|
(5,041
|
)
|
(32.8
|
)
|
21,900
|
29,398
|
(7,498
|
)
|
(25.5
|
)
|
|||||||||||||
Loan
and guaranty servicing income to external parties
|
$
|
24,747
|
31,492
|
(6,745
|
)
|
(21.4)
|
%
|
$
|
50,855
|
61,958
|
(11,103
|
)
|
(17.9)
|
%
|
·
|
FFELP
loan servicing income decreased due to new servicing contracts being
priced at lower rates following the legislative developments in September
2007. This decrease was partially offset by an increase in loan servicing
volume due to entering into new servicing contracts.
|
·
|
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 and the timing of certain activities
offset
by an increase in the volume of guaranteed loans serviced as well
as an
increase in collections due to utilizing an outside collection agency.
|
Intersegment
revenue.
The
decrease in intersegment revenue for the three months ended June 30, 2008
and
the increase for the six months ended June 30, 2008 compared to the same
periods
in 2007 was the result of a decrease in internal call center revenue due
to the
Company’s reduction in direct-to-consumer marketing and an increase in servicing
volume and rates for internal customers.
Operating
expenses.
Excluding restructuring and impairment charges, operating expenses decreased
$3.9 million
and $3.7
million
for the
three and six months ended June 30, 2008 compared to the same period in 2007
as
a result of cost savings from the Company’s September 2007 and January 2008
restructuring plans. This decrease was offset by an increase in operating
expenses resulting from the allocation of additional corporate overhead
expenses, which were included in Corporate Activity and Overhead for the three
and six months ended June 30, 2007
TUITION
PAYMENT PROCESSING AND CAMPUS COMMERCE OPERATING SEGMENT - RESULTS OF
OPERATIONS
The
Company’s 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 six months ended June 30, 2008 compared to the three and six months ended
June 30, 2007
Three
months ended June 30,
|
Six
months ended June 30,
|
||||||||||||||||||
2008
|
2007
|
$
Change
|
2008
|
2007
|
$
Change
|
||||||||||||||
Net
interest income after the provision for loan losses
|
$
|
310
|
668
|
(358
|
)
|
1,075
|
1,673
|
(598
|
)
|
||||||||||
Other
fee-based income
|
10,292
|
9,405
|
887
|
24,114
|
21,176
|
2,938
|
|||||||||||||
Other
income
|
(21
|
)
|
25
|
(46
|
)
|
4
|
28
|
(24
|
)
|
||||||||||
Intersegment
revenue
|
(76
|
)
|
188
|
(264
|
)
|
184
|
340
|
(156
|
)
|
||||||||||
Total
other income
|
10,195
|
9,618
|
577
|
24,302
|
21,544
|
2,758
|
|||||||||||||
Salaries
and benefits
|
5,784
|
5,082
|
702
|
11,214
|
10,000
|
1,214
|
|||||||||||||
Other
expenses
|
2,551
|
2,333
|
218
|
4,611
|
4,493
|
118
|
|||||||||||||
Intersegment
expenses
|
461
|
25
|
436
|
757
|
399
|
358
|
|||||||||||||
Total
operating expenses
|
8,796
|
7,440
|
1,356
|
16,582
|
14,892
|
1,690
|
|||||||||||||
"Base
net income" before income taxes
|
1,709
|
2,846
|
(1,137
|
)
|
8,795
|
8,325
|
470
|
||||||||||||
Income
tax expense
|
530
|
1,082
|
(552
|
)
|
2,727
|
3,164
|
(437
|
)
|
|||||||||||
"Base
net income"
|
$
|
1,179
|
1,764
|
(585
|
)
|
6,068
|
5,161
|
907
|
|||||||||||
Before
Tax Operating Margin
|
16.3
|
%
|
27.7
|
%
|
34.7
|
%
|
35.9
|
%
|
Other
fee-based income.
Other
fee-based income increased for the three and six months ended June 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 six months ended June 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.
ENROLLMENT
SERVICES AND LIST MANAGEMENT OPERATING SEGMENT - RESULTS OF
OPERATIONS
The
Company’s 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 six months ended June 30, 2008 compared to the three and six months ended
June 30, 2007
Three months ended June 30,
|
Six months ended June 30,
|
||||||||||||||||||
2008
|
2007
|
$ Change
|
2008
|
2007
|
$ Change
|
||||||||||||||
Net interest income after the
provision for loan losses
|
$
|
—
|
91
|
(91
|
)
|
8
|
176
|
(168
|
)
|
||||||||||
Other
fee-based income
|
26,067
|
24,923
|
1,144
|
53,289
|
49,870
|
3,419
|
|||||||||||||
Software
services income
|
—
|
157
|
(157
|
)
|
37
|
287
|
(250
|
)
|
|||||||||||
Intersegment
revenue
|
—
|
178
|
(178
|
)
|
—
|
928
|
(928
|
)
|
|||||||||||
Total
other income
|
26,067
|
25,258
|
809
|
53,326
|
51,085
|
2,241
|
|||||||||||||
Salaries
and benefits
|
6,373
|
9,022
|
(2,649
|
)
|
12,896
|
18,391
|
(5,495
|
)
|
|||||||||||
Restructure
expense - severance and contract termination costs
|
(15
|
)
|
—
|
(15
|
)
|
282
|
—
|
282
|
|||||||||||
Other
expenses
|
17,284
|
14,589
|
2,695
|
35,447
|
29,148
|
6,299
|
|||||||||||||
Intersegment
expenses
|
1,580
|
29
|
1,551
|
3,427
|
185
|
3,242
|
|||||||||||||
Total
operating expenses
|
25,222
|
23,640
|
1,582
|
52,052
|
47,724
|
4,328
|
|||||||||||||
"Base
net income" before income taxes
|
845
|
1,709
|
(864
|
)
|
1,282
|
3,537
|
(2,255
|
)
|
|||||||||||
Income
tax expense
|
262
|
649
|
(387
|
)
|
397
|
1,344
|
(947
|
)
|
|||||||||||
"Base
net income"
|
$
|
583
|
1,060
|
(477
|
)
|
885
|
2,193
|
(1,308
|
)
|
||||||||||
Before
Tax Operating Margin
|
3.2
|
%
|
6.7
|
%
|
2.4
|
%
|
6.9
|
%
|
|||||||||||
Before
Tax Operating Margin - excluding restructure expense
|
3.2
|
%
|
6.7
|
%
|
2.9
|
%
|
6.9
|
%
|
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
million,
or
33%,
and $12
million,
or 31%,
for the
three and six months ended June 30, 2008 compared to the same periods in 2007.
Operating
expenses.
Total
operating expenses increased for the three and six months ended June 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 six months ended June 30, 2007.
Excluding intersegment expenses, the before tax operating margin was 9.3% and
8.8% for the three and six months ended June 30, 2008. The increases in
operating expenses were offset as a result of cost savings from the
September 2007 and January 2008 restructuring plans.
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 Company’s 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 segment’s future revenue and profit
margins.
Three
and six months ended June 30, 2008 compared to the three and six months ended
June 30, 2007
Three months ended June 30,
|
Six months ended June 30,
|
||||||||||||||||||
2008
|
2007
|
$ Change
|
2008
|
2007
|
$ Change
|
||||||||||||||
Net interest income after the provision for loan losses
|
$
|
—
|
—
|
—
|
—
|
18
|
(18
|
)
|
|||||||||||
Software
services income
|
4,896
|
5,691
|
(795
|
)
|
11,611
|
11,309
|
302
|
||||||||||||
Intersegment
revenue
|
1,517
|
4,389
|
(2,872
|
)
|
3,333
|
8,221
|
(4,888
|
)
|
|||||||||||
Total
other income
|
6,413
|
10,080
|
(3,667
|
)
|
14,944
|
19,530
|
(4,586
|
)
|
|||||||||||
Salaries
and benefits
|
4,702
|
5,857
|
(1,155
|
)
|
9,870
|
12,332
|
(2,462
|
)
|
|||||||||||
Restructure
expense - severance and contract
|
|||||||||||||||||||
termination
costs
|
(8
|
)
|
—
|
(8
|
)
|
510
|
—
|
510
|
|||||||||||
Other
expenses
|
714
|
751
|
(37
|
)
|
1,333
|
1,535
|
(202
|
)
|
|||||||||||
Intersegment
expenses
|
342
|
403
|
(61
|
)
|
736
|
403
|
333
|
||||||||||||
Total
operating expenses
|
5,750
|
7,011
|
(1,261
|
)
|
12,449
|
14,270
|
(1,821
|
)
|
|||||||||||
"Base
net income" before income taxes
|
663
|
3,069
|
(2,406
|
)
|
2,495
|
5,278
|
(2,783
|
)
|
|||||||||||
Income
tax expense
|
206
|
1,167
|
(961
|
)
|
774
|
2,006
|
(1,232
|
)
|
|||||||||||
"Base
net income"
|
$
|
457
|
1,902
|
(1,445
|
)
|
1,721
|
3,272
|
(1,551
|
)
|
||||||||||
Before
Tax Operating Margin
|
10.3
|
%
|
30.4
|
%
|
16.7
|
%
|
27.0
|
%
|
|||||||||||
Before
Tax Operating Margin - excluding restructure expense
|
10.2
|
%
|
30.4
|
%
|
20.1
|
%
|
27.0
|
%
|
Software
services income.
Software
services income decreased for the three months ended June 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. Software services
income during the first quarter of 2008 compared to 2007 increased due to
additional projects that were completed prior to the second
quarter.
Intersegment
revenue.
Intersegment
revenue decreased for the three and six months ended June 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 internal
customers.
ASSET
GENERATION AND MANAGEMENT OPERATING SEGMENT - RESULTS OF
OPERATIONS
The
Asset
Generation and Management segment includes the acquisition, management, and
ownership of the Company’s student loan assets. Revenues are primarily generated
from the Company’s earnings from the spread, referred to as the Company’s
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 Company’s student loan
portfolio:
As of June 30, 2008
|
As of December 31, 2007
|
||||||||||||
Dollars
|
Percent
|
Dollars
|
Percent
|
||||||||||
Federally insured: (a) (b)
|
|||||||||||||
Stafford
|
|||||||||||||
Originated
prior to 10/1/07
|
$
|
6,668,100
|
25.6
|
%
|
$
|
6,624,009
|
24.8
|
%
|
|||||
Originated
on or after 10/1/07
|
386,669
|
1.5
|
101,901
|
0.4
|
|||||||||
PLUS/SLS
|
|||||||||||||
Originated
prior to 10/1/07
|
424,609
|
1.6
|
414,708
|
1.5
|
|||||||||
Originated
on or after 10/1/07
|
47,133
|
0.2
|
15,233
|
0.1
|
|||||||||
Consolidation
|
|||||||||||||
Originated
prior to 10/1/07
|
17,683,114
|
68.0
|
18,646,993
|
69.8
|
|||||||||
Originated
on or after 10/1/07
|
122,548
|
0.5
|
251,554
|
0.9
|
|||||||||
Non-federally
insured
|
279,953
|
1.1
|
274,815
|
1.0
|
|||||||||
Total
|
25,612,126
|
98.5
|
26,329,213
|
98.5
|
|||||||||
Unamortized
premiums and deferred origination costs
|
429,090
|
1.7
|
452,501
|
1.7
|
|||||||||
Allowance
for loan losses:
|
|||||||||||||
Allowance
- federally insured
|
(24,084
|
)
|
(0.1
|
)
|
(24,534
|
)
|
(0.1
|
)
|
|||||
Allowance
- non-federally insured
|
(23,825
|
)
|
(0.1
|
)
|
(21,058
|
)
|
(0.1
|
)
|
|||||
$
|
25,993,307
|
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 June 30, 2008 and December
31, 2007, $228.7 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 Company’s
consolidated financial statements included in this Quarterly Report.
As of
June 30, 2008, $197.5 million of the loans accounted for as participation
interests sold under this agreement were originated on or after October
1,
2007.
|
(b)
|
As
of June 30, 2008, approximately $27 million
of federally insured student loans were eligible to be sold or
participated to the Department under the Department’s Loan Purchase
Commitment and Participation
Programs.
|
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. The following table sets forth the activity of loans originated
or
acquired through each of the Company’s channels:
Three months ended June 30,
|
Six months ended June 30,
|
||||||||||||
2008
|
2007
|
2008
|
2007
|
||||||||||
Beginning
balance
|
$
|
26,347,354
|
24,617,030
|
26,329,213
|
23,414,468
|
||||||||
Direct
channel:
|
|||||||||||||
Consolidation
loan originations
|
3,284
|
836,711
|
69,029
|
1,900,949
|
|||||||||
Less
consolidation of existing portfolio
|
(988
|
)
|
(438,993
|
)
|
(28,447
|
)
|
(912,788
|
)
|
|||||
Net
consolidation loan originations
|
2,296
|
397,718
|
40,582
|
988,161
|
|||||||||
Stafford/PLUS
loan originations
|
114,228
|
141,882
|
535,329
|
496,709
|
|||||||||
Branding
partner channel
|
127,929
|
255,703
|
601,307
|
457,993
|
|||||||||
Forward
flow channel
|
84,216
|
392,174
|
403,060
|
768,115
|
|||||||||
Other
channels
|
—
|
560,796
|
55,922
|
766,714
|
|||||||||
Total
channel acquisitions
|
328,669
|
1,748,273
|
1,636,200
|
3,477,692
|
|||||||||
Repayments,
claims, capitalized interest, participations, and other
|
(585,443
|
)
|
(397,556
|
)
|
(885,243
|
)
|
(633,363
|
)
|
|||||
Consolidation
loans lost to external parties
|
(46,849
|
)
|
(187,350
|
)
|
(176,267
|
)
|
(426,754
|
)
|
|||||
Loans
sold
|
(431,605
|
)
|
(34,397
|
)
|
(1,291,777
|
)
|
(86,043
|
)
|
|||||
Ending
balance
|
$
|
25,612,126
|
25,746,000
|
25,612,126
|
25,746,000
|
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 Company’s 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 partners and forward flow lenders of which such purchases
were previously deferred. These loans were financed in the Company’s FFELP
warehouse facility prior to the term-out of this agreement.
On
May 7,
2008, the President signed into law H.R. 5715, the Ensuring Continued Access
to
Student Loans Act of 2008 (“HR 5715”). This legislation contains provisions that
expand the federal government’s support of financing the cost of higher
education. Among other things, HR 5715:
·
|
Increases
statutory limits on annual and aggregate borrowing for FFELP loans;
and
|
·
|
Allows
the Department to act as a secondary market and enter into forward
purchasing agreements with lenders.
|
As
a
result of this legislation, the Departments of Education and Treasury developed
a plan. Among other things, this plan:
·
|
Offers
to purchase 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 will
continue originating new federal student loans for the 2008-2009 academic year
to all students regardless of the school they attend. Accordingly, the Company
anticipates an increase in origination activity.
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 Company’s allowance for loan
losses is presented in the following table:
Three months ended June 30,
|
Six months ended June 30,
|
||||||||||||
2008
|
2007
|
2008
|
2007
|
||||||||||
Balance
at beginning of period
|
$
|
46,137
|
26,224
|
45,592
|
26,003
|
||||||||
Provision
for loan losses:
|
|||||||||||||
Federally
insured loans
|
4,000
|
1,665
|
7,500
|
3,118
|
|||||||||
Non-federally
insured loans
|
2,000
|
870
|
3,500
|
2,170
|
|||||||||
Total
provision for loan losses
|
6,000
|
2,535
|
11,000
|
5,288
|
|||||||||
Charge-offs,
net of recoveries:
|
|||||||||||||
Federally
insured loans
|
(3,878
|
)
|
(1,330
|
)
|
(7,200
|
)
|
(2,525
|
)
|
|||||
Non-federally
insured loans
|
(350
|
)
|
(289
|
)
|
(733
|
)
|
(455
|
)
|
|||||
Net
charge-offs
|
(4,228
|
)
|
(1,619
|
)
|
(7,933
|
)
|
(2,980
|
)
|
|||||
Sale
of federally insured loans
|
—
|
—
|
(750
|
)
|
—
|
||||||||
Sale
of non-federally insured loans
|
—
|
—
|
—
|
(1,171
|
)
|
||||||||
Balance
at end of period
|
$
|
47,909
|
27,140
|
47,909
|
27,140
|
||||||||
Allocation
of the allowance for loan losses:
|
|||||||||||||
Federally
insured loans
|
$
|
24,084
|
8,194
|
24,084
|
8,194
|
||||||||
Non-federally
insured loans
|
23,825
|
18,946
|
23,825
|
18,946
|
|||||||||
Total
allowance for loan losses
|
$
|
47,909
|
27,140
|
47,909
|
27,140
|
||||||||
Net
loan charge-offs as a percentage of average student loans
|
0.066
|
%
|
0.026
|
%
|
0.060
|
%
|
0.025
|
%
|
|||||
Total
allowance as a percentage of average student loans
|
0.186
|
%
|
0.110
|
%
|
0.182
|
%
|
0.112
|
%
|
|||||
Total
allowance as a percentage of ending balance of student
loans
|
0.187
|
%
|
0.105
|
%
|
0.187
|
%
|
0.105
|
%
|
|||||
Non-federally
insured allowance as a percentage of the ending balance of non-federally
insured loans
|
8.510
|
%
|
8.061
|
%
|
8.510
|
%
|
8.061
|
%
|
|||||
Average
student loans
|
$
|
25,767,123
|
24,687,280
|
26,313,226
|
24,266,048
|
||||||||
Ending
balance of student loans
|
25,612,126
|
25,746,000
|
25,612,126
|
25,746,000
|
|||||||||
Ending
balance of non-federally insured loans
|
279,953
|
235,023
|
279,953
|
235,023
|
The
allowance for loan losses increased during the three and six months ended June
30, 2008 compared to the same periods 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 Company’s allowance for loan losses related to
the increase in risk share.
Delinquencies
have the potential to adversely impact the Company’s earnings through increased
servicing and collection costs and account charge-offs. The table below shows
the Company’s student loan delinquency amounts:
As of June 30, 2008
|
As of December 31, 2007
|
||||||||||||
Dollars
|
Percent
|
Dollars
|
Percent
|
||||||||||
Federally
Insured Loans:
|
|||||||||||||
Loans
in-school/grace/deferment(1)
|
$
|
7,352,864
|
$
|
7,115,505
|
|||||||||
Loans
in forebearance(2)
|
2,562,434
|
3,015,456
|
|||||||||||
Loans
in repayment status:
|
|||||||||||||
Loans
current
|
13,596,739
|
88.2
|
%
|
13,937,702
|
87.5
|
%
|
|||||||
Loans
delinquent 31-60 days(3)
|
550,423
|
3.6
|
682,956
|
4.3
|
|||||||||
Loans
delinquent 61-90 days(3)
|
327,090
|
2.1
|
353,303
|
2.2
|
|||||||||
Loans
delinquent 91 days or greater(4)
|
942,623
|
6.1
|
949,476
|
6.0
|
|||||||||
Total
loans in repayment
|
15,416,875
|
100.0
|
%
|
15,923,437
|
100.0
|
%
|
|||||||
Total
federally insured loans
|
$
|
25,332,173
|
$
|
26,054,398
|
|||||||||
Non-Federally
Insured Loans:
|
|||||||||||||
Loans
in-school/grace/deferment(1)
|
$
|
103,785
|
$
|
111,946
|
|||||||||
Loans
in forebearance(2)
|
11,659
|
12,895
|
|||||||||||
Loans
in repayment status:
|
|||||||||||||
Loans
current
|
156,341
|
95.0
|
%
|
142,851
|
95.3
|
%
|
|||||||
Loans
delinquent 31-60 days(3)
|
3,163
|
1.9
|
3,450
|
2.3
|
|||||||||
Loans
delinquent 61-90 days(3)
|
1,950
|
1.2
|
1,247
|
0.8
|
|||||||||
Loans
delinquent 91 days or greater(4)
|
3,055
|
1.9
|
2,426
|
1.6
|
|||||||||
Total
loans in repayment
|
164,509
|
100.0
|
%
|
149,974
|
100.0
|
%
|
|||||||
Total
non-federally insured loans
|
$
|
279,953
|
$
|
274,815
|
(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 Company’s 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 June 30,
|
Six months ended June 30,
|
|||||||||||
|
2008
|
2007
|
2008
|
2007
|
|||||||||
Student
loan yield
|
5.65
|
%
|
7.93
|
%
|
5.85
|
%
|
7.90
|
%
|
|||||
Consolidation
rebate fees
|
(0.74
|
)
|
(0.78
|
)
|
(0.74
|
)
|
(0.78
|
)
|
|||||
Premium
and deferred origination costs amortization
|
(0.36
|
)
|
(0.37
|
)
|
(0.37
|
)
|
(0.36
|
)
|
|||||
Student
loan net yield
|
4.55
|
6.78
|
4.74
|
6.76
|
|||||||||
Student
loan cost of funds (a)
|
(3.25
|
)
|
(5.50
|
)
|
(3.61
|
)
|
(5.48
|
)
|
|||||
Student
loan spread
|
1.30
|
1.28
|
1.13
|
1.28
|
|||||||||
Variable-rate
floor income, net of settlements on derivatives (b)
|
(0.23
|
)
|
—
|
(0.24
|
)
|
—
|
|||||||
Core
student loan spread
|
1.07
|
%
|
1.28
|
%
|
0.89
|
%
|
1.28
|
%
|
|||||
Average
balance of student loans
|
$
|
25,767,123
|
24,687,280
|
26,313,226
|
24,266,048
|
||||||||
Average
balance of debt outstanding
|
26,767,459
|
26,158,525
|
27,297,445
|
25,770,551
|
(a)
|
The
student loan cost of funds includes the effects of net settlement
costs on
the Company's derivative instruments (excluding the net settlements
of
$5.7
million and $10.3
million, for the three and six months ended June 30, 2007, respectively,
on those derivatives no longer hedging student loan
assets).
|
(b)
|
Variable-rate
floor income is calculated by the Company on a statutory basis. As
a
result of the disruptions in the debt and secondary capital markets
which
began in August 2007, the full benefit of variable-rate floor income
has
not been realized by the Company due to the widening of the spread
between
short term interest rate indices and the Company’s actual cost of funds.
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
Company’s statutory calculation of variable-rate floor
income.
|
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
Company’s core student loan spread was 0.92%
and
0.75%
for the
three and six months ended June 30, 2008, respectively, and 1.23%
for both
the three and six months ended June 30, 2007.
The
compression of the Company’s core student loan spread during the three and six
months ended June 30, 2008 compared to 2007 was the result of the following
items:
·
|
Historically,
the movement of the various interest rate indices received on the
Company’s 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 Company’s 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 Company’s student loan
net interest income. The increased spread to LIBOR on
asset-backed securities transactions is shown in the below table:
|
![](https://www.sec.gov/Archives/edgar/data/0001258602/000114420408045453/chart1.jpg)
·
|
As
a result of the passage of the College Cost Reduction Act, the yield
on
FFELP loans originated after October 1, 2007 was reduced. As of June
30,
2008, the Company had $556.4 million
of FFELP loans originated after October 1, 2007. The core student
loan
spread on FFELP loans originated after October 1, 2007 for the second
quarter of 2008 was approximately 40 to 50
basis points.
|
The
decrease in the Company’s core student loan spread was offset by a non-recurring
benefit related to the Company’s cost of funds related to certain of its
asset-backed securities. The interest rates on approximately $2.0 billion
of the
Company’s asset-backed securities are set and periodically reset via a “dutch
auction” (“Auction Rate Securites”). 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 month period ended June 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
does not
expect this funding benefit on its Auction Rate Securities in future
periods.
Three
and six months ended June 30, 2008 compared to the three and six months ended
June 30, 2007
Three months ended June 30,
|
Six months ended June 30,
|
||||||||||||||||||
2008
|
2007
|
$
Change
|
2008
|
2007
|
$
Change
|
||||||||||||||
Net
interest income after the provision for loan losses
|
$
|
53,891
|
72,528
|
(18,637
|
)
|
53,234
|
142,607
|
(89,373
|
)
|
||||||||||
Loan
and guaranty servicing income
|
157
|
118
|
39
|
162
|
118
|
44
|
|||||||||||||
Other
fee-based income
|
4,458
|
3,674
|
784
|
9,327
|
6,985
|
2,342
|
|||||||||||||
Other
income
|
393
|
105
|
288
|
381
|
3,148
|
(2,767
|
)
|
||||||||||||
Gain
(loss) on sale of loans
|
48
|
1,010
|
(962
|
)
|
(47,426
|
)
|
2,796
|
(50,222
|
)
|
||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
—
|
—
|
—
|
466
|
—
|
466
|
|||||||||||||
Derivative
settlements, net
|
11,638
|
(461
|
)
|
12,099
|
55,165
|
(885
|
)
|
56,050
|
|||||||||||
Total
other income
|
16,694
|
4,446
|
12,248
|
18,075
|
12,162
|
5,913
|
|||||||||||||
Salaries
and benefits
|
1,954
|
7,167
|
(5,213
|
)
|
4,178
|
14,446
|
(10,268
|
)
|
|||||||||||
Restructure
expense - severance and contract termination costs
|
(52
|
)
|
—
|
(52
|
)
|
1,844
|
—
|
1,844
|
|||||||||||
Impairment
expense
|
—
|
—
|
—
|
9,351
|
—
|
9,351
|
|||||||||||||
Other
expenses
|
5,095
|
7,246
|
(2,151
|
)
|
10,439
|
15,511
|
(5,072
|
)
|
|||||||||||
Intersegment
expenses
|
18,952
|
22,034
|
(3,082
|
)
|
39,554
|
38,670
|
884
|
||||||||||||
Total
operating expenses
|
25,949
|
36,447
|
(10,498
|
)
|
65,366
|
68,627
|
(3,261
|
)
|
|||||||||||
"Base
net income (loss)" before income taxes
|
44,636
|
40,527
|
4,109
|
5,943
|
86,142
|
(80,199
|
)
|
||||||||||||
Income
tax expense (benefit)
|
13,837
|
15,400
|
(1,563
|
)
|
1,842
|
32,734
|
(30,892
|
)
|
|||||||||||
"Base
net income (loss)"
|
$
|
30,799
|
25,127
|
5,672
|
4,101
|
53,408
|
(49,307
|
)
|
|||||||||||
Before
Tax Operating Margin
|
63.2
|
%
|
52.7
|
%
|
8.3
|
%
|
55.7
|
%
|
|||||||||||
Before
Tax Operating Margin - excluding restructure expense, impairment
expense,
and the loss on sale of loans during the first quarter
2008
|
63.2
|
%
|
52.7
|
%
|
54.4
|
%
|
55.7
|
%
|
Net
interest income after the provision for loan losses
Three months ended June 30,
|
Change
|
||||||||||||
2008
|
2007
|
Dollars
|
Percent
|
||||||||||
Loan
interest
|
$
|
345,321
|
487,465
|
(142,144
|
)
|
(29.2)
|
%
|
||||||
Consolidation
rebate fees
|
(47,721
|
)
|
(47,745
|
)
|
24
|
0.1
|
|||||||
Amortization
of loan premiums and deferred origination costs
|
(22,841
|
)
|
(22,634
|
)
|
(207
|
)
|
(0.9
|
)
|
|||||
Total
loan interest
|
274,759
|
417,086
|
(142,327
|
)
|
(34.1
|
)
|
|||||||
Investment
interest
|
7,534
|
16,318
|
(8,784
|
)
|
(53.8
|
)
|
|||||||
Total
interest income
|
282,293
|
433,404
|
(151,111
|
)
|
(34.9
|
)
|
|||||||
Interest
on bonds and notes payable
|
221,856
|
358,308
|
(136,452
|
)
|
(38.1
|
)
|
|||||||
Intercompany
interest
|
546
|
33
|
513
|
1,554.5
|
|||||||||
Provision
for loan losses
|
6,000
|
2,535
|
3,465
|
136.7
|
|||||||||
Net
interest income after provision for loan losses
|
$
|
53,891
|
72,528
|
(18,637
|
)
|
(25.7)
|
%
|
·
|
The
average student loan portfolio increased $1.1 billion, or 4.4%, for
the
three months ended June 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 $142.1 million as a
result
of these factors.
|
·
|
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
Company’s variable rate debt which lowered the Company’s cost of funds
(excluding net derivative settlements) to 3.33% for the three months
ended
June 30, 2008 compared to 5.49% for the same period a year ago. This
was
offset by a $0.6 billion, or 2.3%, increase in average debt for the
three
months ended June 30, 2008 compared to the same period in 2007. Interest
expense was impacted in 2008 by credit market disruptions as further
discussed in this Report.
|
·
|
The
provision for loan loss increased due to an increase in risk share
as a
result of the elimination of the Exceptional Performer program in
the
third quarter of 2007.
|
Six months ended June 30,
|
Change
|
||||||||||||
2008
|
2007
|
Dollars
|
Percent
|
||||||||||
Loan
interest
|
$
|
731,747
|
951,998
|
(220,251
|
)
|
(23.1)
|
%
|
||||||
Consolidation
rebate fees
|
(97,575
|
)
|
(94,165
|
)
|
(3,410
|
)
|
(3.6
|
)
|
|||||
Amortization
of loan premiums and deferred origination costs
|
(48,245
|
)
|
(43,693
|
)
|
(4,552
|
)
|
(10.4
|
)
|
|||||
Total
loan interest
|
585,927
|
814,140
|
(228,213
|
)
|
(28.0
|
)
|
|||||||
Investment
interest
|
16,724
|
33,754
|
(17,030
|
)
|
(50.5
|
)
|
|||||||
Total
interest income
|
602,651
|
847,894
|
(245,243
|
)
|
(28.9
|
)
|
|||||||
Interest
on bonds and notes payable
|
537,777
|
696,795
|
(159,018
|
)
|
(22.8
|
)
|
|||||||
Intercompany
interest
|
640
|
3,204
|
(2,564
|
)
|
(80.0
|
)
|
|||||||
Provision
for loan losses
|
11,000
|
5,288
|
5,712
|
108.0
|
|||||||||
Net
interest income after provision for loan losses
|
$
|
53,234
|
142,607
|
(89,373
|
)
|
(62.7)
|
%
|
·
|
The
average student loan portfolio increased $2.0 billion,
or 8.4%, for the six months ended June 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
$220.3
million
as a result of these factors.
|
·
|
Consolidation
rebate fees increased due to the $0.8 billion,
or 4.6%, increase in the average consolidation loan
portfolio.
|
·
|
The
amortization of loan premiums and deferred origination costs increased
$4.6 million
as a result of an increase in the average student loan
portfolio.
|
·
|
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
Company’s variable rate debt which lowered the Company’s cost of funds
(excluding net derivative settlements) to 3.96% for the six months
ended
June 30, 2008 compared to 5.48% for the same period a year ago. This
was
offset by a $1.5 billion, or 5.9%, increase in average debt for the
six
months ended June 30, 2008 compared to the same period in 2007. Interest
expense was impacted in 2008 by credit market disruptions as further
discussed in this Report.
|
·
|
The
provision for loan loss increased due to an increase in risk share
as a
result of the elimination of the Exceptional Performer program in
the
third quarter of 2007.
|
Other
fee-based income.
Borrower late fees increased $0.8
million
and $1.8
million
for the three and six months ended June 30, 2008 compared to the same periods
in
2007.
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 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 Company’s multi-year committed financing facility for
FFELP loans which reduced the Company’s exposure to certain equity support
provisions included in this facility.
Operating
expenses.
Excluding
the restructure and impairment charges, operating expenses decreased $10.4
million,
or 28.7%, and $14.5 million,
or 21.1%, for the three and six months ended June 30, 2008 compared to same
periods in 2007. This decrease is a result of the September 2007 and January
2008 restructuring plans and the Company capitalizing on the operating leverage
of its business structure and strategies.
LIQUIDITY
AND CAPITAL RESOURCES
The
Company utilizes operating cash flow, secured financing transactions,
asset-backed securitizations, and operating lines of credit to fund operations
and student loan and business acquisitions. The Company has also used its common
stock to partially fund certain business acquisitions. In addition, 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 Company’s bonds and notes outstanding as of June
30, 2008:
As of June 30, 2008
|
||||||||||
Carrying
|
Interest rate
|
|||||||||
amount
|
range
|
Final maturity
|
||||||||
Variable-rate
bonds and notes (a):
|
||||||||||
Bonds
and notes based on indices
|
$
|
21,339,035
|
2.65%
- 4.97%
|
|
09/25/13
- 06/25/41
|
|||||
Bonds
and notes based on auction or remarketing
|
2,841,245
|
0.67%
- 7.00%
|
|
11/01/09
- 07/01/43
|
||||||
Total
variable-rate bonds and notes
|
24,180,280
|
|||||||||
Commercial
paper - FFELP facility (b)
|
1,986,212
|
2.08%
- 2.91%
|
|
05/09/10
|
||||||
Commercial
paper - private loan facility (b)
|
159,800
|
3.08%
|
|
03/14/09
|
||||||
Fixed-rate
bonds and notes (a)
|
207,376
|
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
|
450,000
|
2.90%
|
|
05/08/12
|
||||||
Other
borrowings
|
71,569
|
3.19%
- 5.10%
|
|
05/22/09
- 11/01/15
|
||||||
$
|
27,530,237
|
(a)
Issued in asset-backed securitizations
(b)
Loan
warehouse facilities
Secured
Financing Transactions
The
Company relies 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 Company’s 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 Company’s
secured financing vehicles are loan warehouse facilities and asset-backed
securitizations.
Loan
warehouse facilities
Student
loan warehousing allows 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 private loan warehouse for non-federally insured student
loans, and a single-seller extendible commercial paper conduit for FFELP
loans.
The
multi-year committed facility for FFELP loans, which terminates in May 2010,
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
an
outstanding balance of approximately $2.8 billion
and a final maturity date of May 9, 2010. 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 must refinance or remove
approximately $900 million of loans by May 2009 to satisfy this provision.
Pursuant to the terms of the agreement, since liquidity was not renewed, the
Company’s 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.
Subsequent to July 31, 2008, the Company expects its cost of funds on this
facility to increase approximately 10 to 30 basis points.
The
terms
and conditions of the Company’s warehouse facility for FFELP loans provide for
advance rates related to financed loans subject to a valuation formula based
on
current market conditions. Dislocation in the credit markets including
disruptions in the current capital markets can and will cause short-term
volatility in the loan valuation formulas. Severe volatility and dislocation
in
the credit markets, even if temporary, could cause the valuation assigned to
the
Company’s student loan portfolio financed by the applicable line to be
significantly less than par. Should a significant change in the valuation of
subject loans result in a reduction in advance rate and require equity support
greater than what the Company can or is willing to provide, the facility could
be subject to termination. While the Company does not believe the loan valuation
formula is reflective of the fair market value of its loans, it is subject
to
compliance with provisions of the warehouse documents. As of August 8, 2008,
the
Company has $135.3
million
utilized as equity funding support based on provisions of this
agreement.
The
private loan warehouse facility is an uncommitted facility that is offered
to
the Company by a banking partner, which terminates on March 14, 2009. As of
June
30, 2008, $159.8 million
was outstanding under this facility and $90.2 million was available for future
use. As of August 8, 2008, $132.0
million
was outstanding under this facility and $118.0
million
was available for future use. 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 August 8, 2008, the Company has $54.5
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 Company’s 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.
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
June
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 future.
The
Company expects to access alternative sources of funding to originate new FFELP
student loans, including the Department of Education’s Loan Participation
Program (“Participation Program”), an existing facility with Union Bank and
Trust Company (“Union Bank”), an entity under common control with the Company,
and its $750 million
unsecured operating line of credit.
On
July
1, 2008, pursuant to HR 5715, the Department of Education announced terms under
which it will offer to purchase FFELP student loans and loan participations
from
FFELP lenders. Under the Department’s 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. Lenders
will have until September 30, 2009, to sell loans to the Department. Under
the
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 Department’s
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. The Company is in the process of completing and filing all
relevant documents to participate in the Department of Education’s Participation
Program and expects to utilize the Participation Program to fund a significant
portion of its loan originations for the 2008-2009 academic year.
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 June 30, 2008 and August 8, 2008, approximately
$228.7 million and $56.4
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 Bank’s 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
Company’s consolidated balance sheet.
Asset-backed
securitizations
Of
the
$27.5 billion
of debt outstanding as of June 30, 2008, $24.4 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 Company’s 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
June 30, 2008, the Company had $21.3 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 management’s 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.
Auction
or remarketing based notes
The
interest rates on certain of the Company's 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 $0.9 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 Company’s Auction Rate Securities
have failed in this manner. Under normal conditions, banks have historically
stepped in when investor demand is weak. However, recently 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
June
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 June 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 does not expect this funding benefit on its Auction Rate Securities
in future periods.
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.
Operating
Lines of Credit
The
Company uses its line of credit agreements primarily for general operating
purposes, to fund certain asset and business acquisitions, and to repurchase
stock under the Company’s stock repurchase program. The Company maintains a
$750.0
million
unsecured line of credit supported by various banking entities. At June 30,
2008, $450.0 million
was outstanding under this line and $300.0 million
was available for future uses. The $750.0
million
line of credit terminates in May 2012. 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 August 8, 2008, the Company has contributed $189.8
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
August 8, 2008, the Company has $450.0
million
outstanding under this line of credit and $300.0
million
available for future uses.
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 Company’s
portfolio.
|
As
of
June 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 Company’s other lending facilities,
including its FFELP and private loan warehouses.
The
Company’s operating line of credit does not have any covenants related to
unsecured debt ratings. However, changes in the Company’s ratings (as well as
the amounts the Company borrows) may have modest implications on the pricing
level at which the Company obtains funding.
The
Company also has a $725.0
million
unsecured commercial paper program. Under the program, the Company may issue
commercial paper for general corporate purposes. The maturities of the notes
issued under this program will vary, but may not exceed 397 days from the date
of issue. Notes issued under this program will bear interest at rates that
will
vary based on market conditions at the time of issuance. As of June 30, 2008,
there were no borrowings outstanding on this line and $725.0 million
of remaining authorization. The
Company does not expect to be able to issue unsecured commercial paper in the
near or intermediate future at a cost effective level relative to the Company’s
unsecured line of credit.
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 Company’s
option, the Notes are redeemable in whole at any time or in part from time
to
time at the redemption price described in the Company’s prospectus supplement.
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 Company’s 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 Company’s stock repurchase plan.
Sources
of Liquidity
The
following table details the Company’s primary sources of liquidity and the
available capacity at June 30, 2008:
Sources
of primary liquidity: (a)
|
||||
Cash
and cash equivalents (b)
|
$
|
138,454
|
||
Unencumbered
student loan assets
|
6,858
|
|||
Unused
unsecured line of credit (c)
|
300,000
|
|||
Total
sources of primary liquidity
|
$
|
445,312
|
(a)
|
The
sources of primary liquidity table above does not include the following
items:
|
·
|
FFELP
warehouse facility
-
On July 31, 2008, the Company did not renew the liquidity provisions
of
this 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.
|
·
|
Private
loan warehouse facility
-
As of June 30, 2008, the Company has $90.2 million
of capacity on this facility. However, in January 2008, the Company
suspended originating private loans. As such, the capacity on this
facility is not included in the above table. The Company’s private loan
warehouse facility expires on March 14, 2009.
|
·
|
Extendible
commercial paper warehouse program
-
The Company has $5.0 billion
authorized for future issuance under this facility. 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.
|
·
|
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 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 June 30, 2008 and August 8, 2008, approximately
$228.7 million and $56.4 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
Bank’s 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.
The Company does not include this participation agreement in the
table
above because the Company is limited to the amount they can participate
under this facility by the amount of investments in the grantor
trusts.
|
·
|
Department
of Education’s Loan Participation Program
-
On July 1, 2008, pursuant to HR 5715, the Department of Education
announced terms under which it will offer to purchase FFELP student
loans
and loan participations from FFELP lenders. Under the Participation
Program, the Department will provide interim short-term liquidity
to FFELP
lenders by purchasing participation interest 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 prior to its expiration on September
30, 2009. To be eligible for purchase or participation under the
Department’s program, 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. The Company is in the process
of
completing and filing all relevant documents to participate in the
Department’s program and expects to utilize the Participation Program to
fund a significant portion of its loan originations for the 2008-2009
academic year.
|
·
|
Asset-backed
security investments
-
As part of the Company’s 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 Company’s 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 Company’s 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 Company’s
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 August 8, 2008, the unused unsecured line of credit was
$300.0
million.
|
Contractual
Obligations
The
Company is committed under noncancelable operating leases for certain office
and
warehouse space and equipment. The Company’s contractual obligations as of June
30, 2008 were as follows:
Total
|
Less than
1 year
|
1 to 3 years
|
3 to 5 years
|
More than
5 years
|
||||||||||||
Bonds
and notes payable
|
$
|
27,530,237
|
2,227,217
|
390,173
|
513,847
|
24,399,000
|
||||||||||
Operating
lease obligations
|
41,571
|
9,032
|
16,201
|
11,449
|
4,889
|
|||||||||||
Other
|
7,675
|
7,355
|
320
|
—
|
—
|
|||||||||||
Total
|
$
|
27,579,483
|
2,243,604
|
406,694
|
525,296
|
24,403,889
|
As
of
June 30, 2008, the Company had a reserve of $7.9 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’s bonds and notes payable due in less than one year includes $2.0
billion
of bonds
and notes outstanding related to the Company’s FFELP warehouse facility. On July
31, 2008, the Company was unable to 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 date of May 9, 2010.
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 Company’s 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 Company’s 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 subsequent 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 Company’s Class A Common Stock as of June 30, 2008 of
$11.23
per share, the Company’s 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 June 30, 2008
was
$6.7 million
and is included in “other” in the above
table.
|
Dividends
In
the
first quarter of 2007, the Company began paying dividends of $0.07 per share
on
the Company’s 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.
CRITICAL
ACCOUNTING POLICIES
This
Management’s Discussion and Analysis of Financial Condition and Results of
Operations discusses the Company’s 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 Company’s 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 Company’s
financial condition and results of operations and they require management’s 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 management’s 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 Company’s 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 Company’s 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 Company’s 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 Company’s 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.
The
Company assesses collectibility of revenues and our 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 our 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 FASB Statement No. 142, Goodwill
and Other Intangible Assets.
The
provisions of Statement 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 unit’s goodwill. If the carrying value of a reporting unit’s
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 Company’s
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 Company’s
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.
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 entity’s deferred tax asset and liability balances occurring after
December 31, 2008. The Company is currently evaluating the future
impacts and disclosures of this standard.
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 of SFAS No. 157-2,
but would not expect SFAS No. 157-2 to have a material impact on the Company’s
consolidated results of operations or financial condition.
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. The Statement 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 Board’s 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.
This Statement is effective as of the beginning of an entity’s 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 Company’s 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 parent’s 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 to applied retrospectively to all periods
presented. The Company is currently evaluating the future impacts and
disclosures of this standard.
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 entity’s financial position, financial performance, and cash flows. The
new standard also improves transparency about the location and amounts of
derivative instruments in an entity’s 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 of this standard.
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 Board’s 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.
In
December 2007, the FASB ratified the Emerging Issues Task Force consensus
on EITF Issue No. 07-1, Accounting
for Collaborative Arrangements,
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 Issue 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 of
this standard.
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 142’s
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.
Interest
Rate Risk
The
Company’s 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.
The
following table sets forth the Company’s loan assets and debt instruments by
rate characteristics:
As of June 30, 2008
|
As of December 31, 2007
|
||||||||||||
Dollars
|
Percent
|
Dollars
|
Percent
|
||||||||||
Fixed-rate
loan assets
|
$
|
2,391,089
|
9.3
|
%
|
$
|
1,136,544
|
4.3
|
%
|
|||||
Variable-rate
loan assets
|
23,221,037
|
90.7
|
25,192,669
|
95.7
|
|||||||||
Total
|
$
|
25,612,126
|
100.0
|
%
|
$
|
26,329,213
|
100.0
|
%
|
|||||
Fixed-rate
debt instruments
|
682,376
|
2.5
|
%
|
689,476
|
2.5
|
%
|
|||||||
Variable-rate
debt instruments
|
26,847,861
|
97.5
|
27,426,353
|
97.5
|
|||||||||
Total
|
$
|
27,530,237
|
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 loan’s 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 Company’s 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 fixed rate floor income. For the three and
six months ended June 30, 2008, loan interest income includes approximately
$9.9
million
and
$18.4 million
of fixed
rate floor income, respectively. For the three and six months ended June 30,
2007, loan interest income includes approximately $2.7 million
and $6.2
million
of fixed
rate floor income, respectively.
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 new legislation enacted
in
2006, lenders are required to rebate floor income and variable-rate floor income
to the Department for all new FFELP loans originated on or after April 1, 2006.
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%:
![](https://www.sec.gov/Archives/edgar/data/0001258602/000114420408045453/chart2.jpg)
The
following table shows the Company’s student loan assets that are earning fixed
rate floor income as of June 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)
|
June 30, 2008 (b)
|
|||||||
4.5
- 4.99%
|
4.88
|
%
|
2.24
|
%
|
$
|
942
|
||||
5.0
- 5.49%
|
5.09
|
%
|
2.45
|
%
|
1,046
|
|||||
5.5
- 5.99%
|
5.67
|
%
|
3.03
|
%
|
355,270
|
|||||
6.0
- 6.49%
|
6.19
|
%
|
3.55
|
%
|
425,480
|
|||||
6.5
- 6.99%
|
6.70
|
%
|
4.06
|
%
|
381,260
|
|||||
7.0
- 7.49%
|
7.17
|
%
|
4.53
|
%
|
132,967
|
|||||
7.5
- 7.99%
|
7.71
|
%
|
5.07
|
%
|
229,591
|
|||||
8.0
- 8.99%
|
8.16
|
%
|
5.52
|
%
|
532,306
|
|||||
>
9.0%
|
9.04
|
%
|
6.40
|
%
|
332,227
|
|||||
$
|
2,391,089
|
(a) |
The
estimated variable conversion rate is the estimated short-term interest
rate at which loans would convert to variable rate.
|
(b) |
As
of June 30, 2008, the Company had $206.7 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 June 30, 2008 was 6.17%.
|
The
following table summarizes the outstanding derivative instruments as of June
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
|
700,000
|
3.44
|
|||||
2011
|
500,000
|
(b)
|
3.57
|
||||
2012
|
250,000
|
(c)
|
3.86
|
||||
$
|
1,950,000
|
3.69
|
%
|
(a)
|
For
all interest rate derivatives for which the Company pays a fixed
rate, the
Company receives discrete three-month
LIBOR.
|
(b) |
$250.0
million notional amount of derivatives have an effective start date
in the
first quarter of 2010.
|
(c) |
Derivatives
have an effective start date in the first quarter
2009.
|
In
April
2008 and May 2008, the Company entered into interest rate swaps with notional
amounts of $200.0 million and $250.0 million which had forward-start dates
of
July 25, 2008 and June 25, 2008, respectively. The Company receives a fixed
rate
of 2.9805% and 3.693%, respectively, and pays discrete three-month LIBOR. These
trades offset $450.0 million of fixed rate swaps previously entered into by
the
Company (included in the above table) and were executed in order to maintain
the
Company’s desired hedge ratio.
As
of
June 30, 2008, the Company had $3.9 billion of student loan assets that were
earning variable-rate floor income. For the three and six months ended June
30,
2008, loan interest income includes approximately $21.9 million and $40.7
million of variable-rate floor income, respectively. The Company earned no
variable-rate floor income during the first six months of 2007. As discussed
previously, because the borrower rate resets on these loans on July 1, 2008,
unless there is a decrease in short-term interest rates prior to the next
borrower reset date, the Company will no longer earn variable-rate floor income
on these loans.
The
Company had outstanding interest rate derivatives with a notional amount of
$1.95 billion to hedge a portion of its student loans earning variable-rate
floor income. These derivatives terminated on June 30, 2008. The Company paid
total settlements on these derivatives of $7.2 million and $10.0 million during
the three and six months ended June 30, 2008, respectively.
The
Company is exposed to interest rate risk in the form of basis risk and repricing
risk because the interest rate characteristics of the Company’s 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 Company’s 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 Company's 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 Company's interest rate risk management strategy currently include
interest rate swaps, basis swaps, and cross-currency swaps.
The
following table presents the Company’s student loan assets and related funding
arranged by underlying indices as of June 30, 2008:
Index (e)
|
Frequency of
Variable Resets
|
Assets
|
Debt
outstanding
that funded
student loan
assets (a)
|
|||||||
3
month H15 financial commercial paper (b)
|
Daily
|
$
|
23,962,096
|
—
|
||||||
3
month Treasury bill
|
Varies
|
1,370,077
|
—
|
|||||||
Private
student loans
|
279,953
|
—
|
||||||||
3
month LIBOR (c)
|
Quarterly
|
—
|
21,339,035
|
|||||||
Auction-rate
or remarketing
|
Varies
|
—
|
2,841,245
|
|||||||
Asset-backed
commercial paper
|
Varies
|
—
|
2,146,012
|
|||||||
Fixed
rate
|
—
|
207,376
|
||||||||
Other
(d)
|
921,542
|
—
|
||||||||
$
|
26,533,668
|
26,533,668
|
(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 June 30, 2008:
|
Notional Amount
|
||||||||||||||||
Maturity
|
Effective date in second
quarter 2007
|
Effective date in third
quarter 2007
|
Effective date in second
quarter 2008
|
Effective date in third
quarter 2008
|
Total
|
|||||||||||
2008
|
$
|
1,000,000
|
2,000,000
|
—
|
—
|
3,000,000
|
||||||||||
2009
|
2,000,000
|
4,000,000
|
—
|
3,000,000
|
9,000,000
|
|||||||||||
2010
|
500,000
|
2,000,000
|
2,000,000
|
1,000,000
|
5,500,000
|
|||||||||||
2011
|
—
|
2,700,000
|
—
|
—
|
2,700,000
|
|||||||||||
2012
|
—
|
1,000,000
|
800,000
|
1,600,000
|
3,400,000
|
|||||||||||
$
|
3,500,000
|
11,700,000
|
2,800,000
|
5,600,000
|
23,600,000
|
(b)
|
The
Company’s FFELP student loans earn interest based on the daily average H15
financial commercial paper calculated on a fiscal
quarter.
|
(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.”
|
(d)
|
Assets
include restricted cash and investments, pre-funding on certain debt
transactions, and other assets.
|
(e)
|
Historically,
the movement of the various interest rate indices received on the
Company’s 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 Company’s student loan net interest
income.
|
![](https://www.sec.gov/Archives/edgar/data/0001258602/000114420408045453/chart3.jpg)
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
Company’s derivative transactions with the intent that each is economically
effective. However, the Company’s 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 Company’s operating results.
Changes or shifts in the forward yield curve and fluctuations in currency rates
can significantly impact the valuation of the Company’s 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 Company’s derivatives are included
in “derivative
market value, foreign currency, and put option adjustments and derivative
settlements, net”
in
the
Company’s consolidated statements of operations and resulted in income of $11.5
million
and
$47.5 million
for the
three and six months ended June 30, 2008, respectively, and income of $16.7
million and
$20.3
million for
the
three and six months ended June 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 June 30,
|
Six months ended June 30,
|
||||||||||||
2008
|
2007
|
2008
|
2007
|
||||||||||
Interest
rate swaps - loan portfolio
|
$
|
(7,842
|
)
|
1,977
|
(11,019
|
)
|
4,872
|
||||||
Basis
swaps - loan portfolio
|
5,148
|
—
|
45,605
|
—
|
|||||||||
Interest
rate swaps - other (a)
|
—
|
5,657
|
—
|
10,321
|
|||||||||
Cross-currency
interest rate swaps
|
7,131
|
(2,438
|
)
|
10,614
|
(5,757
|
)
|
|||||||
Derivative
settlements received, net
|
$
|
4,437
|
5,196
|
45,200
|
9,436
|
(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 Company’s 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 Company’s 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 Company’s variable-rate assets and liabilities.
The analysis includes the effects of the Company’s interest rate and basis swaps
in existence during these periods. As a result of the Company’s 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 June 30, 2008
|
|||||||||||||||||||
Change from decrease of 100
basis points
|
Change from increase of 100
basis points
|
Change from increase of 200
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
|
$
|
10,566
|
17.1
|
%
|
(10,566
|
)
|
(17.1)
|
%
|
(21,132
|
)
|
(34.1)
|
%
|
|||||||
Impact
of derivative settlements
|
(8,492
|
)
|
(13.7
|
)
|
8,492
|
13.7
|
16,984
|
27.4
|
|||||||||||
Increase
(decrease) in net income before taxes
|
$
|
2,074
|
3.4
|
%
|
(2,074
|
)
|
(3.4)
|
%
|
(4,148
|
)
|
(6.7)
|
%
|
|||||||
Increase
(decrease) in basic and diluted earning per share
|
$
|
0.03
|
(0.03
|
)
|
(0.06
|
)
|
Three months ended June 30, 2007
|
|||||||||||||||||||
Change from decrease of 100
basis points
|
Change from increase of 100
basis points
|
Change from increase of 200
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
|
$
|
6,519
|
21.1
|
%
|
535
|
1.7
|
%
|
2,192
|
7.1
|
%
|
|||||||||
Impact
of derivative settlements
|
(1,932
|
)
|
(6.3
|
)
|
1,932
|
6.3
|
3,864
|
12.5
|
|||||||||||
Increase
in net income before taxes
|
$
|
4,587
|
14.8
|
%
|
2,467
|
8.0
|
%
|
6,056
|
19.6
|
%
|
|||||||||
Increase
in basic and diluted earning per share
|
$
|
0.06
|
0.03
|
0.07
|
Six months ended June 30, 2008
|
|||||||||||||||||||
Change from decrease of 100
basis points
|
Change from increase of 100
basis points
|
Change from increase of 200
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
|
$
|
22,151
|
56.4
|
%
|
(22,151
|
)
|
(56.4)
|
%
|
(42,560
|
)
|
(108.4)
|
%
|
|||||||
Impact
of derivative settlements
|
(14,785
|
)
|
(37.6
|
)
|
14,785
|
37.6
|
29,570
|
75.3
|
|||||||||||
Increase
(decrease) in net income before taxes
|
$
|
7,366
|
18.8
|
%
|
(7,366
|
)
|
(18.8)
|
%
|
(12,990
|
)
|
(33.1)
|
%
|
|||||||
Increase
(decrease) in basic and diluted earning per share
|
$
|
0.10
|
(0.10
|
)
|
(0.18
|
)
|
Six months ended June 30, 2007
|
|||||||||||||||||||
Change from decrease of 100
basis points
|
Change from increase of 100
basis points
|
Change from increase of 200
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
|
$
|
10,733
|
19.7
|
%
|
3,558
|
6.5
|
%
|
9,357
|
17.1
|
%
|
|||||||||
Impact
of derivative settlements
|
(3,843
|
)
|
(7.1
|
)
|
3,843
|
7.1
|
7,686
|
14.1
|
|||||||||||
Increase
in net income before taxes
|
$
|
6,890
|
12.6
|
%
|
7,401
|
13.6
|
%
|
17,043
|
31.2
|
%
|
|||||||||
Increase
in basic and diluted earning per share
|
$
|
0.08
|
0.09
|
0.21
|
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 Company’s 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
Company’s 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 Company’s operating results.
For
the
three and six months ended June 30, 2008, the Company recorded income of $4.4
million
and an
expense of $88.5 million,
respectively, as a result of re-measurement of the Euro Notes and a loss of
$2.4
million
and
income of $91.7 million,
respectively, for the change in the fair value of the related derivative
instrument. For the three and six months ended June 30, 2007, the Company
recorded expense of $11.3 million and $25.0 million, respectively, as a result
of the re-measurement of the Euro Notes and income of $28.5 million and $36.2
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 Company’s consolidated statements of operations.
Disclosure
Controls and Procedures
Under
supervision and with the participation of certain members of the Company’s
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 Company’s 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 Company’s 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 Company’s 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 Company’s or
any system of disclosure controls and procedures can provide only reasonable
assurance regarding management’s control objectives.
Changes
in Internal Control over Financial Reporting
There
was
no change in the Company’s internal control over financial reporting during the
Company’s last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, the Company’s internal control over financial
reporting.
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 Company’s management that the disposition or
ultimate determination of these claims, lawsuits, and proceedings will not
have
a material adverse effect on the Company’s business, financial position, or
results of operations.
Municipal
Derivative Bid Practices Investigation
As
previously reported in the Company’s Annual Report on Form 10-K for the year
ended December 31, 2007, and the Company’s Quarterly Report on Form 10-Q for the
quarter ended March 31, 2008, on February 8, 2008, Shockley Financial Corp.
(“SFC”), an indirect wholly owned subsidiary of the Company with two associates
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 Justice’s 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. The Company and SFC are cooperating with the investigation.
In
addition, 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. The subpoena seeks
certain information and documents from SFC relating to its GIC business. The
Company and SFC are cooperating with the investigation.
On
or
about June 6, 2008, SFC received a subpoena from the New York Attorney General
(the “NYAG”) relating to the NYAG’s investigation concerning the bidding of
municipal GICs and possible violations of various state and federal laws. The
subpoena seeks certain information and documents from SFC relating to its GIC
business. The Company and SFC are cooperating with the
investigation.
On
or
about June 12, 2008, SFC received a subpoena from the Florida Attorney General
(the “FLAG”) relating to the FLAG’s investigation concerning the bidding of
municipal GICs and possible violations of various state and federal laws. The
subpoena seeks certain information and documents from SFC relating to its GIC
business. The Company and SFC are cooperating with the investigation.
SFC has also been named as a defendant in a total of eight 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 has also been named as a defendant in a total of eight 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 NYAG’s
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 NYAG’s Code of Conduct, which is substantially similar to
the Company's 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 seniors and their parents regarding
the
financial aid process.
On
October 10, 2007, the Company received a subpoena from the NYAG requesting
certain information and documents from the Company in connection with the NYAG’s
investigation into direct-to-consumer marketing practices of student lenders.
The Company is cooperating with the subpoena.
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 Department’s 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 of
Education notified the Company that it would be conducting a review of the
Company’s administration of the FFEL Program under the Higher Education Act. The
Company understands that the Department of Education has selected several
schools and lenders for review. Specifically, the Department is reviewing the
Company’s 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 Department of Education’s requests for information
and documentation and is cooperating with their review.
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
Department’s guidance regarding those rules and regulations.
Department
of Justice
In
connection with the Company’s 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 Company’s 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 Department’s guidance regarding those rules and
regulations.
There
have been no material changes from the risk factors described in Nelnet’s 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 except as set forth below.
The
Company faces liquidity risks associated with financing student loan
originations and acquisitions.
The
Company’s primary funding needs are those required to finance its student loan
portfolio and satisfy its cash requirements for new student loan originations
and acquisitions. In general, the amount, type, and cost of the Company’s
funding, including securitization and unsecured financing from the capital
markets and borrowings from financial institutions, have a direct impact
on the
Company’s operating expenses and financial results and can limit the Company’s
ability to grow its student loan assets. The Company has historically relied
upon secured financing vehicles as its most significant source of funding
for
student loans. The Company’s primary secured financing vehicles have been loan
warehouse facilities and asset-backed securitizations.
As
previously disclosed, with respect to the Company’s loan warehouse facilities
and asset-backed securitizations, the recent unprecedented disruptions in
the
credit markets have had and may continue to have an adverse impact on the
cost
and availability of financing for the Company’s student loan portfolios and, as
a result, have had and may continue to have an adverse impact on the Company’s
results of operations and financial condition. Such adverse credit market
conditions may continue or worsen in the future.
Student
loan warehousing allows the Company to buy and manage student loans prior
to
transferring them into more permanent financing arrangements. The majority
of
the Company’s operating and warehouse financings are provided by third parties,
over which it has limited control. Current conditions in the debt markets
have
resulted in reduced liquidity and increased credit risk premiums for most
market
participants. These conditions can increase the cost and reduce the availability
of debt in the capital markets. If warehouse financing sources are unavailable,
the Company may be unable to meet its financial commitments to schools, branding
partners, or forward flow lenders when due unless the Company is able to
find
alternative funding mechanisms. The Company attempts to mitigate the impact
of
debt market disruptions by obtaining adequate committed and uncommitted
facilities from a variety of reliable sources. There can be no assurance,
however, that the Company will be successful in these efforts, that such
facilities will be adequate, or that the cost of debt will allow the Company
to
operate at profitable levels.
The
Company has historically relied upon a multi-seller bank provided conduit
warehouse to fund the origination and acquisition of FFELP student loans.
The
facility for FFELP loans, which terminates in May 2010, 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 an outstanding balance of
approximately $2.8 billion and a final maturity of May 9, 2010. The FFELP
warehouse facility has a provision requiring the Company to refinance or
remove
75% of the pledged collateral on an annual basis. Therefore the Company
must refinance or remove approximately $900 million of loans by May 2009
to
satisfy this provision.
The
Company expects to access alternative sources of funding to originate new
FFELP
student loans, including the Department of Education’s Loan Participation
Program (“Participation Program”), an existing facility with Union Bank and
Trust Company (“Union Bank”), an entity under common control with the Company,
and the Company’s $750 million
unsecured operating line of credit.
On
July
1, 2008, pursuant to HR 5715, the Department of Education announced terms
under
which it will offer to purchase FFELP student loans and loan participations
from
FFELP lenders. Under the Department’s 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. Lenders
will have until September 30, 2009, to sell loans to the Department. Under
the
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 Department’s
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. The Company is in the process of completing and filing
all
relevant documents to participate in the Department of Education’s Participation
Program and expects to utilize the Participation Program to fund a significant
portion of its loan originations for the 2008-2009 academic year.
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. The agreement automatically renews annually and
is
terminable by either party upon five business days notice. This agreement
provides beneficiaries of Union Bank’s 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.
There
can
be no assurance the Participation Program, the FFELP Participation Agreement,
or
the Company’s unsecured line of credit will be adequate to fund the Company’s
origination and acquisition obligations. As such, the Company’s ability to
originate and acquire student loans would be limited or could be eliminated.
The
Company has historically used its warehouse facilities 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. The Company has historically relied upon, and expects to
continue to rely upon, asset-backed securitizations as its most significant
source of funding for student loans on a long-term basis. If this market
continues to experience difficulties or worsen, the Company may be unable
to
securitize its student loans or to do so on favorable terms, including pricing.
A number of factors could make such securitization more difficult, more
expensive, or unavailable on any terms, including, but not limited to, financial
results and losses, changes within the Company’s organization, specific events
that have an adverse impact on the Company’s reputation, changes in the
activities of the Company’s business partners, disruptions in the capital
markets, specific events that have an adverse impact on the financial services
industry, counter-party availability, changes affecting the Company’s assets,
the Company’s corporate and regulatory structure, interest rate fluctuations,
ratings agencies’ actions, general economic conditions, and the legal,
regulatory, accounting, and tax environments governing the Company’s funding
transactions. In addition, the Company’s ability to raise funds is strongly
affected by the general state of the United States and world economies, and
may
become increasingly difficult due to economic and other factors. If the Company
were unable to continue to securitize student loans on favorable terms, it
could
use alternative funding sources including the purchase program to meet liquidity
needs; 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
find 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 Company’s results of operations. In addition, the
Company’s ability to originate and acquire student loans would be limited or
could be eliminated.
Stock
Repurchases
The
following table summarizes the repurchases of Class A common stock during the
second 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)
|
|||||||||
April
1 - April 30, 2008
|
11,358
|
$
|
12.81
|
11,358
|
7,478,139
|
||||||||
May
1 - May 31, 2008
|
1,162
|
13.83
|
1,162
|
7,390,551
|
|||||||||
June
1 - June 30, 2008
|
1,474
|
11.99
|
1,474
|
7,871,390
|
|||||||||
Total
|
13,994
|
$
|
12.80
|
13,994
|
(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 April, May, or June 2008. Shares of Class A common
stock
purchased pursuant to the 2006 Plan included (i) 3,388 shares, 1,162
shares, and 1,474 shares in April, May, and June, respectively, that
had
been issued to the Company’s 401(k) plan and allocated to employee
participant accounts pursuant to the plan’s 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) 7,970 shares purchased in April
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 Company’s Class A common stock (the “2006
Plan”). On February 7, 2007, the Company’s 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 Company’s 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 Company's 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.
|
As
of
|
Maximum number of
shares that may yet be
purchased under the
2006 Plan
(A)
|
Approximate dollar
value of shares that
may yet be
purchased under
the 2006 ESLP
(B)
|
Closing price on
the last trading
day of the
Company's Class
A Common Stock
(C)
|
(B / C)
Approximate
number of shares
that may yet be
purchased under
the 2006 ESLP
(D)
|
(A + D)
Approximate
number of shares
that may yet be
purchased under
the 2006 Plan and
2006 ESLP
|
|||||||||||
April 30, 2008
|
4,628,256
|
36,450,000
|
12.79
|
2,849,883
|
7,478,139
|
|||||||||||
May
31, 2008
|
4,627,094
|
36,450,000
|
13.19
|
2,763,457
|
7,390,551
|
|||||||||||
June
30, 2008
|
4,625,620
|
36,450,000
|
11.23
|
3,245,770
|
7,871,390
|
Working
capital and dividend restrictions/limitations
The
Company’s credit facilities, including its revolving line of credit which is
available through May of 2012, impose restrictions on the Company’s
minimum consolidated net worth, the ratio of the Company’s Adjusted
EBITDA to corporate debt interest, the indebtedness of the Company's
subsidiaries, and the ratio of Non-FFELP loans to all loans in the
Company's portfolio. In addition, trust indentures and other financing
agreements governing debt issued by the Company's 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 Company’s 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 Company’s 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 Company’s 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 Company’s 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 entity’s 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 Company’s 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.
|
At
the
Company’s annual meeting of shareholders held on May 22, 2008, the following
proposals were submitted to a vote of shareholders and were approved by the
margins indicated:
1.
|
To
elect nine directors to serve on the Company’s Board of Directors for
one-year terms or until their successors are elected and qualified.
All
directors seeking election were in attendance at the annual meeting.
|
Number of Shares
|
||||||||||
Votes For
|
Votes Against
|
Abstain
|
||||||||
James P. Abel
|
149,084,383
|
1,000,456
|
107,672
|
|||||||
Stephen
F. Butterfield
|
149,907,990
|
186,362
|
98,158
|
|||||||
Michael
S. Dunlap
|
149,157,652
|
936,646
|
98,213
|
|||||||
Kathleen
A. Farrell
|
149,150,104
|
935,965
|
106,442
|
|||||||
Thomas
E. Henning
|
149,158,969
|
925,302
|
108,240
|
|||||||
Brian
J. O'Connor
|
149,155,801
|
928,320
|
108,390
|
|||||||
Kimberly
K. Rath
|
149,156,683
|
927,092
|
108,736
|
|||||||
Michael
D. Reardon
|
149,881,696
|
202,574
|
108,240
|
|||||||
James
H. Van Horn
|
149,965,815
|
120,736
|
105,960
|
2. |
To ratify
the appointment of KPMG LLP as independent auditors for
2008.
|
Number of Shares
|
|||||||
Votes For
|
Votes Against
|
Abstain
|
|||||
149,965,815
|
120,736
|
105,960
|
3.
|
To
approve an amendment to the Directors Stock Compensation Plan to
increase
the authorized number of shares of Class A common stock that may
be issued
under the plan from a total of 100,000 shares to a total of 400,000
shares.
|
Number of Shares
|
|||||||
Votes For
|
Votes Against
|
Abstain
|
|||||
145,532,849
|
1,073,119
|
111,764
|
A
shareholder proposal described in the Company’s proxy statement for the meeting
was not properly introduced at the meeting by the shareholder, and thus was
not
submitted to a vote of shareholders.
4.1
|
Indenture
of Trust by and between Nelnet Student Loan Trust 2008-2 and Zions
First
National Bank, dated as of April 1, 2008, filed as Exhibit 4.1 to
Nelnet
Student Loan Trust 2008-2’s Current Report on Form 8-K filed on April 9,
2008 and incorporated herein by reference.
|
|
4.2
|
Indenture
of Trust by and between Nelnet Student Loan Trust 2008-3 and Zions
First
National Bank, dated as of April 15, 2008, filed as Exhibit 4.1 to
Nelnet
Student Loan Trust 2008-3’s Current Report on Form 8-K filed on April 30,
2008 and incorporated herein by reference.
|
|
4.3
|
Indenture
of Trust by and between Nelnet Student Loan Trust 2008-4 and Zions
First
National Bank, dated as of May 1, 2008, filed as Exhibit 4.1 to Nelnet
Student Loan Trust 2008-4’s Current Report on Form 8-K filed on May 23,
2008 and incorporated herein by reference.
|
|
10.1+
|
Nelnet,
Inc. Directors Stock Compensation Plan, as amended through April
18, 2008,
filed as Exhibit 99.1 to Nelnet, Inc.’s Registration Statement on Form S-8
filed on June 27, 2008 and incorporated herein by
reference.
|
|
10.2*
|
Seventh
Amendment of Amended and Restated Participation Agreement, dated
as of
July 1, 2008 by and between Union Bank and Trust Company and Nelnet,
Inc.
(f/k/a/ NELnet, Inc.) (subsequently renamed National Education Loan
Network, 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
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:
August 11, 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
|
78