NELNET INC - Quarter Report: 2009 September (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 September 30, 2009
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
(State
or other jurisdiction of incorporation or organization)
|
84-0748903
(I.R.S.
Employer Identification No.)
|
121
SOUTH 13TH STREET, SUITE 201
LINCOLN,
NEBRASKA
(Address
of principal executive offices)
|
68508
(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 [ ]
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes [ ] No [
]
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large
accelerated filer [ ]
Accelerated filer [X]
Non-accelerated
filer [ ]
Smaller reporting company [ ]
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes [ ]
No [X]
As of
October 31, 2009, there were 38,348,015 and 11,495,377 shares of Class A Common
Stock and Class B Common Stock, par value $0.01 per share, outstanding,
respectively (excluding 11,317,364 shares of Class A Common Stock held by a
wholly owned subsidiary).
NELNET,
INC.
FORM
10-Q
INDEX
September
30, 2009
PART
I. FINANCIAL INFORMATION
|
|||||
Item
1.
|
Financial
Statements
|
2
|
|||
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
32
|
|||
Item
3.
|
Quantitative
and Qualitative Disclosures about Market Risk
|
76
|
|||
Item
4.
|
Controls
and Procedures
|
81
|
|||
PART
II. OTHER INFORMATION
|
|||||
Item
1.
|
Legal
Proceedings
|
81
|
|||
Item
1A.
|
Risk
Factors
|
83
|
|||
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
83
|
|||
Item
6.
|
Exhibits
|
85
|
|||
Signatures
|
86
|
||||
PART
I. FINANCIAL INFORMATION
ITEM
1. FINANCIAL STATEMENTS
NELNET,
INC. AND SUBSIDIARIES
|
||||||||
CONSOLIDATED
BALANCE SHEETS
|
||||||||
(Dollars
in thousands, except share data)
|
||||||||
As
of
|
As
of
|
|||||||
September
30, 2009
|
December
31, 2008
|
|||||||
(unaudited)
|
||||||||
Assets:
|
||||||||
Student
loans receivable (net of allowance for loan losses of
|
||||||||
$50,120
and $50,922, respectively)
|
$ | 23,764,263 | 25,413,008 | |||||
Student
loans receivable - held for sale
|
1,627,794 | — | ||||||
Cash
and cash equivalents:
|
||||||||
Cash
and cash equivalents - not held at a related party
|
15,077 | 13,129 | ||||||
Cash
and cash equivalents - held at a related party
|
319,216 | 176,718 | ||||||
Total
cash and cash equivalents
|
334,293 | 189,847 | ||||||
Restricted
cash and investments
|
798,636 | 997,272 | ||||||
Restricted
cash - due to customers
|
50,783 | 160,985 | ||||||
Accrued
interest receivable
|
389,238 | 471,878 | ||||||
Accounts
receivable (net of allowance for doubtful accounts of
|
||||||||
$1,506
and $1,005, respectively)
|
49,268 | 42,088 | ||||||
Goodwill
|
175,178 | 175,178 | ||||||
Intangible
assets, net
|
59,803 | 77,054 | ||||||
Property
and equipment, net
|
28,116 | 38,747 | ||||||
Other
assets
|
104,333 | 113,666 | ||||||
Fair
value of derivative instruments
|
210,157 | 175,174 | ||||||
Total
assets
|
$ | 27,591,862 | 27,854,897 | |||||
Liabilities:
|
||||||||
Bonds
and notes payable
|
$ | 26,586,093 | 26,787,959 | |||||
Accrued
interest payable
|
24,859 | 81,576 | ||||||
Other
liabilities
|
193,055 | 179,336 | ||||||
Due
to customers
|
50,783 | 160,985 | ||||||
Fair
value of derivative instruments
|
8,998 | 1,815 | ||||||
Total
liabilities
|
26,863,788 | 27,211,671 | ||||||
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 38,349,461 shares as of September 30,
|
||||||||
2009
and 37,794,067 shares as of December 31, 2008
|
383 | 378 | ||||||
Class
B, convertible, $0.01 par value. Authorized 60,000,000
shares;
|
||||||||
issued
and outstanding 11,495,377 shares as of September 30,
|
||||||||
2009
and December 31, 2008
|
115 | 115 | ||||||
Additional
paid-in capital
|
108,442 | 103,762 | ||||||
Retained
earnings
|
620,583 | 540,521 | ||||||
Employee
notes receivable
|
(1,449 | ) | (1,550 | ) | ||||
Total
shareholders' equity
|
728,074 | 643,226 | ||||||
Commitments
and contingencies
|
||||||||
Total
liabilities and shareholders' equity
|
$ | 27,591,862 | 27,854,897 | |||||
See
accompanying notes to consolidated financial statements.
|
2
NELNET,
INC. AND SUBSIDIARIES
|
||||||||||||||||
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
||||||||||||||||
(Dollars
in thousands, except share data)
|
||||||||||||||||
(unaudited)
|
Three
months
|
Nine
months
|
|||||||||||||||
ended
September 30,
|
ended
September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Interest
income:
|
||||||||||||||||
Loan
interest
|
$ | 143,255 | 284,468 | 474,587 | 911,140 | |||||||||||
Investment
interest
|
1,943 | 9,118 | 8,810 | 29,914 | ||||||||||||
Total
interest income
|
145,198 | 293,586 | 483,397 | 941,054 | ||||||||||||
Interest
expense:
|
||||||||||||||||
Interest
on bonds and notes payable
|
76,016 | 234,016 | 328,600 | 791,621 | ||||||||||||
Net
interest income
|
69,182 | 59,570 | 154,797 | 149,433 | ||||||||||||
Less
provision for loan losses
|
7,500 | 7,000 | 23,000 | 18,000 | ||||||||||||
Net
interest income after provision for loan losses
|
61,682 | 52,570 | 131,797 | 131,433 | ||||||||||||
Other
income (expense):
|
||||||||||||||||
Loan
and guaranty servicing revenue
|
26,006 | 29,691 | 81,280 | 78,173 | ||||||||||||
Tuition
payment processing and campus commerce revenue
|
12,987 | 11,863 | 40,373 | 35,980 | ||||||||||||
Enrollment
services revenue
|
30,670 | 29,858 | 88,188 | 83,148 | ||||||||||||
Software
services revenue
|
4,600 | 5,159 | 16,424 | 19,342 | ||||||||||||
Other
income
|
11,094 | 5,408 | 39,483 | 17,787 | ||||||||||||
Gain
(loss) on sale of loans, net
|
8,788 | — | 8,386 | (47,426 | ) | |||||||||||
Derivative
market value, foreign currency,
|
||||||||||||||||
and
put option adjustments and derivative
|
||||||||||||||||
settlements,
net
|
7,740 | 6,874 | 2,740 | 10,468 | ||||||||||||
Total
other income
|
101,885 | 88,853 | 276,874 | 197,472 | ||||||||||||
Operating
expenses:
|
||||||||||||||||
Salaries
and benefits
|
37,810 | 44,739 | 116,216 | 142,131 | ||||||||||||
Other
operating expenses:
|
||||||||||||||||
Cost
to provide enrollment services
|
20,323 | 17,904 | 56,208 | 48,062 | ||||||||||||
Depreciation
and amortization
|
8,769 | 10,781 | 28,379 | 32,218 | ||||||||||||
Professional
and other services
|
6,584 | 10,185 | 20,382 | 25,409 | ||||||||||||
Occupancy
and communications
|
5,122 | 4,194 | 16,064 | 14,949 | ||||||||||||
Trustee
and other debt related fees
|
2,387 | 2,423 | 7,487 | 7,277 | ||||||||||||
Postage
and distribution
|
1,958 | 2,576 | 7,100 | 8,691 | ||||||||||||
Advertising
and marketing
|
1,936 | 1,712 | 5,632 | 5,706 | ||||||||||||
Impairment
expense
|
— | — | — | 18,834 | ||||||||||||
Other
|
7,773 | 9,155 | 25,121 | 27,151 | ||||||||||||
Total
other operating expenses
|
54,852 | 58,930 | 166,373 | 188,297 | ||||||||||||
Total
operating expenses
|
92,662 | 103,669 | 282,589 | 330,428 | ||||||||||||
Income
(loss) before income taxes
|
70,905 | 37,754 | 126,082 | (1,523 | ) | |||||||||||
Income
tax expense
|
(24,501 | ) | (13,969 | ) | (46,020 | ) | (1,793 | ) | ||||||||
Income
(loss) from continuing operations
|
46,404 | 23,785 | 80,062 | (3,316 | ) | |||||||||||
Income
from discontinued operations, net of tax
|
— | — | — | 981 | ||||||||||||
Net
income (loss)
|
$ | 46,404 | 23,785 | 80,062 | (2,335 | ) | ||||||||||
Earnings
(loss) per share, basic and diluted:
|
||||||||||||||||
Income
(loss) from continuing operations
|
$ | 0.93 | 0.48 | 1.60 | (0.07 | ) | ||||||||||
Income
from discontinued operations
|
— | — | — | 0.02 | ||||||||||||
Net
income (loss)
|
$ | 0.93 | 0.48 | 1.60 | (0.05 | ) | ||||||||||
See
accompanying notes to consolidated financial statements.
|
3
NELNET,
INC. AND SUBSIDIARIES
|
|||||||||||||||||||||||||||||||
CONSOLIDATED
STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(LOSS)
|
|||||||||||||||||||||||||||||||
(Dollars
in thousands, except share data)
|
|||||||||||||||||||||||||||||||
(unaudited)
|
|||||||||||||||||||||||||||||||
Preferred
|
Class
A
|
Class
B
|
Additional
|
Employee
|
Total
|
||||||||||||||||||||||||||
stock
|
Common
stock shares
|
Preferred
|
common
|
common
|
paid-in
|
Retained
|
notes
|
shareholders’
|
|||||||||||||||||||||||
shares
|
Class
A
|
Class
B
|
stock
|
stock
|
stock
|
capital
|
earnings
|
receivable
|
equity
|
||||||||||||||||||||||
Balance
as of June 30, 2008
|
— | 37,952,246 | 11,495,377 | $ | — | 380 | 115 | 99,854 | 485,739 | (2,046 | ) | 584,042 | |||||||||||||||||||
Comprehensive
income:
|
|||||||||||||||||||||||||||||||
Net
income
|
— | — | — | — | — | — | — | 23,785 | — | 23,785 | |||||||||||||||||||||
Total
comprehensive income
|
23,785 | ||||||||||||||||||||||||||||||
Issuance
of common stock, net of forfeitures
|
— | 49,650 | — | — | 1 | — | 960 | — | — | 961 | |||||||||||||||||||||
Compensation
expense for stock based awards
|
— | — | — | — | — | — | 1,045 | — | — | 1,045 | |||||||||||||||||||||
Repurchase
of common stock
|
— | (7,564 | ) | — | — | (1 | ) | — | (102 | ) | — | — | (103 | ) | |||||||||||||||||
Balance
as of September 30, 2008
|
— | 37,994,332 | 11,495,377 | $ | — | 380 | 115 | 101,757 | 509,524 | (2,046 | ) | 609,730 | |||||||||||||||||||
Balance
as of June 30, 2009
|
— | 38,325,492 | 11,495,377 | $ | — | 383 | 115 | 107,959 | 574,179 | (1,449 | ) | 681,187 | |||||||||||||||||||
Comprehensive
income:
|
|||||||||||||||||||||||||||||||
Net
income
|
— | — | — | — | — | — | — | 46,404 | — | 46,404 | |||||||||||||||||||||
Total
comprehensive income
|
46,404 | ||||||||||||||||||||||||||||||
Issuance
of common stock, net of forfeitures
|
— | 31,403 | — | — | 1 | — | 241 | — | — | 242 | |||||||||||||||||||||
Compensation
expense for stock based awards
|
— | — | — | — | — | — | 349 | — | — | 349 | |||||||||||||||||||||
Repurchase
of common stock
|
— | (7,434 | ) | — | — | (1 | ) | — | (107 | ) | — | — | (108 | ) | |||||||||||||||||
Balance
as of September 30, 2009
|
— | 38,349,461 | 11,495,377 | $ | — | 383 | 115 | 108,442 | 620,583 | (1,449 | ) | 728,074 | |||||||||||||||||||
Balance
as of December 31, 2007
|
— | 37,980,617 | 11,495,377 | $ | — | 380 | 115 | 96,185 | 515,317 | (3,118 | ) | 608,879 | |||||||||||||||||||
Comprehensive
income (loss):
|
|||||||||||||||||||||||||||||||
Net
loss
|
— | — | — | — | — | — | — | (2,335 | ) | — | (2,335 | ) | |||||||||||||||||||
Total
comprehensive income (loss)
|
(2,335 | ) | |||||||||||||||||||||||||||||
Cash
dividend on Class A and Class B
|
|||||||||||||||||||||||||||||||
common
stock - $0.07 per share
|
— | — | — | — | — | — | — | (3,458 | ) | — | (3,458 | ) | |||||||||||||||||||
Issuance
of common stock, net of forfeitures
|
— | 83,337 | — | — | 1 | — | 2,033 | — | — | 2,034 | |||||||||||||||||||||
Compensation
expense for stock based awards
|
— | — | — | — | — | — | 4,308 | — | — | 4,308 | |||||||||||||||||||||
Repurchase
of common stock
|
— | (69,622 | ) | — | — | (1 | ) | — | (769 | ) | — | — | (770 | ) | |||||||||||||||||
Reduction
of employee stock notes receivable
|
— | — | — | — | — | — | — | — | 1,072 | 1,072 | |||||||||||||||||||||
Balance
as of September 30, 2008
|
— | 37,994,332 | 11,495,377 | $ | — | 380 | 115 | 101,757 | 509,524 | (2,046 | ) | 609,730 | |||||||||||||||||||
Balance
as of December 31, 2008
|
— | 37,794,067 | 11,495,377 | $ | — | 378 | 115 | 103,762 | 540,521 | (1,550 | ) | 643,226 | |||||||||||||||||||
Comprehensive
income:
|
|||||||||||||||||||||||||||||||
Net
income
|
— | — | — | — | — | — | — | 80,062 | — | 80,062 | |||||||||||||||||||||
Total
comprehensive income
|
80,062 | ||||||||||||||||||||||||||||||
Issuance
of common stock, net of forfeitures
|
— | 569,937 | — | — | 6 | — | 3,539 | — | — | 3,545 | |||||||||||||||||||||
Compensation
expense for stock based awards
|
— | — | — | — | — | — | 1,310 | — | — | 1,310 | |||||||||||||||||||||
Repurchase
of common stock
|
— | (14,543 | ) | — | — | (1 | ) | — | (169 | ) | — | — | (170 | ) | |||||||||||||||||
Reduction
of employee stock notes receivable
|
— | — | — | — | — | — | — | — | 101 | 101 | |||||||||||||||||||||
Balance
as of September 30, 2009
|
— | 38,349,461 | 11,495,377 | $ | — | 383 | 115 | 108,442 | 620,583 | (1,449 | ) | 728,074 | |||||||||||||||||||
See
accompanying notes to consolidated financial statements.
|
4
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
||||||||
(Dollars
in thousands)
|
||||||||
(unaudited)
|
||||||||
Nine
months ended September 30,
|
||||||||
2009
|
2008
|
|||||||
Net
income (loss)
|
$ | 80,062 | (2,335 | ) | ||||
Income
from discontinued operations
|
— | 981 | ||||||
Income
(loss) from continuing operations
|
80,062 | (3,316 | ) | |||||
Adjustments
to reconcile income (loss) from continuing operations to net cash
provided
|
||||||||
by
operating activities:
|
||||||||
Depreciation
and amortization, including loan premiums and deferred origination
costs
|
88,118 | 107,944 | ||||||
Provision
for loan losses
|
23,000 | 18,000 | ||||||
Impairment
expense
|
— | 18,834 | ||||||
Derivative
market value adjustment
|
(19,912 | ) | 72,399 | |||||
Foreign
currency transaction adjustment
|
55,979 | (40,361 | ) | |||||
Change
in value of put options issued in business acquisitions
|
— | 3,483 | ||||||
Proceeds
to terminate and/or amend derivative instruments
|
3,820 | 15,403 | ||||||
Payments
to terminate and/or amend derivative instruments
|
(11,710 | ) | (3,679 | ) | ||||
Gain
from repurchase of bonds and notes payable
|
(19,185 | ) | — | |||||
Originations
and purchases of student loans-held for
sale
|
(13,345 | ) | — | |||||
(Gain)
loss on sale of loans, net
|
(8,386 | ) | 47,426 | |||||
Deferred
income tax benefit
|
(30,654 | ) | (23,979 | ) | ||||
Other
non-cash items
|
3,569 | 6,929 | ||||||
Decrease
in accrued interest receivable
|
82,640 | 63,220 | ||||||
(Increase)
decrease in accounts receivable
|
(7,180 | ) | 445 | |||||
Decrease
in other assets
|
9,976 | 13,928 | ||||||
Decrease
in accrued interest payable
|
(56,717 | ) | (37,334 | ) | ||||
Increase
(decrease) in other liabilities
|
34,575 | (1,765 | ) | |||||
Net
cash flows from operating activities - continuing
operations
|
214,650 | 257,577 | ||||||
Net
cash flows from operating activities - discontinued
operations
|
— | — | ||||||
Net
cash provided by operating activities
|
214,650 | 257,577 | ||||||
Cash
flows from investing activities:
|
||||||||
Originations,
purchases, and consolidations of student loans, including loan
premiums
|
||||||||
and
deferred origination costs
|
(2,104,234 | ) | (2,368,229 | ) | ||||
Purchases
of student loans, including loan premiums, from a related
party
|
(39,649 | ) | (212,888 | ) | ||||
Net
proceeds from student loan repayments, claims, capitalized interest,
participations, and other
|
1,507,981 | 1,538,134 | ||||||
Proceeds
from sale of student loans
|
550,176 | 1,267,826 | ||||||
Proceeds
from sale of student loans to a related party
|
61,452 | — | ||||||
Purchases
of property and equipment, net
|
(466 | ) | (5,094 | ) | ||||
Decrease
(increase) in restricted cash and investments, net
|
198,636 | (154,768 | ) | |||||
Purchases
of equity method investments
|
— | (2,988 | ) | |||||
Business
acquisition - contingent consideration
|
— | (18,000 | ) | |||||
Net
cash flows from investing activities - continuing
operations
|
173,896 | 43,993 | ||||||
Net
cash flows from investing activities - discontinued
operations
|
— | — | ||||||
Net
cash provided by investing activities
|
173,896 | 43,993 | ||||||
Cash
flows from financing activities:
|
||||||||
Payments
on bonds and notes payable
|
(3,978,507 | ) | (5,328,782 | ) | ||||
Proceeds
from issuance of bonds and notes payable
|
3,761,543 | 5,225,548 | ||||||
(Payments)
proceeds from issuance of notes payable due to a related party,
net
|
(21,520 | ) | 32,790 | |||||
Payments
of debt issuance costs
|
(5,876 | ) | (14,778 | ) | ||||
Dividends
paid
|
— | (3,458 | ) | |||||
Proceeds
from issuance of common stock
|
329 | 566 | ||||||
Repurchases
of common stock
|
(170 | ) | (770 | ) | ||||
Payments
received on employee stock notes receivable
|
101 | 575 | ||||||
Net
cash flows used in financing activities - continuing
operations
|
(244,100 | ) | (88,309 | ) | ||||
Net
cash flows used in financing activities - discontinued
operations
|
— | — | ||||||
Net
cash used in financing activities
|
(244,100 | ) | (88,309 | ) | ||||
Net
increase in cash and cash equivalents
|
144,446 | 213,261 | ||||||
Cash
and cash equivalents, beginning of period
|
189,847 | 111,746 | ||||||
Cash
and cash equivalents, end of period
|
$ | 334,293 | 325,007 | |||||
Supplemental
disclosures of cash flow information:
|
||||||||
Interest
paid
|
$ | 380,543 | 814,469 | |||||
Income
taxes paid, net of refunds
|
$ | 69,924 | 24,302 | |||||
See
accompanying notes to consolidated financial statements.
|
5
NELNET,
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Information
as of September 30, 2009 and for the three and nine months ended
September
30, 2009 and 2008 is unaudited)
(Dollars
in thousands, except per share amounts, unless otherwise noted)
1.
Basis of Financial Reporting
The
accompanying unaudited consolidated financial statements of Nelnet, Inc. and
subsidiaries (the “Company”) as of September 30, 2009 and for the three and nine
months ended September 30, 2009 and 2008 have been prepared on the same basis as
the audited consolidated financial statements for the year ended December 31,
2008 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 nine months ended September
30, 2009 are not necessarily indicative of the results for the year ending
December 31, 2009. 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, 2008. Certain amounts from 2008 have been reclassified to
conform to the current period presentation. Management has evaluated subsequent
events, and the impact on the reported results and disclosures, through November
9, 2009, which is the date these financial statements were filed with the
Securities and Exchange Commission (“SEC”).
2.
Restructuring Charge
During
the second quarter of 2009, the Company adopted a plan to further streamline its
operations by continuing to reduce its geographic footprint and consolidate
servicing operations and related support services.
Management
has developed a restructuring plan that will result in lower costs and provide
enhanced synergies through cross training, career development, and simplified
communications. The Company will simplify its operating structure to leverage
its larger facilities and technology by closing certain offices and downsizing
its presence in certain geographic locations. Approximately 300 associates will
be impacted by this restructuring plan. However, the majority of these functions
will be relocated to the Company’s Lincoln headquarters and Denver offices.
Implementation of the plan began immediately and is expected to be substantially
complete during the second quarter of 2010.
The
Company estimates that the charge to earnings associated with this restructuring
plan will be fully recognized by December 31, 2010 and will total approximately
$13.0 million, consisting of approximately $6.3 million in severance costs and
approximately $6.7 million in contract terminations, of which $2.8 million and
$3.2 million has been recognized in the second and third quarters of 2009,
respectively, and $1.4 million is expected to be recognized in the fourth
quarter of 2009. Selected information relating to the restructuring charge
follows:
Employee
|
|||||||||
termination
|
Lease
|
||||||||
benefits
|
terminations
|
Total
|
|||||||
Restructuring
costs recognized during the
|
|||||||||
three
month period ended June 30, 2009
|
$ | 1,482 |
(a)
|
1,291 |
(b)
|
2,773 | |||
Cash
payments
|
(672 | ) | — | (672 | ) | ||||
Restructuring
accrual as of June 30, 2009
|
810 | 1,291 | 2,101 | ||||||
Restructuring
costs recognized during the
|
|||||||||
three
month period ended September 30, 2009
|
1,412 |
(a)
|
— | 1,412 | |||||
Adjustment
from initial estimate of charges
|
— | 1,786 |
(b)
|
1,786 | |||||
Cash
payments
|
(29 | ) | (381 | ) | (410 | ) | |||
Restructuring
accrual as of September 30, 2009
|
$ | 2,193 | 2,696 | 4,889 | |||||
(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.
|
6
Selected
information relating to the restructuring charge by operating segment and
Corporate Activity and Overhead follows:
Restructuring
costs
|
||||||||||||||||||||
recognized
during
|
Adjustment
|
|||||||||||||||||||
Restructuring
|
the
three month
|
from
initial
|
Restructuring
|
|||||||||||||||||
accrual
as of
|
period
ended
|
estimate
|
Cash
|
accrual
as of
|
||||||||||||||||
Operating
segment
|
June
30, 2009
|
September
30, 2009
|
of
charges
|
payments
|
September
30, 2009
|
|||||||||||||||
Student
Loan and Guaranty Servicing
|
$ | 1,812 | 860 | 1,786 | (410 | ) | 4,048 | |||||||||||||
Tuition
Payment Processing and
|
||||||||||||||||||||
Campus
Commerce
|
— | — | — | — | — | |||||||||||||||
Enrollment
Services
|
— | — | — | — | — | |||||||||||||||
Software
and Technical Services
|
149 | 292 | — | — | 441 | |||||||||||||||
Asset
Generation and Management
|
— | — | — | — | — | |||||||||||||||
Corporate
Activity and Overhead
|
140 | 260 | — | — | 400 | |||||||||||||||
$ | 2,101 | 1,412 | 1,786 | (410 | ) | 4,889 |
Restructuring
|
Remaining
|
|||||||||||
Estimated
|
costs
recognized
|
restructuring
costs
|
||||||||||
total
restructuring
|
through
|
expected
to be
|
||||||||||
Operating
segment
|
costs
|
September
30, 2009
|
recognized
|
|||||||||
Student
Loan and Guaranty Servicing
|
$ | 10,131 | 4,644 | 5,487 | ||||||||
Tuition
Payment Processing and
|
||||||||||||
Campus
Commerce
|
— | — | — | |||||||||
Enrollment
Services
|
— | — | — | |||||||||
Software
and Technical Services
|
1,078 | 714 | 364 | |||||||||
Asset
Generation and Management
|
— | — | — | |||||||||
Corporate
Activity and Overhead
|
1,763 | 613 | 1,150 | |||||||||
$ | 12,972 | 5,971 | 7,001 |
7
In 2007
and 2008, the Company recorded restructuring charges related to certain
legislative events and disruptions in the capital markets. As a result of the
restructurings, the Company incurred expenses related to severance, contract
terminations, and impairment of long-lived assets. These restructuring plans
were completed by management in December 2007 and January 2008. However, an
accrual related to certain lease terminations remains. Information relating to
such accrual follows:
Restructuring
accrual as of December 31, 2008
|
$ | 3,480 | ||
Cash
payments
|
(228 | ) | ||
Restructuring
accrual as of March 31, 2009
|
3,252 | |||
Cash
payments
|
(228 | ) | ||
Adjustment
from initial estimate of charges
|
515 | |||
Restructuring
accrual as of June 30, 2009
|
3,539 | |||
Cash
payments
|
(229 | ) | ||
Adjustment
from initial estimate of charges
|
142 | |||
Restructuring
accrual as of September 30, 2009
|
$ | 3,452 |
3.
Student Loans Receivable and Allowance for Loan Losses
Student
loans consist of federally insured student loans, non-federally insured student
loans, and student loan participations. If the Company has the ability and
intent to hold loans for the foreseeable future, such loans are held for
investment and carried at amortized cost. Amortized cost includes the
unamortized premiums and capitalized origination costs and fees, all of which
are amortized to interest income. Loans which are held-for-investment also have
an allowance for loan loss as needed. Any loans the Company has the ability and
intent to sell are classified as held for sale and are carried at the lower of
cost or fair value. Loans which are held-for-sale do not have the associated
premium and origination costs and fees amortized into interest income and there
is also no related allowance for loan losses.
As of
September 30, 2009, the Company had $1.6 billion of 2008-2009 academic year
Federal Family Education Loan Program (“FFELP”) loans classified as held for
sale. These loans were funded using the Department of Education’s Loan
Participation Program (the “Participation Program”) and were sold to the
Department of Education (the “Department”) under the Department’s Loan Purchase
Commitment Program (the “Purchase Program”). Under the Purchase Program, the
Department purchases 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. Upon selling the $1.6 billion of loans
held for sale, the Company recognized a gain in October 2009 of $26.9 million.
During the third quarter of 2009, the Company sold $427.7 million (par value) of
student loans under the Purchase Program and recognized a gain of $9.7 million.
The
Company plans to continue to use the Participation Program to fund certain loans
originated through the 2009-2010 academic year. Loans originated by the Company
for the 2009-2010 academic year are classified as held for investment on the
accompanying consolidated balance sheet.
8
Student
loans receivable consisted of the following:
As
of
|
As
of
|
|||||||||||
September
30, 2009
|
December
31, 2008
|
|||||||||||
Held-for-investment
|
Held-for-sale
|
Held-for-investment
|
||||||||||
Federally
insured loans
|
$ | 23,295,203 | 1,607,169 | 24,787,941 | ||||||||
Non-federally
insured loans
|
167,114 | — | 273,108 | |||||||||
23,462,317 | 1,607,169 | 25,061,049 | ||||||||||
Unamortized
loan premiums and deferred origination costs
|
352,066 | 20,625 | 402,881 | |||||||||
Allowance
for loan losses – federally insured loans
|
(29,015 | ) | — | (25,577 | ) | |||||||
Allowance
for loan losses – non-federally insured loans
|
(21,105 | ) | — | (25,345 | ) | |||||||
$ | 23,764,263 | 1,627,794 | 25,413,008 | |||||||||
Allowance
for federally insured loans - held-for-investment as a percentage of such
loans
|
0.12 | % | 0.10 | % | ||||||||
Allowance
for non-federally insured loans as a percentage of such
loans
|
12.63 | % | 9.28 | % | ||||||||
Total
allowance as a percentage of the ending balance of total loans (excluding
loans held-for-sale)
|
0.21 | % | 0.20 | % |
The
Company has provided for an allowance for loan losses related to its student
loan portfolio. Activity in the allowance for loan losses is shown
below:
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Beginning
balance
|
$ | 50,000 | 47,909 | 50,922 | 45,592 | |||||||||||
Provision
for loan losses
|
7,500 | 7,000 | 23,000 | 18,000 | ||||||||||||
Loans
charged off, net of recoveries
|
(4,380 | ) | (5,839 | ) | (13,482 | ) | (13,772 | ) | ||||||||
Sale
of loans
|
(3,000 | ) | — | (10,320 | ) | (750 | ) | |||||||||
Ending
balance
|
$ | 50,120 | 49,070 | 50,120 | 49,070 |
Loan
Sales
The
activity included in “gain (loss) on sale of loans, net” in the accompanying
consolidated statements of operations is detailed below.
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Department's
Purchase Program (a)
|
$ | 9,689 | — | 9,689 | — | |||||||||||
Private
loan participations (b)
|
(695 | ) | — | (695 | ) | — | ||||||||||
FFELP
loan sales to related parties (c)
|
(206 | ) | — | (608 | ) | — | ||||||||||
FFELP
loan sales to third parties (d)
|
— | — | — | (47,426 | ) | |||||||||||
Gain
(loss) on sale of loans, net
|
$ | 8,788 | — | 8,386 | (47,426 | ) |
(a)
|
During
the three months ended September 30, 2009, the Company sold $427.7 million
(par value) of student loans to the Department under the Purchase
Program.
|
(b)
|
During
the three and nine months ended September 30, 2009, the Company
participated $30.5 million and $95.5 million,
respectively, of non-federally insured loans to third parties. Loans
participated under these agreements have been accounted for by the Company
as loan sales. Accordingly, the participation interests sold are not
included on the Company’s consolidated balance sheet. Per the terms of the
servicing agreements, the Company’s servicing operations are obligated to
repurchase loans subject to the participation interests when such loans
become 60 or 90 days delinquent. The activity in the accrual account
related to this repurchase obligation, which is included in “other
liabilities” in the accompanying consolidated balance sheet, is detailed
below.
|
9
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Beginning
balance
|
$ | 7,600 | — | — | — | |||||||||||
Transfer
from allowance for loan losses
|
3,000 | — | 9,800 | — | ||||||||||||
Reserve
for repurchase of delinquent loans (a)
|
— | — | 800 | — | ||||||||||||
Ending
balance
|
$ | 10,600 | — | 10,600 | — | |||||||||||
(a)
The reserve for repurchase of loans is included in "other" under other
operating expenses in the accompanying consolidated statements of
operations.
|
(c)
|
During
the three and nine months ended September 30, 2009, the Company sold $21.4
million (par value) and $61.5 million (par value), respectively, of
federally insured student loans to Union Bank & Trust Company (“Union
Bank”), an entity under common control with the
Company.
|
(d)
|
During
March and April 2008, the Company sold $1.3 billion (par value) of
federally insured student loans in order to reduce the amount of student
loans remaining under the Company’s multi-year committed financing
facility for FFELP loans, which contained certain equity support
provisions (see note 4 for additional information related to the FFELP
warehouse facilities).
|
4.
Bonds and Notes Payable
The
following tables summarize outstanding bonds and notes payable by type of
instrument:
As
of September 30, 2009
|
||||||||
Carrying
|
Interest
rate
|
|||||||
amount
|
range
|
Final
maturity
|
||||||
Variable-rate
bonds and notes (a):
|
||||||||
Bonds
and notes based on indices
|
$ | 19,749,843 | 0.30% - 6.90% |
11/25/13
- 06/25/41
|
||||
Bonds
and notes based on auction or remarketing
|
2,247,420 | 0.33% - 3.75% |
11/01/09
- 07/01/43
|
|||||
Total
variable-rate bonds and notes
|
21,997,263 | |||||||
Commercial
paper - FFELP facility (b)
|
361,279 | 0.22% - 0.38% |
08/03/12
|
|||||
Fixed-rate
bonds and notes (a)
|
186,274 | 5.40% - 6.50% |
11/01/09
- 05/01/29
|
|||||
Unsecured
fixed rate debt
|
264,966 |
5.125%
and 7.40%
|
06/01/10
and 09/15/61
|
|||||
Unsecured
line of credit
|
691,500 | 0.73% - 0.79% |
05/08/12
|
|||||
Department
of Education Participation
|
1,902,909 | 0.91% |
10/15/09
and 09/30/10
|
|||||
Department
of Education Conduit
|
1,155,351 | 0.37% |
05/08/14
|
|||||
Other
borrowings
|
26,551 | 0.26% - 5.10% |
01/01/10
- 11/01/15
|
|||||
$ | 26,586,093 |
10
As
of December 31, 2008
|
||||||||
Carrying
|
Interest
rate
|
|||||||
amount
|
range
|
Final
maturity
|
||||||
Variable-rate
bonds and notes (a):
|
||||||||
Bonds
and notes based on indices
|
$ | 20,509,073 | 0.75% - 5.02% |
09/25/13
- 06/25/41
|
||||
Bonds
and notes based on auction or remarketing
|
2,713,285 | 0.00% - 6.00% |
11/01/09
- 07/01/43
|
|||||
Total
variable-rate bonds and notes
|
23,222,358 | |||||||
Commercial
paper - FFELP facility (b)
|
1,445,327 | 1.32% - 2.94% |
05/09/10
|
|||||
Commercial
paper - private loan facility (b)
|
95,020 | 2.49% |
03/14/09
|
|||||
Fixed-rate
bonds and notes (a)
|
202,096 | 5.30% - 6.68% |
11/01/09
- 05/01/29
|
|||||
Unsecured
fixed rate debt
|
475,000 |
5.125%
and 7.40%
|
06/01/10
and 09/15/61
|
|||||
Unsecured
line of credit
|
691,500 | 0.98% - 2.41% |
05/08/12
|
|||||
Department
of Education Participation
|
622,170 | 3.37% |
09/30/09
|
|||||
Other
borrowings
|
34,488 | 1.25% - 5.47% |
05/22/09
- 11/01/15
|
|||||
$ | 26,787,959 | |||||||
(a)
|
Issued
in asset-backed securitizations
|
(b)
|
Loan
warehouse facilities
|
Secured
Financing Transactions
The
Company has historically relied upon secured financing vehicles as its most
significant source of funding for student loans. The net cash flow the Company
receives from the securitized student loans generally represents the excess
amounts, if any, generated by the underlying student loans over the amounts
required to be paid to the bondholders, after deducting servicing fees and any
other expenses relating to the securitizations. The 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, asset-backed
securitizations, and the government’s Participation and Conduit Programs (as
described below).
Most of
the bonds and notes payable are primarily secured by the student loans
receivable, related accrued interest, and by the amounts on deposit in the
accounts established under the respective bond resolutions or financing
agreements. The student loan interest margin notes, included in fixed rate bonds
and notes in the above tables, are secured by the rights to residual cash flows
from certain variable rate bonds and notes and fixed rate notes. Certain
variable rate bonds and notes and fixed rate bonds are secured by financial
guaranty insurance policies or a letter of credit and reimbursement agreement
issued by Municipal Bond Investors Assurance Corporation, Ambac Assurance
Corporation, and State Street.
Historically,
the Company funded new loan originations using loan warehouse facilities and
asset-backed securitizations. Student loan warehousing has historically allowed
the Company to buy and manage student loans prior to transferring them into more
permanent financing arrangements. In July 2008, the Company did not renew its
liquidity provisions on its FFELP warehouse facility. Accordingly, the facility
became a term facility and no new loan originations could be funded with this
facility. In August 2008, the Company began funding FFELP Stafford and PLUS
student loan originations for the 2008-2009 and 2009-2010 academic years
pursuant to the Department’s Participation Program and a participation agreement
with Union Bank.
Loan
warehouse facilities
Student
loan warehousing has historically allowed the Company to buy and manage student
loans prior to transferring them into more permanent financing arrangements. To
support its funding needs on a short-term basis, the Company historically relied
upon a multi-year committed facility for FFELP loans.
FFELP Warehouse
Facility
On August
3, 2009, the Company entered into a FFELP warehouse facility (the “2009 FFELP
Warehouse Facility”). The 2009 FFELP Warehouse Facility has a maximum financing
amount of $500.0 million, with a revolving financing structure supported by
364-day liquidity provisions, which expire on August 2, 2010. The final maturity
date of the facility is August 3, 2012. In the event the Company is unable to
renew the liquidity provisions by August 2, 2010, the facility would become a
term facility at a stepped-up cost, with no additional student loans being
eligible for financing, and the Company would be required to refinance the
existing loans in the facility by August 3, 2012.
11
The 2009
FFELP Warehouse Facility provides for formula based advance rates depending on
FFELP loan type, up to a maximum of 92 percent to 98 percent of the principle
and interest of loans financed. The advance rates for collateral may increase or
decrease based on market conditions. The facility contains financial covenants
relating to levels of the Company’s consolidated net worth, ratio of adjusted
EBITDA to corporate debt interest, and unencumbered cash. Any violation of these
covenants could result in a requirement for the immediate repayment of any
outstanding borrowings under the facility. Unlike the Company’s prior FFELP
warehouse facility, the new facility does not require the Company to refinance
or remove a percentage of the pledged student loan collateral on an annual
basis. As of September 30, 2009, $361.3 million was outstanding under this
facility and $138.7 million was available for future use.
The
Company’s prior FFELP warehouse facility was supported by 364-day liquidity
which was up for renewal on May 9, 2008. The Company obtained an extension on
this renewal until July 31, 2008. On July 31, 2008, the Company did not renew
the liquidity provisions of this facility. Accordingly, as of July 31, 2008, the
facility became a term facility with a final maturity date of May 9, 2010. The
terms and conditions of the prior FFELP warehouse facility provided for
formula-based advance rates based on market conditions. As of December 31, 2008,
the Company had $1.6 billion of student loans in the facility, $1.4 billion
borrowed under the facility, and $280.6 million in cash posted as equity funding
support for this facility. During 2009, the Company refinanced the student loans
in this facility which allowed the Company to withdraw all remaining equity
funding support from the facility. The Company refinanced these loans using the
following facilities:
·
|
In
March 2009, the Company completed a privately placed asset-backed
securitization of $294.6 million.
|
·
|
In
June 2009, the Company accessed the Department’s Conduit Program (as
further discussed below).
|
·
|
In
August 2009, the Company refinanced all remaining loans using the 2009
FFELP Warehouse Facility and terminated the prior FFELP
facility.
|
Private Loan Warehouse
Facility
On
February 25, 2009, the Company paid $91.5 million on the outstanding debt of its
private loan warehouse facility with operating cash and terminated the facility.
Beginning in January 2008, the Company suspended private student loan
originations.
Asset-backed
securitizations
As part
of the Company’s issuance of asset-backed securities 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.
On
October 22, 2009, the Company completed an asset-backed securities transaction
of $434.0 million. The Company used the proceeds from the sale of these notes
and additional funds of $17.3 million to purchase principal and interest on
student loans, which were previously financed in other asset-backed
securitizations and the 2009 FFELP Warehouse Facility. As of November 6, 2009
$179.1 million was outstanding under the 2009 FFELP Warehouse Facility and
$320.9 million was available for future use.
Department
of Education’s Loan Participation and Purchase Commitment Programs
In August
2008, the Department implemented the Purchase Program and the Participation
Program pursuant to the Ensuring Continued Access to Student Loans Act of 2008
(“ECASLA”). Under the Department’s Purchase Program, the Department will
purchase loans at a price equal to the sum of (i) par value, (ii) accrued
interest, (iii) the one percent origination fee paid to the Department, and (iv)
a fixed amount of $75 per loan. Under the Participation Program, the Department
provides interim short term liquidity to FFELP lenders by purchasing
participation interests in pools of FFELP loans. FFELP lenders are charged a
rate of commercial paper plus 50 basis points on the principal amount of
participation interests outstanding. Loans funded under the Participation
Program for the 2008-2009 academic year had to be either refinanced by the
lender or sold to the Department pursuant to the Purchase Program prior to
October 15, 2009. To be eligible for purchase or participation under the
Department’s programs, loans were originally limited to FFELP Stafford or PLUS
loans made for the academic year 2008-2009, first disbursed between May 1, 2008
and July 1, 2009, with eligible borrower benefits.
On
October 7, 2008, legislation was enacted to extend the Department’s authority to
address FFELP student loans made for the 2009-2010 academic year and allowing
for the extension of the Participation Program and Purchase Program from October
15, 2009 to September 30, 2010. The Department indicated that loans for the
2008-2009 academic year which are funded under the Department's Participation
Program will need to be refinanced or sold to the Department prior to October
15, 2009. On November 8, 2008, the Department announced the replication of the
terms of the Participation and Purchase Programs, in accordance with the October
7, 2008 legislation, which includes FFELP student loans made for the 2009-2010
academic year.
12
As of
September 30, 2009, the Company had $1.9 billion of FFELP loans
funded using the Participation Program, of which $1.6 billion are 2008-2009
academic year loans and are classified as held for sale on the Company’s
consolidated balance sheet. These loans were sold to the Department under its
Purchase Program in October 2009. The Company plans to continue to use the
Participation Program to fund certain loans through the 2009-2010 academic
year.
Department
of Education’s Conduit Program
In
January 2009, the Department published summary terms for its program under which
it will finance eligible FFELP Stafford and PLUS loans in a conduit vehicle
established to provide funding for student lenders (the “Conduit Program”).
Loans eligible for the Conduit Program had to be first disbursed on or after
October 1, 2003, but not later than June 30, 2009, and fully disbursed before
September 30, 2009, and meet certain other requirements. The Conduit Program was
launched on May 11, 2009. Funding for the Conduit Program is provided by the
capital markets at a cost based on market rates, with the Company being advanced
97 percent of the student loan face amount. Excess amounts needed to fund the
remaining 3 percent of the student loan balances are contributed by the Company.
The Conduit Program has a term of five years and expires on May 8, 2014. The
Student Loan Short-Term Notes (“Student Loan Notes”) issued by the Conduit
Program are supported by a combination of (i) notes backed by FFELP loans, (ii)
the Liquidity Agreement with the Federal Financing Bank, and (iii) the Put
Agreement provided by the Department. If the conduit does not have sufficient
funds to pay all Student Loan Notes, then those Student Loan Notes will be
repaid with funds from the Federal Financing Bank. The Federal Financing Bank
will hold the notes for a short period of time and, if at the end of that time,
the Student Loan Notes still cannot be paid off, the underlying FFELP loans that
serve as collateral to the Conduit Program will be sold to the Department
through the Put Agreement at a price of 97 percent of the face amount of the
loans. As of September 30, 2009, the Company had $1.2 billion borrowed under the
facility.
Union
Bank Participation Agreement
The
Company maintains an agreement with Union Bank, as trustee for various grantor
trusts, under which Union Bank has agreed to purchase from the Company
participation interests in student loans (the “FFELP Participation Agreement”).
The Company has the option to purchase the participation interests from the
grantor trusts at the end of a 364-day term upon termination of the
participation certificate. As of September 30, 2009 and December 31, 2008,
$681.9 million and $548.4 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 or an amount in
excess of $750 million if mutually agreed to by both parties. Loans participated
under this agreement have been accounted for by the Company as loan sales.
Accordingly, the participation interests sold are not included on the Company’s
consolidated balance sheet.
Unsecured
Line of Credit
The
Company has a $750.0 million unsecured line of credit that terminates in May
2012. As of September 30, 2009, there was $691.5 million outstanding on this
line. The weighted average interest rate on this line of credit was 0.77% as of
September 30, 2009. 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. The lending
commitment under the Company’s unsecured line of credit is provided by a total
of thirteen banks, with no individual bank representing more than 11% of the
total lending commitment. The bank lending group includes Lehman Brothers Bank
(“Lehman”), a subsidiary of Lehman Brothers Holdings Inc., which represents
approximately 7% of the lending commitment under the line of credit. On
September 15, 2008, Lehman Brothers Holdings Inc. filed a voluntary petition for
relief under Chapter 11 of the United States Bankruptcy Code. The Company does
not expect that Lehman will fund future borrowing requests. As of September 30,
2009, excluding Lehman’s lending commitment, the Company has $51.2 million
available for future use under its unsecured line of credit.
The line
of credit agreement contains certain financial covenants that, if not met, lead
to an event of default under the agreement. The covenants include
maintaining:
·
|
A
minimum consolidated net worth
|
·
|
A
minimum adjusted EBITDA to corporate debt interest (over the last four
rolling quarters)
|
·
|
A
limitation on subsidiary
indebtedness
|
·
|
A
limitation on the percentage of non-guaranteed loans in the Company’s
portfolio
|
13
As of
September 30, 2009, the Company was in compliance with all of these
requirements. Many of these covenants are duplicated in the Company’s other
lending facilities, including its FFELP warehouse facilities.
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) have modest implications on the pricing level
at which the Company obtains funding.
A default
on the 2009 FFELP Warehouse Facility would result in an event of default on the
Company’s unsecured line of credit that would result in the outstanding balance
on the line of credit becoming immediately due and payable.
Debt
Repurchases
During
2009, the Company repurchased outstanding debt as summarized below. There were
no debt repurchases in 2008. Any gains (losses) recorded by the Company from the
repurchase of debt are included in “other income” on the Company’s consolidated
statements of operations.
5.125%
Senior Notes due 2010
|
Junior
Subordinated Hybrid Securities
|
Asset-backed
securities
|
||||||||||||||||||||||||||
Notional
|
Purchase
|
Gain
|
Notional
|
Purchase
|
Gain
|
Notional
|
Purchase
|
Gain
|
||||||||||||||||||||
amount
|
price
|
(loss)
|
amount
|
price
|
(loss)
|
amount
|
price
|
(loss)
|
||||||||||||||||||||
Three
months ended:
|
||||||||||||||||||||||||||||
March
31, 2009
|
$ | 34,866 | 26,791 | 8,075 | — | — | — | — | — | — | ||||||||||||||||||
June
30, 2009
|
35,520 | 31,080 | 4,440 | 1,750 | 350 | 1,400 | 1,100 | 1,078 | 22 | |||||||||||||||||||
September
30, 2009
|
137,898 | 138,505 | (607 | ) | — | — | — | 44,950 | 39,095 | 5,855 | ||||||||||||||||||
Nine
months ended September 30, 2009
|
208,284 | 196,376 | 11,908 | 1,750 | 350 | 1,400 | 46,050 | 40,173 | 5,877 | |||||||||||||||||||
Subsequent
to September 30, 2009
|
||||||||||||||||||||||||||||
through
November 9, 2009
|
— | — | — | — | — | — | 140,200 | 126,159 | 14,041 | |||||||||||||||||||
Total
debt repurchased
|
$ | 208,284 | 196,376 | 11,908 | 1,750 | 350 | 1,400 | 186,250 | 166,332 | 19,918 | ||||||||||||||||||
Balance
as of September 30, 2009
|
$ | 66,716 | $ | 198,250 |
5.
|
Derivative
Financial Instruments
|
The
Company is exposed to certain risks relating to its ongoing business operations.
The primary risks managed by using derivative instruments are interest rate risk
and foreign currency exchange risk.
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 rate
sensitivity of the balance sheet is a key profitability driver. 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.
The
Company issues asset-backed securities, the vast majority being variable rate,
to fund its student loan assets. The variable rate debt is generally indexed to
3-month LIBOR, set by auction, or through a remarketing process. The income
generated by the Company’s student loan assets is generally driven by short term
indices (treasury bills, commercial paper, and certain fixed rates) that are
different from those which affect the Company’s liabilities (generally LIBOR),
which creates basis risk. Moreover, the Company also faces repricing risk due to
the timing of the interest rate resets on its liabilities, which may occur as
infrequently as every quarter, and the timing of the interest rate resets on its
assets, which generally occurs daily. In a declining interest rate environment,
this may cause the Company’s student loan spread to compress, while in a rising
rate environment, it may cause the spread to increase. As of September 30, 2009,
the Company had approximately $23.8 billion of FFELP loans indexed to
three-month financial commercial paper rate and $19.7 billion of debt indexed to
LIBOR.
In using
different index types and different index reset frequencies to fund assets, the
Company is exposed to interest rate risk in the form of basis risk and repricing
risk, which, as noted above, is the risk that the different indices may reset at
different frequencies, or will not move in the same direction or with the same
magnitude. While these indices are short term with rate movements that are
highly correlated over a longer period of time, they have recently become less
correlated. Due to capital market dislocations or other factors not within the
Company’s control, there can be no assurance the indices will regain their high
level of correlation in the future.
14
The
Company has used derivative instruments to hedge the repricing risk due to the
timing of the interest rate resets on its assets and liabilities. The Company
has entered into basis swaps in which the Company (i) receives three-month LIBOR
set discretely in advance and pays a daily weighted average three-month LIBOR
less a spread as defined in the agreements (the “Average/Discrete Basis Swaps”);
and (ii) receives three-month LIBOR and pays one-month LIBOR plus or minus a
spread as defined in the agreements (the “1/3 Basis Swaps”).
However,
the Company does not generally hedge the basis risk due to the different
interest rate indices associated with its assets and liabilities, since the
derivatives needed to hedge this risk are generally illiquid or non-existent and
the relationship between the indices for most of the Company’s assets and
liabilities has been highly correlated over a long period of time.
The
following table summarizes the Company’s basis swaps outstanding as of September
30, 2009 and December 31, 2008 used by the Company to hedge the repricing risk
due to the timing of the interest rate resets on its assets and
liabilities.
As
of September 30, 2009
|
||||||||
Notional
Amount
|
||||||||
Maturity
|
Average/Discrete
Basis Swaps
|
1/3
Basis Swaps
|
||||||
2010
|
$ | — | 1,000,000 | |||||
2011
(a)
|
6,000,000 | — | ||||||
2013
|
— | 500,000 | ||||||
2014
|
— | 500,000 | ||||||
2018
|
— | 1,300,000 | ||||||
2019
|
— | 500,000 | ||||||
2021
|
— | 250,000 | ||||||
2023
|
— | 1,250,000 | ||||||
2024
|
— | 250,000 | ||||||
2028
|
— | 100,000 | ||||||
2039
|
— | 150,000 | ||||||
$ | 6,000,000 | 5,800,000 | ||||||
(a)
Certain of these derivatives have forward effective start dates of
January 2010 ($1.5 billion), February 2010 ($1.5 billion), and March
2010 ($1.5 billion).
|
||||||||
As
of December 31, 2008
|
||||||||
Notional
amount
|
||||||||
Maturity
|
Average/Discrete
Basis Swaps
|
1/3
Basis Swaps
|
||||||
2010
|
$ | 4,500,000 | — | |||||
2011
|
2,700,000 | — | ||||||
2012
|
2,400,000 | — | ||||||
2018
|
— | 1,300,000 | ||||||
2023
|
— | 1,250,000 | ||||||
2028
|
— | 100,000 | ||||||
$ | 9,600,000 | 2,650,000 |
15
During
the three and nine months ended September 30, 2009, the Company terminated
and/or amended certain Average/Discrete Basis Swap agreements for net receipts
of $2.4 million and net payments of $7.9 million, respectively.
FFELP
loans originated prior to April 1, 2006 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 dependent
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 typically continues to decline. In these interest rate
environments, the Company may earn additional spread income that it refers to as
floor income.
Depending
on the type of loan and when it was originated, the borrower rate is either
fixed to term or is reset to an annual rate each July 1. As a result, for loans
where the borrower rate is fixed to term, the Company may earn 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 may earn floor income to the next reset date, which the Company
refers to as variable rate floor income. In accordance with legislation enacted
in 2006, lenders are required to rebate fixed rate floor income and variable
rate floor income to the Department for all FFELP loans first 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 their special allowance payment formulas. 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
September 30, 2009, the Company held the following interest rate derivatives to
hedge fixed-rate student loan assets earning fixed rate floor
income.
As
of September 30, 2009
|
||||||||
Weighted
|
||||||||
average
fixed
|
||||||||
Notional
|
rate
paid by
|
|||||||
Maturity
|
Amount
|
the
Company (a)
|
||||||
2010
|
$ | 1,000,000 | 0.76% | |||||
(a)
For all interest rate derivatives, the Company receives
discrete three-month
LIBOR.
|
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
(the “Euro 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. dollar and
Euro. 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.
For the three and nine months ended
September 30, 2009, the Company recorded an expense of $39.4 million and $56.0 million, respectively, as a result of
re-measurement of the Euro Notes, and income of $44.8 million and $28.9 million, respectively, for the change
in the fair value of the related derivative instruments. For the three and nine
months ended September 30, 2008, the Company recorded income of
$128.9 million and
$40.4 million,
respectively, as a result of re-measurement of the Euro Notes, and an expense of
$129.0 million and
$37.3 million,
respectively, for the change in the fair value of the related derivative
instruments.
The
re-measurement of the Euro-denominated bonds generally 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. Management intends to hold the cross-currency interest
rate swaps through the maturity of the Euro-denominated bonds.
16
Accounting
for Derivative Financial Instruments
The
Company records every derivative instrument 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. As a result, the change in fair value of the Company’s
derivatives at each reporting date are included in “derivative market value,
foreign currency, and put option adjustments and derivative settlements, net” in
the Company’s consolidated statements of operations. 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.
Any
proceeds received or payments made by the Company to terminate a derivative in
advance of its expiration date, or to amend the terms of an existing derivative,
are included in “derivative market value, foreign currency, and put option
adjustments and derivative settlements, net” on the consolidated statements of
operations and are accounted for as a change in fair value on such
derivative.
The
following table summarizes the fair value of the Company’s derivatives not
designated as hedging instruments:
Asset
derivatives
|
Liability
derivatives
|
|||||||||||||||
Fair
value as of
|
Fair
value as of
|
Fair
value as of
|
Fair
value as of
|
|||||||||||||
September
30, 2009
|
December
31, 2008
|
September
30, 2009
|
December
31, 2008
|
|||||||||||||
Interest
Rate swaps
|
$ | — | — | (1,812 | ) | — | ||||||||||
Average/discrete
basis swaps
|
— | 2,817 | (6,660 | ) | (1,800 | ) | ||||||||||
1/3
basis swaps
|
13,966 | 5,037 | (8 | ) | (15 | ) | ||||||||||
Cross-currency
interest rate swaps
|
196,191 | 167,320 | — | — | ||||||||||||
Other
|
— | — | (518 | ) | — | |||||||||||
Total
|
$ | 210,157 | 175,174 | (8,998 | ) | (1,815 | ) |
The
following table summarizes the effect of derivative instruments in the
consolidated statements of operations. All gains and losses recognized in income
related to the Company’s derivative activity are included in “Derivative market
value, foreign currency, and put option adjustments and derivative settlements,
net”, on the consolidated statements of operations.
Derivatives
not designated
|
Amount
of gain (or loss)
|
Amount
of gain (or loss)
|
||||||||||||||
as
hedging instruments
|
recognized
on derivatives
|
recognized
on derivatives
|
||||||||||||||
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Settlements:
|
||||||||||||||||
Interest
rate swaps
|
$ | (436 | ) | (3,175 | ) | $ | (447 | ) | (14,194 | ) | ||||||
Average/discrete
basis swaps
|
646 | (3,999 | ) | 11,707 | 40,711 | |||||||||||
1/3
basis swaps
|
3,071 | — | 20,473 | 894 | ||||||||||||
Cross-currency
interest rate swaps
|
1,633 | 7,963 | 7,074 | 18,578 | ||||||||||||
Other
|
— | — | — | — | ||||||||||||
Total
settlements
|
4,914 | 789 | 38,807 | 45,989 | ||||||||||||
Change
in fair value:
|
||||||||||||||||
Interest
rate swaps
|
(2,822 | ) | (1,335 | ) | (1,811 | ) | 2,763 | |||||||||
Average/discrete
basis swaps
|
1,864 | 10,390 | (16,813 | ) | (40,948 | ) | ||||||||||
1/3
basis swaps
|
(1,115 | ) | — | 8,751 | 2,568 | |||||||||||
Cross-currency
interest rate swaps
|
44,773 | (128,951 | ) | 28,871 | (37,283 | ) | ||||||||||
Other
|
(518 | ) | 35 | 914 | 501 | |||||||||||
Total
change in fair value
|
42,182 | (119,861 | ) | 19,912 | (72,399 | ) | ||||||||||
Total
impact to statements of operations
|
$ | 47,096 | (119,072 | ) | $ | 58,719 | (26,410 | ) |
17
Derivative
Instruments - Credit and Market Risk
By using
derivative instruments, the Company is exposed to credit and market
risk.
When the
fair value of a derivative instrument is negative, the Company would owe the
counterparty if the derivative was settled and, therefore, has no immediate
credit risk. Additionally, if the negative fair value of derivatives with a
counterparty exceeds a specified threshold, the Company may have to make a
collateral deposit with the counterparty. The threshold at which the Company
posts collateral may depend on the Company’s unsecured credit rating. If
interest and foreign currency exchange rates move materially, the Company could
be required to deposit a significant amount of collateral with its derivative
instrument counterparties. The collateral deposits, if significant, could
negatively impact the Company’s liquidity and capital resources.
When the
fair value of a derivative contract is positive, this generally indicates that
the counterparty would owe the Company if the derivative was settled. If the
counterparty fails to perform, credit risk with such counterparty is equal to
the extent of the fair value gain in the derivative less any collateral held by
the Company. As of September 30, 2009, the Company held approximately $308
million of collateral from the counterparty on the cross-currency interest rate
swaps.
The
Company attempts to manage market and credit risks associated with interest and
foreign currency exchange rates by establishing and monitoring limits as to the
types and degree of risk that may be undertaken, and by entering into
transactions with high-quality counterparties that are reviewed periodically by
the Company’s risk committee. The Company also has a policy of requiring that
all derivative contracts be governed by an International Swaps and Derivatives
Association, Inc. Master Agreement.
6.
Derivative Market Value, Foreign Currency, and Put Option Adjustments and
Derivative Settlements, net
The
following table summarizes the components of “Derivative market value, foreign
currency, and put option adjustments and derivative settlements, net” included
in the consolidated statements of operations.
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Change
in fair value of derivatives
|
$ | 42,182 | (119,861 | ) | 19,912 | (72,399 | ) | |||||||||
Foreign
currency transaction adjustment
|
(39,356 | ) | 128,891 | (55,979 | ) | 40,361 | ||||||||||
Change
in fair value of put options
|
||||||||||||||||
issued
in business acquisitions
|
— | (2,945 | ) | — | (3,483 | ) | ||||||||||
Derivative
settlements, net
|
4,914 | 789 | 38,807 | 45,989 | ||||||||||||
Derivative
market value, foreign currency,
|
||||||||||||||||
and
put option adjustments and
|
||||||||||||||||
derivative
settlements, net
|
$ | 7,740 | 6,874 | 2,740 | 10,468 |
7.
Segment Reporting
The
Company has five operating segments as follows: Student Loan and Guaranty
Servicing, Tuition Payment Processing and Campus Commerce, Enrollment Services,
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
generally accepted accounting principles (“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.
18
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, thereby reducing legislative
and political risk.
Fee
Generating 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
|
·
|
Origination
and servicing of non-federally insured student
loans
|
·
|
Servicing
and support outsourcing for guaranty
agencies
|
In June
2009, the Department of Education named the Company as one of four private
sector companies awarded a servicing contract to service all federally-owned
student loans, including FFELP loans purchased by the Department pursuant to
ECASLA. Beginning in August 2010, the contract will also cover the servicing on
new loans originated under the Direct Loan Program. Servicing volume will
initially be allocated by the Department to servicers awarded a contract,
however, performance factors such as customer satisfaction levels and default
rates will determine volume allocations over time. The contract spans five years
with one, five-year renewal option. Servicing loans under this contract will
increase revenue earned by this segment. However, operating margins under this
contract are expected to be lower than historical levels achieved.
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
The
Enrollment Services segment offers products and services that are focused on
helping students plan and prepare for life after high school (content management
and publishing and editing services) and helping colleges recruit and retain
students (lead generation and recruitment services). Content management products
and services include online courses and related services. Publishing and editing
services include test preparation study guides and essay and resume editing
services. Lead generation products and services include vendor lead management
services and admissions lead generation. Recruitment services include pay per
click marketing management, email marketing, list marketing services, and
admissions consulting.
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 solutions.
19
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, and financing its 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.
20
Segment
Results and Reconciliations to GAAP
Three
months ended September 30, 2009
|
||||||||||||||||||||||||||||||
Fee-Based
|
||||||||||||||||||||||||||||||
Student
|
Tuition
|
"Base
net
|
||||||||||||||||||||||||||||
Loan
|
Payment
|
Software
|
Asset
|
Corporate
|
income"
|
|||||||||||||||||||||||||
and
|
Processing
|
and
|
Total
|
Generation
|
Activity
|
Eliminations
|
Adjustments
|
GAAP
|
||||||||||||||||||||||
Guaranty
|
and
Campus
|
Enrollment
|
Technical
|
Fee-
|
and
|
and
|
and
|
to
GAAP
|
Results
of
|
|||||||||||||||||||||
Servicing
|
Commerce
|
Services
|
Services
|
Based
|
Management
|
Overhead
|
Reclassifications
|
Results
|
Operations
|
|||||||||||||||||||||
Total
interest income
|
$ | 23 | 16 | — | — | 39 | 144,310 | 1,191 | (342 | ) | — | 145,198 | ||||||||||||||||||
Interest
expense
|
— | — | — | — | — | 69,914 | 6,444 | (342 | ) | — | 76,016 | |||||||||||||||||||
Net
interest income (loss)
|
23 | 16 | — | — | 39 | 74,396 | (5,253 | ) | — | — | 69,182 | |||||||||||||||||||
Less
provision for loan losses
|
— | — | — | — | — | 7,500 | — | — | — | 7,500 | ||||||||||||||||||||
Net
interest income (loss) after provision for loan losses
|
23 | 16 | — | — | 39 | 66,896 | (5,253 | ) | — | — | 61,682 | |||||||||||||||||||
Other
income (expense):
|
||||||||||||||||||||||||||||||
Loan
and guaranty servicing revenue
|
26,387 | — | — | — | 26,387 | — | (381 | ) | — | — | 26,006 | |||||||||||||||||||
Tuition
payment processing and campus commerce revenue
|
— | 12,987 | — | — | 12,987 | — | — | — | — | 12,987 | ||||||||||||||||||||
Enrollment
services revenue
|
— | — | 30,670 | — | 30,670 | — | — | — | — | 30,670 | ||||||||||||||||||||
Software
services revenue
|
966 | — | — | 3,634 | 4,600 | — | — | — | — | 4,600 | ||||||||||||||||||||
Other
income
|
137 | — | — | — | 137 | 9,959 | 998 | — | — | 11,094 | ||||||||||||||||||||
Gain
(loss) on sale of loans, net
|
— | — | — | — | — | 8,788 | — | — | — | 8,788 | ||||||||||||||||||||
Intersegment
revenue
|
21,525 | 62 | 139 | 3,793 | 25,519 | — | 8,355 | (33,874 | ) | — | — | |||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
— | — | — | — | — | — | — | — | 2,826 | 2,826 | ||||||||||||||||||||
Derivative
settlements, net
|
— | — | — | — | — | 4,914 | — | — | — | 4,914 | ||||||||||||||||||||
Total
other income (expense)
|
49,015 | 13,049 | 30,809 | 7,427 | 100,300 | 23,661 | 8,972 | (33,874 | ) | 2,826 | 101,885 | |||||||||||||||||||
Operating
expenses:
|
||||||||||||||||||||||||||||||
Salaries
and benefits
|
12,468 | 6,399 | 5,337 | 5,756 | 29,960 | 1,693 | 5,919 | 238 | — | 37,810 | ||||||||||||||||||||
Restructure
expense- severance and contract terminination costs
|
2,646 | — | — | 292 | 2,938 | — | 402 | (3,340 | ) | — | — | |||||||||||||||||||
Impairment
expense
|
— | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Cost
to provide enrollment services
|
— | — | 20,323 | — | 20,323 | — | — | — | — | 20,323 | ||||||||||||||||||||
Other
expenses
|
7,613 | 2,265 | 3,266 | 776 | 13,920 | 4,801 | 8,567 | 1,929 | 5,312 | 34,529 | ||||||||||||||||||||
Intersegment
expenses
|
9,398 | 670 | 550 | 786 | 11,404 | 20,764 | 533 | (32,701 | ) | — | — | |||||||||||||||||||
Total
operating expenses
|
32,125 | 9,334 | 29,476 | 7,610 | 78,545 | 27,258 | 15,421 | (33,874 | ) | 5,312 | 92,662 | |||||||||||||||||||
Income
(loss) before income taxes
|
16,913 | 3,731 | 1,333 | (183 | ) | 21,794 | 63,299 | (11,702 | ) | — | (2,486 | ) | 70,905 | |||||||||||||||||
Income
tax (expense) benefit (a)
|
(6,427 | ) | (1,418 | ) | (507 | ) | 70 | (8,282 | ) | (24,054 | ) | 6,976 | — | 859 | (24,501 | ) | ||||||||||||||
Net
income (loss) from continuing operations
|
10,486 | 2,313 | 826 | (113 | ) | 13,512 | 39,245 | (4,726 | ) | — | (1,627 | ) | 46,404 | |||||||||||||||||
Income
from discontinued operations, net of tax
|
— | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Net
income (loss)
|
$ | 10,486 | 2,313 | 826 | (113 | ) | 13,512 | 39,245 | (4,726 | ) | — | (1,627 | ) | 46,404 | ||||||||||||||||
(a)
Income taxes are applied based on 38% of income (loss) before income taxes
for the individual operating segments.
|
||||||||||||||||||||||||||||||
21
Three
months ended September 30, 2008
|
||||||||||||||||||||||||||||||||||||||||
Fee-Based
|
||||||||||||||||||||||||||||||||||||||||
Tuition
|
||||||||||||||||||||||||||||||||||||||||
Student
|
Payment
|
"Base
net
|
||||||||||||||||||||||||||||||||||||||
Loan
|
Processing
|
Software
|
Asset
|
Corporate
|
income"
|
|||||||||||||||||||||||||||||||||||
and
|
and
|
and
|
Total
|
Generation
|
Activity
|
Eliminations
|
Adjustments
|
GAAP
|
||||||||||||||||||||||||||||||||
Guaranty
|
Campus
|
Enrollment
|
Technical
|
Fee-
|
and
|
and
|
and
|
to
GAAP
|
Results
of
|
|||||||||||||||||||||||||||||||
Servicing
|
Commerce
|
Services
|
Services
|
Based
|
Management
|
Overhead
|
Reclassifications
|
Results
|
Operations
|
|||||||||||||||||||||||||||||||
Total
interest income
|
$ | 304 | 396 | 6 | — | 706 | 290,039 | 2,010 | (749 | ) | 1,580 | 293,586 | ||||||||||||||||||||||||||||
Interest
expense
|
— | — | 1 | — | 1 | 224,272 | 10,492 | (749 | ) | — | 234,016 | |||||||||||||||||||||||||||||
Net
interest income (loss)
|
304 | 396 | 5 | — | 705 | 65,767 | (8,482 | ) | — | 1,580 | 59,570 | |||||||||||||||||||||||||||||
Less
provision for loan losses
|
— | — | — | — | — | 7,000 | — | — | — | 7,000 | ||||||||||||||||||||||||||||||
Net
interest income (loss) after
|
||||||||||||||||||||||||||||||||||||||||
provision
for loan losses
|
304 | 396 | 5 | — | 705 | 58,767 | (8,482 | ) | — | 1,580 | 52,570 | |||||||||||||||||||||||||||||
Other
income (expense):
|
||||||||||||||||||||||||||||||||||||||||
Loan
and guaranty servicing revenue
|
29,827 | — | — | — | 29,827 | (136 | ) | — | — | — | 29,691 | |||||||||||||||||||||||||||||
Tuition
payment processing and campus commerce revenue
|
— | 11,863 | — | — | 11,863 | — | — | — | — | 11,863 | ||||||||||||||||||||||||||||||
Enrollment
services revenue
|
— | — | 29,858 | — | 29,858 | — | — | — | — | 29,858 | ||||||||||||||||||||||||||||||
Software
services revenue
|
942 | — | — | 4,217 | 5,159 | — | — | — | — | 5,159 | ||||||||||||||||||||||||||||||
Other
income
|
6 | — | — | — | 6 | 4,079 | 1,323 | — | — | 5,408 | ||||||||||||||||||||||||||||||
Intercompany
revenue
|
18,402 | 58 | 2 | 1,660 | 20,122 | — | 15,671 | (35,793 | ) | — | — | |||||||||||||||||||||||||||||
Derivative
market value, foreign
|
||||||||||||||||||||||||||||||||||||||||
currency,
and put option adjustments
|
— | — | — | — | — | — | — | — | 6,085 | 6,085 | ||||||||||||||||||||||||||||||
Derivative
settlements, net
|
— | — | — | — | — | 789 | — | — | — | 789 | ||||||||||||||||||||||||||||||
Total
other income (expense)
|
49,177 | 11,921 | 29,860 | 5,877 | 96,835 | 4,732 | 16,994 | (35,793 | ) | 6,085 | 88,853 | |||||||||||||||||||||||||||||
Operating
expenses:
|
||||||||||||||||||||||||||||||||||||||||
Salaries
and benefits
|
13,876 | 6,236 | 5,805 | 4,138 | 30,055 | 1,980 | 14,179 | (1,952 | ) | 477 | 44,739 | |||||||||||||||||||||||||||||
Restructure
expense- severance and
|
||||||||||||||||||||||||||||||||||||||||
contract
terminination costs
|
— | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Impairment
expense
|
— | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Cost
to provide enrollment services
|
— | — | 17,904 | — | 17,904 | — | — | — | — | 17,904 | ||||||||||||||||||||||||||||||
Other
expenses
|
10,632 | 2,132 | 2,512 | 568 | 15,844 | 5,354 | 13,477 | (247 | ) | 6,598 | 41,026 | |||||||||||||||||||||||||||||
Intersegment
expenses
|
11,940 | 288 | 1,509 | 826 | 14,563 | 18,200 | 831 | (33,594 | ) | — | — | |||||||||||||||||||||||||||||
Total
operating expenses
|
36,448 | 8,656 | 27,730 | 5,532 | 78,366 | 25,534 | 28,487 | (35,793 | ) | 7,075 | 103,669 | |||||||||||||||||||||||||||||
Income
(loss) before income taxes
|
13,033 | 3,661 | 2,135 | 345 | 19,174 | 37,965 | (19,975 | ) | — | 590 | 37,754 | |||||||||||||||||||||||||||||
Income
tax (expense) benefit (a)
|
(4,823 | ) | (1,354 | ) | (790 | ) | (128 | ) | (7,095 | ) | (14,047 | ) | 7,391 | — | (218 | ) | (13,969 | ) | ||||||||||||||||||||||
Net
income (loss) from continuing operations
|
8,210 | 2,307 | 1,345 | 217 | 12,079 | 23,918 | (12,584 | ) | — | 372 | 23,785 | |||||||||||||||||||||||||||||
Income
from discontinued operations, net of tax
|
— | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Net
income (loss)
|
$ | 8,210 | 2,307 | 1,345 | 217 | 12,079 | 23,918 | (12,584 | ) | — | 372 | 23,785 |
(a)
Income taxes are applied based on the consolidated effective tax rate to
income (loss) before income taxes.
|
22
Nine
months ended September 30, 2009
|
|||||||||||||||||||||||||||||||
Fee-Based
|
|||||||||||||||||||||||||||||||
Tuition
|
|||||||||||||||||||||||||||||||
Student
|
Payment
|
"Base
net
|
|||||||||||||||||||||||||||||
Loan
|
Processing
|
Software
|
Asset
|
Corporate
|
income"
|
||||||||||||||||||||||||||
and
|
and
|
and
|
Total
|
Generation
|
Activity
|
Eliminations
|
Adjustments
|
GAAP
|
|||||||||||||||||||||||
Guaranty
|
Campus
|
Enrollment
|
Technical
|
Fee-
|
and
|
and
|
and
|
to
GAAP
|
Results
of
|
||||||||||||||||||||||
Servicing
|
Commerce
|
Services
|
Services
|
Based
|
Management
|
Overhead
|
Reclassifications
|
Results
|
Operations
|
||||||||||||||||||||||
Total
interest income
|
$ | 102 | 57 | — | — | 159 | 473,130 | 3,930 | (1,324 | ) | 7,502 | 483,397 | |||||||||||||||||||
Interest
expense
|
— | — | — | — | — | 306,846 | 23,078 | (1,324 | ) | — | 328,600 | ||||||||||||||||||||
Net
interest income (loss)
|
102 | 57 | — | — | 159 | 166,284 | (19,148 | ) | — | 7,502 | 154,797 | ||||||||||||||||||||
Less
provision for loan losses
|
— | — | — | — | — | 23,000 | — | — | — | 23,000 | |||||||||||||||||||||
Net
interest income (loss) after provision for loan
losses
|
102 | 57 | — | — | 159 | 143,284 | (19,148 | ) | — | 7,502 | 131,797 | ||||||||||||||||||||
Other
income (expense):
|
|||||||||||||||||||||||||||||||
Loan
and guaranty servicing revenue
|
82,424 | — | — | — | 82,424 | — | (1,144 | ) | — | — | 81,280 | ||||||||||||||||||||
Tuition
payment processing and campus commerce revenue
|
— | 40,373 | — | — | 40,373 | — | — | — | — | 40,373 | |||||||||||||||||||||
Enrollment
services revenue
|
— | — | 88,188 | — | 88,188 | — | — | — | — | 88,188 | |||||||||||||||||||||
Software
services revenue
|
2,766 | — | — | 13,658 | 16,424 | — | — | — | — | 16,424 | |||||||||||||||||||||
Other
income
|
498 | — | — | — | 498 | 18,851 | 20,134 | — | — | 39,483 | |||||||||||||||||||||
Gain
(loss) on sale of loans, net
|
— | — | — | — | — | 8,386 | — | — | — | 8,386 | |||||||||||||||||||||
Intersegment
revenue
|
62,291 | 172 | 416 | 10,813 | 73,692 | — | 25,739 | (99,431 | ) | — | — | ||||||||||||||||||||
Derivative
market value, foreign currency,
|
|||||||||||||||||||||||||||||||
and
put option adjustments
|
— | — | — | — | — | — | — | — | (36,067 | ) | (36,067 | ) | |||||||||||||||||||
Derivative
settlements, net
|
— | — | — | — | — | 38,807 | — | — | — | 38,807 | |||||||||||||||||||||
Total
other income (expense)
|
147,979 | 40,545 | 88,604 | 24,471 | 301,599 | 66,044 | 44,729 | (99,431 | ) | (36,067 | ) | 276,874 | |||||||||||||||||||
Operating
expenses:
|
|||||||||||||||||||||||||||||||
Salaries
and benefits
|
40,527 | 19,346 | 17,295 | 16,656 | 93,824 | 5,203 | 18,420 | (1,390 | ) | 159 | 116,216 | ||||||||||||||||||||
Restructure
expense- severance and contract
|
|||||||||||||||||||||||||||||||
termination
costs
|
5,159 | — | — | 714 | 5,873 | — | 755 | (6,628 | ) | — | — | ||||||||||||||||||||
Impairment
expense
|
— | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||
Cost
to provide enrollment services
|
— | — | 56,208 | — | 56,208 | — | — | — | — | 56,208 | |||||||||||||||||||||
Other
expenses
|
27,350 | 7,012 | 9,602 | 2,292 | 46,256 | 15,635 | 27,287 | 3,736 | 17,251 | 110,165 | |||||||||||||||||||||
Intersegment
expenses
|
28,352 | 1,962 | 1,604 | 2,195 | 34,113 | 59,372 | 1,664 | (95,149 | ) | — | — | ||||||||||||||||||||
Total
operating expenses
|
101,388 | 28,320 | 84,709 | 21,857 | 236,274 | 80,210 | 48,126 | (99,431 | ) | 17,410 | 282,589 | ||||||||||||||||||||
Income
(loss) before income taxes
|
46,693 | 12,282 | 3,895 | 2,614 | 65,484 | 129,118 | (22,545 | ) | — | (45,975 | ) | 126,082 | |||||||||||||||||||
Income
tax (expense) benefit (a)
|
(17,744 | ) | (4,667 | ) | (1,480 | ) | (994 | ) | (24,885 | ) | (49,066 | ) | 11,150 | — | 16,781 | (46,020 | ) | ||||||||||||||
Net
income (loss) from continuing operations
|
28,949 | 7,615 | 2,415 | 1,620 | 40,599 | 80,052 | (11,395 | ) | — | (29,194 | ) | 80,062 | |||||||||||||||||||
Income
from discontinued operations, net of tax
|
— | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||
Net
income (loss)
|
$ | 28,949 | 7,615 | 2,415 | 1,620 | 40,599 | 80,052 | (11,395 | ) | — | (29,194 | ) | 80,062 |
(a)
Income taxes are applied based on 38% of income (loss) before income taxes
for the individual operating segments.
|
23
Nine
months ended September 30, 2008
|
|||||||||||||||||||||||||||||||
Fee-Based
|
|||||||||||||||||||||||||||||||
Tuition
|
|||||||||||||||||||||||||||||||
Student
|
Payment
|
"Base
net
|
|||||||||||||||||||||||||||||
Loan
|
Processing
|
Software
|
Asset
|
Corporate
|
income"
|
||||||||||||||||||||||||||
and
|
and
|
and
|
Total
|
Generation
|
Activity
|
Eliminations
|
Adjustments
|
GAAP
|
|||||||||||||||||||||||
Guaranty
|
Campus
|
Enrollment
|
Technical
|
Fee-
|
and
|
and
|
and
|
to
GAAP
|
Results
of
|
||||||||||||||||||||||
Servicing
|
Commerce
|
Services
|
Services
|
Based
|
Management
|
Overhead
|
Reclassifications
|
Results
|
Operations
|
||||||||||||||||||||||
Total
interest income
|
$ | 1,160 | 1,471 | 16 | — | 2,647 | 892,690 | 4,781 | (1,389 | ) | 42,325 | 941,054 | |||||||||||||||||||
Interest
expense
|
— | — | 3 | — | 3 | 762,689 | 30,318 | (1,389 | ) | — | 791,621 | ||||||||||||||||||||
Net
interest income (loss)
|
1,160 | 1,471 | 13 | — | 2,644 | 130,001 | (25,537 | ) | — | 42,325 | 149,433 | ||||||||||||||||||||
Less
provision for loan losses
|
— | — | — | — | — | 18,000 | — | — | — | 18,000 | |||||||||||||||||||||
Net
interest income (loss) after provision
|
|||||||||||||||||||||||||||||||
for
loan losses
|
1,160 | 1,471 | 13 | — | 2,644 | 112,001 | (25,537 | ) | — | 42,325 | 131,433 | ||||||||||||||||||||
Other
income (expense):
|
|||||||||||||||||||||||||||||||
Loan
and guaranty servicing revenue
|
78,147 | — | — | — | 78,147 | 26 | — | — | — | 78,173 | |||||||||||||||||||||
Tuition
payment processing and campus commerce revenue
|
— | 35,980 | — | — | 35,980 | — | — | — | — | 35,980 | |||||||||||||||||||||
Enrollment
services revenue
|
— | — | 83,148 | — | 83,148 | — | — | — | — | 83,148 | |||||||||||||||||||||
Software
services revenue
|
3,477 | — | 37 | 15,828 | 19,342 | — | — | — | — | 19,342 | |||||||||||||||||||||
Other
income
|
44 | — | — | — | 44 | 13,787 | 3,956 | — | — | 17,787 | |||||||||||||||||||||
Gain
(loss) on sale of loans, net
|
— | — | — | — | — | (47,426 | ) | — | — | — | (47,426 | ) | |||||||||||||||||||
Intersegment
revenue
|
57,008 | 242 | 2 | 4,993 | 62,245 | — | 46,843 | (109,088 | ) | — | — | ||||||||||||||||||||
Derivative
market value, foreign currency,
|
|||||||||||||||||||||||||||||||
and
put option adjustments
|
— | — | — | — | — | 466 | — | — | (35,987 | ) | (35,521 | ) | |||||||||||||||||||
Derivative
settlements, net
|
— | — | — | — | — | 55,954 | — | — | (9,965 | ) | 45,989 | ||||||||||||||||||||
Total
other income (expense)
|
138,676 | 36,222 | 83,187 | 20,821 | 278,906 | 22,807 | 50,799 | (109,088 | ) | (45,952 | ) | 197,472 | |||||||||||||||||||
Operating
expenses:
|
|||||||||||||||||||||||||||||||
Salaries
and benefits
|
40,365 | 17,450 | 18,701 | 14,031 | 90,547 | 6,157 | 41,581 | 1,323 | 2,523 | 142,131 | |||||||||||||||||||||
Restructure
expense- severence and
|
|||||||||||||||||||||||||||||||
contract
terminination costs
|
747 | — | 282 | 487 | 1,516 | 1,845 | 3,746 | (7,107 | ) | — | — | ||||||||||||||||||||
Impairment
expense
|
5,074 | — | — | — | 5,074 | 9,351 | 4,409 | — | — | 18,834 | |||||||||||||||||||||
Cost
to provide enrollment services
|
— | — | 48,062 | — | 48,062 | — | — | — | — | 48,062 | |||||||||||||||||||||
Other
expenses
|
27,130 | 6,743 | 7,801 | 1,901 | 43,575 | 15,793 | 42,263 | 51 | 19,719 | 121,401 | |||||||||||||||||||||
Intersegment
expenses
|
35,040 | 1,045 | 4,936 | 1,562 | 42,583 | 57,754 | 3,018 | (103,355 | ) | — | — | ||||||||||||||||||||
Total
operating expenses
|
108,356 | 25,238 | 79,782 | 17,981 | 231,357 | 90,900 | 95,017 | (109,088 | ) | 22,242 | 330,428 | ||||||||||||||||||||
Income
(loss) before income taxes
|
31,480 | 12,455 | 3,418 | 2,840 | 50,193 | 43,908 | (69,755 | ) | — | (25,869 | ) | (1,523 | ) | ||||||||||||||||||
Income
tax (expense) benefit (a)
|
(10,542 | ) | (4,081 | ) | (1,187 | ) | (902 | ) | (16,712 | ) | (15,889 | ) | 22,824 | — | 7,984 | (1,793 | ) | ||||||||||||||
Net
income (loss) from continuing operations
|
20,938 | 8,374 | 2,231 | 1,938 | 33,481 | 28,019 | (46,931 | ) | — | (17,885 | ) | (3,316 | ) | ||||||||||||||||||
Income
from discontinued operations, net of tax
|
— | — | — | — | — | — | — | — | 981 | 981 | |||||||||||||||||||||
Net
income (loss)
|
$ | 20,938 | 8,374 | 2,231 | 1,938 | 33,481 | 28,019 | (46,931 | ) | — | (16,904 | ) | (2,335 | ) | |||||||||||||||||
(a)
Income taxes are applied based on the consolidated effective tax rate to
income (loss) before income taxes.
|
|||||||||||||||||||||||||||||||
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
|
·
|
Certain
corporate activities and unallocated overhead functions related to
executive management, human resources, accounting and finance, legal,
marketing, and corporate technology
support
|
24
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, 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
|
|||||||||||||||
Loan
|
Payment
|
Software
|
Asset
|
Corporate
|
||||||||||||
and
|
Processing
|
and
|
Generation
|
Activity
|
||||||||||||
Guaranty
|
and
Campus
|
Enrollment
|
Technical
|
and
|
and
|
|||||||||||
Servicing
|
Commerce
|
Services
|
Services
|
Management
|
Overhead
|
Total
|
||||||||||
Three
months ended September 30, 2009
|
||||||||||||||||
Derivative
market value, foreign currency, and
|
||||||||||||||||
put
option adjustments (1)
|
$
|
—
|
—
|
—
|
—
|
(2,826)
|
—
|
(2,826)
|
||||||||
Amortization
of intangible assets (2)
|
1,078
|
1,842
|
2,251
|
141
|
—
|
—
|
5,312
|
|||||||||
Compensation
related to business combinations (3)
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
|||||||||
Variable-rate
floor income, net of settlements on derivatives (4)
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
|||||||||
Income
from discontinued operations, net of tax (5)
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
|||||||||
Net
tax effect (6)
|
(410)
|
(700)
|
(855)
|
(54)
|
1,074
|
86
|
(859)
|
|||||||||
Total
adjustments to GAAP
|
$
|
668
|
1,142
|
1,396
|
87
|
(1,752)
|
86
|
1,627
|
||||||||
Three
months ended September 30, 2008
|
||||||||||||||||
Derivative
market value, foreign currency, and
|
||||||||||||||||
put
option adjustments (1)
|
$
|
—
|
—
|
—
|
—
|
(9,030)
|
2,945
|
(6,085)
|
||||||||
Amortization
of intangible assets (2)
|
1,165
|
1,889
|
3,258
|
286
|
—
|
—
|
6,598
|
|||||||||
Compensation
related to business combinations (3)
|
—
|
—
|
—
|
—
|
—
|
477
|
477
|
|||||||||
Variable-rate
floor income, net of settlements on derivatives (4)
|
—
|
—
|
—
|
—
|
(1,580)
|
—
|
(1,580)
|
|||||||||
Income
from discontinued operations, net of tax (5)
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
|||||||||
Net
tax effect (6)
|
(432)
|
(699)
|
(1,205)
|
(106)
|
3,926
|
(1,266)
|
218
|
|||||||||
Total
adjustments to GAAP
|
$
|
733
|
1,190
|
2,053
|
180
|
(6,684)
|
2,156
|
(372)
|
||||||||
Nine
months ended September 30, 2009
|
||||||||||||||||
Derivative
market value, foreign currency, and
|
||||||||||||||||
put
option adjustments (1)
|
$
|
—
|
—
|
—
|
—
|
37,499
|
(1,432)
|
36,067
|
||||||||
Amortization
of intangible assets (2)
|
3,236
|
5,598
|
7,994
|
423
|
—
|
—
|
17,251
|
|||||||||
Compensation
related to business combinations (3)
|
—
|
—
|
—
|
—
|
—
|
159
|
159
|
|||||||||
Variable-rate
floor income, net of settlements on derivatives (4)
|
—
|
—
|
—
|
—
|
(7,502)
|
—
|
(7,502)
|
|||||||||
Income
from discontinued operations, net of tax (5)
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
|||||||||
Net
tax effect (6)
|
(1,230)
|
(2,127)
|
(3,037)
|
(161)
|
(11,399)
|
1,173
|
(16,781)
|
|||||||||
Total
adjustments to GAAP
|
$
|
2,006
|
3,471
|
4,957
|
262
|
18,598
|
(100)
|
29,194
|
||||||||
Nine
months ended September 30, 2008
|
||||||||||||||||
Derivative
market value, foreign currency, and
|
||||||||||||||||
put
option adjustments (1)
|
$
|
—
|
—
|
—
|
—
|
32,504
|
3,483
|
35,987
|
||||||||
Amortization
of intangible assets (2)
|
3,586
|
5,937
|
9,193
|
858
|
145
|
—
|
19,719
|
|||||||||
Compensation
related to business combinations (3)
|
—
|
—
|
—
|
—
|
—
|
2,523
|
2,523
|
|||||||||
Variable-rate
floor income, net of settlements on derivatives (4)
|
—
|
—
|
—
|
—
|
(32,360)
|
—
|
(32,360)
|
|||||||||
Income
from discontinued operations, net of tax (5)
|
(981)
|
—
|
—
|
—
|
—
|
—
|
(981)
|
|||||||||
Net
tax effect (6)
|
(1,182)
|
(1,954)
|
(3,045)
|
(284)
|
548
|
(2,067)
|
(7,984)
|
|||||||||
Total
adjustments to GAAP
|
$
|
1,423
|
3,983
|
6,148
|
574
|
837
|
3,939
|
16,904
|
||||||||
(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.
|
25
(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.
|
Prior to
October 1, 2008, variable rate floor income was calculated by the Company on a
statutory maximum basis. However, as a result of the disruption in the capital
markets beginning in August 2007, the full benefit of variable rate floor income
calculated on a statutory maximum basis 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. As a result of the ongoing volatility of
interest rates, effective October 1, 2008, the Company changed its calculation
of variable rate floor income to better reflect the economic benefit received by
the Company. The economic benefit received by the Company related to variable
rate floor income was $0.1 million for the three months ended September 30, 2008
and $7.5 million and $25.7 million for the nine months ended September 30, 2009
and 2008, respectively. There was no economic benefit received by the Company
related to variable rate floor income for the three months ended September 30,
2009. Variable rate floor income calculated on a statutory maximum basis was
$0.1 million and $1.6 million for the three months ended September 30, 2009 and
2008, respectively, and $23.9 million and
$42.3 million for the nine months ended September 30, 2009 and 2008,
respectively. Beginning October 1, 2008, the economic benefit received by the
Company has been used to determine base net income.
The
Company has used derivative instruments to hedge variable rate floor income
during certain periods. During the nine months ended September 30, 2008, the
Company made payments (settlements) of $10.0 million on such derivatives. These
settlements are netted with variable-rate floor income and are excluded from
“base net income.”
(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)
|
For
2009, income taxes are applied based on 38% of income (loss) before income
taxes for the individual operating segments. For 2008, income taxes for
each individual operating segment are applied based on the consolidated
effective tax rate.
|
8.
|
Intangible
Assets and Goodwill
|
Intangible
assets consist of the following:
Weighted
|
|||||||||||||
average
|
|||||||||||||
remaining
|
|||||||||||||
useful
life as of
|
As
of
|
As
of
|
|||||||||||
September
30,
|
September
30,
|
December
31,
|
|||||||||||
2009
(months)
|
2009
|
2008
|
|||||||||||
Amortizable
intangible assets:
|
|||||||||||||
Customer
relationships (net of accumulated amortization of $36,557
|
|||||||||||||
and
$29,737, respectively)
|
98 | $ | 43,803 | 50,623 | |||||||||
Trade
names (net of accumulated amortization of $8,265 and
|
|||||||||||||
$5,478,
respectively)
|
35 | 8,794 | 11,581 | ||||||||||
Covenants
not to compete (net of accumulated amortization of
|
|||||||||||||
$19,041
and $14,887, respectively)
|
11 | 4,581 | 8,735 | ||||||||||
Database
and content (net of accumulated amortization of $7,137
|
|||||||||||||
and
$5,447, respectively)
|
14 | 2,343 | 4,033 | ||||||||||
Computer
software (net of accumulated amortization of $8,880
|
|||||||||||||
and
$7,441, respectively)
|
14 | 122 | 1,561 | ||||||||||
Student
lists (net of accumulated amortization of $8,197 and
|
|||||||||||||
$7,855,
respectively)
|
— | — | 342 | ||||||||||
Other
(net of accumulated amortization of $114 and $95,
respectively)
|
77 | 160 | 179 | ||||||||||
Total
- amortizable intangible assets
|
79 | $ | 59,803 | 77,054 |
26
The
Company recorded amortization expense on its intangible assets of $5.3 million
and $6.6 million for the three months ended September 30, 2009 and 2008,
respectively, and $17.3 million and $19.7 million for the nine months ended
September 30, 2009 and 2008, respectively. The Company will continue to amortize
intangible assets over their remaining useful lives. As of September 30, 2009,
the Company estimates it will record amortization expense as
follows:
2009
|
$ | 5,067 | ||
2010
|
15,985 | |||
2011
|
10,031 | |||
2012
|
9,029 | |||
2013
|
6,168 | |||
2014
and thereafter
|
13,523 | |||
$ | 59,803 |
The
following table summarizes the Company’s allocation of goodwill by operating
segment as of September 30, 2009 and December 31, 2008:
Tuition Payment Processing and Campus Commerce | $ | 58,086 | ||
Enrollment Services | 66,613 | |||
Software
and Technical Services
|
8,596 | |||
Asset Generation and Management | 41,883 | |||
$ | 175,178 |
On
February 26, 2009, the President introduced a fiscal year 2010 Federal budget
proposal calling for the elimination of the FFEL Program and a recommendation
that all new student loan originations be funded through the Direct Loan
Program. See note 14 for additional information on legislative developments.
Elimination of the FFEL Program would impact the Company’s operations and
profitability by, among other things, reducing the Company’s interest revenues
as a result of the inability to add new FFELP loans to the Company’s portfolio
and reducing guarantee and third-party FFELP servicing fees as a result of
reduced FFELP loan servicing and origination volume. Additionally, the
elimination of the FFEL Program could reduce education loan software sales and
related consulting fees received from lenders using the Company’s software
products and services and certain other products and services included in the
Company’s Enrollment Services operating segment. The fair value and/or ability
to recover the Company’s goodwill, intangible assets, and other long-lived
assets related to these activities could be adversely affected if the FFEL
Program is eliminated.
9.
Fair Value of Financial Instruments
On
January 1, 2008, the Company expanded disclosures about fair value measurements
on financial assets and liabilities based upon the framework for measuring fair
value defined in authoritative guidance. Effective January 1, 2009, the Company
expanded disclosures about fair value measurements on certain nonfinancial
assets and nonfinancial liabilities, which are recorded at fair value only upon
impairment.
Fair
value 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.
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.
|
27
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 September 30, 2009
|
||||||||||||
Level
1
|
Level
2
|
Total
|
||||||||||
Assets:
|
||||||||||||
Cash
and cash equivalents (a)
|
$ | 334,293 | — | 334,293 | ||||||||
Restricted
cash (a)
|
355,388 | — | 355,388 | |||||||||
Restricted
cash - due to customers (a)
|
50,783 | — | 50,783 | |||||||||
Restricted
investments (a)
|
— | 443,248 | 443,248 | |||||||||
Other
assets (b)
|
4,218 | 5,369 | 9,587 | |||||||||
Fair
value of derivative instruments (c)
|
— | 210,157 | 210,157 | |||||||||
Total
Assets
|
$ | 744,682 | 658,774 | 1,403,456 | ||||||||
Liabilities:
|
||||||||||||
Fair
value of derivative instruments (c)
|
$ | — | 8,998 | 8,998 | ||||||||
Total
Liabilities
|
$ | — | 8,998 | 8,998 | ||||||||
As
of December 31, 2008
|
||||||||||||
Level
1
|
Level
2
|
Total
|
||||||||||
Assets:
|
||||||||||||
Cash
and cash equivalents (a)
|
$ | 189,847 | — | 189,847 | ||||||||
Restricted
cash (a)
|
387,404 | — | 387,404 | |||||||||
Restricted
cash - due to customers (a)
|
160,985 | — | 160,985 | |||||||||
Restricted
investments (a)
|
— | 609,868 | 609,868 | |||||||||
Other
assets (b)
|
4,941 | 3,876 | 8,817 | |||||||||
Fair
value of derivative instruments (c)
|
— | 175,174 | 175,174 | |||||||||
Total
Assets
|
$ | 743,177 | 788,918 | 1,532,095 | ||||||||
Liabilities:
|
||||||||||||
Fair
value of derivative instruments (c)
|
$ | — | 1,815 | 1,815 | ||||||||
Total
Liabilities
|
$ | — | 1,815 | 1,815 |
(a)
|
The
carrying amount for cash and cash equivalents, restricted cash, restricted
cash – due to customers, and restricted investments approximates fair
value due to the variable rate of interest and/or the short maturities of
these instruments.
|
(b)
|
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.
|
(c)
|
All
derivatives are accounted for at fair value on a recurring basis. 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.
|
28
The
following table summarizes the fair values of all of the Company’s financial
instruments on the consolidated balance sheet:
As
of
|
As
of
|
|||||||||||||||
September
30, 2009
|
December
31, 2008
|
|||||||||||||||
Fair
value
|
Carrying
value
|
Fair
value
|
Carrying
value
|
|||||||||||||
Financial
assets:
|
||||||||||||||||
Student
loans receivable
|
$ | 24,121,630 | 23,764,263 | 25,743,732 | 25,413,008 | |||||||||||
Student
loans receivable - held for sale
|
1,654,701 | 1,627,794 | — | — | ||||||||||||
Cash
and cash equivalents
|
334,293 | 334,293 | 189,847 | 189,847 | ||||||||||||
Restricted
cash
|
355,388 | 355,388 | 387,404 | 387,404 | ||||||||||||
Restricted
cash – due to customers
|
50,783 | 50,783 | 160,985 | 160,985 | ||||||||||||
Restricted
investments
|
443,248 | 443,248 | 609,868 | 609,868 | ||||||||||||
Accrued
interest receivable
|
389,238 | 389,238 | 471,878 | 471,878 | ||||||||||||
Other
assets
|
9,587 | 9,587 | 8,817 | 8,817 | ||||||||||||
Derivative
instruments
|
210,157 | 210,157 | 175,174 | 175,174 | ||||||||||||
Financial
liabilities:
|
||||||||||||||||
Bonds
and notes payable
|
26,529,388 | 26,586,093 | 26,512,082 | 26,787,959 | ||||||||||||
Accrued
interest payable
|
24,859 | 24,859 | 81,576 | 81,576 | ||||||||||||
Due
to customers
|
50,783 | 50,783 | 160,985 | 160,985 | ||||||||||||
Derivative
instruments
|
8,998 | 8,998 | 1,815 | 1,815 |
The
methodologies for estimating the fair value of financial assets and liabilities
that are measured at fair value on a recurring basis are discussed above. The
remaining financial assets and liabilities were estimated using the following
methods and assumptions:
Student
Loans Receivable and Student Loans Receivable – Held for Sale
The fair
value of student loans receivable is estimated at amounts recently paid and/or
received or amounts anticipated to be received by the Company to acquire and/or
sell similar loans in the market and/or the characteristics of the
portfolio.
Accrued
Interest Receivable/Payable and Due to Customers
The
carrying amount approximates fair value due to the variable rate of interest
and/or the short maturities of these instruments.
Bonds
and Notes Payable
The fair
value of the bonds and notes payable is based on market prices for securities
that possess similar credit risk and interest rate risk.
Limitations
The fair
value of a financial instrument is the current amount that would be exchanged
between willing parties, other than in a forced liquidation. Fair value is best
determined based upon quoted market prices. However, in many instances, there
are no quoted market prices for the Company’s various financial instruments. In
cases where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those techniques
are significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows. Accordingly, the fair value estimates may
not be realized in an immediate settlement of the instrument.
10.
Shareholders’ Equity
Issuance
of Class A Common Stock
In March
2009, the Company’s 2008 annual performance-based incentives awarded to
management were paid in approximately 455,000 fully vested and unrestricted
shares of Class A common stock issued pursuant to the Company’s Restricted Stock
Plan. It is the Company’s current intention to pay future annual
performance-based incentives to management, if any, in common stock issued
pursuant to the Restricted Stock Plan.
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. On November 5, 2009, the Company's
Board of Directors voted to reinstate the quarterly dividend program.
Accordingly, a dividend of $0.07 per share on the Company's Class A and Class B
Common Stock will be paid on December 15, 2009 to all holders of record as of
December 1, 2009.
29
11.
Earnings per Common Share
Presented
below is a summary of the components used to calculate basic and diluted
earnings per share. On January 1, 2009, the Company began applying the two-class
method of computing earnings per share. The two-class method requires the
calculation of separate earnings per share amounts for the unvested share-based
awards and for common stock. Unvested share-based awards that contain
nonforfeitable rights to dividends are considered securities which participate
in undistributed earnings with common stock. Earnings per share attributable to
common stock is shown in the table below. Prior period earnings per share data
has been retroactively adjusted to conform to the current
presentation.
Three
|
Nine
|
|||||||||||||||
months
ended
|
months
ended
|
|||||||||||||||
September
30,
|
September
30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Net
income (loss) attributable to Nelnet, Inc.
|
$ | 46,404 | 23,785 | 80,062 | (2,335 | ) | ||||||||||
Less
earnings (loss) allocated to unvested restricted
stockholders
|
291 | 168 | 514 | (17 | ) | |||||||||||
Net
income (loss) available to common stockholders
|
$ | 46,113 | 23,617 | 79,548 | (2,318 | ) | ||||||||||
Weighted
average common shares outstanding - basic
|
49,611,423 | 49,176,436 | 49,432,165 | 49,109,340 | ||||||||||||
Dilutive
effect of the assumed vesting of restricted stock awards
|
197,433 | 220,117 | 201,125 | — | ||||||||||||
Weighted
average common shares outstanding - diluted
|
49,808,856 | 49,396,553 | 49,633,290 | 49,109,340 | ||||||||||||
Basic
earnings (loss) per common share
|
$ | 0.93 | 0.48 | 1.60 | (0.05 | ) | ||||||||||
Diluted
earnings (loss) per common share
|
$ | 0.93 | 0.48 | 1.60 | (0.05 | ) |
No
dilutive effect of nonvested restricted stock is presented for the nine months
ended September 30, 2008 as the Company reported a net loss and including these
shares would have been antidilutive for the period. The dilutive effect of these
shares if the Company had net income for the period was not
significant.
12.
Other Income
The
following table summarizes the components of “other income” included in the
consolidated statements of operations.
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Gains
on debt repurchases
|
$ | 5,248 | — | 19,185 | — | |||||||||||
Borrower
late fee income
|
2,859 | 2,748 | 8,648 | 8,907 | ||||||||||||
Gain
on sale of equity method investment (a)
|
— | — | 3,500 | — | ||||||||||||
Other
|
2,987 | 2,660 | 8,150 | 8,880 | ||||||||||||
Other
income
|
$ | 11,094 | 5,408 | 39,483 | 17,787 |
(a)
|
On
September 28, 2007, the Company sold its 50% membership interests in
Premiere Credit of North America, LLC (“Premiere”) for initial proceeds of
$10.0 million. The Company recognized an initial gain on the sale of
Premiere of $3.9 million during the three month period ended September 30,
2007. In January 2009, the Company earned $3.5 million in additional
consideration as a result of the sale of Premiere. This payment
represented contingent consideration that was owed to the Company if
Premiere was awarded a collections contract as defined in the purchase
agreement.
|
13.
Legal Proceedings and Regulatory Reviews
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. In addition, from time
to time the Company receives information and document requests from state or
federal regulators concerning its business practices. The Company cooperates
with these inquiries and responds to the requests. 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 of Education’s guidance regarding those
rules and regulations. 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.
30
United
States ex rel Oberg v. Nelnet, Inc. et al
On
September 28, 2009, the Company was served with a Summons and First Amended
Complaint naming the Company as one of ten defendants in a “qui tam” action
brought by Jon H. Oberg on behalf of the United States of America. Qui tam
actions assert claims by an individual on behalf of the federal government, and
are filed under seal until the government decides, if at all, to intervene in
the case.
An
original complaint in the action was filed under seal in the U.S. District Court
for the Eastern District of Virginia on September 21, 2007, and was unsealed on
August 26, 2009 upon the government’s filing of a Notice of Election to Decline
Intervention in the matter. The First Amended Complaint (the “Oberg Complaint”)
was filed on August 24, 2009 and alleges the defendant student loan lenders
submitted false claims for payment to the Department of Education in order to
obtain special allowance payments on certain student loans at a rate of 9.5%,
which the Oberg Complaint alleges is in excess of amounts permitted by law. The
Oberg Complaint seeks the imposition of civil penalties and treble the amount of
damages sustained by the government in connection with the alleged overbilling
by the defendants for special allowance payments. The Oberg Complaint alleges
that approximately $407 million in unlawful 9.5% special allowance payment
claims were submitted by the Company to the Department of Education.
The 9.5%
special allowance payments received by the Company were disclosed by the Company
on multiple occasions beginning in 2003. In January, 2007, the Company entered
into a settlement agreement with the Department of Education 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 “Settlement Agreement”).
The Settlement Agreement resolved the issues now raised by the Oberg Complaint,
and contains an acknowledgment by the Department of Education that the Company
acted in good faith in connection with its billings for 9.5% special allowance
payments.
United
States ex rel Vigil v. Nelnet, Inc. et al
On November 4, 2009, the
Company was served with a Summons and Third Amended Complaint naming
the Company as one of three defendants in an unrelated qui tam action brought by
Rudy Vigil (the “Vigil Complaint”). This matter was filed under seal in the U.S.
District Court for the District of Nebraska on July 11, 2007 and was unsealed on
October 15, 2009 following the government’s notice that it declined to intervene
in the matter. The Vigil Complaint, filed by a former employee of the Company,
appears to allege that the Company engaged in false advertising and offered
prohibited inducements to student loan borrowers in order to increase the
Company’s loan holdings, and subsequently submitted false claims to the
Department of Education in order to obtain special allowance payments and
default claim payments on such loans.
The
Company believes the allegations in both of the above matters to be frivolous
and without merit and intends to vigorously defend the claims. However,
the Company cannot currently predict the ultimate outcome of this matter or any
liability which may result, which could have a material adverse effect on the
Company's results of operations and financial condition.
Department
of Education Review
The
Department of Education periodically reviews participants in the FFELP for
compliance with program provisions. On June 28, 2007, the Department notified
the Company that it would be conducting a review of the Company’s practices in
connection with the prohibited inducement provisions of the Higher Education Act
and the associated regulations that allow borrowers to have a choice of lenders.
The Company understands that the Department selected several schools and lenders
for review. The Company responded to the Department’s requests for information
and documentation and cooperated with their review. On May 1, 2009, the Company
received the Department’s preliminary program review report, which covered the
Department’s review of the period from October 1, 2002 to September 30, 2007.
The preliminary program review report contained certain initial findings of
noncompliance with the Higher Education Act’s prohibited inducement provisions
and required that the Company provide an explanation for the basis of the
arrangements noted in the preliminary program review report. The Company has
responded and provided an explanation of the arrangements noted in the
Department of Education’s initial findings, and the Department of Education is
expected to issue a final program review determination letter and advise the
Company whether it intends to take any additional action. To the extent any
findings are contained in a final letter, the additional action may include the
assessment of fines or penalties, or the limitation, suspension, and termination
of the Company’s participation in the FFELP.
The
Company believes that it has materially complied with the Higher Education Act’s
prohibited inducement provisions and the rules, regulations, and guidance of the
Department of Education thereunder; however, it cannot predict the ultimate
outcome of the Department of Education’s review.
14.
Recent Developments - Legislation
On
February 26, 2009, the President introduced a fiscal year 2010 Federal budget
proposal calling for the elimination of the FFEL Program and a recommendation
that all new student loan originations be funded through the Federal Direct Loan
Program. On September 17, 2009, the House of Representatives passed H.R. 3221,
the Student Aid and Fiscal Responsibility Act (“SAFRA”), which would eliminate
the FFEL Program and require that, after July 1, 2010, all new federal student
loans be made through the Federal Direct Loan Program. The Senate is expected to
begin its consideration of similar student loan reform legislation sometime in
2009; however, the debate will likely continue into 2010. In addition to the
House-passed legislation, there are several other proposals for changes to the
education financing framework that may be considered that would maintain a role
for private lenders in the origination of federal student loans. These include a
possible extension of ECASLA, which expires on July 1, 2010, and the Student
Loan Community Proposal, a proposal endorsed by a cross-section of FFELP service
providers (including the Company) as an alternative to the 100% federal direct
lending proposal included in SAFRA.
31
Elimination
of the FFEL Program would impact the Company’s operations and profitability by,
among other things, reducing the Company’s interest revenues as a result of the
inability to add new FFELP loans to the Company’s portfolio and reducing
guarantee and third-party FFELP servicing fees as a result of reduced FFELP loan
servicing and origination volume. Additionally, the elimination of the FFEL
Program could reduce education loan software sales and related consulting fees
received from lenders using the Company’s software products and services and
certain other products and services included in the Company’s Enrollment
Services operating segment. The fair value and/or ability to recover the
Company’s goodwill, intangible assets, and other long-lived assets related to
these activities could be adversely affected if the FFEL Program is
eliminated.
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
(Management’s
Discussion and Analysis of Financial Condition and Results of Operations is for
the three and nine months ended September 30, 2009 and 2008. 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, 2008.
Forward-looking
and cautionary statements
This
report contains forward-looking statements and information that are based on
management’s current expectations as of the date of this document. Statements
that are not historical facts, including statements about the Company’s
expectations and statements that assume or are dependent upon future events, are
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 and
the Company’s Annual Report on Form 10-K for the year ended December 31, 2008
and changes in the terms of student loans and the educational credit marketplace
arising from the implementation of, or changes in, applicable laws and
regulations (including changes resulting from new laws, such as any new laws
enacted to implement the Administration’s 2010 budget proposals as they relate
to FFELP), which may reduce the volume, average term, special allowance
payments, and yields on student loans under the FFEL Program of the Department
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. 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; the ability of lenders under the
Company’s credit facilities to fulfill their lending commitments under these
facilities; changes to the terms and conditions of the liquidity programs
offered by the Department; 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; uncertainties inherent in
forecasting future cash flows from student loan assets and related asset-backed
securitizations; the uncertain nature of estimated expenses that may be incurred
and cost savings that may result from restructuring plans; incorrect estimates
or assumptions by management in connection with the preparation of the
consolidated financial statements; and changes in general economic conditions.
Additionally, financial projections may not prove to be accurate and may vary
materially. 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. 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, schools, and financial
institutions 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.
Focused
on long term organic growth, the Company earns its revenues from fee generating
businesses related to its diversified education finance and service operations
and from net interest income on its portfolio of student loans.
32
The
Company has certain business objectives in place for 2009 that
include:
·
|
Grow
and diversify revenue from fee generating
businesses
|
·
|
Manage
operating costs
|
·
|
Maximize
the value of existing portfolio
|
·
|
Eliminate
exposure to liquidity risk and unfunded debt
burden
|
Achieving
these business objectives has impacted the financial condition and operating
results of the Company during the three and nine months ended September 30,
2009. In addition, legislation concerning the student loan industry has impacted
and will continue to impact the financial condition and operating results of the
Company. Each of these items are discussed below.
Grow
and Diversify Revenue from Fee Generating Businesses
In recent
years, the Company has expanded products and services generated from businesses
that are not dependent upon the FFEL Program, thereby reducing legislative and
political risk. Revenues from these businesses are primarily generated from
products and services offered in the Company’s Tuition Payment Processing and
Campus Commerce and Enrollment Services operating segments. As shown below,
revenue earned from businesses less dependent upon the FFEL Program has grown
$5.4 million (17.3%) for the three months ended September 30, 2009 compared to
the same period in 2008, and $17.0 million (19.0%) for the nine months ended
September 30, 2009 compared to the same period in 2008.
Three
months ended September 30,
|
||||||||||||||||
2009
|
2008
|
$
Change
|
%
Change
|
|||||||||||||
Tuition
Payment Processing and Campus Commerce
|
$ | 12,987 | 11,863 | 1,124 | ||||||||||||
Enrollment
Services - Lead Generation
|
23,595 | 19,313 | 4,282 | |||||||||||||
36,582 | 31,176 | $ | 5,406 | 17.3 | % | |||||||||||
Enrollment
Services - Other
|
7,075 | 10,545 | ||||||||||||||
Student
Loan and Guaranty Servicing
|
27,353 | 30,769 | ||||||||||||||
Software
and Technical Services
|
3,634 | 4,217 | ||||||||||||||
Total
revenue from fee generating businesses
|
$ | 74,644 | 76,707 | |||||||||||||
Nine
months ended September 30,
|
||||||||||||||||
2009
|
2008
|
$
Change
|
%
Change
|
|||||||||||||
Tuition
Payment Processing and Campus Commerce
|
$ | 40,373 | 35,980 | 4,393 | ||||||||||||
Enrollment
Services - Lead Generation
|
66,374 | 53,719 | 12,655 | |||||||||||||
106,747 | 89,699 | $ | 17,048 | 19.0 | % | |||||||||||
Enrollment
Services - Other
|
21,814 | 29,466 | ||||||||||||||
Student
Loan and Guaranty Servicing
|
85,190 | 81,624 | ||||||||||||||
Software
and Technical Services
|
13,658 | 15,828 | ||||||||||||||
Total
revenue from fee generating businesses
|
$ | 227,409 | 216,617 |
Department
of Education Servicing Contract
In June
2009, the Department of Education named the Company as one of four private
sector servicers awarded a servicing contract to service all federally-owned
student loans, including FFELP loans purchased by the Department pursuant to
ECASLA. Beginning in August 2010, the contract will also cover the servicing on
new loans originated under the Direct Loan Program. Servicing volume will
initially be allocated by the Department to servicers awarded a contract, and
performance factors such as customer satisfaction levels and default rates will
determine volume allocations over time. The contract spans five years with one,
five-year renewal option. Servicing loans under this contract will further
diversify the Company’s revenue and customer base.
33
The
Company began servicing loans and recognized approximately $30,000 of revenue
under this contract in September 2009. As of September 30, 2009 and October 31,
2009, the Company was servicing approximately $177 million and $2.5 billion,
respectively, of loans under the Department’s servicing contract, which includes
approximately $12 million and $740 million, respectively, of loans not
previously serviced by the Company that were sold by third parties to the
Department as part of the ECASLA Purchase Program.
Manage
Operating Costs
The
Company has continued to focus on managing costs and gaining efficiencies and
continued benefits from prior restructuring activities. As shown below,
excluding the cost to provide enrollment services and restructuring and
impairment charges, operating expenses decreased $16.8 million (19.5%) and $36.7
million (14.3%) for the three and nine months ended September 30, 2009 compared
to the same periods in 2008 and decreased $7.0 million (9.2%) for the three
months ended September 30, 2009 compared to the three month period ended June
30, 2009.
Operating
Expenses
Three
months ended
|
||||||||||||||||
September
30,
2009
|
September
30,
2008
|
$
Change
|
%
Change
|
|||||||||||||
Salaries
and benefits
|
$ | 36,398 | 44,739 | (8,341 | ) | (18.6 | )% | |||||||||
Other
expenses
|
32,601 | 41,026 | (8,425 | ) | (20.5 | ) | ||||||||||
Operating
expenses, excluding the cost
|
||||||||||||||||
to
provide enrollment services and
|
||||||||||||||||
restructure
and impairment expenses
|
68,999 | 85,765 | $ | (16,766 | ) | (19.5 | )% | |||||||||
Cost
to provide enrollment services
|
20,323 | 17,904 | ||||||||||||||
Restructure
expense
|
3,340 | — | ||||||||||||||
Impairment
expense
|
— | — | ||||||||||||||
Total
operating expenses
|
$ | 92,662 | 103,669 | |||||||||||||
Three
months ended
|
||||||||||||||||
September
30,
2009
|
June
30,
2009
|
$
Change
|
%
Change
|
|||||||||||||
Salaries
and benefits
|
$ | 36,398 | 38,699 | (2,301 | ) | (5.9 | )% | |||||||||
Other
expenses
|
32,601 | 37,277 | (4,676 | ) | (12.5 | ) | ||||||||||
Operating
expenses, excluding the cost
|
||||||||||||||||
to
provide enrollment services and
|
||||||||||||||||
restructure
and impairment expenses
|
68,999 | 75,976 | $ | (6,977 | ) | (9.2 | )% | |||||||||
Cost
to provide enrollment services
|
20,323 | 18,092 | ||||||||||||||
Restructure
expense
|
3,340 | 3,288 | ||||||||||||||
Impairment
expense
|
— | — | ||||||||||||||
Total
operating expenses
|
$ | 92,662 | 97,356 | |||||||||||||
Nine
months ended
|
||||||||||||||||
September
30,
2009
|
September
30,
2008
|
$
Change
|
%
Change
|
|||||||||||||
Salaries
and benefits
|
$ | 113,323 | 136,422 | (23,099 | ) | (16.9 | )% | |||||||||
Other
expenses
|
106,430 | 120,003 | (13,573 | ) | (11.3 | ) | ||||||||||
Operating
expenses, excluding the cost
|
||||||||||||||||
to
provide enrollment services and
|
||||||||||||||||
restructure
and impairment expenses
|
219,753 | 256,425 | $ | (36,672 | ) | (14.3 | )% | |||||||||
Cost
to provide enrollment services
|
56,208 | 48,062 | ||||||||||||||
Restructure
expense
|
6,628 | 7,107 | ||||||||||||||
Impairment
expense
|
— | 18,834 | ||||||||||||||
Total
operating expenses
|
$ | 282,589 | 330,428 |
Maximize
the Value of Existing Portfolio
Fixed
rate floor income
The
Company’s core student loan spread (variable student loan spread including fixed
rate floor contribution) for the three and nine months ended September 30, 2009
was 1.27% and 1.10%, respectively, compared to 1.04% and 1.02% for the same
periods in 2008. During the three and nine months ended September 30, 2009, loan
interest income includes $39.3 million (62 basis points of spread contribution)
and $106.6 million (57 basis points), respectively, of fixed rate floor income
compared to $10.0 million (15 basis points) and $29.4 million (15 basis points)
during the same periods in 2008. The increase in fixed rate floor income is due
to lower interest rates in 2009 compared to the same periods in
2008.
34
Loans
originated prior to April 1, 2006 generally earn interest at the higher of a
floating rate based on the Special Allowance Payment or the 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
dependent 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 typically continues to decline. In these
interest rate environments, the Company earns additional spread income that it
refers to as floor income. 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.
If
interest rates remain low, the Company anticipates continuing to earn
significant fixed rate floor income in future periods.
Future
Cash Flow from Portfolio
As of
September 30, 2009, the Company had $19.7 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. Based on cash flow models 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 $1.35 billion as detailed below. These cash flows consist of net
spread and servicing and administrative revenue in excess of estimated cost. The Company expects
the future cash flow would correspond to earnings when excluding the
amortization of loan premiums and deferred origination costs, potential
derivative activity used by the Company to hedge the portfolio, and other
portfolio management and administrative costs. Because the Company does not use
gain-on-sale accounting when issuing asset-backed securitizations, the future
earnings of these transactions are not yet reflected in the Company’s
consolidated financial statements.
![](https://www.sec.gov/Archives/edgar/data/0001258602/000143774909001618/nelnet_10q-09300975.gif)
Eliminate
Exposure to Liquidity Risk and Unfunded Debt Burden
Reducing
Liquidity Risk
The
Company had a FFELP warehouse facility that was due to expire in May 2010 that
provided for formula-based advance rates based on current market conditions,
which required equity support to be posted to the facility under certain
circumstances. As of December 31, 2008, the Company had $1.6 billion of student
loans in this facility, $1.4 billion borrowed under the facility, and $280.6
million in cash posted as equity funding support for the facility. During 2009,
the Company has reduced its liquidity exposure under this facility as a result
of the following transactions:
·
|
In
March 2009, the Company completed a $294.6 million asset-backed
securitization and refinanced loans previously financed in the
facility
|
35
·
|
In
June 2009, the Company accessed the Department’s Conduit Program and
refinanced loans previously financed in the
facility
|
·
|
In
August 2009, the Company entered into a new $500.0 million FFELP warehouse
facility that expires in August 2012. In August 2009, the Company utilized
the new warehouse facility to refinance all remaining loans in the old
warehouse facility. Refinancing these loans allowed the Company to
terminate the prior facility and withdraw all remaining equity funding
support.
|
In
October 2009, the Company completed an asset-backed securities transaction of
$434.0 million. The Company used the proceeds from the sale of these notes to
purchase student loans that were previously financed in the new FFELP warehouse
facility and certain other existing asset-backed securitizations. As of November
6, 2009, $179.1 million was outstanding under the new FFELP warehouse and $320.9
million was available for future use.
Debt
Repurchases
During
2009, the Company repurchased outstanding debt as summarized below. Any gains
(losses) recorded by the Company from the repurchase of debt are included in
“other income” on the Company’s consolidated statements of
operations.
5.125%
Senior Notes due 2010
|
Junior
Subordinated Hybrid Securities
|
Asset-backed
securities
|
||||||||||||||||||||||||||
Notional
|
Purchase
|
Gain
|
Notional
|
Purchase
|
Gain
|
Notional
|
Purchase
|
Gain
|
||||||||||||||||||||
amount
|
price
|
(loss)
|
amount
|
price
|
(loss)
|
amount
|
price
|
(loss)
|
||||||||||||||||||||
Three
months ended:
|
||||||||||||||||||||||||||||
March
31, 2009
|
$ | 34,866 | 26,791 | 8,075 | — | — | — | — | — | — | ||||||||||||||||||
June
30, 2009
|
35,520 | 31,080 | 4,440 | 1,750 | 350 | 1,400 | 1,100 | 1,078 | 22 | |||||||||||||||||||
September
30, 2009
|
137,898 | 138,505 | (607 | ) | — | — | — | 44,950 | 39,095 | 5,855 | ||||||||||||||||||
Nine
months ended September 30, 2009
|
208,284 | 196,376 | 11,908 | 1,750 | 350 | 1,400 | 46,050 | 40,173 | 5,877 | |||||||||||||||||||
Subsequent
to September 30, 2009
|
||||||||||||||||||||||||||||
through
November 9, 2009
|
— | — | — | — | — | — | 140,200 | 126,159 | 14,041 | |||||||||||||||||||
Total
debt repurchased
|
$ | 208,284 | 196,376 | 11,908 | 1,750 | 350 | 1,400 | 186,250 | 166,332 | 19,918 | ||||||||||||||||||
Balance
as of September 30, 2009
|
$ | 66,716 | $ | 198,250 |
Legislation
ECASLA
In August
2008, the Department implemented the Loan Purchase Commitment Program and the
Loan Purchase Participation Program pursuant to ECASLA. During the three months
ended September 30, 2009, the Company sold $427.7 million of student loans to
the Department under the Purchase Program, resulting in a gain of $9.7 million.
As of September 30, 2009, the Company had $1.9 billion of FFELP loans funded
using the Participation Program, of which $1.6 billion are 2008-2009 academic
year loans and are classified as held for sale on the Company’s consolidated
balance sheet. These loans were sold to the Department under its Purchase
Program in October 2009. Upon selling the $1.6 billion of loans held for sale,
the Company recognized a gain of $26.9 million in October 2009. The Company
plans to continue to use the Participation Program to fund certain loans
originated for the 2009-2010 academic year. Gains recorded by the Company
related to loans sold to the Department under the Purchase Program will vary, as
with all loan sales, dependent upon the cost of acquisition and/or origination
and the amortization of such costs.
Recent
Developments
On
February 26, 2009, the President introduced a fiscal year 2010 Federal budget
proposal calling for the elimination of the FFEL Program and a recommendation
that all new student loan originations be funded through the Federal Direct Loan
Program. On September 17, 2009, the House of Representatives passed H.R. 3221,
the Student Aid and Fiscal Responsibility Act, which would eliminate the FFEL
Program and require that, after July 1, 2010, all new federal student loans be
made through the Federal Direct Loan Program. The Senate is expected to begin
its consideration of similar student loan reform legislation sometime in 2009;
however, the debate will likely continue into 2010. In addition to the
House-passed legislation, there are several other proposals for changes to the
education financing framework that may be considered that would maintain a role
for private lenders in the origination of federal student loans. These include a
possible extension of ECASLA, which expires on July 1, 2010, and the Student
Loan Community Proposal, a proposal endorsed by a cross-section of FFELP service
providers (including the Company) as an alternative to the 100% federal direct
lending proposal included in SAFRA.
Elimination
of the FFEL Program would impact the Company’s operations and profitability by,
among other things, reducing the Company’s interest revenues as a result of the
inability to add new FFELP loans to the Company’s portfolio and reducing
guarantee and third-party FFELP servicing fees as a result of reduced FFELP loan
servicing and origination volume. Additionally, the elimination of the FFEL
Program could reduce education loan software sales and related consulting fees
received from lenders using the Company’s software products and services and
certain other products and services included in the Company’s Enrollment
Services operating segment. The fair value and/or ability to recover the
Company’s goodwill, intangible assets, and other long-lived assets related to
these activities could be adversely affected if the FFEL Program is eliminated.
However, as discussed previously, in recent years, the Company has expanded
products and services generated from businesses that are not dependent upon the
FFEL Program, thereby reducing legislative and political risk.
36
In June
2009, the Department of Education named the Company as one of four private
sector companies awarded a servicing contract to service student loans.
Beginning in August 2010, the contract will cover the servicing on new loans
originated under the Direct Loan Program. If legislation is passed that all new
student loan originations be funded through the Direct Loan Program, servicing
loans under this contract will partially offset the loss of revenue if the FFEL
Program is eliminated.
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 1.05% per year consolidation loan rebate fee paid to the
Department, and yield adjustments from borrower benefit programs, are netted
against loan interest income on the 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
or SAP formula set by the Department of Education and the borrower rate. The SAP
formula is based on an applicable index plus a fixed spread that is dependent
upon when the loan was originated, the 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.
In
September 2007, the College Cost Reduction and Access Act of 2007 (the “College
Cost Reduction Act”) was enacted into law. This legislation reduced the annual
yield on FFELP loans originated after October 1, 2007 and should be considered
when reviewing the Company’s results of operations. The Company has mitigated
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 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 collection 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.
37
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.
The federal government currently guarantees 97% of the principal of and the
interest on federally insured student loans disbursed on and after July 1, 2006
(and 98% for those loans disbursed prior to July 1, 2006), which limits the
Company’s loss exposure on the outstanding balance of the Company’s federally
insured portfolio. Also, in accordance with the Student Loan Reform Act of 1993,
student loans disbursed prior to October 1, 1993 are fully insured.
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 when the collection of principal and interest is 30 days past
due 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 revenue from other sources, including loan
and guaranty servicing, payment management activities, enrollment services, and
fees from providing software and technical services.
Student Loan and Guaranty Servicing
Revenue – Loan servicing fees are determined according to individual
agreements with customers and are calculated based on the dollar value of loans,
number of loans, or number of borrowers serviced for each customer. Guaranty
servicing fees, generally, are calculated based on the number of loans serviced,
volume of loans serviced, or amounts collected. Revenue is recognized when
earned pursuant to applicable agreements, and when ultimate collection is
assured.
Tuition Payment Processing and
Campus Commerce Revenue – Tuition payment processing and campus commerce
revenue includes actively managed tuition payment solutions, online payment
processing, detailed information reporting, and data integration services. Fees
for these payment management services are recognized over the period in which
services are provided to customers.
Enrollment Services Revenue –
Enrollment services revenue includes the sale of lists and print products,
subscription-based products and services, and multiple deliverable arrangements.
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. Revenue
from multiple deliverable arrangements is recognized separately for separate
units of accounting based on the units’ relative fair value.
Software Services Revenue –
Software services revenue 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, the cost to provide enrollment
services, costs incurred to provide tuition payment processing, campus commerce,
content management, recruitment, software and technical services to third
parties, the depreciation and amortization of capital assets and intangible
assets, investments in products, services, and technology to meet customer needs
and support continued revenue growth, and other general and administrative
expenses. The cost to provide enrollment services consists of costs incurred to
provide lead generation and publishing and editing services in the Company’s
Enrollment Services operating segment. Operating expenses also includes employee
termination benefits, lease termination costs, and the write-down of certain
assets related to the Company’s restructuring initiatives.
38
Three
and nine months ended September 30, 2009 compared to the three and nine months
ended September 30, 2008
Net
Interest Income (Net of settlements on derivatives)
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||||||||||||
Change
|
Change
|
|||||||||||||||||||||||||||||||
2009
|
2008
|
$ | % |
2009
|
2008
|
$
|
% | |||||||||||||||||||||||||
Interest
income:
|
||||||||||||||||||||||||||||||||
Loan
interest
|
$ | 143,255 | 284,468 | (141,213 | ) | (49.6 | )% | $ | 474,587 | 911,140 | (436,553 | ) | (47.9 | )% | ||||||||||||||||||
Investment
interest
|
1,943 | 9,118 | (7,175 | ) | (78.7 | ) | 8,810 | 29,914 | (21,104 | ) | (70.5 | ) | ||||||||||||||||||||
Total
interest income
|
145,198 | 293,586 | (148,388 | ) | (50.5 | ) | 483,397 | 941,054 | (457,657 | ) | (48.6 | ) | ||||||||||||||||||||
Interest
expense:
|
||||||||||||||||||||||||||||||||
Interest
on bonds and notes payable
|
76,016 | 234,016 | (158,000 | ) | (67.5 | ) | 328,600 | 791,621 | (463,021 | ) | (58.5 | ) | ||||||||||||||||||||
Net
interest income
|
69,182 | 59,570 | 9,612 | 16.1 | 154,797 | 149,433 | 5,364 | 3.6 | ||||||||||||||||||||||||
Provision
for loan losses
|
7,500 | 7,000 | 500 | 7.1 | 23,000 | 18,000 | 5,000 | 27.8 | ||||||||||||||||||||||||
Net
interest income after
|
||||||||||||||||||||||||||||||||
provision
for loan losses
|
61,682 | 52,570 | 9,112 | 17.3 | 131,797 | 131,433 | 364 | 0.3 | ||||||||||||||||||||||||
Derivative
settlements, net (a)
|
4,914 | 789 | 4,125 | 522.8 | 38,807 | 45,989 | (7,182 | ) | (15.6 | ) | ||||||||||||||||||||||
Net
interest income after
|
||||||||||||||||||||||||||||||||
provision
for loan losses (net
|
||||||||||||||||||||||||||||||||
of
settlements on derivatives)
|
$ | 66,596 | 53,359 | 13,237 | 24.8 | % | $ | 170,604 | 177,422 | (6,818 | ) | (3.8 | )% |
(a)
|
The
Company maintains an overall risk management strategy that incorporates
the use of derivative instruments to reduce the economic effect of
interest rate volatility. Management has structured all of the Company’s
derivative transactions with the intent that each is economically
effective; however, the Company’s derivative instruments do not qualify
for hedge accounting. Derivative settlements for each applicable period
should be evaluated with the Company’s net interest income, as discussed
below.
|
Net
interest income after provision for loan losses, net of settlements on
derivatives, changed for the three and nine months ended September 30, 2009
compared to same periods in 2008 as follows:
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||||||||||||
Change
|
Change
|
|||||||||||||||||||||||||||||||
2009
|
2008
|
$ | % |
2009
|
2008
|
$ | % | |||||||||||||||||||||||||
Student
loan interest margin, net
|
||||||||||||||||||||||||||||||||
of
settlements on derivatives (a)
|
$ | 39,749 | 54,955 | (15,206 | ) | (27.7 | )% | $ | 101,685 | 170,638 | (68,953 | ) | (40.4 | )% | ||||||||||||||||||
Fixed
rate floor income, net of
|
||||||||||||||||||||||||||||||||
settlements
on derivatives (b)
|
38,848 | 6,778 | 32,070 | 473.1 | 106,187 | 25,188 | 80,999 | 321.6 | ||||||||||||||||||||||||
Investment
interest (c)
|
1,943 | 9,118 | (7,175 | ) | (78.7 | ) | 8,810 | 29,914 | (21,104 | ) | (70.5 | ) | ||||||||||||||||||||
Corporate
debt interest expense (d)
|
(6,444 | ) | (10,492 | ) | 4,048 | (38.6 | ) | (23,078 | ) | (30,318 | ) | 7,240 | (23.9 | ) | ||||||||||||||||||
Provision
for loan losses (e)
|
(7,500 | ) | (7,000 | ) | (500 | ) | 7.1 | (23,000 | ) | (18,000 | ) | (5,000 | ) | 27.8 | ||||||||||||||||||
Net
interest income after
|
||||||||||||||||||||||||||||||||
provision
for loan losses (net of
|
||||||||||||||||||||||||||||||||
settlements
on derivatives)
|
$ | 66,596 | 53,359 | 13,237 | 24.8 | % | $ | 170,604 | 177,422 | (6,818 | ) | (3.8 | )% |
(a)
|
Student
loan interest margin decreased for the three and nine months ended
September 30, 2009 compared to the same periods in 2008 as a result of a
decrease in the Company’s variable student loan spread as discussed in
this Item 2 under “Asset Generation and Management Operating Segment –
Results of Operations – Student Loan Spread Analysis.” For the three
months ended September 30, 2009 and 2008, variable student loan spread was
0.66% and 0.94%, respectively. For the nine months ended September 30,
2009 and 2008, variable student loan spread was 0.54% and 0.89%,
respectively.
|
(b)
|
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. Due to lower interest rates in the
three and nine months ended September 30, 2009 compared to the same
periods in 2008, the Company received additional fixed rate floor income
on a portion of its student loan portfolio. See Item 3, “Quantitative and
Qualitative Disclosures about Market Risk – Interest Rate Risk” for
additional information.
|
(c)
|
Investment
interest decreased for the three and nine months ended September 30, 2009
compared to the same period in 2008 due to lower interest rates in
2009.
|
39
(d)
|
Corporate
debt interest expense decreased for the three and nine months ended
September 30, 2009 compared to the same periods in 2008 as a result of a
decrease in interest rates, as well as a reduction in debt outstanding due
to the purchase of unsecured fixed rate debt. The weighted average
interest rate and notes outstanding on the Company’s unsecured line of
credit was 0.77% and $691.5 million, respectively, as of September 30,
2009 compared to 3.44% and $645.0 million, respectively, as of September
30, 2008. During the first, second, and third quarters of 2009, the
Company purchased $34.9 million, $35.5 million, and $137.9 million,
respectively, of its 5.125% Senior Notes due
2010.
|
(e)
|
The
provision for loan losses increased for the three and nine months ended
September 30, 2009 compared to 2008 primarily due to increases in
delinquencies.
|
Other
Income
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||||||
Change
|
Change
|
|||||||||||||||||||||||||
2009
|
2008
|
$ | % |
2009
|
2008
|
$ | % | |||||||||||||||||||
Loan
and guaranty servicing revenue (a)
|
$ | 26,006 | 29,691 | (3,685 | ) | (12.4 | )% | $ | 81,280 | 78,173 | 3,107 | 4.0 | % | |||||||||||||
Tuition
payment processing and campus commerce revenue (b)
|
12,987 | 11,863 | 1,124 | 9.5 | 40,373 | 35,980 | 4,393 | 12.2 | ||||||||||||||||||
Enrollment
services revenue (c)
|
30,670 | 29,858 | 812 | 2.7 | 88,188 | 83,148 | 5,040 | 6.1 | ||||||||||||||||||
Software
services revenue (d)
|
4,600 | 5,159 | (559 | ) | (10.8 | ) | 16,424 | 19,342 | (2,918 | ) | (15.1 | ) | ||||||||||||||
Other
income (e)
|
11,094 | 5,408 | 5,686 | 105.1 | 39,483 | 17,787 | 21,696 | 122.0 | ||||||||||||||||||
Gain
(loss) on sale of loans, net (f)
|
8,788 | — | 8,788 | 100.0 | 8,386 | (47,426 | ) | 55,812 | (117.7 | ) | ||||||||||||||||
Derivative
market value, foreign currency,
|
||||||||||||||||||||||||||
and
put option adjustments (g)
|
2,826 | 6,085 | (3,259 | ) | (53.6 | ) | (36,067 | ) | (35,521 | ) | (546 | ) | 1.5 | |||||||||||||
Derivative
settlements, net (h)
|
4,914 | 789 | 4,125 | 522.8 | 38,807 | 45,989 | (7,182 | ) | (15.6 | ) | ||||||||||||||||
Total
other income
|
$ | 101,885 | 88,853 | 13,032 | 14.7 | % | $ | 276,874 | 197,472 | 79,402 | 40.2 | % |
(a)
|
“Loan
and guaranty servicing revenue” increased for the nine months ended
September 30, 2009 compared to the same period in 2008 due to an increase
in FFELP loan servicing revenue. This increase was offset by a decrease in
rehabilitation collections on defaulted loan assets. “Loan and guaranty
servicing revenue” decreased for the three months ended September 30, 2009
compared to the same period in 2008 due to a decrease in rehabilitation
collections on defaulted loan assets. This decrease was offset by an
increase in FFELP loan servicing revenue. See Item 2 under “Student Loan
and Guaranty Servicing Operating Segment – Results of Operations” for
additional information.
|
(b)
|
“Tuition
payment processing and campus commerce revenue” increased due to an
increase in the number of managed tuition payment plans and an increase in
campus commerce transactions processed as discussed in this Item 2 under
“Tuition Payment Processing and Campus Commerce Operating Segment –
Results of Operations.”
|
(c)
|
“Enrollment
services revenue” increased due to an increase in the number of lead
generation transactions processed offset by a reduction in other
enrollment products and services offered as further discussed in this Item
2 under “Enrollment Services Operating Segment – Results of
Operations.”
|
(d)
|
“Software
and technical services revenue” decreased in 2009 compared to the same
periods in 2008 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 as further
discussed in this Item 2 under “Software and Technical Services Operating
Segment – Results of Operations.”
|
(e)
|
The
following table summarizes the components of “other
income”.
|
Three
months ended
September
30,
|
Nine
months ended
September
30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Gains
on debt repurchases
|
$ | 5,248 | — | 19,185 | — | |||||||||||
Borrower
late fee income
|
2,859 | 2,748 | 8,648 | 8,907 | ||||||||||||
Gain
on sale of equity method investment
|
— | — | 3,500 | — | ||||||||||||
Other
|
2,987 | 2,660 | 8,150 | 8,880 | ||||||||||||
Other
income
|
$ | 11,094 | 5,408 | 39,483 | 17,787 |
The
change in other income over all the periods presented is primarily the
result of gains on debt repurchases. In addition, during the first quarter
of 2009, the Company earned $3.5 million in additional consideration from
the sale of an equity method
investment.
|
40
(f)
|
“Gain
(loss) on sale of loans” includes a gain of $9.7 million related to the
sale of $427.7 million of student loans to the Department under the
Purchase Program during the three months ended September 30, 2009. In
addition, 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.”
|
(g)
|
The
change in “derivative market value, foreign currency, and put option
adjustments” was caused by the 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.”
|
(h)
|
Further
detail of the components of derivative settlements is included in Item 3,
“Quantitative and Qualitative Disclosures about Market Risk.” The Company
maintains an overall risk management strategy that incorporates the use of
derivative instruments to reduce the economic effect of interest rate
volatility. Management has structured all of the Company’s derivative
transactions with the intent that each is economically effective; however,
the Company’s derivative instruments do not qualify for hedge accounting.
Derivative settlements for each applicable period should be evaluated with
the Company’s net interest income, as discussed
previously.
|
Operating
Expenses
Three
months ended September 30,
|
Nine
months ended September 30,
|
||||||||||||||||||||||||
2009
|
2008
|
$
Change
|
%
Change
|
2009
|
2008
|
$
Change
|
%
Change
|
||||||||||||||||||
Salaries
and benefits
|
$ | 36,398 | 44,739 | (8,341 | ) | (18.6 | ) % | $ | 113,323 | 136,422 | (23,099 | ) | (16.9 | ) % | |||||||||||
Other
expenses
|
32,601 | 41,026 | (8,425 | ) | (20.5 | ) | 106,430 | 120,003 | (13,573 | ) | (11.3 | ) | |||||||||||||
Operating
expenses, excluding the cost
|
|||||||||||||||||||||||||
to
provide enrollment services and
|
|||||||||||||||||||||||||
restructure
and impairment expenses
|
68,999 | 85,765 | $ | (16,766 | ) | (19.5 | ) % | 219,753 | 256,425 | $ | (36,672 | ) | (14.3 | ) % | |||||||||||
Cost
to provide enrollment services
|
20,323 | 17,904 | 56,208 | 48,062 | |||||||||||||||||||||
Restructure
expense
|
3,340 | — | 6,628 | 7,107 | |||||||||||||||||||||
Impairment
expense
|
— | — | — | 18,834 | |||||||||||||||||||||
Total
operating expenses
|
$ | 92,662 | 103,669 | $ | 282,589 | 330,428 | |||||||||||||||||||
Excluding
the cost to provide enrollment services and restructuring and impairment
charges, operating expenses decreased $16.8 million (19.5%) and $36.7 million
(14.3%) for the three and nine months ended September 30, 2009 compared to the
same periods in 2008. These decreases were the result of continued focus by the
Company on managing costs and gaining efficiencies and continued benefits from
prior restructuring activities.
Income
Taxes
The
Company’s effective tax rate was 34.5% and 36.5% for the three and nine months
ended September 30, 2009. The Company’s effective tax rate for the year ended
December 31, 2008 was 40%. The effective tax rate during 2009 has decreased as
compared to 2008 due to various state tax law changes, expenses incurred in 2008
that were not deductible for tax purposes, and a net decrease in the Company’s
gross unrecognized tax benefits liability.
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”.
41
Financial
Condition as of September 30, 2009 compared to December 31,
2008
As
of
|
As
of
|
|||||||||||||||
September
30,
|
December
31,
|
Change
|
||||||||||||||
2009
|
2008
|
Dollars
|
Percent
|
|||||||||||||
Assets:
|
||||||||||||||||
Student
loans receivable, net
|
$ | 23,764,263 | 25,413,008 | (1,648,745 | ) | (6.5 | ) % | |||||||||
Student
loans receivable - held for sale
|
1,627,794 | — | 1,627,794 | 100.0 | ||||||||||||
Cash,
cash equivalents, and investments
|
1,183,712 | 1,348,104 | (164,392 | ) | (12.2 | ) | ||||||||||
Goodwill
|
175,178 | 175,178 | — | — | ||||||||||||
Intangible
assets, net
|
59,803 | 77,054 | (17,251 | ) | (22.4 | ) | ||||||||||
Fair
value of derivative instruments
|
210,157 | 175,174 | 34,983 | 20.0 | ||||||||||||
Other
assets
|
570,955 | 666,379 | (95,424 | ) | (14.3 | ) | ||||||||||
Total
assets
|
$ | 27,591,862 | 27,854,897 | (263,035 | ) | (0.9 | ) % | |||||||||
Liabilities:
|
||||||||||||||||
Bonds
and notes payable
|
$ | 26,586,093 | 26,787,959 | (201,866 | ) | (0.8 | ) % | |||||||||
Fair
value of derivative instruments
|
8,998 | 1,815 | 7,183 | 395.8 | ||||||||||||
Other
liabilities
|
268,697 | 421,897 | (153,200 | ) | (36.3 | ) | ||||||||||
Total
liabilities
|
26,863,788 | 27,211,671 | (347,883 | ) | (1.3 | ) | ||||||||||
Shareholders'
equity
|
728,074 | 643,226 | 84,848 | 13.2 | ||||||||||||
Total
liabilities and shareholders' equity
|
$ | 27,591,862 | 27,854,897 | (263,035 | ) | (0.9 | ) % |
Total
assets and total liabilities decreased during 2009 primarily due to decreases in
restricted cash and investments and bonds and notes payable, respectively, as a
result of payments on debt and debt repurchases.
OPERATING
SEGMENTS
The
Company has five operating segments as follows: Student Loan and Guaranty
Servicing, Tuition Payment Processing and Campus Commerce, Enrollment Services,
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, 2008. 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.
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 look for ways to diversify its sources of revenue, including those generated
from businesses that are not dependent upon government programs, reducing
legislative and political risk.
“Base net
income” is the primary financial performance measure used by management to
develop the 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.
42
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 September 30, 2009
|
||||||||||||||||||||||||||||||
Fee-Based
|
||||||||||||||||||||||||||||||
Student
|
Tuition
|
"Base
net
|
||||||||||||||||||||||||||||
Loan
|
Payment
|
Software
|
Asset
|
Corporate
|
income"
|
|||||||||||||||||||||||||
and
|
Processing
|
and
|
Total
|
Generation
|
Activity
|
Eliminations
|
Adjustments
|
GAAP
|
||||||||||||||||||||||
Guaranty
|
and
Campus
|
Enrollment
|
Technical
|
Fee-
|
and
|
and
|
and
|
to
GAAP
|
Results
of
|
|||||||||||||||||||||
Servicing
|
Commerce
|
Services
|
Services
|
Based
|
Management
|
Overhead
|
Reclassifications
|
Results
|
Operations
|
|||||||||||||||||||||
Total
interest income
|
$ | 23 | 16 | — | — | 39 | 144,310 | 1,191 | (342 | ) | — | 145,198 | ||||||||||||||||||
Interest
expense
|
— | — | — | — | — | 69,914 | 6,444 | (342 | ) | — | 76,016 | |||||||||||||||||||
Net
interest income (loss)
|
23 | 16 | — | — | 39 | 74,396 | (5,253 | ) | — | — | 69,182 | |||||||||||||||||||
Less
provision for loan losses
|
— | — | — | — | — | 7,500 | — | — | — | 7,500 | ||||||||||||||||||||
Net
interest income (loss) after provision for loan losses
|
23 | 16 | — | — | 39 | 66,896 | (5,253 | ) | — | — | 61,682 | |||||||||||||||||||
Other
income (expense):
|
||||||||||||||||||||||||||||||
Loan
and guaranty servicing revenue
|
26,387 | — | — | — | 26,387 | — | (381 | ) | — | — | 26,006 | |||||||||||||||||||
Tuition
payment processing and campus commerce revenue
|
— | 12,987 | — | — | 12,987 | — | — | — | — | 12,987 | ||||||||||||||||||||
Enrollment
services revenue
|
— | — | 30,670 | — | 30,670 | — | — | — | — | 30,670 | ||||||||||||||||||||
Software
services revenue
|
966 | — | — | 3,634 | 4,600 | — | — | — | — | 4,600 | ||||||||||||||||||||
Other
income
|
137 | — | — | — | 137 | 9,959 | 998 | — | — | 11,094 | ||||||||||||||||||||
Gain
(loss) on sale of loans, net
|
— | — | — | — | — | 8,788 | — | — | — | 8,788 | ||||||||||||||||||||
Intersegment
revenue
|
21,525 | 62 | 139 | 3,793 | 25,519 | — | 8,355 | (33,874 | ) | — | — | |||||||||||||||||||
Derivative
market value, foreign currency, and put option adjustments
|
— | — | — | — | — | — | — | — | 2,826 | 2,826 | ||||||||||||||||||||
Derivative
settlements, net
|
— | — | — | — | — | 4,914 | — | — | — | 4,914 | ||||||||||||||||||||
Total
other income (expense)
|
49,015 | 13,049 | 30,809 | 7,427 | 100,300 | 23,661 | 8,972 | (33,874 | ) | 2,826 | 101,885 | |||||||||||||||||||
Operating
expenses:
|
||||||||||||||||||||||||||||||
Salaries
and benefits
|
12,468 | 6,399 | 5,337 | 5,756 | 29,960 | 1,693 | 5,919 | 238 | — | 37,810 | ||||||||||||||||||||
Restructure
expense- severance and contract terminination costs
|
2,646 | — | — | 292 | 2,938 | — | 402 | (3,340 | ) | — | — | |||||||||||||||||||
Impairment
expense
|
— | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Cost
to provide enrollment services
|
— | — | 20,323 | — | 20,323 | — | — | — | — | 20,323 | ||||||||||||||||||||
Other
expenses
|
7,613 | 2,265 | 3,266 | 776 | 13,920 | 4,801 | 8,567 | 1,929 | 5,312 | 34,529 | ||||||||||||||||||||
Intersegment
expenses
|
9,398 | 670 | 550 | 786 | 11,404 | 20,764 | 533 | (32,701 | ) | — | — | |||||||||||||||||||
Total
operating expenses
|
32,125 | 9,334 | 29,476 | 7,610 | 78,545 | 27,258 | 15,421 | (33,874 | ) | 5,312 | 92,662 | |||||||||||||||||||
Income
(loss) before income taxes
|
16,913 | 3,731 | 1,333 | (183 | ) | 21,794 | 63,299 | (11,702 | ) | — | (2,486 | ) | 70,905 | |||||||||||||||||
Income
tax (expense) benefit (a)
|
(6,427 | ) | (1,418 | ) | (507 | ) | 70 | (8,282 | ) | (24,054 | ) | 6,976 | — | 859 | (24,501 | ) | ||||||||||||||
Net
income (loss) from continuing operations
|
10,486 | 2,313 | 826 | (113 | ) | 13,512 | 39,245 | (4,726 | ) | — | (1,627 | ) | 46,404 | |||||||||||||||||
Income
from discontinued operations, net of tax
|
— | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Net
income (loss)
|
$ | 10,486 | 2,313 | 826 | (113 | ) | 13,512 | 39,245 | (4,726 | ) | — | (1,627 | ) | 46,404 |
(a) Income
taxes are applied based on 38% of income (loss) before income taxes for the
individual operating segments.
Three
months ended September 30, 2009:
|
||||||||||||||||||||||||
Before
Tax Operating Margin
|
34.5 | % | 28.6 | % | 4.3 | % | (2.5 | %) | 21.7 | % | 69.9 | % | ||||||||||||
Before
Tax Operating Margin -
|
||||||||||||||||||||||||
excluding
net interest income for
|
||||||||||||||||||||||||
fee
generating businesses and
|
||||||||||||||||||||||||
restructure
expense
|
39.9 | % | 28.5 | % | 4.3 | % | 1.5 | % | 24.6 | % | 69.9 | % | ||||||||||||
Three
months ended September 30, 2008:
|
||||||||||||||||||||||||
Before
Tax Operating Margin
|
26.3 | % | 29.7 | % | 7.1 | % | 5.9 | % | 19.7 | % | 59.8 | % | ||||||||||||
Before
Tax Operating Margin -
|
||||||||||||||||||||||||
excluding
net interest income for
|
||||||||||||||||||||||||
fee
generating businesses
|
25.9 | % | 27.4 | % | 7.1 | % | 5.9 | % | 19.1 | % | 59.8 | % |
43
Three
months ended September 30, 2008
|
|||||||||||||||||||||||||||||||
Fee-Based
|
|||||||||||||||||||||||||||||||
Tuition
|
|||||||||||||||||||||||||||||||
Student
|
Payment
|
"Base
net
|
|||||||||||||||||||||||||||||
Loan
|
Processing
|
Software
|
Asset
|
Corporate
|
income"
|
||||||||||||||||||||||||||
and
|
and
|
and
|
Total
|
Generation
|
Activity
|
Eliminations
|
Adjustments
|
GAAP
|
|||||||||||||||||||||||
Guaranty
|
Campus
|
Enrollment
|
Technical
|
Fee-
|
and
|
and
|
and
|
to
GAAP
|
Results
of
|
||||||||||||||||||||||
Servicing
|
Commerce
|
Services
|
Services
|
Based
|
Management
|
Overhead
|
Reclassifications
|
Results
|
Operations
|
||||||||||||||||||||||
Total
interest income
|
$ | 304 | 396 | 6 | — | 706 | 290,039 | 2,010 | (749 | ) | 1,580 | 293,586 | |||||||||||||||||||
Interest
expense
|
— | — | 1 | — | 1 | 224,272 | 10,492 | (749 | ) | — | 234,016 | ||||||||||||||||||||
Net
interest income (loss)
|
304 | 396 | 5 | — | 705 | 65,767 | (8,482 | ) | — | 1,580 | 59,570 | ||||||||||||||||||||
Less
provision for loan losses
|
— | — | — | — | — | 7,000 | — | — | — | 7,000 | |||||||||||||||||||||
Net
interest income (loss) after provision
|
|||||||||||||||||||||||||||||||
for
loan losses
|
304 | 396 | 5 | — | 705 | 58,767 | (8,482 | ) | — | 1,580 | 52,570 | ||||||||||||||||||||
Other
income (expense):
|
|||||||||||||||||||||||||||||||
Loan
and guaranty servicing revenue
|
29,827 | — | — | — | 29,827 | (136 | ) | — | — | — | 29,691 | ||||||||||||||||||||
Tuition
payment processing and campus commerce revenue
|
— | 11,863 | — | — | 11,863 | — | — | — | — | 11,863 | |||||||||||||||||||||
Enrollment
services revenue
|
— | — | 29,858 | — | 29,858 | — | — | — | — | 29,858 | |||||||||||||||||||||
Software
services revenue
|
942 | — | — | 4,217 | 5,159 | — | — | — | — | 5,159 | |||||||||||||||||||||
Other
income
|
6 | — | — | — | 6 | 4,079 | 1,323 | — | — | 5,408 | |||||||||||||||||||||
Intercompany
revenue
|
18,402 | 58 | 2 | 1,660 | 20,122 | — | 15,671 | (35,793 | ) | — | — | ||||||||||||||||||||
Derivative
market value, foreign currency,
|
|||||||||||||||||||||||||||||||
and
put option adjustments
|
— | — | — | — | — | — | — | — | 6,085 | 6,085 | |||||||||||||||||||||
Derivative
settlements, net
|
— | — | — | — | — | 789 | — | — | — | 789 | |||||||||||||||||||||
Total
other income (expense)
|
49,177 | 11,921 | 29,860 | 5,877 | 96,835 | 4,732 | 16,994 | (35,793 | ) | 6,085 | 88,853 | ||||||||||||||||||||
Operating
expenses:
|
|||||||||||||||||||||||||||||||
Salaries
and benefits
|
13,876 | 6,236 | 5,805 | 4,138 | 30,055 | 1,980 | 14,179 | (1,952 | ) | 477 | 44,739 | ||||||||||||||||||||
Restructure
expense- severance and
|
|||||||||||||||||||||||||||||||
contract
terminination costs
|
— | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||
Impairment
expense
|
— | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||
Cost
to provide enrollment services
|
— | — | 17,904 | — | 17,904 | — | — | — | — | 17,904 | |||||||||||||||||||||
Other
expenses
|
10,632 | 2,132 | 2,512 | 568 | 15,844 | 5,354 | 13,477 | (247 | ) | 6,598 | 41,026 | ||||||||||||||||||||
Intersegment
expenses
|
11,940 | 288 | 1,509 | 826 | 14,563 | 18,200 | 831 | (33,594 | ) | — | — | ||||||||||||||||||||
Total
operating expenses
|
36,448 | 8,656 | 27,730 | 5,532 | 78,366 | 25,534 | 28,487 | (35,793 | ) | 7,075 | 103,669 | ||||||||||||||||||||
Income
(loss) before income taxes
|
13,033 | 3,661 | 2,135 | 345 | 19,174 | 37,965 | (19,975 | ) | — | 590 | 37,754 | ||||||||||||||||||||
Income
tax (expense) benefit (a)
|
(4,823 | ) | (1,354 | (790 | ) | (128 | ) | (7,095 | ) | (14,047 | ) | 7,391 | — | (218 | ) | (13,969 | ) | ||||||||||||||
Net
income (loss) from continuing operations
|
8,210 | 2,307 | 1,345 | 217 | 12,079 | 23,918 | (12,584 | ) | — | 372 | 23,785 | ||||||||||||||||||||
Income
from discontinued operations, net of tax
|
— | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||
Net
income (loss)
|
$ | 8,210 | 2,307 | 1,345 | 217 | 12,079 | 23,918 | (12,584 | ) | — | 372 | 23,785 | |||||||||||||||||||
(a)
Income taxes are applied based on the consolidated effective tax rate to
income (loss) before income taxes.
|
44
Nine
months ended September 30, 2009
|
|||||||||||||||||||||||||||||||
Fee-Based
|
|||||||||||||||||||||||||||||||
|
Tuition
|
|
|||||||||||||||||||||||||||||
Student
|
Payment
|
|
|
|
"Base
net
|
||||||||||||||||||||||||||
Loan
|
Processing
|
Software
|
|
Asset
|
Corporate
|
|
income"
|
|
|||||||||||||||||||||||
and
|
and
|
|
and
|
Total
|
Generation
|
Activity
|
Eliminations
|
Adjustments
|
GAAP
|
||||||||||||||||||||||
Guaranty
|
Campus
|
Enrollment
|
Technical
|
Fee-
|
and
|
and
|
and
|
to
GAAP
|
Results
of
|
||||||||||||||||||||||
Servicing
|
Commerce
|
Services
|
Services
|
Based
|
Management
|
Overhead
|
Reclassifications
|
Results
|
Operations
|
||||||||||||||||||||||
Total
interest income
|
$ | 102 | 57 | — | — | 159 | 473,130 | 3,930 | (1,324 | ) | 7,502 | 483,397 | |||||||||||||||||||
Interest
expense
|
— | — | — | — | — | 306,846 | 23,078 | (1,324 | ) | — | 328,600 | ||||||||||||||||||||
Net
interest income (loss)
|
102 | 57 | — | — | 159 | 166,284 | (19,148 | ) | — | 7,502 | 154,797 | ||||||||||||||||||||
Less
provision for loan losses
|
— | — | — | — | — | 23,000 | — | — | — | 23,000 | |||||||||||||||||||||
Net
interest income (loss) after provision for loan
losses
|
102 | 57 | — | — | 159 | 143,284 | (19,148 | ) | — | 7,502 | 131,797 | ||||||||||||||||||||
Other
income (expense):
|
|||||||||||||||||||||||||||||||
Loan
and guaranty servicing revenue
|
82,424 | — | — | — | 82,424 | — | (1,144 | ) | — | — | 81,280 | ||||||||||||||||||||
Tuition
payment processing and campus commerce revenue
|
— | 40,373 | — | — | 40,373 | — | — | — | — | 40,373 | |||||||||||||||||||||
Enrollment
services revenue
|
— | — | 88,188 | — | 88,188 | — | — | — | — | 88,188 | |||||||||||||||||||||
Software
services revenue
|
2,766 | — | — | 13,658 | 16,424 | — | — | — | — | 16,424 | |||||||||||||||||||||
Other
income
|
498 | — | — | — | 498 | 18,851 | 20,134 | — | — | 39,483 | |||||||||||||||||||||
Gain
(loss) on sale of loans, net
|
— | — | — | — | — | 8,386 | — | — | — | 8,386 | |||||||||||||||||||||
Intersegment
revenue
|
62,291 | 172 | 416 | 10,813 | 73,692 | — | 25,739 | (99,431 | ) | — | — | ||||||||||||||||||||
Derivative
market value, foreign currency,
|
|||||||||||||||||||||||||||||||
and
put option adjustments
|
— | — | — | — | — | — | — | — | (36,067 | ) | (36,067 | ) | |||||||||||||||||||
Derivative
settlements, net
|
— | — | — | — | — | 38,807 | — | — | — | 38,807 | |||||||||||||||||||||
Total
other income (expense)
|
147,979 | 40,545 | 88,604 | 24,471 | 301,599 | 66,044 | 44,729 | (99,431 | ) | (36,067 | ) | 276,874 | |||||||||||||||||||
Operating
expenses:
|
|||||||||||||||||||||||||||||||
Salaries
and benefits
|
40,527 | 19,346 | 17,295 | 16,656 | 93,824 | 5,203 | 18,420 | (1,390 | ) | 159 | 116,216 | ||||||||||||||||||||
Restructure
expense- severance and contract
|
|||||||||||||||||||||||||||||||
termination
costs
|
5,159 | — | — | 714 | 5,873 | — | 755 | (6,628 | ) | — | — | ||||||||||||||||||||
Impairment
expense
|
— | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||
Cost
to provide enrollment services
|
— | — | 56,208 | — | 56,208 | — | — | — | — | 56,208 | |||||||||||||||||||||
Other
expenses
|
27,350 | 7,012 | 9,602 | 2,292 | 46,256 | 15,635 | 27,287 | 3,736 | 17,251 | 110,165 | |||||||||||||||||||||
Intersegment
expenses
|
28,352 | 1,962 | 1,604 | 2,195 | 34,113 | 59,372 | 1,664 | (95,149 | ) | — | — | ||||||||||||||||||||
Total
operating expenses
|
101,388 | 28,320 | 84,709 | 21,857 | 236,274 | 80,210 | 48,126 | (99,431 | ) | 17,410 | 282,589 | ||||||||||||||||||||
Income
(loss) before income taxes
|
46,693 | 12,282 | 3,895 | 2,614 | 65,484 | 129,118 | (22,545 | ) | — | (45,975 | ) | 126,082 | |||||||||||||||||||
Income
tax (expense) benefit (a)
|
(17,744 | ) | (4,667 | ) | (1,480 | ) | (994 | ) | (24,885 | ) | (49,066 | ) | 11,150 | — | 16,781 | (46,020 | ) | ||||||||||||||
Net
income (loss) from continuing operations
|
28,949 | 7,615 | 2,415 | 1,620 | 40,599 | 80,052 | (11,395 | ) | — | (29,194 | ) | 80,062 | |||||||||||||||||||
Income
from discontinued operations, net of tax
|
— | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||
Net
income (loss)
|
$ | 28,949 | 7,615 | 2,415 | 1,620 | 40,599 | 80,052 | (11,395 | ) | — | (29,194 | ) | 80,062 |
(a) Income
taxes are applied based on 38% of income (loss) before taxes for the individual
operating segments.
Nine
months ended September 30, 2009:
|
||||||||||||||||||||||||
Before
Tax Operating Margin
|
31.5 | % | 30.2 | % | 4.4 | % | 10.7 | % | 21.7 | % | 61.7 | % | ||||||||||||
Before
Tax Operating Margin -
|
||||||||||||||||||||||||
excluding
net interest income for fee generating
|
||||||||||||||||||||||||
businesses
and restructure expense
|
35.0 | % | 30.2 | % | 4.4 | % | 13.6 | % | 23.6 | % | 61.7 | % | ||||||||||||
Nine
months ended September 30, 2008:
|
||||||||||||||||||||||||
Before
Tax Operating Margin
|
22.5 | % | 33.0 | % | 4.1 | % | 13.6 | % | 17.8 | % | 32.6 | % | ||||||||||||
Before
Tax Operating Margin -
|
||||||||||||||||||||||||
excluding
net interest income for fee generating
|
||||||||||||||||||||||||
businesses,
restructure expense, impairment expense,
|
||||||||||||||||||||||||
and
the loss on sale of loans in the first quarter
|
||||||||||||||||||||||||
of
2008
|
26.1 | % | 30.3 | % | 4.4 | % | 16.0 | % | 19.4 | % | 56.3 | % |
45
Nine
months ended September 30, 2008
|
|||||||||||||||||||||||||||||||
Fee-Based
|
|||||||||||||||||||||||||||||||
Tuition
|
|||||||||||||||||||||||||||||||
Student
|
Payment
|
"Base
net
|
|||||||||||||||||||||||||||||
Loan
|
Processing
|
Software
|
Asset
|
Corporate
|
income"
|
||||||||||||||||||||||||||
and
|
and
|
and
|
Total
|
Generation
|
Activity
|
Eliminations
|
Adjustments
|
GAAP
|
|||||||||||||||||||||||
Guaranty
|
Campus
|
Enrollment
|
Technical
|
Fee-
|
and
|
and
|
and
|
to
GAAP
|
Results
of
|
||||||||||||||||||||||
Servicing
|
Commerce
|
Services
|
Services
|
Based
|
Management
|
Overhead
|
Reclassifications
|
Results
|
Operations
|
||||||||||||||||||||||
Total
interest income
|
$ | 1,160 | 1,471 | 16 | — | 2,647 | 892,690 | 4,781 | (1,389 | ) | 42,325 | 941,054 | |||||||||||||||||||
Interest
expense
|
— | — | 3 | — | 3 | 762,689 | 30,318 | (1,389 | ) | — | 791,621 | ||||||||||||||||||||
Net
interest income (loss)
|
1,160 | 1,471 | 13 | — | 2,644 | 130,001 | (25,537 | ) | — | 42,325 | 149,433 | ||||||||||||||||||||
Less
provision for loan losses
|
— | — | — | — | — | 18,000 | — | — | — | 18,000 | |||||||||||||||||||||
Net
interest income (loss) after provision
|
|||||||||||||||||||||||||||||||
for
loan losses
|
1,160 | 1,471 | 13 | — | 2,644 | 112,001 | (25,537 | ) | — | 42,325 | 131,433 | ||||||||||||||||||||
Other
income (expense):
|
|||||||||||||||||||||||||||||||
Loan
and guaranty servicing revenue
|
78,147 | — | — | — | 78,147 | 26 | — | — | — | 78,173 | |||||||||||||||||||||
Tuition
payment processing and campus commerce revenue
|
— | 35,980 | — | — | 35,980 | — | — | — | — | 35,980 | |||||||||||||||||||||
Enrollment
services revenue
|
— | — | 83,148 | — | 83,148 | — | — | — | — | 83,148 | |||||||||||||||||||||
Software
services revenue
|
3,477 | — | 37 | 15,828 | 19,342 | — | — | — | — | 19,342 | |||||||||||||||||||||
Other
income
|
44 | — | — | — | 44 | 13,787 | 3,956 | — | — | 17,787 | |||||||||||||||||||||
Gain
(loss) on sale of loans, net
|
— | — | — | — | — | (47,426 | ) | — | — | — | (47,426 | ) | |||||||||||||||||||
Intersegment
revenue
|
57,008 | 242 | 2 | 4,993 | 62,245 | — | 46,843 | (109,088 | ) | — | — | ||||||||||||||||||||
Derivative
market value, foreign currency,
|
|||||||||||||||||||||||||||||||
and
put option adjustments
|
— | — | — | — | — | 466 | — | — | (35,987 | ) | (35,521 | ) | |||||||||||||||||||
Derivative
settlements, net
|
— | — | — | — | — | 55,954 | — | — | (9,965 | ) | 45,989 | ||||||||||||||||||||
Total
other income (expense)
|
138,676 | 36,222 | 83,187 | 20,821 | 278,906 | 22,807 | 50,799 | (109,088 | ) | (45,952 | ) | 197,472 | |||||||||||||||||||
Operating
expenses:
|
|||||||||||||||||||||||||||||||
Salaries
and benefits
|
40,365 | 17,450 | 18,701 | 14,031 | 90,547 | 6,157 | 41,581 | 1,323 | 2,523 | 142,131 | |||||||||||||||||||||
Restructure
expense- severence and
|
|||||||||||||||||||||||||||||||
contract
terminination costs
|
747 | — | 282 | 487 | 1,516 | 1,845 | 3,746 | (7,107 | ) | — | — | ||||||||||||||||||||
Impairment
expense
|
5,074 | — | — | — | 5,074 | 9,351 | 4,409 | — | — | 18,834 | |||||||||||||||||||||
Cost
to provide enrollment services
|
— | — | 48,062 | — | 48,062 | — | — | — | — | 48,062 | |||||||||||||||||||||
Other
expenses
|
27,130 | 6,743 | 7,801 | 1,901 | 43,575 | 15,793 | 42,263 | 51 | 19,719 | 121,401 | |||||||||||||||||||||
Intersegment
expenses
|
35,040 | 1,045 | 4,936 | 1,562 | 42,583 | 57,754 | 3,018 | (103,355 | ) | — | — | ||||||||||||||||||||
Total
operating expenses
|
108,356 | 25,238 | 79,782 | 17,981 | 231,357 | 90,900 | 95,017 | (109,088 | ) | 22,242 | 330,428 | ||||||||||||||||||||
Income
(loss) before income taxes
|
31,480 | 12,455 | 3,418 | 2,840 | 50,193 | 43,908 | (69,755 | ) | — | (25,869 | ) | (1,523 | ) | ||||||||||||||||||
Income
tax (expense) benefit (a)
|
(10,542 | ) | (4,081 | ) | (1,187 | ) | (902 | ) | (16,712 | ) | (15,889 | ) | 22,824 | — | 7,984 | (1,793 | ) | ||||||||||||||
Net
income (loss) from continuing operations
|
20,938 | 8,374 | 2,231 | 1,938 | 33,481 | 28,019 | (46,931 | ) | — | (17,885 | ) | (3,316 | ) | ||||||||||||||||||
Income
from discontinued operations, net of tax
|
— | — | — | — | — | — | — | — | 981 | 981 | |||||||||||||||||||||
Net
income (loss)
|
$ | 20,938 | 8,374 | 2,231 | 1,938 | 33,481 | 28,019 | (46,931 | ) | — | (16,904 | ) | (2,335 | ) | |||||||||||||||||
(a)
Income taxes are applied based on the consolidated effective tax rate to
income (loss) before income taxes.
|
Non-GAAP
Performance Measures
In
accordance with the rules and regulations of the Securities and Exchange
Commission, the Company prepares financial statements in accordance with
generally accepted accounting principles. 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, establish corporate performance targets, allocate
resources, track results, evaluate performance, 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.
46
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, 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
|
||||||||||||||||
Loan
|
Payment
|
Software
|
Asset
|
Corporate
|
|||||||||||||
and
|
Processing
|
and
|
Generation
|
Activity
|
|||||||||||||
Guaranty
|
and
Campus
|
Enrollment
|
Technical
|
and
|
and
|
||||||||||||
Servicing
|
Commerce
|
Services
|
Services
|
Management
|
Overhead
|
Total
|
|||||||||||
Three
months ended September 30, 2009
|
|||||||||||||||||
Derivative
market value, foreign currency, and
|
|||||||||||||||||
put
option adjustments
|
$
|
—
|
—
|
—
|
—
|
(2,826)
|
—
|
(2,826)
|
|||||||||
Amortization
of intangible assets
|
1,078
|
1,842
|
2,251
|
141
|
—
|
—
|
5,312
|
||||||||||
Compensation
related to business combinations
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
||||||||||
Variable-rate
floor income, net of settlements on derivatives
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
||||||||||
Income
from discontinued operations, net of tax
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
||||||||||
Net
tax effect (a)
|
(410)
|
(700)
|
(855)
|
(54)
|
1,074
|
86
|
(859)
|
||||||||||
Total
adjustments to GAAP
|
$
|
668
|
1,142
|
1,396
|
87
|
(1,752)
|
86
|
1,627
|
|||||||||
Three
months ended September 30, 2008
|
|||||||||||||||||
Derivative
market value, foreign currency, and
|
|||||||||||||||||
put
option adjustments
|
$
|
—
|
—
|
—
|
—
|
(9,030)
|
2,945
|
(6,085)
|
|||||||||
Amortization
of intangible assets
|
1,165
|
1,889
|
3,258
|
286
|
—
|
—
|
6,598
|
||||||||||
Compensation
related to business combinations
|
—
|
—
|
—
|
—
|
—
|
477
|
477
|
||||||||||
Variable-rate
floor income, net of settlements on derivatives
|
—
|
—
|
—
|
—
|
(1,580)
|
—
|
(1,580)
|
||||||||||
Income
from discontinued operations, net of tax
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
||||||||||
Net
tax effect (a)
|
(432)
|
(699)
|
(1,205)
|
(106)
|
3,926
|
(1,266)
|
218
|
||||||||||
Total
adjustments to GAAP
|
$
|
733
|
1,190
|
2,053
|
180
|
(6,684)
|
2,156
|
(372)
|
|||||||||
Nine
months ended September 30, 2009
|
|||||||||||||||||
Derivative
market value, foreign currency, and
|
|||||||||||||||||
put
option adjustments
|
$
|
—
|
—
|
—
|
—
|
37,499
|
(1,432)
|
36,067
|
|||||||||
Amortization
of intangible assets
|
3,236
|
5,598
|
7,994
|
423
|
—
|
—
|
17,251
|
||||||||||
Compensation
related to business combinations
|
—
|
—
|
—
|
—
|
—
|
159
|
159
|
||||||||||
Variable-rate
floor income, net of settlements on derivatives
|
—
|
—
|
—
|
—
|
(7,502)
|
—
|
(7,502)
|
||||||||||
Income
(loss) from discontinued operations, net of tax
|
—
|
—
|
—
|
—
|
—
|
—
|
—
|
||||||||||
Net
tax effect (a)
|
(1,230)
|
(2,127)
|
(3,037)
|
(161)
|
(11,399)
|
1,173
|
(16,781)
|
||||||||||
Total
adjustments to GAAP
|
$
|
2,006
|
3,471
|
4,957
|
262
|
18,598
|
(100)
|
29,194
|
|||||||||
Nine
months ended September 30, 2008
|
|||||||||||||||||
Derivative
market value, foreign currency, and
|
|||||||||||||||||
put
option adjustments
|
$
|
—
|
—
|
—
|
—
|
32,504
|
3,483
|
35,987
|
|||||||||
Amortization
of intangible assets
|
3,586
|
5,937
|
9,193
|
858
|
145
|
—
|
19,719
|
||||||||||
Compensation
related to business combinations
|
—
|
—
|
—
|
—
|
—
|
2,523
|
2,523
|
||||||||||
Variable-rate
floor income, net of settlements on derivatives
|
—
|
—
|
—
|
—
|
(32,360)
|
—
|
(32,360)
|
||||||||||
Loss
from discontinued operations, net of tax
|
(981)
|
—
|
—
|
—
|
—
|
—
|
(981)
|
||||||||||
Net
tax effect (a)
|
(1,182)
|
(1,954)
|
(3,045)
|
(284)
|
548
|
(2,067)
|
(7,984)
|
||||||||||
Total
adjustments to GAAP
|
$
|
1,423
|
3,983
|
6,148
|
574
|
837
|
3,939
|
16,904
|
|||||||||
(a)
|
For
2009, income taxes are applied based on 38% of income (loss) before income
taxes for the individual operating segments. For 2008, income taxes for
each individual operating segment are applied based on the consolidated
effective tax rate.
|
47
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. As such,
the Company recognizes changes in fair value of derivative instruments currently
in earnings. 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”, 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 generally
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.
In 2008,
“base net income” also excluded the change in fair value of put options issued
by the Company for certain business acquisitions. The put options were valued by
the Company each reporting period using a Black-Scholes pricing model.
Therefore, the fair value of those options were primarily affected by the strike
price and term of the underlying option, the Company’s stock price, and the
dividend yield and volatility of the Company’s stock. The Company believed those
point-in-time estimates of value that were subject to fluctuations made it
difficult to evaluate the ongoing results of operations against the Company’s
business plans and affected the period-to-period comparability of the results of
operations. In 2008, the Company settled all of its obligations related to these
put options.
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.
48
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.
Prior to
October 1, 2008, variable rate floor income was calculated by the Company on a
statutory maximum basis. However, as a result of the disruption in the capital
markets beginning in August 2007, the full benefit of variable rate floor income
calculated on a statutory maximum basis 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. As a result of the ongoing volatility of
interest rates, effective October 1, 2008, the Company changed its calculation
of variable rate floor income to better reflect the economic benefit received by
the Company. The economic benefit received by the Company related to variable
rate floor income was $0.1 million for the three months ended September 30, 2008
and $7.5 million and $25.7 million for the nine months ended September 30, 2009
and 2008, respectively. There was no economic benefit received by the Company
related to variable rate floor income for the three months ended September 30,
2009. Variable rate floor income calculated on a statutory maximum basis was
$0.1 million and $1.6 million for the three months ended September 30, 2009 and
2008, respectively, and $23.9 million and $42.3
million for the nine months ended September 30, 2009 and 2008, respectively.
Beginning October 1, 2008, the economic benefit received by the Company has been
used to determine base net income.
The
Company has used derivative instruments to hedge variable rate floor income
during certain periods. During the nine months ended September 30, 2008, the
Company made payments (settlements) of $10.0 million on such derivatives. These
settlements are netted with variable-rate floor income and are excluded from
“base net income.”
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 operating segment provides for the servicing
of the Company’s student loan portfolio and the portfolios of third parties and
servicing provided to guaranty agencies. The servicing and business process
outsourcing activities include loan origination activities, loan conversion
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.
Loan
servicing fees are determined according to individual agreements with customers
and are calculated based on the dollar value of loans, number of loans, or
number of borrowers serviced for each customer. In addition, the Company earns
servicing revenue for the origination of loans, conversion and deconversion of
loan portfolios. Guaranty servicing fees, generally, are calculated based on the
number of loans serviced, volume of loans serviced, or amounts
collected.
In June
2009, the Department of Education named the Company as one of four private
sector companies awarded a servicing contract to service all federally-owned
student loans, including FFELP loans purchased by the Department pursuant to
ECASLA. Beginning in August 2010, the contract will also cover the servicing on
new loans originated under the Direct Loan Program. Servicing volume will
initially be allocated by the Department to servicers awarded a contract,
however, performance factors such as customer satisfaction levels and default
rates will determine volume allocations over time. The contract spans five years
with one, five-year renewal option. Servicing loans under this contract will
increase revenue earned by this segment. However, operating margins under this
contract are expected to be lower than historical levels achieved.
The
Company began servicing loans and recognized approximately $30,000 of revenue
under this contract in September 2009. As of September 30, 2009 and October 31,
2009, the Company was servicing approximately $177 million and $2.5 billion,
respectively, of loans under the Department’s servicing contract, which includes
approximately $12 million and $740 million, respectively, of loans not
previously serviced by the Company that were sold by third parties to the
Department as part of the ECASLA Purchase Program.
49
Student
Loan Servicing Volumes (dollars in millions)
![](https://www.sec.gov/Archives/edgar/data/0001258602/000143774909001618/nelnet_10q-09300982.gif)
(a)
|
As
of September 30, 2009, the Company was servicing $1.9 billion of
loans owned by the Company and approximately $1.5 billion of loans for
third parties that were disbursed on or after May 1, 2008 and may be
eligible to be sold to the Department of Education pursuant to its Loan
Purchase Commitment Program. The Company expects to retain servicing
rights on all loans sold to the Department which are currently being
serviced by the Company.
|
(b)
|
Includes
loans that are accounted for as participation interests sold under an
agreement with Union Bank.
|
50
Three
and nine months ended September 30, 2009 compared to the three and nine months
ended September 30, 2008
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||||||
Change
|
Change
|
|||||||||||||||||||||||||
2009
|
2008
|
$ | % |
2009
|
2008
|
$ | % | |||||||||||||||||||
Net
interest income
|
$ | 23 | 304 | (281 | ) | (92.4 | )% | $ | 102 | 1,160 | (1,058 | ) | (91.2 | )% | ||||||||||||
Loan
and guaranty servicing revenue
|
26,387 | 29,827 | (3,440 | ) | (11.5 | ) | 82,424 | 78,147 | 4,277 | 5.5 | ||||||||||||||||
Software
services revenue
|
966 | 942 | 24 | 2.5 | 2,766 | 3,477 | (711 | ) | (20.4 | ) | ||||||||||||||||
Other
income
|
137 | 6 | 131 | 2,183.3 | 498 | 44 | 454 | 1,031.8 | ||||||||||||||||||
Intersegment
revenue
|
21,525 | 18,402 | 3,123 | 17.0 | 62,291 | 57,008 | 5,283 | 9.3 | ||||||||||||||||||
Total
other income
|
49,015 | 49,177 | (162 | ) | (0.3 | ) | 147,979 | 138,676 | 9,303 | 6.7 | ||||||||||||||||
Salaries
and benefits
|
12,468 | 13,876 | (1,408 | ) | (10.1 | ) | 40,527 | 40,365 | 162 | 0.4 | ||||||||||||||||
Restructure
expense
|
2,646 | — | 2,646 | 100.0 | 5,159 | 747 | 4,412 | 590.6 | ||||||||||||||||||
Impairment
expense
|
— | — | — | — | — | 5,074 | (5,074 | ) | (100.0 | ) | ||||||||||||||||
Other
expenses
|
7,613 | 10,632 | (3,019 | ) | (28.4 | ) | 27,350 | 27,130 | 220 | 0.8 | ||||||||||||||||
Intersegment
expenses
|
9,398 | 11,940 | (2,542 | ) | (21.3 | ) | 28,352 | 35,040 | (6,688 | ) | (19.1 | ) | ||||||||||||||
Total
operating expenses
|
32,125 | 36,448 | (4,323 | ) | (11.9 | ) | 101,388 | 108,356 | (6,968 | ) | (6.4 | ) | ||||||||||||||
"Base
net income" before income taxes
|
16,913 | 13,033 | 3,880 | 29.8 | 46,693 | 31,480 | 15,213 | 48.3 | ||||||||||||||||||
Income
tax expense
|
(6,427 | ) | (4,823 | ) | (1,604 | ) | 33.3 | (17,744 | ) | (10,542 | ) | (7,202 | ) | 68.3 | ||||||||||||
"Base
net income"
|
$ | 10,486 | 8,210 | 2,276 | 27.7 | % | $ | 28,949 | 20,938 | 8,011 | 38.3 | % | ||||||||||||||
Before
Tax Operating Margin
|
34.5 | % | 26.3 | % | 31.5 | % | 22.5 | % | ||||||||||||||||||
Before
Tax Operating Margin -
|
||||||||||||||||||||||||||
excluding
net interest income, restructure expense
|
||||||||||||||||||||||||||
and
impairment expense
|
39.9 | % | 25.9 | % | 35.0 | % | 26.1 | % |
Net
interest income.
Investment income decreased as a result of decreases in interest rates on
cash held in 2009 compared to 2008.
Loan and
guaranty servicing revenue and intersegment revenue.
Three
months ended September 30,
|
|||||||||||||||||||
2009
|
2008
|
||||||||||||||||||
Origination | Servicing | Total | Origination | Servicing | Total | ||||||||||||||
revenue
|
revenue
|
revenue
|
revenue
|
revenue
|
revenue
|
||||||||||||||
FFELP
servicing (a)
|
$ | 857 | 13,556 | 14,413 | 1,678 | 12,362 | 14,040 | ||||||||||||
Private
servicing
|
514 | 1,760 | 2,274 | 240 | 1,776 | 2,016 | |||||||||||||
Government
servicing
|
— | 31 | 31 | — | — | — | |||||||||||||
Guaranty
servicing (b)
|
82 | 9,587 | 9,669 | 131 | 13,640 | 13,771 | |||||||||||||
Loan
and guaranty servicing revenue
|
1,453 | 24,934 | 26,387 | 2,049 | 27,778 | 29,827 | |||||||||||||
Intersegment
revenue (c)
|
2,364 | 19,161 | 21,525 | 1,730 | 16,672 | 18,402 | |||||||||||||
Total
servicing revenue
|
$ | 3,817 | 44,095 | 47,912 | 3,779 | 44,450 | 48,229 |
(a)
|
FFELP
origination revenue decreased in 2009 compared to 2008 due to lenders
exiting the FFELP marketplace as a result of legislative changes and
disruptions in the capital markets. FFELP servicing revenue increased in
2009 due to the receipt of $1.7 million in conversion fees associated with
the loss of life of loan servicing and transfer related activities for
third party clients that sold loans to the Department of Education under
the Purchase Program.
|
(b)
|
Guaranty
servicing revenue decreased in 2009 due to the receipt of $6.1 million in
fees received from rehabilitation collections on defaulted loan assets in
the third quarter of 2008. In the third quarter of 2009, revenue from
rehabilitation collections on defaulted loans was $0.6
million.
|
(c)
|
Intersegment
origination revenue increased in 2009 compared to the same period in 2008
due to an increase in the Company’s disbursement volume. Intersegment
servicing revenue increased in 2009 compared to the same period in 2008
due to an increase in the number of loans transferred between various
financings as the Company was executing certain financing strategies and
conversion fees received upon the Company selling $427.7 million of
student loans to the Department under the Purchase
Program.
|
51
Nine
months ended September 30,
|
||||||||||||||||||
2009
|
2008
|
|||||||||||||||||
Origination | Servicing |
Total
|
|
Origination | Servicing |
Total
|
||||||||||||
revenue
|
revenue
|
revenue
|
revenue
|
revenue
|
revenue
|
|||||||||||||
FFELP
servicing (a)
|
$ | 1,632 | 42,878 | 44,510 | 3,234 | 35,620 |
38,854
|
|||||||||||
Private
servicing
|
618 | 5,523 | 6,141 | 421 | 5,737 |
6,158
|
||||||||||||
Government
servicing
|
— | 31 | 31 | — | — |
-
|
||||||||||||
Guaranty
servicing (b)
|
296 | 31,446 | 31,742 | 400 | 32,735 |
33,135
|
||||||||||||
Loan
and guaranty servicing revenue
|
2,546 | 79,878 | 82,424 | 4,055 | 74,092 |
78,147
|
||||||||||||
Intersegment
revenue (c)
|
6,531 | 55,760 | 62,291 | 3,906 | 53,102 |
57,008
|
||||||||||||
Total
servicing revenue
|
$ | 9,077 | 135,638 | 144,715 | 7,961 | 127,194 |
135,155
|
|||||||||||
(a)
|
FFELP
origination revenue decreased in 2009 compared to 2008 due to lenders
exiting the FFELP marketplace as a result of legislative changes and
disruptions in the capital markets. FFELP servicing revenue increased in
2009 due to the receipt of $3.8 million in conversion fees associated with
the loss of life of loan servicing and transfer related activities for
third party clients that sold loans to the Department of Education under
the Purchase Program.
|
(b)
|
Guaranty
servicing revenue decreased in 2009 due to the receipt of $11.7 million in
fees received from rehabilitation collections on defaulted loan assets in
2008. In 2009, the revenue from rehabilitation collections on defaulted
loans was $6.9 million. This decrease was offset by an increase in
consolidation collection revenue in
2009.
|
(c)
|
Intersegment
origination revenue increased in 2009 compared to the same period in 2008
due to an increase in the Company’s disbursement volume. Intersegment
servicing revenue increased in 2009 compared to the same period in 2008
due to an increase in the number of loans transferred between various
financings as the Company was executing certain financing strategies and
conversion fees received upon the Company selling $427.7 million of
student loans to the Department under the Purchase
Program.
|
Operating
expenses.
Excluding restructure and impairment charges and collection fees paid related to
rehabilitation sales, operating expenses decreased $4.8 million (14.3%) and $3.2
million (3.3%) for the three and nine months ended September 30, 2009 compared
to the same periods in 2008. These decreases were a result of cost savings from
the Company’s restructuring plans.
52
TUITION
PAYMENT PROCESSING AND CAMPUS COMMERCE OPERATING SEGMENT – RESULTS OF
OPERATIONS
The
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.
This
segment of the Company’s business is subject to seasonal fluctuations which
correspond, or are related to, the traditional school year. Tuition management
revenue is recognized over the course of the academic term, but the peak
operational activities take place in summer and early fall. Revenue associated
with providing electronic commerce subscription services is recognized over the
service period with the highest revenue months being July through September and
December and January. The Company’s operating expenses do not follow the
seasonality of the revenues. This is primarily due to fixed year-round personnel
costs and seasonal marketing costs.
Three
and nine months ended September 30, 2009 compared to the three and nine months
ended September 30, 2008
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||||||
Change
|
Change
|
|||||||||||||||||||||||||
2009
|
2008
|
$ | % |
2009
|
2008
|
$ | % | |||||||||||||||||||
Net
interest income
|
$ | 16 | 396 | (380 | ) | (96.0 | )% | $ | 57 | 1,471 | (1,414 | ) | (96.1 | )% | ||||||||||||
Tuition
payment processing and campus commerce revenue
|
12,987 | 11,863 | 1,124 | 9.5 | 40,373 | 35,980 | 4,393 | 12.2 | ||||||||||||||||||
Intersegment
revenue
|
62 | 58 | 4 | 6.9 | 172 | 242 | (70 | ) | (28.9 | ) | ||||||||||||||||
Total
other income
|
13,049 | 11,921 | 1,128 | 9.5 | 40,545 | 36,222 | 4,323 | 11.9 | ||||||||||||||||||
Salaries
and benefits
|
6,399 | 6,236 | 163 | 2.6 | 19,346 | 17,450 | 1,896 | 10.9 | ||||||||||||||||||
Other
expenses
|
2,265 | 2,132 | 133 | 6.2 | 7,012 | 6,743 | 269 | 4.0 | ||||||||||||||||||
Intersegment
expenses
|
670 | 288 | 382 | 132.6 | 1,962 | 1,045 | 917 | 87.8 | ||||||||||||||||||
Total
operating expenses
|
9,334 | 8,656 | 678 | 7.8 | 28,320 | 25,238 | 3,082 | 12.2 | ||||||||||||||||||
"Base
net income" before income taxes
|
3,731 | 3,661 | 70 | 1.9 | 12,282 | 12,455 | (173 | ) | (1.4 | ) | ||||||||||||||||
Income
tax expense
|
(1,418 | ) | (1,354 | ) | (64 | ) | 4.7 | (4,667 | ) | (4,081 | ) | (586 | ) | 14.4 | ||||||||||||
"Base
net income"
|
$ | 2,313 | 2,307 | 6 | 0.3 | % | $ | 7,615 | 8,374 | (759 | ) | (9.1 | )% | |||||||||||||
Before
Tax Operating Margin
|
28.6 | % | 29.7 | % | 30.2 | % | 33.0 | % | ||||||||||||||||||
Before
Tax Operating Margin, excluding net interest income
|
28.5 | % | 27.4 | % | 30.2 | % | 30.3 | % |
Net
interest income.
Investment income decreased as a result of decreases in interest rates on
cash held in 2009 compared to 2008.
Tuition
payment processing and campus commerce revenue. Tuition payment
processing and campus commerce revenue increased in 2009 compared to the same
periods in 2008 as a result of an increase in the number of managed tuition
payment plans as well as an increase in campus commerce transactions
processed.
Operating
expenses.
Operating expenses increased for the three and nine months ended
September 30, 2009 compared to the same periods in 2008 as a result of incurring
additional costs associated with salaries and benefits to support the increase
in the number of managed tuition payment plans and campus commerce transactions.
In addition, the Company continues to invest in new products and services to
meet customer needs and expand product and service offerings. These investments
increased operating expenses for the three and nine months ended September 30,
2009 compared to the same period in 2008.
Before
tax operating margin, excluding net interest income. The Company evaluates the
results of this segment based on operating margins excluding net interest
income. Net interest income earned by the Company during any given period is
subject to the underlying interest rate earned on cash and is a factor beyond
the Company’s control which can affect the period-to-period comparability of
results of operations.
53
ENROLLMENT
SERVICES OPERATING SEGMENT – RESULTS OF OPERATIONS
The
Enrollment Services segment offers products and services that are focused on
helping students plan and prepare for life after high school (content management
and publishing and editing services) and helping colleges recruit and retain
students (lead generation and recruitment services). Content management products
and services include online courses and related services. Publishing and editing
services include test preparation study guides and essay and resume editing
services. Lead generation products and services include vendor lead management
services and admissions lead generation. Recruitment services include pay per
click marketing management, email marketing, list marketing services, and
admissions consulting.
Three
and nine months ended September 30, 2009 compared to the three and nine months
ended September 30, 2008
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||||||
Change
|
Change
|
|||||||||||||||||||||||||
2009
|
2008
|
$ | % |
2009
|
2008
|
$ | % | |||||||||||||||||||
Net
interest income
|
$ | — | 5 | (5 | ) | (100.0 | )% | $ | — | 13 | (13 | ) | (100.0 | )% | ||||||||||||
Enrollment
services revenue
|
30,670 | 29,858 | 812 | 2.7 | 88,188 | 83,148 | 5,040 | 6.1 | ||||||||||||||||||
Software
services revenue
|
— | — | — | — | — | 37 | (37 | ) | (100.0 | ) | ||||||||||||||||
Intersegment
revenue
|
139 | 2 | 137 | 6,850.0 | 416 | 2 | 414 | 20,700.0 | ||||||||||||||||||
Total
other income
|
30,809 | 29,860 | 949 | 3.2 | 88,604 | 83,187 | 5,417 | 6.5 | ||||||||||||||||||
Salaries
and benefits
|
5,337 | 5,805 | (468 | ) | (8.1 | ) | 17,295 | 18,701 | (1,406 | ) | (7.5 | ) | ||||||||||||||
Restructure
expense - severance and
|
||||||||||||||||||||||||||
contract
termination costs
|
— | — | — | — | — | 282 | (282 | ) | (100.0 | ) | ||||||||||||||||
Cost
to provide enrollment services
|
20,323 | 17,904 | 2,419 | 13.5 | 56,208 | 48,062 | 8,146 | 16.9 | ||||||||||||||||||
Other
expenses
|
3,266 | 2,512 | 754 | 30.0 | 9,602 | 7,801 | 1,801 | 23.1 | ||||||||||||||||||
Intersegment
expenses
|
550 | 1,509 | (959 | ) | (63.6 | ) | 1,604 | 4,936 | (3,332 | ) | (67.5 | ) | ||||||||||||||
Total
operating expenses
|
29,476 | 27,730 | 1,746 | 6.3 | 84,709 | 79,782 | 4,927 | 6.2 | ||||||||||||||||||
"Base
net income" before income taxes
|
1,333 | 2,135 | (802 | ) | (37.6 | ) | 3,895 | 3,418 | 477 | 14.0 | ||||||||||||||||
Income
tax expense
|
(507 | ) | (790 | ) | 283 | (35.8 | ) | (1,480 | ) | (1,187 | ) | (293 | ) | 24.7 | ||||||||||||
"Base
net income"
|
$ | 826 | 1,345 | (519 | ) | (38.6 | )% | $ | 2,415 | 2,231 | 184 | 8.2 | % | |||||||||||||
Before
Tax Operating Margin
|
4.3 | % | 7.1 | % | 4.4 | % | 4.1 | % | ||||||||||||||||||
Before
Tax Operating Margin -
|
||||||||||||||||||||||||||
excluding
net interest income and
|
||||||||||||||||||||||||||
restructure
expense
|
4.3 | % | 7.1 | % | 4.4 | % | 4.4 | % |
54
Enrollment
services revenue, cost to provide enrollment services, and gross
profit.
Three
months ended September 30, 2009
|
||||||||||||||||||||
Publishing
|
Content
|
|||||||||||||||||||
and
|
management
|
|||||||||||||||||||
Lead
|
editing
|
and
recruitment
|
||||||||||||||||||
generation
(a)
|
services
(b)
|
Subtotal
|
services
(c)
|
Total
|
||||||||||||||||
Enrollment
services revenue
|
$ | 23,595 | 3,148 | 26,743 | 3,927 | 30,670 | ||||||||||||||
Cost
to provide enrollment services
|
19,085 | 1,238 | 20,323 | |||||||||||||||||
Gross
profit
|
$ | 4,510 | 1,910 | 6,420 | ||||||||||||||||
Gross
profit %
|
19.1% | 60.7% | 24.0% | |||||||||||||||||
Three
months ended September 30, 2008
|
||||||||||||||||||||
Publishing
|
Content
|
|||||||||||||||||||
and
|
management
|
|||||||||||||||||||
Lead
|
editing
|
and
recruitment
|
||||||||||||||||||
generation
(a)
|
services
(b)
|
Subtotal
|
services
(c)
|
Total
|
||||||||||||||||
Enrollment
services revenue
|
$ | 19,313 | 5,018 | 24,331 | 5,527 | 29,858 | ||||||||||||||
Cost
to provide enrollment services
|
15,985 | 1,919 | 17,904 | |||||||||||||||||
Gross
profit
|
$ | 3,328 | 3,099 | 6,427 | ||||||||||||||||
Gross
profit %
|
17.2% | 61.8% | 26.4% | |||||||||||||||||
Nine
months ended September 30, 2009
|
||||||||||||||||||||
Publishing
|
Content
|
|||||||||||||||||||
and
|
management
|
|||||||||||||||||||
Lead
|
editing
|
and
recruitment
|
||||||||||||||||||
generation
(a)
|
services
(b)
|
Subtotal
|
services
(c)
|
Total
|
||||||||||||||||
Enrollment
services revenue
|
$ | 66,374 | 8,100 | 74,474 | 13,714 | 88,188 | ||||||||||||||
Cost
to provide enrollment services
|
52,735 | 3,473 | 56,208 | |||||||||||||||||
Gross
profit
|
$ | 13,639 | 4,627 | 18,266 | ||||||||||||||||
Gross
profit %
|
20.5% | 57.1% | 24.5% | |||||||||||||||||
Nine
months ended September 30, 2008
|
||||||||||||||||||||
Publishing
|
Content
|
|||||||||||||||||||
and
|
management
|
|||||||||||||||||||
Lead
|
editing
|
and
recruitment
|
||||||||||||||||||
generation
(a)
|
services
(b)
|
Subtotal
|
services
(c)
|
Total
|
||||||||||||||||
Enrollment
services revenue
|
$ | 53,719 | 11,291 | 65,010 | 18,138 | 83,148 | ||||||||||||||
Cost
to provide enrollment services
|
43,459 | 4,603 | 48,062 | |||||||||||||||||
Gross
profit
|
$ | 10,260 | 6,688 | 16,948 | ||||||||||||||||
Gross
profit %
|
19.1% | 59.2% | 26.1% |
(a)
|
Lead
generation revenue increased $4.3 million (22.2%) and $12.7 million
(23.6%) for the three and nine months ended September 30, 2009 compared to
the same periods in 2008 as a result of an increase in lead generation
services volume. The gross profit for lead generation services increased
due to the Company’s focus on eliminating lower margin sales and creating
cost efficiencies.
|
(b)
|
Publishing
and editing services revenue decreased $1.9 million (37.3%) and $3.2
million (28.3%) for the three and nine months ended September 30, 2009
compared to the same periods in 2008 due to competition related to online
delivery of similar products, as well as a general downturn in economic
conditions. The gross profit for publishing and editing services decreased
as a result of a shift in the mix of products
sold.
|
(c)
|
Content
management and recruitment services revenue decreased $1.6 million (28.9%)
and $4.4 million (24.4%) for the three and nine months ended September 30,
2009 compared to the same periods in 2008. These decreases were the result
of decreases of $1.1 million and $3.1 million for the three and nine
months ended September 30, 2009 compared to the same periods in 2008
associated with the Company’s pay per click marketing management, email
marketing, and admissions consulting services and a decrease of $0.5
million and $1.4 million associated with the Company’s list marketing
services for the three and nine months ended September 30, 2009 compared
to the same periods in 2008 as a result of legislative developments in the
student loan industry.
|
55
Operating
expenses. Excluding
restructure charges and the cost to provide enrollment services, operating
expenses decreased $0.7 million (6.8%) and $2.9 million (9.3%), respectively,
for the three and nine months ended September 30, 2009 compared to the same
period in 2008 as a result of continued focus on cost efficiencies.
SOFTWARE
AND TECHNICAL SERVICES OPERATING SEGMENT – RESULTS OF OPERATIONS
The
Software and Technical Services operating segment develops student loan
servicing software, which is used internally by the Company and also licensed to
third-party student loan holders and servicers. This segment also provides
information technology products and services, with core areas of business in
educational loan software solutions, business intelligence, technical consulting
services, and Enterprise Content Management solutions.
Many of
the Company’s external customers receiving services in this segment have been
negatively impacted as a result of the passage of the College Cost Reduction Act
and disruptions in the capital markets. These events could decrease the demand
for products and services and affect this segment’s future revenue and profit
margins.
Three
and nine months ended September 30, 2009 compared to the three and nine months
ended September 30, 2008
Three
months ended September 30,
|
Nine
months ended September 30,
|
||||||||||||||||||||||||||
Change
|
Change
|
||||||||||||||||||||||||||
2009
|
2008
|
$ | % |
2009
|
2008
|
$ | % | ||||||||||||||||||||
Software
services revenue
|
$ | 3,634 | 4,217 | (583 | ) | (13.8 | )% | $ | 13,658 | 15,828 | (2,170 | ) | (13.7 | )% | |||||||||||||
Intersegment
revenue
|
3,793 | 1,660 | 2,133 | 128.5 | 10,813 | 4,993 | 5,820 | 116.6 | |||||||||||||||||||
Total
other income
|
7,427 | 5,877 | 1,550 | 26.4 | 24,471 | 20,821 | 3,650 | 17.5 | |||||||||||||||||||
Salaries
and benefits
|
5,756 | 4,138 | 1,618 | 39.1 | 16,656 | 14,031 | 2,625 | 18.7 | |||||||||||||||||||
Restructure
expense - severance and
|
|||||||||||||||||||||||||||
contract
termination costs
|
292 | — | 292 | 100.0 | 714 | 487 | 227 | 46.6 | |||||||||||||||||||
Other
expenses
|
776 | 568 | 208 | 36.6 | 2,292 | 1,901 | 391 | 20.6 | |||||||||||||||||||
Intersegment
expenses
|
786 | 826 | (40 | ) | (4.8 | ) | 2,195 | 1,562 | 633 | 40.5 | |||||||||||||||||
Total
operating expenses
|
7,610 | 5,532 | 2,078 | 37.6 | 21,857 | 17,981 | 3,876 | 21.6 | |||||||||||||||||||
"Base
net income" before income taxes
|
(183 | ) | 345 | (528 | ) | (153.0 | ) | 2,614 | 2,840 | (226 | ) | (8.0 | ) | ||||||||||||||
Income
tax expense
|
70 | (128 | ) | 198 | (154.7 | ) | (994 | ) | (902 | ) | (92 | ) | 10.2 | ||||||||||||||
"Base
net income"
|
$ | (113 | ) | 217 | (330 | ) | (152.1 | )% | $ | 1,620 | 1,938 | (318 | ) | (16.4 | )% | ||||||||||||
Before
Tax Operating Margin
|
(2.5 | %) | 5.9 | % | 10.7 | % | 13.6 | % | |||||||||||||||||||
Before
Tax Operating Margin -
|
|||||||||||||||||||||||||||
excluding
restructure expense
|
1.5 | % | 5.9 | % | 13.6 | % | 16.0 | % |
Software
services revenue. Software services revenue
decreased in 2009 compared to 2008 as the result of a reduction in the number of
projects for existing external customers and the loss of external customers due
to the legislative developments in the student loan industry throughout 2008 and
2009.
Intersegment
revenue.
Intersegment revenue increased in 2009 compared to the same periods in
2008 as a result of an increase in the number of projects for internal
customers.
Operating
expenses.
Operating expenses increased in 2009 compared to the same periods in 2008 as a
result of costs associated with salaries and benefits to support the increase in
intersegment revenue.
56
ASSET
GENERATION AND MANAGEMENT OPERATING SEGMENT – RESULTS OF OPERATIONS
The Asset
Generation and Management Operating Segment includes the origination,
acquisition, management, and ownership of the Company’s student loan assets,
which has historically been the Company’s largest product and service offering.
The Company generates a substantial portion of its earnings from the spread,
referred to as the Company’s student loan spread, between the yield it receives
on its student loan portfolio and the costs associated with originating,
acquiring, and financing its 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. 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
tables below outline the components of the Company’s student loan
portfolio:
As
of September 30, 2009
|
||||||||||||||||||||||||
2008-2009 | ||||||||||||||||||||||||
Originated
|
Originated
|
Academic
Year
|
2009-2010 | |||||||||||||||||||||
prior
to
|
between
10/1/07
|
Loans - held |
Academic
Year
|
|||||||||||||||||||||
Total
|
10/1/07
|
and
6/3/08 (a)
|
for
sale (b)
|
Loans
(b)
|
||||||||||||||||||||
Federally
insured:
|
||||||||||||||||||||||||
Stafford
|
$ | 8,321,669 | 32.8 | % | $ | 6,140,869 | 452,558 | 1,445,080 | 283,162 | |||||||||||||||
PLUS/SLS
|
615,513 | 2.4 | % | 369,335 | 47,585 | 162,089 | 36,504 | |||||||||||||||||
Consolidation
|
15,965,190 | 62.9 | % | 15,778,158 | 187,032 | — | — | |||||||||||||||||
Total
federally insured
|
24,902,372 | 98.1 | % | $ | 22,288,362 | 687,175 | 1,607,169 | 319,666 | ||||||||||||||||
100.0 | % | 89.4 | % | 2.8 | % | 6.5 | % | 1.3 | % | |||||||||||||||
Non-federally
insured
|
167,114 | 0.6 | % | |||||||||||||||||||||
Total
student loans receivable (gross)
|
25,069,486 | 98.7 | % | |||||||||||||||||||||
Unamortized
premiums and deferred
|
||||||||||||||||||||||||
origination
costs - held for investment
|
352,066 | 1.4 | % | |||||||||||||||||||||
Unamortized
premiums and deferred
|
||||||||||||||||||||||||
origination
costs - held for sale
|
20,625 | 0.1 | % | |||||||||||||||||||||
Allowance
for loan losses:
|
||||||||||||||||||||||||
Federally
insured
|
(29,015 | ) | (0.1 | %) | ||||||||||||||||||||
Non-federally
insured
|
(21,105 | ) | (0.1 | %) | ||||||||||||||||||||
Total
student loans receivable (net)
|
$ | 25,392,057 | 100.0 | % |
57
As
of December 31, 2008
|
||||||||||||||||||||
Originated
|
Originated
|
2008-2009
|
||||||||||||||||||
prior
to
|
between
10/1/07
|
Academic
Year
|
||||||||||||||||||
Total
|
10/1/07
|
and
6/3/08 (a)
|
Loans
(b)
|
|||||||||||||||||
Federally
insured:
|
||||||||||||||||||||
Stafford
|
$ | 7,602,568 | 29.9 | % | $ | 6,641,817 | 390,658 | 570,093 | ||||||||||||
PLUS/SLS
|
527,670 | 2.1 | % | 412,142 | 48,346 | 67,182 | ||||||||||||||
Consolidation
|
16,657,703 | 65.5 | % | 16,614,950 | 42,753 | — | ||||||||||||||
Total
federally insured
|
24,787,941 | 97.5 | % | $ | 23,668,909 | 481,757 | 637,275 | |||||||||||||
100.0 | % | 95.5 | % | 1.9 | % | 2.6 | % | |||||||||||||
Non-federally
insured
|
273,108 | 1.1 | % | |||||||||||||||||
Total
student loans receivable (gross)
|
25,061,049 | 98.6 | % | |||||||||||||||||
Unamortized
premiums and deferred
|
||||||||||||||||||||
origination
costs
|
402,881 | 1.6 | % | |||||||||||||||||
Allowance
for loan losses:
|
||||||||||||||||||||
Federally
insured
|
(25,577 | ) | (0.1 | %) | ||||||||||||||||
Non-federally
insured
|
(25,345 | ) | (0.1 | %) | ||||||||||||||||
Total
student loans receivable (net)
|
$ | 25,413,008 | 100.0 | % | ||||||||||||||||
(a)
|
Federally
insured student loans originated on or after October 1, 2007 earn a
reduced annual yield as a result of the enactment of the College Cost
Reduction Act in September 2007.
|
(b)
|
2008-2009
and 2009-2010 Academic Year loans are eligible to be participated and sold
to the Department under the Department’s Participation and Purchase
Programs. As of September 30, 2009, the 2008-2009 Academic Year loans
classified as held for sale were sold to the Department under the
Department’s Purchase Program in October 2009. As of September 30, 2009,
the 2009-2010 Academic Year loans are classified as loans held for
investment in the Company’s consolidated balance
sheet.
|
Origination
and Acquisition
The
Company has historically originated and acquired 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.
58
The
following table sets forth the activity of loans originated or acquired through
each of the Company’s channels:
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Beginning
balance
|
$ | 25,299,539 | 25,612,126 | 25,061,049 | 26,329,213 | |||||||||||
Direct
channel:
|
||||||||||||||||
Consolidation
loan originations
|
— | 44 | — | 69,073 | ||||||||||||
Less
consolidation of existing portfolio
|
— | (27 | ) | — | (28,474 | ) | ||||||||||
Net
consolidation loan originations
|
— | 17 | — | 40,599 | ||||||||||||
Stafford/PLUS
loan originations
|
496,720 | 416,721 | 1,295,156 | 952,050 | ||||||||||||
Branding
partner channel
|
70,217 | 334,685 | 665,788 | 935,992 | ||||||||||||
Forward
flow channel
|
75,260 | 114,488 | 126,304 | 517,548 | ||||||||||||
Other
channels
|
19,257 | — | 39,627 | 55,922 | ||||||||||||
Total
channel acquisitions
|
661,454 | 865,911 | 2,126,875 | 2,502,111 | ||||||||||||
Repayments,
claims, capitalized interest, participations, and other
|
(261,922 | ) | (369,940 | ) | (1,198,890 | ) | (1,255,183 | ) | ||||||||
Consolidation
loans lost to external parties
|
(149,984 | ) | (106,684 | ) | (322,573 | ) | (282,951 | ) | ||||||||
Loans
sold
|
(479,601 | ) | — | (596,975 | ) | (1,291,777 | ) | |||||||||
Ending
balance
|
$ | 25,069,486 | 26,001,413 | 25,069,486 | 26,001,413 |
The
Company has significant financing needs that it meets through the capital
markets. Since August 2007, the capital markets have experienced unprecedented
disruptions. 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 the direct to consumer
channel. Accordingly, beginning in January 2008, the Company suspended
Consolidation and private student loan originations and 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.
Historically,
the Company funded new loan originations using loan warehouse facilities and
asset-backed securitizations. Student loan warehousing has historically allowed
the Company to buy and manage student loans prior to transferring them into more
permanent financing arrangements. In July 2008, the Company did not renew its
liquidity provisions on its FFELP warehouse facility. Accordingly, the facility
became a term facility and no new loan originations could be funded with this
facility. In August 2008, the Company began funding FFELP Stafford and PLUS
student loan originations for the 2008-2009 academic year pursuant to the
Department’s Participation Program.
On
October 7, 2008, legislation was enacted to extend the Department’s authority to
address FFELP student loans made for the 2009-2010 academic year and allowing
for the extension of the Participation Program from September 30, 2009 to
September 30, 2010. The Company plans to continue to use the Participation
Program and a participation agreement with Union Bank to fund loans for the
2009-2010 academic year. These facilities are allowing the Company to continue
originating new federal student loans to all students regardless of the school
they attend.
59
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 September 30,
|
Nine
months ended September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Balance
at beginning of period
|
$ | 50,000 | 47,909 | 50,922 | 45,592 | |||||||||||
Provision
for loan losses:
|
||||||||||||||||
Federally
insured loans
|
4,500 | 4,500 | 15,000 | 12,000 | ||||||||||||
Non-federally
insured loans
|
3,000 | 2,500 | 8,000 | 6,000 | ||||||||||||
Total
provision for loan losses
|
7,500 | 7,000 | 23,000 | 18,000 | ||||||||||||
Charge-offs,
net of recoveries:
|
||||||||||||||||
Federally
insured loans
|
(3,578 | ) | (4,218 | ) | (11,042 | ) | (11,418 | ) | ||||||||
Non-federally
insured loans
|
(802 | ) | (1,621 | ) | (2,440 | ) | (2,354 | ) | ||||||||
Net
charge-offs
|
(4,380 | ) | (5,839 | ) | (13,482 | ) | (13,772 | ) | ||||||||
Sale
of federally insured loans
|
— | — | (520 | ) | (750 | ) | ||||||||||
Sale
of non-federally insured loans
|
(3,000 | ) | — | (9,800 | ) | — | ||||||||||
Balance
at end of period
|
$ | 50,120 | 49,070 | 50,120 | 49,070 | |||||||||||
Allocation
of the allowance for loan losses:
|
||||||||||||||||
Federally
insured loans
|
$ | 29,015 | 24,366 | 29,015 | 24,366 | |||||||||||
Non-federally
insured loans
|
21,105 | 24,704 | 21,105 | 24,704 | ||||||||||||
Total
allowance for loan losses
|
$ | 50,120 | 49,070 | 50,120 | 49,070 | |||||||||||
Net
loan charge-offs as a percentage of average student loans
|
0.070 | % | 0.090 | % | 0.070 | % | 0.070 | % | ||||||||
Total
allowance as a percentage of the ending balance of student
|
||||||||||||||||
loans
(excluding loans held-for-sale)
|
0.214 | % | 0.189 | % | 0.214 | % | 0.189 | % | ||||||||
Allowance
for non-federally insured loans as a percentage such loans
|
12.629 | % | 8.966 | % | 12.629 | % | 8.966 | % | ||||||||
Average
student loans
|
$ | 25,056,836 | 26,035,006 | 25,148,707 | 26,220,486 | |||||||||||
Ending
balance of student loans (excluding loans held-for-sale)
|
23,462,317 | 26,001,413 | 23,462,317 | 26,001,413 | ||||||||||||
Ending
balance of non-federally insured loans
|
167,114 | 275,520 | 167,114 | 275,520 |
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 September 30, 2009
|
As
of December 31, 2008
|
|||||||||||||||
Dollars
|
Percent
|
Dollars
|
Percent
|
|||||||||||||
Federally
Insured Loans:
|
||||||||||||||||
Loans
in-school/grace/deferment(1)
|
$ | 8,042,550 | $ | 7,374,602 | ||||||||||||
Loans
in forebearance(2)
|
2,412,644 | 2,484,478 | ||||||||||||||
Loans
in repayment status:
|
||||||||||||||||
Loans
current
|
12,464,768 | 86.2 | % | 13,169,101 | 88.2 | % | ||||||||||
Loans
delinquent 31-60 days(3)
|
629,064 | 4.4 | 536,112 | 3.6 | ||||||||||||
Loans
delinquent 61-90 days(3)
|
325,522 | 2.3 | 240,549 | 1.6 | ||||||||||||
Loans
delinquent 91 days or greater(4)
|
1,027,824 | 7.1 | 983,099 | 6.6 | ||||||||||||
Total
loans in repayment
|
14,447,178 | 100.0 | % | 14,928,861 | 100.0 | % | ||||||||||
Total
federally insured loans
|
$ | 24,902,372 | $ | 24,787,941 | ||||||||||||
Non-Federally
Insured Loans:
|
||||||||||||||||
Loans
in-school/grace/deferment(1)
|
$ | 45,022 | $ | 84,237 | ||||||||||||
Loans
in forebearance(2)
|
1,722 | 9,540 | ||||||||||||||
Loans
in repayment status:
|
||||||||||||||||
Loans
current
|
112,063 | 93.1 | % | 169,865 | 94.7 | % | ||||||||||
Loans
delinquent 31-60 days(3)
|
3,165 | 2.6 | 3,315 | 1.8 | ||||||||||||
Loans
delinquent 61-90 days(3)
|
1,871 | 1.6 | 1,743 | 1.0 | ||||||||||||
Loans
delinquent 91 days or greater(4)
|
3,271 | 2.7 | 4,408 | 2.5 | ||||||||||||
Total
loans in repayment
|
120,370 | 100.0 | % | 179,331 | 100.0 | % | ||||||||||
Total
non-federally insured loans
|
$ | 167,114 | $ | 273,108 | ||||||||||||
(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.
|
60
(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 September 30,
|
Nine
months ended September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Variable
student loan yield
|
2.64 | % | 5.23 | % | 2.95 | % | 5.54 | % | ||||||||
Consolidation
rebate fees
|
(0.68 | ) | (0.72 | ) | (0.70 | ) | (0.74 | ) | ||||||||
Premium
and deferred origination costs amortization
|
(0.31 | ) | (0.33 | ) | (0.29 | ) | (0.35 | ) | ||||||||
Variable
student loan net yield
|
1.65 | 4.18 | 1.96 | 4.45 | ||||||||||||
Student
loan cost of funds - interest expense
|
(1.07 | ) | (3.30 | ) | (1.58 | ) | (3.73 | ) | ||||||||
Student
loan cost of funds - derivative settlements
|
0.08 | 0.06 | 0.20 | 0.25 | ||||||||||||
Variable
student loan spread
|
0.66 | 0.94 | 0.58 | 0.97 | ||||||||||||
Variable
rate floor income,
|
||||||||||||||||
net
of settlements on derivatives (a)
|
— | — | (0.04 | ) | (0.08 | ) | ||||||||||
Fixed
rate floor income,
|
||||||||||||||||
net
of settlements on derivatives
|
0.61 | 0.10 | 0.56 | 0.13 | ||||||||||||
Core
student loan spread
|
1.27 | % | 1.04 | % | 1.10 | % | 1.02 | % | ||||||||
Average
balance of student loans
|
$ | 25,056,836 | 26,035,006 | 25,148,707 | 26,220,486 | |||||||||||
Average
balance of debt outstanding
|
25,677,213 | 26,769,955 | 25,704,825 | 27,120,342 |
(a)
|
As
a result of the ongoing volatility of interest rates, effective October 1,
2008, the Company changed its calculation of variable rate floor income to
better reflect the economic benefit received by the Company. The economic
benefit received by the Company related to variable rate floor income was
$0.1 million for the three months ended September 30, 2008 and $7.5
million and $25.7 million for the nine months ended September 30, 2009 and
2008, respectively. There was no economic benefit received by the Company
related to variable rate floor income for the three months ended September
30, 2009. Variable rate floor income calculated on a statutory maximum
basis was $0.1 million and $1.6 million for the three months ended
September 30, 2009 and 2008, respectively, and $23.9 million
and $42.3 million for the nine months ended September 30, 2009 and 2008,
respectively. Beginning October 1, 2008, and for presentation of prior
periods, the economic benefit received by the Company has been used to
determine core student loan spread. For the student loan spread analysis
shown above, variable-rate floor income for prior periods was changed to
reflect the economic benefit to conform to the current period
presentation.
|
The
Company’s core student loan spread during the three and nine months ended
September 30, 2009 compared to 2008 was impacted by the following
items:
Increases
·
|
The
amortization of loan premiums and deferred origination costs, which is a
reduction to core student loan spread, decreased as a result of reduced
costs to acquire or originate loans and a decrease in the yield earned on
student loans.
|
·
|
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. Due to lower interest rates in the three and nine
month period ended September 30, 2009 compared to the same period in 2008,
the Company received additional fixed rate floor income on a portion of
its student loan portfolio. See Item 3, “Quantitative and Qualitative
Disclosures about Market Risk – Interest Rate Risk” for additional
information.
|
·
|
The
Company has used derivative instruments to hedge the repricing risk due to
the timing of the interest rate resets on its assets and liabilities. The
Company has entered into basis swaps in which the Company receives
three-month LIBOR and pays one-month LIBOR plus or minus a spread as
defined in the agreements. During the three and nine months ended
September 30, 2009, the Company received $3.1 million and $20.5 million,
respectively, of settlements on its 1/3 Basis Swaps. During the first
quarter of 2008, the Company received $0.9 million of settlements on its
1/3 Basis Swaps. No 1/3 Basis Swaps were outstanding during the three
months ended September 30, 2008.
|
61
Decreases
·
|
The
passage of the College Cost Reduction Act has reduced the yield on all
FFELP loans originated after October 1, 2007. As of September 30, 2009,
10.6% of the Company’s federally insured student loan portfolio was
originated after October 1, 2007 as compared to 4.1% as of
September 30, 2008.
|
·
|
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. The short term movement of the indices was dislocated
beginning in August 2007. Due to the unintended consequences of government
intervention in the commercial paper markets and limited issuances of
qualifying financial commercial paper, the relationship between the
three-month financial CP and LIBOR rates has widened from historical
levels. To address this issue, the Department announced that for purposes
of calculating the FFELP loan index from October 27, 2008 to December 31,
2008, the Federal Reserve’s Commercial Paper Funding Facility rate was
used for those days in which no three-month financial commercial paper
rate was available. This action partially mitigated the volatility between
CP and LIBOR for the three-month period ended on December 31, 2008.
However, the Department of Education did not make a similar adjustment for
2009, which negatively impacted the Company’s net interest income for the
three and nine months ended September 30,
2009.
|
·
|
The
spread to LIBOR on asset-backed securities transactions has increased
significantly since August 2007. The Company issued $4.4 billion of notes
in asset-backed securities transactions in 2008 ($1.2 billion in March
2008, $1.9 billion in April 2008, and $1.3 billion in May 2008) and an
additional $0.3 billion in March 2009. Prior to completing these
asset-backed securities transactions, these loans were funded in the
Company’s FFELP warehouse facility in which the cost of funds were lower
than the asset-backed securities
transactions.
|
·
|
The
Company has used derivative instruments to hedge the repricing risk due to
the timing of the interest rate resets on its assets and liabilities. 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 Average/Discrete Basis Swaps”). The Company received less
settlements on its Average/Discrete Basis Swaps in the first and second
quarters of 2009 compared to the same periods in 2008 due to the
significant drop in interest rates in 2008 which triggered larger
settlements during the first and second quarters of
2008.
|
62
Three
and nine months ended September 30, 2009 compared to the three and nine months
ended September 30, 2008
Three
months ended September 30,
|
Nine
months ended September 30,
|
|||||||||||||||||||||||||
Change
|
Change
|
|||||||||||||||||||||||||
2009
|
2008
|
$ | % |
2009
|
2008
|
$ | % | |||||||||||||||||||
Net
interest income after provision
|
||||||||||||||||||||||||||
for
loan losses
|
$ | 66,896 | 58,767 | 8,129 | 13.8 | % | $ | 143,284 | 112,001 | 31,283 | 27.9 | % | ||||||||||||||
Loan
and guaranty servicing revenue
|
— | (136 | ) | 136 | (100.0 | ) | — | 26 | (26 | ) | (100.0 | ) | ||||||||||||||
Other
income
|
9,959 | 4,079 | 5,880 | 144.2 | 18,851 | 13,787 | 5,064 | 36.7 | ||||||||||||||||||
Gain
(loss) on sale of loans, net
|
8,788 | — | 8,788 | 100.0 | 8,386 | (47,426 | ) | 55,812 | (117.7 | ) | ||||||||||||||||
Derivative
market value, foreign currency,
|
||||||||||||||||||||||||||
and
put option adjustments
|
— | — | — | — | — | 466 | (466 | ) | (100.0 | ) | ||||||||||||||||
Derivative
settlements, net
|
4,914 | 789 | 4,125 | 522.8 | 38,807 | 55,954 | (17,147 | ) | (30.6 | ) | ||||||||||||||||
Total
other income
|
23,661 | 4,732 | 18,929 | 400.0 | 66,044 | 22,807 | 43,237 | 189.6 | ||||||||||||||||||
Salaries
and benefits
|
1,693 | 1,980 | (287 | ) | (14.5 | ) | 5,203 | 6,157 | (954 | ) | (15.5 | ) | ||||||||||||||
Restructure
expense - severance and contract
|
||||||||||||||||||||||||||
termination
costs
|
— | — | — | — | — | 1,845 | (1,845 | ) | (100.0 | ) | ||||||||||||||||
Impairment
expense
|
— | — | — | — | — | 9,351 | (9,351 | ) | (100.0 | ) | ||||||||||||||||
Other
expenses
|
4,801 | 5,354 | (553 | ) | (10.3 | ) | 15,635 | 15,793 | (158 | ) | (1.0 | ) | ||||||||||||||
Intersegment
expenses
|
20,764 | 18,200 | 2,564 | 14.1 | 59,372 | 57,754 | 1,618 | 2.8 | ||||||||||||||||||
Total
operating expenses
|
27,258 | 25,534 | 1,724 | 6.8 | 80,210 | 90,900 | (10,690 | ) | (11.8 | ) | ||||||||||||||||
"Base
net income" before income taxes
|
63,299 | 37,965 | 25,334 | 66.7 | 129,118 | 43,908 | 85,210 | 194.1 | ||||||||||||||||||
Income
tax expense
|
(24,054 | ) | (14,047 | ) | (10,007 | ) | 71.2 | (49,066 | ) | (15,889 | ) | (33,177 | ) | 208.8 | ||||||||||||
"Base
net income"
|
$ | 39,245 | 23,918 | 15,327 | 64.1 | % | $ | 80,052 | 28,019 | 52,033 | 185.7 | % | ||||||||||||||
Before
Tax Operating Margin
|
69.9 | % | 59.8 | % | 61.7 | % | 32.6 | % | ||||||||||||||||||
Before
Tax Operating Margin -
|
||||||||||||||||||||||||||
excluding
restructure expense,
|
||||||||||||||||||||||||||
impairment
expense, and loss on sale
|
||||||||||||||||||||||||||
of
loans during the first quarter of 2008
|
69.9 | % | 59.8 | % | 61.7 | % | 56.3 | % | ||||||||||||||||||
Net
interest income after provision for loan losses.
Three
months ended September 30,
|
Change
|
|||||||||||||||
2009
|
2008
|
Dollars
|
Percent
|
|||||||||||||
Loan
interest
|
$ | 205,978 | 351,331 | (145,353 | ) | (41.4 | )% | |||||||||
Consolidation
rebate fees
|
(43,191 | ) | (47,105 | ) | 3,914 | 8.3 | ||||||||||
Amortization
of loan premiums and
|
||||||||||||||||
deferred
origination costs
|
(19,532 | ) | (21,338 | ) | 1,806 | 8.5 | ||||||||||
Total
loan interest
|
143,255 | 282,888 | (139,633 | ) | (49.4 | ) | ||||||||||
Investment
interest
|
1,055 | 7,151 | (6,096 | ) | (85.2 | ) | ||||||||||
Total
interest income
|
144,310 | 290,039 | (145,729 | ) | (50.2 | ) | ||||||||||
Interest
on bonds and notes payable
|
69,572 | 223,523 | (153,951 | ) | (68.9 | ) | ||||||||||
Intercompany
interest
|
342 | 749 | (407 | ) | (54.3 | ) | ||||||||||
Provision
for loan losses
|
7,500 | 7,000 | 500 | 7.1 | ||||||||||||
Net
interest income after provision
|
||||||||||||||||
for
loan losses
|
$ | 66,896 | 58,767 | 8,129 | 13.8 | % |
`
·
|
Loan
interest income decreased $145.4 million as a result of a decrease in the
average student loan portfolio of $1.0 billion (3.8%) and a decrease in
the yield earned on student loans due to a decrease in interest rates for
the three months ended September 30, 2009 compared to the same period in
2008. In addition, the passage of the College Cost Reduction Act has
reduced the yield on all FFELP loans originated after October 1, 2007. As
of September 30, 2009, 10.6% of the Company’s federally insured student
loan portfolio was originated after October 1, 2007 as compared to 4.2% as
of September 30, 2008. These decreases were
offset by an increase of $29.3 million due to an increase in fixed rate
floor income.
|
·
|
Consolidation
rebate fees decreased due to the $1.7 billion (9.7%) decrease in the
average consolidation portfolio.
|
·
|
The
amortization of loan premiums and deferred origination costs decreased as
a result of reduced costs to acquire or originate loans and a decrease in
the yield earned on student loans.
|
63
·
|
Investment
income decreased as a result of lower interest rates in the second quarter
of 2009 as compared to the same period in
2008.
|
·
|
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 1.07% for the three months ended
September 30, 2009 compared to 3.30% for the same period a year ago. In
addition, average debt decreased by $1.1 billion (4.1%) for the three
months ended September 30, 2009 compared to the same period in
2008.
|
·
|
The
provision for loan losses increased for the three months ended September
30, 2009 compared to the same period in 2008 primarily due to increases in
delinquencies.
|
Nine
months ended September 30,
|
Change
|
|||||||||||||||
2009
|
2008
|
Dollars
|
Percent
|
|||||||||||||
Loan
interest
|
$ | 653,553 | 1,083,078 | (429,525 | ) | (39.7 | )% | |||||||||
Consolidation
rebate fees
|
(131,496 | ) | (144,680 | ) | 13,184 | 9.1 | ||||||||||
Amortization
of loan premiums and
|
||||||||||||||||
deferred
origination costs
|
(54,972 | ) | (69,583 | ) | 14,611 | 21.0 | ||||||||||
Total
loan interest
|
467,085 | 868,815 | (401,730 | ) | (46.2 | ) | ||||||||||
Investment
interest
|
6,045 | 23,875 | (17,830 | ) | (74.7 | ) | ||||||||||
Total
interest income
|
473,130 | 892,690 | (419,560 | ) | (47.0 | ) | ||||||||||
Interest
on bonds and notes payable
|
305,522 | 761,300 | (455,778 | ) | (59.9 | ) | ||||||||||
Intercompany
interest
|
1,324 | 1,389 | (65 | ) | (4.7 | ) | ||||||||||
Provision
for loan losses
|
23,000 | 18,000 | 5,000 | 27.8 | ||||||||||||
Net
interest income (loss) after provision
|
||||||||||||||||
for
loan losses
|
$ | 143,284 | 112,001 | 31,283 | (27.9 | )% |
·
|
Loan
interest income decreased $429.5 million as a result of a decrease in the
average student loan portfolio of $1.1 billion (4.1%) and a decrease in
the yield earned on student loans due to a decrease in interest rates for
the nine months ended September 30, 2009 compared to the same period in
2008. In addition, the passage of the College Cost Reduction Act has
reduced the yield on all FFELP loans originated after October 1, 2007. As
of September 30, 2009, 10.6% of the Company’s federally insured student
loan portfolio was originated after October 1, 2007 as compared to 4.2% as
of September 30, 2008. These
decreases were offset by an increase of $77.2 million due to an increase
in fixed rate floor income.
|
·
|
Consolidation
rebate fees decreased due to the $2.2 billion (12.1%) decrease in the
average consolidation portfolio.
|
·
|
The
amortization of loan premiums and deferred origination costs decreased as
a result of reduced costs to acquire or originate loans and a decrease in
the yield earned on student loans.
|
·
|
Investment
income decreased as a result of lower interest rates for the nine months
ended September 30, 2009 as compared to the same period in
2008.
|
·
|
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 1.58% for the nine months ended
September 30, 2009 compared to 3.73% for the same period a year ago. In
addition, average debt decreased by $1.4 billion (5.2%) for the nine
months ended September 30, 2009 compared to the same period in
2008.
|
·
|
The
provision for loan losses increased for the nine months ended September
30, 2009 compared to the same period in 2008 primarily due to increases in
delinquencies.
|
Other
income. The increase in other income is due to the Company purchasing
certain asset-backed securities resulting in the recognition of a gain of $5.9
million during the three months ended September 30, 2009.
64
Gain
(loss) on sale of loans, net.
A summary
of gains (losses) from the sale of student loan assets during 2008 and 2009
follows:
Three
months ended September 30,
|
Nine
months ended September 30,
|
||||||||||||||
2009
|
2008
|
2009
|
2008
|
||||||||||||
Department's
Purchase Program (a)
|
$ | 9,689 | — | 9,689 | — | ||||||||||
Private
loan participations (b)
|
(695 | ) | — | (695 | ) | — | |||||||||
FFELP
loan sales to a related party (c)
|
(206 | ) | — | (608 | ) | — | |||||||||
FFELP
loan sales to a third party (d)
|
— | — | — | (47,426 | ) | ||||||||||
Gain
(loss) on sale of loans, net
|
$ | 8,788 | — | 8,386 | (47,426 | ) |
(a)
|
During
the three months ended September 30, 2009, the Company sold $427.7 million
of student loans to the Department under the Purchase
Program.
|
(b)
|
During
the three and nine months ended September 30, 2009, the Company
participated $30.5 million and $95.5 million,
respectively, of non-federally insured loans to third parties, which
resulted in the recognition of a net loss on the sale of these loans for
both periods.
|
(c)
|
During
the three and nine months ended September 30, 2009, the Company sold $21.4
million (par value) and $61.5
million (par value), respectively, of federally insured student
loans.
|
(d)
|
The
Company sold $1.3 billion (par value) of student loans to third parties in
2008 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.
|
Derivative
settlements, net.
The Company maintains an overall risk management strategy that
incorporates the use of derivative instruments to reduce the economic effect of
interest rate volatility. Management has structured all of the Company’s
derivative transactions with the intent that each is economically effective;
however, the Company’s derivative instruments do not qualify for hedge
accounting. Derivative settlements for each applicable period should be
evaluated with the Company’s net interest income as shown in this Item 2,
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations – Asset Generation and Management Operating Segment – Results of
Operations – Student Loan Spread Analysis.”
Intersegment
expenses.
Intersegment expenses increased in 2009 compared to the same periods in
2008 due to additional fees paid to the Student Loan and Guaranty Servicing
operating segment. These additional fees relate to an increase in origination
fees due to an increase in disbursement volume, an increase in fees related to
the number of loans transferred between various financings as the Company was
executing financing strategies, and incurring conversion fees as a result of the
Company selling $427.7 million of student loans to the Department under the
Purchase Program.
LIQUIDITY
AND CAPITAL RESOURCES
The
Company’s fee generating businesses are non-capital intensive and all produce
positive operating cash flows. As such, a minimal amount of debt and equity
capital is allocated to the fee-based segments and any liquidity or capital
needs are satisfied using cash flow from operations. Therefore, the Liquidity
and Capital Resources discussion is concentrated on the Company’s liquidity and
capital needs to fund new FFELP student loan originations and meet existing debt
obligations, primarily related to debt facilities in the Asset Generation and
Management operating segment and unsecured corporate debt.
The
Company has historically utilized operating cash flow, secured financing
transactions (which include warehouse facilities and asset-backed
securitizations), operating lines of credit, and other borrowing arrangements to
fund its Asset Generation and Management operations and student loan
acquisitions. In addition, the Company has used operating cash flow, borrowings
on its unsecured line of credit, and unsecured debt offerings to fund corporate
activities, business acquisitions, and repurchases of common stock.
The
Company may issue equity and debt securities in the future in order to improve
capital, increase liquidity, refinance upcoming maturities, or provide for
general corporate purposes. Moreover, the Company may from time-to-time
repurchase certain amounts of its outstanding secured and unsecured debt
securities, including debt securities which the Company may issue in the future,
for cash and/or through exchanges for other securities. Such repurchases or
exchanges may be made in open market transactions, privately negotiated
transactions, or otherwise. Any such repurchases or exchanges will depend on
prevailing market conditions, the Company’s liquidity requirements, contractual
restrictions, compliance with securities laws, and other factors. The amounts
involved in any such transactions may be material.
65
Liquidity
Needs
The
Company has two primary liquidity needs:
·
|
Fund
new FFELP Stafford and PLUS loan originations for the 2009-2010 academic
year
|
·
|
Satisfy
debt obligations, specifically its unsecured senior notes and unsecured
line of credit
|
The
following table summarizes the Company’s debt obligations as of September 30,
2009.
Carrying
|
Interest
rate
|
||||||||
amount
|
range
|
Final
maturity
|
|||||||
Asset
Generation and Management:
|
|||||||||
Bonds
and notes issued in asset-backed securitizations
|
$ | 22,183,537 | 0.30% - 6.90% |
11/01/09
- 07/01/43
|
|||||
DOE
Participation
|
1,902,909 | 0.91% |
10/15/2009
and 09/30/10
|
||||||
FFELP
warehouse facility
|
361,279 | 0.22% - 0.38% |
08/03/12
|
||||||
DOE
Conduit
|
1,155,351 | 0.37% |
05/08/14
|
||||||
25,603,076 | |||||||||
Unsecured
Corporate Debt and other:
|
|||||||||
Senior
notes
|
66,716 | 5.125% |
06/01/10
|
||||||
Unsecured
line of credit
|
691,500 | 0.73% - 0.79% |
05/08/12
|
||||||
Junior
Subordinated Hybrid securities
|
198,250 | 7.40% |
09/15/61
|
||||||
Other
borrowings
|
26,551 | 0.26% - 5.10% |
01/10/10
- 11/01/15
|
||||||
983,017 | |||||||||
$ | 26,586,093 |
Bonds and notes issued in
asset backed securitizations are structured to substantially match the maturity
of the funded assets and there are minimal liquidity issues related to these
facilities. Other secured bonds and notes included under Asset Generation and
Management in the above table are limited obligation borrowings which are
secured by student loan assets and related collateral.
Sources
of Liquidity
Sources
of Liquidity Available for New FFELP Stafford and PLUS Loans
The
Company has unlimited sources of liquidity available for new FFELP Stafford and
PLUS loan originations for the 2009-2010 academic year under the Department’s
Participation and Purchase Programs. In addition, the Company maintains an
agreement with Union Bank, as trustee for various grantor trusts, under which
Union Bank has agreed to purchase from the Company participation interests in
student loans, and in August 2009, the Company entered into a FFELP warehouse
facility that has a maximum financing amount of $500.0 million with a revolving
financing structure.
The
Company plans to fund all 2009-2010 academic year loans using the Participation
Program, the agreement with Union Bank, and the new FFELP warehouse facility.
These facilities are described in further detail below.
Department of Education’s
Loan Participation and Purchase Commitment Programs
In August
2008, the Department implemented the Purchase and Participation Programs
pursuant to ECASLA. Under the Department’s Purchase Program, the Department will
purchase loans at a price equal to the sum of (i) par value, (ii) accrued
interest, (iii) the one percent origination fee paid to the Department, and (iv)
a fixed amount of $75 per loan. Under the Participation Program, the Department
provides interim short term liquidity to FFELP lenders by purchasing
participation interests in pools of FFELP loans. FFELP lenders are charged a
rate of commercial paper plus 50 basis points on the principal amount of
participation interests outstanding. Loans funded under the Participation
Program for the 2008-2009 academic year were required to be either refinanced by
the lender or sold to the Department pursuant to the Purchase Program prior to
its expiration on October 15, 2009. To be eligible for purchase or participation
under the Department’s programs, loans were originally limited to FFELP Stafford
or PLUS loans made for the academic year 2008-2009, first disbursed between May
1, 2008 and July 1, 2009, with eligible borrower benefits.
On
October 7, 2008, legislation was enacted to extend the Department’s authority to
address FFELP student loans made for the 2009-2010 academic year and allowing
for the extension of the Participation Program and Purchase Program from
September 30, 2009 to September 30, 2010. The Department indicated that loans
for the 2008-2009 academic year funded under the Department's Participation
Program were required to be refinanced or sold to the Department prior to
October 15, 2009. On November 8, 2008, the Department announced the replication
of the terms of the Participation and Purchase Programs, in accordance with the
October 7, 2008 legislation, which will include FFELP student loans made for the
2009-2010 academic year.
As of
September 30, 2009, the Company had $1.9 billion of FFELP loans funded using the
Participation Program, of which $1.6 billion were 2008-2009 academic year loans
and are classified as held for sale on the Company’s consolidated balance sheet.
These loans were sold to the Department under its Purchase Program in October
2009. Upon selling the $1.6 billion of loans, the Company recognized a gain of
$26.9 million.
Union Bank Participation
Agreement
The
Company maintains an agreement with Union Bank, as trustee for various grantor
trusts, under which Union Bank has agreed to purchase from the Company
participation interests in student loans (the “FFELP Participation Agreement”).
The Company has the option to purchase the participation interests from the
grantor trusts at the end of a 364-day period upon termination of the
participation certificate. As of September 30, 2009, $681.9 million 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 or an amount in
excess of $750 million if mutually agreed to by both parties. Loans participated
under this agreement have been accounted for by the Company as loan sales.
Accordingly, the participation interests sold are not included on the Company’s
consolidated balance sheet.
66
FFELP Warehouse
Facility
On August
3, 2009, the Company entered into a FFELP warehouse facility (the “2009 FFELP
Warehouse Facility”). The 2009 FFELP Warehouse Facility has a maximum financing
amount of $500.0 million, with a revolving financing structure supported by
364-day liquidity provisions, which expire on August 2, 2010. The final maturity
date of the facility is August 3, 2012. In the event the Company is unable to
renew the liquidity provisions by August 2, 2010, the facility would become a
term facility at a stepped-up cost, with no additional student loans being
eligible for financing, and the Company would be required to refinance the
existing loans in the facility by August 3, 2012.
The 2009
FFELP Warehouse Facility provides for formula based advance rates depending on
FFELP loan type up to a maximum of 92 percent to 98 percent of the principal and
interest financed. The advance rates for collateral may increase or decrease
based on market conditions. The facility contains financial covenants relating
to levels of the Company’s consolidated net worth, ratio of adjusted EBITDA to
corporate debt interest, and unencumbered cash. Any violation of these covenants
could result in a requirement for the immediate repayment of any outstanding
borrowings under the facility. Unlike the Company’s prior FFELP warehouse
facility, the new facility does not require the Company to refinance or remove a
percentage of the pledged student loan collateral on an annual basis. As of
November 6, 2009, $179.1 million was outstanding under this facility and $320.9
million was available for future use. Upon termination or expiration
of the facility, the company would expect to access the securitization market,
use operating cash, rely on sale of assets, or transfer collateral to satisfy
any remaining obligations.
Asset-backed
securities
transactions
Depending
on market conditions, the Company anticipates continuing to access the
asset-backed securities market. Asset-backed securities transactions would be
used to refinance student loans included in the FFELP warehouse facility, the
DOE Conduit facility for certain loans disbursed before September 30, 2009,
and/or existing asset-backed security transactions. The FFELP warehouse facility
and DOE Conduit facility have advance rates that are less than par. As of
November 9, 2009, the Company has approximately $13 million and $60 million,
respectively, advanced in operating cash in these facilities. Depending on the
terms of asset-backed security transactions, refinancing loans included in these
facilities could produce positive cash flow to the Company and are contemplated
by management when making student loan financing decisions.
On
October 22, 2009, the Company completed an asset-backed securities transaction
of $434.0 million. The Company used the proceeds from the sale of these notes to
purchase student loans previously financed in other asset-backed securitizations
and the FFELP warehouse facility.
Sources
of Liquidity Available to Satisfy Debt Obligations
The
sources of liquidity available to satisfy debt obligations include:
·
|
Sources
of liquidity currently
available
|
·
|
Cash
generated from operations
|
·
|
Cash
generated from existing
portfolio
|
67
Sources of liquidity
currently available
The
following table details the Company’s sources of liquidity currently available
(as of November 9, 2009):
Sources of primary liquidity: (a) | |||
Cash
and cash equivalents (b)
|
$ | 375,000 | |
Unencumbered
FFELP student loan assets
|
|
22,000
|
|
Unencumbered
private student loan assets
|
136,000
|
||
Unused
unsecured line of credit (c)
|
51,000
|
||
Total sources of primary liquidity | $ |
584,000
|
(a)
|
The
sources of primary liquidity table above does not include 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)
|
The
lending commitment under the Company’s unsecured line of credit is
provided by a total of thirteen banks, with no individual bank
representing more than 11% of the total lending commitment. The bank
lending group includes Lehman Brothers Bank, a subsidiary of Lehman
Brothers Holdings Inc., which represents approximately 7% of the lending
commitment under the line of credit. On September 15, 2008, Lehman
Brothers Holdings Inc. filed a voluntary petition for relief under Chapter
11 of the United States Bankruptcy Code. The Company does not expect
Lehman to fund future borrowing requests. The amount included in the table
above excludes Lehman’s commitment.
|
Cash generated from
operations
The
Company has historically generated positive cash flow from operations. For the
nine months ended September 30, 2009, the Company has net cash flow from
operating activities of $214.7
million.
68
Cash generated from existing
portfolio
Of the
$26.6 billion of debt outstanding as of September 30, 2009, $19.7 billion was
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. Based on
cash flow models 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 $1.35 billion as detailed below. These cash
flows consist of net spread and servicing and administrative revenue in excess
of estimated cost.
The Company expects the future cash flow would correspond to earnings when
excluding the amortization of loan premiums and deferred origination
costs, potential derivative activity used by the Company to hedge the portfolio,
and other portfolio management and administrative costs. Because the Company
does not use gain-on-sale accounting when issuing asset-backed securitizations,
the future earnings of these transactions are not yet reflected in the Company’s
consolidated financial statements.
![](https://www.sec.gov/Archives/edgar/data/0001258602/000143774909001618/nelnet_10q-09300975.gif)
Unsecured
Line of Credit
The
Company has a $750.0 million unsecured line of credit that terminates in May
2012. As of September 30, 2009, there was $691.5 million outstanding on this
line. The weighted average interest rate on this line of credit was 0.77% as of
September 30, 2009. 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. The lending
commitment under the Company’s unsecured line of credit is provided by a total
of thirteen banks, with no individual bank representing more than 11% of the
total lending commitment. The bank lending group includes Lehman Brothers Bank,
a subsidiary of Lehman Brothers Holdings Inc., which represents approximately 7%
of the lending commitment under the line of credit. On September 15, 2008,
Lehman Brothers Holdings Inc. filed a voluntary petition for relief under
Chapter 11 of the United States Bankruptcy Code. The Company does not expect
Lehman to fund future borrowing requests. As of November 9, 2009, excluding
Lehman’s lending commitment, the Company had $51.2 million available for future
use under its unsecured line of credit.
69
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:
·
|
A
minimum consolidated net
worth
|
·
|
A
minimum adjusted EBITDA to corporate debt interest (over the last four
rolling quarters)
|
·
|
A
limitation on subsidiary
indebtedness
|
·
|
A
limitation on the percentage of non-guaranteed loans in the Company’s
portfolio
|
As of
September 30, 2009, the Company was in compliance with all of these
requirements. Many of these covenants are duplicated in the Company’s other
lending facilities, including its FFELP warehouse facilities.
A default
on the 2009 FFELP Warehouse Facility would result in an event of default on the
Company’s unsecured line of credit that would result in the outstanding balance
on the line of credit becoming immediately due and payable.
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) have modest implications on the pricing level
at which the Company obtains funding.
Debt
Repurchases
Due to
the Company’s improved cash position, the Company repurchased debt during 2009
as summarized below. Any gains recorded by the Company from the purchase of debt
are included in “other income” on the Company’s consolidated statement of
operations.
5.125%
Senior Notes due 2010
|
Junior
Subordinated
Hybrid
Securities
|
Asset-backed
securities (a)
|
||||||||||||||||||||||||||||||||||
Notional
|
Purchase
|
Gain
|
Notional
|
Purchase
|
Gain
|
Notional
|
Purchase
|
Gain
|
||||||||||||||||||||||||||||
amount
|
price
|
(loss)
|
amount
|
price
|
(loss)
|
amount
|
price
|
(loss)
|
||||||||||||||||||||||||||||
Three
months ended:
|
||||||||||||||||||||||||||||||||||||
March
31, 2009
|
$ | 34,866 | 26,791 | 8,075 | — | — | — | — | — | — | ||||||||||||||||||||||||||
June
30, 2009
|
35,520 | 31,080 | 4,440 | 1,750 | 350 | 1,400 | 1,100 | 1,078 | 22 | |||||||||||||||||||||||||||
September
30, 2009
|
137,898 | 138,505 | (607 | ) | — | — | — | 44,950 | 39,095 | 5,855 | ||||||||||||||||||||||||||
Nine
months ended September 30, 2009
|
208,284 | 196,376 | 11,908 | 1,750 | 350 | 1,400 | 46,050 | 40,173 | 5,877 | |||||||||||||||||||||||||||
Subsequent
to September 30, 2009
|
||||||||||||||||||||||||||||||||||||
through
November 9, 2009
|
— | — | — | — | — | — | 140,200 | 126,159 | 14,041 | |||||||||||||||||||||||||||
Total
debt repurchased
|
$ | 208,284 | 196,376 | 11,908 | 1,750 | 350 | 1,400 | 186,250 | 166,332 | 19,918 | ||||||||||||||||||||||||||
Balance
as of September 30, 2009
|
$ | 66,716 | $ | 198,250 |
(a)
|
In
accordance with the various indentures, the Company expects to continue to
use funds available in the trust to purchase certain asset-backed
securities for cash in open market transactions, privately negotiated
transactions, or otherwise to redeem such securities. Under the terms of
the indentures, the purchase price paid in any such transaction must be
less than the par amount of securities acquired. Any redemptions in the
normal course must be made at par. Any such transaction will depend on
prevailing market conditions, liquidity requirements, contractual
restrictions, compliance with securities laws, and other
factors.
|
The
Company's 5.125% Senior Notes due 2010 (the "Senior Notes") were previously
covered debt under a Replacement Capital Covenant dated September 27, 2006 (the
"RCC"). Under the RCC, if $100 million or more of the Senior Notes remained
outstanding, the Company was restricted in its ability to repurchase or redeem
its Junior Subordinated Hybrid Securities. On September 17, 2009, the Company
announced that less than $100 million of the Senior Notes remained outstanding,
and therefore the RCC no longer provided any benefit to the holders of the
Senior Notes. The Company has no other eligible senior debt or eligible
subordinated debt under the terms of the RCC, therefore the RCC and the
restrictions on repurchase or redemption of the Junior Subordinated Hybrid
Securities are of no further force and effect.
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 September 30, 2009 were
as follows:
Total
|
Less
than 1 year
|
1
to 3 years
|
3
to 5 years
|
More
than
5
years
|
||||||||||||||||
Bonds
and notes payable
|
$ | 26,586,093 | 2,384,286 | 803,338 | 1,436,564 | 21,961,905 | ||||||||||||||
Operating
lease obligations (a)
|
29,476 | 8,483 | 11,999 | 7,799 | 1,195 | |||||||||||||||
Other
|
31,764 | 31,764 | — | — | — | |||||||||||||||
Total
|
$ | 26,647,333 | 2,424,533 | 815,337 | 1,444,363 | 21,963,100 |
(a)
|
Operating
lease obligations are presented net of approximately $1.9 million in
sublease arrangements.
|
70
As of
September 30, 2009, the Company had a reserve of $5.7 million for uncertain
income tax positions (including the federal benefit received from state
positions and accrued interest). This obligation is not included in the above
table as the timing and resolution of the income tax positions cannot be
reasonably estimated at this time.
The
Company has an obligation to purchase $31.8 million of private loans from an
unrelated financial institution in quarterly installments of approximately $5.0
million through the third quarter of 2010 with any remaining amount to be
purchased at that time. This obligation is included in “other” in the above
table.
During
the three and nine month periods ended September 30, 2009, the Company
participated $30.5 million and $95.5 million, respectively, of non-federally
insured loans to third parties. The Company has accounted for these
participations as loan sales. Accordingly, the participation interests sold are
not included on the Company’s consolidated balance sheet. Per the terms of the
servicing agreements, the Company’s servicing operations are obligated to
repurchase loans subject to the participation interests when such loans become
60 or 90 days delinquent. As of September 30, 2009, the Company has $10.6
million accrued related to this obligation which is included in “other
liabilities” in the Company’s consolidated balance sheet. This obligation is not
included in the above table.
The
Company has commitments with its branding partners and forward flow lenders
which obligate the Company to purchase loans originated under specific criteria,
although the branding partners and forward flow lenders are typically not
obligated to provide the Company with a minimum amount of loans. These
commitments generally run for periods ranging from one to five years and are
generally renewable. Commitments to purchase loans under these arrangements are
not included in the table above.
As a
result of the Company’s previous acquisitions, the Company has certain
contractual obligations or commitments as follows:
·
|
LoanSTAR
Funding Group, Inc. (“LoanSTAR”) – As part of the agreement for the
acquisition of the capital stock of LoanSTAR from the Greater Texas
Foundation (“Texas Foundation”), the Company agreed to sell student loans
in an aggregate amount sufficient to permit the Texas Foundation to
maintain a portfolio of loans equal to no less than $200 million through
October 2010. The sales price for such loans is the fair value mutually
agreed upon between the Company and the Texas Foundation. To satisfy this
obligation, the Company is obligated to sell loans to the Texas Foundation
on a quarterly basis; however, the Foundation recently has chosen not to
purchase such loans.
|
·
|
infiNET
Integrated Solutions, Inc. (“infiNET”) – Stock price guarantee of
$104.8375 per share on 95,380 shares of Class A Common Stock (less the
greater of $41.9335 or the gross sales price such seller obtains from a
sale of the shares occurring prior to February 28, 2011 as defined in the
agreement) issued as part of the original purchase price. The obligation
to pay this guaranteed stock price is due February 28, 2011 and is not
included in the table above. Based upon the closing sale price of the
Company’s Class A Common Stock as of September 30, 2009 of $12.44 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.
|
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. On November 5, 2009, the Company's
Board of Directors voted to reinstate the quarterly dividend program.
Accordingly, a dividend of $0.07 per share on the Company's Class A and Class B
Common Stock will be paid on December 15, 2009 to all holders of record as of
December 1, 2009.
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, 2008, 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,
impairment assessments related to goodwill and intangible assets, income taxes,
and accounting for derivatives.
71
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 when the collection of principal
and interest is 30 days past due 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 and liquidity 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. 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 Income – Other 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 collectability 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 collectability of revenues and its allowance for doubtful
accounts based on a number of factors, including past transaction history with
the customer and the credit-worthiness of the customer. An allowance for
doubtful accounts is established to record accounts receivable at estimated net
realizable value. If the Company determines that collection of revenues is not
reasonably assured at or prior to delivery of the Company’s services, revenue is
recognized upon the receipt of cash.
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.
The Company performs a two-step impairment test 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.
72
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. 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.
Derivative
Accounting
The
Company records every derivative instrument, including certain derivative
instruments embedded in other contracts, at fair value on the balance sheet as
either an asset or liability. The Company determines the fair value for its
derivative contracts using either (i) pricing models that consider current
market conditions and the contractual terms of the derivative contract or (ii)
counterparty valuations. These factors include interest rates, time value,
forward interest rate curve, and volatility factors, as well as foreign exchange
rates. Pricing models and their underlying assumptions impact the amount and
timing of unrealized gains and losses recognized, and the use of different
pricing models or assumptions could produce different financial results.
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. Accordingly, changes in the
fair value of derivative instruments are reported in current period earnings.
Net settlements on derivatives are included in “derivative market value, foreign
currency, and put option adjustments and derivative settlements, net” on the
consolidated statements of operations.
RECENT
ACCOUNTING PRONOUNCEMENTS
In
September 2006, the FASB issued authoritative guidance on fair value
measurements. The guidance defines fair value, establishes a framework for
measuring fair value, and expands disclosures about fair value measurements. The
Company expanded disclosures about fair value measurements as of January 1,
2008, the effective date for the Company.
In
February 2008, the FASB delayed issuing guidance to expand disclosure
requirements about fair value measurements on nonfinancial assets and
nonfinancial liabilities to fiscal years beginning after November 15, 2008, and
interim periods within those fiscal years (January 1, 2009 for the Company).
Effective January 1, 2009, the Company expanded disclosures about fair value
measurements on certain nonfinancial assets and nonfinancial liabilities, which
are recorded at fair value only upon impairment.
In light
of the economic turmoil occurring in the United States, the FASB issued
authoritative guidance on October 10, 2008 in regards to determining the fair
value of a financial asset when the market for that asset is not active. The
guidance clarified, among other things, that quotes and other market inputs need
not be solely used to determine fair value if they do not relate to an active
market. The guidance points out that when relevant observable market information
is not available, an approach that incorporates management’s judgments about the
assumptions that market participants would use in pricing the asset in a current
sale transaction would be acceptable (such as a discounted cash flow analysis).
Regardless of the valuation technique applied, entities must include appropriate
risk adjustments that market participants would make, including adjustments for
nonperformance risk (credit risk) and liquidity risk.
73
In April
2009, the FASB released guidance on determining fair value when volume and level
of activity for the asset or liability have significantly decreased and
identifying transactions that are not orderly. The guidance requires disclosure
in interim and annual periods of the inputs and valuation techniques used to
measure fair value and a discussion of changes in valuation techniques. The
guidance became effective for the Company for the interim period ended June 30,
2009 and will be applied prospectively. The guidance does not have a material
impact on the preparation of and disclosures in the Company’s consolidated
financial statements.
In
December 2007, the FASB issued authoritative guidance, 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. The guidance also requires changes to certain presentation and
disclosure requirements. For the Company, the guidance was effective January 1,
2009 and does not have a material impact on the preparation of the Company’s
consolidated financial statements. The guidance is to be applied to all NCIs
prospectively, except for the presentation and disclosure requirements, which
are to be applied retrospectively to all periods presented.
In March
2008, the FASB issued authoritative guidance on 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 guidance 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, and how derivative instruments and related hedged items affect
its financial position, financial performance, and cash flows. The guidance was
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008, with early application encouraged. The
Company adopted the guidance as of January 1, 2009, the effective date for the
Company (see note 5 in the notes to the consolidated financial statements
included in this Quarterly Report on Form 10-Q).
In April
2009, the FASB issued authoritative guidance on the recognition and presentation
of other-than-temporary impairment. The guidance amends the requirements for the
recognition and measurement of other-than-temporary impairments for debt
securities by modifying the pre-existing "intent and ability" indicator. Under
the new guidance, an other-than-temporary impairment is triggered when there is
an intent to sell the security, it is more likely than not that the security
will be required to be sold before recovery, or the security is not expected to
recover the entire amortized cost basis of the security. Additionally, the
guidance changes the presentation of an other-than-temporary impairment in the
income statement for those impairments involving credit losses. The credit loss
component will be recognized in earnings and the remainder of the impairment
will be recorded in other comprehensive income. The guidance was effective for
the Company for the interim period ended June 30, 2009. The guidance does not
have a material impact on the preparation of and disclosures in the Company’s
consolidated financial statements.
In April
2009, the FASB issued authoritative guidance on interim disclosure about fair
value of financial instruments. The guidance requires interim disclosures
regarding the fair values of financial instruments. Additionally, the guidance
requires disclosure of the methods and significant assumptions used to estimate
the fair value of financial instruments on an interim basis as well as changes
of the methods and significant assumptions from prior periods. The guidance does
not change the accounting treatment for these financial instruments and was
effective for the Company for the interim period ended June 30, 2009 (see note 8
in the notes to the consolidated financial statements included in this Quarterly
Report on Form 10-Q).
In May
2009, the FASB issued authoritative guidance establishing general standards of
accounting for and disclosing events that occur after the balance sheet date but
before financial statements are issued or are available to be issued. It
requires entities to disclose the date through which it has evaluated subsequent
events and the basis for that date. The guidance was effective for interim and
annual periods ending after June 15, 2009. The Company adopted the guidance on
June 30, 2009, the effective date for the Company (see note 1 in the notes to
the financial statements included in this Quarterly Report on Form
10-Q).
In June
2009, the FASB issued authoritative guidance on improving the relevance,
representational faithfulness, and comparability of the information that a
reporting entity provides in its financial statements about a transfer of
financial assets; the effects of a transfer on its financial position, financial
performance, and cash flows; and a transferor’s continuing involvement, if any,
in transferred financial assets. The guidance removes the concept of a
qualifying special-purpose entity. Additionally, the guidance defines the term
participating interest
to establish specific conditions for reporting a transfer of a portion of a
financial asset as a sale, and also requires that a transferor recognize and
initially measure at fair value all assets obtained (including a transferor’s
beneficial interest) and liabilities incurred as a result of a transfer of
financial assets accounted for as a sale. The guidance is effective for fiscal
periods ending after November 15, 2009 (January 1, 2010 for the Company). The
Company is currently evaluating the impacts and disclosures related to this
guidance.
74
In June
2009, the FASB issued authoritative guidance for determining whether an entity
is a variable interest entity in addition to subjecting enterprises to a number
of other requirements including, among other things: (i) requiring an enterprise
to perform an analysis to determine whether the enterprise’s variable interest
or interests give it a controlling financial interest in a variable interest
entity and specifies the characteristics the primary beneficiary of a variable
interest entity must have to be designated as such; (ii) requiring an enterprise
to assess whether it has an implicit financial responsibility to ensure that a
variable interest entity operates as designed when determining whether it has
the power to direct the activities of the variable interest entity that most
significantly impact the entity’s economic performance; (iii) requiring the
ongoing reassessments of whether an enterprise is the primary beneficiary of a
variable interest entity; (iv) the elimination of the quantitative approach
previously required for determining the primary beneficiary of a variable
interest entity, and (v) adding an additional reconsideration event for
determining whether an entity is a variable interest entity when any changes in
facts and circumstances occur such that investors of the equity investment at
risk, as a group, lose the power from voting or similar rights of the investment
to direct the activities of the entity that have the most significant impact on
the entity’s economic performance. The guidance is effective for fiscal and
interim periods ending after November 15, 2009 (January 1, 2010 for the
Company). The Company is currently evaluating the impacts and disclosures
related to this guidance.
In June
2009, the FASB issued authoritative guidance on the FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles. The
guidance establishes the FASB Accounting Standards Codification as the source of
authoritative accounting principles recognized by FASB to be applied by
nongovernmental entities in the preparation of financial statements in
conformity with GAAP. The Company adopted the guidance on September 30, 2009,
the effective date for the Company.
In August
2009, the FASB issued authoritative guidance allowing companies to determine the
fair value of a liability by using the perspective of an investor that holds the
related obligation as an asset. The guidance is effective for interim and annual
periods beginning after August 27, 2009 and applies to all fair-value
measurements of liabilities required by GAAP. The guidance does not have a
material impact on the preparation of and disclosures in the Company’s
consolidated financial statements.
In
October 2009, the FASB issued authoritative guidance on revenue recognition.
Under the new guidance on arrangements that include software elements, tangible
products that have software components that are essential to the functionality
of the tangible product will no longer be within the scope of the software
revenue recognition guidance, and software-enabled products will now be subject
to other relevant revenue recognition guidance. The guidance will be effective
prospectively for revenue arrangements entered into or materially modified in
fiscal years beginning on or after June 15, 2010 (January 1, 2011 for the
Company), with early adoption permitted. The Company is currently evaluating the
impacts and disclosures related to this new guidance.
In
October 2009, the FASB issued authoritative guidance on revenue arrangements
with multiple deliverables that are outside the scope of the software revenue
recognition guidance. Under the new guidance, when vendor specific objective
evidence or third party evidence for deliverables in an arrangement cannot be
determined, a best estimate of the selling price is required to separate
deliverables and allocate arrangement consideration using the relative selling
price method. The new guidance includes new disclosure requirements on how the
application of the relative selling price method affects the timing and amount
of revenue recognition. The guidance is effective prospectively for revenue
arrangements entered into or materially modified in fiscal years beginning on or
after June 15, 2010 (January 1, 2011 for the Company), with early adoption
permitted. The Company is currently evaluating the impacts and disclosures
related to this new guidance.
75
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(All
dollars are in thousands, except share amounts, unless otherwise
noted)
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 September 30, 2009
|
As
of December 31, 2008
|
|||||||||||||||
Dollars
|
Percent
|
Dollars
|
Percent
|
|||||||||||||
Fixed-rate
loan assets
|
$ | 8,858,739 | 35.3 | % | $ | 2,532,609 | 10.1 | % | ||||||||
Variable-rate
loan assets
|
16,210,747 | 64.7 | 22,528,440 | 89.9 | ||||||||||||
Total
|
$ | 25,069,486 | 100.0 | % | $ | 25,061,049 | 100.0 | % | ||||||||
Fixed-rate
debt instruments
|
$ | 451,240 | 1.7 | % | $ | 677,096 | 2.5 | % | ||||||||
Variable-rate
debt instruments
|
26,134,853 | 98.3 | 26,110,863 | 97.5 | ||||||||||||
Total
|
$ | 26,586,093 | 100.0 | % | $ | 26,787,959 | 100.0 | % |
Loans
originated prior to April 1, 2006 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 dependent
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 typically continues to decline. In these interest rate
environments, the Company may earn additional spread income that it refers to as
floor income.
Depending
on the type of loan and when it was originated, the borrower rate is either
fixed to term or is reset to an annual rate each July 1. As a result, for loans
where the borrower rate is fixed to term, the Company may earn 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 may earn 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 fixed rate floor income and
variable rate floor income to the Department for all new FFELP loans first
originated on or after April 1, 2006.
For the
three months ended September 30, 2009 and 2008, loan interest income includes
approximately $39.3 million and $6.8 million, respectively, of fixed rate floor
income. For the nine months ended September 30, 2009 and 2008, loan interest
income includes approximately $106.6 million and $25.2 million, respectively, of
fixed rate floor income.
As a
result of the ongoing volatility of interest rates, effective October 1, 2008,
the Company changed its calculation of variable rate floor income to better
reflect the economic benefit received by the Company related to this income
taking into consideration the volatility of certain rate indices which offset
the value received. The economic benefit received by the Company related to
variable rate floor income was $0.1 million for the three months ended September
30, 2008 and $7.5 million and $25.7 million for the nine months ended September
30, 2009 and 2008, respectively. There was no economic benefit received by the
Company related to variable rate floor income for the three months ended
September 30, 2009. Variable rate floor income calculated on a statutory maximum
basis was $0.1 million and $1.6 million for the three months ended September 30,
2009 and 2008, respectively, and $23.9 million
and $42.3 million for the nine months ended September 30, 2009 and 2008,
respectively.
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 their special allowance payment formulas. 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.
76
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/0001258602/000143774909001618/graph-77.jpg)
The
following table shows the Company’s student loan assets that are earning fixed
rate floor income as of September 30, 2009:
Borrower/
|
Estimated
|
Balance
of
|
||||||||||||
Fixed
|
lender
|
variable
|
assets
earning fixed-rate
|
|||||||||||
interest
|
weighted
|
conversion
|
floor
income as of
|
|||||||||||
rate
range
|
average
yield
|
rate
(a)
|
September
30, 2009
|
|||||||||||
3.0
- 3.49%
|
3.21 | % | 0.57 | % | $ | 1,873,340 | ||||||||
3.5
- 3.99%
|
3.65 | % | 1.01 | % | 1,936,910 | |||||||||
4.0
- 4.49%
|
4.20 | % | 1.56 | % | 1,536,050 | |||||||||
4.5
- 4.99%
|
4.72 | % | 2.08 | % | 845,801 | |||||||||
5.0
- 5.49%
|
5.25 | % | 2.61 | % | 550,018 | |||||||||
5.5
- 5.99%
|
5.67 | % | 3.03 | % | 328,894 | |||||||||
6.0
- 6.49%
|
6.19 | % | 3.55 | % | 387,812 | |||||||||
6.5
- 6.99%
|
6.70 | % | 4.06 | % | 343,523 | |||||||||
7.0
- 7.49%
|
7.17 | % | 4.53 | % | 119,245 | |||||||||
7.5
- 7.99%
|
7.71 | % | 5.07 | % | 202,473 | |||||||||
8.0
- 8.99%
|
8.16 | % | 5.52 | % | 460,447 | |||||||||
>
9.0%
|
9.04 | % | 6.40 | % | 274,226 | |||||||||
$ | 8,858,739 |
(a)
|
The
estimated variable conversion rate is the estimated short-term interest
rate at which loans would convert to variable rate. As of September 30,
2009, the short-term interest rate was 29 basis
points.
|
The
following table summarizes the outstanding derivatives instruments as of
September 30, 2009 used by the Company to hedge fixed-rate student loan
assets.
Weighted
|
||||||||
average
fixed
|
||||||||
Notional
|
rate
paid by
|
|||||||
Maturity
|
Amount
|
the Company (a) | ||||||
2010
|
$ | 1,000,000 | 0.76 | % |
(a)
|
For
all interest rate derivatives for which the Company pays a fixed rate, the
Company receives discrete three-month
LIBOR.
|
77
As of
September 30, 2009, the Company had $3.3 billion of student loan assets that
were eligible to earn variable-rate floor income.
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 FFELP student loan assets and related
funding arranged by underlying indices as of September 30, 2009:
Index
(f)
|
Frequency
of Variable Resets
|
Assets
|
Debt
outstanding that funded student loan assets (a)
|
|||||||
3
month H15 financial commercial paper (b)
|
Daily
|
$ | 23,823,346 | 1,902,909 | ||||||
3
month Treasury bill
|
Varies
|
1,079,026 | — | |||||||
3
month LIBOR (c)
|
Quarterly
|
— | 19,749,843 | |||||||
Auction-rate
or remarketing
|
Varies
|
— | 2,247,420 | |||||||
Asset-backed
commercial paper (d)
|
Varies
|
— | 1,516,630 | |||||||
Fixed
rate
|
— | 186,274 | ||||||||
Other
(e)
|
700,704 | — | ||||||||
$ | 25,603,076 | 25,603,076 |
(a)
|
The
Company has certain basis swaps outstanding in which the Company (i)
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 “Average/Discrete Basis Swaps”); and (ii)
receives three-month LIBOR and pays one-month LIBOR plus or minus a spread
as defined in the agreements (the "1/3 Basis
Swaps"). The Company entered into these derivative instruments to
better match the interest rate characteristics on its student loan assets
and the debt funding such assets. The following table summarizes these
derivatives as of September 30,
2009:
|
Notional
Amount
|
||||||||
Maturity
|
Average/Discrete
Basis Swaps
|
1/3
Basis Swaps
|
||||||
2010
|
$ | — | 1,000,000 | |||||
2011
(a)
|
6,000,000 | — | ||||||
2013
|
— | 500,000 | ||||||
2014
|
— | 500,000 | ||||||
2018
|
— | 1,300,000 | ||||||
2019
|
— | 500,000 | ||||||
2021
|
— | 250,000 | ||||||
2023
|
— | 1,250,000 | ||||||
2024
|
— | 250,000 | ||||||
2028
|
— | 100,000 | ||||||
2039
|
— | 150,000 | ||||||
$ | 6,000,000 | 5,800,000 |
(a) |
Certain
of these derivatives have forward effective start dates of January 2010
($1.5 billion), February 2010 ($1.5 billion), and March 2010 ($1.5
billion).
|
78
(b)
|
The
Company’s FFELP student loans earn interest based on the daily average H15
financial commercial paper index calculated on a fiscal quarter. The
Company’s funding includes FFELP student loans under the Department’s
Participation Program. The interest rate on the principal amount of
participation interests outstanding under the Department’s Participation
Program is based on a rate of commercial paper plus 50 basis points, which
is set a quarter in arrears, while the earnings on the student loans is
based primarily on the daily average H15 financial commercial paper index
calculated on the current 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)
|
Asset-backed
commercial paper consists of $361 million funded in the Company’s FFELP
warehouse facility and $1.2 billion funded through the Department’s
Conduit Program. Funding for the Conduit Program is provided by the
capital markets at a cost based on market
rates.
|
(e)
|
Assets
include restricted cash and investments and other
assets.
|
(f)
|
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. 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 as compared to historical
periods.
|
Financial
Statement Impact of Derivative Instruments
The
Company recognizes changes in the fair value of derivative instruments currently
in earnings unless specific hedge accounting criteria 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; 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 $42.2
million and $19.9 million for the three and nine months ended September 30,
2009, respectively, and expense of $119.9 million and $72.4 million for the
three and nine months ended September 30, 2008, 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 September 30
|
Nine
months ended September 30
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Settlements:
|
||||||||||||||||
Interest
rate swaps
|
$ | (436 | ) | (3,175 | ) | $ | (447 | ) | (14,194 | ) | ||||||
Average/discrete
basis swaps
|
646 | (3,999 | ) | 11,707 | 40,711 | |||||||||||
1/3
basis swaps
|
3,071 | — | 20,473 | 894 | ||||||||||||
Cross-currency
interest rate swaps
|
1,633 | 7,963 | 7,074 | 18,578 | ||||||||||||
Total
settlements
|
$ | 4,914 | 789 | $ | 38,807 | 45,989 |
79
Sensitivity
Analysis
The
following tables summarize the effect on the Company’s earnings, based upon a
sensitivity analysis performed by the Company assuming hypothetical increases in
interest rates of 100 basis points and 300 basis points while funding spreads
remain constant. In addition, as it relates to the effect on earnings, a
sensitivity analysis was performed assuming the funding index increases 10 basis
points and 30 basis points while holding the asset index constant, if the
funding index is different than the asset index. 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.
Three
months ended September 30, 2009
|
||||||||||||||||||||||||||||||||
Interest
Rates
|
||||||||||||||||||||||||||||||||
Change from increase | Change from increase |
Asset
and funding index mismatches
|
||||||||||||||||||||||||||||||
of
100 basis points
|
of
300 basis points
|
Increase
of 10 basis points
|
Increase
of 30 basis points
|
|||||||||||||||||||||||||||||
Dollar
|
Percent
|
Dollar
|
Percent
|
Dollar
|
Percent
|
Dollar
|
Percent
|
|||||||||||||||||||||||||
Effect
on earnings:
|
||||||||||||||||||||||||||||||||
Increase
(decrease) in pre-tax net income
|
||||||||||||||||||||||||||||||||
before
impact of derivative settlements
|
$ | (17,600 | ) | (24.8 | )% | (30,431 | ) | (42.9 | )% | (6,472 | ) | (9.1 | )% | (19,416 | ) | (27.4 | )% | |||||||||||||||
Impact
of derivative settlements
|
1,377 | 1.9 | 4,130 | 5.8 | — | — | — | — | ||||||||||||||||||||||||
Increase
(decrease) in net income before taxes
|
$ | (16,223 | ) | (22.9 | )% | (26,301 | ) | (37.1 | )% | (6,472 | ) | (9.1 | )% | (19,416 | ) | (27.4 | )% | |||||||||||||||
Increase
(decrease) in basic and diluted
|
||||||||||||||||||||||||||||||||
earnings
per share
|
$ | (0.21 | ) | (0.35 | ) | (0.09 | ) | (0.26 | ) |
Three
months ended September 30, 2008
|
||||||||||||||||||||||||||||||||
Interest
Rates
|
||||||||||||||||||||||||||||||||
Change
from increase
|
Change
from increase
|
Asset
and funding index mismatches
|
||||||||||||||||||||||||||||||
of
100 basis points
|
of
300 basis points
|
Increase
of 10 basis points
|
Increase
of 30 basis points
|
|||||||||||||||||||||||||||||
Dollar
|
Percent
|
Dollar
|
Percent
|
Dollar
|
Percent
|
Dollar
|
Percent
|
|||||||||||||||||||||||||
Effect
on earnings:
|
||||||||||||||||||||||||||||||||
Increase
(decrease) in pre-tax net income
|
||||||||||||||||||||||||||||||||
before
impact of derivative settlements
|
$ | (2,299 | ) | (6.1 | )% | (3,931 | ) | (10.4 | )% | (6,743 | ) | (17.9 | )% | (20,229 | ) | (53.6 | )% | |||||||||||||||
Impact
of derivative settlements
|
3,101 | 8.2 | 4,650 | 12.3 | — | — | — | — | ||||||||||||||||||||||||
Increase
(decrease) in net income before taxes
|
$ | 802 | 2.1 | % | 719 | 1.9 | % | (6,743 | ) | (17.9 | )% | (20,229 | ) | (53.6 | )% | |||||||||||||||||
Increase
(decrease) in basic and diluted
|
||||||||||||||||||||||||||||||||
earnings
per share
|
$ | 0.01 | 0.01 | (0.09 | ) | (0.26 | ) |
Nine
months ended September 30, 2009
|
||||||||||||||||||||||||||||||||
Change
from increase of 100 basis points
|
Change
from increase of 300 basis points
|
Asset
and funding index mismatches
|
||||||||||||||||||||||||||||||
Dollar
|
Percent
|
Dollar
|
Percent
|
Increase
of 10 basis points
|
Increase
of 30 basis points
|
|||||||||||||||||||||||||||
Effect
on earnings:
|
||||||||||||||||||||||||||||||||
Increase
(decrease) in pre-tax net income
|
||||||||||||||||||||||||||||||||
before
impact of derivative settlements
|
$ | (80,676 | ) | (63.0 | )% | (102,677 | ) | (80.2 | )% | (19,229 | ) | (15.0 | )% | (57,685 | ) | (45.0 | )% | |||||||||||||||
Impact
of derivative settlements
|
1,418 | 1.1 | 4,212 | 3.3 | — | — | — | — | ||||||||||||||||||||||||
Increase
(decrease) in net income before taxes
|
$ | (79,258 | ) | (61.9 | )% | (98,465 | ) | (76.9 | )% | (19,229 | ) | (15.0 | )% | (57,685 | ) | (45.0 | )% | |||||||||||||||
Increase
(decrease) in basic and diluted
|
||||||||||||||||||||||||||||||||
earning
per share
|
$ | (1.02 | ) | (1.26 | ) | (0.25 | ) | (0.74 | ) |
Nine
months ended September 30, 2008
|
||||||||||||||||||||||||||||||||
Change
from increase of 100 basis points
|
Change
from increase of 300 basis points
|
Asset
and funding index mismatches
|
||||||||||||||||||||||||||||||
Dollar
|
Percent
|
Dollar
|
Percent
|
Increase
of 10 basis points
|
Increase
of 30 basis points
|
|||||||||||||||||||||||||||
Effect
on earnings:
|
||||||||||||||||||||||||||||||||
Increase
(decrease) in pre-tax net income
|
||||||||||||||||||||||||||||||||
before
impact of derivative settlements
|
$ | (24,704 | ) | (1,622.1 | )% | (51,031 | ) | (3,350.7 | )% | (20,239 | ) | (1,328.9 | )% | (60,719 | ) | (3,986.8 | )% | |||||||||||||||
Impact
of derivative settlements
|
17,818 | 1,169.9 | 48,799 | 3,204.1 | — | — | — | — | ||||||||||||||||||||||||
Increase
(decrease) in net income before taxes
|
$ | (6,886 | ) | (452.2 | )% | (2,232 | ) | (146.6 | )% | (20,239 | ) | (1,328.9 | )% | (60,719 | ) | (3,986.8 | )% | |||||||||||||||
Increase
in basic and diluted
|
||||||||||||||||||||||||||||||||
earning
per share
|
$ | (0.09 | ) | (0.03 | ) | (0.26 | ) | (0.78 | ) |
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. dollar and Euro. 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.
80
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 accounting authoritative guidance;
consequently, the change in fair value is included in the Company’s operating
results.
For the
three and nine months ended September 30, 2009, the Company recorded an expense
of $39.4 million and $56.0 million, respectively, as a result of re-measurement
of the Euro Notes and income of $44.8 million and $28.9 million, respectively,
for the change in the fair value of the related derivative instruments. For the
three and nine months ended September 30, 2008, the Company recorded income of
$128.9 million and $40.4 million, respectively, as a result of the
re-measurement of the Euro Notes and losses of $129.0 million and $37.3 million,
respectively, for the change in the fair value of the related derivative
instruments. 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.
The
re-measurement of the Euro-denominated bonds generally 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. Management intends to hold the cross-currency interest
rate swaps through the maturity of the Euro-denominated bonds.
ITEM
4. CONTROLS AND PROCEDURES
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.
PART
II. OTHER INFORMATION
ITEM
1. LEGAL PROCEEDINGS
General
The
Company is subject to various claims, lawsuits, and proceedings that arise in
the normal course of business. These matters principally consist of claims by
student loan borrowers disputing the manner in which their student loans have
been processed and disputes with other business entities. In addition, from time
to time the Company receives information and document requests from state or
federal regulators concerning its business practices. The Company cooperates
with these inquiries and responds to the requests. 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. 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.
81
Regulatory
Reviews
The
Department of Education periodically reviews participants in the FFELP for
compliance with program provisions. On June 28, 2007, the Department notified
the Company that it would be conducting a review of the Company’s practices in
connection with the prohibited inducement provisions of the Higher Education Act
and the associated regulations that allow borrowers to have a choice of lenders.
The Company understands that the Department selected several schools and lenders
for review. The Company responded to the Department’s requests for information
and documentation and cooperated with their review. On May 1, 2009, the Company
received the Department’s preliminary program review report, which covered the
Department’s review of the period from October 1, 2002 to September 30, 2007.
The preliminary program review report contained certain initial findings of
noncompliance with the Higher Education Act’s prohibited inducement provisions
and required that the Company provide an explanation for the basis of the
arrangements noted in the preliminary program review report. The Company has
responded and provided an explanation of the arrangements noted in the
Department of Education’s initial findings, and the Department of Education is
expected to issue a final program review determination letter and advise the
Company whether it intends to take any additional action. To the extent any
findings are contained in a final letter, the additional action may include the
assessment of fines or penalties, or the limitation, suspension, and termination
of the Company’s participation in the FFELP.
In
connection with the Company’s settlement agreement 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 “Settlement Agreement”), the Company was informed in February
2007 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 these reviews, 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.
United
States ex rel Oberg v. Nelnet, Inc. et al
On
September 28, 2009, the Company was served with a Summons and First Amended
Complaint naming the Company as one of ten defendants in a “qui tam” action
brought by Jon H. Oberg on behalf of the United States of America. Qui tam
actions assert claims by an individual on behalf of the federal government, and
are filed under seal until the government decides, if at all, to intervene in
the case.
An
original complaint in the action was filed under seal in the U.S. District Court
for the Eastern District of Virginia on September 21, 2007, and was unsealed on
August 26, 2009 upon the government’s filing of a Notice of Election to Decline
Intervention in the matter. The First Amended Complaint (the “Oberg Complaint”)
was filed on August 24, 2009 and alleges the defendant student loan lenders
submitted false claims for payment to the Department of Education in order to
obtain special allowance payments on certain student loans at a rate of 9.5%,
which the Oberg Complaint alleges is in excess of amounts permitted by law.
The Oberg Complaint seeks the imposition of civil penalties and treble the
amount of damages sustained by the government in connection with the alleged
overbilling by the defendants for special allowance payments. The Oberg
Complaint alleges that approximately $407 million in unlawful 9.5% special
allowance payment claims were submitted by the Company to the Department of
Education.
The 9.5%
special allowance payments received by the Company were disclosed by the Company
on multiple occasions beginning in 2003. In January, 2007, the Company entered
into the Settlement Agreement. The Settlement Agreement resolved the issues now
raised by the Oberg Complaint, and contains an acknowledgment by the Department
of Education that the Company acted in good faith in connection with its
billings for 9.5% special allowance payments.
United
States ex rel Vigil v. Nelnet, Inc. et al
On November 4, 2009,
the Company was served with a Summons and Third Amended Complaint
naming the Company as one of three defendants in an unrelated qui tam action
brought by Rudy Vigil (the “Vigil Complaint”). This matter was filed under seal
in the U.S. District Court for the District of Nebraska on July 11, 2007 and was
unsealed on October 15, 2009 following the government’s notice that it declined
to intervene in the matter. The Vigil Complaint, filed by a former employee of
the Company, appears to allege that the Company engaged in false advertising and
offered prohibited inducements to student loan borrowers in order to increase
the Company’s loan holdings, and subsequently submitted false claims to the
Department of Education in order to obtain special allowance payments and
default claim payments on such loans.
The
Company believes the allegations in both of the above matters to be frivolous
and without merit and intends to vigorously defend the claims. However, the
Company cannot currently predict the ultimate outcome of this matter or any
liability which may result, which could have a material adverse effect on the
Company's results of operations and financial condition.
82
There
have been no material changes from the risk factors described in the Company’s
Annual Report on Form 10-K for the year ended December 31, 2008 in response to
Item 1A of Part I of such Form 10-K.
ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Stock
Repurchases
The
following table summarizes the repurchases of Class A common stock during the
third quarter of 2009 by the Company or any “affiliated purchaser” of the
Company, as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of
1934.
Total
number of
|
Maximum
number
|
|||||||||||||||
shares
purchased
|
of
shares that may
|
|||||||||||||||
Total
number
|
Average
|
as
part of publicly
|
yet
be purchased
|
|||||||||||||
of
shares
|
price
paid
|
announced
plans
|
under
the plans
|
|||||||||||||
Period
|
purchased
(1)
|
per
share
|
or
programs (2) (3)
|
or
programs (4)
|
||||||||||||
July
1 - July 31, 2009
|
776 | $ | 14.41 | 776 | 7,394,184 | |||||||||||
August
1 - August 31, 2009
|
3,346 | 14.66 | 3,346 | 7,309,615 | ||||||||||||
September
1 - September 30, 2009
|
3,312 | 14.14 | 3,312 | 7,766,855 | ||||||||||||
Total
|
7,434 | $ | 14.40 | 7,434 |
(1)
|
The
total number of shares includes: (i) shares purchased pursuant to the 2006
Plan discussed in footnote (2) below; and (ii) shares purchased pursuant
to the 2006 ESLP discussed in footnote (3) below, of which there were none
for the months of July, August, or September 2009. Shares of Class A
common stock purchased pursuant to the 2006 Plan included 776 shares,
3,346 shares, and 3,312 shares in July, August, and September,
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.
|
(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.
|
83
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
|
|||||||||||||||
July
31, 2009
|
4,843,449 | 36,450,000 | 14.29 | 2,550,735 | 7,394,184 | |||||||||||||||
August
31, 2009
|
4,840,103 | 36,450,000 | 14.76 | 2,469,512 | 7,309,615 | |||||||||||||||
September
30, 2009
|
4,836,791 | 36,450,000 | 12.44 | 2,930,064 | 7,766,855 |
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 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
|
·
|
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
|
·
|
purchase
common stock for issuance pursuant to any employee benefit
plans
|
84
ITEM
6. EXHIBITS
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
85
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
NELNET,
INC.
|
|||
Date:
November 9, 2009
|
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
|