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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 MARCH 31, 2001 OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
(Amended by Exch Act Rel No. 312905. eff 4/26/93.)
Commission File Number: 001-13251
------------------------
USA EDUCATION, INC.
(FORMERLY SLM HOLDING CORPORATION)
(Exact name of registrant as specified in its charter)
DELAWARE 52-2013874
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11600 SALLIE MAE DRIVE, RESTON, VIRGINIA 20193
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
(703) 810-3000
------------------------
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
CLASS OUTSTANDING AT MARCH 31, 2001
- ---------------------------- -----------------------------
Common Stock, $.20 par value 162,968,769 shares
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USA EDUCATION, INC.
FORM 10-Q
INDEX
MARCH 31, 2001
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements........................................ 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 31
Item 2. Changes in Securities....................................... 31
Item 3. Defaults Upon Senior Securities............................. 31
Item 4. Submission of Matters to a Vote of Security Holders......... 31
Item 5. Other Information........................................... 31
Item 6. Exhibits and Reports on Form 8-K............................ 31
Signatures............................................................. 32
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
USA EDUCATION, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
MARCH 31, DECEMBER 31,
2001 2000
----------- ------------
(UNAUDITED)
ASSETS
Student loans............................................... $38,524,502 $37,647,297
Warehousing advances........................................ 1,013,768 987,352
Academic facilities financings
Bonds--available-for-sale................................. 493,190 498,775
Loans..................................................... 343,960 352,393
----------- -----------
Total academic facilities financings.................... 837,150 851,168
Investments
Trading................................................... 1,957 --
Available-for-sale........................................ 4,700,342 4,244,762
Held-to-maturity.......................................... 1,015,438 961,260
----------- -----------
Total investments....................................... 5,717,737 5,206,022
Cash and cash equivalents................................... 1,055,928 734,468
Other assets, principally accrued interest receivable....... 3,719,544 3,365,481
----------- -----------
Total assets............................................ $50,868,629 $48,791,788
=========== ===========
LIABILITIES
Short-term borrowings....................................... $37,473,211 $30,463,988
Long-term notes............................................. 9,849,246 14,910,939
Other liabilities........................................... 1,912,111 1,787,642
----------- -----------
Total liabilities....................................... 49,234,568 47,162,569
----------- -----------
COMMITMENTS AND CONTINGENCIES
MINORITY INTEREST IN SUBSIDIARY............................. 213,883 213,883
STOCKHOLDERS' EQUITY
Preferred stock, Series A, par value $.20 per share,
20,000,000 shares authorized: 3,300,000 shares issued at
stated value of $50 per share............................. 165,000 165,000
Common stock, par value $.20 per share, 250,000,000 shares
authorized: 195,699,344 and 190,851,936 shares issued,
respectively.............................................. 39,140 38,170
Additional paid-in capital.................................. 424,543 225,211
Unrealized gains on investments (net of tax of $237,046 and
$167,624, respectively)................................... 440,228 311,301
Retained earnings........................................... 1,809,316 1,810,902
----------- -----------
Stockholders' equity before treasury stock.................. 2,878,227 2,550,584
Common stock held in treasury at cost:
32,730,575 and 26,707,091 shares, respectively............ 1,458,049 1,135,248
----------- -----------
Total stockholders' equity.............................. 1,420,178 1,415,336
----------- -----------
Total liabilities and stockholders' equity.............. $50,868,629 $48,791,788
=========== ===========
See accompanying notes to consolidated financial statements.
3
USA EDUCATION, INC.
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED MARCH 31,
-------------------------------
2001 2000
----------- -----------
(UNAUDITED) (UNAUDITED)
INTEREST INCOME:
Student loans............................................. $713,033 $667,657
Warehousing advances...................................... 14,585 16,699
Academic facilities financings:
Taxable................................................. 8,035 8,894
Tax-exempt.............................................. 6,167 8,275
-------- --------
Total academic facilities financings...................... 14,202 17,169
Investments............................................... 132,853 118,191
-------- --------
Total interest income....................................... 874,673 819,716
INTEREST EXPENSE:
Short-term debt........................................... 510,670 573,056
Long-term debt............................................ 184,195 84,791
-------- --------
Total interest expense...................................... 694,865 657,847
-------- --------
Net interest income......................................... 179,808 161,869
Less: provision for losses.................................. 13,599 9,438
-------- --------
Net interest income after provision for losses.............. 166,209 152,431
-------- --------
OTHER INCOME:
Gains on student loan securitizations..................... 9,478 42,330
Servicing and securitization revenue...................... 120,011 62,119
Gains (losses) on sales of securities..................... (23,590) 43,002
Guarantor servicing fees.................................. 55,183 --
Derivative market value adjustment........................ (137,276) --
Other..................................................... 30,672 28,140
-------- --------
Total other income.......................................... 54,478 175,591
-------- --------
OPERATING EXPENSES:
Salaries and benefits..................................... 92,567 53,871
Other..................................................... 74,806 42,367
-------- --------
Total operating expenses.................................... 167,373 96,238
-------- --------
Income before income taxes and minority interest in net
earnings of subsidiary.................................... 53,314 231,784
-------- --------
INCOME TAXES:
Current................................................... 39,137 141,361
Deferred.................................................. (18,298) (65,900)
-------- --------
Total income taxes.......................................... 20,839 75,461
Minority interest in net earnings of subsidiary............. 2,674 2,674
-------- --------
NET INCOME.................................................. 29,801 153,649
Preferred stock dividends................................... 2,875 2,907
-------- --------
Net income attributable to common stock..................... $ 26,926 $150,742
======== ========
Basic earnings per share.................................... $ 0.17 $ 0.96
======== ========
Average common shares outstanding........................... 163,051 157,197
======== ========
Diluted earnings per share.................................. $ 0.16 $ 0.93
======== ========
Average common and common equivalent shares outstanding..... 169,939 162,256
======== ========
See accompanying notes to consolidated financial statements.
4
USA EDUCATION, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
PREFERRED COMMON STOCK SHARES ADDITIONAL
STOCK --------------------------------------- PREFERRED COMMON PAID-IN
SHARES ISSUED TREASURY OUTSTANDING STOCK STOCK CAPITAL
--------- ----------- ----------- ----------- --------- -------- ----------
BALANCE AT DECEMBER 31, 1999....... 3,300,000 186,069,619 (28,493,072) 157,576,547 $165,000 $37,214 $ 62,827
Comprehensive income:
Net Income.......................
Other comprehensive income, net
of tax:
Change in unrealized gains
(losses) on investments, net
of tax.......................
Comprehensive income.............
Cash dividends:
Common stock ($.16 per
share).......................
Preferred stock ($.88 per
share).......................
Issuance of common shares.......... 167,476 167,476 33 7,647
Premiums on equity forward purchase
contracts........................ (9,734)
Repurchase of common shares........ (1,139,837) (1,139,837)
--------- ----------- ----------- ----------- -------- ------- --------
BALANCE AT MARCH 31, 2000.......... 3,300,000 186,237,095 (29,632,909) 156,604,186 $165,000 $37,247 $ 60,740
========= =========== =========== =========== ======== ======= ========
BALANCE AT DECEMBER 31, 2000....... 3,300,000 190,851,936 (26,707,091) 164,144,845 $165,000 $38,170 $225,211
Comprehensive income:
Net income.......................
Other comprehensive income, net
of tax:
Change in unrealized gains
(losses) on investments, net
of tax.......................
Comprehensive income.............
Cash dividends:
Common stock ($.18 per
share).......................
Preferred stock ($.87 per
share).......................
Issuance of common shares.......... 4,847,408 4,847,408 970 207,386
Premiums on equity forward purchase
contracts........................ (8,054)
Repurchase of common shares........ (6,023,484) (6,023,484)
--------- ----------- ----------- ----------- -------- ------- --------
BALANCE AT MARCH 31, 2001.......... 3,300,000 195,699,344 (32,730,575) 162,968,769 $165,000 $39,140 $424,543
========= =========== =========== =========== ======== ======= ========
UNREALIZED
GAINS TOTAL
(LOSSES) ON RETAINED TREASURY STOCKHOLDERS'
INVESTMENTS EARNINGS STOCK EQUITY
----------- ---------- ------------ -------------
BALANCE AT DECEMBER 31, 1999....... $297,735 $1,462,034 $ (1,183,896) $ 840,914
Comprehensive income:
Net Income....................... 153,649 153,649
Other comprehensive income, net
of tax:
Change in unrealized gains
(losses) on investments, net
of tax....................... (2,364) (2,364)
----------
Comprehensive income............. 151,285
Cash dividends:
Common stock ($.16 per
share)....................... (25,139) (25,139)
Preferred stock ($.88 per
share)....................... (2,907) (2,907)
Issuance of common shares.......... 7,680
Premiums on equity forward purchase
contracts........................ (9,734)
Repurchase of common shares........ (49,573) (49,573)
-------- ---------- ------------ ----------
BALANCE AT MARCH 31, 2000.......... $295,371 $1,587,637 $ (1,233,469) $ 912,526
======== ========== ============ ==========
BALANCE AT DECEMBER 31, 2000....... $311,301 $1,810,902 $ (1,135,248) $1,415,336
Comprehensive income:
Net income....................... 29,801 29,801
Other comprehensive income, net
of tax:
Change in unrealized gains
(losses) on investments, net
of tax....................... 128,927 128,927
----------
Comprehensive income............. 158,728
Cash dividends:
Common stock ($.18 per
share)....................... (28,512) (28,512)
Preferred stock ($.87 per
share)....................... (2,875) (2,875)
Issuance of common shares.......... 208,356
Premiums on equity forward purchase
contracts........................ (8,054)
Repurchase of common shares........ (322,801) (322,801)
-------- ---------- ------------ ----------
BALANCE AT MARCH 31, 2001.......... $440,228 $1,809,316 $ (1,458,049) $1,420,178
======== ========== ============ ==========
See accompanying notes to consolidated financial statements.
5
USA EDUCATION, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED MARCH 31,
-----------------------------
2001 2000
------------- -------------
(UNAUDITED) (UNAUDITED)
OPERATING ACTIVITIES
Net income.................................................. $ 29,801 $ 153,649
Adjustments to reconcile net income to net cash provided
by operating activities:
(Gains) on student loan securitizations................. (9,478) (42,330)
Losses (gains) on sales of securities................... 23,590 (43,002)
Provision for losses.................................... 13,599 9,438
(Increase) decrease in accrued interest receivable...... (114,030) 44,390
(Decrease) in accrued interest payable.................. (73,952) (4,289)
(Increase) in other assets.............................. (130,816) (2,900)
Increase in other liabilities........................... 167,408 42,704
------------- -------------
Total adjustments..................................... (123,679) 4,011
------------- -------------
Net cash (used in) provided by operating activities......... (93,878) 157,660
------------- -------------
INVESTING ACTIVITIES
Student loans purchased................................... (3,627,527) (2,850,410)
Reduction of student loans purchased:
Installment payments.................................... 782,694 564,247
Claims and resales...................................... 139,332 128,185
Proceeds from securitization of student loans........... 1,815,320 4,079,650
Proceeds from sales of student loans.................... 703 37,110
Warehousing advances made............................... (341,873) (262,116)
Warehousing advance repayments.......................... 315,457 431,975
Academic facilities financings made..................... (480) (9,000)
Academic facilities financings repayments............... 19,445 12,398
Investments purchased................................... (25,113,784) (9,995,711)
Proceeds from sale or maturity of investments........... 24,617,108 11,200,348
------------- -------------
Net cash (used in) provided by investing activities......... (1,393,605) 3,336,676
------------- -------------
FINANCING ACTIVITIES
Short-term borrowings issued.............................. 330,815,625 173,032,184
Short-term borrowings repaid.............................. (327,999,666) (174,416,718)
Long-term notes issued.................................... 2,158,470 3,419,520
Long-term notes repaid.................................... (3,011,600) (5,933,627)
Equity forward contracts and stock issued................. 200,302 (2,054)
Common stock repurchased.................................. (322,801) (49,573)
Common dividends paid..................................... (28,512) (25,139)
Preferred dividends paid.................................. (2,875) (2,907)
------------- -------------
Net cash provided by (used in) financing activities......... 1,808,943 (3,978,314)
------------- -------------
Net increase (decrease) in cash and cash equivalents........ 321,460 (483,978)
Cash and cash equivalents at beginning of year.............. 734,468 589,750
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 1,055,928 $ 105,772
============= =============
Cash disbursements made for:
Interest.................................................. $ 673,393 $ 629,991
============= =============
Income taxes.............................................. $ 84,400 $ --
============= =============
See accompanying notes to consolidated financial statements.
6
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AT MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED
MARCH 31, 2001 AND 2000 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of USA
Education, Inc. (the "Company"), formerly SLM Holding Corporation, have been
prepared in accordance with generally accepted accounting principles ("GAAP")
for interim financial information. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete consolidated financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates. Operating results for the three months ended
March 31, 2001 are not necessarily indicative of the results for the year ending
December 31, 2001.
2. NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities," which requires that every derivative
instrument, including certain derivative instruments embedded in other
contracts, be recorded on the balance sheet as either an asset or liability
measured at its fair value. SFAS 133, as amended by Statement of Financial
Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging
Activities--Deferral of Effective Date of FASB Statement No. 133," and Statement
of Financial Accounting Standards No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities," was effective for the Company's
financial statements beginning January 1, 2001. SFAS 133, as amended, requires
that changes in the derivative instrument's fair value be recognized currently
in earnings unless specific hedge accounting criteria are met. Special
accounting for derivative financial instruments that qualify as fair value
hedges allows a derivative instrument's gains and losses to offset related fair
value changes on the hedged item in the income statement. Derivative financial
instruments that qualify as cash flow hedges are reported as adjustments to
stockholders' equity as a component of other comprehensive income. Hedge
accounting for derivative instruments requires that a company formally document,
designate and assess the effectiveness of transactions that receive hedge
accounting treatment. SFAS 133 could result in increased period to period
volatility in reported net income. The Company implemented the new standard on
January 1, 2001 (see Note 6). In conjunction with the implementation of SFAS
133, the Company reclassed $2 million of held-to-maturity securities to trading
securities as permitted under the transition provisions of SFAS 133.
In October 2000, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 140 ("SFAS 140"), "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities--a Replacement of FASB Statement No. 125." SFAS 140 requires new
disclosures about securitizations and retained interests in securitized
financial assets and revises the criteria involving qualifying special purpose
entities. Under SFAS 140, entities are required to disclose information about
securitizations regarding accounting policies, securitization characteristics,
key assumptions used and cash flows between the securitization special purpose
entities and the transferor. Additionally, entities are required to disclose
information related to retained interests in
7
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED
MARCH 31, 2001 AND 2000 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2. NEW ACCOUNTING PRONOUNCEMENTS (CONTINUED)
securitized financial assets, information regarding accounting policies for
subsequent measuring of retained interests, key assumptions used in subsequent
fair value measurements, sensitivity analysis showing hypothetical effects on
fair values based on unfavorable variations from key assumptions and general
characteristics of the securitized assets such as principal balances,
delinquencies and credit losses. These new disclosure requirements are to be
provided for fiscal years ending after December 15, 2000. Additionally,
SFAS 140 revised the criteria involving qualifying special purpose entities.
These revisions related to special purpose entities are to be applied
prospectively to transfers of financial assets and extinguishments of
liabilities occurring after March 31, 2001 (see Note 4).
3. ALLOWANCE FOR LOSSES
The following table summarizes changes in the allowance for losses for the
three months ended March 31, 2001, and 2000, respectively.
THREE MONTHS ENDED
MARCH 31,
-------------------
2001 2000
-------- --------
BALANCE AT BEGINNING OF YEAR................................ $322,056 $303,743
Additions
Provisions for losses..................................... 13,599 9,438
Recoveries................................................ 1,215 2,755
Deductions
Reductions for student loan sales and securitizations..... (3,671) (8,009)
Write-offs................................................ (26,887) (7,873)
-------- --------
BALANCE AT END OF PERIOD.................................... $306,312 $300,054
======== ========
4. STUDENT LOAN SECURITIZATION
When the Company sells student loans in securitizations, it retains
interest-only strips and servicing rights, all of which are retained interests
in the securitized receivables. Gain or loss on sale of the receivables depends
in part on the previous carrying amount of the financial assets involved in the
transfer, allocated between the assets sold and the retained interests based on
their relative fair values at the date of transfer. To obtain fair values,
quoted market prices are used if available. However, quotes are generally not
available for retained interests, so the Company estimates fair value, both
initially and on a quarterly basis going forward, based on the present value of
future expected cash flows estimated using management's best estimates of the
key assumptions - credit losses, prepayment speeds and discount rates.
During the first quarter of 2001, the Company sold $1.5 billion of student
loans in one securitization transaction and securitized $288 million through the
recycling provisions of the USA Group securitizations. The Company recorded a
pre-tax securitization gain of $9 million or .53 percent of the portfolios
securitized in the first quarter of 2001. In the first quarter of 2000, the
Company sold $4.0 billion of student loans in two securitization transactions
and recorded a pre-tax securitization gain
8
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED
MARCH 31, 2001 AND 2000 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
4. STUDENT LOAN SECURITIZATION (CONTINUED)
of $42 million or 1.05 percent of the portfolios securitized. At March 31, 2001
and December 31, 2000, securitized student loans outstanding totaled
$30.5 billion and $29.9 billion, respectively.
In those securitizations, the Company retained servicing responsibilities
and received annual servicing fees of 0.9 percent per annum of the outstanding
balance of student loans other than consolidation loans and 0.5 percent per
annum of the outstanding balance of consolidation loans. The Company also
receives rights to future cash flows arising after the investors in the trust
have received the return for which they have contracted. Trust investors and the
securitization trusts have no recourse to the Company's other assets. The
Company's retained interests are subordinate to investors' interests. Their
value is subject to credit, prepayment, and interest rate risks.
Key economic assumptions used in measuring the fair value of retained
interests at the date of securitization resulting from the student loan
securitization transaction completed during the first quarter of 2001 were as
follows:
Prepayment speed........................................... 7% per annum
Weighted-average life...................................... 4.4 years
Expected credit losses..................................... 0.5%
Residual cash flows discounted at.......................... 12%
Expected credit losses resulting from loans securitized in 2001 are
dependent on the portfolio's expected rate of defaulted loans, the level of
insurance guarantee which ranges from 98 percent to 100 percent of the unpaid
principal and interest of the defaulted loan, and the expected level of
defaulted loans not eligible for insurance guarantee due to servicing
deficiencies (approximately one percent of defaulted loans). The expected dollar
amount of credit losses is divided by the portfolio's principal balance to
arrive at the expected credit loss percentage. Except for net proceeds, there
were no cash flows between the Company and the securitization trust that closed
during the first quarter of 2001.
5. COMMON STOCK
Basic earnings per common share ("Basic EPS") are calculated using the
weighted average number of shares of common stock outstanding during each
period. Diluted earnings per common share ("Diluted EPS") reflect the potential
dilutive effect of additional common shares that are issuable upon
9
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED
MARCH 31, 2001 AND 2000 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
5. COMMON STOCK (CONTINUED)
exercise of outstanding stock options and warrants, determined by the treasury
stock method, and equity forwards, determined by the reverse treasury stock
method, as follows:
NET INCOME
ATTRIBUTABLE
TO COMMON AVERAGE EARNINGS
STOCK SHARES PER SHARE
------------ ----------- ---------
(THOUSANDS) (THOUSANDS)
THREE MONTHS ENDED MARCH 31, 2001
Basic EPS................................................... $ 26,926 163,051 $ .17
Dilutive effect of stock options, warrants, equity forwards
and deferred compensation................................. -- 6,888 (.01)
-------- ------- -----
Diluted EPS................................................. $ 26,926 169,939 $ .16
======== ======= =====
THREE MONTHS ENDED MARCH 31, 2000
Basic EPS................................................... $150,742 157,197 $ .96
Dilutive effect of stock options, warrants and equity
forwards.................................................. -- 5,059 (.03)
-------- ------- -----
Diluted EPS................................................. $150,742 162,256 $ .93
======== ======= =====
6. DERIVATIVE FINANCIAL INSTRUMENTS
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company maintains an overall interest rate risk management strategy that
incorporates the use of derivative instruments to minimize significant unplanned
fluctuations in earnings that are caused by interest rate volatility. The
Company's goal is to manage interest rate sensitivity by modifying the repricing
or maturity characteristics of certain balance sheet assets and liabilities so
that the net interest margin is not, on a material basis, adversely affected by
movements in interest rates. As a result of interest rate fluctuations, hedged
assets and liabilities will appreciate or depreciate in market value. Income or
loss on the derivative instruments that are linked to the hedged assets and
liabilities will generally offset the effect of this unrealized appreciation or
depreciation. The Company views this strategy as a prudent management of
interest rate sensitivity, such that earnings are not exposed to undue risk
presented by changes in interest rates.
Derivative instruments that are used as part of the Company's interest rate
risk management strategy include interest rate swaps, futures contracts, and
interest rate floor and cap contracts with indices that relate to the pricing of
specific balance sheet assets and liabilities. As a matter of policy, the
Company does not use highly leveraged derivative instruments for interest rate
risk management. Interest rate swaps generally involve the exchange of fixed and
variable rate interest payments between two parties, based on a common notional
principal amount and maturity date. Interest rate futures generally involve
exchange-traded contracts to buy or sell Treasury or Agency securities in the
future at specified prices or exchange-traded Eurodollar/LIBOR contracts whose
value is derived from changes in LIBOR loan rates. Interest rate floor and cap
contracts generally involve the paying or receiving of interest above or below a
stated strike rate in exchange for an upfront premium payment.
10
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED
MARCH 31, 2001 AND 2000 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
The Company also enters into various interest rate contracts for trading and
macro risk management purposes. Trading activities (which include derivative
transactions entered into for risk management purposes and which do not
otherwise qualify for hedge accounting) primarily involve providing various
derivative products to counterparties and managing overall enterprise risk and
risks in other trading portfolios.
By using derivative instruments, the Company is exposed to credit and market
risk. If the counterparty fails to perform, credit risk is equal to the extent
of the fair value gain in a derivative. When the fair value of a derivative
contract is positive, this generally indicates that the counterparty owes the
Company. When the fair value of a derivative contract is negative, the Company
owes the counterparty and, therefore, it has no repayment risk. The Company
minimizes the credit (or repayment) risk in derivative instruments by entering
into transactions with high-quality counterparties that are reviewed
periodically by the Company's credit committee. The Company also maintains a
policy of requiring that all derivative contracts be governed by an
International Swaps and Derivative Association Master Agreement; depending on
the nature of the derivative transaction, bilateral collateral arrangements may
be required as well. When the Company has more than one outstanding derivative
transaction with a counterparty, and there exists a legally enforceable master
netting agreement with the counterparty (i.e. a legal right of a setoff of
receivable and payable derivative contracts), the "net" mark-to-market exposure
represents the netting of the positive and negative exposures with the same
counterparty. When there is a net negative exposure, the Company considers its
exposure to the counterparty to be zero. The Company's policy is to use master
netting agreements with all counterparties.
Market risk is the adverse effect that a change in interest rates, or
implied volatility rates, has on the value of a financial instrument. The
Company manages the market risk associated with interest rates by establishing
and monitoring limits as to the types and degree of risk that may be undertaken.
The Company's Audit/Finance Committee of the Board of Directors, as part of
its oversight of the Company's asset/liability and treasury functions, monitors
the Company's derivative activities. The Company is responsible for implementing
various hedging strategies. The resulting hedging strategies are then
incorporated into the Company's overall interest rate risk management and
trading strategies.
FAIR VALUE HEDGES
The Company enters into interest rate swaps to convert fixed rate assets
into variable rate assets and fixed rate debt into variable rate debt. The
Company's risk management policy is to match the interest rate sensitivity of
its assets and liabilities based on the Company's overall match funding
strategy.
At March 31, 2001, the Company held fair value hedges with a net fair value
loss position of $67 million on a notional amount of $1.8 billion. For the
quarter ended March 31, 2001, the Company recognized a net loss of $9 million
(reported as "Derivative market value adjustment" in the income statement),
which represented the ineffective portion of all fair value hedges. All
components of each derivative's gain or loss are included in the assessment of
hedge effectiveness, unless otherwise noted.
11
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED
MARCH 31, 2001 AND 2000 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
CASH FLOW HEDGES
The Company uses futures contracts to hedge its interest rate risk on its
assets and liabilities. The Company uses this strategy primarily to minimize its
exposure to volatility in interest rates.
At March 31, 2001, the Company held cash flow hedges with a net fair value
loss position of $44 million on a notional amount of $27.4 billion. For the
quarter ended March 31, 2001, the Company included $39 million of after-tax
unrealized losses in other comprehensive income. Of the total other
comprehensive income, the Company recognized $1 million of after-tax net losses
related to the amortization of closed futures contracts, and $15 million of
after-tax net losses on derivatives (reported as gains and losses on sales of
securities) as a result of the discontinuance of cash flow hedges related to
certain forecasted transactions. The Company expects to amortize $8 million of
after-tax net losses over the next 12 months related to futures contracts closed
as of March 31, 2001. All components of each derivative's gain or loss are
included in the assessment of hedge effectiveness, unless otherwise noted.
Gains and losses on derivative contracts that are reclassified from
accumulated other comprehensive income to current period earnings are included
in other operating income. Portions of the deferred net losses on derivative
instruments accumulated in the other comprehensive income are expected to be
reclassified as earnings during the next twelve months. This expectation is
based on the anticipated issuance of debt, at which time the Company will begin
recognizing the deferred net gains as an adjustment to interest cost. The
maximum term over which the Company is hedging its exposure to the variability
of future cash flows (for all forecasted transactions, excluding interest
payments on variable rate debt) is one year.
TRADING ACTIVITIES
RISK MANAGEMENT
The Company purchases interest rate caps and futures contracts and sells
interest rate floors and futures contracts to lock in reset rates on floating
rate debt and interest rate swaps, and to partially offset the embedded floor
options in student loan assets. These relationships do not satisfy hedging
qualifications under SFAS 133, but are considered economic hedges for risk
management purposes. The Company uses this strategy to minimize its exposure to
floating rate volatility.
The Company also uses basis swaps to "lock-in" a desired spread between the
Company's interest-earning assets and interest-bearing liabilities. These swaps
usually possess a term of one to seven years, with a pay rate indexed to
Treasury bill rates. The specific terms and notional amounts of the swaps are
determined based on management's review of its asset/liability structure, its
assessment of future interest rate relationships, as well as on other factors
such as short-term strategic initiatives.
The Company also uses various purchased option-based products for overall
asset/liability management purposes, including options on interest rate swaps,
floor contracts, and cap contracts. These purchased products are not linked to
specific assets and liabilities on the balance sheet and, therefore, do not
qualify for hedge accounting treatment.
12
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED
MARCH 31, 2001 AND 2000 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
OTHER
Interest rate derivative instruments utilized by the Company in its trading
operations include interest rate and basis swaps, interest rate caps and floors,
and Eurodollar, LIBOR and Agency futures contracts.
At March 31, 2001, the Company held trading derivatives with a net fair
value loss position of $442 million on a notional amount of $57.7 billion. For
the quarter ended March 31, 2001, the Company recognized a net loss of
$129 million (reported as "Derivative market value adjustment" in the income
statement), which represented the total change in fair value for the derivatives
designated as "trading." Also, $9 million of net derivative after-tax gains at
transition were reclassified from other comprehensive income to other operating
income. As of March 31, 2001, $32 million of transition adjustment net after-tax
gains on derivative instruments accumulated in other comprehensive income are
expected to be reclassified as earnings during the next twelve months.
13
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
THREE MONTHS ENDED MARCH 31, 2001 AND 2000
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
OVERVIEW
SLM HOLDING CORPORATION ("SLM HOLDING") WAS FORMED ON FEBRUARY 3, 1997 AS A
WHOLLY OWNED SUBSIDIARY OF THE STUDENT LOAN MARKETING ASSOCIATION (THE "GSE").
ON AUGUST 7, 1997, IN ACCORDANCE WITH THE STUDENT LOAN MARKETING ASSOCIATION
REORGANIZATION ACT OF 1996 (THE "PRIVATIZATION ACT") AND APPROVAL BY
SHAREHOLDERS OF AN AGREEMENT AND PLAN OF REORGANIZATION, THE GSE WAS REORGANIZED
INTO A SUBSIDIARY OF SLM HOLDING (THE "REORGANIZATION"). EFFECTIVE AS OF
JULY 31, 2000, SLM HOLDING CORPORATION WAS RENAMED USA EDUCATION, INC. UPON THE
COMPLETION OF THE ACQUISITION OF THE GUARANTEE SERVICING, STUDENT LOAN SERVICING
AND SECONDARY MARKET OPERATIONS OF USA GROUP, INC. ("USA GROUP"). USA
EDUCATION, INC. IS A HOLDING COMPANY THAT OPERATES THROUGH A NUMBER OF
SUBSIDIARIES INCLUDING THE GSE. REFERENCES HEREIN TO THE "COMPANY" REFER TO THE
GSE AND ITS SUBSIDIARIES FOR PERIODS PRIOR TO THE REORGANIZATION AND TO USA
EDUCATION, INC. AND ITS SUBSIDIARIES FOR PERIODS AFTER THE REORGANIZATION.
The Company is the nation's largest private source of financing and
servicing for education loans in the United States, primarily through its
participation in the Federal Family Education Loan Program ("FFELP"), formerly
the Guaranteed Student Loan Program. The Company's products and services include
student loan purchases and commitments to purchase student loans, as well as
operational support to originators of student loans and to post-secondary
education institutions, guarantor servicing and other education-related
financial services. The Company also originates, purchases, holds and services
unguaranteed private loans.
The following Management's Discussion and Analysis contains forward-looking
statements and information that are based on management's current expectations
as of the date of this document. Discussions that utilize the words "intend,"
"anticipate," "believe," "estimate" and "expect" and similar expressions, as
they relate to the Company's management, are intended to identify
forward-looking statements. Such forward-looking statements are subject to
risks, uncertainties, assumptions and other factors that may cause the actual
results of the Company to be materially different from those reflected in such
forward-looking statements. Such factors include, among others, changes in the
terms of student loans and the educational credit marketplace arising from the
implementation of applicable laws and regulations and from changes in such laws
and regulations; which may reduce the volume, average term and costs of yields
on student loans under the FFELP or result in loans being originated or
refinanced under non-FFELP 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 and consumer lending
or in financing preferences of lenders, educational institutions, students and
their families; and 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.
14
SELECTED FINANCIAL DATA
CONDENSED STATEMENTS OF INCOME
THREE MONTHS
ENDED INCREASE
MARCH 31, (DECREASE)
------------------- -------------------
2001 2000 $ %
-------- -------- -------- --------
Net interest income......................................... $180 $162 $ 18 11%
Less: provision for losses.................................. 14 9 5 44
---- ---- ----- ----
Net interest income after provision for losses.............. 166 153 13 9
Gains on student loan securitizations....................... 9 42 (33) (78)
Servicing and securitization revenue........................ 120 62 58 93
Gains (losses) on sales of securities....................... (23) 43 (66) 155
Guarantor servicing fees.................................... 55 -- 55 100
Derivative market value adjustment.......................... (137) -- (137) (100)
Other income................................................ 31 28 3 9
Operating expenses.......................................... 167 96 71 74
Income taxes................................................ 21 75 (54) (72)
Minority interest in net earnings of subsidiary............. 3 3 -- --
---- ---- ----- ----
NET INCOME.................................................. 30 154 (124) (81)
Preferred stock dividends................................... 3 3 -- --
---- ---- ----- ----
Net income attributable to common stock..................... $ 27 $151 $(124) (82)%
==== ==== ===== ====
BASIC EARNINGS PER SHARE.................................... $.17 $.96 $(.79) (83)%
==== ==== ===== ====
DILUTED EARNINGS PER SHARE.................................. $.16 $.93 $(.77) (83)%
==== ==== ===== ====
Dividends per common share.................................. $.18 $.16 $ .02 9%
==== ==== ===== ====
CONDENSED BALANCE SHEETS
INCREASE
(DECREASE)
MARCH 31, DECEMBER 31, -------------------
2001 2000 $ %
--------- ------------ -------- --------
ASSETS
Student loans............................................ $38,525 $37,647 $ 878 2%
Warehousing advances..................................... 1,014 987 27 3
Academic facilities financings........................... 837 851 (14) (2)
Cash and investments..................................... 6,774 5,941 833 14
Other assets............................................. 3,719 3,366 353 11
------- ------- ------ ---
Total assets......................................... $50,869 $48,792 $2,077 4%
======= ======= ====== ===
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings.................................... $37,473 $30,464 $7,009 23%
Long-term notes.......................................... 9,850 14,911 (5,061) (34)
Other liabilities........................................ 1,912 1,788 124 7
------- ------- ------ ---
Total liabilities.................................... 49,235 47,163 2,072 4
------- ------- ------ ---
Minority interest in subsidiary.......................... 214 214 -- --
Stockholders' equity before treasury stock............... 2,878 2,550 328 13
Common stock held in treasury at cost.................... 1,458 1,135 323 28
------- ------- ------ ---
Total stockholders' equity........................... 1,420 1,415 5 --
------- ------- ------ ---
Total liabilities and stockholders' equity........... $50,869 $48,792 $2,077 4%
======= ======= ====== ===
15
RESULTS OF OPERATIONS
EARNINGS SUMMARY
The Company's "core cash basis" net income was $145 million ($.84 diluted
earnings per share) for the three months ended March 31, 2001 versus
$109 million ($.66 diluted earnings per share) for the three months ended
March 31, 2000. "Core cash basis" results measure only the recurring earnings of
the Company. Accordingly, securitization transactions are treated as financings,
not sales, and thereby gains on such sales are eliminated. In addition, the
effect of floor revenue, certain one-time gains and losses on sales of
investment securities and student loans, certain integration charges, and the
amortization of goodwill are also excluded from net income calculated in
accordance with generally accepted accounting principles ("GAAP"). Similarly, in
order to preserve consistency in "core cash basis" reporting, the non-cash,
mark-to-market effects of Statement of Financial Standards No. 133
("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities,"
which became effective as of January 1, 2001, also are excluded. (See "Pro-forma
Statements of Income" for a detailed discussion of "core cash basis" net
income.)
The increase in "core cash basis" net income in the first quarter of 2001
versus the first quarter of 2000 is mainly due to the $14.6 billion increase in
the average balance of the Company's managed portfolio of student loans,
partially offset by higher funding costs, and to the net increase in fee income
as a result of the acquisition of the operations of USA Group in July 2000.
For the three months ended March 31, 2001, the Company's net income
calculated in accordance with GAAP was $30 million ($.16 diluted earnings per
share), versus net income of $154 million ($.93 diluted earnings per share) in
the first quarter of 2000. The decrease in GAAP net income in the first quarter
of 2001 versus the year-ago quarter is mainly due to the net impact of SFAS 133
resulting in net after-tax losses of $114 million. The after-tax, mark-to-market
losses due to the implementation of SFAS 133 include $75 million losses on Floor
Revenue Contracts (defined below under "Student Loan Floor Revenue Contracts"),
$23 million losses on interest rate swaps, $8 million losses on Eurodollar
futures contracts, and $8 million losses due to the amortization of the Floor
Revenue Contracts that were de-designated as hedges on December 31, 2000. The
decrease in GAAP net income in the first quarter 2001 versus the year-ago
quarter is also due to an increase in after-tax losses on sales of securities of
$35 million, a decrease in after-tax securitization gains of $21 million, and an
increase in after-tax operating expenses of $46 million, principally due to the
acquisition of the operations of USA Group and Student Loan Funding Resources
("SLFR") in July 2000. These decreases in net income were partially offset by an
increase in after-tax floor revenues of $23 million, an increase in after-tax
servicing and securitization revenues of $38 million, an increase in after-tax
fee income of $19 million, and an after-tax mark-to-market gain of $17 million
on Floor Revenue Contracts indexed to LIBOR that were considered trading
positions.
During the first quarter of 2001, the Company securitized $1.5 billion of
student loans in one transaction and securitized $288 million through the
recycling provisions of the USA Group securitizations. The Company recorded
after-tax securitization gains of $6 million in the first quarter of 2001. The
Company securitized $4.0 billion of student loans in two transactions during the
first quarter of 2000 and recorded after-tax securitization gains of
$28 million.
During the first quarter of 2001, the Company repurchased 5.5 million common
shares through its open market purchases and equity forward settlements and
issued a net 4.3 million shares as a result of benefit plans. Common shares
outstanding at March 31, 2001 totaled 163 million.
NET INTEREST INCOME
Net interest income is derived largely from the Company's portfolio of
student loans that remain on-balance sheet. The "Taxable Equivalent Net Interest
Income" analysis set forth below is designed to facilitate a comparison of
non-taxable asset yields to taxable yields on a similar basis. Additional
16
information regarding the return on the Company's student loan portfolio is set
forth under "Student Loans--Student Loan Spread Analysis."
Taxable equivalent net interest income for the three months ended March 31,
2001 versus the three months ended March 31, 2000 increased by $9 million while
the net interest margin decreased by 12 basis points. The increase in taxable
equivalent net interest income for the three months ended March 31, 2001 was
principally due to the $4.9 billion increase in the average balance of student
loans over the year-ago quarter. The decrease in the net interest margin for the
first quarter of 2001 versus the first quarter of 2000 was due to a lower return
on the investment portfolio and the impact of SFAS 133 on cost of funds,
partially offset by an increase in floor revenue.
TAXABLE EQUIVALENT NET INTEREST INCOME
The amounts in this table and the following table are adjusted for the
impact of certain tax-exempt and tax-advantaged investments based on the
marginal federal corporate tax rate of 35 percent.
THREE MONTHS
ENDED INCREASE
MARCH 31, (DECREASE)
------------------- -------------------
2001 2000 $ %
-------- -------- -------- --------
Interest income
Student loans............................................. $713 $668 $45 7%
Warehousing advances...................................... 15 17 (2) (13)
Academic facilities financings............................ 14 17 (3) (17)
Investments............................................... 133 118 15 12
Taxable equivalent adjustment............................. -- 9 (9) (100)
---- ---- --- ----
Total taxable equivalent interest income................ 875 829 46 5
Interest expense............................................ 695 658 37 6
---- ---- --- ----
Taxable equivalent net interest income...................... $180 $171 $ 9 5%
==== ==== === ====
AVERAGE BALANCE SHEETS
The following table reflects the rates earned on earning assets and paid on
liabilities for the three months ended March 31, 2001 and 2000.
THREE MONTHS ENDED MARCH 31,
--------------------------------------------
2001 2000
------------------- -------------------
BALANCE RATE BALANCE RATE
-------- -------- -------- --------
AVERAGE ASSETS
Student loans............................................... $38,709 7.47% $33,766 7.95%
Warehousing advances........................................ 984 6.01 1,006 6.68
Academic facilities financings.............................. 852 8.34 1,049 8.29
Investments................................................. 8,625 6.09 7,342 6.75
------- ---- ------- ----
Total interest earning assets............................... 49,170 7.21% 43,163 7.73%
==== ====
Non-interest earning assets................................. 4,238 2,371
------- -------
Total assets.............................................. $53,408 $45,534
======= =======
AVERAGE LIABILITIES AND STOCKHOLDERS' EQUITY
Six month floating rate notes............................... $ 4,797 5.54% $ 4,914 6.31%
Other short-term borrowings................................. 32,158 5.61 33,056 6.03
Long-term notes............................................. 13,008 5.74 5,270 6.47
------- ---- ------- ----
Total interest bearing liabilities.......................... 49,963 5.64% 43,240 6.12%
==== ====
Non-interest bearing liabilities............................ 2,136 1,419
Stockholders' equity........................................ 1,309 875
------- -------
Total liabilities and stockholders' equity................ $53,408 $45,534
======= =======
Net interest margin......................................... 1.48% 1.60%
==== ====
17
RATE/VOLUME ANALYSIS
The Rate/Volume Analysis below shows the relative contribution of changes in
interest rates and asset volumes.
INCREASE
(DECREASE)
TAXABLE ATTRIBUTABLE TO
EQUIVALENT CHANGE IN
INCREASE -------------------
(DECREASE) RATE VOLUME
---------- -------- --------
THREE MONTHS ENDED MARCH 31, 2001 VS. THREE MONTHS ENDED
MARCH 31, 2000
Taxable equivalent interest income.......................... $46 $(53) $99
Interest expense............................................ 37 (53) 90
--- ---- ---
Taxable equivalent net interest income...................... $ 9 $ -- $ 9
=== ==== ===
STUDENT LOANS
STUDENT LOAN SPREAD ANALYSIS
The following table analyzes the reported earnings from student loans both
on-balance sheet and those off-balance sheet in securitization trusts. For
student loans off-balance sheet, the Company will continue to earn servicing fee
revenues over the life of the securitized student loan portfolios. The
off-balance sheet information presented in "Securitization Program--Servicing
and Securitization Revenue" analyzes the on-going servicing revenue and residual
interest earned on the securitized portfolios of student loans. For an analysis
of the Company's student loan spread for the entire portfolio of managed student
loans on a similar basis to the on-balance sheet analysis, see "'Core Cash
Basis' Student Loan Spread and Net Interest Income."
THREE MONTHS ENDED
MARCH 31,
----------------------
2001 2000
-------- --------
ON-BALANCE SHEET
Adjusted student loan yields................................ 8.18% 8.62%
Consolidated loan rebate fees............................... (.28) (.25)
Offset fees................................................. (.14) (.14)
Borrower benefits........................................... (.07) (.08)
Premium amortization........................................ (.22) (.20)
------- -------
Student loan income......................................... 7.47 7.95
Cost of funds............................................... (5.81) (6.11)
------- -------
Student loan spread......................................... 1.66% 1.84%
======= =======
OFF-BALANCE SHEET
Servicing and securitization revenue........................ 1.62% 1.23%
======= =======
AVERAGE BALANCES
Student loans............................................... $38,709 $33,766
Securitized loans........................................... 30,028 20,328
------- -------
Managed student loans....................................... $68,737 $54,094
======= =======
The Company's portfolio of student loans originated under the FFELP has a
variety of unique interest rate characteristics. The Company earns interest at
the greater of the borrower's rate or a floating rate determined by reference to
the average of the applicable floating rates (91-day Treasury
18
bill, commercial paper or 52-week Treasury bill) in a calendar quarter, plus a
fixed spread which is dependent upon when the loan was originated. If the
floating rate exceeds the borrower rate, the Department of Education makes a
payment directly to the Company based upon the special allowance payment ("SAP")
formula established under the Higher Education Act. If the floating rate is less
than the rate the borrower is obligated to pay, the Company simply earns
interest at the borrower rate. In all cases, the rate a borrower is obligated to
pay is the lowest interest rate or the floor that the Company can earn on a
student loan. The borrowers' interest rates are either fixed to term or are
reset annually on July 1 of each year depending on when the loan was originated.
The Company generally finances its student loan portfolio with floating rate
debt tied to the average of the 91-day Treasury bill auctions, commercial paper
or 52-week Treasury bill, either directly or through the use of derivative
financial instruments intended to mimic the interest rate characteristics of the
student loans. Such borrowings generally float over all interest rate ranges. As
a result, in periods of declining interest rates, the portfolio of managed
student loans may be earning at the borrower rate while the Company's funding
costs (exclusive of fluctuations in funding spreads) generally continue to
decline along with short-term interest rates. When this happens, the difference
between the interest earned from the rate paid by the borrower and the interest
that would be earned as derived from the SAP formula is referred to as "Floor
Revenue." For loans where the borrower's interest rate is fixed to term,
declining interest rates may benefit the spread earned on student loans for
extended periods of time. For loans where the borrower's interest rate is reset
annually, any benefit of a declining interest rate environment will only enhance
student loan spreads through the next annual reset of the borrower's interest
rates, which occurs on July 1 of each year.
Due to the decline in Treasury bill and commercial paper rates during the
first quarter of 2001, the Company realized $12 million in Floor Revenue from
student loans earning at the minimum borrower rate in the first quarter of 2001
versus $2 million of such earnings in the year-ago quarter.
The on-balance sheet cost of funds did not decrease in tandem with the
student loan yield due to the impact from SFAS 133 treatment of Eurodollar
futures which increased first quarter 2001 cost of funds by 24 basis points as
compared to the year-ago quarter. This was partially offset by the impact of the
decline in Treasury bill and commercial paper rates on student loans earning at
the minimum borrower rate which increased the on-balance sheet student loan
spread by 11 basis points versus the year-ago quarter.
The following table analyzes the ability of the FFELP student loans in the
Company's managed student loan portfolio to earn at the minimum borrower
interest rate at March 31, 2001 and 2000, based on the last Treasury bill
auctions of 4.31 percent and 5.88 percent, respectively, which were applicable
to those periods (dollars in billions).
MARCH 31, 2001 MARCH 31, 2000
------------------------------ ------------------------------
ANNUALLY ANNUALLY
FIXED RESET FIXED RESET
BORROWER BORROWER BORROWER BORROWER
RATE RATE TOTAL RATE RATE TOTAL
-------- -------- -------- -------- -------- --------
Student loans eligible to earn at the minimum
borrower rate................................... $16.2 $39.4 $55.6 $13.1 $29.5 $42.6
Less notional amount of floor interest
contracts....................................... (7.6) -- (7.6) (5.3) (3.1) (8.4)
----- ----- ----- ----- ----- -----
Net student loans eligible to earn at the minimum
borrower rate................................... $ 8.6 $39.4 $48.0 $ 7.8 $26.4 $34.2
===== ===== ===== ===== ===== =====
Net student loans earning at the minimum
borrower rate................................... $ 7.7 $39.3 $47.0 $ 2.1 $ -- $ 2.1
===== ===== ===== ===== ===== =====
19
STUDENT LOAN FLOOR REVENUE CONTRACTS
Periodically, the Company has entered into contracts with third parties to
monetize the value of the minimum borrower interest rate feature of its
portfolio of FFELP student loans. Under these contracts, referred to as "Floor
Revenue Contracts," the Company receives an upfront payment and agrees to pay
the difference between (1) the minimum borrower interest rate less the
applicable SAP rate ("the strike rate") and (2) the average of the 91-day
Treasury bill rates over the period of the contract. If the strike rate is less
than the average of the Treasury bill rates, then no payment is required. Prior
to the implementation of SFAS 133, these upfront payments were amortized over
the average life of the contracts.
Effective December 31, 2000, in anticipation of the adoption of SFAS 133,
the Floor Revenue Contracts were de-designated as effective hedges and
marked-to-market. The net effect of the fair market value of these contracts and
the unamortized upfront payments totaled $104 million and was reclassified to
student loan premium and will be amortized over the average life of the student
loan portfolio ("SFAS 133 transition adjustment"). At March 31, 2001, the
unamortized SFAS 133 transition adjustment in student loan premium totaled
$96 million. First quarter 2001 amortization totaled $4 million and the premium
write-off due to securitization totaled $4 million.
In the first quarter of 2001, the Company recognized $115 million in
pre-tax, mark-to-market losses attributable to Floor Revenue Contracts with
$14.3 billion notional amount due to the implementation of SFAS 133. In the
first quarter of 2000, the amortization of the upfront payments received from
the sale of Floor Revenue Contracts on the Company's on-balance sheet student
loans was $6 million.
ON-BALANCE SHEET FUNDING COSTS
The Company's borrowings are generally variable-rate indexed principally to
the 91-day Treasury bill rate. The following table summarizes the average
balance of on-balance sheet debt (by index, after giving effect to the impact of
interest rate swaps) for the three months ended March 31, 2001 and 2000 (dollars
in millions).
THREE MONTHS ENDED MARCH 31,
--------------------------------------------
2001 2000
------------------- -------------------
AVERAGE AVERAGE AVERAGE AVERAGE
INDEX BALANCE RATE BALANCE RATE
- ----- -------- -------- -------- --------
Treasury bill, principally 91-day........................ $32,922 5.56% $33,639 6.15%
LIBOR.................................................... 1,850 6.16 1,768 6.02
Discount notes........................................... 10,554 5.62 4,647 5.70
Fixed.................................................... 2,261 6.16 1,422 5.98
Zero coupon.............................................. 183 11.14 164 11.17
Commercial paper......................................... 921 5.76 947 6.25
Auction rate securities.................................. 1,101 4.85 -- --
Other.................................................... 171 5.74 653 5.50
------- ----- ------- -----
Total.................................................... $49,963 5.64% $43,240 6.12%
======= ===== ======= =====
20
The following table details the spreads for the Company's Treasury bill
indexed borrowings and London Interbank Offered Rate ("LIBOR") indexed
borrowings:
THREE MONTHS ENDED
MARCH 31,
-------------------
INDEXED BORROWINGS 2001 2000
- ------------------ -------- --------
TREASURY BILL
Weighted average Treasury bill.............................. 5.03% 5.61%
Borrowing spread............................................ .53 .54
---- ----
Weighted average borrowing rate............................. 5.56% 6.15%
==== ====
LIBOR
Weighted average LIBOR...................................... 6.17% 6.24%
Borrowing spread............................................ (.01) (.22)
---- ----
Weighted average borrowing rate............................. 6.16% 6.02%
==== ====
SECURITIZATION PROGRAM
During the first quarter of 2001, the Company completed a securitization
transaction in which a total of $1.5 billion of student loans were sold to a
special purpose finance subsidiary and by that subsidiary to a trust that issued
asset-backed securities to fund the student loans to term. Also in the first
quarter 2001, the Company securitized $288 million through the recycling
provisions of the USA Group securitizations. During the first quarter of 2000,
the Company securitized $4.0 billion through two transactions.
GAINS ON STUDENT LOAN SECURITIZATIONS
For the three months ended March 31, 2001, the Company recorded pre-tax
securitization gains of $9 million, which was .53 percent of the portfolio
securitized, versus $42 million gains in the first quarter of 2000 or
1.05 percent of the portfolio securitized. The decrease in the first quarter
2001 securitization gain as a percentage of the portfolio securitized versus the
year-ago quarter is mainly due to the increase in the premium balance of loans
securitized due to the SFAS 133 transition adjustment (see "Student Loan Floor
Revenue Contracts"). Gains on future securitizations will continue to vary
depending on the size and the loan characteristics of the loan portfolios
securitized and the funding costs prevailing in the securitization debt markets.
SERVICING AND SECURITIZATION REVENUE
The following table summarizes the components of servicing and
securitization revenue:
THREE MONTHS ENDED
MARCH 31,
-------------------
2001 2000
-------- --------
Servicing revenue less amortization of servicing asset...... $ 64 $45
Securitization revenue...................................... 56 17
---- ---
Total servicing and securitization revenue.................. $120 $62
==== ===
In the first quarter of 2001, servicing and securitization revenue was
1.62 percent of average securitized loans versus 1.23 percent in the year-ago
quarter. The increase in servicing and securitization revenue as a percentage of
the average balance of securitized student loans in the first quarter of 2001
versus the first quarter of 2000 is principally due to the impact of the decline
in
21
Treasury bill and commercial paper rates during the first quarter of 2001, which
increased the earnings from those student loans in the trusts that were earning
the minimum borrower rate in a manner similar to on-balance sheet student loans.
OTHER INCOME
Other income, exclusive of gains on student loan securitizations, servicing
and securitization revenue, the "Derivative market value adjustment", gains on
sales of student loans, and certain one-time gains and losses on sales of
investment securities totaled $86 million for the three months ended March 31,
2001 versus $28 million for the three months ended March 31, 2000. Other income
mainly includes guarantor servicing fees, late fees earned on student loans,
revenue received from servicing third party portfolios of student loans, and
commitment fees for letters of credit. Guarantor servicing fees arise primarily
from four categories of services that correspond to the student loan life cycle.
They include fees from loan originations, the maintenance of loan guarantees,
default prevention, and collections. Included in other operating income for the
first quarter of 2001 was $74 million of income attributable to the guarantor
servicing, loan servicing and other income from the USA Group transaction which
closed in July 2000.
OPERATING EXPENSES
The following table summarizes the components of operating expenses:
THREE MONTHS ENDED
MARCH 31,
-------------------
2001 2000
-------- --------
Servicing and acquisition expenses.......................... $ 94 $60
General and administrative expenses......................... 73 36
---- ---
Total operating expenses.................................... $167 $96
==== ===
Operating expenses include costs to service the Company's managed student
loan portfolio, operational costs incurred in the process of acquiring student
loan portfolios, general and administrative expenses and, beginning in
August 2000, operational costs associated with its guarantor servicing
operations. Operating expenses for the three months ended March 31, 2001 and
2000 were $167 million and $96 million, respectively. The increase in general
and administrative expenses of $37 million and the increase in servicing and
acquisition expenses of $34 million over the year-ago quarter was mainly due to
the addition of operating expenses connected with the acquisitions of SLFR and
USA Group which closed in July 2000.
STUDENT LOAN PURCHASES
The following table summarizes the components of the Company's student loan
purchase activity:
THREE MONTHS ENDED
MARCH 31,
-------------------------
2001 2000
-------- --------
Control channels............................................ $2,827 $1,908
Other commitment clients.................................... 209 283
Spot purchases.............................................. 127 154
Consolidations.............................................. 169 208
Other....................................................... 296 297
------ ------
Subtotal.................................................... 3,628 2,850
Managed loans acquired...................................... 14 --
------ ------
Total managed loans acquired................................ $3,642 $2,850
====== ======
22
The Company purchased $3.6 billion of student loans in the first quarter of
2001 compared with $2.9 billion in the year-ago quarter.
In the first quarter of 2001, the Company's control channels of loan
originations totaled $3.1 billion versus $2.1 billion in the year-ago quarter.
The pipeline of loans currently serviced and committed for purchase by the
Company was $5.3 billion at March 31, 2001 versus $3.5 billion at March 31,
2000.
The following table summarizes the activity in the Company's managed
portfolio of student loans for the three months ended March 31, 2001 and 2000.
THREE MONTHS ENDED
MARCH 31,
-------------------------
2001 2000
-------- --------
Beginning balance........................................... $67,515 $53,276
Purchases................................................... 3,642 2,850
Capitalized interest on securitized loans................... 183 138
Repayments, claims, other................................... (1,840) (1,303)
Loan sales.................................................. (1) (38)
SFAS 133 student loan premium............................... (104) --
Loans consolidated from USA Education, Inc.................. (343) (187)
------- -------
Ending balance.............................................. $69,052 $54,736
======= =======
PRO-FORMA STATEMENTS OF INCOME
Under GAAP, the Company's securitization transactions have been treated as
sales. At the time of sale, in accordance with SFAS 140, the Company records an
asset equal to the present value of the estimated future net cash flows from the
portfolio of loans sold and a gain equal to the difference between that asset
and the allocated cost basis of the loans sold. Interest earned on the interest
residual and fees earned for servicing the loan portfolios are recognized over
the life of the securitization transaction as servicing and securitization
revenue. Under SFAS 140, income recognition is effectively accelerated through
the recognition of a gain at the time of sale while the ultimate realization of
such income remains dependent on the actual performance, over time, of the loans
that were securitized.
Effective for the fiscal year beginning January 1, 2001, the Company adopted
SFAS 133 which requires that every derivative instrument be recorded in the
balance sheet as either an asset or liability measured at its fair value (see
Notes 2 and 6 to "Consolidated Financial Statements"). Most of the derivative
contracts into which the Company enters are effective economic hedges for its
interest rate management strategy but are not effective hedges under SFAS 133.
The majority of these hedges are treated as "trading" for GAAP purposes and,
therefore, the resulting mark-to-market is taken into GAAP earnings. For
example, SFAS 133 requires that the Company mark-to-market its written options
but not its embedded options in its student loan assets. Effectively, in this
case, SFAS 133 recognizes the liability, but not the corresponding asset.
Management believes that, in addition to results of operations as reported
in accordance with GAAP, another important performance measure is pro-forma
results of operations under the assumption that the securitization transactions
are financings and that the securitized student loans were not sold. As such, no
gain on sale or subsequent servicing and securitization revenue is recognized.
Instead, the earnings of the student loans in the trusts and the related
financing costs are reflected over the life of the underlying pool of loans. The
pro-forma results of operations also exclude the effect of floor income, certain
one-time gains and losses on sales of investment securities and student loans,
certain integration charges, the non-cash, mark-to-market effects of SFAS 133,
and the
23
amortization of goodwill. Management refers to these pro-forma results as "core
cash basis" statements of income. Management monitors and reports the periodic
"core cash basis" earnings of the Company's managed student loan portfolio and
believes that they assist in a better understanding of the Company's student
loan business.
The following table presents the "core cash basis" statements of income and
reconciliations to GAAP net income as reflected in the Company's consolidated
statements of income.
THREE MONTHS ENDED
MARCH 31,
-------------------------
2001 2000
-------- --------
"CORE CASH BASIS" STATEMENTS OF INCOME:
Insured student loans....................................... $1,271 $1,077
Advances/Facilities/Investments............................. 168 153
------ ------
Total interest income....................................... 1,439 1,230
Interest expense............................................ (1,143) (986)
------ ------
Net interest income......................................... 296 244
Less: provision for losses.................................. 19 14
------ ------
Net interest income after provision for losses.............. 277 230
------ ------
Other income:
Guarantor servicing fees.................................. 55 --
Other..................................................... 57 28
------ ------
Total other income.......................................... 112 28
Total operating expenses.................................... 159 95
------ ------
Income before taxes and minority interest in net earnings of
subsidiary................................................ 230 163
Income taxes................................................ 82 51
Minority interest in net earnings of subsidiary............. 3 3
------ ------
"Core cash basis" net income................................ 145 109
Preferred stock dividends................................... 3 3
------ ------
"Core cash basis" net income attributable to common stock... $ 142 $ 106
====== ======
"Core cash basis" diluted earnings per share................ $ .84 $ .66
====== ======
24
THREE MONTHS ENDED
MARCH 31,
-------------------
2001 2000
-------- --------
RECONCILIATION OF GAAP NET INCOME TO "CORE CASH BASIS" NET
INCOME:
GAAP net income............................................. $ 30 $ 154
"Core cash basis" adjustments:
Net interest income, excluding floor income............... 155 84
Floor income.............................................. (38) (2)
Provision for losses...................................... (6) (5)
Gains on student loan securitizations..................... (9) (42)
Servicing and securitization revenue...................... (120) (62)
(Gains)/losses on sales of securities..................... 12 (43)
Goodwill amortization..................................... 8 2
Net impact of SFAS 133.................................... 175 --
------- -------
Total "core cash basis" adjustments......................... 177 (68)
Net tax effect (A).......................................... (62) 23
------- -------
"Core cash basis" net income................................ $ 145 $ 109
======= =======
- ------------------------
(A) Such tax effect is based upon the Company's marginal tax rate for the
respective period.
"CORE CASH BASIS" STUDENT LOAN SPREAD AND NET INTEREST INCOME
The following table analyzes the reported earnings from the Company's
portfolio of managed student loans, which includes those on-balance sheet and
those off-balance sheet in securitization trusts. The line captioned "Adjusted
student loan yields" reflects contractual student loan yields.
THREE MONTHS ENDED
MARCH 31,
-------------------
2001 2000
-------- --------
"Core cash basis" student loan yields....................... 8.13% 8.61%
Consolidated loan rebate fees............................... (.19) (.17)
Offset fees................................................. (.08) (.08)
Borrower benefits........................................... (.10) (.09)
Premium amortization........................................ (.26) (.26)
------- -------
Student loan income......................................... 7.50 8.01
Cost of funds............................................... (5.77) (6.24)
------- -------
"Core cash basis" student loan spread....................... 1.73% 1.77%
======= =======
AVERAGE BALANCES
Student loans............................................... $68,737 $54,094
======= =======
The Company generally earns interest at the greater of the borrower's rate
or a floating rate determined by reference to the applicable floating rates
(91-day Treasury bill, commercial paper or 52-week Treasury bill) in a calendar
quarter, plus a fixed spread which is dependent upon when the loan was
originated. In all cases, the rate the borrower pays sets a minimum rate for
determining the yield the Company earns on the loan. The Company generally
finances its student loan portfolio with floating rate debt tied to the average
of the 91-day Treasury bill auctions, the commercial paper index or the 52-week
Treasury bill, either directly or through the use of derivative financial
instruments, to mimic the interest rate characteristics of the student loans.
Such borrowings, however, generally do not have minimum rates. As a result, in
certain declining interest rate environments, the portfolio of
25
managed student loans may be earning at the minimum borrower rate while the
Company's funding costs (exclusive of fluctuations in funding spreads) will
generally decline along with short term interest rates. For loans where the
borrower's interest rate is fixed to term, lower interest rates may benefit the
spread earned on student loans for extended periods of time. For loans where the
borrower's interest rate is reset annually, any benefit of a low interest rate
environment will only enhance student loan spreads through the next annual reset
of the borrower's interest rate, which occurs on July 1 of each year. Due to the
decline in Treasury bill and commercial paper rates in the first quarter of
2001, the Company realized $38 million in Floor Revenue from student loans
earning at the minimum borrower rate in the first quarter of 2001 versus
$2 million of such earnings in the year-ago quarter. These earnings have been
excluded from student loan income to calculate the "core cash basis" student
loan spread.
While Floor Revenue is excluded from "core cash basis" results, the
amortization of the upfront payments received from the Floor Revenue Contracts
is included as an addition to student loan income in the "core cash basis"
results. For the three months ended March 31, 2001 and 2000, the amortization of
the upfront payments received from the Floor Revenue Contracts with fixed
borrower rates was $8 million and $5 million, respectively, and for Floor
Revenue Contracts with annually reset borrower rates was $5 million and
$1 million, respectively. In addition, during the three months ended March 31,
2001, a loss of $12 million of unamortized upfront payments was recognized in
premium income due to the extinguishment of $1.2 billion of Floor Revenue
Contracts on annual reset loans. At March 31, 2001, unamortized payments
received from the sale of Floor Revenue Contracts totaled $133 million,
$114 million of which related to contracts on fixed rate loans and $19 million
of which related to contracts on annual reset loans. The $13.2 billion of
outstanding fixed borrower rate Floor Revenue Contracts at March 31, 2001 have
expiration dates through the year 2008, while the $1.1 billion of annually reset
borrower rate contracts outstanding at March 31, 2001 have expiration dates
through the year 2003.
The decrease in the first quarter of 2001 "core cash basis" student loan
spread versus the year-ago quarter is primarily attributable to the increase in
the average balance of consolidation loans as a percentage of total managed
loans which decreased the "core cash basis" student loan spread by 2 basis
points.
The "core cash basis" net interest margin for the first quarters of 2001 and
2000 was 1.52 percent and 1.60 percent, respectively. The decrease in the first
quarter of 2001 "core cash basis" net interest margin versus the first quarter
of 2000 is mainly due to the decrease in the student loan spread discussed
above, the increased percentage of long-term debt as a percentage of total
liabilities, and an increase in short-term investments which earn income at a
lower spread.
FEDERAL AND STATE TAXES
The Company is subject to federal and state taxes, however, the GSE is
exempt from all state, local, and District of Columbia income, franchise, sales
and use, personal property and other taxes, except for real property taxes. This
tax exemption applies only to the GSE and does not apply to USA Education, Inc.
or its other operating subsidiaries that are subject to taxation at the state
and local level. As business activity increasingly occurs outside of the GSE,
the impact of state and local taxes will increase accordingly. This was the
primary reason for the Company's effective tax rate to increase from the
statutory rate of 35 percent to 39 percent for the first quarter of 2001.
The Company maintains a portfolio of tax-advantaged assets principally to
support education-related financing activities. That portfolio was primarily
responsible for the decrease in the effective federal income tax rate from the
statutory rate of 35 percent to 33 percent in the first quarter of 2000. State
taxes were immaterial in the three months ended March 31, 2000 as the majority
of the Company's business activities were conducted in the GSE.
26
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary requirements for capital are to fund the Company's
operations, to purchase student loans and to repay its debt obligations while
continuing to meet the GSE's statutory capital adequacy ratio test. The
Company's primary sources of liquidity are through debt issuances by its GSE
subsidiary, off-balance sheet financings through securitizations, borrowings
under its commercial paper and senior notes programs, and cash generated by its
subsidiaries' operations and distributed through dividends to the Company.
The Company's unsecured financing requirements are driven by three principal
factors: refinancing of existing liabilities as they mature; financing of
student loan portfolio growth; and the Company's level of securitization
activity.
In the first quarter of 2001, the Company completed one securitization
transaction totaling $1.5 billion in student loans and an additional
$300 million through the recycling provisions of the securitizations acquired
from USA Group. The Company manages the resulting off-balance sheet basis risk
with on-balance sheet financing and derivative instruments, which principally
consists of basis swaps and Eurodollar futures.
During the first quarter of 2001, the Company used the net proceeds from
student loan securitizations of $1.8 billion, net proceeds from the issuance of
debt of $2.0 billion, and repayments and claim payments on student loans of
$922 million to purchase student loans of $3.6 billion, to increase investments
by $497 million, and to repurchase $323 million of the Company's common stock.
Operating activities used net cash of $94 million in the first quarter of
2001, a decrease of $252 million from the net cash inflows of $158 million in
the year-ago quarter.
During the first quarter of 2001, the Company issued $2.2 billion of
long-term notes to refund maturing and repurchased obligations. At March 31,
2001, the Company had $9.8 billion of outstanding long-term debt issues of which
$486 million had stated maturities that could be accelerated through call
provisions. The Company uses interest rate and foreign currency swaps
(collateralized where appropriate), purchases of U.S. Treasury securities, and
other hedging techniques to reduce its exposure to interest rate and currency
fluctuations that arise from its financing activities and to match the variable
interest rate characteristics of its earning assets. (See "Interest Rate Risk
Management.")
On January 1, 2000, the GSE's statutory capital adequacy ratio was increased
from 2.00 percent to 2.25 percent. At March 31, 2001, the GSE's statutory
capital adequacy ratio, after the effect of the dividends to be paid in the
second quarter of 2001, was 2.32 percent.
INTEREST RATE RISK MANAGEMENT
INTEREST RATE GAP ANALYSIS
The Company's principal objective in financing its operations is to minimize
its sensitivity to changing interest rates by matching the interest rate
characteristics of its borrowings to specific assets in order to lock in
spreads. The Company funds its floating rate managed loan assets (most of which
have weekly rate resets) with variable rate debt and fixed rate debt converted
to variable rates with interest rate swaps. The Company also uses interest rate
cap agreements, foreign currency swaps, options on securities, and financial
futures contracts to further reduce interest rate risk and foreign currency
exposure on certain of its borrowings. Investments are funded on a "pooled"
approach, i.e., the pool of liabilities that funds the investment portfolio has
an average rate and maturity or reset date that corresponds to the average rate
and maturity or reset date of the investments which they fund.
In addition to term match funding, $14.7 billion of the Company's
asset-backed securities match the interest rate characteristics of the majority
of the student loans in the trusts by being indexed to the 91-day Treasury bill.
At March 31, 2001, there were approximately $3.4 billion of PLUS student loans
27
outstanding in the trusts, which have interest rates that reset annually based
on the final auction of 52-week Treasury bills before each July 1. In addition,
at March 31, 2001, approximately $16.3 billion of asset-backed securities had
been indexed to LIBOR. In its securitization transactions, the Company retains
this basis risk and manages it through its on-balance sheet financing
activities. The effect of this basis risk management is included in the
following table as the impact of securitized student loans.
In the table below the Company's variable rate assets and liabilities are
categorized by reset date of the underlying index. Fixed rate assets and
liabilities are categorized based on their maturity dates. The notional amount
of interest rate swap contracts is included in the "Off-balance Sheet Financial
Instruments" section of the table below. An interest rate gap is the difference
between volumes of assets and volumes of liabilities maturing or repricing
during specific future time intervals. The following gap analysis reflects
rate-sensitive positions at March 31, 2001 and is not necessarily reflective of
positions that existed throughout the period.
INTEREST RATE SENSITIVITY PERIOD
---------------------------------------------------------------------------
3 MONTHS 3 MONTHS TO 6 MONTHS TO 1 TO 2 2 TO 5 OVER 5
OR LESS 6 MONTHS 1 YEAR YEARS YEARS YEARS
--------- ----------- ----------- -------- -------- --------
ASSETS
Student loans..................................... $35,253 $2,731 $ 541 $ -- $ -- $ --
Warehousing advances.............................. 988 13 -- -- 2 11
Academic facilities financings.................... 36 24 16 120 257 384
Cash and investments.............................. 3,597 1,103 20 7 151 1,896
Other assets...................................... 29 34 67 139 428 3,022
------- ------ ------- ----- ------ ------
Total assets.................................... 39,903 3,905 644 266 838 5,313
------- ------ ------- ----- ------ ------
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings............................. 35,806 1,114 553 -- -- --
Long-term notes................................... 7,544 12 -- 414 1,340 540
Other liabilities................................. -- -- -- -- -- 1,912
Minority interest in subsidiary................... -- -- -- -- -- 214
Stockholders' equity.............................. -- -- -- -- -- 1,420
------- ------ ------- ----- ------ ------
Total liabilities and stockholders' equity...... 43,350 1,126 553 414 1,340 4,086
------- ------ ------- ----- ------ ------
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
Interest rate swaps............................... 3,943 (1,423) (1,805) 250 38 (1,003)
Impact of securitized student loans............... (3,391) 3,391 -- -- -- --
------- ------ ------- ----- ------ ------
Total off-balance sheet financial instruments... 552 1,968 (1,805) 250 38 (1,003)
------- ------ ------- ----- ------ ------
Period gap........................................ $(2,895) $4,747 $(1,714) $ 102 $ (464) $ 224
======= ====== ======= ===== ====== ======
Cumulative gap.................................... $(2,895) $1,852 $ 138 $ 240 $ (224) $ --
======= ====== ======= ===== ====== ======
Ratio of interest-sensitive assets to
interest-sensitive liabilities.................. 92.0% 343.8% 104.3% 30.7% 30.6% 424.3%
======= ====== ======= ===== ====== ======
Ratio of cumulative gap to total assets........... 5.7% (3.6)% (0.3)% (0.5)% .4% --%
======= ====== ======= ===== ====== ======
INTEREST RATE SENSITIVITY ANALYSIS
The effect of short-term movements in interest rates on the Company's
results of operations and financial position has been limited through the
Company's risk management activities. The Company performed a sensitivity
analysis to determine the effect of a hypothetical increase in market interest
rates of 10 percent on the Company's variable rate assets and liabilities and a
hypothetical 10 percent increase in spreads to their underlying index. Based on
this analysis, there has not been a material change in market risk from
December 31, 2000 as reported in the Company's Form 10-K.
28
AVERAGE TERMS TO MATURITY
The following table reflects the average terms to maturity for the Company's
managed earning assets and liabilities at March 31, 2001 (in years):
ON- OFF-
BALANCE BALANCE
SHEET SHEET MANAGED
-------- -------- --------
EARNING ASSETS
Student loans............................................... 7.3 4.2 5.9
Warehousing advances........................................ 5.5 -- 5.5
Academic facilities financings.............................. 6.6 -- 6.6
Cash and investments........................................ 4.2 -- 4.2
--- --- ---
Total earning assets........................................ 6.8 4.2 5.8
--- --- ---
BORROWINGS
Short-term borrowings....................................... .4 -- .4
Long-term borrowings........................................ 4.1 4.2 4.2
--- --- ---
Total borrowings............................................ 1.2 4.2 2.4
=== === ===
In the above table, Treasury receipts and variable rate asset-backed
securities, although generally liquid in nature, extend the weighted average
remaining term to maturity of cash and investments to 4.2 years. As student
loans are securitized, the need for long-term on-balance sheet financing will
decrease.
COMMON STOCK
The Company repurchased 5.5 million shares during the first quarter of 2001
through open market purchases and equity forward settlements and issued a net
4.3 million shares as a result of benefit plans. At March 31, 2001, the total
common shares that could potentially be acquired over the next four years under
outstanding equity forward contracts was 16.5 million, and the Company had a
remaining authority to enter into additional share repurchases and equity
forward contracts for 10.9 million shares.
29
The following table summarizes the Company's common share repurchase and
equity forward activity for the three months ended March 31, 2001 and 2000. (All
amounts in the tables are common shares in millions.)
THREE MONTHS ENDED
MARCH 31,
-------------------
2001 2000
-------- --------
COMMON SHARES REPURCHASED:
Open market............................................... 2.7 --
Equity forwards........................................... 2.8 1.1
------ ------
Total shares repurchased.................................... 5.5 1.1
====== ======
Average purchase price per share............................ $54.51 $43.78
====== ======
EQUITY FORWARD CONTRACTS:
Outstanding at beginning of year............................ 18.2 21.4
New contracts............................................... 1.1 1.7
Exercises................................................... (2.8) (1.1)
------ ------
Outstanding at end of period................................ 16.5 22.0
====== ======
Remaining Board of Director authority at end of period...... 10.9 1.9
====== ======
As of March 31, 2001, the expiration dates and range of purchase prices for
outstanding equity forward contracts are as follows:
OUTSTANDING RANGE OF MARKET
YEAR OF MATURITY CONTRACTS PRICES
- ---------------- ----------- -----------------------
2001........................................................ 1.5 $32.11 - $43.06
2002........................................................ 5.0 41.01 - 45.55
2003........................................................ 7.1 33.93 - 63.00
2004........................................................ 1.7 39.82 - 45.62
2005........................................................ 1.2 30.00 - 36.04
----
16.5
====
OTHER RELATED EVENTS AND INFORMATION
OTHER DEVELOPMENTS
Effective as of March 27, 2001, J. Paul Carey resigned as Executive Vice
President of the Company. Mr. Carey continued to serve as President and a
director of the Student Loan Marketing Association until May 8, 2001. Effective
as of May 8, 2001, Marianne M. Keler, Esquire, was appointed as the President of
the Student Loan Marketing Association. Ms. Keler continues to serve as an
Executive Vice President and the General Counsel of the Company.
30
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Nothing to report.
ITEM 2. CHANGES IN SECURITIES.
Nothing to report.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Nothing to report.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Nothing to report.
ITEM 5. OTHER INFORMATION.
Effective as of March 27, 2001, J. Paul Carey resigned as Executive Vice
President of the Company. Mr. Carey continued to serve as President and a
director of the Student Loan Marketing Association until May 8, 2001. Effective
as of May 8, 2001, Marianne M. Keler, Esquire, was appointed as the President of
the Student Loan Marketing Association. Ms. Keler continues to serve as an
Executive Vice President and the General Counsel of the Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
None.
(b) Reports on Form 8-K
We filed four Current Reports on Form 8-K with the Commission during the
quarter ended March 31, 2001 or thereafter. They were filed on:
- February 22, 2001 in connection with our press release announcing our
earnings for the fourth quarter ended December 31, 2000 and our
supplemental financial information for the same period
- February 27, 2001 in connection with the issuance of $500,000,000 of our
Senior Notes due February 18, 2003
- March 7, 2001 in connection with the sale of 7,241,513 shares of our
common stock by the Lumina Foundation for Education, Inc.
- April 17, 2001 in connection with the issuance of $115,000,000 of our
Senior Notes due February 18, 2003, increasing the aggregate principal
amount of the outstanding notes of this series to $615,000,000
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned hereunto duly authorized.
USA EDUCATION, INC.
(Registrant)
By: /s/ JOHN F. REMONDI
-----------------------------------------
John F. Remondi
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
(Principal Financial and Accounting Officer
and Duly Authorized Officer)
Date: May 15, 2001
32
