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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 JUNE 30, 2001 OR
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 (IRS Employer
incorporation or organization) Identification No.)
11600 SALLIE MAE DRIVE, RESTON, VIRGINIA 20193
(Address of principal executive offices) (Zip Code)
(703) 810-3000
(Registrant's telephone number, including area code)
------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
CLASS OUTSTANDING AT JUNE 30, 2001
- ---------------------------- ----------------------------
Common Stock, $.20 par value 160,523,989 shares
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USA EDUCATION, INC.
FORM 10-Q
INDEX
JUNE 30, 2001
PAGE
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.............................. 3
Item 2. Management's Discussion and Analysis of Financial
Condition
and Results of Operations........................... 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................. 35
Item 2. Changes in Securities............................. 35
Item 3. Defaults Upon Senior Securities................... 35
Item 4. Submission of Matters to a Vote of Security
Holders................................................. 35
Item 5. Other Information................................. 36
Item 6. Exhibits and Reports on Form 8-K.................. 36
SIGNATURES.................................................. 37
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
USA EDUCATION, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
JUNE 30, DECEMBER 31,
2001 2000
----------- ------------
(UNAUDITED)
ASSETS
Student loans............................................... $39,778,407 $37,647,297
Warehousing advances........................................ 950,244 987,352
Academic facilities financings
Bonds--available-for-sale................................. 438,003 498,775
Loans..................................................... 338,388 352,393
----------- -----------
Total academic facilities financings.................... 776,391 851,168
Investments
Trading................................................... 1,945 --
Available-for-sale........................................ 4,144,634 4,244,762
Held-to-maturity.......................................... 1,033,720 961,260
----------- -----------
Total investments....................................... 5,180,299 5,206,022
Cash and cash equivalents................................... 809,181 734,468
Other assets, principally accrued interest receivable....... 3,730,875 3,365,481
----------- -----------
Total assets............................................ $51,225,397 $48,791,788
=========== ===========
LIABILITIES
Short-term borrowings....................................... $35,215,782 $30,463,988
Long-term notes............................................. 12,470,888 14,910,939
Other liabilities........................................... 1,732,795 1,787,642
----------- -----------
Total liabilities....................................... 49,419,465 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 and 3,300,000
shares, respectively, issued at stated value of $50 per
share..................................................... 165,000 165,000
Common stock, par value $.20 per share, 375,000,000 shares
authorized, 198,922,031 and 190,851,936 shares issued,
respectively.............................................. 39,784 38,170
Additional paid-in capital.................................. 549,070 225,211
Unrealized gains on investments (net of tax of $261,208 and
$167,624, respectively)................................... 485,100 311,301
Retained earnings........................................... 2,060,176 1,810,902
----------- -----------
Stockholders' equity before treasury stock.................. 3,299,130 2,550,584
Common stock held in treasury at cost: 38,398,042 and
26,707,091 shares, respectively........................... 1,707,081 1,135,248
----------- -----------
Total stockholders' equity................................ 1,592,049 1,415,336
----------- -----------
Total liabilities and stockholders' equity................ $51,225,397 $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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------- -------------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
INTEREST INCOME:
Student loans...................................... $674,510 $634,465 $1,387,543 $1,302,122
Warehousing advances............................... 10,722 11,156 25,307 27,855
Academic facilities financings:
Taxable.......................................... 7,918 11,135 15,953 20,029
Tax-exempt....................................... 5,746 7,925 11,913 16,200
-------- -------- ---------- ----------
Total academic facilities financings............... 13,664 19,060 27,866 36,229
Investments........................................ 95,952 142,367 228,805 260,558
-------- -------- ---------- ----------
Total interest income................................ 794,848 807,048 1,669,521 1,626,764
INTEREST EXPENSE:
Short-term debt.................................... 444,083 543,945 954,753 1,117,001
Long-term debt..................................... 123,362 101,462 307,557 186,253
-------- -------- ---------- ----------
Total interest expense............................... 567,445 645,407 1,262,310 1,303,254
-------- -------- ---------- ----------
Net interest income.................................. 227,403 161,641 407,211 323,510
Less: provision for losses........................... 13,271 7,900 26,870 17,338
-------- -------- ---------- ----------
Net interest income after provision for losses....... 214,132 153,741 380,341 306,172
-------- -------- ---------- ----------
OTHER INCOME:
Gains on student loan securitizations.............. 18,300 26,024 27,778 68,354
Servicing and securitization revenue............... 193,732 68,548 313,743 130,667
(Losses) gains on sales of securities.............. (47,584) 790 (78,919) 43,792
Guarantor servicing fees........................... 58,045 -- 113,228 --
Derivative market value adjustment................. 116,884 -- (51,280) --
Other.............................................. 56,843 29,952 126,148 58,092
-------- -------- ---------- ----------
Total other income................................... 396,220 125,314 450,698 300,905
OPERATING EXPENSES:
Salaries and benefits.............................. 84,318 47,347 176,885 101,218
Other.............................................. 85,949 47,697 160,755 90,064
-------- -------- ---------- ----------
Total operating expenses............................. 170,267 95,044 337,640 191,282
-------- -------- ---------- ----------
Income before income taxes and minority interest in
net earnings of subsidiary......................... 440,085 184,011 493,399 415,795
-------- -------- ---------- ----------
INCOME TAXES:
Current............................................ 220,068 66,327 259,205 207,689
Deferred........................................... (64,451) (5,483) (82,749) (71,384)
-------- -------- ---------- ----------
Total income taxes................................... 155,617 60,844 176,456 136,305
Minority interest in net earnings of subsidiary...... 2,673 2,673 5,347 5,347
-------- -------- ---------- ----------
NET INCOME........................................... 281,795 120,494 311,596 274,143
Preferred stock dividends............................ 2,875 2,886 5,750 5,793
-------- -------- ---------- ----------
Net income attributable to common stock.............. $278,920 $117,608 $ 305,846 $ 268,350
======== ======== ========== ==========
Basic earnings per share............................. $ 1.74 $ .75 $ 1.89 $ 1.71
======== ======== ========== ==========
Average common shares outstanding.................... 160,707 156,090 161,872 156,643
======== ======== ========== ==========
Diluted earnings per share........................... $ 1.68 $ .73 $ 1.82 $ 1.66
======== ======== ========== ==========
Average common and common equivalent shares
outstanding........................................ 166,408 161,969 168,164 162,113
======== ======== ========== ==========
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
STOCK --------------------------------------- PREFERRED
SHARES ISSUED TREASURY OUTSTANDING STOCK
--------- ----------- ----------- ----------- ---------
BALANCE AT MARCH 31, 2000................................... 3,300,000 186,237,095 (29,632,909) 156,604,186 $165,000
Comprehensive income:
Net income..............................................
Other comprehensive income, net of tax:
Change in unrealized gains (losses) on investments,
net of tax..........................................
Comprehensive income......................................
Cash dividends:
Common stock ($.16 per share)...........................
Preferred stock ($.88 per share)........................
Issuance of common shares................................. 29,784 50,000 79,784
Premiums on equity forward purchase contracts.............
Repurchase of common shares................................. (1,480,122) (1,480,122)
--------- ----------- ----------- ----------- --------
BALANCE AT JUNE 30, 2000.................................... 3,300,000 186,266,879 (31,063,031) 155,203,848 $165,000
========= =========== =========== =========== ========
BALANCE AT MARCH 31, 2001................................... 3,300,000 195,699,344 (32,730,575) 162,968,769 $165,000
Comprehensive income:
Net income..............................................
Other comprehensive income, net of tax:
Change in unrealized gains (losses) on investments,
net of tax..........................................
Comprehensive income......................................
Cash dividends:
Common stock ($.17 per share)...........................
Preferred stock ($.87 per share)........................
Issuance of common shares................................. 3,222,687 192,422 3,415,109
Premiums on equity forward purchase contracts.............
Repurchase of common shares............................... (5,859,889) (5,859,889)
--------- ----------- ----------- ----------- --------
BALANCE AT JUNE 30, 2001.................................... 3,300,000 198,922,031 (38,398,042) 160,523,989 $165,000
========= =========== =========== =========== ========
UNREALIZED
GAINS (LOSSES)
COMMON ADDITIONAL ON RETAINED
STOCK PAID-IN CAPITAL INVESTMENTS EARNINGS
-------- --------------- -------------- ----------
BALANCE AT MARCH 31, 2000................................... $37,247 $ 60,740 $295,371 $1,587,637
Comprehensive income:
Net income.............................................. 120,494
Other comprehensive income, net of tax:
Change in unrealized gains (losses) on investments,
net of tax.......................................... 7
Comprehensive income......................................
Cash dividends:
Common stock ($.16 per share)........................... (24,962)
Preferred stock ($.88 per share)........................ (2,886)
Issuance of common shares................................. 6 1,247
Premiums on equity forward purchase contracts............. (9,245)
Repurchase of common shares.................................
------- -------- -------- ----------
BALANCE AT JUNE 30, 2000.................................... $37,253 $ 52,742 $295,378 $1,680,283
======= ======== ======== ==========
BALANCE AT MARCH 31, 2001................................... $39,140 $424,543 $440,228 $1,809,316
Comprehensive income:
Net income.............................................. 281,795
Other comprehensive income, net of tax:
Change in unrealized gains (losses) on investments,
net of tax.......................................... 44,872
Comprehensive income......................................
Cash dividends:
Common stock ($.17 per share)........................... (28,060)
Preferred stock ($.87 per share)........................ (2,875)
Issuance of common shares................................. 644 135,848
Premiums on equity forward purchase contracts............. (11,321)
Repurchase of common shares...............................
------- -------- -------- ----------
BALANCE AT JUNE 30, 2001.................................... $39,784 $549,070 $485,100 $2,060,176
======= ======== ======== ==========
TOTAL
TREASURY STOCKHOLDERS'
STOCK EQUITY
----------- -------------
BALANCE AT MARCH 31, 2000................................... $(1,233,469) $ 912,526
Comprehensive income:
Net income.............................................. 120,494
Other comprehensive income, net of tax:
Change in unrealized gains (losses) on investments,
net of tax.......................................... 7
----------
Comprehensive income...................................... 120,501
Cash dividends:
Common stock ($.16 per share)........................... (24,962)
Preferred stock ($.88 per share)........................ (2,886)
Issuance of common shares................................. 2,366 3,619
Premiums on equity forward purchase contracts............. (9,245)
Repurchase of common shares................................. (61,542) (61,542)
----------- ----------
BALANCE AT JUNE 30, 2000.................................... $(1,292,645) $ 938,011
=========== ==========
BALANCE AT MARCH 31, 2001................................... $(1,458,049) $1,420,178
Comprehensive income:
Net income.............................................. 281,795
Other comprehensive income, net of tax:
Change in unrealized gains (losses) on investments,
net of tax.......................................... 44,872
----------
Comprehensive income...................................... 326,667
Cash dividends:
Common stock ($.17 per share)........................... (28,060)
Preferred stock ($.87 per share)........................ (2,875)
Issuance of common shares................................. 43 136,535
Premiums on equity forward purchase contracts............. (11,321)
Repurchase of common shares............................... (249,075) (249,075)
----------- ----------
BALANCE AT JUNE 30, 2001.................................... $(1,707,081) $1,592,049
=========== ==========
See accompanying notes to consolidated financial statements.
5
USA EDUCATION, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
PREFERRED COMMON STOCK SHARES
STOCK ---------------------------------------- PREFERRED
SHARES ISSUED TREASURY OUTSTANDING STOCK
--------- ----------- ----------- ------------ ---------
BALANCE AT DECEMBER 31, 1999............................... 3,300,000 186,069,619 (28,493,072) 157,576,547 $165,000
Comprehensive income:
Net income.............................................
Other comprehensive income, net of tax:
Change in unrealized gains (losses) on investments,
net of tax.........................................
Comprehensive income.....................................
Cash dividends...........................................
Common stock ($.32 per share)..........................
Preferred stock ($1.76 per share)......................
Issuance of common shares................................ 197,260 50,000 247,260
Premiums on equity forward purchase contracts............
Repurchase of common shares.............................. (2,619,959) (2,619,959)
--------- ----------- ----------- ------------ --------
BALANCE AT JUNE 30, 2000................................... 3,300,000 186,266,879 (31,063,031) 155,203,848 $165,000
========= =========== =========== ============ ========
BALANCE AT DECEMBER 31, 2000............................... 3,300,000 190,851,936 (26,707,091) 164,144,845 $165,000
Comprehensive income:
Net income.............................................
Other comprehensive income, net of tax:
Change in unrealized gains (losses) on investments,
net of tax.........................................
Comprehensive income.....................................
Cash dividends...........................................
Common stock ($.35 per share)..........................
Preferred stock ($1.74 per share)......................
Issuance of common shares................................ 8,070,095 192,422 8,262,517
Premiums on equity forward purchase contracts............
Repurchase of common shares.............................. (11,883,373) (11,883,373)
--------- ----------- ----------- ------------ --------
BALANCE AT JUNE 30, 2001................................... 3,300,000 198,922,031 (38,398,042) 160,523,989 $165,000
========= =========== =========== ============ ========
UNREALIZED
GAINS (LOSSES)
COMMON ADDITIONAL ON RETAINED TREASURY
STOCK PAID-IN CAPITAL INVESTMENTS EARNINGS STOCK
-------- --------------- -------------- ---------- -----------
BALANCE AT DECEMBER 31, 1999............................... $37,214 $ 62,827 $297,735 $1,462,034 $(1,183,896)
Comprehensive income:
Net income............................................. 274,143
Other comprehensive income, net of tax:
Change in unrealized gains (losses) on investments,
net of tax......................................... (2,357)
Comprehensive income.....................................
Cash dividends...........................................
Common stock ($.32 per share).......................... (50,101)
Preferred stock ($1.76 per share)...................... (5,793)
Issuance of common shares................................ 39 8,894 2,366
Premiums on equity forward purchase contracts............ (18,979)
Repurchase of common shares.............................. (111,115)
------- -------- -------- ---------- -----------
BALANCE AT JUNE 30, 2000................................... $37,253 $ 52,742 $295,378 $1,680,283 $(1,292,645)
======= ======== ======== ========== ===========
BALANCE AT DECEMBER 31, 2000............................... $38,170 $225,211 $311,301 $1,810,902 $(1,135,248)
Comprehensive income:
Net income............................................. 311,596
Other comprehensive income, net of tax:
Change in unrealized gains (losses) on investments,
net of tax......................................... 173,799
Comprehensive income.....................................
Cash dividends...........................................
Common stock ($.35 per share).......................... (56,572)
Preferred stock ($1.74 per share)...................... (5,750)
Issuance of common shares................................ 1,614 343,234 12,126
Premiums on equity forward purchase contracts............ (19,375)
Repurchase of common shares.............................. (583,959)
------- -------- -------- ---------- -----------
BALANCE AT JUNE 30, 2001................................... $39,784 $549,070 $485,100 $2,060,176 $(1,707,081)
======= ======== ======== ========== ===========
TOTAL
STOCKHOLDERS'
EQUITY
-------------
BALANCE AT DECEMBER 31, 1999............................... $ 840,914
Comprehensive income:
Net income............................................. 274,143
Other comprehensive income, net of tax:
Change in unrealized gains (losses) on investments,
net of tax......................................... (2,357)
----------
Comprehensive income..................................... 271,786
Cash dividends...........................................
Common stock ($.32 per share).......................... (50,101)
Preferred stock ($1.76 per share)...................... (5,793)
Issuance of common shares................................ 11,299
Premiums on equity forward purchase contracts............ (18,979)
Repurchase of common shares.............................. (111,115)
----------
BALANCE AT JUNE 30, 2000................................... $ 938,011
==========
BALANCE AT DECEMBER 31, 2000............................... $1,415,336
Comprehensive income:
Net income............................................. 311,596
Other comprehensive income, net of tax:
Change in unrealized gains (losses) on investments,
net of tax......................................... 173,799
----------
Comprehensive income..................................... 485,395
Cash dividends...........................................
Common stock ($.35 per share).......................... (56,572)
Preferred stock ($1.74 per share)...................... (5,750)
Issuance of common shares................................ 356,974
Premiums on equity forward purchase contracts............ (19,375)
Repurchase of common shares.............................. (583,959)
----------
BALANCE AT JUNE 30, 2001................................... $1,592,049
==========
See accompanying notes to consolidated financial statements.
6
USA EDUCATION, INC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
SIX MONTHS ENDED JUNE 30,
-----------------------------
2001 2000
------------- -------------
(UNAUDITED) (UNAUDITED)
OPERATING ACTIVITIES
Net income.................................................. $ 311,596 $ 274,143
Adjustments to reconcile net income to net cash provided
by operating activities:
(Gains) on student loan securitizations................. (27,778) (68,354)
Losses (gains) on sales of securities................... 78,919 (43,792)
Derivative market value adjustment...................... 51,280 --
Provision for losses.................................... 26,870 17,338
(Increase) decrease in accrued interest receivable...... (38,953) 27,206
(Decrease) increase in accrued interest payable......... (76,089) 6,857
(Increase) in other assets.............................. (199,319) (2,781)
(Decrease) increase in other liabilities................ (25,594) 146,523
------------- -------------
Total adjustments..................................... (210,664) 82,997
------------- -------------
Net cash provided by operating activities................... 100,932 357,140
------------- -------------
INVESTING ACTIVITIES
Student loans purchased................................... (7,490,734) (5,558,685)
Reduction of student loans purchased:
Installment payments.................................... 1,616,813 1,046,026
Claims and resales...................................... 279,701 250,775
Proceeds from securitization of student loans........... 3,404,475 6,627,425
Proceeds from sales of student loans.................... 50,410 124,225
Warehousing advances made................................. (527,011) (436,588)
Warehousing advance repayments............................ 564,119 798,932
Academic facilities financings made....................... (480) (10,000)
Academic facilities financings reductions................. 80,141 72,650
Investments purchased..................................... (31,722,380) (17,641,361)
Proceeds from sale or maturity of investments............. 31,700,366 18,935,686
------------- -------------
Net cash (used in) provided by investing activities......... (2,044,580) 4,209,085
------------- -------------
FINANCING ACTIVITIES
Short-term borrowings issued.............................. 530,168,259 328,090,112
Short-term borrowings repaid.............................. (532,766,851) (331,465,504)
Long-term notes issued.................................... 9,063,072 5,549,013
Long-term notes repaid.................................... (4,137,437) (6,898,128)
Equity forward contracts and stock issued................. 337,599 (7,680)
Common stock repurchased.................................. (583,959) (111,115)
Common dividends paid..................................... (56,572) (50,101)
Preferred dividends paid.................................. (5,750) (5,793)
------------- -------------
Net cash provided by (used in) financing activities......... 2,018,361 (4,899,196)
------------- -------------
Net increase (decrease) in cash and cash equivalents........ 74,713 (332,971)
Cash and cash equivalents at beginning of period............ 734,468 589,750
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 809,181 $ 256,779
============= =============
Cash disbursements made for:
Interest.................................................. $ 1,064,857 $ 1,181,659
============= =============
Income taxes.............................................. $ 94,400 $ 50,000
============= =============
See accompanying notes to consolidated financial statements.
7
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AT JUNE 30, 2001 AND FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, 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 and six
months ended June 30, 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 to the extent that
those changes are the same. 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 companies 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 reclassified
$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
8
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT JUNE 30, 2001 AND FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, 2001 AND 2000 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2. NEW ACCOUNTING PRONOUNCEMENTS (CONTINUED)
transferor. Additionally, entities are required to disclose information related
to retained interests in 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).
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations,"
and Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill
and Other Intangible Assets." SFAS 141 requires companies to use the purchase
method of accounting for all business combinations initiated after June 30,
2001, and broadens the criteria for recording identifiable intangible assets
separate from goodwill. SFAS 142 requires companies to cease systematically
amortizing goodwill (and other intangible assets with indefinite lives) to
results of operations, but rather perform an assessment for impairment by
applying a fair-value-based test on an annual basis (or an interim basis if
circumstances indicate a possible impairment). Future impairment losses are to
be recorded as an operating expense, except at the transition date, when any
impairment write-off of existing goodwill is to be recorded as a "cumulative
effect of change in accounting principle." In accordance with SFAS 142, any
goodwill and indefinite-life intangibles resulting from acquisitions completed
after June 30, 2001 will not be amortized. Effective January 1, 2002, the
Company will cease the amortization of goodwill and indefinite-life intangibles
existing at June 30, 2001 in accordance with SFAS 142. Beginning in the first
quarter of 2002, the Company will be required to test its goodwill for
impairment, which could have an adverse effect on the Company's future results
of operations if an impairment occurs. The Company is in the process of
evaluating the financial statement impact of the adoption of SFAS 142.
9
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT JUNE 30, 2001 AND FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, 2001 AND 2000 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
3. ALLOWANCE FOR LOSSES
The following table summarizes changes in the allowance for losses for the
three and six months ended June 30, 2001 and 2000, respectively.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
BALANCE AT BEGINNING OF PERIOD.............. $306,312 $300,054 $322,056 $303,743
Additions
Provisions for losses..................... 13,271 7,900 26,870 17,338
Recoveries................................ 2,832 631 4,047 3,386
Deductions
Reductions for student loans sales and
securitizations......................... (5,164) (4,960) (8,835) (12,969)
Write-offs................................ (6,859) (4,233) (33,746) (12,106)
-------- -------- -------- --------
BALANCE AT END OF PERIOD.................... $310,392 $299,392 $310,392 $299,392
======== ======== ======== ========
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.
For the three months ended June 30, 2001, the Company sold $1.5 billion of
student loans in one securitization transaction and securitized $60 million of
student loans through the recycling provisions of the USA Group securitizations.
The Company recorded a pre-tax securitization gain of $18 million or
1.17 percent of the portfolios securitized in the second quarter of 2001. For
the three months ended June 30, 2000, the Company sold $2.5 billion of student
loans in one securitization transaction and recorded a pre-tax securitization
gain of $26 million or 1.03 percent of the portfolios securitized. For the six
months ended June 30, 2001, the Company sold $3.0 billion of student loans in
two securitization transactions and securitized $348 million through the
recycling provisions of the USA Group securitizations. The Company recorded a
pre-tax securitization gain of $28 million or 0.83 percent of the portfolios
securitized in the six months ended June 30, 2001. In the six months ended
June 30, 2000, the Company sold $6.5 billion of student loans in three separate
transactions and recorded a pre-tax securitization gain of $68 million or
1.05 percent of the portfolios securitized. At June 30, 2001 and December 31,
2000, securitized student loans outstanding totaled $31.0 billion and
$29.9 billion, respectively.
10
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT JUNE 30, 2001 AND FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, 2001 AND 2000 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
4. STUDENT LOAN SECURITIZATION (CONTINUED)
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 second quarter of 2001 were as
follows:
Prepayment speed............................................ 7% per annum
Weighted-average life....................................... 4.3 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. The following table summarizes
the cash flows received from securitization trusts entered into during the three
and six months ended June 30, 2001 (dollars in millions):
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 2001 JUNE 30, 2001
------------- -------------
Proceeds from new securitizations................... 1,501 3,024
Servicing fees received............................. 3 3
Cash flows received on interest-only strips......... -- --
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
11
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT JUNE 30, 2001 AND FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, 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 JUNE 30, 2001
Basic EPS.................................... $278,920 160,707 $1.74
Dilutive effect of stock options, warrants,
equity forwards, and deferred
compensation............................... -- 5,701 (.06)
-------- ------- -----
Diluted EPS.................................. $278,920 166,408 $1.68
======== ======= =====
THREE MONTHS ENDED JUNE 30, 2000
Basic EPS.................................... $117,608 156,090 $ .75
Dilutive effect of stock options, warrants
and equity forwards........................ -- 5,879 (.02)
-------- ------- -----
Diluted EPS.................................. $117,608 161,969 $ .73
======== ======= =====
NET INCOME
ATTRIBUTABLE
TO COMMON AVERAGE EARNINGS
STOCK SHARES PER SHARE
------------ ----------- ---------
(THOUSANDS) (THOUSANDS)
SIX MONTHS ENDED JUNE 30, 2001
Basic EPS.................................... $305,846 161,872 $1.89
Dilutive effect of stock options, warrants,
equity forwards and deferred
compensation............................... -- 6,292 (.07)
-------- ------- -----
Diluted EPS.................................. $305,846 168,164 $1.82
======== ======= =====
SIX MONTHS ENDED JUNE 30, 2000
Basic EPS.................................... $268,350 156,643 $1.71
Dilutive effect of stock options, warrants,
and equity forwards........................ -- 5,470 (.05)
-------- ------- -----
Diluted EPS.................................. $268,350 162,113 $1.66
======== ======= =====
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
12
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT JUNE 30, 2001 AND FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, 2001 AND 2000 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
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, interest rate 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.
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 Derivatives 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
legally enforceable netting provisions 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 agreements containing netting provisions with all
counterparties.
13
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT JUNE 30, 2001 AND FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, 2001 AND 2000 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
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 June 30, 2001, the Company held fair value hedges with a net fair value
loss position of $41 million on a notional amount of $3.6 billion. For the three
and six months ended June 30, 2001, the Company recognized a net loss of
$16 million and $25 million, respectively (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.
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 June 30, 2001, the Company held cash flow hedges with a net fair value
loss position of $22 million on a notional amount of $57.5 billion. For the
three and six months ended June 30, 2001, the Company included $7 million of
after-tax unrealized gains and $32 million of after-tax unrealized losses,
respectively, in other comprehensive income. For the three and six months ended
June 30, 2001, the Company recognized $4 million and $5 million, respectively,
of after-tax net losses out of other comprehensive income related to the
amortization of closed futures contracts. For the three and six months ended
June 30, 2001, the Company recognized $28 million and $43 million, respectively,
of after-tax net losses out of other comprehensive income 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 June 30, 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 are reclassified from accumulated
other comprehensive income to current period earnings when the stated hedged
transactions occur (in which case gains and losses are amortized over the lives
of the transactions) or are deemed unlikely to occur (in which case gains and
losses are taken immediately). Portions of the deferred net losses on derivative
instruments
14
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT JUNE 30, 2001 AND FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, 2001 AND 2000 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
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.
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 June 30, 2001, the
Company held trading derivatives with a net fair value loss position of
$397 million on a notional amount of $40.0 billion. For the three and six months
ended June 30, 2001, the Company recognized a net gain of $114 million and a net
loss of $47 million, respectively (reported as "derivative market value
adjustment" in the income statement), which represented the total change in fair
value for the derivatives designated as "trading." For the three and six months
ended June 30, 2001, $8 million and $16 million, respectively, of net derivative
after-tax gains at transition were reclassified from other comprehensive income
to other operating income. As of June 30, 2001, $33 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
12 months.
15
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 AND SIX MONTHS ENDED JUNE 30, 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.
16
SELECTED FINANCIAL DATA
CONDENSED STATEMENTS OF INCOME
THREE
MONTHS SIX MONTHS
ENDED INCREASE ENDED INCREASE
JUNE 30, (DECREASE) JUNE 30, (DECREASE)
------------------- ------------------- ------------------- -------------------
2001 2000 $ % 2001 2000 $ %
-------- -------- -------- -------- -------- -------- -------- --------
Net interest income....................... $ 227 $162 $ 65 41% $ 407 $ 323 $ 84 26%
Less: provision for losses................ 13 8 5 68 27 17 10 55
----- ---- ---- ---- ----- ----- ----- ----
Net interest income after provision for
losses.................................. 214 154 60 39 380 306 74 24
Gains on student loan securitizations..... 18 26 (8) (30) 28 68 (40) (59)
Servicing and securitization revenue...... 194 69 125 183 314 131 183 140
(Losses) on sales of securities........... (48) -- (48) (100) (79) 44 (123) (280)
Guarantor servicing fees.................. 58 -- 58 100 113 -- 113 100
Derivative market value adjustment........ 117 -- 117 100 (51) -- (51) (100)
Other income.............................. 57 30 27 90 126 58 68 117
Operating expenses........................ 170 95 75 79 338 191 147 77
Income taxes.............................. 156 61 95 156 176 136 40 29
Minority interest in net earnings of
subsidiary.............................. 2 3 (1) -- 5 6 (1) --
----- ---- ---- ---- ----- ----- ----- ----
Net income................................ $ 282 $120 $162 134% $ 312 $ 274 $ 38 14%
Preferred dividends....................... 3 3 -- -- 6 6 -- --
----- ---- ---- ---- ----- ----- ----- ----
Net income attributable to common stock... $ 279 $117 $162 137% $ 306 $ 268 $ 38 14%
===== ==== ==== ==== ===== ===== ===== ====
Basic earnings per share.................. $1.74 $.75 $.99 131% $1.89 $1.71 $ .18 10%
===== ==== ==== ==== ===== ===== ===== ====
Diluted earnings per share................ $1.68 $.73 $.95 131% $1.82 $1.66 $ .16 10%
===== ==== ==== ==== ===== ===== ===== ====
Dividends per common share................ $ .17 $.16 $.01 9% $ .35 $ .32 $ .03 10%
===== ==== ==== ==== ===== ===== ===== ====
CONDENSED BALANCE SHEETS
INCREASE
(DECREASE)
JUNE 30, DECEMBER 31, -------------------
2001 2000 $ %
-------- ------------ -------- --------
ASSETS
Student loans............................................... $39,778 $37,647 $ 2,131 6%
Warehousing advances........................................ 950 987 (37) (4)
Academic facilities financings.............................. 776 851 (75) (9)
Cash and investments........................................ 5,990 5,941 49 1
Other assets................................................ 3,731 3,366 365 11
------- ------- ------- ---
Total assets................................................ $51,225 $48,792 $ 2,433 5%
======= ======= ======= ===
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings....................................... $35,216 $30,464 $ 4,752 16%
Long-term notes............................................. 12,471 14,911 (2,440) (16)
Other liabilities........................................... 1,732 1,788 (56) (3)
------- ------- ------- ---
Total liabilities........................................... 49,419 47,163 2,256 5
------- ------- ------- ---
Minority interest in subsidiary............................. 214 214 -- --
Stockholders' equity before treasury stock.................. 3,299 2,550 749 29
Common stock held in treasury at cost....................... 1,707 1,135 572 50
------- ------- ------- ---
Total stockholders' equity.................................. 1,592 1,415 177 12
------- ------- ------- ---
Total liabilities and stockholders' equity.................. $51,225 $48,792 $ 2,433 5%
======= ======= ======= ===
17
RESULTS OF OPERATIONS
EARNINGS SUMMARY
For the three months ended June 30, 2001, the Company's "core cash basis"
net income was $153 million ($.90 diluted earnings per share), versus "core cash
basis" net income of $117 million ($.70 diluted earnings per share) in the
second quarter of 2000. For the six months ended June 30, 2001, the Company's
"core cash basis" net income was $298 million ($1.74 diluted earnings per share)
versus $226 million ($1.36 diluted earnings per share) for the six months ended
June 30, 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 income, 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 second quarter of 2001
versus the second 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, lower
funding costs, and a net increase in fee income as a result of the acquisition
of the operations of USA Group in July 2000. For the six months ended June 30,
2001, the increase in "core cash basis" net income versus the year-ago period is
mainly due to the $14.6 billion increase in the average balance of the Company's
managed portfolio of student loans, lower funding costs, and a net increase in
fee income.
For the three months ended June 30, 2001, the Company's net income
calculated in accordance with GAAP was $282 million ($1.68 diluted earnings per
share), versus net income of $120 million ($.73 diluted earnings per share) in
the second quarter of 2000. The increase in GAAP net income in the second
quarter of 2001 versus the year-ago quarter is mainly due to the net impact of
SFAS 133 resulting in net after-tax gains of $75 million. The second quarter
2001 after-tax, mark-to-market gains due to the implementation of SFAS 133
include $62 million gains on Floor Revenue Contracts (defined below under
"Student Loan Floor Revenue Contracts"), $2 million gains on interest rate
swaps, $9 million gains on Eurodollar futures contracts, and $6 million gains
from the transition amortization. These gains were offset by $4 million
after-tax losses due to the amortization of the Floor Revenue Contracts that
were de-designated as hedges on December 31, 2000. The increase in GAAP net
income in the second quarter 2001 versus the year-ago quarter is also due to an
$8.4 billion increase in the average balance of the Company's on-balance sheet
portfolio of student loans, an increase in after-tax servicing and
securitization revenue of $81 million, an increase in after-tax guarantor
servicing fees of $36 million (due to the acquisition of the operations of USA
Group in July 2000), an increase in after-tax floor revenues of $17 million, and
lower funding costs. These increases in net income were partially offset by an
increase in after-tax losses on sales of securities of $32 million, a decrease
in after-tax securitization gains of $5 million, and an increase in after-tax
operating expenses of $49 million, principally due to the acquisition of the
operations of USA Group and Student Loan Funding Resources ("SLFR") in
July 2000.
For the six months ended June 30, 2001, the Company's GAAP net income was
$312 million ($1.82 diluted earnings per share), versus GAAP net income of
$274 million ($1.66 diluted earnings per share) for the six months ended
June 30, 2000. The increase in year-to-date 2001 GAAP net income versus
year-to-date 2000 GAAP net income is due to a $6.7 billion increase in the
average balance of the Company's on-balance sheet portfolio of student loans, an
increase in after-tax servicing and securitization revenue of $119 million, an
increase in after-tax guarantor servicing fees of $70 million,
18
an increase in after-tax floor revenues of $23 million, and lower funding costs.
These increases in net income were partially offset by the net impact of
SFAS 133 resulting in net after-tax losses of $39 million, an increase in
after-tax losses on sales of securities of $73 million, a decrease in after-tax
securitization gains of $26 million, and an increase in after-tax operating
expenses of $95 million.
For the six months ended June 30, 2001, the Company repurchased
11.0 million common shares, through its open market purchases and equity forward
settlements and issued a net of 7.4 million shares as a result of benefit plans.
Common shares outstanding at June 30, 2001 totaled 160.5 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
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 June 30,
2001 versus the three months ended June 30, 2000 increased by $64 million while
the net interest margin increased by 30 basis points. The increase in taxable
equivalent net interest income for the three months ended June 30, 2001 is
principally due to the lower interest rate environment which led to an increase
of $26 million in floor revenue. The increase in taxable equivalent net interest
income is also due to the $8.4 billion increase in the average balance of
student loans over the year-ago quarter, which increased the percentage of
average student loans to total average earning assets. The increase in the net
interest margin for the second quarter of 2001 versus the second quarter of 2000
is principally due to an increase in floor revenue, partially offset by a lower
return on the investment portfolio.
Taxable equivalent net interest income for the six months ended June 30,
2001 versus the six months ended June 30, 2000 increased by $73 million while
the net interest margin increased by 10 basis points. The increase in taxable
equivalent net interest income for the six months ended June 30, 2001 versus the
year-ago period is principally due to an increase of $36 million in floor
revenue, and the $6.7 billion increase in the average balance of student loans
over the year-ago period.
TAXABLE EQUIVALENT NET INTEREST INCOME
The amounts in the following table are adjusted for the impact of certain
tax-exempt and tax-advantaged investments based on the marginal corporate tax
rate of 35 percent.
THREE MONTHS SIX MONTHS
ENDED INCREASE ENDED INCREASE
JUNE 30, (DECREASE) JUNE 30, (DECREASE)
------------------- ------------------- ------------------- -------------------
2001 2000 $ % 2001 2000 $ %
-------- -------- -------- -------- -------- -------- -------- --------
INTEREST INCOME
Student loans....................... $674 $634 $40 6% $1,388 $1,302 $ 86 7%
Warehousing advances................ 11 11 - (4) 25 28 (3) (9)
Academic facilities financings...... 14 19 (5) (28) 28 36 (8) (23)
Investments......................... 96 143 (47) (33) 229 261 (32) (12)
Taxable equivalent adjustment....... 6 8 (2) (15) 6 17 (11) (61)
---- ---- --- --- ------ ------ ---- ---
Total taxable equivalent interest
income.............................. 801 815 (14) (2) 1,676 1,644 32 2
Interest expense...................... 567 645 (78) (12) 1,262 1,303 (41) (3)
---- ---- --- --- ------ ------ ---- ---
Taxable equivalent net interest
income.............................. $234 $170 $64 38% $ 414 $ 341 $ 73 21%
==== ==== === === ====== ====== ==== ===
19
AVERAGE BALANCE SHEETS
The following table reflects the rates earned on earning assets and paid on
liabilities for the three and six months ended June 30, 2001 and 2000.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
----------------------------------------- -----------------------------------------
2001 2000 2001 2000
------------------- ------------------- ------------------- -------------------
BALANCE RATE BALANCE RATE BALANCE RATE BALANCE RATE
-------- -------- -------- -------- -------- -------- -------- --------
AVERAGE ASSETS
Student loans....................... $39,674 6.82% $31,272 8.16% $39,195 7.14% $32,519 8.05%
Warehousing advances................ 953 4.51 653 6.87 968 5.27 829 6.75
Academic facilities financings...... 810 8.30 1,010 9.29 830 8.32 1,030 8.78
Investments......................... 6,653 6.00 8,453 6.94 7,634 6.05 7,898 6.85
------- ---- ------- ---- ------- ---- ------- ----
Total interest earning assets......... 48,090 6.68% 41,388 7.92% 48,627 6.95% 42,276 7.82%
==== ==== ==== ====
Non-interest earning assets........... 4,295 2,127 4,267 2,249
------- ------- ------- -------
Total assets.......................... $52,385 $43,515 $52,894 $44,525
======= ======= ======= =======
AVERAGE LIABILITIES AND STOCKHOLDERS'
EQUITY
Six month floating rate notes....... $ 4,362 4.43% $ 4,393 6.35% $ 4,578 5.01% $ 4,654 6.33%
Other short-term borrowings......... 34,978 4.54 30,306 6.30 33,576 5.05 31,680 6.16
Long-term notes..................... 9,583 5.16 6,450 6.33 11,286 5.50 5,860 6.39
------- ---- ------- ---- ------- ---- ------- ----
Total interest bearing liabilities.... 48,923 4.65% 41,149 6.31% 49,440 5.15% 42,194 6.21%
==== ==== ==== ====
Non-interest bearing liabilities...... 2,021 1,425 2,079 1,423
Stockholders' equity.................. 1,441 941 1,375 908
------- ------- ------- -------
Total liabilities and stockholders'
equity............................ $52,385 $43,515 $52,894 $44,525
======= ======= ======= =======
Net interest margin................... 1.95% 1.65% 1.72% 1.62%
==== ==== ==== ====
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 JUNE 30, 2001 VS. THREE MONTHS ENDED
JUNE 30, 2000
Taxable equivalent interest income....................... $(14) $(131) $117
Interest expense......................................... (78) (172) 94
---- ----- ----
Taxable equivalent net interest income................... $ 64 $ 41 $ 23
==== ===== ====
SIX MONTHS ENDED JUNE 30, 2001 VS. SIX MONTHS ENDED
JUNE 30, 2000
Taxable equivalent interest income....................... $ 32 $(187) $219
Interest expense......................................... (41) (231) 190
---- ----- ----
Taxable equivalent net interest income................... $ 73 $ 44 $ 29
==== ===== ====
20
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
ON-BALANCE SHEET
Adjusted student loan yields............................ 7.54% 8.79% 7.86% 8.69%
Consolidation loan rebate fees.......................... (.29) (.27) (.29) (.26)
Offset fees............................................. (.14) (.13) (.14) (.13)
Borrower benefits....................................... (.07) (.06) (.07) (.07)
Premium amortization.................................... (.22) (.17) (.22) (.18)
------- ------- ------- -------
Student loan income..................................... 6.82 8.16 7.14 8.05
Cost of funds........................................... (4.92) (6.25) (5.36) (6.18)
------- ------- ------- -------
Student loan spread..................................... 1.90% 1.91% 1.78% 1.87%
======= ======= ======= =======
OFF-BALANCE SHEET
Servicing and securitization revenue.................... 2.55% 1.14% 2.09% 1.18%
======= ======= ======= =======
AVERAGE BALANCES
Student loans........................................... $39,674 $31,272 $39,195 $32,519
Securitized loans....................................... 30,480 24,248 30,255 22,288
------- ------- ------- -------
Managed student loans................................... $70,154 $55,520 $69,450 $54,807
======= ======= ======= =======
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 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.
21
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 continued decline in Treasury bill and commercial paper rates
during the second quarter of 2001, the Company realized $27 million in Floor
Revenue from student loans earning at the minimum borrower rate in the second
quarter of 2001 versus $0.6 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 second quarter 2001 cost of funds by 39 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 26 basis points versus the year-ago quarter.
For the six months ended June 30, 2001, the Company earned Floor Revenue of
$38 million of which $15 million was attributable to student loans whose minimum
borrower rates are fixed to term and $23 million was attributable to student
loans whose minimum borrower rates adjust annually on July 1. For the six months
ended June 30, 2000, the Company earned Floor Revenue of $3 million, of which
$2 million was attributable to student loans whose minimum borrower rates are
fixed to term and $1 million was attributable to student loans whose minimum
borrower rates adjust annually on July 1. The increase in Floor Revenue
increased the year-to-date 2001 on-balance sheet student loan spread by
18 basis points versus the year-ago period.
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 June 30, 2001 and 2000, based on the last Treasury bill
auctions of June 2001 and June 2000 for fixed rate loans (3.45 percent and
5.84 percent, respectively) and based on the last Treasury bill auctions of May
2001 and May 2000 for variable rate loans (3.69 percent and 5.89 percent,
respectively).
JUNE 30, 2001 JUNE 30, 2000
------------------------------ ------------------------------
ANNUALLY ANNUALLY
FIXED RESET FIXED RESET
BORROWER BORROWER BORROWER BORROWER
(DOLLARS IN BILLIONS) RATE RATE TOTAL RATE RATE TOTAL
- --------------------- -------- -------- -------- -------- -------- --------
Student loans eligible to earn at the minimum
borrower rate.................................. $16.6 $40.4 $57.0 $13.3 $30.5 $43.8
Less notional amount of floor interest
contracts...................................... (7.3) - (7.3) (4.3) (1.4) (5.7)
----- ----- ----- ----- ----- -----
Net student loans eligible to earn at the minimum
borrower rate.................................. $ 9.3 $40.4 $49.7 $ 9.0 $29.1 $38.1
===== ===== ===== ===== ===== =====
Net student loans earning at the minimum borrower
rate........................................... $ 9.3 $40.4 $49.7 $ 2.0 $- $ 2.0
===== ===== ===== ===== ===== =====
22
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. For the three and six months ended June 30,
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
$5 million and $10 million, respectively.
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 June 30, 2001, the
unamortized balance of the SFAS 133 transition adjustment in student loan
premium totaled $90 million. For the three and six months ended June 30, 2001,
amortization of the transition adjustment totaled $3 million and $7 million,
respectively, and the premium write-off due to securitization totaled
$4 million and $8 million, respectively.
For the three and six months ended June 30, 2001, the Company recognized
$95 million in pre-tax, mark-to-market gains and $25 million in pre-tax,
mark-to-market losses, respectively, attributable to Floor Revenue Contracts due
to the implementation of SFAS 133. At June 30, 2001, the outstanding notional
amount of Floor Revenue Contracts totaled $15.5 billion, which included
$8.2 billion of forward starting contracts.
ON-BALANCE SHEET FUNDING COSTS
The Company's borrowings are generally variable rate indexed principally to
the 91-day Treasury bill, commercial paper or 52-week Treasury bill. 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
and six months ended June 30, 2001 and 2000.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
----------------------------------------- -----------------------------------------
2001 2000 2001 2000
------------------- ------------------- ------------------- -------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
INDEX BALANCE RATE BALANCE RATE BALANCE RATE BALANCE RATE
- ----- -------- -------- -------- -------- -------- -------- -------- --------
Treasury bill, principally
91-day....................... $31,627 4.34% $32,597 6.35% $32,271 4.96% $33,118 6.25%
LIBOR.......................... 1,966 5.07 1,415 6.24 1,908 5.60 1,591 6.12
Discount notes................. 7,912 4.90 3,795 6.18 9,226 5.31 4,221 5.92
Fixed.......................... 4,529 5.77 1,409 5.98 3,401 5.90 1,416 5.98
Zero coupon.................... 189 11.14 169 11.17 186 11.14 167 11.17
Commercial paper............... 1,417 4.14 963 6.65 1,171 4.78 955 6.45
Auction rate securities........ 1,101 4.09 - - 1,101 4.47 - -
Other.......................... 182 4.50 801 6.19 176 5.09 726 5.88
------- ----- ------- ----- ------- ----- ------- -----
Total.......................... $48,923 4.65% $41,149 6.31% $49,440 5.15% $42,194 6.21%
======= ===== ======= ===== ======= ===== ======= =====
23
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- -------------------------
INDEXED BORROWINGS 2001 2000 2001 2000
- ------------------ -------- -------- -------- --------
TREASURY BILL
Weighted average Treasury bill......... 3.82% 5.84% 4.43% 5.72%
Borrowing spread....................... .52 .51 .53 .53
---- ---- ---- ----
Weighted average borrowing rate........ 4.34% 6.35% 4.96% 6.25%
==== ==== ==== ====
LIBOR
Weighted average LIBOR................. 4.82% 6.48% 5.47% 6.34%
Borrowing spread....................... .25 (.24) .13 (.22)
---- ---- ---- ----
Weighted average borrowing rate........ 5.07% 6.24% 5.60% 6.12%
==== ==== ==== ====
SECURITIZATION PROGRAM
During the second 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 trusts that issued
asset-backed securities to fund the student loans to term. Also in the second
quarter 2001, the Company sold $60 million of student loans through the
recycling provisions of the USA Group securitizations. During the second quarter
of 2000, the Company securitized $2.5 billion of student loans. For the six
months ended June 30, 2001, the Company sold $3.0 billion of student loans in
two separate transactions, and sold $348 million of student loans through the
recycling provisions of the USA Group securitizations. For the six months ended
June 30, 2000, the Company sold $6.5 billion of student loans in three separate
transactions.
GAINS ON STUDENT LOAN SECURITIZATIONS
For the three months ended June 30, 2001 the Company recorded pre-tax
securitization gains of $18 million, which was 1.17 percent of the portfolio
securitized, versus $26 million gains in the second quarter of 2000 or
1.03 percent of the portfolio securitized. For the six months ended June 30,
2001, the Company recorded pre-tax securitization gains of $28 million, which
was 0.83 percent of the portfolios securitized versus $68 million gains in the
six months ended June 30, 2000 or 1.05 percent of the portfolios securitized.
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 at the time of the
transactions.
SERVICING AND SECURITIZATION REVENUE
The following table summarizes the components of servicing and
securitization revenue:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
Servicing revenue less amortization of
servicing asset...................... $ 66 $ 54 $130 $ 99
Securitization revenue................. 128 15 184 32
---- ---- ---- ----
Total servicing and securitization
revenue.............................. $194 $ 69 $314 $131
==== ==== ==== ====
24
In the three and six months ended June 30, 2001, servicing and
securitization revenue was 2.55 percent and 2.09 percent, respectively, of
average securitized loans versus 1.14 percent and 1.18 percent, respectively, in
the corresponding year-ago periods. The increase in servicing and securitization
revenue as a percentage of the average balance of securitized student loans in
the three and six months ended 2001 versus the corresponding year-ago periods is
principally due to the impact of the decline in Treasury bill and commercial
paper rates during the second 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 gains and losses on sales of securities totaled
$115 million and $30 million for the three months ended June 30, 2001 and 2000,
respectively, and $239 million and $58 million for the six months ended
June 30, 2001 and 2000, respectively. 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 three and six months
ended June 30, 2001 was $76 million and $150 million, respectively, of income
attributable to the guarantor servicing, loan servicing and other fee income as
a result of the USA Group transaction which closed in July 2000.
OPERATING EXPENSES
The following table summarizes the components of operating expenses:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
Servicing and acquisition expenses..... $107 $ 59 $202 $119
General and administrative expenses.... 63 36 136 72
---- ---- ---- ----
Total operating expenses............... $170 $ 95 $338 $191
==== ==== ==== ====
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 June 30, 2001 and 2000
were $170 million and $95 million, respectively. For the six months ended
June 30, 2001 and 2000, total operating expenses were $338 million and
$191 million, respectively. The increase in operating expenses for the three and
six months ended June 30, 2001 over the corresponding year-ago periods is mainly
due to the addition of operating expenses connected with the acquisitions of
SLFR and USA Group which closed in July 2000.
25
STUDENT LOAN PURCHASES
The following table summarizes the components of the Company's student loan
purchase activity:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
Control channels....................... $2,746 $1,700 $5,573 $3,608
Other commitment clients............... 298 528 507 811
Spot purchases......................... 222 56 349 210
Consolidations......................... 313 159 482 367
Other.................................. 284 265 580 563
------ ------ ------ ------
Subtotal............................... 3,863 2,708 7,491 5,559
Managed loans acquired................. 18 - 32 -
------ ------ ------ ------
Total managed loans acquired........... $3,881 $2,708 $7,523 $5,559
====== ====== ====== ======
For the three months ended June 30, 2001, the Company purchased
$3.9 billion of student loans compared with $2.7 billion in the year-ago period.
For the six months ended June 30, 2001, the Company purchased $7.5 billion of
student loans compared with $5.6 billion in the year-ago period.
In the second quarter of 2001, the Company's control channels of loan
originations totaled $1.3 billion versus $0.7 billion in the year-ago quarter.
The pipeline of loans currently serviced and committed for purchase by the
Company was $4.3 billion at June 30, 2001 versus $2.6 billion at June 30, 2000.
The following table summarizes the activity in the Company's managed
portfolio of student loans for the three and six months ended June 30, 2001 and
2000.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
Beginning balance....................................... $69,052 $54,736 $67,515 $53,276
Purchases............................................... 3,881 2,708 7,523 5,559
Capitalized interest on securitized loans............... 188 133 371 271
Repayments, claims, other............................... (1,885) (1,268) (3,725) (2,572)
Loan sales.............................................. (50) (88) (51) (126)
SFAS 133 student loan premium........................... - - (104) -
Loans consolidated from USA Education, Inc.............. (403) (272) (746) (459)
------- ------- ------- -------
Ending balance.......................................... $70,783 $55,949 $70,783 $55,949
======= ======= ======= =======
26
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 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.
27
The following tables present 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
"Core Cash Basis" Statements of Income:
Insured student loans................................ $1,145 $ 1,131 $ 2,416 $ 2,208
Advances/Facilities/Investments...................... 118 174 286 327
------ ------- ------- -------
Total interest income................................ 1,263 1,305 2,702 2,535
Interest expense..................................... (949) (1,050) (2,092) (2,036)
------ ------- ------- -------
Net interest income.................................. 314 255 610 499
Less: provision for losses........................... 19 14 38 28
------ ------- ------- -------
Net interest income after provision for losses....... 295 241 572 471
------ ------- ------- -------
Other Income:
Gains (losses) on sales of securities.............. (1) 1 - 1
Guarantor servicing fees........................... 58 - 113 -
Other.............................................. 44 29 100 57
------ ------- ------- -------
Total other income................................... 101 30 213 58
Total operating expenses............................. 158 93 318 188
------ ------- ------- -------
Income before taxes and minority interest in net
earnings of subsidiary............................. 238 178 467 341
Income taxes......................................... 83 59 164 110
Minority interest in net earnings of subsidiary...... 2 2 5 5
------ ------- ------- -------
"Core cash basis" net income......................... $ 153 $ 117 $ 298 $ 226
Preferred stock dividends............................ 3 3 6 6
------ ------- ------- -------
"Core cash basis" net income attributable to common
stock.............................................. $ 150 $ 114 $ 292 $ 220
====== ======= ======= =======
"Core cash basis" diluted earnings per share......... $ .90 $ .70 $ 1.74 $ 1.36
====== ======= ======= =======
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
RECONCILIATION OF GAAP NET INCOME TO "CORE CASH BASIS"
NET INCOME:
GAAP net income...................................... $ 282 $ 120 $ 312 $ 274
"Core cash basis" adjustments:
Net interest income, excluding floor income........ 173 94 320 178
Floor income....................................... (102) - (140) (2)
Provision for losses............................... (6) (6) (11) (11)
Gains on student loan securitizations.............. (18) (26) (28) (68)
Servicing and securitization revenue............... (194) (69) (314) (131)
(Gains) losses on sales of securities.............. 49 - 69 (43)
Goodwill amortization.............................. 12 2 20 4
Net impact of SFAS 133............................. (116) - 59 -
------ ------- ------- -------
Total "core cash basis" adjustments.................. (202) (5) (25) (73)
Net tax effect (A)................................... 73 2 11 25
------ ------- ------- -------
"Core cash basis" net income......................... $ 153 $ 117 $ 298 $ 226
====== ======= ======= =======
- ------------------------
(A) Such tax effect is based upon the Company's marginal tax rate for the
respective period.
28
"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 " 'Core
cash basis' student loan yields" reflects contractual student loan yields.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
"Core cash basis" student loan yields................... 7.19% 8.78% 7.65% 8.70%
Consolidation loan rebate fees.......................... (.19) (.17) (.19) (.17)
Offset fees............................................. (.08) (.07) (.08) (.08)
Borrower benefits....................................... (.11) (.10) (.11) (.09)
Premium amortization.................................... (.26) (.25) (.26) (.26)
------- ------- ------- -------
Student loan income..................................... 6.55 8.19 7.01 8.10
Cost of funds........................................... (4.74) (6.43) (5.25) (6.33)
------- ------- ------- -------
"Core cash basis" student loan spread................... 1.81% 1.76% 1.76% 1.77%
======= ======= ======= =======
AVERAGE BALANCES
Student loans........................................... $70,154 $55,520 $69,450 $54,807
======= ======= ======= =======
The Company generally 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 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
managed student loans may be earning at the minimum borrower rate while the
Company's funding costs (exclusive of 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 second quarter of
2001, the Company realized $102 million in Floor Revenue from student loans
earning at the minimum borrower rate in the second quarter of 2001 versus
$0.6 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 Floor Revenue Contracts with
fixed borrower rates is included as an addition to student loan income in the
"core cash basis" results. For the three and six months ended June 30, 2001, the
amortization of the upfront payments received from the Floor Revenue Contracts
with fixed borrower rates was $9 million and $18 million, respectively, versus
$4 million and $9 million, respectively, for the three and six months ended
June 30, 2000. At June 30, 2001, unamortized payments received from the sale of
Floor Revenue Contracts on fixed rate loans totaled $132 million. The
$7.3 billion of outstanding fixed borrower rate Floor Revenue Contracts at
June 30, 2001 have expiration dates through the year 2008.
29
The increase in the "core cash basis" student loan spread for the three
months ended June 30, 2001 versus the corresponding year-ago quarter is
primarily attributable to lower funding costs. In the second quarter of 2001,
the Company utilized some of the floor revenues to extinguish certain derivative
positions and issue new positions for longer terms at lower rates. The second
quarter 2001 "core cash basis" student loan spread also benefited from the
Company's sale of long-term floor contracts against its portfolio of fixed
borrower-rate student loans. The decrease in the "core cash basis" student loan
spread for the six months ended June 30, 2001 versus the corresponding year-ago
period is primarily attributable to the increase in the average balance of
consolidation loans as a percentage of total managed loans, which decreased the
spread by 2 basis points.
For the three months ended June 30, 2001, "core cash basis" net interest
income was $314 million versus $255 million for the three months ended June 30,
2000. For the six months ended June 30, 2001, "core cash basis" net interest
income was $610 million versus $499 million for the six months ended June 30,
2000. The increase in the "core cash basis" net interest income earned in the
three and six months ended June 30, 2001 versus the corresponding year-ago
periods is primarily attributable to the increase in the average balance of
managed loans, and the increase in student loans as a percentage of average
earning assets.
"CORE CASH BASIS" OTHER INCOME
"Core cash basis" other operating income excludes gains on student loan
securitizations, servicing and securitization revenue, the effect of SFAS 133,
gains on sales of student loans, and certain one-time gains and losses on sales
of investment securities. Such income was $101 million for the three months
ended June 30, 2001 versus $30 million in the year-ago quarter, and
$213 million for the six months ended June 30, 2001 versus $58 million in the
year-ago period. "Core cash basis" other operating income mainly includes
guarantor servicing fees, late fees earned on student loans, and fees received
from servicing third party portfolios of student loans. The increase in "core
cash basis" other operating income for the three and six months ended June 30,
2001 versus the year-ago periods is principally due to fee income attributable
to the acquisition of USA Group. Guarantor servicing fees, late fees and third
party servicing fees contributed $58 million, $13 million and $14 million,
respectively, to "core cash basis" other operating income during the three
months ended June 30, 2001, and $113 million, $28 million and $29 million,
respectively, during the six months ended June 30, 2001.
FEDERAL AND STATE TAXES
The Company is subject to federal and state taxes. Its subsidiary, the GSE,
however, 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 36 percent for the three and
six months ended June 30, 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 for the three and six months ended
June 30, 2000. State taxes were immaterial in the three and six months ended
June 30, 2000 as the majority of the Company's business activities were
conducted in the GSE during that period.
30
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 six months of 2001, the Company completed two securitization
transactions totaling $3.0 billion in student loans and an additional
$348 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 six months of 2001, the Company used the net proceeds from
student loan securitizations of $3.4 billion, net proceeds from the issuance of
debt of $2.3 billion, net proceeds from the issuance of stock and equity forward
contracts of $338 million, and repayments and claim payments on student loans of
$1.9 billion to purchase student loans of $7.5 billion, to increase investments
by $22 million, and to repurchase $584 million of the Company's common stock.
Operating activities provided cash inflows of $101 million in the first six
months of 2001, a decrease of $256 million from the net cash inflows of
$357 million in the corresponding year-ago period.
During the first six months of 2001, the Company issued $9.1 billion of
long-term notes to refund maturing and repurchased obligations. At June 30,
2001, the Company had $12.5 billion of outstanding long-term debt issues of
which $691 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 June 30, 2001, the GSE was in compliance
with the new ratio with a statutory capital adequacy ratio, after the effect of
the dividends to be paid in the third quarter of 2001, of 2.61 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 the interest rate characteristics of
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.
31
In addition to term match funding, $16.1 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 June 30, 2001, there were approximately $3.4 billion of PLUS student loans
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 June 30, 2001, approximately $16.6 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 June 30, 2001 and is not necessarily reflective of
positions that existed throughout the period.
INTEREST RATE SENSITIVITY
----------------------------------------------------------------
3 MONTHS 6 MONTHS
3 MONTHS TO TO 1 TO 2 2 TO 5 OVER 5
OR LESS 6 MONTHS 1 YEAR YEARS YEARS YEARS
-------- -------- --------- -------- -------- --------
ASSETS
Student loans.............................. $36,762 $126 $ 2,890 $ -- $ -- $ --
Warehousing advances....................... 938 -- -- -- 1 11
Academic facilities financings............. 7 11 44 108 228 378
Cash and investments....................... 3,967 10 13 7 225 1,768
Other assets............................... 95 113 390 188 406 2,539
------- ---- -------- ------ ------- ------
Total assets............................... 41,769 260 3,337 303 860 4,696
------- ---- -------- ------ ------- ------
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings...................... 33,702 162 1,352 -- -- --
Long-term notes............................ 7,242 -- -- 1,146 3,539 544
Other liabilities.......................... -- -- -- -- -- 1,732
Minority interest in subsidiary............ -- -- -- -- -- 214
Stockholders' equity....................... -- -- -- -- -- 1,592
------- ---- -------- ------ ------- ------
Total liabilities and stockholders'
equity................................... 40,944 162 1,352 1,146 3,539 4,082
------- ---- -------- ------ ------- ------
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
Interest rate swaps........................ (985) -- 940 865 126 (946)
------- ---- -------- ------ ------- ------
Total off-balance sheet financial
instruments.............................. (985) - 940 865 126 (946)
------- ---- -------- ------ ------- ------
Period gap................................. $ (160) $ 98 $ 2,925 $ 22 $(2,553) $ (332)
======= ==== ======== ====== ======= ======
Cumulative gap............................. $ (160) $(62) $ 2,863 $2,885 $ 332 $ --
======= ==== ======== ====== ======= ======
Ratio of interest-sensitive assets to
interest-sensitive liabilities........... 101.8% 90.7% 218.0 % 10.0 % 12.8 % 396.5%
======= ==== ======== ====== ======= ======
Ratio of cumulative gap to total assets.... .3% .1% (5.6)% (5.6)% (0.6)% --%
======= ==== ======== ====== ======= ======
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
32
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.
AVERAGE TERMS TO MATURITY
The following table reflects the average terms to maturity for the Company's
earning assets and liabilities at June 30, 2001 (in years):
ON- OFF-
BALANCE BALANCE
SHEET SHEET MANAGED
-------- -------- --------
EARNING ASSETS
Student loans...................................... 7.3 4.2 5.9
Warehousing advances............................... 5.2 - 5.2
Academic facilities financings..................... 6.8 - 6.8
Cash and investments............................... 4.8 - 4.8
--- --- ---
Total earning assets............................... 6.9 4.2 5.8
--- --- ---
BORROWINGS
Short-term borrowings.............................. .4 - .4
Long-term borrowings............................... 3.9 4.2 4.1
--- --- ---
Total borrowings................................... 1.3 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 4.8 years. As student
loans are securitized, the need for long-term on-balance sheet financing will
decrease.
COMMON STOCK
The Company repurchased 11.0 million shares of common stock during the six
months ended June 30, 2001, through open market purchases and equity forward
settlements and issued a net 7.4 million shares as a result of benefit plans. At
June 30, 2001, the total common shares that could potentially be acquired over
the next four years under outstanding equity forward contracts was
13.0 million, and the Company had a remaining authority to enter into additional
share repurchases and equity forward contracts for 8.9 million shares.
33
The following table summarizes the Company's common share repurchase and
equity forward activity for the three and six months ended June 30, 2001 and
2000. (All amounts in the tables are common shares in millions.)
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
Common shares repurchased:
Open market............................................... - - 2.7 .1
Equity forwards........................................... 5.5 1.4 8.3 2.5
------ ------ ------ ------
Total shares repurchased.................................... 5.5 1.4 11.0 2.6
====== ====== ====== ======
Average purchase price per share............................ $41.04 $41.83 $47.72 $42.66
====== ====== ====== ======
Equity forward contracts:
Outstanding at beginning of period........................ 16.5 22.0 18.2 21.4
New contracts............................................. 2.0 - 3.1 1.7
Exercises................................................. (5.5) (1.4) (8.3) (2.5)
------ ------ ------ ------
Outstanding at end of period................................ 13.0 20.6 13.0 20.6
====== ====== ====== ======
Board of director authority remaining at end of period...... 8.9 1.9 8.9 1.9
====== ====== ====== ======
As of June 30, 2001, the expiration dates and range of purchase prices for
outstanding equity forward contracts are as follows:
JUNE 30, 2001
-----------------------------
OUTSTANDING RANGE OF MARKET
YEAR OF MATURITY CONTRACTS PRICES
- ---------------- ----------- ---------------
2001............................................. 1.0 $69.54 - $72.52
2002............................................. 1.5 43.06 - 68.82
2003............................................. 7.1 33.93 - 63.00
2004............................................. 2.2 39.82 - 73.45
2005............................................. 1.2 30.00 - 36.04
------
Total............................................ 13.0
======
34
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.
At the Company's annual meeting of shareholders held on May 10, 2001, the
following proposals were approved by the margins indicated:
1. To elect 16 directors to serve on the Company's Board of Directors for
one-year terms or until their successors are elected and qualified.
NUMBER OF SHARES
-----------------------------
VOTES FOR VOTES WITHHELD
----------- ---------------
Charles L. Daley...................................... 141,643,449 998,266
William M. Diefenderfer, III.......................... 141,644,047 997,668
Thomas J. Fitzpatrick................................. 141,634,582 1,007,133
Edward A. Fox......................................... 141,650,380 991,335
Diane Suitt Gilleland................................. 141,650,469 991,246
Earle A. Goode........................................ 141,650,562 991,153
Ann Torre Grant....................................... 141,651,351 990,364
Ronald F. Hunt........................................ 141,652,518 989,194
Benjamin J. Lambert, III.............................. 141,642,141 999,544
James C. Lintzenich................................... 141,633,398 1,008,317
Albert L. Lord........................................ 141,650,077 991,638
Barry A. Munitz....................................... 141,652,874 988,841
A. Alexander Porter, Jr............................... 141,651,098 990,617
Wolfgang Schoellkopf.................................. 141,643,736 997,979
Steven L. Shapiro..................................... 141,649,188 992,527
Barry L. Williams..................................... 141,651,894 989,821
2. To amend the Company's Certificate of Incorporation to increase the
authorized number of shares of the Company's common stock from 250,000,000
shares to 375,000,000 shares.
NUMBER OF SHARES
- ------------------------------------------------
VOTES FOR VOTES AGAINST ABSTAIN
- --------------------- ------------- --------
140,110,051..... 2,234,219 297,445
35
3. To ratify the appointment of Arthur Andersen LLP as the Company's
independent auditors for 2001.
NUMBER OF SHARES
- ------------------------------------------------
VOTES FOR VOTES AGAINST ABSTAIN
- --------------------- ------------- --------
141,468,834..... 737,126 435,755
ITEM 5. OTHER INFORMATION.
Nothing to report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
None.
(b) Reports on Form 8-K.
The Company filed two Current Reports on Form 8-K during the quarter ended
June 30, 2001 or thereafter. They were filed on:
- April 17, 2001 in connection with the issuance of $115,000,000 of the
Company's Senior Notes due February 18, 2003, increasing the aggregate
principal amount of the outstanding notes of that series to $615,000,000;
and
- June 18, 2001 in connection with the issuance of $380,000,000 of the
Company's Senior Notes due June 16, 2004.
36
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: August 14, 2001
37
