- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                            ------------------------

                                   FORM 10-Q

(MARK ONE)


        
   /X/     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
           SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________ (Amended by Exch Act Rel No. 312905. eff 4/26/93.) Commission File Number: 001-13251 ------------------------ USA EDUCATION, INC. (FORMERLY SLM HOLDING CORPORATION) (Exact name of registrant as specified in its charter) DELAWARE 52-2013874 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 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 SEPTEMBER 30, 2001 - ---------------------------- --------------------------------- Common Stock, $.20 par value 156,770,155 shares
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- USA EDUCATION, INC. FORM 10-Q INDEX SEPTEMBER 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................................. 35 Item 6. Exhibits and Reports on Form 8-K.................. 35 SIGNATURES.................................................. 36
2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS USA EDUCATION, INC. CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
SEPTEMBER 30, DECEMBER 31, 2001 2000 ------------- ------------ (UNAUDITED) ASSETS Student loans............................................... $40,643,809 $37,647,297 Warehousing advances........................................ 979,642 987,352 Academic facilities financings Bonds -- available-for-sale............................... 420,976 498,775 Loans..................................................... 339,459 352,393 ----------- ----------- Total academic facilities financings.................... 760,435 851,168 Investments Trading................................................... 1,363 - Available-for-sale........................................ 4,182,975 4,244,762 Held-to-maturity.......................................... 976,010 961,260 ----------- ----------- Total investments....................................... 5,160,348 5,206,022 Cash and cash equivalents................................... 2,073,010 734,468 Other assets, principally accrued interest receivable....... 4,243,591 3,365,481 ----------- ----------- Total assets............................................ $53,860,835 $48,791,788 =========== =========== LIABILITIES Short-term borrowings....................................... $31,749,596 $30,463,988 Long-term notes............................................. 17,654,066 14,910,939 Other liabilities........................................... 2,717,664 1,787,642 ----------- ----------- Total liabilities....................................... 52,121,326 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, 202,165,146 and 190,851,936 shares issued, respectively.............................................. 40,433 38,170 Additional paid-in capital.................................. 769,360 225,211 Unrealized gains on investments (net of tax of $380,169 and $167,624, respectively)................................... 706,028 311,301 Retained earnings........................................... 1,836,364 1,810,902 ----------- ----------- Stockholders' equity before treasury stock.................. 3,517,185 2,550,584 Common stock held in treasury at cost: 45,394,991 and 26,707,091 shares, respectively........................... 1,991,559 1,135,248 ----------- ----------- Total stockholders' equity.............................. 1,525,626 1,415,336 ----------- ----------- Total liabilities and stockholders' equity.............. $53,860,835 $48,791,788 =========== ===========
See accompanying notes to consolidated financial statements. 3 USA EDUCATION, INC. CONSOLIDATED STATEMENTS OF INCOME (DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ------------------------- 2001 2000 2001 2000 ----------- ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) INTEREST INCOME: Student loans............................................ $ 591,721 $ 769,965 $1,979,264 $2,072,087 Warehousing advances..................................... 10,625 13,194 35,932 41,049 Academic facilities financings: Taxable................................................ 7,759 8,441 23,712 28,471 Tax-exempt............................................. 5,244 7,403 17,157 23,602 --------- --------- ---------- ---------- Total academic facilities financings..................... 13,003 15,844 40,869 52,073 Investments.............................................. 83,942 99,983 312,747 360,541 --------- --------- ---------- ---------- Total interest income...................................... 699,291 898,986 2,368,812 2,525,750 INTEREST EXPENSE: Short-term debt.......................................... 330,348 587,214 1,285,100 1,704,215 Long-term debt........................................... 171,324 151,439 478,882 337,692 --------- --------- ---------- ---------- Total interest expense..................................... 501,672 738,653 1,763,982 2,041,907 --------- --------- ---------- ---------- Net interest income........................................ 197,619 160,333 604,830 483,843 Less: provision for losses................................. 15,299 5,428 42,169 22,766 --------- --------- ---------- ---------- Net interest income after provision for losses............. 182,320 154,905 562,661 461,077 --------- --------- ---------- ---------- OTHER INCOME: Gains on student loan securitizations.................... 27,143 22,656 54,921 91,010 Servicing and securitization revenue..................... 118,940 80,027 432,683 210,694 (Losses) gains on sales of securities.................... (24,788) 147 (103,707) 43,939 Guarantor servicing fees................................. 75,166 54,271 188,394 54,271 Derivative market value adjustment....................... (552,832) -- (604,112) -- Other.................................................... 68,636 48,815 194,784 106,907 --------- --------- ---------- ---------- Total other income......................................... (287,735) 205,916 162,963 506,821 OPERATING EXPENSES: Salaries and benefits.................................... 88,380 86,727 265,510 187,945 Other.................................................... 95,733 80,389 256,243 170,454 Integration charge....................................... -- 53,000 -- 53,000 --------- --------- ---------- ---------- Total operating expenses................................... 184,113 220,116 521,753 411,399 --------- --------- ---------- ---------- Income before income taxes and minority interest in net earnings of subsidiary................................... (289,528) 140,705 203,871 556,499 --------- --------- ---------- ---------- INCOME TAXES: Current.................................................. 111,882 67,042 371,087 208,945 Deferred................................................. (210,538) (21,229) (293,287) (26,827) --------- --------- ---------- ---------- Total income taxes......................................... (98,656) 45,813 77,800 182,118 Minority interest in net earnings of subsidiary............ 2,673 2,674 8,020 8,021 --------- --------- ---------- ---------- NET INCOME................................................. (193,545) 92,218 118,051 366,360 Preferred stock dividends.................................. 2,875 2,865 8,625 8,657 --------- --------- ---------- ---------- Net income attributable to common stock.................... $(196,420) $ 89,353 $ 109,426 $ 357,703 ========= ========= ========== ========== Basic earnings per share................................... $ (1.25) $ .56 $ .68 $ 2.26 ========= ========= ========== ========== Average common shares outstanding.......................... 157,074 160,652 160,255 157,989 ========= ========= ========== ========== Diluted earnings per share................................. $ (1.25) $ .55 $ .66 $ 2.20 ========= ========= ========== ========== Average common and common equivalent shares outstanding.... 157,074 163,279 166,114 162,504 ========= ========= ========== ==========
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 JUNE 30, 2000.................................... 3,300,000 186,266,879 (31,063,031) 155,203,848 $165,000 Comprehensive income: Net income.............................................. Other comprehensive income, net of tax: Change in unrealized gains (losses) on investments, net of tax.......................................... Comprehensive income...................................... Cash dividends: Common stock ($.16 per share)........................... Preferred stock ($.88 per share)........................ Issuance of common shares................................. 1,326,121 9,034,505 10,360,626 Premiums on equity forward purchase contracts............. Repurchase of common shares............................... (1,504,496) (1,504,496) --------- ----------- ----------- ----------- -------- BALANCE AT SEPTEMBER 30, 2000............................... 3,300,000 187,593,000 (23,533,022) 164,059,978 $165,000 ========= =========== =========== =========== ======== BALANCE AT JUNE 30, 2001.................................... 3,300,000 198,922,031 (38,398,042) 160,523,989 $165,000 Comprehensive income: Net income.............................................. Other comprehensive income, net of tax: Change in unrealized gains (losses) on investments, net of tax.......................................... Comprehensive income...................................... Cash dividends: Common stock ($.18 per share)........................... Preferred stock ($.87 per share)........................ Issuance of common shares................................. 3,243,115 3,243,115 Issuance of preferred shares.............................. Tax benefit related to employee stock option and purchase plan.................................................... Premiums on equity forward purchase contracts............. Repurchase of common shares............................... (6,996,949) (6,996,949) --------- ----------- ----------- ----------- -------- BALANCE AT SEPTEMBER 30, 2001............................... 3,300,000 202,165,146 (45,394,991) 156,770,155 $165,000 ========= =========== =========== =========== ======== UNREALIZED GAINS (LOSSES) COMMON ADDITIONAL ON RETAINED STOCK PAID-IN CAPITAL INVESTMENTS EARNINGS -------- --------------- -------------- ---------- BALANCE AT JUNE 30, 2000.................................... $37,253 $ 52,742 $295,378 $1,680,283 Comprehensive income: Net income.............................................. 92,218 Other comprehensive income, net of tax: Change in unrealized gains (losses) on investments, net of tax.......................................... 3,596 Comprehensive income...................................... Cash dividends: Common stock ($.16 per share)........................... (26,043) Preferred stock ($.88 per share)........................ (2,865) Issuance of common shares................................. 266 61,194 Premiums on equity forward purchase contracts............. (37,419) Repurchase of common shares............................... ------- -------- -------- ---------- BALANCE AT SEPTEMBER 30, 2000............................... $37,519 $ 76,517 $298,974 $1,743,593 ======= ======== ======== ========== BALANCE AT JUNE 30, 2001.................................... $39,784 $549,070 $485,100 $2,060,176 Comprehensive income: Net income.............................................. (193,545) Other comprehensive income, net of tax: Change in unrealized gains (losses) on investments, net of tax.......................................... 220,928 Comprehensive income...................................... Cash dividends: Common stock ($.18 per share)........................... (27,392) Preferred stock ($.87 per share)........................ (2,875) Issuance of common shares................................. 649 141,695 Issuance of preferred shares.............................. Tax benefit related to employee stock option and purchase plan.................................................... 94,654 Premiums on equity forward purchase contracts............. (16,059) Repurchase of common shares............................... ------- -------- -------- ---------- BALANCE AT SEPTEMBER 30, 2001............................... $40,433 $769,360 $706,028 $1,836,364 ======= ======== ======== ========== TOTAL TREASURY STOCKHOLDERS' STOCK EQUITY ----------- ------------- BALANCE AT JUNE 30, 2000.................................... $(1,292,645) $ 938,011 Comprehensive income: Net income.............................................. 92,218 Other comprehensive income, net of tax: Change in unrealized gains (losses) on investments, net of tax.......................................... 3,596 ---------- Comprehensive income...................................... 95,814 Cash dividends: Common stock ($.16 per share)........................... (26,043) Preferred stock ($.88 per share)........................ (2,865) Issuance of common shares................................. 370,000 431,460 Premiums on equity forward purchase contracts............. (37,419) Repurchase of common shares............................... (63,678) (63,678) ----------- ---------- BALANCE AT SEPTEMBER 30, 2000............................... $ (986,323) $1,335,280 =========== ========== BALANCE AT JUNE 30, 2001.................................... $(1,707,081) $1,592,049 Comprehensive income: Net income.............................................. (193,545) Other comprehensive income, net of tax: Change in unrealized gains (losses) on investments, net of tax.......................................... 220,928 ---------- Comprehensive income...................................... 27,383 Cash dividends: Common stock ($.18 per share)........................... (27,392) Preferred stock ($.87 per share)........................ (2,875) Issuance of common shares................................. 142,344 Issuance of preferred shares.............................. -- Tax benefit related to employee stock option and purchase plan.................................................... 94,654 Premiums on equity forward purchase contracts............. (16,059) Repurchase of common shares............................... (284,478) (284,478) ----------- ---------- BALANCE AT SEPTEMBER 30, 2001............................... $(1,991,559) $1,525,626 =========== ==========
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 $165,000 Comprehensive income: Net income.............................................. Other comprehensive income, net of tax: Change in unrealized gains (losses) on investments, net of tax.......................................... Comprehensive income...................................... Cash dividends: Common stock ($.48 per share)........................... Preferred stock ($2.64 per share)....................... Issuance of common shares................................. 1,523,381 9,084,505 10,607,886 Premiums on equity forward purchase contracts............. Repurchase of common shares............................... (4,124,455) (4,124,455) --------- ----------- ----------- ----------- -------- BALANCE AT SEPTEMBER 30, 2000............................... 3,300,000 187,593,000 (23,533,022) 164,059,978 $165,000 ========= =========== =========== =========== ======== BALANCE AT DECEMBER 31, 2000................................ 3,300,000 190,851,936 (26,707,091) 164,144,845 $165,000 Comprehensive income: Net income.............................................. Other comprehensive income, net of tax: Change in unrealized gains (losses) on investments, net of tax.......................................... Comprehensive income...................................... Cash dividends: Common stock ($.54 per share)........................... Preferred stock ($2.61 per share)....................... Issuance of common shares................................. 11,313,210 192,422 11,505,632 Tax benefit related to employee stock option and purchase plan.................................................... Premiums on equity forward purchase contracts............. Repurchase of common shares............................... (18,880,322) (18,880,322) --------- ----------- ----------- ----------- -------- BALANCE AT SEPTEMBER 30, 2001............................... 3,300,000 202,165,146 (45,394,991) 156,770,155 $165,000 ========= =========== =========== =========== ======== UNREALIZED GAINS (LOSSES) COMMON ADDITIONAL ON RETAINED STOCK PAID-IN CAPITAL INVESTMENTS EARNINGS -------- --------------- -------------- ---------- BALANCE AT DECEMBER 31, 1999................................ $37,214 $ 62,827 $297,735 $1,462,034 Comprehensive income: Net income.............................................. 366,360 Other comprehensive income, net of tax: Change in unrealized gains (losses) on investments, net of tax.......................................... 1,239 Comprehensive income...................................... Cash dividends: Common stock ($.48 per share)........................... (76,144) Preferred stock ($2.64 per share)....................... (8,657) Issuance of common shares................................. 305 70,088 Premiums on equity forward purchase contracts............. (56,398) Repurchase of common shares............................... ------- -------- -------- ---------- BALANCE AT SEPTEMBER 30, 2000............................... $37,519 $ 76,517 $298,974 $1,743,593 ======= ======== ======== ========== BALANCE AT DECEMBER 31, 2000................................ $38,170 $225,211 $311,301 $1,810,902 Comprehensive income: Net income.............................................. 118,051 Other comprehensive income, net of tax: Change in unrealized gains (losses) on investments, net of tax.......................................... 394,727 Comprehensive income...................................... Cash dividends: Common stock ($.54 per share)........................... (83,964) Preferred stock ($2.61 per share)....................... (8,625) Issuance of common shares................................. 2,263 484,929 Tax benefit related to employee stock option and purchase plan.................................................... 94,654 Premiums on equity forward purchase contracts............. (35,434) Repurchase of common shares............................... ------- -------- -------- ---------- BALANCE AT SEPTEMBER 30, 2001............................... $40,433 $769,360 $706,028 $1,836,364 ======= ======== ======== ========== TOTAL TREASURY STOCKHOLDERS' STOCK EQUITY ----------- ------------- BALANCE AT DECEMBER 31, 1999................................ $(1,183,896) $ 840,914 Comprehensive income: Net income.............................................. 366,360 Other comprehensive income, net of tax: Change in unrealized gains (losses) on investments, net of tax.......................................... 1,239 ---------- Comprehensive income...................................... 367,599 Cash dividends: Common stock ($.48 per share)........................... (76,144) Preferred stock ($2.64 per share)....................... (8,657) Issuance of common shares................................. 372,366 442,759 Premiums on equity forward purchase contracts............. (56,398) Repurchase of common shares............................... (174,793) (174,793) ----------- ---------- BALANCE AT SEPTEMBER 30, 2000............................... $ (986,323) $1,335,280 =========== ========== BALANCE AT DECEMBER 31, 2000................................ $(1,135,248) $1,415,336 Comprehensive income: Net income.............................................. 118,051 Other comprehensive income, net of tax: Change in unrealized gains (losses) on investments, net of tax.......................................... 394,727 ---------- Comprehensive income...................................... 512,778 Cash dividends: Common stock ($.54 per share)........................... (83,964) Preferred stock ($2.61 per share)....................... (8,625) Issuance of common shares................................. 12,126 499,318 Tax benefit related to employee stock option and purchase plan.................................................... 94,654 Premiums on equity forward purchase contracts............. (35,434) Repurchase of common shares............................... (868,437) (868,437) ----------- ---------- BALANCE AT SEPTEMBER 30, 2001............................... $(1,991,559) $1,525,626 =========== ==========
See accompanying notes to consolidated financial statements. 6 USA EDUCATION, INC CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 2001 2000 -------------- -------------- (UNAUDITED) (UNAUDITED) OPERATING ACTIVITIES Net income.................................................. $ 118,051 $ 366,360 Adjustments to reconcile net income to net cash provided by operating activities: (Gains) on student loan securitizations................... (54,921) (91,010) Losses (gains) on sales of securities..................... 103,707 (43,939) Derivative market value adjustment........................ 604,112 -- Provision for losses...................................... 42,169 22,766 (Increase) in accrued interest receivable................. (145,613) (49,294) (Decrease) increase in accrued interest payable........... (67,829) 3,592 (Increase) in other assets................................ (341,208) (160) Increase in other liabilities............................. 228,958 455,532 ------------- ------------- Total adjustments......................................... 369,375 297,487 ------------- ------------- Net cash provided by operating activities................... 487,426 663,847 ------------- ------------- INVESTING ACTIVITIES Student loans purchased..................................... (10,731,679) (8,426,740) Reduction of student loans purchased: Installment payments...................................... 2,292,611 1,723,354 Claims and resales........................................ 440,793 375,137 Proceeds from securitization of student loans............. 4,970,633 8,734,901 Proceeds from sales of student loans...................... 50,417 126,172 Warehousing advances made................................... (837,999) (800,324) Warehousing advance repayments.............................. 845,709 982,454 Academic facilities financings made......................... (11,510) (11,609) Academic facilities financings reductions................... 111,655 155,075 Investments purchased....................................... (38,934,861) (32,888,320) Proceeds from sale or maturity of investments............... 39,013,801 34,302,642 Purchase of subsidiaries, net of cash acquired.............. -- (448,754) ------------- ------------- Net cash (used in) provided by investing activities......... (2,790,430) 3,823,988 ------------- ------------- FINANCING ACTIVITIES Short-term borrowings issued................................ 648,502,997 580,847,220 Short-term borrowings repaid................................ (652,914,671) (584,160,609) Long-term notes issued...................................... 16,336,464 13,523,596 Long-term notes repaid...................................... (7,880,756) (14,710,000) Equity forward contracts and stock issued................... 558,538 386,361 Common stock repurchased.................................... (868,437) (174,793) Common dividends paid....................................... (83,964) (76,144) Preferred dividends paid.................................... (8,625) (8,657) ------------- ------------- Net cash provided by (used in) financing activities......... 3,641,546 (4,373,026) ------------- ------------- Net increase in cash and cash equivalents................... 1,338,542 114,809 Cash and cash equivalents at beginning of period............ 734,468 589,750 ------------- ------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 2,073,010 $ 704,559 ============= ============= Cash disbursements made for: Interest.................................................. $ 1,693,011 $ 1,788,202 ============= ============= Income taxes.............................................. $ 166,400 $ 95,000 ============= =============
See accompanying notes to consolidated financial statements. 7 USA EDUCATION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (INFORMATION AT SEPTEMBER 30, 2001 AND FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 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 nine months ended September 30, 2001 are not necessarily indicative of the results for the year ending December 31, 2001. RECLASSIFICATIONS Certain reclassifications have been made to the balances as of and for the three and nine months ended September 30, 2000 to be consistent with classifications adopted for 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 8 USA EDUCATION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AT SEPTEMBER 30, 2001 AND FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 IS UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2. NEW ACCOUNTING PRONOUNCEMENTS (CONTINUED) requires new disclosures about securitizations and retained interests in securitized financial assets and revises the criteria involving qualifying special purpose entities. Under SFAS 140, entities are required to disclose information about securitizations regarding accounting policies, securitization characteristics, key assumptions used and cash flows between the securitization special purpose entities and the transferor. Additionally, entities are required to disclose information related to retained interests in 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 SEPTEMBER 30, 2001 AND FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 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 nine months ended September 30, 2001 and 2000, respectively.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- 2001 2000 2001 2000 -------- -------- -------- -------- BALANCE AT BEGINNING OF PERIOD...................... $310,392 $299,392 $322,056 $303,743 Additions Provisions for losses............................. 15,299 5,428 42,169 22,766 Recoveries........................................ 2,830 16,373 6,877 21,159 Deductions Reductions for student loans sales and securitizations................................. (3,188) (3,679) (12,023) (16,648) Write-offs........................................ (12,086) (5,990) (45,832) (19,496) -------- -------- -------- -------- BALANCE AT END OF PERIOD............................ $313,247 $311,524 $313,247 $311,524 ======== ======== ======== ========
4. STUDENT LOAN SECURITIZATION When the Company sells student loans in securitizations, it retains interest-only strips and servicing rights, all of which are retained interests in the securitized receivables. Gain or loss on sale of the receivables depends in part on the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the retained interests based on their relative fair values at the date of transfer. To obtain fair values, quoted market prices are used if available. However, quotes are generally not available for retained interests, so the Company estimates fair value, both initially and on a quarterly basis going forward, based on the present value of future expected cash flows estimated using management's best estimates of the key assumptions--credit losses, prepayment speeds and discount rates. During the third quarter of 2001, the Company sold $1.5 billion of student loans in one securitization transaction and securitized $44 million through the recycling provisions of certain securitizations. The Company recorded a pre-tax securitization gain of $27 million or 1.74 percent of the portfolios securitized in the third quarter of 2001. For the three months ended September 30, 2000, the Company sold $2.0 billion of student loans in one securitization transaction and recorded a pre-tax securitization gain of $23 million or 1.10 percent of the portfolios securitized. For the nine months ended September 30, 2001, the Company sold $4.5 billion of student loans in three securitization transactions and securitized $392 million through the recycling provisions of certain securitizations. The Company recorded a pre-tax securitization gain of $55 million or 1.12 percent of the portfolios securitized in the nine months ended September 30, 2001. In the nine months ended September 30, 2000, the Company sold $8.5 billion of student loans in four separate transactions and recorded a pre-tax securitization gain of $91 million or 1.07 percent of the portfolios securitized. At September 30, 2001 and December 31, 2000, securitized student loans outstanding totaled $31.2 billion and $29.9 billion, respectively. 10 USA EDUCATION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AT SEPTEMBER 30, 2001 AND FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 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 third quarter of 2001 were as follows: Prepayment speed........................................ 7% per annum Weighted-average life................................... 5.5 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 nine months ended September 30, 2001 (dollars in millions):
THREE MONTHS NINE MONTHS ENDED ENDED SEPTEMBER 30, SEPTEMBER 30, 2001 2001 -------------- -------------- Proceeds from new securitizations.................. 1,566 4,971 Servicing fees received............................ 7 10 Cash flows received on interest-only strips........ 4 4
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 SEPTEMBER 30, 2001 AND FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 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 SEPTEMBER 30, 2001 Basic EPS................................................... $(196,420) 157,074 $(1.25) Dilutive effect of stock options, warrants, equity forwards, and deferred compensation................................. -- -- -- --------- ------- ------ Diluted EPS................................................. $(196,420) 157,074 $(1.25) ========= ======= ====== THREE MONTHS ENDED SEPTEMBER 30, 2000 Basic EPS................................................... $ 89,353 160,652 $ .56 Dilutive effect of stock options, warrants and equity forwards.................................................. -- 2,627 (.01) --------- ------- ------ Diluted EPS................................................. $ 89,353 163,279 $ .55 ========= ======= ======
NET INCOME ATTRIBUTABLE TO COMMON AVERAGE EARNINGS STOCK SHARES PER SHARE ------------ ----------- --------- (THOUSANDS) (THOUSANDS) NINE MONTHS ENDED SEPTEMBER 30, 2001 Basic EPS................................................... $ 109,426 160,255 $ .68 Dilutive effect of stock options, warrants, equity forwards and deferred compensation................................. -- 5,859 (.02) --------- ------- ------ Diluted EPS................................................. $ 109,426 166,114 $ .66 ========= ======= ====== NINE MONTHS ENDED SEPTEMBER 30, 2000 Basic EPS................................................... $ 357,703 157,989 $ 2.26 Dilutive effect of stock options, warrants, and equity forwards.................................................. - 4,515 (.06) --------- ------- ------ Diluted EPS................................................. $ 357,703 162,504 $ 2.20 ========= ======= ======
6. DERIVATIVE FINANCIAL INSTRUMENTS DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES The Company maintains an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. The Company's goal is to manage interest rate sensitivity by modifying the repricing or maturity characteristics of certain balance sheet assets and liabilities so that the net interest margin is not, on a material basis, adversely affected by movements in interest rates. As a result of 12 USA EDUCATION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AT SEPTEMBER 30, 2001 AND FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 IS UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 6. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED) 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 credit risk. The Company minimizes the credit (or repayment) risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company's credit committee. The Company also maintains a policy of requiring that all derivative contracts be governed by an International Swaps and Derivative Association Master Agreement. Depending on the nature of the derivative transaction, bilateral collateral arrangements may be required as well. When the Company has more than one outstanding derivative transaction with a counterparty, and there exists 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. 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. 13 USA EDUCATION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AT SEPTEMBER 30, 2001 AND FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 IS UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 6. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED) 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 September 30, 2001, the Company held fair value hedges with a net fair value loss position of $35 million on a notional amount of $7.2 billion. For the three and nine months ended September 30, 2001, the Company recognized a net loss of $31 million and $56 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. The Company also enters into basis swaps to convert variable rate assets and variable rate debt from one floating rate index to another floating rate index. At September 30, 2001, the Company held cash flow hedges with a net fair value loss position of $67 million on a notional amount of $25.5 billion. For the three and nine months ended September 30, 2001, the Company included $66 million of after-tax unrealized losses and $98 million of after-tax unrealized losses, respectively, in other comprehensive income. For the three and nine months ended September 30, 2001, the Company recognized $2 million and $6 million, respectively, of after-tax net losses out of other comprehensive income related to the amortization of closed futures contracts. For the three and nine months ended September 30, 2001, the Company recognized $16 million and $59 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 $7 million of after-tax net losses over the next 12 months related to futures contracts closed as of September 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 SEPTEMBER 30, 2001 AND FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 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 and commercial paper 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 September 30, 2001, the Company held trading derivatives with a net fair value loss position of $967 million on a notional amount of $71.9 billion. For the three and nine months ended September 30, 2001, the Company recognized a net loss of $522 million and a net loss of $554 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 nine months ended September 30, 2001, $8 million and $25 million, respectively, of net derivative after-tax gains at transition were reclassified from other comprehensive income to other operating income. As of September 30, 2001, $34 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 NINE MONTHS ENDED SEPTEMBER 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 non-federally insured 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 NINE MONTHS ENDED INCREASE ENDED INCREASE SEPTEMBER 30, (DECREASE) SEPTEMBER 30, (DECREASE) ------------------- ------------------- ------------------- ------------------- 2001 2000 $ % 2001 2000 $ % -------- -------- -------- -------- -------- -------- -------- -------- Net interest income....................... $ 198 $160 $ 38 23% $ 605 $ 484 $ 121 25% Less: provision for losses................ 15 5 10 182 42 23 19 85 ------ ---- ------ ----- ----- ----- ------ ----- Net interest income after provision for losses.................................. 183 155 28 18 563 461 102 22 Gains on student loan securitizations..... 27 23 4 20 55 91 (36) (40) Servicing and securitization revenue...... 119 80 39 49 433 211 222 105 (Losses) gains on sales of securities..... (25) -- (25) (100) (104) 44 (148) (336) Guarantor servicing fees.................. 75 55 20 39 188 55 133 247 Derivative market value adjustment........ (553) -- (553) (100) (604) -- (604) (100) Other income.............................. 68 48 20 41 195 106 89 82 Operating expenses and integration charge.................................. 184 220 (36) (16) 522 412 110 27 Income taxes.............................. (99) 46 (145) (315) 78 182 (104) (57) Minority interest in net earnings of subsidiary.............................. 3 3 -- -- 8 8 -- -- ------ ---- ------ ----- ----- ----- ------ ----- Net income................................ $ (194) $ 92 $ (286) (310)% $ 118 $ 366 $ (248) (68)% Preferred dividends....................... 3 3 - - 9 8 1 1 ------ ---- ------ ----- ----- ----- ------ ----- Net income attributable to common stock... $ (197) $ 89 $ (286) (320)% $ 109 $ 358 $ (249) (69)% ====== ==== ====== ===== ===== ===== ====== ===== Basic earnings per share.................. $(1.25) $.56 $(1.81) (325)% $ .68 $2.26 $(1.58) (70)% ====== ==== ====== ===== ===== ===== ====== ===== Diluted earnings per share................ $(1.25) $.55 $(1.80) (327)% $ .66 $2.20 $(1.54) (70)% ====== ==== ====== ===== ===== ===== ====== ===== Dividends per share....................... $ .18 $.16 $ .02 9% $ .54 $ .48 $ .06 12% ====== ==== ====== ===== ===== ===== ====== =====
CONDENSED BALANCE SHEETS
INCREASE (DECREASE) SEPTEMBER 30, DECEMBER 31, ------------------- 2001 2000 $ % ------------- ------------ -------- -------- ASSETS Student loans....................................... $40,644 $37,647 $2,997 8% Warehousing advances................................ 980 987 (7) (1) Academic facilities financings...................... 760 851 (91) (11) Cash and investments................................ 7,233 5,941 1,292 22 Other assets........................................ 4,244 3,366 878 26 ------- ------- ------ ------ Total assets........................................ $53,861 $48,792 $5,069 10% ======= ======= ====== ====== LIABILITIES AND STOCKHOLDERS' EQUITY Short-term borrowings............................... $31,750 $30,464 $1,286 4% Long-term notes..................................... 17,654 14,911 2,743 18 Other liabilities................................... 2,718 1,788 930 52 ------- ------- ------ ------ Total liabilities................................... 52,122 47,163 4,959 10 ------- ------- ------ ------ Minority interest in subsidiary..................... 214 214 -- -- Stockholders' equity before treasury stock.......... 3,517 2,550 967 38 Common stock held in treasury at cost............... 1,992 1,135 857 75 ------- ------- ------ ------ Total stockholders' equity.......................... 1,525 1,415 110 8 ------- ------- ------ ------ Total liabilities and stockholders' equity.......... $53,861 $48,792 $5,069 10% ======= ======= ====== ======
17 RESULTS OF OPERATIONS EARNINGS SUMMARY For the three months ended September 30, 2001, the Company's "core cash basis" net income was $163 million ($.99 diluted earnings per share), versus "core cash basis" net income of $128 million ($.77 diluted earnings per share) in the third quarter of 2000. For the nine months ended September 30, 2001, the Company's "core cash basis" net income was $461 million ($2.72 diluted earnings per share) versus $355 million ($2.13 diluted earnings per share) for the nine months ended September 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 and intangible assets are also excluded from net income calculated in accordance with generally accepted accounting principles ("GAAP"). In addition, for "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 third quarter of 2001 versus the third quarter of 2000 is mainly due to the $7.4 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 nine months ended September 30, 2001, the increase in "core cash basis" net income versus the year-ago period is mainly due to the $12.2 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 September 30, 2001, the Company's net income calculated in accordance with GAAP was a loss of $(194) million ($(1.25) diluted earnings per share), versus net income of $92 million ($.55 diluted earnings per share) in the third quarter of 2000. The decrease in GAAP net income in the third quarter of 2001 versus the year-ago quarter is mainly due to the net impact of SFAS 133 resulting in net after-tax losses of $377 million. The third quarter 2001 after-tax, mark-to-market losses due to the implementation of SFAS 133 include $237 million losses on Floor Revenue Contracts (defined below under "Student Loan Floor Revenue Contracts"), $73 million losses on interest rate swap contracts, $49 million losses on Eurodollar futures contracts that did not meet hedge effectiveness criteria under SFAS 133, and $18 million after-tax losses due to the amortization of the Floor Revenue Contracts that were de-designated as hedges on December 31, 2000. In addition, a $6 million after-tax loss on Eurodollar futures contracts was also recognized. These after-tax losses were partially offset by an after-tax gain of $6 million attributable to transition amortization. The decrease in GAAP net income in the third quarter 2001 versus the year-ago quarter is also due to an increase in after-tax losses on sales of securities of $8 million. These decreases in net income were partially offset by a $3.7 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 $25 million, an increase in after-tax guarantor servicing fees of $14 million (due to the acquisition of the operations of USA Group in July 2000), an increase in after-tax floor revenues of $13 million, an increase in after-tax securitization gains of $3 million, and lower funding costs. For the nine months ended September 30, 2001, the Company's GAAP net income was $118 million ($.66 diluted earnings per share), versus GAAP net income of $366 million ($2.20 diluted earnings per share) for the nine months ended September 30, 2000. The decrease in year-to-date 2001 GAAP net income versus year-to-date 2000 GAAP net income is due to the net impact of SFAS 133 resulting in net after-tax losses of $416 million, an increase in after-tax losses on sales of securities of 18 $52 million, a decrease in after-tax securitization gains of $23 million, and an increase in after-tax operating expenses of $72 million. These decreases in net income were partially offset by a $5.7 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 $144 million, an increase in after-tax guarantor servicing fees of $87 million, an increase in after-tax floor revenues of $36 million, and lower funding costs. For the nine months ended September 30, 2001, the Company repurchased 17.6 million common shares through its open market purchases and equity forward settlements and issued a net of 10.2 million shares as a result of benefit plans. Common shares outstanding at September 30, 2001 totaled 156.8 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 September 30, 2001 versus the three months ended September 30, 2000 increased by $37 million while the net interest margin increased by 15 basis points. The increase in taxable equivalent net interest income for the three months ended September 30, 2001 is principally due to the lower interest rate environment which led to an increase of $20 million in floor revenue. The increase in the net interest margin for the third quarter of 2001 versus the third 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 nine months ended September 30, 2001 versus the nine months ended September 30, 2000 increased by $110 million while the net interest margin increased by 11 basis points. The increase in taxable equivalent net interest income for the nine months ended September 30, 2001 versus the year-ago period was principally due to an increase of $56 million in floor revenue, and the $5.7 billion increase in the average balance of on-balance sheet 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 NINE MONTHS ENDED INCREASE ENDED INCREASE SEPTEMBER 30, (DECREASE) SEPTEMBER 30, (DECREASE) ------------------- ------------------- ------------------- ------------------- 2001 2000 $ % 2001 2000 $ % -------- -------- -------- -------- -------- -------- -------- -------- INTEREST INCOME Student loans........................... $592 $770 $(178) (23)% $1,979 $2,072 $ (93) (4)% Warehousing advances.................... 10 13 (3) (19) 36 41 (5) (12) Academic facilities financing........... 13 16 (3) (18) 41 52 (11) (22) Investments............................. 84 100 (16) (16) 313 361 (48) (13) Taxable equivalent adjustment........... 5 5 - 4 11 22 (11) (47) ---- ---- ----- --- ------ ------ ----- --- Total taxable equivalent interest income.................................. 704 904 (200) (22) 2,380 2,548 (168) (7) Interest expense.......................... 502 739 (237) (32) 1,764 2,042 (278) (14) ---- ---- ----- --- ------ ------ ----- --- Taxable equivalent net interest income.... $202 $165 $ 37 23% $ 616 $ 506 $ 110 22% ==== ==== ===== === ====== ====== ===== ===
19 AVERAGE BALANCE SHEETS The following table reflects the rates earned on earning assets and paid on liabilities for the three and nine months ended September 30, 2001 and 2000.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------------------- ----------------------------------------- 2001 2000 2001 2000 ------------------- ------------------- ------------------- ------------------- BALANCE RATE BALANCE RATE BALANCE RATE BALANCE RATE -------- -------- -------- -------- -------- -------- -------- -------- AVERAGE ASSETS Student loans........................... $40,180 5.84% $36,440 8.41% $39,526 6.69% $33,836 8.18% Warehousing advances.................... 964 4.37 737 7.12 967 4.97 798 6.87 Academic facilities financings.......... 757 8.29 963 8.19 806 8.31 1,007 8.59 Investments............................. 6,818 5.01 5,792 6.92 7,359 5.73 7,191 6.87 ------- ---- ------- ---- ------- ---- ------- ---- Total interest earning assets............. 48,719 5.74% 43,932 8.18% 48,658 6.54% 42,832 7.95% ==== ==== ==== ==== Non-interest earning assets............... 4,428 2,926 4,321 2,476 ------- ------- ------- ------- Total assets.............................. $53,147 $46,858 $52,979 $45,308 ======= ======= ======= ======= AVERAGE LIABILITIES AND STOCKHOLDERS' EQUITY Six month floating rate notes........... $ 4,011 3.82% $ 4,310 6.58% $ 4,387 4.64% $ 4,538 6.41% Other short-term borrowings............. 29,818 3.88 30,731 6.68 32,310 4.69 31,362 6.33 Long-term notes......................... 15,529 4.38 9,038 6.67 12,716 5.04 6,927 6.51 ------- ---- ------- ---- ------- ---- ------- ---- Total interest bearing liabilities........ 49,358 4.03% 44,079 6.67% 49,413 4.77% 42,827 6.37% ==== ==== ==== ==== Non-interest bearing liabilities.......... 2,367 1,604 2,175 1,484 Stockholders' equity...................... 1,422 1,175 1,391 997 ------- ------- ------- ------- Total liabilities and stockholders' equity.................................. $53,147 $46,858 $52,979 $45,308 ======= ======= ======= ======= Net interest margin....................... 1.65% 1.50% 1.69% 1.58% ==== ==== ==== ====
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 SEPTEMBER 30, 2001 VS. THREE MONTHS ENDED SEPTEMBER 30, 2000 Taxable equivalent interest income.......................... $(200) $(268) $ 68 Interest expense............................................ (237) (298) 61 ----- ----- ---- Taxable equivalent net interest income...................... $ 37 $ 30 $ 7 ===== ===== ==== NINE MONTHS ENDED SEPTEMBER 30, 2001 VS. NINE MONTHS ENDED SEPTEMBER 30, 2000 Taxable equivalent interest income.......................... $(168) $(451) $283 Interest expense............................................ (278) (522) 244 ----- ----- ---- Taxable equivalent net interest income...................... $ 110 $ 71 $ 39 ===== ===== ====
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 NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- 2001 2000 2001 2000 -------- -------- -------- -------- ON-BALANCE SHEET Adjusted student loan yields............................ 6.57% 9.10% 7.40% 8.84% Consolidation loan rebate fees.......................... (.30) (.26) (.29) (.26) Offset fees............................................. (.13) (.14) (.13) (.13) Borrower benefits....................................... (.07) (.07) (.07) (.07) Premium amortization.................................... (.23) (.22) (.22) (.20) ------- ------- ------- ------- Student loan income..................................... 5.84 8.41 6.69 8.18 Cost of funds........................................... (3.93) (6.62) (4.87) (6.34) ------- ------- ------- ------- Student loan spread..................................... 1.91% 1.79% 1.82% 1.84% ======= ======= ======= ======= OFF-BALANCE SHEET Servicing and securitization revenue.................... 1.50% 1.15% 1.89% 1.17% ======= ======= ======= ======= AVERAGE BALANCES Student loans........................................... $40,180 $36,440 $39,526 $33,836 Securitized loans....................................... 31,370 27,756 30,631 24,124 ------- ------- ------- ------- Managed student loans................................... $71,550 $64,196 $70,157 $57,960 ======= ======= ======= =======
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. 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, the 52-week Treasury bill, or the one-year constant maturity Treasury rate, 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 21 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 may 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 third quarter of 2001, the Company realized $20 million in Floor Revenue from student loans earning at the minimum borrower rate in the third quarter of 2001 versus no such earnings in the year-ago quarter. For the nine months ended September 30, 2001, the Company earned Floor Revenue of $58 million of which $29 million was attributable to student loans whose minimum borrower rates are fixed to term and $29 million was attributable to student loans whose minimum borrower rates adjust annually on July 1. For the nine months ended September 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 September 30, 2001 and 2000, based on the last Treasury bill auctions of September 2001 and September 2000 for fixed rate loans (2.43 percent and 6.18 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).
SEPTEMBER 30, 2001 SEPTEMBER 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.................................. $ 17.1 $40.6 $ 57.7 $16.0 $36.9 $52.9 Less notional amount of floor interest contracts...................................... (12.7) (5.0) (17.7) (4.7) (2.0) (6.7) ------ ----- ------ ----- ----- ----- Net student loans eligible to earn at the minimum borrower rate.................................. $ 4.4 $35.6 $ 40.0 $11.3 $34.9 $46.2 ====== ===== ====== ===== ===== ===== Net student loans earning at the minimum borrower rate.................................. $ 4.4 $35.6 $ 40.0 $ -- $ -- $ -- ====== ===== ====== ===== ===== =====
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 or the commercial paper rates over the period of the contract. If the strike rate is less than the average of the Treasury bill rates or the commercial paper 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 nine months ended September 30, 2000, the amortization of the upfront payments received from the sale of 22 Floor Revenue Contracts on the Company's on-balance sheet student loans was $7 million and $18 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 September 30, 2001, the unamortized balance of the SFAS 133 transition adjustment in student loan premium totaled $83 million. For the three and nine months ended September 30, 2001, amortization of the transition adjustment totaled $3 million and $10 million, respectively, and the premium write-off due to securitization totaled $3 million and $11 million, respectively. For the three and nine months ended September 30, 2001, the Company recognized $364 million and $389 million, respectively, in pre-tax, mark-to-market losses attributable to Floor Revenue Contracts due to the implementation of SFAS 133. At September 30, 2001, the outstanding notional amount of Floor Revenue Contracts totaled $17.8 billion. ON-BALANCE SHEET FUNDING COSTS The Company's borrowings are generally variable rate indexed principally to the 91-day Treasury bill, commercial paper, 52-week Treasury bill, or the one-year constant maturity Treasury rate. The following table summarizes the average balance of on-balance sheet debt (by index, after giving effect to the impact of interest rate swaps) for the three and nine months ended September 30, 2001 and 2000.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 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..... $34,029 3.86% $30,923 6.70% $32,233 4.54% $30,140 6.47% LIBOR.................... 2,082 4.04 2,468 6.71 1,967 5.04 1,886 6.38 Discount notes........... 3,634 3.66 4,365 6.48 7,341 5.03 4,270 6.11 Fixed.................... 5,627 5.31 2,621 6.33 4,781 5.73 4,061 5.67 Zero coupon.............. 194 11.14 174 11.17 189 11.14 169 11.17 Commercial paper......... 2,464 3.35 1,271 6.78 1,607 4.04 1,061 6.59 Auction rate securities............. 1,101 3.29 1,495 5.80 1,101 4.07 502 5.80 Other.................... 227 4.41 762 6.82 194 4.82 738 6.20 ------- ----- ------- ----- ------- ----- ------- ----- Total.................... $49,358 4.03% $44,079 6.67% $49,413 4.77% $42,827 6.37% ======= ===== ======= ===== ======= ===== ======= =====
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 NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- INDEXED BORROWINGS 2001 2000 2001 2000 - ------------------ -------- -------- -------- -------- TREASURY BILL Weighted average Treasury bill........................ 3.36% 6.18% 4.05% 5.94% Borrowing spread...................................... .50 .52 .49 .53 ---- ---- ---- ---- Weighted average borrowing rate....................... 3.86% 6.70% 4.54% 6.47% ==== ==== ==== ==== LIBOR Weighted average LIBOR................................ 3.79% 6.85% 4.87% 6.57% Borrowing spread...................................... .25 (.14) .17 (.19) ---- ---- ---- ---- Weighted average borrowing rate....................... 4.04% 6.71% 5.04% 6.38% ==== ==== ==== ====
SECURITIZATION PROGRAM During the third 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 third quarter 2001, the Company sold $44 million of student loans through the recycling provisions of certain securitizations. During the third quarter of 2000, the Company securitized $2.0 billion of student loans. For the nine months ended September 30, 2001, the Company sold $4.5 billion of student loans in three separate transactions, and sold $392 million through the recycling provisions of certain securitizations. For the nine months ended September 30, 2000, the Company sold $8.5 billion of student loans in four separate transactions. GAINS ON STUDENT LOAN SECURITIZATIONS For the three months ended September 30, 2001 the Company recorded pre-tax securitization gains of $27 million, which was 1.74 percent of the portfolio securitized, versus $23 million gains in the third quarter of 2000 or 1.10 percent of the portfolio securitized. For the nine months ended September 30, 2001, the Company recorded pre-tax securitization gains of $55 million, which was 1.12 percent of the portfolios securitized versus $91 million gains in the nine months ended September 30, 2000 or 1.07 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 NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- 2001 2000 2001 2000 -------- -------- -------- -------- Servicing revenue less amortization of servicing asset..................... $ 67 $58 $197 $157 Securitization revenue................ 52 22 236 54 ---- --- ---- ---- Total servicing and securitization revenue............................. $119 $80 $433 $211 ==== === ==== ====
24 In the three and nine months ended September 30, 2001, servicing and securitization revenue was 1.50 percent and 1.89 percent, respectively, of average securitized loans versus 1.15 percent and 1.17 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 nine 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 third 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 $143 million and $103 million for the three months ended September 30, 2001 and 2000, respectively, and $383 million and $161 million for the nine months ended September 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 nine months ended September 30, 2001 was $98 million and $248 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 NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- 2001 2000 2001 2000 -------- -------- -------- -------- Servicing and acquisition expenses.................... $117 $100 $319 $218 General and administrative expenses................... 67 67 203 140 Integration charge.................................... -- 53 -- 53 ---- ---- ---- ---- Total operating expenses.............................. $184 $220 $522 $411 ==== ==== ==== ====
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. The Company recorded an integration charge of $53 million in the third quarter of 2000 to cover severance costs, costs to close facilities and move functional responsibilities as well as costs to align system capabilities and move the data center. Exclusive of this one-time integration charge, operating expenses for the three months ended September 30, 2001 and 2000 were $184 million and $167 million, respectively. For the nine months ended September 30, 2001 and 2000, total operating expenses exclusive of this one-time integration charge were $522 million and $358 million, respectively. The increase in operating expenses for the three and nine months ended September 30, 2001 over the corresponding year-ago periods is mainly due to the addition of operating expenses connected with the acquisitions of Student Loan Funding Resources, Inc. ("SLFR") and USA Group, each of 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 NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- 2001 2000 2001 2000 -------- -------- -------- -------- Preferred channel...................................... $2,277 $ 1,693 $ 7,850 $ 5,301 Other commitment clients............................... 269 415 776 1,226 Spot purchases......................................... 137 279 486 489 Consolidations......................................... 268 219 750 586 Acquisitions........................................... -- 4,524 -- 4,524 Other.................................................. 290 262 870 824 ------ ------- ------- ------- Subtotal............................................... 3,241 7,392 10,732 12,950 Managed loans acquired................................. 257 5,373 660 5,644 ------ ------- ------- ------- Total managed loans acquired........................... $3,498 $12,765 $11,392 $18,594 ====== ======= ======= =======
For the three months ended September 30, 2001, the Company purchased $3.5 billion of student loans compared with $12.8 billion in the year-ago period. Included in the third quarter of 2000 purchases are $6.8 billion of student loans acquired from USA Group and $3.1 billion of student loans acquired from SLFR. For the nine months ended September 30, 2001, the Company purchased $11.4 billion of student loans compared with $18.6 billion in the year-ago period. In the third quarter of 2001, the Company's preferred channel of loan originations totaled $3.3 billion versus $2.5 billion in the year-ago quarter. The pipeline of loans currently serviced and committed for purchase by the Company was $5.2 billion at September 30, 2001 versus $4.0 billion at September 30, 2000. The following table summarizes the activity in the Company's managed portfolio of student loans for the three and nine months ended September 30, 2001 and 2000.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- 2001 2000 2001 2000 -------- -------- -------- -------- Beginning balance....................................... $70,783 $55,947 $67,515 $53,276 Purchases............................................... 3,267 12,557 10,790 18,115 Capitalized interest on securitized loans............... 231 208 602 479 Repayments, claims, other............................... (1,791) (1,614) (5,516) (4,187) Loan sales.............................................. -- -- (51) (126) SFAS 133 student loan premium........................... -- -- (104) -- Loans consolidated from USA Education, Inc.............. (661) (410) (1,407) (869) ------- ------- ------- ------- Ending balance.......................................... $71,829 $66,688 $71,829 $66,688 ======= ======= ======= =======
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 26 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 and intangible assets. 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 table presents the "core cash basis" statements of income and reconciliations to GAAP net income as reflected in the Company's consolidated statements of income.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- 2001 2000 2001 2000 -------- -------- -------- -------- "CORE CASH BASIS" STATEMENTS OF INCOME: Student loans.......................................... $1,051 $1,366 $ 3,467 $ 3,574 Advances/Facilities/Investments........................ 103 139 389 466 ------ ------ ------- ------- Total interest income.................................. 1,154 1,505 3,856 4,040 Interest expense....................................... (834) (1,238) (2,926) (3,274) ------ ------ ------- ------- Net interest income.................................... 320 267 930 766 Less: provision for losses............................. 21 11 59 39 ------ ------ ------- ------- Net interest income after provision for losses......... 299 256 871 727 ------ ------ ------- ------- OTHER INCOME: Gains on sales of securities......................... -- -- -- 1 Guarantor servicing fees............................. 75 55 188 55 Other................................................ 56 49 156 106 ------ ------ ------- ------- Total other income..................................... 131 104 344 162 Total operating expenses............................... 173 161 490 349 ------ ------ ------- ------- Income before taxes and minority interest in net earnings of subsidiary............................... 257 199 725 540 Income taxes........................................... 92 68 256 177 Minority interest in net earnings of subsidiary........ 2 3 8 8 ------ ------ ------- ------- "Core cash basis" net income........................... $ 163 $ 128 $ 461 $ 355 Preferred stock dividends.............................. 3 3 9 9 ------ ------ ------- ------- "Core cash basis" net income attributable to common stock................................................ $ 160 $ 125 $ 452 $ 346 ====== ====== ======= ======= "Core cash basis" diluted earnings per share........... $ .99 $ .77 $ 2.72 $ 2.13 ====== ====== ======= =======
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- 2001 2000 2001 2000 -------- -------- -------- -------- RECONCILIATION OF GAAP NET INCOME TO "CORE CASH BASIS" NET INCOME: GAAP net income....................................... $(194) $ 92 $ 118 $ 366 "Core cash basis" adjustments: Net interest income, excluding floor income......... 136 107 456 285 Floor income........................................ (42) -- (181) (3) Provision for losses................................ (6) (6) (17) (16) Gains on student loan securitizations............... (27) (22) (55) (91) Servicing and securitization revenue................ (119) (80) (433) (211) Losses (gains) on sales of securities............... 13 -- 80 (43) Goodwill amortization............................... 11 6 31 9 Integration charge.................................. -- 53 -- 53 Net impact of SFAS 133.............................. 580 -- 640 -- ----- ---- ----- ----- Total "core cash basis" adjustments................... 546 58 521 (17) Net tax effect (A).................................... (189) (22) (178) 6 ----- ---- ----- ----- "Core cash basis" net income.......................... $ 163 $128 $ 461 $ 355 ===== ==== ===== =====
- ------------------------ (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 NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- 2001 2000 2001 2000 -------- -------- -------- -------- "Core cash basis" student loan yields................... 6.48% 9.10% 7.25% 8.85% Consolidation loan rebate fees.......................... (.20) (.18) (.19) (.17) Offset fees............................................. (.07) (.08) (.08) (.08) Borrower benefits....................................... (.12) (.10) (.11) (.10) Premium amortization.................................... (.26) (.27) (.26) (.26) ------- ------- ------- ------- Student loan income..................................... 5.83 8.47 6.61 8.24 Cost of funds........................................... (4.04) (6.80) (4.83) (6.51) ------- ------- ------- ------- "Core cash basis" student loan spread................... 1.79% 1.67% 1.78% 1.73% ======= ======= ======= ======= AVERAGE BALANCES Student loans........................................... $71,550 $64,196 $70,157 $57,960 ======= ======= ======= =======
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, the 52-week Treasury bill or the one-year constant maturity Treasury rate, 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 third quarter of 2001, the Company realized $42 million in Floor Revenue from student loans earning at the minimum borrower rate in the third quarter of 2001 versus no 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 nine months ended September 30, 2001, the amortization of the upfront payments received from the Floor Revenue Contracts with fixed borrower rates was $24 million and $42 million, respectively, versus $0.01 million and $1 million, respectively, for the three and nine months ended September 30, 2000. At September 30, 2001, unamortized payments received from the sale of Floor Revenue Contracts on fixed rate loans totaled $242 million. The $12.7 billion of outstanding fixed borrower rate Floor Revenue Contracts at September 30, 2001 have expiration dates through the year 2008. 29 The increase in the "core cash basis" student loan spread for the three and nine months ended September 30, 2001 versus the corresponding year-ago periods is primarily attributable to lower funding costs. The third 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. For the three months ended September 30, 2001, "core cash basis" net interest income was $320 million versus $267 million for the three months ended September 30, 2000. For the nine months ended September 30, 2001, "core cash basis" net interest income was $930 million versus $766 million for the nine months ended September 30, 2000. The increase in the "core cash basis" net interest income earned in the three and nine months ended September 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 $131 million for the three months ended September 30, 2001 versus $104 million in the year-ago quarter, and $344 million for the nine months ended September 30, 2001 versus $162 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 nine months ended September 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 $75 million, $12 million and $13 million, respectively, to "core cash basis" other operating income during the three months ended September 30, 2001, and $188 million, $40 million and $42 million, respectively, during the nine months ended September 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 38 percent for the three and nine months ended September 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 nine months ended September 30, 2000. State taxes were immaterial in the three and nine months ended September 30, 2000 as the majority of the Company's business activities were conducted in the GSE during that period. 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 30 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 nine months of 2001, the Company completed three securitization transactions totaling $4.5 billion in student loans and an additional $392 million through the recycling provisions of certain securitizations. 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 nine months of 2001, the Company used the net proceeds from student loan securitizations of $5.0 billion, net proceeds from the issuance of debt of $4.0 billion, net proceeds from the issuance of stock and equity forward contracts of $559 million, and repayments and claim payments on student loans of $2.7 billion to purchase student loans of $10.7 billion, and to repurchase $868 million of the Company's common stock. Operating activities provided cash inflows of $487 million in the first nine months of 2001, a decrease of $177 million from the net cash inflows of $664 million in the corresponding year-ago period. During the first nine months of 2001, the Company issued $16.3 billion of long-term notes to refund maturing and repurchased obligations. At September 30, 2001, the Company had $17.7 billion of outstanding long-term debt issues of which $2.2 billion 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.") At September 30, 2001, the GSE was in compliance with its regulatory capital requirements, and had a statutory capital adequacy ratio of 2.51 percent after the effect of the dividends to be paid in the fourth quarter. 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. In addition to term match funding, $14.1 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 September 30, 2001, there were approximately $3.2 billion of PLUS student loans outstanding in the trusts, which have interest rates that reset annually based on the final auction of one-year constant maturity Treasury and the 91-day Treasury bill before each July 1. In addition, at September 30, 2001, approximately $18.9 billion of asset-backed securities had been indexed to LIBOR. 31 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. Loans under the FFELP have unique interest rate characteristics that provide for an interest rate floor in certain interest rate environments. For purposes of the following table, FFELP loans are shown as variable rate assets. 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 September 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........................ $37,323 $ 147 $3,174 $ -- $ -- $ -- Warehousing advances................. 955 13 -- -- 2 10 Academic facilities financings....... 3 5 58 108 216 370 Cash and investments................. 5,118 9 7 8 270 1,821 Other assets......................... 160 189 570 201 461 2,663 ------- ------- ------ ------- ------- ------- Total assets....................... 43,559 363 3,809 317 949 4,864 ------- ------- ------ ------- ------- ------- LIABILITIES AND STOCKHOLDERS' EQUITY Short-term borrowings................ 27,552 906 3,292 -- -- -- Long-term notes...................... 8,801 -- -- 7,145 1,191 517 Other liabilities.................... -- -- -- -- -- 2,718 Minority interest in subsidiary...... -- -- -- -- -- 214 Stockholders' equity................. -- -- -- -- -- 1,525 ------- ------- ------ ------- ------- ------- Total liabilities and stockholders' equity........................... 36,353 906 3,292 7,145 1,191 4,974 ------- ------- ------ ------- ------- ------- OFF-BALANCE SHEET FINANCIAL INSTRUMENTS Interest rate swaps.................. (5,903) 496 2,405 1,810 2,108 (916) Impact of securitized student loans.............................. (3,170) - 3,170 - - - ------- ------- ------ ------- ------- ------- Total off-balance sheet financial instruments........................ (9,073) 496 5,575 1,810 2,108 (916) ------- ------- ------ ------- ------- ------- Period gap........................... $(1,867) $ (47) $6,092 $(5,018) $ 1,866 $(1,026) ======= ======= ====== ======= ======= ======= Cumulative gap....................... $(1,867) $(1,914) $4,178 $ (840) $ 1,026 $ -- ======= ======= ====== ======= ======= ======= Ratio of interest-sensitive assets to interest-sensitive liabilities..... 119.4% 19.2% 98.4% 1.6% 41.0% 425.7% ======= ======= ====== ======= ======= ======= Ratio of cumulative gap to total assets............................. 3.5% 3.6% (7.8)% 1.6% (1.9)% --% ======= ======= ====== ======= ======= =======
INTEREST RATE SENSITIVITY ANALYSIS The effect of short-term movements in interest rates on the Company's results of operations and financial position has been limited through the Company's risk management activities. The Company performed a sensitivity analysis to determine the effect of a hypothetical increase in market interest rates of 10 percent on the Company's variable rate assets and liabilities and a hypothetical 10 percent 32 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 September 30, 2001 (in years):
ON-BALANCE OFF-BALANCE SHEET SHEET MANAGED ---------- ----------- -------- EARNING ASSETS Student loans............................................... 7.4 4.1 6.0 Warehousing advances........................................ 5.6 -- 5.6 Academic facilities financings.............................. 6.8 -- 6.8 Cash and investments........................................ 3.9 -- 3.9 --- --- --- Total earning assets........................................ 6.8 4.1 5.8 --- --- --- BORROWINGS Short-term borrowings....................................... .4 -- .4 Long-term borrowings........................................ 3.5 4.1 3.9 --- --- --- Total borrowings............................................ 1.5 4.1 2.5 --- --- ---
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 3.9 years. As student loans are securitized, the need for long-term on-balance sheet financing will decrease. COMMON STOCK The Company repurchased 17.6 million shares of common stock during the nine months ended September 30, 2001, through open market purchases and equity forward settlements and issued a net 10.2 million shares as a result of benefit plans. At September 30, 2001, the total common shares that could potentially be acquired over the next three years under outstanding equity forward contracts was 11.5 million, and the Company had a remaining authority to enter into additional share repurchases and equity forward contracts for 3.8 million shares. 33 The following table summarizes the Company's common share repurchase and equity forward activity for the three and nine months ended September 30, 2001 and 2000. (All amounts in the tables are common shares in millions.)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- 2001 2000 2001 2000 -------- -------- -------- -------- Common shares repurchased: Open market......................................... -- 1.5 2.7 1.5 Equity forwards..................................... 6.6 -- 14.9 2.5 ------ ------ ------ ------ Total shares repurchased.............................. 6.6 1.5 17.6 4.0 ====== ====== ====== ====== Average purchase price per share...................... $38.51 $42.32 $44.27 $42.53 ====== ====== ====== ====== Equity forward contracts: Outstanding at beginning of period.................. 13.0 20.6 18.2 21.4 New contracts....................................... 5.1 3.4 8.2 5.1 Exercises........................................... (6.6) (3.4) (14.9) (5.9) ------ ------ ------ ------ Outstanding at end of period.......................... 11.5 20.6 11.5 20.6 ====== ====== ====== ====== Board of director authority remaining at end of period.............................................. 3.8 5.4 3.8 5.4 ====== ====== ====== ======
As of September 30, 2001, the expiration dates and range of purchase prices for outstanding equity forward contracts are as follows:
SEPTEMBER 30, 2001 ----------------------------- OUTSTANDING RANGE OF MARKET YEAR OF MATURITY CONTRACTS PRICES - ---------------- ----------- --------------- 2002.............................................. .5 $43.50-$43.50 2003.............................................. 7.2 45.20- 80.97 2004.............................................. 3.8 45.62- 81.01 ----- Total............................................. 11.5 =====
OTHER RELATED EVENTS AND INFORMATION OTHER DEVELOPMENTS LEVERAGED LEASES The Company has investments in leveraged leases totaling $294 million, of which $281 million represent general obligations of major U.S. commercial airlines. The airline industry has been in a state of uncertainty since the events of September 11, 2001. All payment obligations remain current and the Company has not been notified of any counterparty's intention to default on any payment obligations. In the event of default, any potential loss would be partially mitigated by recoveries on the sale of the aircraft collateral and elimination of expected tax liabilities reflected in the balance sheet of $257 million. Any potential loss would be increased by incremental tax obligations related to forgiveness of debt obligations. 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. Nothing to report. ITEM 5. OTHER INFORMATION. Nothing to report. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits (b) Reports on Form 8-K The Company filed one Current Report on Form 8-K during the quarter ended September 30, 2001 or thereafter. It was filed on: - November 7, 2001 in connection with the issuance of $500,000,000 of the Company's Medium Term Notes due October 25, 2004. 35 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: November 14, 2001 36