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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBERS 001-13251
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USA EDUCATION, INC.
(TO BE RENAMED SLM CORPORATION EFFECTIVE MAY 17, 2002)
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 52-2013874
(State of Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
11600 SALLIE MAE DRIVE, RESTON, 20193
VIRGINIA (Zip Code)
(Address of Principal Executive
Offices)
(703) 810-3000
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $.20 per share.
6.97% Cumulative Redeemable Preferred Stock, Series A, par value $.20 per share
Securities registered pursuant to Section 12(g) of the Act:
None.
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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 / /
The aggregate market value of voting stock held by non-affiliates of the
registrant as of February 28, 2002 was approximately $14,190,456,446 (based on
closing sale price of $92.75 per share as reported for the New York Stock
Exchange--Composite Transactions).
On that date, there were 155,103,954 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement relating to the registrant's Annual Meeting
of Shareholders scheduled to be held May 16, 2002 are incorporated by reference
into Part III of this Report.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
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This Report contains forward-looking statements and information that are
based on management's current expectations as of the date of this document. When
used in this report, the words "anticipate," "believe," "estimate," "intend" and
"expect" and similar expressions are intended to identify forward-looking
statements. These forward-looking statements are subject to risks,
uncertainties, assumptions and other factors that may cause the actual results
to be materially different from those reflected in such forward-looking
statements. These factors include, among others, 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 these laws and regulations,
which may reduce the volume, average term and costs of yields on student loans
under the Federal Family Education Loan Program ("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 or in financing preferences of lenders, educational institutions,
students and their families; changes in the general interest rate environment
and in the securitization markets for education loans, which may increase the
costs or limit the availability of financings necessary to initiate, purchase or
carry education loans; losses from loan defaults; and changes in prepayment
rates and credit spreads.
PART I.
ITEM 1. BUSINESS
We believe that the industry data on the FFELP and the Federal Direct Loan
Program (the "FDLP") contained in this report are based on reliable sources and
represent the best available information for these purposes, including published
and unpublished U.S. Department of Education ("DOE") data and industry
publications.
GENERAL
USA Education, Inc. (to be renamed SLM Corporation effective on May 17,
2002), a Delaware Corporation (the "Company"), is the nation's leading private
source of funding, delivery and servicing support for higher education loans for
students and their parents. The Company's mission is to make education
accessible and affordable for all Americans at all times in their lives. The
Company provides a wide range of financial services, processing capabilities and
information technology to meet the needs of educational institutions, lenders,
students, and guarantee agencies. It was formed in 1997 in connection with the
reorganization (the "Reorganization") of the Student Loan Marketing Association,
a government-sponsored enterprise (the "GSE") that had been established by an
act of Congress in 1972. The Student Loan Marketing Association Reorganization
Act of 1996 (the "Privatization Act") required the GSE to propose to
shareholders a plan of reorganization under which their share ownership would
convert to an equivalent share ownership in a state-chartered holding company
that would own all of the stock of the GSE. Under the Privatization Act, the
Reorganization was approved by the GSE's shareholders on July 31, 1997 and
effected on August 7, 1997. The Privatization Act requires the GSE to transfer
its business to the Company and dissolve on or before September 30, 2008. In
January 2002, however, the GSE's board of directors announced that it expects to
complete the dissolution of the GSE by September 30, 2006. During the period
prior to the dissolution of the GSE (the "Wind-Down Period"), the GSE is subject
to various limitations on its business and activities. See "Operations During
the Wind-Down Period" and "Regulation--The Privatization Act."
As of December 31, 2001, the Company's managed portfolio of student loans
(including loans owned and loans securitized) totaled approximately
$71.7 billion, of which $67.5 billion or 94 percent is federally insured. The
Company also had commitments to purchase $21.6 billion of additional student
loans as of December 31, 2001. While the Company continues to be the leading
purchaser of student loans, its business has expanded since the creation of the
GSE in 1972, resulting in a greater emphasis
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on direct relationships with school customers as well as loan and guarantee
originations, account administration and debt collections.
Primarily a provider of education credit, the Company serves a diverse range
of clients, including approximately 6,000 educational and financial institutions
and guarantee agencies. The Company serves in excess of 7 million borrowers
through its ownership or management of student loans.
On July 31, 2000, the Company acquired the guarantee servicing, student loan
servicing and secondary market operations of USA Group, Inc. ("USA Group"). With
this acquisition, the Company broadened its offering of education
finance-related services to include servicing and administrative support for
guarantee agencies. In addition, the acquisition opened new channels and
affiliations for loan volume growth and has further diversified the Company's
sources of revenue. Prior to the USA Group acquisition, the Company derived
substantially all of its income from interest earnings or "spread income" from
its portfolio of student loans.
To expand and diversify its in-house expertise in the area of student loan
delinquency, default prevention and collection services, the Company acquired
two collection companies that specialize in education credit. Pioneer Credit
Recovery, acquired on January 2, 2002, was the number one student loan
collection service for the DOE in 2001. General Revenue Corporation, acquired on
January 31, 2002, is the nation's largest university-focused collection agency.
These acquisitions are expected to contribute to the growth of fee income
beginning in 2002.
The Company believes that it has achieved its leadership position in the
education finance industry due to its focus on customer relationships, a
comprehensive set of value-added products and services, superior loan servicing
capabilities and a sound financial management strategy. In recognition of the
increasingly important role that college and university administrators play in
the student loan process, the Company's primary marketing focus is the school
financial aid office where its strategy is to deliver simple, flexible and
cost-effective products and services to schools and students. This strategy,
combined with superior servicing and technology capabilities, has helped the
Company build valuable partnerships with schools, lenders, guarantee agencies
and others.
INDUSTRY OVERVIEW
HIGHER EDUCATION CREDIT
The higher education credit marketplace consists of a number of programs
that are structured to provide affordable financing to students and their
families to fund post-secondary education. The majority of student loans are
made to finance post-secondary education under federally sponsored programs,
although many students and parents secure additional education credit through
private (not federally insured) student loan programs. The primary federally
sponsored student loan programs are the FFELP and the FDLP. The largest student
loan program, formerly called the Guaranteed Student Loan Program and now known
as the FFELP, was created in 1965 to ensure low-cost access by families to a
full range of post-secondary educational institutions. In 1972, to encourage
further bank participation in the Guaranteed Student Loan Program, Congress
established the GSE as a for-profit, stockholder-owned national secondary market
for student loans. Under FFELP loan programs, banks and other lenders that
satisfy statutory eligibility requirements can originate loans to students at
below-market interest rates as a result of the federal government's guarantee
and its payment to lenders of market-based adjustments or special allowance
payments ("SAP"). The FFELP industry is currently administered through a network
of approximately 3,500 lending institutions and approximately 4,000 educational
institutions. Thirty-six state-sponsored or non-profit guarantee agencies are
responsible for guaranteeing the loans on behalf of the DOE. In addition to the
Company, a number of non-profit entities, banks and other financial
intermediaries operate as secondary markets for student loans.
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The Higher Education Act of 1965, as amended (the "Higher Education Act"),
is reauthorized by Congress approximately every six years. The Higher Education
Act was last reauthorized on October 7, 1998 in the form of the Higher Education
Amendments of 1998 (the "Reauthorization Legislation"), legislation that lowered
both the borrower interest rate on Stafford loans--the primary loan program
under the FFELP--and the lender's rate after SAP. The provisions of the FFELP
are also subject to revision from time to time by Congress.
The second largest federally sponsored student loan program and the
Company's primary competitor is the FDLP. In 1993, Congress expanded a
previously established pilot program into the FDLP, which is administered and
marketed to schools by the DOE. Established as an alternative to the private
sector-based FFELP, the FDLP accounted for approximately 29 percent of all new
federally sponsored student loans issued in the federal fiscal year 2001. Under
the FDLP, the federal government lends directly to borrowers and contracts with
third parties for loan administration and collection services while financing
its lending activity through U.S. Treasury borrowings. Loans offered through the
FDLP generally have the same terms as those offered through FFELP.
Under FFELP, there are four primary lending products that fund access to
education. The Company's student loan purchases and originations have primarily
involved these loan types. They include:
- subsidized Stafford loans,
- unsubsidized Stafford loans,
- Parental Loans to Undergraduate Students (PLUS) and
- consolidations loans.
Payment of principal and interest on FFELP loans are guaranteed (98 percent
to 100 percent, depending on loan origination date) against default by the
borrower as well as in other circumstances. In addition, the holder of a federal
student loan is entitled to receive interest subsidy payments and, in certain
cases, SAP from the DOE. (See "Appendix A" for a detailed discussion of the
FFELP and FDLP.) A holder of federal student loans also must comply with DOE
regulatory requirements in order to benefit from the guarantee.
Demand for student loans has risen substantially over the last several
years. Higher education tuition cost and fee increases continue to exceed the
inflation rate. Approximately 58 percent of all full-time college students today
depend on some form of borrowing, compared to 48 percent in 1990. In addition,
federal legislation enacted in late 1992 expanded loan limits and borrower
eligibility. All of these factors contributed to annual federally sponsored
student loan volume growing by approximately 66 percent from the 1994 federal
fiscal year to the 2001 federal fiscal year. In dollars, the FDLP and FFELP
annual student loan origination volume grew from approximately $24 billion as of
September 30, 1994 to approximately $39.9 billion as of September 30, 2001.
According to DOE projections, demand for student loans will continue to grow.
Total FDLP and FFELP student loan origination volume is projected to reach
$70 billion in the 2009 federal fiscal year. The Company believes that lender
participation in the FFELP is relatively concentrated, with an estimated
82 percent of loans being originated by the top 50 participants during the
federal fiscal year ended September 30, 2001.
While the FDLP grew at a much higher rate during the first four years of the
program (federal fiscal years 1994-1997), the FDLP has lost market share during
the past three years. During the federal fiscal year 2001, FFELP student loans
represented 71 percent, or $28.3 billion, of the total student loan market.
FFELP student loans represented only 66 percent of the total student loan market
in the federal fiscal year 1997.
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GUARANTOR SERVICES AND STUDENT LOAN COLLECTIONS
Guarantee agencies are non-profit institutions or state agencies that play a
crucial role in the disbursement, guarantee, retention and collection of FFELP
loans. Currently, there are thirty-six guarantors that guarantee FFELP loans
made by eligible institutions. Student loans originated under the FFELP are
insured for 98 percent of loan principal and accrued interest by a designated
guarantee agency. Loans originated prior to October 1, 1993 are 100 percent
insured. Student loans are also guaranteed as to 100 percent of principal and
accrued interest in the event of death, disability or bankruptcy. Guarantee
agencies, in turn, are reinsured by the DOE.
In addition to providing the primary guarantee on FFELP loans, guarantee
agencies are charged, under the Higher Education Act, with responsibility for
the following:
- "loan origination"--initial loan and guarantee processing,
- "account maintenance"--maintaining records on all loans on which it has
issued a guarantee,
- "default aversion"--assisting lenders to prevent default by delinquent
borrowers,
- "collection retention"--post-default loan administration and collections.
Guarantee agencies receive revenues from statutorily prescribed sources
(fees charged to the DOE) plus earnings on investments to fund these activities.
See Appendix A--"Guarantee Agencies Under the FFELP."
The Company has guarantor-servicing contracts with United Student Aid
Funds, Inc. ("USA Funds"), which is the designated guarantor for nine states,
and nine other guarantee agencies. Based on all FFELP student loans originated
in 2001, the Company's market share for guarantor services was approximately
33 percent. The balance of the market share consisted of guarantors that provide
their own guarantor servicing and guarantors that are currently outsourcing with
a 40 percent and 27 percent market share, respectively.
As noted above, guarantee agencies are required to attempt collection on
their defaulted accounts. As of December 31, 2001, the Company was performing
collections services on approximately $5.0 billion of defaulted student loans on
behalf of its guarantor clients (primarily USA Funds) through its collection
subsidiary Education Debt Services, Inc ("EDSI").
Generally, there are three sources of defaulted student loans on which
collection services can be provided: guarantee agencies, the DOE and
campus-based loan programs. As of December 31, 2001, the total volume of
defaulted federal student loans was approximately $30 billion. Approximately
61 percent of these loans are being pursued by guarantee agencies. The balance
of the portfolio is held by the DOE, which in turn has contracted with various
collection agencies to recover or rehabilitate the loans. Finally, there are a
number of campus-based federal loan programs for which the college or university
is required to attempt collection on defaulted loans.
PRODUCTS AND SERVICES
Over the past decade, a number of developments have significantly changed
the student loan industry. The developments--primarily, the reduction in the
legislated asset yield, the implementation of the FDLP, the concentration of
participating lenders, the advent of student loan securitization and the
Company's 1997 reorganization--led the Company to reassess its bank-oriented
loan purchase strategy. As a result, the Company changed the focus of its
marketing efforts to the college campus, specifically the financial aid offices.
Management believes that the keys to the success of this campus-centered
marketing strategy are:
- strategic lender partnerships and loan origination,
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- an expanded sales force offering a broad range of products and services,
- premium loan delivery and technology solutions,
- customer service solutions, and
- private credit alternatives.
As of December 31, 2001, the Company's managed portfolio of federally
insured student loans totaled $67.5 billion, including $65.7 billion of FFELP
loans (including loans owned and loans securitized) and $1.8 billion of Health
Education Assistance Programs loans ("HEAL") guaranteed by the U.S. Department
of Health and Human Services.
STRATEGIC LENDING PARTNERSHIPS AND LOAN ORIGINATION. Through dedicated
lender relationships and direct origination, the Company intends to build its
preferred channel--loans originated and serviced on the Company's servicing
platform that are committed for sale to or owned from inception by the Company.
The loans acquired or originated in this fashion are more profitable to the
Company as they are acquired at a lower average cost and have a longer average
life and lower servicing costs. Loan volume disbursed from the Company's
preferred channel totaled $10.1 billion in 2001 and $7.3 billion in 2000, a
38 percent increase year-over-year.
The Company's preferred channel volume was approximately 79 percent of its
total purchase volume in 2001 and 61 percent of its purchase volume in 2000. In
2001 as in 2000, the primary contributors to the Company's preferred channel
volume were its joint venture with Chase Manhattan Bank and its strategic
alliance with Bank One. During the federal fiscal year ending September 30,
2001, Chase and Bank One were the first and second largest originators,
respectively, of federally insured student loans.
The Company entered into its joint venture with Chase Manhattan Bank (the
"Joint Venture") in 1994 and restructured it in 1998 such that the Company now
purchases all loans originated by Chase. The Company is currently in the process
of negotiating an extension of the restructured Joint Venture. If the Company
and Chase are unable to agree on an extension, the Joint Venture will revert to
its pre-1998 structure in which the Company would only hold a 50 percent
participation interest in the loans originated by Chase.
On December 31, 1999, USA Group entered into an agreement to establish a
strategic alliance with Bank One, one of the nation's largest education loan
originators. This alliance was transferred to the Company as part of the
Company's acquisition of USA Group's business operations. Under this alliance,
Education One Group, Inc., which is now a wholly owned subsidiary of the
Company, is the sole, limited purpose agent of Bank One operating exclusively to
market and originate Bank One's education loans. Under the Company's renewable,
multi-year agreement, which strengthened and expanded its then existing
arrangement with Bank One, the Company's affiliates will service and purchase a
significant share of Bank One's annual new loan volume.
In 1998, the Company began to originate a nominal amount of FFELP and
private loans through its wholly owned subsidiaries, SLM Education Loan Corp and
SLM Financial. In order to accelerate its loan origination efforts, the Company
completed two strategic acquisitions: Nellie Mae in 1999 and Student Loan
Funding Resources Inc. ("SLFR") in 2000. In 2001, the Company originated
$1.6 billion in student loan volume through its own brands.
The Company also purchases student loans through other (non-preferred
channel) purchase commitment contracts. Reflecting its efforts to drive volume
to the preferred channel, the Company's non-preferred channel purchases declined
during 2001 to $1.0 billion compared to $1.4 billion in 2000. The Company enters
into commitment contracts with lenders to purchase loans up to a specified
aggregate principal amount over the term of the contract, which is generally
three years. Under all commitment contracts (including preferred channel
commitments), lenders have the right, and in most
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cases the obligation, to sell to the Company the loans they own over a specified
period of time at a purchase price that is based on certain loan
characteristics.
The Company supplements its commitment purchases with spot market purchases.
In a spot market purchase, the Company competes with other market participants
to purchase a portfolio of eligible loans from a selling holder. Excluding
business acquisitions, the Company made approximately 5 percent and 8 percent of
its purchases of educational loans through spot purchases in 2001 and 2000,
respectively. In general, spot market purchase volume is more costly than volume
purchased under commitment contracts.
EXPANDING SALES FORCE. Beginning in 1997 and in conjunction with its joint
venture with Chase Manhattan Bank ("Chase"), the Company began to focus on its
campus-based strategy which required an expanded sales force and solid
relationships with its primary lenders. By the end of 2001, the Company's sales
forces totaled in excess of 200 individuals representing brands such as Chase,
Bank One, Sallie Mae, Nellie Mae, SLFR and SLM Financial. Management believes
this sales coverage, together with the service level and product set provided by
the Company, will maximize the potential that the Company or one of its brands
will be placed on a college or university's preferred lender list.
PREMIUM LOAN DELIVERY SYSTEMS AND TECHNOLOGY. In concert with its focus to
drive volume to its preferred channel through the financial aid office, the
Company launched Laureate, its Internet-based student loan delivery system, for
the 1999-2000 academic year. In addition, with the acquisition of the business
operations of USA Group, the Company now offers NetWizard, an alternative
Internet-based student loan delivery system. These systems provide real-time
data linkage among schools, borrowers, lenders and guarantors. With the addition
of electronic signatures for applications and promissory notes via the Web, the
Company has delivered a fully paperless application process for student loans.
In conjunction with commitment contracts, the Company frequently provides
selling institutions with loan origination and interim servicing support in the
form of ExportSS-Registered Trademark- through one of the Company's loan
servicing centers. The Company also offers selling institutions operational
support in the form of PortSS-Registered Trademark-, an automated loan
administration system for the lender's use at its own offices before loan sale.
Through TransportSS(SM), the Company also offers commitment clients the ability
to originate loans and then transfer them to the Company for servicing. PortSS,
ExportSS and TransportSS provide the Company and the lender assurance that the
Company will efficiently administer loans and that borrowers will have access to
the Company's repayment options and benefits. In 2001 and 2000, 93 percent and
87 percent, respectively, of the Company's preferred channel purchase commitment
volume came from users of ExportSS, PortSS, and TransportSS. While USA Group did
not offer a similar set of products and services, it sought to foster efficient
loan administration through arrangements with "alliance lenders," who generally
are entitled to the full complement of USA Group's products and services. See
"Strategic Lending Partnerships and Loan Originations."
CUSTOMER SERVICE SOLUTIONS. The Company has developed several customer
service solutions for financial aid officers including College Answer and Parent
Answer. These services direct borrower and parent inquiries to Sallie Mae call
center representatives and relieve the financial aid officer of most of the
questions regarding loan processing. In addition, these services simplify and
accelerate the loan application and loan delivery process and, in the case of a
PLUS loan, credit approval. College Answer is the Company's most customized
service and offers front-end and back-end assistance, including general
information, financial aid counseling and award letter tracking. Parent Answer
offers assistance to parents applying for a PLUS loan with prompt pre-approval
services by Internet, telephone or fax. In addition, the Company has introduced
PLUS Success to offer credit counseling and to help parents who are not
initially credit eligible become PLUS eligible. More than 1,300 colleges
participated in Parent Answer services during 2001 and Sallie Mae's PLUS volume
exceeded $1.2 billion, a 43 percent increase over 2000.
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PRIVATE CREDIT SOLUTIONS. To meet the full range of needs of financial aid
directors and students, the Company offers a wide complement of funding
alternatives to fill the gap between the price of admission and federal
financial aid. In the spring of 1996, the Company introduced the Signature
Education(SM) Loan Program. Signature Student(SM) Loans are available to
students at most four-year colleges and universities to supplement their federal
loans. Non-creditworthy students are required to have a co-borrower. Students
may borrow as much as the costs of attendance minus other financial aid they are
eligible to receive. Signature loans are insured by the Company through its
HEMAR Insurance Corporation of America (HICA) subsidiary. Under agreements with
the Company, lenders originated approximately $880 million in Signature private
loans in 2001. The majority of this volume represents loans made to borrowers
with creditworthy co-borrowers. The Company also purchases loans originated
under various other HICA-insured loan programs, including the loan affinity
programs MEDLOANS(SM), LAWLOANS(SM), and MBA LOANS(SM). These three loan
programs accounted for $200 million in private loans during 2001. The Company
also originates private credit loans on campus through the Nellie Mae, Student
Loan Funding and Bank One brands. In 2001, the Company originated $76 million,
$2 million and $28 million, respectively, through these brands. Unlike loans
made under the FFELP, the Company directly, or through HICA, bears the credit
risk associated with its private credit loan portfolio.
Beginning in 1999, SLM Financial, a wholly owned subsidiary of the Company,
substantially expanded the Company's private credit product line, focusing on
career training and lifelong learning. With the creation of SLM Financial, the
Company began offering the Career Training Loan(SM) through partnerships with
higher education associations, colleges and universities, technical and trade
schools and other adult learning centers. This loan, which is made by lender
partners, is available to borrowers enrolled in career training courses or a
distance learning school; attending a two-year or four-year proprietary school;
or attending a four-year college less than half-time. In addition, the Company
made available its K-12 Family Education Loan(SM) to parents and other family
members of children attending private K-12 schools. Under this loan program,
families can borrow up to the entire cost of education including additional
money for education-related expenses such as the purchase of a computer or
musical instrument. SLM Financial also offers mortgages, home equity and other
secured and unsecured consumer loans. All SLM Financial loans are underwritten
and priced based upon standardized consumer credit scoring criteria. During
2001, SLM Financial originated $791 million in loans of which 61 percent was
education related.
BORROWER BENEFITS AND REPAYMENT OPTIONS. To satisfy customer preferences
and compete more effectively in the student loan marketplace, the Company has
developed a comprehensive set of loan programs and services for borrowers,
including numerous loan restructuring and repayment options and programs that
encourage and reward good repayment habits. The Company also provides counseling
and information programs, including a Web site, that help borrowers and
reinforce relationships with college and university customers and lender
partners.
Under the Company's Great Rewards-Registered Trademark- Program, Stafford
loan FFELP borrowers who make their first 48 scheduled monthly payments on time
receive a two percentage-point interest rate reduction for the remaining term of
the loan.
The Company introduced Sallie Mae Cash Back-SM- for the 2002-2003 academic
year. Under this program, borrowers who secure a Stafford loan with a Sallie Mae
lender partner can get cash back equal to 3.3 percent of the original loan
amount. To qualify for this benefit, a borrower must enroll in the Company's
Internet Self-Service-SM-, agree to receive account information at a valid
e-mail address and make the loan's initial 33 scheduled payments on time. Sallie
Mae Cash Back replaces the Company's Great Rewards Program and Direct Repay Plan
for new Stafford loan borrowers for the 2002-2003 academic year. The Company
also provides financial aid administrators at colleges and universities with
innovative products and services that simplify the lending process, including
electronic
8
funds transfer services and loan information and management software that
enables college application data to be transferred electronically between
program participants.
The Company's Direct Repay Plan allows FFELP borrowers to authorize the
automatic withdrawal of funds from their checking or savings account to cover
monthly education loan payments. Borrowers can receive a one-quarter
percentage-point interest rate reduction on eligible loans as long as they make
on-time payments through the plan.
The Company's Flex Repay Account allows students to extend loan repayment to
make their payments more affordable while minimizing total loan costs in
comparison to loan consolidation. In addition, the Company offers graduated,
income-sensitive and extended repayment options.
The Company also offers eligible borrowers a program for consolidation of
eligible insured loans into a single new insured loan with a term of 10 to
30 years. As of December 31, 2001, the Company owned approximately
$14.0 billion of such consolidation loans, known as SMART
LOAN-Registered Trademark- Accounts.
During the fourth quarter of 2001, a combination of low rates, the 80 basis
point advantage on direct loan consolidations and aggressive marketing by
certain FFELP competitors whose primary business is marketing student loan
consolidations for other lenders all resulted in a significant increase in the
level of student loans consolidated away from the Company's managed portfolio.
On a net basis, approximately $1.3 billion of student loans were consolidated
away from the Company in 2001 compared to $406 million in 2000. If interest
rates remain at or near current levels on July 1, 2002 (the date on which the
interest rates for annually adjusted variable rate student loans are reset),
management expects significant levels of consolidation activity to continue.
Management, however, also expects to see net consolidation activity level off or
decline throughout 2002 as fewer loans will be eligible for consolidation, the
Company continues to increase the marketing of its own consolidation loans and
the FDLP's 80 basis point interest rate advantage expired for applications
submitted after September 30, 2001.
LOAN SERVICING
Through Sallie Mae Servicing L.P., a wholly owned Delaware limited
partnership, the Company is now the nation's largest servicer of FFELP loans.
Management believes that the Company is recognized as the premier service
quality and technology provider in the student loan industry. Management also
believes that the Company's processing capability and service excellence are
integral to its school-based growth strategy. As of December 31, 2001, the
Company serviced approximately $73.4 billion of FFELP loans, including
approximately $28.2 billion of loans owned by the GSE and its affiliates,
$30.5 billion owned by 32 securitization trusts sponsored by the GSE or its
subsidiaries and $14.7 billion of loans owned by other parties. As of
December 31, 2001, the Company also serviced approximately $6.0 billion in
non-FFELP loans including approximately $1.8 billion in HEAL loans and
$4.2 billion in private loans.
The Company currently has four loan servicing centers, located in Florida,
Indiana, Pennsylvania and Texas. This geographic coverage, together with total
systems integration among centers, facilitates operations and customer service.
The DOE and the various guarantee agencies prescribe rules and regulations
that govern the servicing of federally insured student loans. The Company's
origination and servicing systems, internal procedures and highly trained staff
support compliance with these regulations, and are designed to promote asset
integrity and provide superior service to borrowers. The Company must comply
with DOE and guarantee agency regulations in order to benefit from the guarantee
on its FFELP student loans.
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GUARANTOR SERVICING
As a result of its acquisition of the business operations of USA Group, the
Company now provides a full complement of administrative support for loan
guarantors, ranging from loan origination and account maintenance to default
prevention and post-default collections. The Company provides administrative
support to USA Funds, the nation's largest guarantor of education loans and the
designated guarantor in Arizona, Hawaii and the Pacific Islands, Indiana,
Kansas, Maryland, Mississippi, Nevada and Wyoming. In addition, the Company has
guarantor-servicing contracts with guarantors serving nine other states.
During 2001, the Company processed $7.4 billion and $2.4 billion in
education loans for USA Funds and the Company's other guarantor servicing
customers, respectively. All of these customers use the Company's EAGLE-TM-
guarantee system that tracks FFELP loan origination and guarantee activities
that the Company administers on behalf of its customers.
The Company has two primary contracts with USA Funds: a guarantee services
agreement under which the Company provides comprehensive outsourcing of
guarantee operations functions including, among other things, guarantee
processing, portfolio management, loan disbursement services, claim review and
debt collections; and a default aversion agreement under which the Company
provides all default aversion activities required under the FFELP as well as
certain mutually agreed upon special default reduction activities. The contracts
run through 2004 and are automatically extended thereafter on an annual basis
unless terminated by either party.
With the acquisition of Pioneer Credit Recovery and General Revenue
Corporation ("GRC"), the Company intends to further increase its penetration of
the guarantor, government and school markets. Its strategy is to build a fully
diversified delinquency, default and collection services operation that serves
the entire spectrum of collections, including guarantors (FFELP loans), the DOE
(FFELP and FDLP), and campus-based programs (Perkins and private).
Guarantor-based loans are collected by EDSI and GRC and a variety of outside
collection agencies. Pioneer Credit Recovery is currently the top-ranked student
loan collections service for the DOE's collections contract while General
Revenue Corporation is the nation's largest university-focused collection
agency, serving over 700 higher education institutions.
FINANCING/SECURITIZATION
The Company obtains funds for its operations primarily from the sale of GSE
debt securities, student loan asset-backed securities and debt securities issued
by the Company in the domestic and overseas capital markets. The debt and
asset-backed securities are sold through public offerings and private placements
of U.S. dollar denominated and foreign currency denominated debt of varying
maturities and interest rate characteristics. The Company uses interest rate and
currency exchange agreements (collateralized where appropriate), U.S. Treasury
securities, interest rate futures contracts and other hedging techniques to
reduce its exposure to interest rate and currency fluctuations arising out of
its financing activities and to match the characteristics of its assets and
liabilities.
GSE debt securities are currently rated at the highest credit rating level
by Moody's Investors Service, Inc. ("Moody's") and Standard & Poor's Credit
Market Services, a division of The McGraw-Hill Companies, Inc. ("S&P"). Under
the Privatization Act, the GSE may issue debt with maturity dates through
September 30, 2008 to fund student loan and other permitted asset purchases.
Upon the GSE's dissolution in accordance with the Privatization Act, the GSE
must transfer any remaining GSE obligations into a defeasance trust for the
benefit of the holders of such obligations together with cash or full faith and
credit obligations of the United States, or an agency thereof, in amounts
sufficient, as determined by the Secretary of the Treasury, to pay the principal
and interest on the deposited obligations. If the GSE has insufficient assets to
fully fund such GSE debt, the Company must transfer sufficient assets to the
trust to account for this shortfall. The Privatization Act requires
10
that upon the dissolution of the GSE on or before September 30, 2008, the GSE
shall repurchase or redeem or make proper provisions for repurchase or
redemption of the GSE's outstanding preferred stock.
Since late 1995, the Company has been diversifying its funding sources,
independent of its GSE borrower status. Part of this diversification is
accomplished through securitizing its student loan assets. Securitization is an
off-balance sheet funding mechanism that the Company effects through the sale of
portfolios of student loans by the GSE to SLM Funding Corporation, a
bankruptcy-remote, special-purpose, wholly owned subsidiary of the GSE. SLM
Funding Corporation, in turn sells the student loans to an independent owner
trust that issues securities to fund the purchase of the student loans. The
securitization trusts typically issue several classes of debt securities rated
at the highest investment grade level. The GSE has not guaranteed such debt
securities and has no obligation to ensure their repayment. As a result, neither
the assets nor the associated debt are included in the Company's financial
statements. Because the securities issued by the trusts through securitization
are not GSE securities, the Company has been and in the future expects to be
able to fund its student loans to term through securitization, even for those
assets with final maturities that extend beyond the Wind-Down Period. The DOE
has concurred with the Company's position that a 30 basis point per annum offset
fee imposed on loans held by the GSE does not apply to securitized loans. The
Company anticipates that securitization will remain a primary student loan
funding mechanism for the Company when it begins to conduct student loan
purchase activity through a non-GSE subsidiary.
In addition to the foregoing, the Company obtains funding on an unsecured
basis through a commercial paper program and a medium term note program. In the
fourth quarter of 1999, the Company established a $1 billion commercial paper
program. This program is supported by a $600 million 364-day revolving credit
agreement, which the Company renewed in the fourth quarter of 2001, and a
$400 million five-year revolving credit agreement. Prior to the establishment of
this commercial paper program, the Company secured credit ratings of A1, P1 and
F1+ on its short term debt and A, A3 and A+ on its long term debt from S&P,
Moody's and Fitch IBCA, Inc., respectively. In addition, the Company issued a
total of $1.5 billion of senior notes, beginning in the fourth quarter of 2000
and continuing issuances of its senior notes through 2001.
In the fourth quarter of 2001, the Company established its medium term note
program. On October 31, 2001, the Company entered into a distribution agreement
with various underwriters under which the Company may issue, from time to time,
up to $3 billion of its notes with maturities between nine months and 30 years.
Through December 31, 2001, the Company has issued $625 million of medium term
notes and an additional $715 million of such notes in the first quarter of 2002.
OPERATIONS DURING THE WIND-DOWN PERIOD
Privatization enables the Company to commence new business activities
without regard to restrictions in the GSE's charter. During the Wind-Down
Period, the GSE generally is prohibited from conducting new business except in
connection with student loan purchases through September 30, 2007 or with other
outstanding contractual commitments, and from issuing new debt obligations that
mature beyond September 30, 2008. As described earlier, however, the Company
intends to wind down the GSE by 2006. Accordingly, the GSE intends to cease its
student loan purchases by such time and does not intend to issue any new debt
obligations that mature beyond September 30, 2006. The GSE has transferred
personnel and certain assets to the Company or other non-GSE affiliates.
Although student loans, warehousing advances and other program-related or
financial assets (such as portfolio investments, letters of credit, swap
agreements and forward purchase commitments) have not been transferred to date,
the Company expects to begin transferring certain financial assets beginning in
2002 and throughout the Wind-Down Period. Neither the Company nor any of its
non-GSE affiliates may make secondary market purchases of FFELP loans for so
long as the GSE is actively acquiring insured student loans. During the
Wind-Down Period, GSE operations will be managed under arm's-length
11
service agreements between the GSE and one or more of its non-GSE affiliates.
The Privatization Act also provides certain restrictions on intercompany
relations between the GSE and its affiliates during the Wind-Down Period.
COMPETITION
The Company's largest competitor is the Federal Direct Loan Program. Based
on DOE reports, the Company estimates that total student loan originations for
the federal fiscal years 2001 and 2000 were $39.9 billion and $37.5 billion,
respectively, of which FDLP originations represented approximately 29 percent
and 32 percent, respectively. The DOE projects that FDLP originations will
represent approximately 30 percent of total student loan originations in the
2002 federal fiscal year.
The Company also faces competition on a national basis from several large
commercial banks and non-profit secondary market agencies and on a state or
local basis from smaller banks and state-based secondary markets. The
availability of securitization for student loan assets also fostered competition
from new and established market participants. Management believes that the
Company's market share in the FFELP industry has been a function of school and
student desire for borrower benefits and superior customer service as more fully
described above. See "PRODUCTS AND SERVICES--Strategic Lending Partnerships and
Loan Origination."
The DOE offers FFELP borrowers the opportunity to refinance or consolidate
their FFELP loans into FDLP loans if the borrowers also have a FDLP loan or upon
certification that the holder of their FFELP loans does not offer an
income-sensitive payment plan acceptable to the borrower. During 2001 and 2000,
approximately $1.3 billion and $519 million, respectively, of the Company's
FFELP loans were consolidated into the FDLP. In early 1995, the Company began
offering an income-sensitive payment plan. The FDLP, however, also provides an
income-contingent option not available under the FFELP program that may be more
attractive to certain borrowers. Under this repayment option, the government
will ultimately forgive student loan debt after 25 years.
REGULATION
As a government-sponsored enterprise, the GSE is organized under federal law
and its government charter restricts its operations. Although privatization
permits the Company's private activities to expand through non-GSE subsidiaries,
the GSE's operations continue to be subject to broad federal regulation during
the Wind-Down Period.
THE PRIVATIZATION ACT
The Privatization Act established the basic framework for the Reorganization
and imposes certain restrictions on the operations of the Company and its
subsidiaries during the Wind-Down Period. The Privatization Act amends the GSE's
charter to require certain enhanced regulatory oversight of the GSE to ensure
its financial safety and soundness. See "GSE Regulation."
REORGANIZATION. The Privatization Act required the GSE to propose to
shareholders a plan of reorganization under which their share ownership in the
GSE would be automatically converted to an equivalent share ownership in a
state-chartered holding company that would own all of the common stock of the
GSE. On July 31, 1997, the GSE's shareholders approved the Reorganization in
fulfillment of this provision. The Privatization Act requires that the GSE be
liquidated on or before September 30, 2008, upon which time its federal charter
will be rescinded. As described earlier, however, the GSE's board of directors
expects to wind down the GSE by 2006. During the Wind-Down Period, the Company
will remain a passive entity that supports the operations of the GSE and its
other non-GSE subsidiaries, and any new business activities will be conducted
through such subsidiaries.
12
The Privatization Act requires all personnel and certain assets to be
transferred to non-GSE subsidiaries of the Company in connection with the
Reorganization, including the transfer of the GSE's interest in certain
subsidiaries. The GSE's student loans and related contracts, warehousing
advances and other program-related or financial assets (such as portfolio
investments, letters of credit, swap agreements and forward purchase
commitments) and any non-material assets that the GSE Board determines to be
necessary for or appropriate to continued GSE operations, may be retained by the
GSE. Employees of the GSE were transferred to the Management Company at the
effective time of the Reorganization.
During the Wind-Down Period, the GSE is restricted in the new business
activities it may undertake. The GSE may continue to purchase student loans only
through September 30, 2007, and warehousing advance, letter of credit and
standby bond purchase activity by the GSE is limited to takedowns on contractual
financing and guarantee commitments in place at the effective time of the
Reorganization. In addition, the Company and its non-GSE subsidiaries may not
make secondary market purchases of FFELP loans for so long as the GSE is
actively acquiring insured student loans.
In certain circumstances, the GSE will continue to serve as a lender of last
resort and will provide secondary market support for the FFELP upon the request
of the Secretary of Education. If and to the extent that the GSE performs such
functions, however, it will not be required to pay a statutorily imposed 30
basis point offset fee on such loans. The GSE may transfer assets and declare
dividends, from time to time, if it maintains a minimum capital ratio of at
least 2.25 percent. In the event that the GSE does not maintain the required
minimum capital ratio, the Company is required to supplement the GSE's capital
to achieve such minimum capital ratio. In addition, in connection with any
dividend declarations, the GSE will supplement the statutory minimum capital
ratio with a risk-based capital measurement formula that is based on discussions
with the U.S. Department of Treasury's Office of Sallie Mae Oversight.
The GSE's debt obligations, including debt obligations that were outstanding
at the time of the Reorganization, continue to be outstanding obligations of the
GSE and will not be transferred to any other entity (except in connection with
the defeasance trust described below). See "GSE Dissolution After
Reorganization." The Privatization Act provides that the Reorganization does not
modify the attributes accorded to the debt obligations of the GSE by the GSE's
charter. During the Wind-Down Period, the GSE can continue to issue debt in the
government agency market to finance student loans and other permissible asset
purchases. The maturity date of such issuances, however, may not extend beyond
September 30, 2008, the GSE's final dissolution date. This restriction does not
apply to debt issued to finance any lender of last resort or secondary market
purchase activity requested by the Secretary of Education. The Privatization Act
is clear that the Reorganization (and the subsequent transfer of any remaining
GSE debt to the defeasance trust described below) will not modify the legal
status of any GSE debt obligations, whether such obligations existed at the time
of Reorganization or are subsequently issued.
OVERSIGHT AUTHORITY. During the Wind-Down Period, the Secretary of the
Treasury has extended oversight authority to monitor the activities of the GSE
and, in certain cases, the Company and its non-GSE subsidiaries to the extent
that the activities of such entities are reasonably likely to have a material
impact on the financial condition of the GSE. The U.S. Department of the
Treasury has established the Office of Sallie Mae Oversight to perform these
functions. During this period, the Secretary of the Treasury may require that
the GSE submit periodic reports regarding any potentially material financial
risk of its affiliates and its procedures for monitoring and controlling such
risk. The Company is expressly prohibited from transferring ownership of the GSE
or causing the GSE to file bankruptcy without the approval of the Secretary of
the Treasury and the Secretary of Education. The Secretary of Education and the
Secretary of the Treasury have express authority to request that the Attorney
General bring an action, or may bring an action under the direction and control
of the Attorney General, in the United States District Court for the District of
Columbia, for the enforcement
13
of any provision of the GSE's safety and soundness requirements or the
requirements of the Privatization Act in general.
RESTRICTIONS ON INTERCOMPANY RELATIONS. The Privatization Act restricts
intercompany relations between the GSE and its affiliates during the Wind-Down
Period. Specified corporate formalities must be followed to ensure that the
separate corporate identities of the GSE and its affiliates are maintained.
Specifically, the Privatization Act provides that the GSE must not extend credit
to, nor guarantee any debt obligations of, the Company or its subsidiaries. The
Privatization Act also provides that (i) the funds and assets of the GSE must at
all times be maintained separately from the funds and assets of the Company and
its subsidiaries, (ii) the GSE must maintain books and records that clearly
reflect the assets and liabilities of the GSE, separate from the assets and
liabilities of the Company or its subsidiaries, (iii) the GSE must maintain a
corporate office that is physically separate from any office of the Company and
its subsidiaries, (iv) no director of the GSE who is appointed by the President
may serve as a director of the Company and (v) at least one officer of the GSE
must be an officer solely of the GSE.
Furthermore, the Privatization Act mandates that transactions between the
GSE and the Company, including any loan servicing arrangements, shall be on
terms no less favorable to the GSE than the GSE could obtain from an unrelated
third party, and any amounts collected on behalf of the GSE by the Company under
a servicing contract or other arrangement between the GSE and the Company shall
be immediately deposited by the Company to an account under the sole control of
the GSE.
LIMITATIONS ON COMPANY ACTIVITIES. During the Wind-Down Period, the Company
must remain a passive entity that holds the stock of its subsidiaries and
provides funding and management support to such subsidiaries. The Privatization
Act contemplates that until the GSE is dissolved, the Company's business
activities will be conducted through subsidiaries. However, the Privatization
Act extends to the Company and its subsidiaries the GSE's "eligible lender"
status for loan consolidation and secondary market purchases.
The Company and its non-GSE subsidiaries generally may not begin to make
secondary market purchases of FFELP student loans for so long as the GSE is
actively acquiring insured student loans. Subject to the foregoing, the Company
may elect, at any time, to transfer new student loan purchase activity from the
GSE to one of its non-GSE subsidiaries. In addition, the Company is permitted to
and, in the third quarter of 1998, began to originate FFELP loans. Under the
Higher Education Act, loans acquired after August 10, 1993 and held by the GSE
are subject to a 30 basis point per annum offset fee. The offset fee does not
apply to securitized loans or to loans held or securitized by the Company or its
non-GSE subsidiaries.
Although the GSE may not finance the activities of the Company's non-GSE
subsidiaries, it may, subject to its minimum capital requirements, dividend
retained earnings and surplus capital to the Company, which in turn may use such
amounts to support its non-GSE subsidiaries. The Privatization Act further
directs that, unless and until distributed as dividends by the GSE, under no
circumstances shall the assets of the GSE be available or used to pay claims or
debts of or incurred by the Company.
In exchange for the payment of $5 million to the District of Columbia
Financial Responsibility and Management Assistance Authority (the "Control
Board"), the Company and its other subsidiaries may continue to use the name
"Sallie Mae," but not the name "Student Loan Marketing Association," as part of
their legal names or as a trademark or service mark. Interim disclosure
requirements in connection with securities offerings and promotional materials
are required to avoid marketplace confusion regarding the separateness of the
GSE and its affiliated entities. During the Wind-Down Period, the "Sallie Mae"
name may not be used by any Company unit that issues debt obligations or other
securities to any person or entity other than the Company or its subsidiaries.
In addition, the Company issued certain warrants to purchase the Company's
Common Stock (the "Warrants") to the
14
Control Board in August 1997. These provisions of the Privatization Act were
part of the terms negotiated with the Administration and Congress in conjunction
with the GSE's privatization.
GSE DISSOLUTION AFTER REORGANIZATION. The Privatization Act provides that
the GSE will liquidate and dissolve on September 30, 2008, unless an earlier
dissolution is requested by the GSE and the Secretary of Education makes no
finding that the GSE continues to be needed as a lender of last resort under the
GSE charter or to purchase loans under certain agreements with the Secretary of
Education. As described earlier, the GSE's board of directors announced in
January 2002 that it expects to complete the dissolution of the GSE by 2006. In
connection with such dissolution, the GSE must transfer any remaining GSE
obligations into a defeasance trust for the benefit of the holders of such
obligations, along with cash or full faith and credit obligations of the United
States, or an agency thereof, in amounts sufficient, as determined by the
Secretary of the Treasury, to pay the principal and interest on the deposited
obligations. As of December 31, 2001, the GSE had $1.6 billion in current
carrying value of debt obligations outstanding with maturities after
September 30, 2006. If the GSE has insufficient assets to fund fully such GSE
debt obligations outstanding at the time of dissolution, the Company must
transfer sufficient assets to the trust to account for this shortfall. Upon
dissolution, the GSE charter will terminate, and any assets that the GSE
continues to hold after establishment of the trust or that remain in the trust
after full payment of the remaining obligations of the GSE assumed by the trust
will be transferred to the Company or its affiliates, as determined by the
Company's Board of Directors.
GSE REGULATION
The GSE's structure and the scope of its business activities are set forth
in its charter. The charter, which is subject to review and change by Congress,
sets forth certain restrictions on the GSE's business and financing activities
and charges the federal government with certain oversight responsibilities with
respect to these activities. The GSE's charter grants the GSE certain exemptions
from federal and state laws. The GSE's charter's primary regulatory restrictions
and exemptions, including certain provisions added by the Privatization Act, are
summarized as follows:
1. Seven members of the GSE's 21-member Board of Directors are
appointed by the President of the United States. The other 14 members are
elected by the Company as the holder of the GSE's Common Stock. The Chairman
of the Board is designated by the President of the United States from among
the Board's 21 members.
2. Debt obligations issued by the GSE are exempt from state taxation to
the same extent as U.S. government obligations. The GSE is exempt from all
taxation by any state or by any county, municipality or local taxing
authority except with respect to real property taxes. The GSE is not exempt
from federal corporate income taxes.
3. All stock and other securities of the GSE are deemed to be exempt
securities under the laws administered by the Securities and Exchange
Commission (the "Commission") to the same extent as obligations of the
United States.
4. The GSE may conduct its business without regard to any qualification
or similar statute in any state of the United States, including the District
of Columbia, the Commonwealth of Puerto Rico and the territories and
possessions of the United States (although the scope of the GSE's business
is generally limited by its federal charter).
5. The issuance of GSE debt obligations must be approved by the
Secretary of the Treasury.
6. The GSE is required to have its financial statements examined
annually by independent certified public accountants and to submit a report
of the examination to the Secretary of the Treasury. The Department of the
Treasury is also authorized to conduct audits of the GSE and to otherwise
monitor the GSE's financial condition. The GSE is required to submit annual
reports of
15
its operations and activities to the President of the United States and
Congress. The GSE must pay up to $800,000 per year to the Department of the
Treasury to cover the costs of its oversight.
7. The GSE is subject to certain "safety and soundness" regulations,
including the requirement that the GSE maintain a 2.25 percent capital
adequacy ratio. The GSE may pay dividends only upon certification that, at
the time of a dividend declaration and after giving effect to the payment of
such dividend, the capital adequacy ratio is satisfied.
8. The Secretary of Education and the Secretary of the Treasury have
certain enforcement powers under the GSE's charter.
9. A 30 basis point annual offset fee, unique to the GSE, is payable to
the Secretary of Education on student loans purchased and held by the GSE on
or after August 10, 1993.
10. In certain circumstances, at the request of the Secretary of
Education, the GSE is required to act as a lender of last resort to make
FFELP loans when other private lenders are not available. Such loans are not
subject to the 30 basis point offset fee on loans held by the GSE.
OTHER REGULATION
Under the Higher Education Act, the GSE is an "eligible lender" for purposes
only of purchasing and holding loans made by other lenders and making
consolidation and lender of last resort loans. Like other participants in
insured student loan programs, the Company is subject, from time to time, to a
review of its student loan operations by the General Accounting Office, the DOE
and certain guarantee agencies. The laws relating to insured student loan
programs are subject to revision from time to time and changes to such laws are
beyond the Company's control. In addition, Sallie Mae Servicing, as a servicer
of student loans, is subject to certain DOE regulations regarding financial
responsibility and administrative capability that govern all third party
servicers of insured student loans. Failure to satisfy such standards may result
in the loss of the government guarantee of FFELP loans. Also, in connection with
its guarantor servicing operations, the Company must comply with, on behalf of
its guarantor servicing customers, certain DOE regulations that govern guarantor
activities as well as agreements for reimbursement between the Secretary of
Education and the Company's guarantor servicing customers. Failure to comply
with these regulations or the provisions of these agreements may result in the
termination of the Secretary of Education's reimbursement obligation. The
Company's private credit business is subject to federal and state consumer
lending laws and its collections business is regulated by federal and state debt
collection laws. HICA, a South Dakota stock insurance company, is subject to the
ongoing regulatory authority of the South Dakota Division of Insurance and that
of comparable governmental agencies in six other states.
NON-DISCRIMINATION AND LIMITATIONS ON AFFILIATION WITH DEPOSITORY INSTITUTIONS
The Privatization Act also amended the Higher Education Act to provide that
the GSE and any successor entity (including the Company) functioning as a
secondary market for federally insured student loans may not engage, directly or
indirectly, in any pattern or practice that results in a denial of a borrower's
access to insured loans because of the borrower's race, sex, color, religion,
national origin, age, disability status, income, attendance at a particular
institution, length of a borrower's educational program or the borrower's
academic year at an eligible institution.
The Omnibus Appropriations Act of 1998, signed into law by the President on
October 21, 1998, contains several provisions that amend the Federal Deposit
Insurance Act. These provisions provide an exception to the prohibition on
affiliations between government-sponsored entities and depository institutions
contained in the Federal Deposit Insurance Act. This exception allows the
Company to become affiliated with a depository institution upon certain
conditions and with the approval of the Secretary of the Treasury. Among the
conditions are: the dissolution of the GSE cannot be adversely
16
affected by the affiliation; the dissolution of the GSE must occur within two
years after the affiliation is consummated subject to the ability of the
Secretary to extend such deadline for up to two one-year periods; and the GSE
must be separate and distinct from the affiliated depository institution and
cannot extend credit, provide credit enhancement or purchase any obligation of
the depository institution.
ITEM 2. PROPERTIES
The following table lists the principal facilities owned by the Company:
APPROXIMATE
LOCATION FUNCTION SQUARE FEET
- -------- ------------------------------- -----------
Reston, VA..................... Operations/Headquarters 395,000
Fishers, IN.................... Loan Servicing Data Center 450,000
Wilkes Barre, PA............... Loan Servicing Center 135,000
Killeen, TX.................... Loan Servicing Center 133,000
Lynn Haven, FL................. Loan Servicing Center 133,000
Castleton, IN.................. Loan Servicing Center 100,000
The Company leases approximately 71,000 square feet for its collections
center in Summerlin, Nevada and 65,000 square feet of space for its
inbound/outbound call center in Chandler, Arizona. Effective January 2002, the
Company leases approximately 79,864 square feet of office space in Cincinnati,
Ohio for the headquarters and collections center for General Revenue
Corporation. With the exception of the Pennsylvania loan servicing center, none
of the Company's facilities is encumbered by a mortgage. The Company believes
that its headquarters and loan servicing centers are generally adequate to meet
its long-term student loan and new business goals. The Company's principal
office is located in owned space at 11600 Sallie Mae Drive, Reston, Virginia,
20193.
As of December 31, 2001, the Company employed 6,011 employees nationwide.
ITEM 3. LEGAL PROCEEDINGS.
The Company, together with a number of other FFELP industry participants,
filed a lawsuit challenging the Department of Education's interpretation of and
non-compliance with provisions in the Higher Education Act governing origination
fees and repayment incentives on loans made under the FDLP, as well as interest
rates for Direct Consolidation Loans. The lawsuit, which was filed November 3,
2000 in the United States District Court for the District of Columbia, alleges
that the Department's interpretations of and non-compliance with these statutory
provisions are contrary to the statute's unambiguous text, and are arbitrary,
capricious, an abuse of discretion, or otherwise not in accordance with law, and
violate both the HEA and the Administrative Procedure Act. The Company and the
other plaintiffs and the Department of Education have filed cross-motions for
summary judgment.
On January 25, 2002, the Student Loan Marketing Association (the "GSE") was
served with a putative class action complaint brought by three Wisconsin
residents. The plaintiffs seek to bring the complaint on behalf of a nationwide
class of borrowers who allegedly paid undisclosed improper and excessive late
fees over the past three years. In addition, plaintiffs allege that the GSE
charged excessive interest by capitalizing interest on a quarterly basis in
violation of the terms of the promissory notes. The plaintiffs seek damages of
$1,500 per violation plus punitive damages and allege that the class consists of
two million borrowers. The Company has moved to dismiss the complaint and
believes that the plaintiffs' claims are preempted by federal law.
17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
Nothing to report.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed and traded on the New York Stock
Exchange under the symbol SLM. The number of holders of record of the Company's
Common Stock as of March 18, 2002 was approximately 554. The following table
sets forth the high and low sales prices for the Company's Common Stock for each
full quarterly period within the two most recent fiscal years.
COMMON STOCK PRICES
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
2000 High 43.88 38.69 48.94 68.25
Low 28.50 27.81 36.88 44.88
2001 High 76.05 74.80 83.55 87.40
Low 58.13 65.25 73.98 81.25
The Company paid regular quarterly dividends of $.16 per share on the Common
Stock for the first three quarters of 2000, $.175 for the fourth quarter of 2000
and the first three quarters of 2001 and $.20 for the fourth quarter of 2001 and
the first quarter of 2002.
18
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA 1997-2001
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
The following table sets forth selected financial and other operating
information of the Company. The selected financial data in the table is derived
from the Consolidated Financial Statements of the Company. The data should be
read in conjunction with the Consolidated Financial Statements, related notes,
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in the Company's Form 10-K to the Securities and Exchange
Commission.
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
OPERATING DATA:
Net interest income............................ $ 873 $ 642 $ 694 $ 651 $ 781
Net income..................................... 384 465 501 501 508
Basic earnings per common share................ 2.34 2.84 3.11 2.99 2.80
Diluted earnings per common share.............. 2.28 2.76 3.06 2.95 2.78
Dividends per common share..................... .73 .66 .61 .57 .52
Return on common stockholders' equity.......... 30% 49% 78% 81% 65%
Net interest margin............................ 1.82 1.52 1.85 1.93 1.80
Return on assets............................... .78 1.06 1.28 1.41 1.12
Dividend payout ratio.......................... 32 24 20 19 19
Average equity/average assets.................. 2.66 2.34 1.59 1.65 1.64
BALANCE SHEET DATA:
Student loans.................................. $41,001 $37,647 $33,809 $28,283 $29,443
Total assets................................... 52,874 48,792 44,025 37,210 39,832
Total borrowings............................... 48,350 45,375 41,988 35,399 37,717
Stockholders' equity........................... 1,672 1,415 841 654 675
Book value per common share.................... 9.69 7.62 4.29 3.98 3.89
OTHER DATA:
Securitized student loans outstanding.......... $30,725 $29,868 $19,467 $18,059 $14,262
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1999-2001
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
OVERVIEW
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 STUDENT LOAN
MARKETING ASSOCIATION (THE "GSE") WAS REORGANIZED INTO A SUBSIDIARY OF USA
EDUCATION, INC. (THE "REORGANIZATION"). 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. USA EDUCATION, INC. WILL BE RENAMED SLM
CORPORATION EFFECTIVE MAY 17, 2002.
The Company is the largest private source of funding, delivery and servicing
support 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, student loan
servicing and collections, as well as operational support to originators of
student loans and to post-secondary education institutions, guarantors 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; changes in the general interest rate environment and in the
securitization markets for education loans, which may increase the costs or
limit the availability of financings necessary to initiate, purchase or carry
education loans; losses from default; and changes in prepayment rates and credit
spreads.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses the Company's Consolidated Financial Statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and the reported amounts of income and expenses during the reporting
periods. Management bases its estimates and judgments on historical experience
and on various other factors that are believed to be reasonable under the
circumstances. Actual results may differ from these
20
estimates under varying assumptions or conditions. Note 2 of the "Notes to the
Consolidated Financial Statements" includes a summary of the significant
accounting policies and methods used in the preparation of the Company's
Consolidated Financial Statements.
On an on-going basis, management evaluates its estimates and judgments,
particularly as they relate to accounting policies that management believes are
most "critical" -- that is, they are most important to the portrayal of the
Company's financial condition and results and they require management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain. These
accounting policies include: securitization accounting, provision for loan
losses, sales of floor revenue contracts and derivative accounting.
SECURITIZATION ACCOUNTING. The Company regularly engages in securitization
transactions as part of its financing strategy. When the Company sells student
loans to a securitization trust, it retains any excess residual cash flows
("residual interest"), servicing rights, and in some cases, a cash reserve
account, all of which are retained interests in the securitized receivables.
Gains and losses from securitizations are recognized in the Consolidated
Statements of Income when the Company transfers the financial assets in
accordance with 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." The
gain or loss on securitization is based upon the previous carrying amount of the
financial assets involved in the transfer and the fair value of the retained
interest at the date of transfer. 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
commensurate with the risks involved. The use of different estimates or
assumptions could have a material impact on the Company's Consolidated Financial
Statements.
PROVISION FOR LOAN LOSSES. The allowance for student loan losses is
established primarily through a charge to the provision for student loan losses.
Provisions are made to the reserve for estimated losses in outstanding loan
balances principally for the Company's non-insured student loans. The estimated
losses are based on historical default rates by program type and are regularly
evaluated by the Company for adequacy by considering factors such as changes in
the nature and volume of the loan portfolio, changes in actual and forecasted
default rates, and evaluating actual versus projected charge-offs. A large
percentage of the Company's non-federally insured loans have not matured to a
point at which predictable loan loss patterns have developed. Accordingly, the
evaluation of the provision for loan losses is inherently subjective as it
requires material estimates that may be susceptible to significant changes.
SALES OF FLOOR REVENUE CONTRACTS. Management continually evaluates the
projected balance of the student loan portfolio that contains an embedded option
for earning additional income when short-term interest rates fall below certain
levels. This evaluation primarily considers prepayment rates, projected volume
through originations and purchases and default rates. Based on these
projections, management enters into floor revenue contracts (see "Student Loan
Floor Revenue Contracts"). Fluctuations in the value of such contracts are
recorded currently in income. If the estimates used in the projections differ
materially from the actual portfolio balances, it could have a material impact
on the Company's Consolidated Financial Statements.
DERIVATIVE ACCOUNTING. The Company maintains an overall interest rate risk
management strategy that incorporates the use of derivative instruments to
minimize significant unplanned fluctuation in earnings that are caused by
interest rate volatility. 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.
Effective January 1, 2001, the Company adopted Statement of Financial Accounting
Standards No. 133 ("SFAS 133"), "Accounting for Derivative
21
Instruments and Hedging Activities," which requires that every derivative
instrument, including certain derivative instruments embedded in other
contracts, be recorded in the balance sheet as either an asset or liability
measured at its fair value. Most of the derivative contracts into which the
Company enters are effective economic hedges for its interest rate risk
management strategy but are not effective hedges under SFAS 133. This results in
the majority of these hedges being classified as "trading" for GAAP purposes and
therefore the resulting mark-to-market is included in GAAP earnings. Mark-to-
market values for certain derivative contracts are derived from pricing models
that consider current market and contractual prices for the underlying financial
instruments, as well as time value and yield curve or volatility factors
underlying the positions. Pricing models and their underlying assumptions impact
the amount and timing of unrealized gains and losses recognized, and the use of
different pricing models or assumptions could produce different financial
results.
Other accounting policies involve estimates, assumptions and judgments that,
if varied, may cause actual results to be materially different from those
reported.
22
SELECTED FINANCIAL DATA
CONDENSED STATEMENTS OF INCOME
INCREASE (DECREASE)
YEARS ENDED --------------------------------------------------
DECEMBER 31, 2001 VS. 2000 2000 VS. 1999
--------------------------------- ---------------------- ----------------------
2001 2000 1999 $ % $ %
-------- -------- -------- -------- -------- -------- --------
Net interest income................... $ 873 $ 642 $ 694 $ 231 36% $ (52) (7)%
Less: provision for losses............ 66 32 34 34 105 (2) (7)
----- ----- ----- ----- ------ ----- ----
Net interest income after provision
for losses.......................... 807 610 660 197 32 (50) (8)
Gains on student loan
securitizations..................... 75 92 35 (17) (18) 57 160
Servicing and securitization
revenue............................. 634 296 289 338 115 7 2
(Losses) gains on sales of
securities.......................... (178) 19 43 (197) (1,058) (24) (57)
Guarantor servicing fees.............. 255 128 -- 127 99 128 100
Derivative market value adjustment.... (452) -- -- (452) (100) -- --
Other income.......................... 184 153 84 31 20 69 82
Operating expenses and integration
charge.............................. 708 586 359 122 21 227 63
Income taxes.......................... 223 236 240 (13) (5) (4) (2)
Minority interest in net earnings of
subsidiary.......................... 10 11 11 (1) (6) -- --
----- ----- ----- ----- ------ ----- ----
NET INCOME............................ 384 465 501 (81) (17) (36) (7)
Preferred stock dividends............. 12 12 1 -- -- 11 701
----- ----- ----- ----- ------ ----- ----
Net income attributable to common
stock............................... $ 372 $ 453 $ 500 $ (81) (18)% $ (47) (9)%
===== ===== ===== ===== ====== ===== ====
BASIC EARNINGS PER SHARE.............. $2.34 $2.84 $3.11 $(.50) (18)% $(.27) (9)%
===== ===== ===== ===== ====== ===== ====
DILUTED EARNINGS PER SHARE............ $2.28 $2.76 $3.06 $(.48) (17)% $(.30) (10)%
===== ===== ===== ===== ====== ===== ====
Dividends per common share............ $ .73 $ .66 $ .61 $ .07 11% $ .05 7%
===== ===== ===== ===== ====== ===== ====
CONDENSED BALANCE SHEETS
INCREASE (DECREASE)
--------------------------------------------------
DECEMBER 31, 2001 VS. 2000 2000 VS. 1999
------------------- ---------------------- ----------------------
2001 2000 $ % $ %
-------- -------- -------- -------- -------- --------
ASSETS
Student loans........................... $41,001 $37,647 $3,354 9% $ 3,838 11%
Warehousing advances.................... 1,036 987 49 5 (56) (5)
Academic facilities financings.......... 732 851 (119) (14) (177) (17)
Cash and investments.................... 5,787 5,941 (154) (3) 166 3
Other assets............................ 4,318 3,366 952 28 996 42
------- ------- ------ ---- ------- ----
Total assets............................ $52,874 $48,792 $4,082 8% $ 4,767 11%
======= ======= ====== ==== ======= ====
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings................... $31,065 $30,464 $ 601 2% $(7,027) (19)%
Long-term notes......................... 17,285 14,911 2,374 16 10,415 232
Other liabilities....................... 2,852 1,788 1,064 60 805 82
------- ------- ------ ---- ------- ----
Total liabilities....................... 51,202 47,163 4,039 9 4,193 10
------- ------- ------ ---- ------- ----
Minority interest in subsidiary......... -- 214 (214) (100) -- --
Stockholders' equity before treasury
stock................................. 3,750 2,550 1,200 47 525 26
Common stock held in treasury at cost... 2,078 1,135 943 83 (49) (4)
------- ------- ------ ---- ------- ----
Total stockholders' equity.............. 1,672 1,415 257 18 574 68
------- ------- ------ ---- ------- ----
Total liabilities and stockholders'
equity................................ $52,874 $48,792 $4,082 8% $ 4,767 11%
======= ======= ====== ==== ======= ====
23
RESULTS OF OPERATIONS
EARNINGS SUMMARY
For the year ended December 31, 2001, the Company's net income calculated in
accordance with generally accepted accounting principles ("GAAP") was
$384 million ($2.28 diluted earnings per share), versus net income of
$465 million ($2.76 diluted earnings per share) in 2000. The decrease in 2001
reported net income from 2000 is attributable to several significant factors.
The Company increased the on-balance sheet average balance of student loans by
$5.4 billion, and the lower interest rate environment in 2001 increased
after-tax floor income by $77 million. Offsetting these increases were a
$79 million after-tax increase in operating expense principally due to the
acquisitions of USA Group, Inc. ("USA Group") and Student Loan Funding
Resources, Inc. ("SLFR"), and a $128 million after-tax decrease in gains on
sales of securities. These decreases to net income were only partially offset by
the increases in after-tax servicing and securitization revenue of
$220 million. After-tax fee income increased net income by $82 million,
principally due to the additional guarantor and third party servicing fee income
attributable to the acquisition of USA Group. In addition, GAAP net income
includes a net after-tax year-to-date loss of $294 million attributable to
Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting
for Derivative Instruments and Hedging Activites," mark-to-market effect. (For
additional discussion of SFAS 133, see Note 10 in the "Notes to Consolidated
Financial Statements.")
During 2001, the Company repurchased 19.4 million common shares through its
open market purchases and equity forward settlements (or 12 percent of its
outstanding shares) at a cost of $859 million, and issued a net 10.7 million
shares from benefit plans. As a result, common shares outstanding decreased to
155.5 million at December 31, 2001 from 164.1 million at December 31, 2000.
The Company's "core cash basis" net income was $624 million for the year
ended December 31, 2001 ($3.75 diluted earnings per share) versus $492 million
($2.93 diluted earnings per share) for the year ended December 31, 2000. (See
"Pro-forma Statements of Income" for a detailed discussion of "core cash basis"
net income.) During 2001, the Company acquired $13.5 billion of managed student
loans.
Student loan acquisitions increased the average balance of managed loans
outstanding by $10.3 billion for the year ended December 31, 2001. The higher
average student loan balance and a lower cost of funds primarily due to the
Company locking in floor income through term hedges (see "'Core Cash Basis'
Student Loan Spread and Net Interest Income"), increased after-tax "core cash
basis" earnings by $121 million. In addition, after-tax fee income increased by
$82 million from the year ended December 31, 2000, principally due to the full
year effect of the additional guarantor and third party servicing fee income
attributable to the acquisition of USA Group. (See "Other Income.") These
increases to "core cash basis" net income were partially offset by the after-tax
increase to operating expenses of $95 million principally due to the
acquisitions of USA Group and SLFR, which closed on July 31, 2000 and July 7,
2000, respectively.
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." Information regarding
the provision for losses is contained in Note 5 in the "Notes to Consolidated
Financial Statements."
Taxable equivalent net interest income for the year ended December 31, 2001
versus the year ended December 31, 2000 increased by $225 million while the net
interest margin increased by 30 basis
24
points. The increase in taxable equivalent net interest income for the year
ended December 31, 2001 was primarily due to the lower interest rate environment
in 2001, which led to an increase of $119 million in floor income, and the
$5.4 billion increase in the average balance of student loans. The net interest
margin increase is reflective of the higher average balance of student loans as
a percentage of average total earning assets and the increase in floor income.
This is partially offset by the increase in the Company's portfolio of
lower-yielding loans due to the acquisition of loans earlier in their life
cycles which has decreased the average special allowance payment ("SAP") in the
student loan yield.
Taxable equivalent net interest income for the year ended December 31, 2000
versus the year ended December 31, 1999 decreased by $59 million while the net
interest margin decreased by 33 basis points. The decrease in taxable equivalent
net interest income for the year ended December 31, 2000 was primarily due to
the higher interest rate environment in 2000, which led to a decrease of
$63 million in floor income. The net interest margin decrease is reflective of
the higher average balance of investments as a percentage of average total
earning assets. In addition, the increase in the Company's portfolio of
lower-yielding loans due to the acquisition of loans earlier in their life
cycles has decreased the average SAP in the student loan yield.
TAXABLE EQUIVALENT NET INTEREST INCOME
The amounts in this table and the following table are adjusted for the
impact of certain tax-exempt and tax-advantaged investments based on the
marginal federal corporate tax rate of 35 percent.
INCREASE (DECREASE)
-----------------------------------------------
YEARS ENDED DECEMBER 31, 2001 VS. 2000 2000 VS. 1999
------------------------------ ------------------- ----------------------
2001 2000 1999 $ % $ %
-------- -------- -------- -------- -------- -------- --------
Interest income
Student loans.......................... $2,528 $2,854 $2,427 $(326) (11)% $427 18%
Warehousing advances................... 43 57 68 (14) (25) (11) (16)
Academic facilities financings......... 53 67 74 (14) (21) (7) (10)
Investments............................ 373 501 240 (128) (26) 261 109
Taxable equivalent adjustment.......... 18 24 31 (6) (25) (7) (23)
------ ------ ------ ----- --- ---- ---
Total taxable equivalent interest
income................................. 3,015 3,503 2,840 (488) (14) 663 23
Interest expense......................... 2,124 2,837 2,115 (713) (25) 722 34
------ ------ ------ ----- --- ---- ---
Taxable equivalent net interest income... $ 891 $ 666 $ 725 $ 225 34% $(59) (8)%
====== ====== ====== ===== === ==== ===
25
AVERAGE BALANCE SHEETS
The following table reflects the taxable equivalent rates earned on earning
assets and paid on liabilities for the years ended December 31, 2001, 2000 and
1999.
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------
2001 2000 1999
------------------- ------------------- -------------------
BALANCE RATE BALANCE RATE BALANCE RATE
-------- -------- -------- -------- -------- --------
AVERAGE ASSETS
Student loans............................... $40,025 6.32% $34,637 8.24% $33,028 7.35%
Warehousing advances........................ 968 4.48 825 6.84 1,173 5.78
Academic facilities financings.............. 787 8.30 974 8.50 1,144 8.16
Investments................................. 7,212 5.25 7,486 6.81 3,932 6.42
------- ----- ------- ---- ------- ----
Total interest earning assets................. 48,992 6.15% 43,922 7.98% 39,277 7.23%
===== ==== ====
Non-interest earning assets................... 4,495 2,711 2,166
------- ------- -------
Total assets.................................. $53,487 $46,633 $41,443
======= ======= =======
AVERAGE LIABILITIES AND STOCKHOLDERS' EQUITY
Six month floating rate notes............... $ 4,112 4.17% $ 4,660 6.49% $ 4,644 5.38%
Other short-term borrowings................. 31,540 4.18 30,670 6.40 28,560 5.30
Long-term notes............................. 14,047 4.51 8,636 6.61 6,292 5.60
------- ----- ------- ---- ------- ----
Total interest bearing liabilities............ 49,699 4.27% 43,966 6.45% 39,496 5.35%
===== ==== ====
Non-interest bearing liabilities.............. 2,366 1,574 1,287
Stockholders' equity.......................... 1,422 1,093 660
------- ------- -------
Total liabilities and stockholders' equity.... $53,487 $46,633 $41,443
======= ======= =======
Net interest margin........................... 1.82% 1.52% 1.85%
===== ==== ====
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
---------- -------- --------
2001 VS. 2000
Taxable equivalent interest income................. $(488) $(805) $317
Interest expense................................... (713) (971) 258
----- ----- ----
Taxable equivalent net interest income............. $ 225 $ 166 $ 59
===== ===== ====
2000 VS. 1999
Taxable equivalent interest income................. $ 663 $ 327 $336
Interest expense................................... 722 431 291
----- ----- ----
Taxable equivalent net interest income............. $ (59) $(104) $ 45
===== ===== ====
26
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."
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
ON-BALANCE SHEET
Student loan yields.............................. 7.05% 8.91% 8.02%
Consolidation loan rebate fees................... (.30) (.27) (.22)
Offset fees...................................... (.13) (.13) (.15)
Borrower benefits................................ (.07) (.07) (.06)
Premium amortizations............................ (.23) (.20) (.24)
------- ------- -------
Student loan income.............................. 6.32 8.24 7.35
Student loan cost of funds....................... (4.31) (6.42) (5.32)
------- ------- -------
Student loan spread.............................. 2.01% 1.82% 2.03%
======= ======= =======
OFF-BALANCE SHEET
Servicing and securitization revenue............. 2.07% 1.15% 1.63%
======= ======= =======
AVERAGE BALANCES (IN MILLIONS OF DOLLARS)
On-balance sheet student loans................... $40,025 $34,637 $33,028
Securitized loans................................ 30,594 25,711 17,670
------- ------- -------
Managed student loans............................ $70,619 $60,348 $50,698
======= ======= =======
The Company's portfolio of student loans originated under the FFELP has a
variety of unique interest rate characteristics. 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, 52-week Treasury bill, or the constant maturity Treasury rate)
in a calendar quarter, plus a fixed spread which is dependent upon when the loan
was originated. If the resulting floating rate exceeds the borrower rate, the
Department of Education pays the difference directly to the Company. This
payment is referred to as SAP. If the resulting 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 the borrower pays sets a minimum rate for
determining the yield the Company earns on the loan. 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 commerical
paper index, the 52-week Treasury bill, or the 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
in general, however, 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 fluctuations in funding spreads) will generally decline
27
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 rates, which occurs on July 1 of each year. The effect of
this enhanced spread is referred to as floor income.
Low average Treasury bill rates in 2001 benefited the Company's on-balance
sheet student loan income, net of payments under floor revenue contracts (see
"Student Loan Floor Revenue Contracts"), by $119 million of which $43 million
was attributable to student loans with minimum borrower rates fixed to term and
$76 million was attributable to student loans with minimum borrower rates
adjusting annually.
Higher average Treasury bill rates in 2000 compared to 1999 decreased the
Company's benefit from student loans earning at the minimum borrower rate
included in student loan income, net of payments under floor revenue contracts,
to $3 million, of which $2 million was attributable to student loans with
minimum borrower rates fixed to term and $1 million was attributable to student
loans with minimum borrower rates adjusting annually.
The 19 basis point increase in the student loan spread in 2001 versus 2000
is due primarily to the increase in floor income, attributable to lower
short-term interest rates. The student loan spread in 2000 decreased by 21 basis
points from 1999. This was due mainly to the decrease in floor income,
attributable to higher short-term interest rates in 2000.
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 December 31, 2001 and 2000, based on the last Treasury bill
auction of the year (1.74 percent in 2001 and 5.86 percent in 2000). Commercial
paper rate loans are based upon the final commercial paper rate of the year
(1.81 percent in 2001 and 6.39 percent in 2000).
DECEMBER 31, 2001 DECEMBER 31, 2000
------------------------------------ ------------------------------------
FIXED FIXED
BORROWER ANNUALLY RESET BORROWER ANNUALLY RESET
RATE BORROWER RATE TOTAL RATE BORROWER RATE TOTAL
-------- -------------- -------- -------- -------------- --------
Student loans eligible to earn at the
minimum borrower rate.................. $18.2 $39.4 $57.6 $16.3 $37.4 $53.7
Less notional amount of floor revenue
contracts.............................. (13.5) (5.0) (18.5) (5.8) -- (5.8)
----- ----- ----- ----- ----- -----
Net student loans eligible to earn at the
minimum borrower rate.................. $ 4.7 $34.4 $39.1 $10.5 $37.4 $47.9
===== ===== ===== ===== ===== =====
Net student loans earning at the minimum
borrower rate.......................... $ 4.7 $34.4 $39.1 $ .9 $ 5.1 $ 6.0
===== ===== ===== ===== ===== =====
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 spread
("the strike rate") and (2) the average of the index over the period of the
contract. If the strike rate is less than the average of the index, then no
payment is required. Prior to the implementation of SFAS 133, these upfront
payments were amortized over the average life of the contracts. Floor revenue
contracts sold on loans where the borrower rate is reset annually have
historically had terms through the next reset date, a period of one year or
less, while floor revenue contracts sold on loans where the borrower
28
rate is fixed to term have multi-year terms. The $13.5 billion of outstanding
fixed borrower rate floor revenue contracts at December 31, 2001 have expiration
dates through the year 2008.
For the years ended December 31, 2000 and 1999, the amortization of the
upfront payments received from the sale of floor revenue contracts on the
Company's on-balance sheet student loans with fixed borrower rates was
$23 million and $20 million, respectively, and for floor revenue contracts with
annually reset borrower rates was $1 million and $21 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 payment was a loss totaling $104 million. This loss was
reclassified to student loan premium and is being amortized over the average
life of the student loan portfolio. At December 31, 2001, the unamortized
balance related to the fair market value of these contracts in student loan
premium totaled $77 million. For the year ended December 31, 2001, the related
amortization totaled $13 million, and the premium write-off due to
securitization totaled $14 million.
Since these contracts are no longer considered effective hedges for GAAP,
the Company marks to market the floor revenue contracts. For the year ended
December 31, 2001, the Company recognized $258 million in pre-tax,
mark-to-market losses attributable to floor revenue contracts due to the
implementation of SFAS 133. At December 31, 2001, the outstanding notional
amount of floor revenue contracts totaled $18.5 billion.
ACTIVITY IN THE ALLOWANCE FOR LOAN LOSSES
The provision for loan losses represents the periodic expense of maintaining
an allowance sufficient to absorb losses, net of recoveries, inherent in the
portfolio of student loans. The Company evaluates the adequacy of the provision
for losses on its federally insured portfolio of student loans separately from
its non-federally insured portfolio. For the federally insured portfolio, the
Company primarily considers trends in student loan claims rejected for payment
by guarantors due to servicing defects as well as overall default rates on those
FFELP student loans subject to the two percent risk-sharing, i.e., those loans
that are insured as to 98 percent of principal and accrued interest. Once a
student loan is rejected for claim payment, the Company's policy is to continue
to pursue the recovery of principal and interest. Due to the nature of the FFELP
assets and the extensive collection efforts in which the Company engages, the
Company currently writes off an unpaid claim once it has aged to two years.
29
For the non-federally insured portfolio of student loans, the Company
primarily considers recent trends in delinquencies, charge-offs and recoveries,
historical trends in loan volume by program, economic conditions and credit and
underwriting policies. A large percentage of the Company's non-federally insured
loans have not matured to a point at which predictable loan loss patterns have
developed. Accordingly, the evaluation of the provision for loan losses is
inherently subjective as it requires material estimates that may be susceptible
to significant changes. Management believes that the provision for loan losses
is adequate to cover anticipated losses in the student loan portfolio. An
analysis of the Company's allowance for loan losses is presented in the
following table.
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
Balance at beginning of year................................ $ 227 $ 206 $ 203
Provision for loan losses................................... 75 30 34
Reserves acquired in acquisition............................ -- 8 9
Other....................................................... 25 21 3
Charge-offs:
Non-federally insured loans............................... (42) (11) (16)
Federally insured loans................................... (16) (15) (25)
------- ------- -------
Total charge-offs....................................... (58) (26) (41)
Recoveries:
Non-federally insured loans............................... 3 1 3
Federally insured loans................................... 7 4 4
------- ------- -------
Total recoveries........................................ 10 5 7
Net charge-offs............................................. (48) (21) (34)
------- ------- -------
Reduction for sale of student loans......................... (14) (17) (9)
------- ------- -------
Balance at end of year...................................... $ 265 $ 227 $ 206
======= ======= =======
Allocation of the allowance for loan losses:
Non-federally insured loans................................. $ 202 $ 177 $ 148
Federally insured loans..................................... 63 50 58
------- ------- -------
Total................................................... $ 265 $ 227 $ 206
======= ======= =======
Net charge-offs as a percentage of average student loans.... .12% .06% .10%
Total allowance as a percentage of average student loans.... .66% .66% .62%
Non-federally insured allowance as a percentage of the
ending balance of non-federally insured loans............. 4.57% 5.48% 6.66%
Average student loans....................................... $40,025 $34,637 $33,028
Ending student loans........................................ $41,001 $37,647 $33,809
The increase in the provision for loan losses for the year ended
December 31, 2001 versus December 31, 2000 of $45 million is primarily
attributable to the 39 percent increase in volume of non-federally insured
student loans year over year. As the volume of non-federally insured loans
increases and begins to age, the Company obtains more historical data on default
rates for these loans. Based on management's assumptions and on actual loan
performance, the Company re-evaluates the requirements for its provision for
loan losses. In 2001, non-federally insured loan write-offs increased by
$31 million over 2000 which is primarily attributable to the increased volume
and aging of this portfolio. These factors did not significantly impact the
provision for loan losses in 2000 or 1999.
30
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
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 years ended December 31, 2001, 2000 and 1999
(dollars in millions).
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------
2001 2000 1999
------------------- ------------------- -------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
INDEX BALANCE RATE BALANCE RATE BALANCE RATE
- ----- -------- -------- -------- -------- -------- --------
Treasury bill, principally 91-day......... $31,459 4.06% $30,823 6.54% $26,559 5.33%
LIBOR..................................... 2,004 4.53 1,900 6.49 2,597 5.14
Discount notes............................ 7,168 4.42 5,300 6.26 3,424 4.90
Fixed..................................... 5,180 5.53 3,552 5.75 5,655 5.57
Zero coupon............................... 192 11.14 171 11.17 153 11.14
Commercial paper.......................... 2,357 3.03 969 6.65 302 5.69
Auction rate securities................... 1,101 3.67 653 5.65 -- --
Other..................................... 238 3.59 598 6.25 806 5.08
------- ----- ------- ----- ------- -----
Total..................................... $49,699 4.27% $43,966 6.45% $39,496 5.35%
======= ===== ======= ===== ======= =====
SECURITIZATION PROGRAM
In 2001, the Company completed four securitization transactions in which a
total of $6.0 billion of student loans were sold to a special purpose finance
subsidiary and by that subsidiary to special purpose trusts that issued
asset-backed securities to fund the student loans to term. Also in 2001, the
Company sold $435 million of student loans through the recycling provisions of
prior securitizations.
In 2000, the Company completed four securitization transactions in which a
total of $8.8 billion of student loans were sold to a special purpose finance
subsidiary and by that subsidiary to special purpose trusts that issued
asset-backed securities to fund the student loans to term. In addition, the
Company acquired the securitization revenue streams of $5.2 billion of student
loans previously securitized by USA Group. In 1999, the Company completed three
securitization transactions in which a total of $4.0 billion of student loans
were securitized. The Company accounts for its securitization transactions in
accordance with SFAS 140, which establishes the accounting for certain financial
asset transfers, including securitization transactions. Under SFAS 140, the
Company records a gain on sale based upon the difference between the cost basis
of the assets sold and the fair value of the assets received. As a result, the
Company records an asset, the residual interest, which approximates the present
value of the expected net cash flows from the trust to the Company over the life
of the portfolio securitized. In addition, the Company continues to service the
loans in the trusts through Sallie Mae Servicing L.P., formerly known as Sallie
Mae Servicing Corporation, for a fee, and earns that fee over the life of the
portfolio. When the contract servicing fee is greater than current market
servicing rates, the present value of such excess servicing fees is recognized
as a servicing asset and amortized over the life of the portfolio serviced.
31
GAINS ON STUDENT LOAN SECURITIZATIONS
For the years ended December 31, 2001, 2000 and 1999, the Company recorded
pre-tax securitization gains of $75 million, $92 million and $35 million,
respectively. Gains for the years ended December 31, 2001, 2000 and 1999,
measured as a percentage of the securitized portfolios, were 1.16 percent,
1.04 percent and .88 percent, respectively. During 2001, the Company securitized
$2.8 billion less than in 2000. The decrease in gains in 2001 versus 2000 is
primarily due to the lower volume of loans securitized. The increase in the gain
percentage in 2001 versus 2000 is principally due to lower financing spreads.
The increase in the gains and gain percentage in 2000 versus 1999 is due to
increased volume and lower financing spreads, respectively. Gains on future
securitizations will continue to vary depending on the size and the loan
characteristics of the loan portfolios securitized and the funding costs
prevailing in the securitization debt markets.
SERVICING AND SECURITIZATION REVENUE
Servicing and securitization revenue, the ongoing revenue from securitized
loan pools, includes both the revenue the Company receives for servicing loans
in the securitization trusts and the income earned on the residual interest
asset. The following table summarizes the components of servicing and
securitization revenue:
YEARS ENDED
DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
Servicing revenue less amortization of servicing
asset................................................. $266 $219 $158
Securitization revenue.................................. 368 77 131
---- ---- ----
Total servicing and securitization revenue.............. $634 $296 $289
==== ==== ====
The increase in servicing revenue is mainly due to the increase in the
average balance of securitized student loans to $30.6 billion in 2001 from
$25.7 billion in 2000 and $17.5 billion in 1999. The average balance of the
retained interest was $1.4 billion in 2001, $849 million in 2000 and
$701 million in 1999. The Company's securitized loan portfolio benefits from low
average Treasury bill rates in a manner similar to the on-balance sheet
portfolio of student loans. In 2001 and 1999, low average Treasury bill rates
enhanced securitization revenue by $216 million and $42 million, respectively.
The increase in Treasury bill rates during 2000 reduced these earnings to
$0.2 million for the year ended December 31, 2000 and was the principal cause of
the reduction in securitization revenue in 2000 versus 1999.
GAIN ON SALE OF STUDENT LOANS
During the fourth quarter of 1999, the Company sold $900 million of student
loan assets and recorded a pre-tax gain of $27 million. As part of the
transaction the Company entered into long-term servicing agreements with four
companies to service the loans sold. No such sales occurred in 2001 or 2000.
OTHER INCOME
Other income, exclusive of gains on student loan securitizations, servicing
and securitization revenue, the effect of SFAS 133 and gains and losses on sales
of investment securities and student loans, totaled $439 million in 2001 versus
$281 million in 2000 and $84 million in 1999. Other income mainly includes
guarantor servicing fees (as a result of the USA Group transaction which closed
in July 2000), 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
32
originations, the maintenance of loan guarantees, default prevention, and
collections. Guarantor servicing fees totaled $255 million in 2001 versus
$128 million in 2000. Late fees totaled $56 million in 2001, versus $42 million
in 2000 and $38 million in 1999. Third party servicing fees totaled $53 million
in 2001, versus $39 million in 2000 and $5 million in 1999. Commitment fees for
letters of credit totaled $11 million in 2001, versus $16 million in 2000 and
$19 million in 1999.
For the year ended December 31, 2001, $3 million of SFAS 133 transition
adjustment losses were reclassified from other comprehensive income to other
income (see Note 10 in the "Notes to Consolidated Financial Statements"). Other
income for 2001 also includes an $18 million loss recognized by the Company in
the fourth quarter, on the impairment of assets generated from the scheduled
sale of its Sallie Mae Solutions product line.
In 2000, the Company entered into LIBOR floor revenue contracts that were an
effective economic hedge of a segment of its student loan portfolio. These
positions did not meet the hedge effectiveness requirements under GAAP and were
marked-to-market which resulted in a $25 million pre-tax loss recorded in other
income for the year ended December 31, 2000. No such transactions were in effect
for 1999.
OPERATING EXPENSES
The following table summarizes the components of operating expenses:
YEARS ENDED DECEMBER 31,
------------------------------------
2001 2000 1999
-------- -------- --------
Servicing and acquisition expenses................... $414 $320 $239
General and administrative expenses.................. 294 213 120
Integration charge................................... -- 53 --
---- ---- ----
Total operating expenses............................. $708 $586 $359
==== ==== ====
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 2000 to
cover severance costs, costs to close facilities and move functional
responsibilities as well as costs to align system capabilities and move the
Company's data center. Exclusive of this one-time integration charge, operating
expenses for the years ended December 31, 2001, 2000 and 1999 were
$708 million, $533 million and $359 million, respectively. Operating expenses
increased during 2001 and 2000 as a direct result of the acquisitions of SLFR
and the business operations of USA Group, each of which occurred in July 2000.
In 2001, the acquisitions increased operating expenses for the full year and in
2000, for half of the year. The Company has maintained an aggressive integration
plan that is designed to eliminate the duplicate operations and merge the
complimentary operations of all the consolidated entities.
33
STUDENT LOAN PURCHASES
The following table summarizes the components of the Company's student loan
purchase activity:
YEARS ENDED DECEMBER 31,
------------------------------------
2001 2000 1999
-------- -------- --------
Preferred channel............................ $ 9,524 $ 6,595 $ 7,161
Other commitment clients..................... 949 1,405 1,788
Spot purchases............................... 678 885 115
Consolidations............................... 1,172 824 920
Other........................................ 1,209 1,149 1,111
USA Group acquisition........................ -- 1,421 --
SLFR acquisition............................. -- 3,103 --
Nellie Mae acquisition....................... -- -- 2,585
------- ------- -------
Subtotal..................................... 13,532 15,382 13,680
Managed loans acquired....................... 894 5,912 457
------- ------- -------
Total........................................ $14,426 $21,294 $14,137
======= ======= =======
The Company purchased $13.5 billion and acquired the securitization revenue
streams of $0.9 billion of managed loans for a total of $14.4 billion of student
loans in 2001 compared with $21.3 billion in 2000 and $14.1 billion in 1999.
Included in the 2000 purchases are $1.4 billion of student loans acquired from
USA Group and $3.1 billion of student loans acquired from SLFR. Included in the
1999 purchases are $2.6 billion of student loans acquired in the Nellie Mae
acquisition. The Company's preferred channel represents all loans originated on
the Company's origination systems.
In 2001, the Company's preferred channel loan originations totaled
$10.1 billion versus $7.3 billion in 2000. The pipeline of loans currently
serviced and committed for purchase by the Company was $5.6 billion at
December 31, 2001 versus $4.5 billion at December 31, 2000.
The following table summarizes the activity in the Company's managed
portfolio of student loans for the years ended December 31, 2001, 2000 and 1999.
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
BEGINNING BALANCE................................ $67,515 $53,276 $46,342
Purchases........................................ 12,519 19,508 12,711
Capitalized interest............................. 1,907 1,786 1,426
Repayments, claims, other........................ (7,559) (5,718) (5,094)
Write-offs to reserves........................... (77) (30) (41)
Loan sales....................................... (143) (137) (910)
Loans consolidated from USA Education, Inc....... (2,436) (1,170) (1,158)
------- ------- -------
ENDING BALANCE................................... $71,726 $67,515 $53,276
======= ======= =======
LEVERAGED LEASES
The Company has investments in leveraged leases totaling $296 million and
$291 million as of December 31, 2001 and 2000, respectively, of which
$282 million and $276 million as of December 31, 2001 and 2000, respectively,
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
34
mitigated by recoveries on the sale of the aircraft collateral and elimination
of expected tax liabilities reflected in the balance sheet of $259 million and
$263 million at December 31, 2001 and 2000, respectively. Any potential loss
would be increased by incremental tax obligations related to forgiveness of debt
obligations.
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 a
gain which approximates the present value of the estimated future net cash flows
from the portfolios of loans sold. Interest earned on the residual interest and
fees earned for servicing the loan portfolios are recognized over the life of
the securitization transaction as servicing and securitization revenue. Income
recognition is effectively accelerated through the recognition of a gain at the
time of sale while the ultimate realization of such income remains dependent on
the actual performance, over time, of the loans that were securitized.
Most of the derivative contracts into which the Company enters are effective
economic hedges for its interest rate risk management strategy but are not
effective hedges under SFAS 133 because they do not typically extend to the full
term of the hedged item. The majority of these hedges are treated as "trading"
for GAAP purposes and therefore the resulting mark-to-market is taken into GAAP
earnings. In addition, SFAS 133 requires that the Company mark-to-market its
written options but none of 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 assumptions that the securitization transactions
are financings and that the securitized student loans were not sold. In
addition, the effects of SFAS 133 are excluded from the pro-forma results of
operations and the economic hedge effects of derivative instruments are
recognized. The pro-forma results of operations also exclude the benefit of
floor income, certain gains and losses on sales of investment securities and
student loans, a one-time integration charge related to the July 2000
acquisition of USA Group and the amortization and changes in market value of
goodwill and intangible assets. The following pro-forma statements of income
present the Company's results of operations under these assumptions. Management
refers to these pro-forma results as "core cash basis" statements of income.
Management monitors the periodic "core cash basis" earnings of the Company's
managed student loan portfolio and believes that they assist in a better
understanding of the Company's student loan business.
The following table presents the "core cash basis" statements of income and
reconciliations to GAAP net income as reflected in the Company's Consolidated
Statements of Income.
35
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
"CORE CASH BASIS" STATEMENTS OF INCOME:
Insured student loans............................. $ 4,325 $ 5,015 $ 3,642
Advances/Facilities/Investments................... 468 652 386
------- ------- -------
Total interest income............................. 4,793 5,667 4,028
Interest expense.................................. (3,522) (4,628) (3,101)
------- ------- -------
Net interest income............................... 1,271 1,039 927
Less: provision for losses........................ 89 53 51
------- ------- -------
Net interest income after provision for losses.... 1,182 986 876
------- ------- -------
Other Income:
(Losses) gains on sales of securities......... (2) 1 1
Guarantor servicing fees...................... 255 128 --
Other......................................... 202 152 83
------- ------- -------
Total other income................................ 455 281 84
Total operating expenses.......................... 660 514 356
------- ------- -------
Income before taxes and minority interest in net
earnings of subsidiary.......................... 977 753 604
Income taxes...................................... 343 250 188
Minority interest in net earnings of subsidiary... 10 11 11
------- ------- -------
"Core cash basis" net income...................... 624 492 405
Preferred stock dividends......................... 11 12 1
------- ------- -------
"Core cash basis" net income attributable to
common stock.................................... $ 613 $ 480 $ 404
======= ======= =======
"Core cash basis" diluted earnings per share...... $ 3.75 $ 2.93 $ 2.48
======= ======= =======
36
YEARS ENDED DECEMBER 31,
------------------------------------
2001 2000 1999
-------- -------- --------
RECONCILIATION OF GAAP NET INCOME TO "CORE CASH
BASIS" NET INCOME:
GAAP net income.................................... $ 384 $ 465 $ 501
"Core cash basis" adjustments:
Net interest income on securitized loans....... 651 400 340
Floor income on managed loans.................. (335) (3) (107)
Provision for losses........................... (23) (21) (17)
Gains on student loan securitizations.......... (75) (92) (35)
Servicing and securitization revenue........... (634) (296) (289)
Losses (gains) on sales of securities.......... 140 (18) (41)
Goodwill change in market value................ 18 -- --
Goodwill and intangible amortization........... 48 19 3
Integration charge............................. -- 53 --
Net impact of derivative accounting(1)......... 570 -- --
Other.......................................... (1) -- (1)
----- ----- -----
Total "core cash basis" adjustments................ 359 42 (147)
Net tax effect(2).................................. (119) (15) 51
----- ----- -----
"Core cash basis" net income....................... $ 624 $ 492 $ 405
===== ===== =====
- ------------------------
(1) The "Net impact of derivative accounting" represents the reversal of
SFAS 133 income statement items and "core cash basis" adjustments related
to derivatives. The SFAS 133 items include the reversal of a $452 million
net, mark-to-market loss on derivative positions offset by the reversal of a
loss of $3 million attributable to the amortization of derivative items
included in other comprehensive income at transition. The "core cash basis"
adjustment for derivatives includes an $89 million gain representing the
amortization of premiums on floor and cap hedges, the reversal of a
$13 million net loss representing the amortization of floor revenue
contracts de-designated as effective hedges on December 31, 2000, and the
reversal of a $13 million net loss on Eurodollar futures contracts. These
adjustments are based upon the guidance for derivative accounting prior to
SFAS 133.
(2) Such tax effect is based upon the Company's marginal tax rate for the
respective period.
"CORE CASH BASIS" SELECTED FINANCIAL DATA
The following table presents the "core cash basis" selected financial and
other operating information of the Company.
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
"CORE CASH BASIS" RESULTS:
Net interest income............................ $ 1,271 $ 1,039 $ 927 $ 892 $ 937
Net income..................................... 624 492 405 381 384
Diluted earnings per common share.............. 3.75 2.93 2.48 2.24 2.10
Net interest margin............................ 1.64% 1.53% 1.68% 1.76% 1.75%
Return on assets............................... .79 .71 .71 .72 .70
37
"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 loans both on-balance sheet
and those off-balance sheet in securitization trusts.
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
"Core cash basis" adjusted student loan yields... 6.77% 8.92% 7.78%
Consolidation loan rebate fees................... (.20) (.18) (.15)
Offset fees...................................... (.07) (.08) (.09)
Borrower benefits................................ (.11) (.09) (.08)
Premium amortization............................. (.26) (.26) (.28)
------- ------- -------
Student loan income.............................. 6.13 8.31 7.18
Cost of funds.................................... (4.32) (6.61) (5.40)
------- ------- -------
"Core cash basis" student loan spread............ 1.81% 1.70% 1.78%
======= ======= =======
AVERAGE BALANCES
Managed student loans............................ $70,619 $60,348 $50,698
======= ======= =======
While the Company may earn floor income, depending on the interest rate
environment, on its student loan portfolio (see "Student Loan Spread Analysis"),
these earnings are excluded from "core cash basis" results. However, the
amortization of the upfront payments received from the floor revenue contracts
with fixed borrower rates is included as an addition to student loan income in
the "core cash basis" results.
For the years ended December 31, 2001, 2000 and 1999, the amortization of
the upfront payments received from the floor revenue contracts with fixed
borrower rates was $72 million, $23 million and $20 million, respectively.
The 11 basis point increase in the 2001 "core cash basis" student loan
spread versus 2000 was mainly due to the Company locking in floor revenue
through term hedges and as a result of better funding spreads. In addition, the
"core cash basis" student loan spread increased due to higher yields on the
student loan portfolio from the mix (private loans versus federal loans) and a
higher percentage of federal loans in a repayment status.
In 2000, "core cash basis" financing spreads, relative to the Treasury bill,
increased by 6 basis points versus 1999. This was due to wider financing spreads
in both the GSE and securitization debt markets and to the higher percentage of
the student loan portfolio being funded by the Company's asset-backed
securities. The Company's asset-backed securities have a higher cost of funds
than the Company's GSE debt because they are term match-funded and do not
benefit from the GSE's status. The higher funding costs on the Company's
asset-backed securities is partially mitigated by the absence of offset fees on
securitized loans. The net effect of increased funding costs and lower offset
fees in 2000 versus 1999 was 5 basis points.
In 2001, net interest income, on a "core cash basis," was $1.3 billion
compared with $1.0 billion in 2000 and $927 million in 1999. The increase in net
interest income for the year ended December 31, 2001 versus the year-ago period
was due to the increase in the average balance of managed student loans of
$10.3 billion and the increase in the student loan spread. The increase in net
interest income in 2000 over 1999 is mainly due to the increase in the average
balance of managed student loans.
38
"CORE CASH BASIS" PROVISION AND ALLOWANCE FOR LOAN LOSSES
The provision for loan losses represents the periodic expense of maintaining
an allowance sufficient to absorb losses, net of recoveries, inherent in the
managed portfolio of student loans. The Company evaluates the adequacy of the
provision for losses on its federally insured portfolio of managed student loans
separately from its non-federally insured portfolio. For the federally insured
portfolio, the Company primarily considers trends in student loan claims
rejected for payment by guarantors due to servicing defects as well as overall
default rates on those FFELP student loans subject to the two percent
risk-sharing. Once a student loan is rejected for claim payment, the Company's
policy is to continue to pursue the recovery of principal and interest. Due to
the guaranteed nature of the FFELP assets and the extensive collection efforts
in which the Company engages, the Company currently writes off an unpaid claim
once it has aged to two years.
For the non-federally insured portfolio of student loans, the Company
primarily considers recent trends in delinquencies, charge-offs and recoveries,
historical trends in loan volume by program, economic conditions and credit and
underwriting policies. A large percentage of the Company's non-federally insured
loans have not matured to a point at which predictable loan loss patterns have
developed. Accordingly, the evaluation of the provision for loan losses is
inherently subjective as it requires material estimates that may be susceptible
to significant changes. Management believes that the provision for loan losses
is adequate to cover anticipated losses in the student loan portfolio. An
analysis of the Company's allowance for loan losses is presented in the
following table.
"CORE CASH BASIS" ACTIVITY IN THE ALLOWANCE FOR LOAN LOSSES
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
Balance at beginning of year................................ $ 335 $ 260 $ 237
Provision for loan losses................................... 98 51 51
Reserves acquired in acquisition............................ -- 23 9
Other....................................................... 35 27 3
Charge-offs:
Non-federally insured loans............................. (42) (11) (16)
Federally insured loans................................. (39) (20) (29)
------- ------- -------
Total charge-offs..................................... (81) (31) (45)
Recoveries:
Non-federally insured loans............................. 3 1 3
Federally insured loans................................. 7 4 4
------- ------- -------
Total recoveries...................................... 10 5 7
Net charge-offs............................................. (71) (26) (38)
------- ------- -------
Reduction for sales of student loans........................ -- -- (2)
------- ------- -------
Balance at end of year...................................... $ 397 $ 335 $ 260
======= ======= =======
Allocation of the allowance for loan losses:
Non-federally insured loans................................. $ 202 $ 177 $ 148
Federally insured loans..................................... 195 158 112
------- ------- -------
Total................................................. $ 397 $ 335 $ 260
======= ======= =======
Net charge-offs as a percentage of average managed student
loans..................................................... .10% .04% .08%
Total allowance as a percentage of average managed student
loans..................................................... .56% .56% .51%
Non-federally insured allowance as a percentage of the
ending balance of non-federally insured loans............. 4.57% 5.48% 6.66%
Average managed student loans............................... $70,619 $60,348 $50,698
Ending managed student loans................................ $71,726 $67,515 $53,276
39
The 2001 "core cash basis" provision for loan losses includes $40 million
for potential loan losses on the non-federally insured student loans and
$58 million for potential loan losses due to risk-sharing and other claims on
FFELP loans. The 2000 "core cash basis" provision for loan losses includes
$6 million for potential loan losses on the non-federally insured student loans
and $45 million for potential loan losses due to risk-sharing and other claims
on FFELP loans. The 1999 "core cash basis" provision includes $12 million for
potential loan losses on the non-federally insured portfolio and $39 million for
potential loan losses due to risk-sharing and other claims on FFELP loans.
The provision and allowance for loan losses presented on a "core cash basis"
are directly tied to the activity presented for the Company's on-balance sheet
student loan portfolio. The increased volume and aging of the Company's
non-federally insured student loans and management's estimates as to their
effects on the allowance for loan losses were the primary causes for the
increase in the provision for loan losses of $47 million in 2001 versus 2000.
This increased volume and aging also contributed to the $31 million increase in
write-offs in 2001 versus 2000.
DELINQUENCIES--NON-FEDERALLY INSURED STUDENT LOANS
The following table shows the loan delinquency trends for the years
presented on the Company's non-federally insured student loan portfolio.
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
Loans in school/deferment........................... $1,429 $ 865 $ 614
Loans in repayment
Loans current................................... 2,245 1,665 1,068
Loans current in forbearance.................... 313 208 247
Loans delinquent 30-59 days..................... 101 201 70
Loans delinquent 60-89 days..................... 45 36 19
Loans delinquent greater than 90 days........... 91 74 57
------ ------ ------
Total loans in repayment........................ 2,795 2,184 1,461
------ ------ ------
Ending non-federally insured loan portfolio......... $4,224 $3,049 $2,075
====== ====== ======
"CORE CASH BASIS" 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
constant maturity Treasury rate. The following table summarizes the average
balance of debt (by index, after giving effect to the impact of interest rate
swaps) for the years ended December 31, 2001, 2000 and 1999 (dollars in
millions).
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------
2001 2000 1999
------------------- ------------------- -------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
INDEX BALANCE RATE BALANCE RATE BALANCE RATE
- ----- -------- -------- -------- -------- -------- --------
Treasury bill, principally 91-day......... $56,082 4.21% $50,972 6.65% $44,057 5.41%
LIBOR..................................... 2,714 4.94 5,850 6.90 3,390 5.36
Discount notes............................ 7,168 4.42 5,300 6.26 3,424 4.90
Fixed..................................... 8,637 5.73 5,633 6.18 5,655 5.57
Zero coupon............................... 192 11.14 171 11.17 153 11.14
Commercial paper.......................... 4,229 3.09 969 6.65 302 5.69
Auction rate securities................... 1,101 3.67 653 5.65 -- --
Other..................................... 65 5.12 123 6.96 266 5.34
------- ----- ------- ----- ------- -----
Total..................................... $80,188 4.39% $69,671 6.64% $57,247 5.42%
======= ===== ======= ===== ======= =====
40
"CORE CASH BASIS" OTHER INCOME
"Core cash basis" other income excludes gains on student loan
securitizations, servicing and securitization revenue, the effects of SFAS 133,
gains on sales of student loans, and certain one-time gains and losses on sales
of investment securities. For the years ended December 31, 2001, 2000 and 1999,
"core cash basis" other income was $455 million, $281 million, and $84 million,
respectively. "Core cash basis" other income mainly includes guarantor servicing
fees, late fees earned on student loans, fees received from servicing third
party portfolios of student loans, and commitment fees for letters of credit.
The increase in "core cash basis" other income for 2001 versus 2000 and 1999 is
principally due to fee income attributable to the acquisition of USA Group in
July 2000. Guarantor servicing fees, late fees, third party servicing fees, and
commitment fees for letters of credit contributed $255 million, $56 million,
$53 million, and $11 million, respectively, to "core cash basis" other income
during the year ended December 31, 2001, versus $128 million, $42 million,
$39 million, and $16 million, respectively, for the year ended December 31,
2000. For the year ended December 31, 1999, "core cash basis" other income
included $38 million in late fees, $5 million in third party servicing fees, and
$19 million in commitment fees for letters of credit.
In the fourth quarter of 2001, the Company recognized an $18 million loss on
the impairment of assets generated from the scheduled sale of its Sallie Mae
Solutions product line. This loss has been excluded from "core cash basis" other
income.
FEDERAL AND STATE TAXES
The Company's overall effective tax rate for the years ended December 31,
2001, 2000 and 1999 is 36 percent, 33 percent and 32 percent, respectively. The
Company maintains a portfolio of tax-advantaged assets principally to support
education-related financing activities. That portfolio was responsible for a
decrease in the effective tax rate for the years ended December 31, 2001, 2000
and 1999 of two percent, two percent, and three percent, respectively. The GSE
is exempt from all state, local and District of Columbia income, franchise,
sales and use, personal property and other taxes, except for real property
taxes. However, this tax exemption applies only to the GSE and does not apply to
USA Education, Inc. or its other operating subsidiaries. Under the Privatization
Act, the Company's GSE and non-GSE activities are separated, with non-GSE
activities being subject to taxation at the state and local levels. State taxes
for the years ended December 31, 2001, 2000 and 1999 increased the Company's
effective tax rate by three percent, two percent and one percent, respectively.
As increasing business activity occurs outside of the GSE, the impact of
state and local taxes will increase accordingly. Ultimately all business
activities will occur outside of the GSE, which could increase the Company's
effective income tax rate by as much as five percentage points from the 1999
effective tax rate. The loss of the GSE tax exemption for sales and use and
personal property taxes could increase operating costs by one percentage point.
LIQUIDITY AND CAPITAL RESOURCES
GENERAL
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 the GSE,
off-balance sheet financings through securitizations, borrowings under its
commercial paper and medium term notes programs, other senior note issuances by
the Company, and cash generated by
41
its subsidiaries' operations and distributed through dividends to the Company.
The Company's borrowings are broken down as follows:
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------
2001 2000 1999
------------------- ------------------- -------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
-------- -------- -------- -------- -------- --------
GSE........................................... $47,877 4.27% $43,325 6.45% $39,274 5.35%
Company....................................... 1,822 4.45 641 6.94 222 5.85
Securitizations (off-balance sheet)........... 30,489 4.58 25,705 6.97 17,751 5.56
------- ---- ------- ---- ------- ----
Total......................................... $80,188 4.39% $69,671 6.64% $57,247 5.42%
======= ==== ======= ==== ======= ====
GSE FINANCING ACTIVITIES
The GSE secures financing to fund its on-balance sheet portfolio of student
loans, along with its other operations, by issuing debt securities in the
domestic and overseas capital markets, through public offerings and private
placements of U.S. dollar-denominated and foreign currency-denominated debt of
varying maturities and interest rate characteristics. The GSE's debt securities
are currently rated at the highest credit rating level by both Moody's and S&P.
Historically, the agencies' ratings of the GSE have been largely a factor of its
status as a government-sponsored enterprise. Since the Privatization Act did not
modify the attributes of debt issued by the GSE, management anticipates that the
GSE will retain its current credit ratings.
The GSE'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 level of securitization activity.
SECURITIZATION ACTIVITIES
In addition to the GSE debt, student loan securitization has been an
important source of funding for the Company's managed student loan portfolio
since 1995. As student loans are securitized and are removed from the balance
sheet, the need for long-term financing decreases. Over the long term,
securitization is expected to provide the principal source of long-term funding
for the Company's managed portfolio of student loans. Management believes that
securitizations represent an efficient source of funding.
The Company's asset-backed securities generally have a higher cost of funds
than its traditional on-balance sheet financing because the asset-backed
securities are term match-funded and do not benefit from the GSE's status.
However, the increased funding costs of the asset-backed securities are
mitigated by the absence of the offset fees on securitized loans. Securitization
also allows the Company to obtain term financing at a lower cost than otherwise
would be achievable without the GSE's government-sponsored status.
Securitizations to date have been structured to achieve an "AAA" credit rating
on over 96 percent of its securities sold (with an "A" credit rating on the
remaining subordinated securities). In 2001, the Company completed four
securitization transactions totaling $6.0 billion in student loans and an
additional $435 million through the recycling provisions of certain
securitizations.
In both late 1998 and early 1999, the Russian bond default in August 1998
caused financing spreads on potential Treasury bill indexed securitization
transactions to be wider and thus more costly than previous years' transactions.
As a result, the Company did not enter into a securitization transaction from
September 1998 through May of 1999. Financial market conditions did improve to a
point at which it was economical to securitize student loans, and in the second
quarter of 1999, the Company reentered the asset-backed securities market by
completing a $1.0 billion securitization. In 1999, the Company completed three
securitization transactions totaling $4.0 billion in student loans.
42
During 1999, demand for Treasury bill securities remained high causing Treasury
bill rates to remain low relative to other market indices. As a consequence, the
Company issued $3.8 billion in LIBOR based asset-backed securities, the first
issuances indexed to LIBOR in the history of the program. The Company's 2000 and
2001 securitization transactions continue to be indexed to LIBOR. The Company is
managing this off-balance sheet basis risk through on-balance sheet financing
activities, principally through basis swaps.
COMPANY FINANCING ACTIVITIES
In order to finance non-GSE activities and in preparation for the eventual
wind-down of the GSE, USA Education is developing additional financing vehicles.
While continued use of the securitization market will be the core of the
Company's financing strategy, these efforts will be supplemented by commercial
paper, asset-backed commercial paper, bank lines of credit, underwritten
long-term debt, and a medium-term note program. In the third quarter of 1999,
the Company received credit ratings that will facilitate its access to the
private funding markets: short-term debt ratings of A-1, F1+ and P-1, and
long-term senior unsecured debt ratings of A, A+ and A3 were issued by S&P,
Moody's and Fitch IBCA, Inc., respectively. Upon receiving its initial credit
ratings, the Company initiated its commercial paper program. Effective
October 26, 2001, the Company renewed its $600 million 364-day revolving credit
facility for an additional 364-day period. Liquidity support for the Company's
commercial paper program is provided by this $600 million 364-day revolving
credit facility which matures on October 25, 2002, and a $400 million 5-year
revolving credit facility which matures on October 29, 2004.
On October 3, 2000, the Company issued $500 million of its Senior Notes due
September 16, 2002. During 2001, the Company issued an additional $1.6 billion
of long term notes under its medium term note program and other senior note
offerings.
During 2001, the Company used the proceeds from student loan securitizations
of $6.5 billion, repayments and claim payments on student loans of
$3.5 billion, net proceeds from debt issuances of $3.0 billion, and the net
proceeds from sales of student loans to purchase student loans of
$13.5 billion.
Operating activities provided net cash inflows of $839 million in 2001, an
increase of $94 million from the net cash inflows of $745 million in 2000.
During 2001, the Company issued $19.6 billion of long-term notes to refund
maturing and repurchased obligations. At December 31, 2001, the Company had
$17.3 billion of outstanding long-term debt issues of which $2.5 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.")
GSE WIND-DOWN
Until the GSE is dissolved, the Privatization Act places a number of
limitations on the Company. Under the Privatization Act, the GSE must wind down
its operations and dissolve on or before September 30, 2008. The Company has the
option of effecting an earlier dissolution of the GSE if certain conditions are
met. On January 23, 2002, the GSE's board of directors approved management's
plans to accelerate the wind-down of the entity by at least two years, with a
view to effecting dissolution of the GSE no later than September 30, 2006. Any
GSE debt obligations outstanding at the date of such dissolution are required to
be defeased through creation of a fully collateralized trust, consisting of U.S.
government or agency obligations with cash flows matching the interest and
principal obligations of the defeased debt. The Privatization Act requires that
on the dissolution date, the GSE shall repurchase or redeem, or make proper
provisions for repurchase or redemption of any
43
outstanding preferred stock. The GSE redeemed its Series A Adjustable Rate
Cumulative Preferred Stock, its only outstanding preferred stock, in the fourth
quarter of 2001. Also upon the GSE's dissolution, all of its remaining assets
will transfer to the Company.
The Privatization Act effectively requires that the GSE maintain a minimum
statutory capital adequacy ratio (the ratio of stockholders' equity to total
assets plus 50 percent of the credit equivalent amount of certain off-balance
sheet items) of at least 2.25 percent or be subject to certain "safety and
soundness" requirements designed to restore such statutory ratio. While the GSE
may not finance the activities of its non-GSE affiliates, it may, subject to its
minimum capital requirements, dividend retained earnings and surplus capital to
USA Education, Inc., which in turn may contribute such amounts to its non-GSE
subsidiaries. The Privatization Act requires management to certify to the
Secretary of the Treasury that, after giving effect to the payment of dividends,
the statutory capital ratio test would have been met at the time the dividend
was declared. At December 31, 2001, the GSE's statutory capital adequacy ratio,
after the effect of the dividends to be paid in the first quarter of 2002, was
2.95 percent.
The GSE has also received guidance from the U.S. Department of Treasury's
Office of Sallie Mae Oversight regarding safety and soundness considerations
affecting its wind-down. As a result, in connection with any dividend
declarations, the GSE will supplement the statutory minimum capital ratio
requirement with a risk-based capital measurement formula. Management does not
expect the capital levels of the Company's consolidated balance sheet to change
as a result of this supplemental formula.
The Privatization Act imposes certain restrictions on intercompany relations
between the GSE and its affiliates during the wind-down period. In particular,
the GSE must not extend credit to, nor guarantee, any debt obligations of USA
Education, Inc. or its non-GSE subsidiaries.
The Privatization Act provides that the GSE may continue to issue new debt
obligations maturing on or before September 30, 2008. The legislation further
provides that the legal status and attributes of the GSE's debt obligations,
including the exemptions from SEC registration and state taxes, will be fully
preserved until their respective maturities. Such debt obligations will remain
GSE debt obligations, whether such obligations were outstanding at the time of,
or issued subsequent to, the Reorganization. The obligations of USA Education,
Inc. do not have GSE status.
INTEREST RATE RISK MANAGEMENT
INTEREST RATE GAP ANALYSIS
The Company's principal objective in financing its operations is to minimize
its sensitivity to changing interest rates by matching the interest rate
characteristics of its borrowings to specific assets in order to lock in
spreads. The Company funds its floating rate managed loan assets (most of which
have weekly rate resets) with variable rate debt and fixed rate debt converted
to variable rates with interest rate swaps. The Company also uses interest rate
cap agreements, foreign currency swaps, options on securities, and financial
futures contracts to further reduce interest rate risk and foreign currency
exposure on certain of its borrowings. Investments are funded on a "pooled"
approach, i.e., the pool of liabilities that funds the investment portfolio has
an average rate and maturity or reset date that corresponds to the average rate
and maturity or reset date of the investments which they fund.
In addition to term match funding at December 31, 2001, $13.4 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 December 31, 2001, there were approximately $2.9 billion of
PLUS student loans outstanding in the trusts, which have interest rates that
reset annually based on the final auction of 52-week Treasury bills before each
July 1. In addition, at December 31, 2001, there were approximately
$19.8 billion of asset-backed securities indexed to
44
LIBOR. In its securitization transactions, the Company retains this basis risk
and manages it within the trusts through its on-balance sheet financing and
hedging 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. 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 December 31, 2001 and is not necessarily
reflective of positions that existed throughout the period.
INTEREST RATE SENSITIVITY PERIOD
---------------------------------------------------------------
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........................... $ 37,535 $2,818 $ 648 $ -- $ -- $ --
Warehousing advances.................... 1,024 -- -- -- 2 10
Academic facilities financings.......... 13 48 55 97 163 356
Cash and investments.................... 4,044 58 124 10 244 1,307
Other assets............................ 614 58 332 199 488 2,627
-------- ------ ------ ------ ------- ------
Total assets........................ 43,230 2,982 1,159 306 897 4,300
-------- ------ ------ ------ ------- ------
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings................... 24,897 3,253 2,915 -- -- --
Long-term notes......................... 7,085 -- 262 2,117 7,276 545
Other liabilities....................... 972 -- -- -- -- 1,880
Stockholders' equity.................... -- -- -- -- -- 1,672
-------- ------ ------ ------ ------- ------
Total liabilities and stockholders'
equity............................ 32,954 3,253 3,177 2,117 7,276 4,097
-------- ------ ------ ------ ------- ------
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
Interest rate swaps (notional amount)... (7,134) 2,140 1,750 1,960 2,163 (879)
Impact of securitized student loans..... (2,935) 2,935 -- -- -- --
-------- ------ ------ ------ ------- ------
Total off-balance sheet financial
instruments........................... (10,069) 5,075 1,750 1,960 2,163 (879)
-------- ------ ------ ------ ------- ------
Period gap.............................. $ 207 $4,804 $ (268) $ 149 $(4,216) $ (676)
-------- ------ ------ ------ ------- ------
Cumulative gap.......................... $ 207 $5,011 $4,743 $4,892 $ 676 $ --
======== ====== ====== ====== ======= ======
Ratio of interest-sensitive assets to
interest-sensitive liabilities........ 133.2% 89.9% 26.0% 5.1% 5.6% 307.0%
======== ====== ====== ====== ======= ======
Ratio of cumulative gap to total
assets................................ (.4)% (9.5)% (9.0)% (9.3)% (1.3)% --%
======== ====== ====== ====== ======= ======
INTEREST RATE SENSITIVITY ANALYSIS
While the Company follows a policy to minimize its sensitivity to changing
interest rates by generally funding its floating rate student loan portfolio
with floating rate debt, in low interest rate environments, the student loan
portfolio earns at a minimum fixed interest rate. During 2001, the Company was
in a low interest environment where the student loans were earning at a fixed
minimum rate, while the funding costs for these loans continued to decrease.
The Company chose to lock-in a portion of the income associated with this
mismatch through the use of futures and swap contracts. The result of these
hedging transactions was to convert a portion of
45
floating rate debt into fixed rate debt, matching the fixed rate nature of the
student loans during the low interest rate environment. Therefore, in certain
low interest rate environments, the relative spread between the student loan
asset rate and the converted fixed rate liability is fixed.
If interest rates rise dramatically, then rates earned on the student loan
asset will reach a point where it will become floating again. For those student
loans where the fixed loan rate (in low interest rate environments) was
economically hedged by fixed rate funding (through the use of derivatives), a
higher spread will be earned in a high interest rate environment. The impact of
the dramatic increase in rates on the hedging positions described above resulted
in an approximate $260 million increase to earnings in the scenario in which
interest rates are increased by 300 basis points for the year ended
December 31, 2001. The positions were not effective in the year 2000.
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 following tables summarize the effect
on earnings for the years ended December 31, 2001 and 2000 and the effect on
fair values at December 31, 2001 and 2000 based upon a sensitivity analysis
performed by the Company assuming a hypothetical increase in market interest
rates of 100 basis points and 300 basis points while funding spreads remained
constant. The Company has chosen to show the effects of a hypothetical increase
to interest rates, as an increase gives rise to a larger absolute value change
to the financial statements. The effect on earnings was performed on the
Company's variable rate assets, liabilities, and hedging instruments while the
effect on fair values was performed on the Company's fixed rate assets,
liabilities, and hedging instruments.
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000
------------------------------ ------------------------------
INTEREST RATES: INTEREST RATES:
INCREASE 100 INCREASE 300 INCREASE 100 INCREASE 300
BASIS POINTS BASIS POINTS BASIS POINTS BASIS POINTS
------------ ------------ ------------ ------------
EFFECT ON EARNINGS
Pre-tax net income before SFAS 133........... $ (136) $ 35 $ (3) $ 34
SFAS 133 mark-to-market...................... 358 875 -- --
------ ------- ------ ------
Net income before taxes...................... $ 222 $ 910 $ (3) $ 34
====== ======= ====== ======
Diluted earnings per share before SFAS 133... $(.541) $ .140 $(.013) $ .135
====== ======= ====== ======
Diluted earnings per share with SFAS 133..... $ .882 $ 3.620 $(.013) $ .135
====== ======= ====== ======
DECEMBER 31,
------------------------------------------------------------------
2001 2000
------------------------------ ------------------------------
INTEREST RATES: INTEREST RATES:
INCREASE 100 INCREASE 300 INCREASE 100 INCREASE 300
BASIS POINTS BASIS POINTS BASIS POINTS BASIS POINTS
------------ ------------ ------------ ------------
EFFECT ON FAIR VALUES
Assets
Student loans.............................. $ (403) $ (845) $ (154) $ (282)
Other earning assets....................... (101) (285) (113) (320)
Non interest earning assets................ (272) (408) -- --
------ ------- ------ ------
Total assets............................... $ (776) $(1,538) $ (267) $ (602)
====== ======= ====== ======
Liabilities
Interest bearing liabilities............... $ 187 $ 544 $ 51 $ 146
Non interest bearing liabilities........... (394) (770) (111) (206)
------ ------- ------ ------
Total liabilities.......................... $ (207) $ (226) $ (60) $ (60)
====== ======= ====== ======
46
At December 31, 2001 and 2000, the Company had outstanding liabilities
totaling $38.2 billion and $42.9 billion, respectively, that mature in
two years. If the Company had to refinance these obligations at a higher funding
spread of five basis points, the annualized increase to interest expense would
be $19 million and $21 million, respectively. If the Company had to refinance
total outstanding liabilities at December 31, 2001 and 2000, the annualized
increase to interest expense would be $24 million and $23 million, respectively.
AVERAGE TERMS TO MATURITY
The following table reflects the average terms to maturity for the Company's
managed earning assets and liabilities at December 31, 2001:
AVERAGE TERMS TO MATURITY (IN YEARS)
ON-BALANCE OFF-BALANCE
SHEET SHEET MANAGED
---------- ----------- --------
EARNING ASSETS
Student loans................................. 7.7 4.1 6.1
Warehousing advances.......................... 5.4 -- 5.4
Academic facilities financings................ 6.8 -- 6.8
Cash and investments.......................... 4.2 -- 4.2
--- --- ---
Total earning assets.......................... 7.2 4.1 6.0
=== === ===
BORROWINGS
Short-term borrowings......................... .3 -- .3
Long-term borrowings.......................... 3.6 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 4.2 years. As student
loans are securitized, the need for long-term on-balance sheet financing will
decrease.
COMMON STOCK
The Company repurchased 19.4 million common shares during 2001 through its
open market purchases and equity forward settlements. The Company also issued a
net 10.7 million shares from its benefit plans. The net result was a decrease in
outstanding shares to 155.5 million at December 31, 2001. At December 31, 2001,
the total common shares that could potentially be acquired over the next three
years under outstanding equity forward contracts was 11.2 million shares, and
the Company has remaining authority to enter into additional share repurchases
and equity forward contracts for 2.3 million shares.
The Company's equity forward contracts permit the counterparty to terminate
the contracts prior to their maturity date based on several factors including a
significant drop in the Company's common stock price or a significant decrease
in the credit ratings of the Company and/or the GSE (see Note 15 in the "Notes
to the Consolidated Financial Statements"). In addition, the Company has
negotiated with each of its equity forward counterparties a limit on the total
number of shares that the Company can be required to deliver to the counterparty
in settlement of the transactions. As of December 31, 2001 and December 31,
2000, the aggregate maximum number of shares that the Company could be required
to deliver was 67.2 million and 55.9 million shares, respectively.
47
YEARS ENDED
DECEMBER 31,
-----------------------
2001 2000
-------- --------
Common shares repurchased:
Open market............................................ 2.7 2.1
Equity forwards........................................ 16.7 4.9
------ ------
Total shares repurchased................................. 19.4 7.0
------ ------
Average purchase price per share......................... $44.32 $44.26
====== ======
Equity forward contracts:
Outstanding at beginning of year......................... 18.2 21.4
New contracts............................................ 9.7 1.7
Exercises................................................ (16.7) (4.9)
------ ------
Outstanding at end of year............................... 11.2 18.2
====== ======
Remaining repurchase authority at end of year............ 2.3 4.8
====== ======
As of December 31, 2001, the expiration dates and range of purchase prices
for outstanding equity forward contracts are as follows:
OUTSTANDING RANGE OF MARKET
YEAR OF MATURITY CONTRACTS PRICES
- ---------------- ----------- --------------------
2003.............................................. 6.7 45.56 -- 80.97
2004.............................................. 4.0 68.61 -- 82.26
2005.............................................. .5 86.11
----
11.2
====
OTHER RELATED EVENTS AND INFORMATION
LEGISLATIVE DEVELOPMENT
On February 8, 2002, President Bush signed Public Law 107-139, an act that
includes a provision that makes permanent the change to the index on which
lender returns are set in the FFELP from the 91-day Treasury bill rate to the
90-day commercial paper rate. The act also provides that borrower rates will
remain indexed to the 91-day Treasury bill until July 1, 2006 and that loans
made on or after July 1, 2006 will have a fixed rate for borrowers: 6.8% for
Stafford loans and 7.9% for PLUS loans.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
See Note 2 to the Consolidated Financial Statements, "Significant Accounting
Policies--Recently Issued Accounting Pronouncements."
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Included within Management's Discussion and Analysis of Financial Condition
and Results of Operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements listed under the heading "(a)
1. Financial Statements" of Item 14 hereof, which financial statements are
incorporated by reference in response to this Item 8.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
48
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information as to the directors and executive officers of the Company
set forth under the captions "PROPOSAL 1--ELECTION OF DIRECTORS--Information
Concerning Nominees" and "Executive Officers" in the Proxy Statement to be filed
on Schedule 14A relating to the Company's Annual Meeting of Stockholders
scheduled to be held on May 16, 2002 (the "Proxy Statement") is incorporated
into this Report by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the caption "EXECUTIVE COMPENSATION" in the
Proxy Statement is incorporated into this Report by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under the caption "STOCK OWNERSHIP" and "GENERAL
INFORMATION--Principal Shareholders" in the Proxy Statement is incorporated into
this Report by reference thereto. There are no arrangements known to the
Company, the operation of which may at a subsequent date result in a change in
control of the Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Nothing to report.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS
The following consolidated financial statements of USA Education, Inc. and
the Report of the Independent Auditors thereon are included in Item 8 above:
Report of Independent Auditors.............................. F-2
Consolidated Balance Sheets as of December 31, 2001 and
2000...................................................... F-3
Consolidated Statements of Income for the years ended
December 31, 2001, 2000 and 1999.......................... F-4
Consolidated Statements of Changes in Stockholders' Equity
for the years ended December 31, 2001, 2000 and 1999...... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999.......................... F-6
Notes to Consolidated Financial Statements.................. F-7
2. FINANCIAL STATEMENT SCHEDULES
All schedules are omitted because they are not applicable or the required
information is shown in the consolidated financial statements or notes thereto.
3. EXHIBITS
The exhibits listed in the accompanying index to exhibits are filed or
incorporated by reference as part of this annual report.
The Company will furnish at cost a copy of any exhibit filed with or
incorporated by reference into this Form 10-K. Oral or written requests for
copies of any exhibits should be directed to the Corporate Secretary.
49
(b) REPORTS ON FORM 8-K
We filed two Current Reports on Form 8-K with the Commission during the
quarter ended December 31, 2001 or thereafter. They were filed on:
- November 7, 2001 in connection with entering into a distribution agreement
with certain agents in connection with the Company's offering of up to
$3 billion of its medium term notes, Series A
- February 19, 2002 in connection with our press release announcing our
earnings for the fourth quarter ended December 31, 2001 and our
supplemental financial information for the same period
(c) EXHIBITS
*2 Agreement and Plan of Reorganization by and among the
Student Loan Marketing Association, SLM Holding
Corporation, and Sallie Mae Merger Company
**3.1 Amended and Restated Certificate of Incorporation of the
Registrant
**3.2 By-Laws of the Registrant
**4 Warrant Certificate No. W-2, dated as of August 7, 1997
*10.1 Board of Directors Restricted Stock Plan
*10.2 Board of Directors Stock Option Plan
*10.3 Deferred Compensation Plan for Directors
*10.4 Incentive Performance Plan
*10.5 Stock Compensation Plan
*10.6 1993-1998 Stock Option Plan
*10.7 Supplemental Pension Plan
*10.8 Supplemental Employees' Thrift & Savings Plan (Sallie Mae
401(K) Supplemental Savings Plan)
***10.9 Directors Stock Plan
***10.10 Management Incentive Plan
*21 Subsidiaries of the Registrant
+23 Consent of Arthur Andersen LLP
+99 Company's Letter to Commission Concerning Representations
from Arthur Andersen LLP
- ------------------------
* Incorporated by reference to the correspondingly numbered exhibits to the
Registrant's Registration Statement on Form S-4, as amended (File
No. 333-21217)
** Incorporated by reference to the correspondingly numbered exhibits to the
Registrant's Registration on Form S-1 (File No. 333-38391)
*** Incorporated by reference to the Registrant's Definitive Proxy Statement on
Schedule 14A, as filed with the Securities and Exchange Commission on
April 10, 1998 (File No. 001-13251)
+ Filed with the Securities and Exchange Commission with this Form 10-K
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: March 28, 2002 USA EDUCATION, INC.
By: /s/ ALBERT L. LORD
-----------------------------------------
Albert L. Lord
CHIEF EXECUTIVE OFFICER
Pursuant to the requirement of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
Chief Executive Officer
/s/ ALBERT L. LORD (Principal Executive
------------------------------------------- Officer) March 28, 2002
Albert L. Lord and Director
Executive Vice President and
/s/ JOHN F. REMONDI Chief Financial Officer
------------------------------------------- (Principal Financial and March 28, 2002
John F. Remondi Accounting Officer)
/s/ EDWARD A. FOX
------------------------------------------- Chairman of the Board of March 28, 2002
Edward A. Fox Directors
/s/ CHARLES L. DALEY
------------------------------------------- Director March 28, 2002
Charles L. Daley
/s/ WILLIAM M. DIEFENDERFER, III
------------------------------------------- Director March 28, 2002
William M. Diefenderfer, III
/s/ THOMAS J. FITZPATRICK
------------------------------------------- President and Chief March 28, 2002
Thomas J. Fitzpatrick Operating Officer
51
SIGNATURE TITLE DATE
--------- ----- ----
/s/ DIANE SUITT GILLELAND
------------------------------------------- Director March 28, 2002
Diane Suitt Gilleland
/s/ EARL A. GOODE
------------------------------------------- Director March 28, 2002
Earl A. Goode
/s/ ANN TORRE GRANT
------------------------------------------- Director March 28, 2002
Ann Torre Grant
/s/ RONALD F. HUNT
------------------------------------------- Director March 28, 2002
Ronald F. Hunt
/s/ BENJAMIN J. LAMBERT, III
------------------------------------------- Director March 28, 2002
Benjamin J. Lambert, III
/s/ JAMES C. LINTZENICH
------------------------------------------- Director March 28, 2002
James C. Lintzenich
/s/ BARRY A. MUNITZ
------------------------------------------- Director March 28, 2002
Barry A. Munitz
/s/ A. ALEXANDER PORTER, JR.
------------------------------------------- Director March 28, 2002
A. Alexander Porter, Jr.
/s/ WOLFGANG SCHOELLKOPF
------------------------------------------- Director March 28, 2002
Wolfgang Schoellkopf
/s/ STEVEN L. SHAPIRO
------------------------------------------- Director March 28, 2002
Steven L. Shapiro
/s/ BARRY L. WILLIAMS
------------------------------------------- Director March 28, 2002
Barry L. Williams
52
CONSOLIDATED FINANCIAL STATEMENTS
INDEX
PAGE
--------
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Income........................... F-4
Consolidated Statements of Changes in Stockholders'
Equity.................................................... F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
USA Education, Inc.:
We have audited the accompanying consolidated balance sheets of USA
Education, Inc., and subsidiaries as of December 31, 2001 and 2000, and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for each of the three years ended December 31, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of USA Education, Inc. and
subsidiaries as of December 31, 2001 and 2000, and the consolidated results of
their operations and their cash flows for each of the three years ended
December 31, 2001 in conformity with accounting principles generally accepted in
the United States.
As discussed in Notes 2 and 10 to the consolidated financial statements,
effective January 1, 2001, the Company changed its method of accounting for
derivatives.
Arthur Andersen LLP
Vienna, VA
January 16, 2002
F-2
USA EDUCATION, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31,
-------------------------
2001 2000
----------- -----------
ASSETS
Student loans, net.......................................... $41,000,870 $37,647,297
Warehousing advances........................................ 1,035,906 987,352
Academic facilities financings
Bonds--available-for-sale................................. 396,895 498,775
Loans..................................................... 335,346 352,393
----------- -----------
Total academic facilities financings........................ 732,241 851,168
Investments
Trading................................................... 791 --
Available-for-sale........................................ 4,053,719 4,244,762
Held-to-maturity.......................................... 1,017,642 961,260
----------- -----------
Total investments........................................... 5,072,152 5,206,022
Cash and cash equivalents................................... 715,001 734,468
Residual interest and servicing assets...................... 1,859,450 961,252
Other assets................................................ 2,458,339 2,404,229
----------- -----------
Total assets................................................ $52,873,959 $48,791,788
=========== ===========
LIABILITIES
Short-term borrowings....................................... $31,064,821 $30,463,988
Long-term notes............................................. 17,285,350 14,910,939
Other liabilities........................................... 2,851,326 1,787,642
----------- -----------
Total liabilities........................................... 51,201,497 47,162,569
----------- -----------
COMMITMENTS AND CONTINGENCIES
MINORITY INTEREST IN SUBSIDIARY............................. -- 213,883
STOCKHOLDERS' EQUITY
Preferred stock, Series A, par value $.20 per share, 20,000
shares authorized, 3,300 and 3,300 shares issued,
respectively, at stated value of
$50 per share............................................. 165,000 165,000
Common stock, par value $.20 per share, 375,000 shares
authorized: 202,736 and 190,852 shares issued,
respectively.............................................. 40,547 38,170
Additional paid-in capital.................................. 805,804 225,211
Unrealized gains on investments and derivatives (net of tax
of $360,876 and $167,624, respectively)................... 670,199 311,301
Retained earnings........................................... 2,068,490 1,810,902
----------- -----------
Stockholders' equity before treasury stock.................. 3,750,040 2,550,584
Common stock held in treasury at cost:
47,241 and 26,707 shares, respectively.................... 2,077,578 1,135,248
----------- -----------
Total stockholders' equity.................................. 1,672,462 1,415,336
----------- -----------
Total liabilities and stockholders' equity.................. $52,873,959 $48,791,788
=========== ===========
See accompanying notes to consolidated financial statements.
F-3
USA EDUCATION, INC.
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31,
------------------------------------
2001 2000 1999
---------- ---------- ----------
INTEREST INCOME:
Student loans............................................. $2,527,818 $2,854,231 $2,426,506
Warehousing advances...................................... 43,401 56,410 67,828
Academic facilities financings:
Taxable................................................. 31,408 36,819 39,123
Tax-exempt.............................................. 22,077 29,890 35,235
---------- ---------- ----------
Total academic facilities financings...................... 53,485 66,709 74,358
Investments............................................... 372,827 501,309 239,883
---------- ---------- ----------
Total interest income....................................... 2,997,531 3,478,659 2,808,575
INTEREST EXPENSE:
Short-term debt........................................... 1,490,173 2,266,229 1,762,147
Long-term debt............................................ 633,942 570,642 352,638
---------- ---------- ----------
Total interest expense...................................... 2,124,115 2,836,871 2,114,785
---------- ---------- ----------
Net interest income......................................... 873,416 641,788 693,790
Less: provision for losses.................................. 65,991 32,119 34,358
---------- ---------- ----------
Net interest income after provision for losses.............. 807,425 609,669 659,432
---------- ---------- ----------
OTHER INCOME:
Gains on student loan securitizations..................... 75,199 91,846 35,280
Servicing and securitization revenue...................... 634,320 295,646 288,584
(Losses) gains on sales of securities..................... (178,287) 18,622 43,001
Guarantor servicing fees.................................. 255,171 128,375 --
Derivative market value adjustment........................ (452,425) -- --
Other..................................................... 183,639 153,143 83,925
---------- ---------- ----------
Total other income.......................................... 517,617 687,632 450,790
---------- ---------- ----------
OPERATING EXPENSES:
Salaries and benefits..................................... 362,904 280,886 138,571
Other..................................................... 344,750 251,824 219,999
Integration charge........................................ -- 53,000 --
---------- ---------- ----------
Total operating expenses.................................... 707,654 585,710 358,570
---------- ---------- ----------
Income before income taxes and minority interest in net
earnings of subsidiary.................................... 617,388 711,591 751,652
---------- ---------- ----------
Income taxes:
Current................................................... 451,954 267,837 360,494
Deferred.................................................. (228,632) (31,957) (120,367)
---------- ---------- ----------
Total income taxes.......................................... 223,322 235,880 240,127
Minority interest in net earnings of subsidiary............. 10,070 10,694 10,694
---------- ---------- ----------
NET INCOME.................................................. 383,996 465,017 500,831
Preferred stock dividends................................... 11,501 11,522 1,438
---------- ---------- ----------
Net income attributable to common stock..................... $ 372,495 $ 453,495 $ 499,393
========== ========== ==========
Basic earnings per common share............................. $ 2.34 $ 2.84 $ 3.11
========== ========== ==========
Average common shares outstanding........................... 159,078 159,482 160,577
========== ========== ==========
Diluted earnings per common share........................... $ 2.28 $ 2.76 $ 3.06
========== ========== ==========
Average common and common equivalent shares outstanding..... 163,400 164,355 163,158
========== ========== ==========
See accompanying notes to consolidated financial statements.
F-4
USA EDUCATION, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
PREFERRED COMMON STOCK SHARES
STOCK ----------------------------------------- PREFERRED COMMON
SHARES ISSUED TREASURY OUTSTANDING STOCK STOCK
---------- ----------- ----------- ------------- ---------- ---------
BALANCE AT DECEMBER 31, 1998.............. 184,453,866 (20,327,213) 164,126,653 $ -- $36,891
Comprehensive income:
Net income............................
Other comprehensive income, net of
tax:
Change in unrealized gains (losses)
on investments, net of tax........
Comprehensive income....................
Cash dividends:
Common stock ($.61 per share).........
Preferred stock ($.44 per share)......
Issuance of common shares............... 1,615,753 1,615,753 323
Issuance of preferred shares............ 3,300,000 165,000
Tax benefit related to employee stock
option and purchase plan..............
Premiums on equity forward purchase
contracts.............................
Repurchase of common shares............. (8,165,859) (8,165,859)
--------- ----------- ----------- ----------- -------- -------
BALANCE AT DECEMBER 31, 1999.............. 3,300,000 186,069,619 (28,493,072) 157,576,547 $165,000 $37,214
Comprehensive income:
Net income............................
Other comprehensive income, net of
tax.................................
Change in unrealized gains (losses)
on investments, net of tax........
Comprehensive income....................
Cash dividends:
Common stock ($.66 per share).........
Preferred stock ($3.49 per share).....
Issuance of common shares............... 4,782,317 9,084,505 13,866,822 956
Tax benefit related to employee stock
option and purchase plan..............
Premiums on equity forward purchase
contracts.............................
Repurchase of common shares............. (7,298,524) (7,298,524)
--------- ----------- ----------- ----------- -------- -------
BALANCE AT DECEMBER 31, 2000.............. 3,300,000 190,851,936 (26,707,091) 164,144,845 $165,000 $38,170
Comprehensive income:
Net income............................
Other comprehensive income, net of
tax:
Change in unrealized gains (losses)
on investments, net of tax........
Change in unrealized gains (losses)
on derivatives, net of tax........
Comprehensive income....................
Cash dividends:
Common stock ($.73 per share).........
Preferred stock ($3.48 per share).....
Issuance of common shares............... 11,884,450 164,255 12,048,705 2,377
Tax benefit related to employee stock
option and purchase plan..............
Premiums on equity forward purchase
contracts.............................
Repurchase of common shares............. (20,698,002) (20,698,002)
--------- ----------- ----------- ----------- -------- -------
BALANCE AT DECEMBER 31, 2001.............. 3,300,000 202,736,386 (47,240,838) 155,495,548 $165,000 $40,547
========= =========== =========== =========== ======== =======
ADDITIONAL ACCUMULATED OTHER TOTAL
PAID-IN RETAINED TREASURY COMPREHENSIVE STOCKHOLDERS'
CAPITAL EARNINGS STOCK INCOME (LOSS) EQUITY
----------- ---------- ----------- -------------------- --------------
BALANCE AT DECEMBER 31, 1998.............. $ 26,871 $1,060,334 $ (842,209) $371,739 $ 653,626
Comprehensive income:
Net income............................ 500,831 500,831
Other comprehensive income, net of
tax:
Change in unrealized gains (losses)
on investments, net of tax........ (74,004) (74,004)
----------
Comprehensive income.................... 426,827
Cash dividends:
Common stock ($.61 per share)......... (97,693) (97,693)
Preferred stock ($.44 per share)...... (1,438) (1,438)
Issuance of common shares............... 61,464 61,787
Issuance of preferred shares............ (3,397) 161,603
Tax benefit related to employee stock
option and purchase plan.............. 7,510 7,510
Premiums on equity forward purchase
contracts............................. (29,621) (29,621)
Repurchase of common shares............. (341,687) (341,687)
-------- ---------- ----------- -------- ----------
BALANCE AT DECEMBER 31, 1999.............. $ 62,827 $1,462,034 $(1,183,896) $297,735 $ 840,914
Comprehensive income:
Net income............................ 465,017 465,017
Other comprehensive income, net of
tax.................................
Change in unrealized gains (losses)
on investments, net of tax........ 13,566 13,566
----------
Comprehensive income.................... 478,583
Cash dividends:
Common stock ($.66 per share)......... (104,627) (104,627)
Preferred stock ($3.49 per share)..... (11,522) (11,522)
Issuance of common shares............... 201,958 372,366 575,280
Tax benefit related to employee stock
option and purchase plan.............. 25,393 25,393
Premiums on equity forward purchase
contracts............................. (64,967) (64,967)
Repurchase of common shares............. (323,718) (323,718)
-------- ---------- ----------- -------- ----------
BALANCE AT DECEMBER 31, 2000.............. $225,211 $1,810,902 $(1,135,248) $311,301 $1,415,336
Comprehensive income:
Net income............................ 383,996 383,996
Other comprehensive income, net of
tax:
Change in unrealized gains (losses)
on investments, net of tax........ 409,232 409,232
Change in unrealized gains (losses)
on derivatives, net of tax........ (50,334) (50,334)
----------
Comprehensive income.................... 742,894
Cash dividends:
Common stock ($.73 per share)......... (114,907) (114,907)
Preferred stock ($3.48 per share)..... (11,501) (11,501)
Issuance of common shares............... 510,391 10,358 523,126
Tax benefit related to employee stock
option and purchase plan.............. 118,642 118,642
Premiums on equity forward purchase
contracts............................. (48,440) (48,440)
Repurchase of common shares............. (952,688) (952,688)
-------- ---------- ----------- -------- ----------
BALANCE AT DECEMBER 31, 2001.............. $805,804 $2,068,490 $(2,077,578) $670,199 $1,672,462
======== ========== =========== ======== ==========
See accompanying notes to consolidated financial statements.
F-5
USA EDUCATION, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31,
---------------------------------------------
2001 2000 1999
------------- ------------- -------------
OPERATING ACTIVITIES
Net income................................................ $ 383,996 $ 465,017 $ 500,831
Adjustments to reconcile net income to net cash provided
by operating activities:................................
(Gains) on student loan securitizations................. (75,199) (91,846) (35,280)
Losses (gains) on sales of securities................... 178,287 (18,622) (43,001)
Derivative market value adjustment...................... 452,425 -- --
Provision for losses.................................... 65,991 32,119 34,358
Integration charge...................................... -- 53,000 --
(Increase) decrease in accrued interest receivable...... (144,588) 46,709 (165,048)
(Decrease) increase in accrued interest payable......... (39,455) (11,606) 4,347
(Increase) decrease in other assets..................... (583,725) (152,761) 20,208
Increase in other liabilities........................... 601,656 422,637 21,809
------------- ------------- -------------
Total adjustments......................................... 455,392 279,630 (162,607)
------------- ------------- -------------
Net cash provided by operating activities................... 839,388 744,647 338,224
------------- ------------- -------------
INVESTING ACTIVITIES
Student loans purchased................................... (13,531,337) (10,857,818) (11,095,260)
Reduction of student loans:
Installment payments.................................... 2,895,784 2,362,634 2,760,492
Claims and resales...................................... 627,168 481,829 474,105
Proceeds from securitization of student loans........... 6,531,106 8,805,758 4,085,540
Proceeds from sales of student loans.................... 142,808 136,944 926,123
Warehousing advances made................................. (1,087,536) (1,075,067) (876,728)
Warehousing advance repayments............................ 1,038,982 1,130,410 1,016,765
Academic facilities financings made....................... (11,883) (11,609) (35,919)
Academic facilities financings repayments................. 134,932 190,608 163,635
Investments purchased..................................... (45,450,862) (55,750,718) (12,972,279)
Proceeds from sale or maturity of investments............. 45,553,861 55,887,600 11,699,915
Purchase of subsidiaries, net of cash acquired............ -- (448,754) (317,722)
------------- ------------- -------------
Net cash (used in) provided by investing activities......... (3,156,977) 851,817 (4,171,333)
------------- ------------- -------------
FINANCING ACTIVITIES
Short-term borrowings issued.............................. 809,283,108 689,320,696 510,412,470
Short-term borrowings repaid.............................. (816,749,157) (690,106,439) (508,290,421)
Long-term notes issued.................................... 19,558,823 17,162,579 12,234,054
Long-term notes repaid.................................... (9,095,001) (17,924,421) (9,809,617)
Minority interest -- preferred stock redemption........... (213,883) -- --
Equity forward contracts and stock issued................. 593,328 535,706 201,279
Common stock repurchased.................................. (952,688) (323,718) (341,687)
Common dividends paid..................................... (114,907) (104,627) (97,693)
Preferred dividends paid.................................. (11,501) (11,522) (1,438)
------------- ------------- -------------
Net cash provided by (used in) financing activities......... 2,298,122 (1,451,746) 4,306,947
------------- ------------- -------------
Net (decrease) increase in cash and cash equivalents........ (19,467) 144,718 473,838
Cash and cash equivalents at beginning of year.............. 734,468 589,750 115,912
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR.................... $ 715,001 $ 734,468 $ 589,750
============= ============= =============
Cash disbursements made for:
Interest.................................................. $ 2,161,144 $ 2,432,427 $ 1,794,629
============= ============= =============
Income taxes.............................................. $ 350,900 $ 140,000 $ 398,500
============= ============= =============
See accompanying notes to consolidated financial statements.
F-6
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. ORGANIZATION AND PRIVATIZATION
On August 7, 1997, pursuant to the Student Loan Marketing Association
Reorganization Act of 1996 (the "Privatization Act") and approval by
shareholders of an agreement and plan of reorganization, the Student Loan
Marketing Association (the "GSE") was reorganized (the "Reorganization") into a
subsidiary of USA Education, Inc. 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.
Under the terms of the Reorganization each outstanding share of common
stock, par value $.20 per share, of the GSE was converted into one share of
common stock, par value $.20 per share, of USA Education, Inc. The GSE
transferred all employees to non-GSE subsidiaries on August 7, 1997 and also
transferred certain assets, including stock in certain subsidiaries, to USA
Education, Inc. or one of its non-GSE subsidiaries on December 31, 1997. This
transfer of the subsidiaries and assets and the related exchange of stock was
accounted for at historical cost similar to a pooling of interests.
The GSE was chartered by Congress to provide liquidity for originators of
student loans made under federally sponsored student loan programs and otherwise
to support the credit needs of students and educational institutions. The GSE is
predominantly engaged in the purchase of student loans insured under federally
sponsored programs. The GSE also makes secured loans (warehousing advances) to
providers of education credit, and provides financing to educational
institutions for their physical plant and equipment (academic facilities
financings).
The Privatization Act provides that the GSE may continue to issue new debt
obligations maturing on or before September 30, 2008. The legislation further
provides that the legal status and attributes of the GSE's debt obligations,
including the Securities and Exchange Commission registration and state tax
exemptions, will be fully preserved until their respective maturities. Such debt
obligations remained GSE debt obligations, whether such obligations were
outstanding at the time of, or issued subsequent to, the Reorganization. The
obligations of USA Education do not have GSE status. Therefore, as the Company
issues more of its obligations through non-GSE subsidiaries, the Company's cost
of funds will increase. The Privatization Act requires the GSE to transfer its
business to the Company and dissolve on or before September 30, 2008. The GSE's
Board of Directors expects to complete the dissolution of the GSE by
September 30, 2006. The Privatization Act also requires any GSE debt obligations
outstanding at the date of such dissolution to be defeased through creation of a
fully collateralized trust, consisting of U.S. government or agency obligations
with cash flows matching the interest and principal obligations of the defeased
debt. The Privatization Act further requires that the GSE's outstanding
adjustable rate cumulative preferred stock be redeemed on September 30, 2008 or
at such earlier time when the GSE is dissolved. The GSE redeemed its Series A
Adjustable Rate Cumulative Preferred Stock, its only outstanding preferred
stock, in the fourth quarter of 2001. Also upon the GSE's dissolution, all of
its remaining assets will transfer to the Company. This dissolution plan and
defeasance plan is dependent on many factors including the ability of the
Company to acquire the GSE's assets and provide the GSE with cash or assets to
defease the debt.
The Omnibus Appropriations Act of 1998, signed into law by the President on
October 21, 1998, amends the Federal Deposit Insurance Act by, among other
things, providing an exception to its current prohibition on affiliations
between government-sponsored entities and depository institutions. This
exception allows USA Education, Inc. to become affiliated with a depository
institution upon
F-7
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. ORGANIZATION AND PRIVATIZATION (CONTINUED)
satisfaction of certain conditions and with the approval of the Secretary of the
Treasury. Among the conditions are that: the dissolution of the GSE cannot be
adversely affected by the affiliation; the dissolution of the GSE must occur
within two years after the affiliation is consummated subject to the ability of
the Secretary to extend such deadline for up to two one-year periods; and the
GSE must be separate and distinct from the affiliated depository institution and
cannot extend credit, provide credit enhancement or purchase any obligation of
the depository institution. No such affiliation currently exists.
2. SIGNIFICANT ACCOUNTING POLICIES
LOANS
Loans, consisting of federally insured student loans, non-federally insured
student loans, student loan participations, warehousing advances, academic
facilities financings, and other private loans are carried at their purchase
price which, for student loans, includes unamortized premiums and unearned
purchase discounts.
STUDENT LOAN INCOME
The Company recognizes student loan income as earned, including amortization
of premiums and the accretion of discounts. Additionally, income is recognized
based upon the expected yield of the loan after giving effect to estimates for
borrower utilization of incentives for timely and complete payment. Payments
under floor revenue contracts are netted against student loan income.
ALLOWANCE FOR STUDENT LOAN LOSSES
The Company has established an allowance for potential losses on the
existing on-balance sheet portfolio of student loans. These student loan assets
are presented net of the allowance on the balance sheet. In evaluating the
adequacy of the allowance for losses, the Company considers several factors
including trends in student loan claims rejected for payment by guarantors,
default rates on non-federally insured student loans and the amount of Federal
Family Education Loan Program ("FFELP") loans subject to two percent
risk-sharing. The allowance is based on periodic evaluations of its loan
portfolios considering past experience, changes to federal student loan
programs, current economic conditions and other relevant factors. The allowance
is maintained at a level that management believes is adequate to provide for
estimated credit losses. This evaluation is inherently subjective as it requires
estimates that may be susceptible to significant changes.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents includes term federal funds and bank deposits with
original terms to maturity less than three months.
INVESTMENTS
Investments are held to provide liquidity, to economically hedge certain
financing activities and to serve as a source of short-term income. Securities
that are actively traded are accounted for at fair market value with unrealized
gains and losses included in investment income. Securities that are
F-8
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
intended to be held-to-maturity are accounted for at amortized cost. Securities
that fall outside of the two previous categories are considered as
available-for-sale. Such securities are carried at market value, with the
after-tax unrealized gain or loss, along with after-tax unrealized gain or loss
on instruments which hedge such securities, carried as a separate component of
stockholders' equity. The amortized cost of debt securities in this category is
adjusted for amortization of premiums and accretion of discounts.
The Company purchases U.S. Treasury and federal agency securities ("U.S.
government securities") under agreements to resell the securities. These
purchases are recorded as securities purchased under resale agreements, an asset
in the Consolidated Balance Sheets. The Company can use these securities as
collateral for repurchase agreements. The Company's policy is to take possession
or control of the security underlying the resale agreement. The securities are
revalued daily to determine if additional collateral is necessary from the
borrower. The Company enters into sales of U.S. government securities under
repurchase agreements, which are treated as financings, and the obligations to
repurchase such securities sold are reflected as a liability in the Consolidated
Balance Sheets. The dollar amount of the U.S. government securities underlying
the repurchase agreements remains in investment securities.
RESIDUAL INTEREST AND SERVICING ASSET
The residual interest and servicing asset results from the securitization of
student loans. Accordingly, the Company records this asset which includes a
residual interest, servicing rights and, in some cases, a cash reserve account.
The Company receives sales treatment on its securitizations that has resulted in
a gain on student loan securitizations on the Consolidated Statements of Income.
This gain is based upon the difference between the cost basis of the assets sold
and the fair value of the assets received. Furthermore, the Company records
servicing and securitization revenue, the ongoing revenue from securitized
pools, for both the revenue it receives for servicing loans in the
securitization trusts and the income earned on the residual interest asset.
GOODWILL AND INTANGIBLE ASSETS
The unamortized balance of goodwill at December 31, 2001 and 2000 was
$282 million and $320 million, respectively, and was included in other assets.
Goodwill is amortized on a straight-line basis over a 10 to 20 year period. For
the years ended December 31, 2001, 2000, and 1999, goodwill amortization totaled
approximately $38 million, $19 million and $3 million, respectively.
Intangible assets, included in other assets, are amortized on a
straight-line basis over a 3 to 18 year period. The following table summarizes
the unamortized balances of intangible assets acquired in the
F-9
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
July 2000 purchase of USA Group, Inc. ("USA Group") as further discussed in
Note 3 (dollars in millions):
DECEMBER 31,
------------------- USEFUL
2001 2000 LIFE
-------- -------- ------------------
Customer relationships...................................... $139 $143 3-18 years
Software/technology......................................... 72 77 7 years
Trademarks.................................................. 43 43 Indefinite
Assembled workforce......................................... 26 26 Indefinite
Employment non-compete agreements........................... 4 5 3 years
---- ----
$284 $294
==== ====
INTEREST EXPENSE
Interest expense is based upon contractual interest rates adjusted for net
payments/receipts under derivative financial instruments, which include interest
rate swap agreements and foreign currency exchange agreements, the amortization
of debt issuance costs, amortization of premiums and the accretion of discounts
and deferred gains and losses on hedge transactions entered into to reduce
interest rate risk.
GUARANTOR SERVICING FEES
The Company performs services including loan origination, account
maintenance, default aversion and collections for various guarantor agencies and
the Department of Education ("DOE"). The fees associated with these services are
accrued as they are earned. The majority of the fees result from the guarantor
servicing contract the Company has entered into with United States Aid Funds,
Inc. ("USA Funds").
INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," using the asset and liability method. Under the
asset and liability method, deferred tax assets and liabilities are determined
for temporary differences between the carrying amounts of assets or liabilities
for book purposes versus tax purposes, based on the enacted tax rates which are
expected to be in effect when the underlying items of income and expense are
expected to be realized. The Company and its eligible subsidiaries file a
consolidated U.S. federal income tax return.
EARNINGS PER COMMON SHARE
Basic earnings per common share were computed using the weighted average of
common shares outstanding during the year. Diluted earnings per common share
were computed using the weighted average of common and common equivalent shares
outstanding during the year. Common equivalent shares include shares issuable
upon exercise of incentive stock options and non-qualified stock options. Equity
forward sale transactions are included in common equivalent shares if the
average market price of the Company's stock is less than the forward contract's
exercise price.
F-10
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONSOLIDATION
The consolidated financial statements include the accounts of USA
Education, Inc. and its subsidiaries, after eliminating intercompany accounts
and transactions. As further discussed in Note 9, the Company does not
consolidate certain qualified special purpose entities created for
securitization purposes.
USE OF ESTIMATES
The Company's financial reporting and accounting policies conform to
accounting principles generally accepted in the United States ("GAAP"). The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Key accounting policies that include significant judgments and estimates include
securitization accounting, provision for loan losses, floor revenue sale
contracts and derivative accounting.
RECLASSIFICATIONS
Certain reclassifications have been made to the balances as of and for the
years ended December 31, 2000 and 1999, to be consistent with classifications
adopted for 2001.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
DERIVATIVE ACCOUNTING
In June 1998, the FASB 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 in 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 Accounting Standards No. 138, "Accounting
for Derivative Instruments and Hedging Activities--Accounting for Certain
Derivative Instruments and Certain Hedging Activities," were effective for the
Company's financial statements beginning January 1, 2001.
Upon adoption, all derivatives were recognized on the balance sheet at their
fair value. On the date the derivative contract is entered into, the Company
designates the derivative as (1) a hedge of the fair value of a recognized asset
or liability or of an unrecognized firm commitment ("fair value hedge"), (2) a
hedge of a forecasted transaction or of the variability of cash flows to be
received or paid related to a recognized asset or liability ("cash flow hedge"),
or (3) hedge accounting not sought by the Company ("trading"). In order to
qualify as a fair value or cash flow hedge, the derivative must be highly
effective in mitigating the value or cash flow fluctuation of the hedged item.
Changes in the fair value of a derivative that is highly effective as and that
is designated and qualifies as a fair value hedge, along with the gain or loss
on the hedged asset or liability that is attributable to the hedged risk
(including gains or losses on the firm commitments), are recorded in current
period earnings. Changes
F-11
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
in the fair value of a derivative that is highly effective as and that is
designated and qualifies as a cash flow hedge are recorded in other
comprehensive income until earnings are affected by the variability of cash
flows (e.g., when periodic settlements on a variable-rate asset or liability are
recorded in earnings). Last, changes in the fair value of derivative instruments
where hedge accounting is not sought are reported in current period earnings.
The Company will discontinue hedge accounting prospectively when (1) the
derivative is determined to be ineffective in offsetting changes in the fair
value or cash flows of a hedged item, including firm commitments or forecasted
transactions; (2) the derivative expires or is sold, terminated, or exercised;
(3) the derivative is de-designated as a hedge instrument, because it is
unlikely that a forecasted transaction will occur; (4) the hedged-firm
commitment no longer meets the definition of a firm commitment; or (5) the
designation of the derivative as a hedge instrument is determined to be
inappropriate by management.
When hedge accounting is discontinued because it is determined that the
derivative no longer qualifies as an effective fair value hedge, the derivative
will continue to be carried on the balance sheet at its fair value with
subsequent changes in fair value recorded through earnings, and the hedged asset
or liability will no longer be adjusted for changes in fair value. The premium
or discount related to the hedged item will be amortized into earnings. When
hedge accounting is discontinued because the hedged item no longer meets the
definition of a firm commitment, the derivative will continue to be carried on
the balance sheet at its fair value with subsequent changes in fair value
recorded through earnings, and any asset or liability that was recorded pursuant
to recognition of the firm commitment will be removed from the balance sheet and
recognized as a gain or loss in current period earnings. When hedge accounting
is discontinued because it is probable that a forecasted transaction will not
occur, the derivative will continue to be carried on the balance sheet at its
fair value with subsequent changes in fair value recorded through earnings, and
gains and losses that were accumulated in other comprehensive income will be
recognized immediately in earnings. In all other situations in which hedge
accounting is discontinued, the derivative will be carried at its fair value on
the balance sheet, with changes in its fair value recognized in current period
earnings.
In accordance with the transition provisions of SFAS 133, the Company
recorded at January 1, 2001 a net-of-tax cumulative-effect-type net gain of
$1 million in earnings and a net-of-tax cumulative-effect-type loss of
$39 million in other comprehensive income. The Company expects to amortize
$2 million of net-of-tax losses related to transition amounts during the next 12
months.
EQUITY DERIVATIVE ACCOUNTING
On March 16, 2000, the Emerging Issues Task Force ("EITF") issued EITF Issue
No. 00-7, "Application of Issue No. 96-13, 'Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own Stock,' to
Equity Derivative Instruments That Contain Certain Provisions That Require Net
Cash Settlement If Certain Events Outside the Control of the Issuer Occur." The
EITF announced a consensus that any equity derivative contract that could
require net cash settlement (as defined in EITF Issue No. 96-13) must be
accounted for as an asset or liability and cannot be included in the permanent
equity of the Company. In addition, any equity derivative contracts that could
require physical settlement by a cash payment to the counterparty in exchange
for the issuer's shares, must be accounted for as temporary equity. On
September 20, 2000, the EITF
F-12
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
reached a final consensus on EITF Issue No. 00-19, "Determination of Whether
Share Settlement is within the Control of the Issuer for Purposes of Applying
Issue No. 96-13." EITF Issue No. 00-19 provides that in order for the contract
to be accounted for as permanent equity, the contract's provisions should put
the company's counterparty in no better position than the company's common
shareholders. The EITF also confirmed the effective date of EITF Issue No. 00-7
to be June 30, 2001 for contracts entered into before September 20, 2000. If the
contract is entered into after September 20, 2000, EITF Issue No. 00-19 is
applicable at contract inception. As of December 31, 2001, the Company's equity
forward contracts satisfy the requirements of EITF No. 00-7 and EITF No. 00-19
to allow accounting through permanent equity.
SECURITIZATION ACCOUNTING
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 required new
disclosures about securitizations and retained interests in securitized
financial assets and revised 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,
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 included in Note 9. Additionally, SFAS 140 revises the criteria
involving qualifying special purpose entities. These revisions related to
special purpose entities have been applied prospectively to transfers of
financial assets and extinguishments of liabilities occurring after March 31,
2001.
In July 2000, FASB issued EITF No. 99-20 ("EITF No. 99-20"), "Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets." This statement requires that all changes in
assumptions regarding expected future cash flows related to such assets that are
used to calculate income yields be recognized prospectively through revised
income yields unless impairment is required to be recognized, at which time an
investment is written down to fair value. Impairment is deemed to have occurred
when the current present value of expected cash flows is less than the inception
date present value of expected cash flows initially projected to remain at the
current date. EITF No. 99-20 was implemented on April 1, 2001 and did not have a
material impact.
GOODWILL ACCOUNTING
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
F-13
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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), 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 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.
3. ACQUISITIONS
In July 1999, the Company completed the purchase of Nellie Mae Corporation
for $332 million in cash and stock in an acquisition accounted for as a
purchase. As a result of the purchase, the Company recorded $90 million in
goodwill. At the time of the acquisition, Nellie Mae had an outstanding student
loan portfolio of $2.6 billion. Nellie Mae's results of operations for the year
ended December 31, 1999 were immaterial to the Company's financial position and
its results of operations. The fair value of Nellie Mae's assets and liabilities
at the date of acquisition are presented below (dollars in millions):
Student loans............................................... $ 2,585
Cash and investments........................................ 15
Goodwill.................................................... 90
Other assets................................................ 97
Short-term borrowings....................................... (1,373)
Long-term notes............................................. (1,029)
Other liabilities........................................... (53)
-------
Fair value of net assets acquired........................... $ 332
=======
In July 2000, the Company completed the acquisition of Student Loan Funding
Resources, Inc. ("SLFR") from the Thomas J. Conlan Education Foundation for
$120 million in cash. SLFR was the eighth largest holder of federal student
loans in the nation with a $3.1 billion portfolio. As a result of the purchase,
the Company recorded $51 million in goodwill. SLFR's results of operations for
the years ended December 31, 2000 and 1999 were immaterial to the Company's
financial position and its results of operations. The fair value of SLFR's
assets and liabilities at the date of acquisition are presented below (dollars
in millions):
Student loans............................................... $ 3,103
Cash and investments........................................ 368
Goodwill.................................................... 51
Other assets................................................ 112
Short-term borrowings....................................... (753)
Long-term notes............................................. (2,692)
Other liabilities........................................... (69)
-------
Fair value of net assets acquired........................... $ 120
=======
F-14
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
3. ACQUISITIONS (CONTINUED)
In July 2000, the Company completed the acquisition of the guarantee
servicing, student loan servicing and secondary market operations of USA
Group, Inc. ("USA Group"). The acquisition price was $806 million in cash and
stock. As a result of the purchase, the Company recorded $149 million in
goodwill and $294 million in intangibles. USA Group's results of operations for
the years ended December 31, 2000 and 1999 were immaterial to the Company's
financial position and its results of operations. The fair value of USA Group's
assets and liabilities at the date of acquisition are presented below (dollars
in millions):
Student loans............................................... $ 1,421
Cash and investments........................................ 217
Goodwill.................................................... 149
Intangibles................................................. 294
Other assets................................................ 374
Long-term notes............................................. (1,489)
Other liabilities........................................... (160)
-------
Fair value of net assets acquired........................... $ 806
=======
4. STUDENT LOANS
The Company purchases student loans from originating lenders and originates
student loans on its own behalf. The Company's portfolio consists principally of
loans originated under two federally sponsored programs--the Federal Family
Education Loan Program ("FFELP") and the Health Education Assistance Loan
Program ("HEAL"). The Company also purchases and originates private education
loans.
The FFELP is subject to comprehensive reauthorization every six years and to
frequent statutory and regulatory changes. The most recent reauthorization was
the Higher Education Amendments of 1998.
There are three principal categories of FFELP loans: Stafford loans, PLUS
loans, and consolidation loans. Generally, Stafford and PLUS loans have
repayment periods of between five and ten years. Consolidation loans have
repayment periods of twelve to thirty years. FFELP loans obligate the borrower
to pay interest at a stated fixed rate or an annually reset variable rate that
has a cap. The interest rates are either fixed to term or reset annually on
July 1 of each year depending on when the loan was originated. The Company earns
interest at the greater of the borrower's rate or a floating rate. If the
floating rate exceeds the borrower rate, the DOE makes a payment directly to the
Company based upon the Special Allowance Payment ("SAP") formula. SAP is
generally paid whenever the average of all of the applicable floating rates
(91-day Treasury bill, commercial paper, 52-week Treasury bill, or the constant
maturity Treasury rate) in a calendar quarter, plus a spread of between 1.74 and
3.50 percentage points depending on the loan status and origination date,
exceeds the rate of interest which the borrower is obligated to pay. (See
"Appendix A--Special Allowance Payments.") If the floating rate determined by
the SAP formula 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 sets a minimum rate for determining the yield that
the Company earns on the loan.
F-15
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
4. STUDENT LOANS (CONTINUED)
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 constant maturity Treasury rate,
either directly or through the use of derivative financial instruments which are
intended to mimic the interest rate characteristics of the student loans. Such
borrowings in general, however, do not have minimum rates. As a result, in
certain declining interest rate environments, the portfolio of student loans may
be earning at the minimum borrower rate while the Company's funding costs
(exclusive of fluctuations in funding spreads) will generally decline along with
short-term interest rates. For loans where the borrower's interest rate is fixed
to term, lower interest rates may benefit the spread earned on student loans for
extended periods of time. For loans where the borrower's interest rate is reset
annually, any benefit of a low interest rate environment will only enhance
student loan spreads through the next annual reset of the borrower's interest
rates, which occurs on July 1 of each year.
The Company is required to pay to the DOE a 30 basis point offset fee on
Stafford and PLUS loans purchased and held by the GSE after August 10, 1993, and
a 105 basis point consolidation loan rebate fee on all consolidation loans
purchased and held after October 1, 1993 or a 62 basis point consolidation loan
rebate fee on all consolidation applications received between October 1, 1998
and January 31, 1999. Each fee is payable to the DOE. Also, all loans acquired
after October 1, 1993 are subject to risk sharing on claim payments under which
the loan is guaranteed for 98 percent of the balance plus accrued interest.
The estimated average remaining term of student loans in the Company's
portfolio was approximately 7.7 years and 7.2 years at December 31, 2001 and
2000, respectively. The following table reflects the distribution of the
Company's student loan portfolio by program.
DECEMBER 31,
-------------------------
2001 2000
----------- -----------
FFELP--Stafford.................................... $18,396,404 $18,844,378
FFELP--PLUS/SLS.................................... 2,637,087 1,992,605
FFELP--Consolidation loans......................... 13,968,700 11,692,286
HEAL............................................... 1,774,551 2,069,064
Non-federally insured.............................. 4,224,128 3,048,964
----------- -----------
Total student loans, net........................... $41,000,870 $37,647,297
=========== ===========
As of December 31, 2001 and 2000, 78 percent and 81 percent, respectively,
of the Company's on-balance sheet student loan portfolio was in repayment.
The Company's FFELP loans are insured against the borrower's default, death,
disability or bankruptcy. Insurance on FFELP loans is provided by certain state
or non-profit guarantee agencies, which are reinsured by the federal government.
FFELP loans originated prior to October 1, 1993 are reinsured 100 percent by the
federal government, while FFELP loans originated after October 1, 1993, except
in cases of death, disability and bankruptcy which are 100 percent insured, are
reinsured for 98 percent of their unpaid balance resulting in two percent
risk-sharing for holders of these loans. At December 31, 2001 and 2000, the
Company owned $18.8 billion and $18.3 billion of 100 percent
F-16
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
4. STUDENT LOANS (CONTINUED)
reinsured FFELP loans, and $16.2 billion and $14.2 billion of 98 percent
reinsured loans, respectively. HEAL loans are directly insured 100 percent by
the federal government.
Both FFELP and HEAL loans are subject to regulatory requirements relating to
servicing. In the event of default on a student loan or the borrower's death,
disability or bankruptcy, the Company files a claim with the insurer or
guarantor of the loan, who, provided the loan has been properly originated and
serviced, and in the case of HEAL loans, litigated, pays the Company the unpaid
principal balance and accrued interest on the loan less risk-sharing, where
applicable.
Claims not immediately honored by the guarantor because of servicing or
origination defects are returned for remedial servicing, during which period
income is not earned. On certain paid claims, guarantors assess a penalty for
minor servicing defects. Costs associated with claims on defaulted student
loans, which include such penalties, reduced interest income on student loans by
$7 million, $5 million and $5 million for the years ended December 31, 2001,
2000 and 1999, respectively.
Non-federally insured loans are primarily education-related student loans to
students attending post-secondary educational institutions or career training
institutions. The Company bears all risk of loss on these loans.
5. ALLOWANCE FOR LOSSES
The provision for loan losses represents the periodic expense of maintaining
an allowance sufficient to absorb losses, net of recoveries, inherent in the
portfolio of student loans. The Company evaluates the adequacy of the provision
for losses on its federally insured portfolio of student loans separately from
its non-federally insured portfolio. For the federally insured portfolio, the
Company primarily considers trends in student loan claims rejected for payment
by guarantors due to servicing defects as well as overall default rates on those
FFELP student loans subject to the two percent risk-sharing, i.e., those loans
that are insured as to 98 percent of principal and accrued interest. Once a
student loan is rejected for claim payment, the Company's policy is to continue
to pursue the recovery of principal and interest. Due to the nature of the FFELP
assets and the extensive collection efforts in which the Company engages, the
Company currently writes off an unpaid claim once it has aged to two years.
For the non-federally insured portfolio of student loans, the Company
primarily considers recent trends in delinquencies, charge-offs and recoveries,
historical trends in loan volume by program, economic conditions and credit and
underwriting policies. A large percentage of the Company's non-federally insured
loans have not matured to a point at which predictable loan loss patterns have
developed. Accordingly, the evaluation of the provision for loan losses is
inherently subjective as it requires material estimates that may be susceptible
to significant changes.
F-17
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
5. ALLOWANCE FOR LOSSES (CONTINUED)
The following table shows the loan delinquency trends for the years
presented on the Company's non-federally insured student loan portfolio.
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
Loans in school/deferment........................... $1,429 $ 865 $ 614
Loans in repayment
Loans current................................... 2,245 1,665 1,068
Loans current in forbearance.................... 313 208 247
Loans delinquent 30-59 days..................... 101 201 70
Loans delinquent 60-89 days..................... 45 36 19
Loans delinquent greater than 90 days........... 91 74 57
------ ------ ------
Total loans in repayment........................ 2,795 2,184 1,461
------ ------ ------
Ending non-federally insured student loan
portfolio......................................... $4,224 $3,049 $2,075
====== ====== ======
The following table summarizes changes in the allowance for student loan
losses for the years ended December 31, 2001, 2000 and 1999, respectively.
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
BALANCE AT BEGINNING OF YEAR.................. $227,406 $206,032 $202,864
Additions
Provisions for losses..................... 74,754 30,477 33,740
Recoveries................................ 10,089 5,109 6,354
Reserves acquired......................... -- 7,585 9,434
Other..................................... 24,922 21,226 3,334
Deductions
Reductions for student loan sales and
securitizations......................... (13,608) (16,648) (8,445)
Charge-offs............................... (58,423) (26,375) (41,249)
-------- -------- --------
BALANCE AT END OF YEAR........................ $265,140 $227,406 $206,032
======== ======== ========
The provision for losses reflected in the Consolidated Statements of Income
also includes a $9 million benefit, a $2 million provision and a $1 million
provision for the years ended December 31, 2001, 2000 and 1999, respectively,
for the maintenance of certain reserves.
6. INVESTMENTS
At December 31, 2001 and 2000, all investments that are classified as
trading and available-for-sale securities are carried at fair market value. In
the year ended December 31, 2000 the fair market value of U.S. Treasury
securities was adjusted for unrealized gains and losses on $1.1 billion
(notional) of interest rate swaps (see Note 10), which are held to reduce
interest rate risk related to these securities ($43 million of unrealized losses
at December 31, 2000). With the adoption of SFAS 133 on January 1,
F-18
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. INVESTMENTS (CONTINUED)
2001, the fair value of these interest rate swaps are recorded as a derivative
valuation in the other liabilities section of the balance sheet. Securities
classified as held-to-maturity are carried at cost. A summary of investments at
December 31, 2001 and 2000 follows:
DECEMBER 31, 2001
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
Trading
U.S. Treasury and other U.S. government agency
obligations
U.S. Treasury securities (Rabbi Trust)....... $ 763 $ 28 $ -- $ 791
---------- -------- -------- ----------
Total investment securities trading.......... $ 763 $ 28 $ -- $ 791
========== ======== ======== ==========
Available-for-sale
U.S. Treasury and other U.S. government
agencies obligations
U.S. Treasury securities..................... $1,087,183 $502,324 $(11,470) $1,578,037
State and political subdivisions of the U.S.
student loan revenue bonds................... 106,499 2,501 -- 109,000
Asset-backed and other securities
Asset-backed securities...................... 2,202,652 1,554 (3,261) 2,200,945
Commercial paper............................. 43,437 -- -- 43,437
Third party repurchase agreements............ 110,700 -- -- 110,700
Discount notes............................... 1,811 26 -- 1,837
Other securities............................. 9,784 -- (21) 9,763
---------- -------- -------- ----------
Total investment securities
available-for-sale......................... $3,562,066 $506,405 $(14,752) $4,053,719
========== ======== ======== ==========
Held-to-maturity
Other.......................................... $1,017,642 $ 274 $ -- $1,017,916
---------- -------- -------- ----------
Total investment securities held-to-maturity..... $1,017,642 $ 274 $ -- $1,017,916
========== ======== ======== ==========
F-19
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. INVESTMENTS (CONTINUED)
DECEMBER 31, 2000
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
Available-for-sale
U.S. Treasury and other U.S. government agency
obligations
U.S. Treasury securities..................... $ 975,995 $506,205 $(54,491) $1,427,709
State and political subdivisions of the U.S.
student loan revenue bonds................... 123,765 2,172 -- 125,937
Asset-backed and other securities
Asset-backed securities...................... 1,440,451 894 (7,640) 1,433,705
Commercial paper............................. 1,109,955 -- -- 1,109,955
Third party repurchase agreements............ 108,600 -- -- 108,600
Discount notes............................... 34,558 27 (1) 34,584
Other securities............................. 5,143 -- (871) 4,272
---------- -------- -------- ----------
Total investment securities
available-for-sale......................... $3,798,467 $509,298 $(63,003) $4,244,762
========== ======== ======== ==========
Held-to-maturity
Other.......................................... $ 961,260 $ 130 $ (75) $ 961,315
---------- -------- -------- ----------
Total investment securities held-to-maturity..... $ 961,260 $ 130 $ (75) $ 961,315
========== ======== ======== ==========
The Company sold available-for-sale securities with a carrying value of
$2.8 billion, $960 million and $194 million for the years ended December 31,
2001, 2000 and 1999, respectively. These sales resulted in gross realized gains
of $3 million, $37 million and $14 million for the years ended December 31,
2001, 2000 and 1999, respectively. These sales resulted in gross realized losses
of $1 million for each of the years ended December 31, 2001 and 2000. There were
no gross realized losses in 1999.
Included in the Company's December 31, 2001 and December 31, 2000 balances
of held-to-maturity assets were investments in leveraged leases of $296 million
and $291 million, respectively. As of December 31, 2001 and December 31, 2000,
$282 million and $276 million, respectively, of these leveraged leases 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. 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 $259 million and $263 million at
December 31, 2001 and December 31, 2000, respectively. Any potential loss would
be increased by incremental tax obligations related to forgiveness of debt
obligations.
F-20
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. INVESTMENTS (CONTINUED)
As of December 31, 2001, stated maturities and maturities if accelerated to
the put or call dates for investments are shown in the following table:
DECEMBER 31, 2001
------------------------------------------------
HELD-TO- AVAILABLE-FOR-SALE
MATURITY ------------------------ TRADING
---------- MATURITY TO --------
STATED STATED PUT OR CALL STATED
YEAR OF MATURITY MATURITY MATURITY DATE MATURITY
- ---------------- ---------- ---------- ----------- --------
2002............................. $ 15,249 $ 292,346 $ 307,619 $618
2003............................. 99,055 102,199 95,847 173
2004............................. 6,458 215,434 207,547 --
2005............................. 10,614 721,349 726,911 --
2006............................. 4,500 637,728 634,233 --
2007-2011........................ 423,840 1,828,309 1,825,208 --
After 2011....................... 457,926 256,354 256,354 --
---------- ---------- ---------- ----
Total............................ $1,017,642 $4,053,719 $4,053,719 $791
========== ========== ========== ====
7. SHORT-TERM BORROWINGS
Short-term borrowings have an original or remaining term to maturity of one
year or less. The following tables summarize outstanding short-term notes at
December 31, 2001, 2000 and 1999, the weighted average interest rates at the end
of each period, and the related average balances, weighted average interest
rates and weighted average effective interest rates, which include the effects
of related derivative instruments (see Note 10) during the periods.
DECEMBER 31, 2001 YEAR ENDED DECEMBER 31, 2001
---------------------- ----------------------------------
WEIGHTED
WEIGHTED WEIGHTED AVERAGE
AVERAGE AVERAGE EFFECTIVE
ENDING INTEREST AVERAGE INTEREST INTEREST
BALANCE RATE BALANCE RATE RATE
----------- -------- ----------- -------- ---------
Six month floating rate notes............... $ 3,149,421 1.90% $ 4,111,595 4.04% 4.17%
Other floating rate notes................... 2,901,235 1.99 8,183,464 4.31 4.33
Discount notes.............................. 7,345,038 2.35 8,834,578 4.34 4.37
Fixed rate notes............................ 1,550,000 3.17 782,657 3.75 3.46
Commercial paper............................ 449,712 1.94 524,911 4.22 4.54
Securities sold--not yet purchased and
repurchase agreements..................... -- -- 65,215 5.12 5.12
Short-term portion of long-term notes....... 15,669,415 2.57 13,149,619 4.01 3.99
----------- ---- ----------- ---- ----
Total short-term borrowings................. $31,064,821 2.42% $35,652,039 4.16% 4.18%
=========== ==== =========== ==== ====
Maximum outstanding at any month end........ $41,669,088
===========
F-21
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
7. SHORT-TERM BORROWINGS (CONTINUED)
DECEMBER 31, 2000 YEAR ENDED DECEMBER 31, 2000
---------------------- ----------------------------------
WEIGHTED
WEIGHTED WEIGHTED AVERAGE
AVERAGE AVERAGE EFFECTIVE
ENDING INTEREST AVERAGE INTEREST INTEREST
BALANCE RATE BALANCE RATE RATE
----------- -------- ----------- -------- ---------
Six month floating rate notes............... $ 5,199,084 6.56% $ 4,659,778 6.41% 6.49%
Other floating rate notes................... 10,408,129 6.62 10,851,918 6.54 6.54
Discount notes.............................. 6,274,994 6.33 5,808,364 6.19 6.24
Fixed rate notes............................ 360,000 6.54 2,043,618 5.96 6.01
Commercial paper............................ 619,248 6.75 600,781 6.47 6.89
Securities sold--not yet purchased and
repurchase agreements..................... -- -- 123,948 6.96 6.96
Short-term portion of long-term notes....... 7,602,533 6.37 11,242,038 6.28 6.40
----------- ---- ----------- ---- ----
Total short-term borrowings................. $30,463,988 6.49% $35,330,445 6.35% 6.41%
=========== ==== =========== ==== ====
Maximum outstanding at any month end........ $39,064,856
===========
DECEMBER 31, 1999 YEAR ENDED DECEMBER 31, 1999
---------------------- ----------------------------------
WEIGHTED
WEIGHTED WEIGHTED AVERAGE
AVERAGE AVERAGE EFFECTIVE
ENDING INTEREST AVERAGE INTEREST INTEREST
BALANCE RATE BALANCE RATE RATE
----------- -------- ----------- -------- ---------
Six month floating rate notes.............. $ 4,849,106 5.81% $ 4,644,440 5.30% 5.38%
Other floating rate notes.................. 12,478,317 5.83 10,223,891 5.35 5.42
Discount notes............................. 1,406,163 5.45 4,407,311 4.90 5.00
Fixed rate notes........................... 3,777,793 5.84 3,370,924 5.41 5.20
Commercial paper........................... 394,968 6.47 56,822 5.82 6.10
Securities sold--not yet purchased and
repurchase agreements.................... -- -- 94,575 4.87 4.91
Short-term portion of long-term notes...... 14,584,904 5.84 10,405,996 5.43 5.33
----------- ---- ----------- ---- ------
Total short-term borrowings................ $37,491,251 5.76% $33,203,959 5.31% 5.31%
=========== ==== =========== ==== ======
Maximum outstanding at any month end....... $39,618,707
===========
To match the interest rate characteristics of short-term notes with the rate
characteristics of certain assets, the Company enters into interest rate swaps
with independent parties. Under these agreements, the Company makes periodic
payments, indexed to the related asset rates, in exchange for periodic payments
which generally match the Company's interest obligations on fixed or variable
rate notes (see Note 10).
8. LONG-TERM NOTES
The following tables summarize outstanding long-term notes at December 31,
2001 and 2000, the weighted average interest rates and related notional amount
of derivatives used to economically hedge
F-22
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
8. LONG-TERM NOTES (CONTINUED)
at the end of the periods, and the related average balances and weighted average
effective interest rates, which include the effects of related derivative
instruments (see Note 10), during the periods. The derivative instruments
presented in the tables represent derivatives considered to be economic hedges
of the related long-term notes for risk management purposes. However, some may
not be considered effective hedges under SFAS 133.
YEAR ENDED
DECEMBER 31, 2001 DECEMBER 31, 2001
------------------------------------ -----------------------
WEIGHTED
WEIGHTED AVERAGE
AVERAGE NOTIONAL EFFECTIVE
ENDING INTEREST AMOUNT OF AVERAGE INTEREST
BALANCE RATE DERIVATIVES BALANCE RATE
----------- -------- ----------- ----------- ---------
Floating rate notes:
U.S. dollar denominated:
Interest bearing, due 2003-2047....... $ 7,084,942 2.13% $ 2,460,000 $ 8,261,573 4.24%
----------- ----- ----------- ----------- -----
Fixed rate notes:
U.S. dollar denominated:
Interest bearing, due 2003-2019....... 9,998,045 4.59 8,720,000 5,594,100 4.69
Zero coupon, due 2014-2022............ 202,363 11.79 -- 191,523 11.14
----------- ----- ----------- ----------- -----
Total fixed rate notes.................... 10,200,408 4.73 8,720,000 5,785,623 4.90
----------- ----- ----------- ----------- -----
Total long-term notes..................... $17,285,350 3.66% $11,180,000 $14,047,196 4.51%
=========== ===== =========== =========== =====
YEAR ENDED
DECEMBER 31, 2000 DECEMBER 31, 2000
------------------------------------ ----------------------
WEIGHTED
WEIGHTED AVERAGE
AVERAGE NOTIONAL EFFECTIVE
ENDING INTEREST AMOUNT OF AVERAGE INTEREST
BALANCE RATE DERIVATIVES BALANCE RATE
----------- -------- ----------- ---------- ---------
Floating rate notes:
U.S. dollar denominated:
Interest bearing, due 2002-2047......... $13,345,844 6.50% $ 441,650 $6,846,997 6.55%
----------- ----- ---------- ---------- -----
Fixed rate notes:
U.S. dollar denominated:
Interest bearing, due 2002-2019......... 1,384,060 6.32 650,000 1,617,895 6.39
Zero coupon, due 2014-2022.............. 181,035 11.79 -- 171,313 11.17
----------- ----- ---------- ---------- -----
Total fixed rate notes...................... 1,565,095 6.95 650,000 1,789,208 6.85
----------- ----- ---------- ---------- -----
Total long-term notes....................... $14,910,939 6.55% $1,091,650 $8,636,205 6.61%
=========== ===== ========== ========== =====
F-23
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
8. LONG-TERM NOTES (CONTINUED)
At December 31, 2001, the Company had outstanding long-term debt issues with
call features totaling $2.5 billion. As of December 31, 2001, the stated
maturities and maturities if accelerated to the call dates for long-term notes
are shown in the following table:
DECEMBER 31, 2001
-------------------------
STATED MATURITY TO
YEAR OF MATURITY MATURITY CALL DATE
- ---------------- ----------- -----------
2002............................................... $ -- $ 2,330,000
2003............................................... 7,135,933 5,205,933
2004............................................... 7,069,372 6,869,372
2005............................................... 459,477 259,477
2006............................................... 1,100,550 1,100,550
2007-2047.......................................... 1,520,018 1,520,018
----------- -----------
$17,285,350 $17,285,350
=========== ===========
To match the interest rate characteristics of its long-term notes with the
interest rate characteristics of its assets, the Company enters into interest
rate swaps with independent parties. Under these agreements, the Company makes
periodic payments, generally indexed to the related asset rates, in exchange for
periodic payments which generally match the Company's interest obligations on
fixed or variable rate borrowings (see Note 10).
Prior to and grandfathered from the issuance of SFAS 140, the Company has
engaged in several transactions in which debt is considered to be extinguished
by in-substance defeasance as governed by the provisions of SFAS No. 76,
"Extinguishment of Debt." In these transactions, the Company irrevocably placed
assets with an escrow agent in a trust to be used solely for satisfying
scheduled payments of both the interest and principal of the defeased debt. The
possibility that the Company will be required to make future payments on that
debt is considered to be remote. The trusts are restricted to owning only
monetary assets that are essentially risk-free as to the amount, timing and
collection of interest and principal. As of December 31, 2001, the amount of
debt considered to be extinguished was $852 million.
9. STUDENT LOAN SECURITIZATION
When the Company sells receivables in securitizations of student loans, it
retains a residual interest, servicing rights and, in some cases, a cash reserve
account, all of which are retained interests in the securitized receivables. At
December 31, 2001 and 2000, the balance of these assets was $1.9 billion and
$961 million, respectively. Gain or loss on sale of the receivables is based
upon 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, 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 commensurate
with the risks involved.
F-24
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
9. STUDENT LOAN SECURITIZATION (CONTINUED)
The following table summarizes the changes in the fair value of the retained
interest for the years ended December 31, 2001 and 2000, respectively.
DECEMBER 31,
----------------------
2001 2000
---------- ---------
Fair value at beginning of year............................. $ 961,252 $ 757,677
Additions from new securitizations.......................... 127,958 281,595
Deductions from excess trust cash received.................. (425,472) (165,226)
Fair market value adjustments(1)............................ 729,317 468
Securitization revenue and other income..................... 466,395 86,738
---------- ---------
Fair value at end of year................................... $1,859,450 $ 961,252
========== =========
- ------------------------
(1) Includes the mark-to-market on the retained interest as well as the
mark-to-market on the embedded floor option within the retained interest.
The Company revalues its retained interest on a quarterly basis. The fair
market value adjustment is performed by considering the actual quarters' cash
flows and projected future cash flows based on current market spread curves.
Also included in the fair market value adjustment is the fair market value of
the imbedded floor revenue options associated with the securitized loans. As of
December 31, 2001, the fair market value of the embedded floor revenue options
included in the balance of the retained interest in securitized receivables was
$485 million.
During 2001 and 2000, the Company sold student loan receivables in
securitization transactions. In those securitizations, the Company retained
servicing responsibilities. The Company receives 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 for the securitization transactions engaged in by its
subsidiary, the Student Loan Marketing Association. 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. Interest rate
risks exist to the extent that the securitized assets, which are Treasury
bill-based or commercial paper-based, are utilized as collateral for either
LIBOR-based debt, or Treasury bill-based debt or commercial paper-based debt
that resets on dates that are not consistent with the securitized asset reset
dates.
For the years ended December 31, 2001, 2000 and 1999, the Company recognized
pre-tax securitization gains of $75 million, $92 million and $35 million,
respectively.
The weighted average life of the student loans securitized during the year
2001 was 4.8 years. Key economic assumptions used in measuring the fair value of
retained interests at the date of
F-25
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
9. STUDENT LOAN SECURITIZATION (CONTINUED)
securitization resulting from student loan securitizations completed during the
year 2001 (weighted based on principal amounts securitized) were as follows:
Prepayment speed............................................ 7% per annum
Expected credit losses...................................... .52%
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 range 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 (paid to)
securitization trusts during the year ended December 31, 2001 and 2000 (dollars
in millions):
2001 2000
-------- --------
Proceeds from new securitizations.......................... $6,091 $8,673
Collections used to purchase new balances in revolving
securitizations.......................................... 441 133
Servicing fees received.................................... 261 227
Cash flows received on residual interest................... 458 200
Cash received upon release from reserve accounts........... 463 203
Servicing advances......................................... -- --
Reimbursements of servicing advances....................... -- --
Prepayment interest shortfalls paid out as compensating
interest................................................. -- --
Losses on the student loan pool are calculated by summing the actual and
projected future credit losses and dividing them by the original balance of each
pool of assets. The following table reflects
F-26
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
9. STUDENT LOAN SECURITIZATION (CONTINUED)
static pool losses for the years ended December 31, 2001, 2000 and 1999. Amounts
shown are calculated based on all securitizations occurring in that year.
STUDENT LOANS
SECURITIZED IN
------------------------------
2001 2000 1999
-------- -------- --------
ACTUAL AND PROJECTED CREDIT LOSSES (%) AS OF:
DECEMBER 31, 2001
Actual to date............................................. .01% .05% .07%
Projected.................................................. .54 .51 .46
--- --- ---
Total...................................................... .55% .56% .53%
=== === ===
DECEMBER 31, 2000
Actual to date............................................. --% .01% .04%
Projected.................................................. -- .55 .55
--- --- ---
Total...................................................... --% .56% .59%
=== === ===
DECEMBER 31, 1999
Actual to date............................................. --% --% --%
Projected.................................................. -- -- .53
--- --- ---
Total...................................................... --% --% .53%
=== === ===
The following table reflects key economic assumptions at December 31, 2001
and 2000, and the sensitivity of the current fair value of residual cash flows
to immediate 10 percent and 20 percent adverse changes in those assumptions
(dollars in millions):
STUDENT LOANS
-------------------
2001 2000
-------- --------
Balance sheet carrying value of residual interest--fair
value (millions).......................................... $1,844 $ 937
Weighted-average life (in years)............................ 4.1 4.2
Prepayment speed assumptions
Impact on fair value of 10% adverse change................ $(19.9) $(17.0)
Impact on fair value of 20% adverse change................ (39.6) (33.8)
Expected default rate
Impact on fair value of 10% adverse change................ (14.2) (10.3)
Impact on fair value of 20% adverse change................ (28.4) (20.6)
Residual cash flows discount rate
Impact on fair value of 10% adverse change................ (42.0) (33.7)
Impact on fair value of 20% adverse change................ (81.9) (66.7)
Difference between Treasury bill and LIBOR swap spread*
Impact on fair value of 10% adverse change................ (37.2) (42.7)
Impact on fair value of 20% adverse change................ (74.6) (85.4)
- ------------------------
* Changes impact only LIBOR indexed securitized notes and certificates only.
F-27
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
9. STUDENT LOAN SECURITIZATION (CONTINUED)
These sensitivities are hypothetical and should be used with caution. Also,
in this table the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption. In reality, changes in one factor may result in changes in another
(for example, increases in market interest rates may result in lower prepayments
and increased credit losses), which might magnify or counteract the
sensitivities.
The following table reflects the historical loss and delinquency amounts for
the managed portfolio for the years ended December 31, 2001 and 2000 (dollars in
millions):
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2001 2001 2000 2000
--------------------- --------------------- --------------------- ---------------------
TOTAL CREDIT TOTAL CREDIT
PRINCIPAL PRINCIPAL LOSSES PRINCIPAL PRINCIPAL LOSSES
AMOUNT IN CLAIM AVERAGE NET OF AMOUNT IN CLAIM AVERAGE NET OF
OF LOANS STATUS BALANCE RECOVERIES OF LOANS STATUS BALANCE RECOVERIES
STUDENT LOAN RECEIVABLES --------- --------- -------- ---------- --------- --------- -------- ----------
Comprised of:
Loans held in portfolio....... $41,001 $151 $40,025 $48 $37,647 $111 $34,637 $21
Loans securitized............. 30,725 183 30,594 23 29,868 101 25,711 5
------- ---- ------- --- ------- ---- ------- ---
Total loans managed........... $71,726 $334 $70,619 $71 $67,515 $212 $60,348 $26
======= ==== ======= === ======= ==== ======= ===
10. DERIVATIVE FINANCIAL INSTRUMENTS
RISK MANAGEMENT STRATEGY
The Company maintains an overall interest rate risk management strategy that
incorporates the use of derivative instruments to minimize the economic effect
of 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. Management
believes certain derivative transactions are economically effective; however,
those transactions may not qualify for hedge accounting under SFAS 133 (as
discussed below) and thus may adversely impact earnings. As a result of interest
rate fluctuations, hedged assets and liabilities will appreciate or depreciate
in market value. Income or loss on the derivative instruments that are linked to
the hedged assets and liabilities will generally offset the effect of this
unrealized appreciation or depreciation. The Company views this strategy as a
prudent management of interest rate sensitivity.
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
F-28
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
10. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
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. At
December 31, 2001 and 2000, such net positive exposure is $15 million and
$16 million, respectively.
Market risk is the adverse effect that a change in interest rates, or
implied volatility rates, has on the value of a financial instrument. The
Company manages the market risk associated with interest rates by establishing
and monitoring limits as to the types and degree of risk that may be undertaken.
The Company's Audit/Finance Committee of the Board of Directors, as part of
its oversight of the Company's asset/liability and treasury functions, monitors
the Company's derivative activities. The Company is responsible for implementing
various hedging strategies. The resulting hedging strategies are then
incorporated into the Company's overall interest rate risk management and
trading strategies.
SFAS 133
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. On January 1,
2001, the Company adopted SFAS 133 which requires that every derivative
instrument, including certain derivative instruments embedded in other
contracts, be recorded in the balance sheet as either an asset or liability
measured at its fair value. Derivative instruments are classified and accounted
for by the Company as either fair value, cash flow, or trading as defined by
SFAS 133.
FAIR VALUE HEDGES
Fair value hedges are generally used by the Company to hedge the exposure to
changes in fair value of a recognized fixed rate asset or liability. The Company
enters into interest rate swaps to convert fixed rate assets into variable rate
assets and fixed rate debt into variable rate debt. For hedges of fixed rate
debt, the Company considers all components of the derivatives gain and/or loss
when assessing hedge effectiveness. For hedges of fixed rate assets, the Company
considers only the changes due to interest rate movements when assessing
effectiveness.
CASH FLOW HEDGES
Cash flow hedges are generally used by the Company to hedge the exposure of
variability in cash flows of a forecasted transaction. The Company uses futures
contracts to hedge its interest rate risk on its assets and liabilities. This
strategy is used primarily to minimize the exposure to volatility in interest
rates. Gains and losses on derivative contracts are accumulated in other
comprehensive income and reclassified to current period earnings when the stated
hedged transactions occur (in which case gains and losses are amortized over the
life of the transaction) or are deemed unlikely to occur (in which case gains
and losses are taken immediately). The Company expects to reclassify $6 million
of after-tax
F-29
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
10. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
net losses during the next 12 months related to futures contracts closed as of
December 31, 2001. In addition, the Company expects to reclassify as earnings
portions of the accumulated deferred net losses related to open futures
contracts during the next 12 months based on the anticipated issuance of debt.
In assessing hedge effectiveness, all components of each derivative's gains or
losses are included in the assessment.
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
When instruments do not qualify as hedges under SFAS 133, they are
classified as trading. The Company purchases interest rate caps and futures
contracts and sells interest rate floors, caps, 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, commercial paper, 52 week Treasury bill, or constant maturity Treasury
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, and on other factors such as short-term
strategic initiatives. In addition, interest rate swaps and futures contracts
which do not qualify as fair value or cash flow hedges are classified as
trading.
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.
F-30
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
10. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
SUMMARY OF DERIVATIVE FINANCIAL STATEMENT IMPACT
The following tables summarize the fair and notional value of all derivative
instruments and their impact on other comprehensive income and earnings.
DECEMBER 31,
-----------------------------------------------------------------------
CASH FLOW FAIR VALUE TRADING
------------------- ------------------- -------------------
2001 2000 2001 2000 2001 2000
-------- -------- -------- -------- -------- --------
FAIR VALUES (DOLLARS IN MILLIONS)
Interest rate swaps.......................... $ -- $ -- $ (18) $ (43)(1) $(128) $ --
Floor/Cap contracts.......................... -- -- -- -- (745) (235)
Futures...................................... (40) (57) -- -- (61) --
Hedged item.................................. -- -- 366 398 -- --
NOTIONAL VALUES (DOLLARS IN BILLIONS)
Interest rate swaps.......................... $ -- $ -- $ 8.1 $ 1.1 $48.3 $ --
Floor/Cap contracts.......................... -- -- -- -- 20.7 8.1
Futures...................................... 25.0 28.8 -- -- 36.0 --
- ------------------------
(1) Reverse swaps hedging Treasury receipts were recorded on the Consolidated
Balance Sheets as an offset to the investment's fair value for
December 31, 2000.
YEAR ENDED DECEMBER 31, 2001
---------------------------------
CASH FLOW FAIR VALUE TRADING
--------- ---------- --------
CHANGES TO OTHER COMPREHENSIVE INCOME, NET OF TAX
(DOLLARS IN MILLIONS)
Other comprehensive income, net............................. $(52) $ -- $ 2(5)
==== ==== =====
EARNINGS SUMMARY (DOLLARS IN MILLIONS)
Recognition of closed futures contracts' gains/losses into
earnings(1)............................................... $(86) $ -- $ (92)
Amortization of transition adjustment(2).................... -- -- (3)
Mark-to-market earnings(3).................................. -- (7)(4) (445)
---- ---- -----
Total earnings impact....................................... $(86) $ (7) $(540)
==== ==== =====
- ------------------------
(1) Reported as interest expense (for hedges where the stated transaction
occurred) or as gains and losses on sales of securities (for discontinued
hedges and closed futures contracts classified as "trading") in the
Consolidated Statements of Income.
(2) Reported as a component of other operating income in the Consolidated
Statements of Income.
(3) Reported as derivative market value adjustment in the Consolidated
Statements of Income.
(4) The mark-to-market earnings for fair value hedges represent amounts
related to ineffectiveness.
(5) Represents amortization out of other comprehensive income, net.
F-31
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
10. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
The following table shows the components of the change in accumulated other
comprehensive income net, for derivatives (dollars in millions).
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME, NET
-------------
Balance, December 31, 2000 $ --
Transition adjustment..................................... (39)
Transition adjustment amortization........................ 2
Additions due to changes in fair value of cash flow
hedges.................................................. (69)
Amortizations............................................. 8
Discontinued hedges....................................... 48
----
Balance, December 31, 2001.................................. $(50)
====
The table below reconciles the mark-to-market earnings to the change in fair
values from December 31, 2000 to December 31, 2001 (dollars in millions).
YEARS ENDED
DECEMBER 31, 2001
---------------------
FAIR VALUE TRADING
---------- --------
Change in value of hedged item.............................. $(32) $ --
Change in value of derivatives.............................. 25 (699)
Premiums received from caps/floors.......................... -- 300
Extinguishment of floor contracts........................... -- (46)
---- -----
Total mark-to-market earnings............................... $ (7) $(445)
==== =====
DERIVATIVE INSTRUMENTS
INTEREST RATE SWAPS
The Company enters into three general types of interest rate swaps under
which it pays the following: 1) a floating rate in exchange for a fixed rate
(standard swaps); 2) a fixed rate in exchange for a floating rate (reverse
swaps); and 3) a floating rate in exchange for another floating rate, based upon
different market indices (basis/reverse basis swaps). At December 31, 2001, the
Company had outstanding $7.3 billion, $1.2 billion and $46.2 billion of notional
principal amount of standard swaps, reverse swaps and basis/reverse basis swaps,
respectively. Of the Company's $54.7 billion notional amount of interest rate
swaps outstanding at December 31, 2001, $20.1 billion was hedging debt and
$34.6 billion was hedging assets. At December 31, 2000, the Company had notional
principal outstanding of $2.1 billion, $3.5 billion and $11.5 billion of
standard swaps, reverse swaps and basis/ reverse basis swaps, respectively. Of
the Company's $17.1 billion notional amount of interest rate swaps outstanding
at December 31, 2000, $4.9 billion was hedging debt and $12.2 billion was
hedging assets.
F-32
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
10. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
In addition, at December 31, 2001, the Company had entered into
$1.7 billion of forward interest rate swaps which were priced in October and
December of 2001 but are not effective until 2002. The fair values of these
swaps are recorded on the Consolidated Balance Sheets at December 31, 2001.
The following tables summarize the notional amount of interest rate swaps
that are hedging borrowings at December 31, 2001 and 2000 (dollars in billions).
DECEMBER 31, 2001
---------------------------------------------------
SWAPS
------------------------
BASIS/ TOTAL
BORROWINGS STANDARD REVERSE BASIS DERIVATIVES
---------- -------- ------------- -----------
SHORT-TERM BORROWINGS
Six month floating rate notes.......................... $ -- $ -- $ -- $ --
Other floating rate notes.............................. .8 -- 1.5 1.5
Discount notes......................................... 1.7 .7 1.7 2.4
Fixed rate notes....................................... 1.6 1.6 1.6 3.2
Short-term portion of long-term notes.................. 1.1 .7 1.1 1.8
----- ---- ----- -----
Total short-term borrowings...................... 5.2 3.0 5.9 8.9
----- ---- ----- -----
LONG-TERM NOTES
Floating rate notes:
U.S. dollar denominated:
Interest bearing................................... 1.5 -- 2.5 2.5
Fixed rate notes:
U.S. dollar denominated:
Interest bearing................................... 4.4 4.3 4.4 8.7
----- ---- ----- -----
Total long-term notes............................ 5.9 4.3 6.9 11.2
----- ---- ----- -----
Total notes...................................... $11.1 $7.3 $12.8 $20.1
===== ==== ===== =====
DECEMBER 31, 2000
---------------------------------------------------
SWAPS
------------------------
BASIS/ TOTAL
BORROWINGS STANDARD REVERSE BASIS DERIVATIVES
---------- -------- ------------- -----------
SHORT-TERM BORROWINGS
Six month floating rate notes.......................... $ -- $ -- $ -- $ --
Other floating rate notes.............................. .2 -- .2 .2
Discount notes......................................... .8 -- .8 .8
Fixed rate notes....................................... .4 .4 -- .4
Short-term portion of long-term notes.................. 1.5 1.3 1.1 2.4
---- ---- ----- -----
Total short-term borrowings...................... 2.9 1.7 2.1 3.8
---- ---- ----- -----
LONG-TERM NOTES
Floating rate notes:
U.S. dollar denominated:
Interest bearing................................... .4 -- .4 .4
Fixed rate notes:
U.S. dollar denominated:
Interest bearing................................... .4 .4 .3 .7
---- ---- ----- -----
Total long-term notes............................ .8 .4 .7 1.1
---- ---- ----- -----
Total notes...................................... $3.7 $2.1 $ 2.8 $ 4.9
==== ==== ===== =====
F-33
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
10. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
The following table summarizes the activity for the Company's interest rate
swaps and futures contracts held or issued for economic hedging purposes for the
years ended December 31, 1999, 2000 and 2001 (dollars in millions).
NOTIONAL PRINCIPAL FUTURES
INTEREST RATE CONTRACT
SWAPS AMOUNT
------------------ ---------
Balance, December 31, 1998........................ $ 30,599 $ 566
Issuances/Opens................................. 13,634 4,314
Maturities/Expirations.......................... (19,863) --
Terminations/Closes............................. (30) (3,850)
-------- ---------
Balance, December 31, 1999........................ 24,340 1,030
Issuances/Opens................................. 10,524 66,566
Maturities/Expirations.......................... (17,662) --
Terminations/Closes............................. (104) (38,762)
-------- ---------
Balance, December 31, 2000........................ 17,098 28,834
Issuances/Opens................................. 79,871 258,468
Maturities/Expirations.......................... (42,250) --
Terminations/Closes............................. -- (226,337)
-------- ---------
Balance, December 31, 2001........................ $ 54,719 $ 60,965
======== =========
The increase from December 31, 2000 to December 31, 2001 in the notional
principal amount of interest rate swaps outstanding is primarily due to an
increase in basis swaps that were executed to economically hedge interest rate
differences between Treasury bill, commercial paper and LIBOR indexes. The
increase from December 31, 2000 to December 31, 2001 in futures contracts
outstanding is primarily due to the economic hedging of interest rate risk on
annual reset student loans.
Net payments related to the debt-related swaps are recorded in interest
expense. For the year ended December 31, 2001, the Company received net payments
on debt-related swaps decreasing interest expense by $55 million. For the years
ended December 31, 2000 and 1999, the Company made or received net payments on
debt-related swaps increasing interest expense by $5 million and decreasing
interest expense by $26 million, respectively.
At December 31, 2001, the Company had interest rate swaps with put features
totaling $3.5 billion. As of December 31, 2001, stated maturities of interest
rate swaps and maturities, if accelerated to the put dates, are shown in the
following table (dollars in millions). The maturities of interest rate swaps
generally coincide with the maturities of the associated assets or borrowings.
DECEMBER 31, 2001
----------------------
STATED MATURITY
YEAR OF MATURITY/PUT MATURITY TO PUT DATE
- -------------------- -------- -----------
2002.................................................... $24,773 $27,073
2003.................................................... 9,230 7,330
2004.................................................... 6,840 6,640
2005.................................................... 268 68
2006.................................................... 2,512 2,512
2007-2008............................................... 11,096 11,096
------- -------
$54,719 $54,719
======= =======
F-34
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
10. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
FUTURES CONTRACTS
The Company enters into financial futures contracts to hedge the risk of
future interest rate changes. The contracts provide a better matching of
interest rate reset dates on debt with the Company's assets. They are also used
as anticipatory hedges of debt to be issued to fund the Company's assets.
FLOOR REVENUE CONTRACTS
The Company enters into floor revenue contracts with third parties, under
which the Company receives an upfront payment and agrees to pay the difference
between a fixed rate, which is based on the minimum borrower interest rate less
the applicable Special Allowance Payment ("SAP") rate ("the Strike Rate") and
the average of 91-day Treasury bill or commercial paper rates over the period of
the contract. If the Strike Rate is less than the average Treasury bill or
commercial paper rate, then no payment is required.
During 2001, 2000 and 1999, the Company entered into floor revenue contracts
with notional principal balances of $20.5 billion, $10.0 billion and
$5.0 billion, respectively, in exchange for upfront payments of $293 million,
$122 million and $6 million, respectively. For the years ended December 31, 2000
and 1999, the amortization of the upfront payments on fixed and variable floor
revenue contracts increased student loan income by $24 million and $41 million,
respectively, of which $23 million and $20 million, respectively, related to
contracts with fixed borrower rates and $1 million and $21 million,
respectively, related to contracts with annually reset borrower rates. With the
adoption of SFAS 133 on January 1, 2001, the upfront floor premiums are no
longer being amortized to student loan income but are reported as other
liabilities as part of the derivative valuation. For the years ended
December 31, 2001, 2000 and 1999, payments by the Company to floor revenue
contract counterparties under the contracts totaled $243 million, $1 million and
$60 million, respectively.
In 2000, the Company entered into LIBOR floor revenue contracts. These
positions do not meet the hedge effectiveness requirements under GAAP and were
marked-to-market at December 31, 2000, which resulted in a pre-tax loss of
$25 million included in other income. No such transactions were in effect for
1999.
11. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires estimation of the fair values of financial instruments. The following
is a summary of the assumptions and methods used to estimate those values.
STUDENT LOANS
Fair value was determined by analyzing amounts that the Company has paid
recently to acquire similar loans in the secondary market.
F-35
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
11. FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
WAREHOUSING ADVANCES AND ACADEMIC FACILITIES FINANCINGS
The fair values of both warehousing advances and academic facilities
financings were determined through standard bond pricing formulas using current
market interest rates and credit spreads.
CASH AND INVESTMENTS
For investments with remaining maturities of three months or less, carrying
value approximated fair value. Investments in U.S. Treasury securities were
valued at market quotations. All other investments were valued through standard
bond pricing formulas using current market interest rates and credit spreads.
SHORT-TERM BORROWINGS AND LONG-TERM NOTES
For borrowings with remaining maturities of three months or less, carrying
value approximated fair value. Beginning in 2000, the fair value of financial
liabilities was determined through standard bond pricing formulas using current
market interest rates and credit spreads.
ON AND OFF-BALANCE SHEET DERIVATIVE FINANCIAL INSTRUMENTS
Beginning in 2000, the fair value of on and off-balance sheet financial
instruments was determined through standard bond pricing formulas using current
market interest rates and credit spreads.
F-36
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
11. FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
The following table summarizes the fair values of the Company's financial
assets and liabilities, including off-balance sheet financial instruments
(dollars in millions):
DECEMBER 31, 2001 DECEMBER 31, 2000
-------------------------------- --------------------------------
FAIR CARRYING FAIR CARRYING
VALUE VALUE DIFFERENCE VALUE VALUE DIFFERENCE
-------- -------- ---------- -------- -------- ----------
EARNING ASSETS
Student loans................................ $42,181 $41,001 $1,180 $38,039 $37,647 $ 392
Warehousing advances......................... 1,038 1,036 2 990 987 3
Academic facilities financings............... 756 732 24 857 851 6
Cash and investments......................... 5,787 5,787 -- 5,941 5,940 1
------- ------- ------ ------- ------- -----
Total earning assets......................... 49,762 48,556 1,206 45,827 45,425 402
------- ------- ------ ------- ------- -----
INTEREST BEARING LIABILITIES
Short-term borrowings........................ 31,125 31,065 (60) 30,463 30,464 1
Long-term notes.............................. 17,565 17,285 (280) 15,037 14,911 (126)
------- ------- ------ ------- ------- -----
Total interest bearing liabilities........... 48,690 48,350 (340) 45,500 45,375 (125)
------- ------- ------ ------- ------- -----
ON-BALANCE SHEET DERIVATIVE FINANCIAL
INSTRUMENTS
Floor revenue contracts...................... (739) (739) -- (235) (235) --
Interest rate swaps and options.............. (146) (146) -- -- -- --
Cap contracts................................ (6) (6) -- -- -- --
OFF-BALANCE SHEET DERIVATIVE FINANCIAL
INSTRUMENTS
Interest rate swaps and options.............. -- -- -- (58) -- (58)
------ -----
Excess of fair value over carrying value..... $ 866 $ 219
====== =====
12. COMMITMENTS AND CONTINGENCIES
The GSE has committed to purchase student loans during specified periods and
to lend funds under the warehousing advance commitments, academic facilities
financing commitments and letters of credit programs.
Letters of credit support the issuance of state student loan revenue bonds.
They represent unconditional guarantees of the GSE to repay holders of the bonds
in the event of a default. In the event that letters of credit are drawn upon,
such loans are collateralized by the student loans underlying the bonds. Under
the terms of the Privatization Act, any future activity under warehousing
advance commitments, academic facilities financing commitments and letter of
credit activity by the GSE is limited to guarantee commitments which were in
place on August 7, 1997.
F-37
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
12. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Commitments outstanding are summarized below:
DECEMBER 31,
-------------------------
2001 2000
----------- -----------
Student loan purchase commitments.................. $21,633,098 $16,422,898
Warehousing advance commitments.................... 2,627,233 2,794,215
Letters of credit.................................. 3,279,047 3,534,301
----------- -----------
$27,539,378 $22,751,414
=========== ===========
The following schedule summarizes expirations of commitments to the earlier
of call date or maturity date outstanding at December 31, 2001.
DECEMBER 31, 2001
---------------------------------------
STUDENT LOAN WAREHOUSING LETTERS OF
PURCHASES ADVANCES CREDIT
------------ ----------- ----------
2002.................................... $ 7,871,252 $2,627,233 $3,020,377
2003.................................... 2,759,473 -- --
2004.................................... 2,717,269 -- 213,151
2005 - 2008............................. 8,285,104 -- 45,519
----------- ---------- ----------
Total................................... $21,633,098 $2,627,233 $3,279,047
=========== ========== ==========
MINIMUM STATUTORY CAPITAL ADEQUACY RATIO
The Privatization Act effectively requires that the GSE maintain a minimum
statutory capital adequacy ratio (the ratio of stockholders' equity to total
assets plus 50 percent of the credit equivalent amount of certain off-balance
sheet items) of at least 2.25 percent or be subject to certain "safety and
soundness" requirements designed to restore such statutory ratio. Management
anticipates being able to meet the required capital levels from the GSE's
current and retained earnings. While the GSE may not finance the activities of
its non-GSE affiliates, it may, subject to its minimum capital requirements,
dividend retained earnings and surplus capital to USA Education, Inc., which in
turn may contribute such amounts to its non-GSE subsidiaries. The Privatization
Act requires management to certify to the Secretary of the Treasury that, after
giving effect to the payment of dividends, the statutory capital ratio test
would have been met at the time the dividend was declared. At December 31, 2001,
the GSE's statutory capital adequacy ratio, after the effect of the dividends to
be paid in the first quarter of 2002, was 2.95 percent.
The Student Loan Marketing Association Reorganization Act of 1996 (the
"Privatization Act") requires the GSE to be dissolved on or before
September 30, 2008. On January 23, 2002, the GSE's Board of Directors approved
management's plans to accelerate the wind-down of the entity by at least two
years, with a view to effecting dissolution of the GSE no later than
September 30, 2006. The GSE has also received guidance from the U.S. Department
of Treasury's Office of Sallie Mae Oversight regarding safety and soundness
considerations affecting its wind-down. As a result, in connection with any
dividend declarations, the GSE will supplement the statutory minimum capital
ratio requirement
F-38
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
12. COMMITMENTS AND CONTINGENCIES (CONTINUED)
with a risk-based capital measurement formula. Management does not expect the
capital levels of the Company's consolidated balance sheet to change as a result
of this supplemental formula.
CONTINGENCIES
From time to time, the Company may be involved as a party to certain legal
proceedings arising in the normal course of its business. While litigation and
claims resolution are subject to many uncertainties and cannot be predicted with
assurance, it is management's opinion that any resulting losses would not have a
material effect on the Company's Consolidated Financial Statements.
On January 25, 2002, the GSE was served with a putative class action
complaint brought by three Wisconsin residents. The plaintiffs seek to bring the
complaint on behalf of a nationwide class of borrowers who allegedly paid
undisclosed improper and excessive late fees over the past three years. In
addition, plaintiffs allege that the GSE charged excessive interest by
capitalizing interest on a quarterly basis in violation of the terms of the
promissory notes. The plaintiffs seek damages of $1,500 per violation plus
punitive damages and allege that the class consists of two million borrowers.
The Company has moved to dismiss the complaint and believes that the plaintiffs'
claims are preempted by federal law.
13. MINORITY INTEREST
Upon the Reorganization on August 7, 1997, each outstanding share of common
stock of the GSE was converted into one share of common stock of SLM Holding.
The outstanding preferred stock of the GSE was not affected by the
Reorganization and was reflected as minority interest in the consolidated
financial statements until the GSE redeemed its preferred stock on December 10,
2001.
The GSE's preferred stock dividends were cumulative and payable quarterly at
4.50 percentage points below the highest yield of certain long-term and
short-term U.S. Treasury obligations. The dividend rate for any dividend period
was subject to the limitation of not less than 5 percent per annum nor greater
than 14 percent per annum. For the years ended December 31, 2001, 2000 and 1999,
the GSE's preferred dividend rate was 5 percent and reduced net income by
$10 million.
14. PREFERRED STOCK
On November 16, 1999, the Company sold 3.3 million shares of 6.97 percent
Cumulative Redeemable Preferred Stock, Series A in a registered public offering.
The proceeds from the sale to the Company, before expenses, were $165 million
and were used for general corporate purposes. The shares do not have any
maturity date but are subject to the Company's option, beginning November 16,
2009, to redeem the shares at any time, in whole or in part, at the redemption
price of $50 plus accrued and unpaid dividends up to the redemption date. The
shares have no preemptive or conversion rights.
Dividends on the shares of the Series A Preferred Stock are not mandatory.
Holders of the Series A Preferred Stock will be entitled to receive cumulative,
quarterly cash dividends at the annual rate of $3.485 per share, when, as, and
if declared by the Board of Directors of the Company. For each of the years
ended December 31, 2001 and 2000, dividends paid on Series A Preferred Stock
reduced net income by $12 million.
F-39
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
15. COMMON STOCK
The Board of Directors has authorized and reserved up to 38.4 million common
shares for issuance under various compensation and benefit plans. At
December 31, 2001, under these authorizations, the Company had 23.4 million
shares in reserve and a remaining authority for issuance of 14.2 million shares.
The Company has engaged in repurchases of its common stock since 1986. In
2001 and 2000, the Company supplemented its open market common stock purchases
by entering into equity forward transactions to purchase 9.7 million and
1.7 million shares, respectively, on a cash or net share settled basis. In
January 2001, the Board of Directors increased the common share repurchase
authority including equity forward contracts by 10 million shares. At
December 31, 2001, the total common shares that could be potentially acquired
over the next three years under outstanding equity forward contracts was
11.2 million shares, and the Company had remaining authority to enter into
additional share repurchases and equity forward contracts for 2.3 million
shares.
The equity forward contracts permit the counterparty to terminate the
contracts prior to their maturity date if the price of the Company's common
stock falls below pre-determined levels. Under these contracts, the counterparty
has the right to terminate a small portion of the contract beginning at one
stock price and then to terminate the same percentage of the contract as the
stock price reaches each lower pre-determined level. This continues until the
counterparty has the right to terminate the entire contract. The Company refers
to the price at which the counterparty can begin to terminate the entire
contract the "initial trigger price" and the price at which the counterparty can
terminate the entire contract the "final trigger price." For equity forward
contracts in effect as of December 31, 2001, the initial trigger price ranges
from approximately $44.50 to $25.00 and the final trigger price ranges from
approximately $40.50 to $17.00.
In addition, some of the Company's equity forward contracts also have a
termination event based upon the credit rating of the Company and/or the GSE.
Under this termination event, the counterparty has the right to terminate all
outstanding equity forward contracts if the unsecured and unsubordinated
long-term debt rating of the GSE falls to or below BBB- for S&P or Ba3 for
Moody's. If either rating is suspended or withdrawn, or the GSE is not rated by
either rating agency, then the termination event is determined by reference to
unsecured and unsubordinated long-term debt rating of USA Education, Inc. This
provision or one substantially the same is contained in the contracts of three
of the Company's six equity forward counterparties, with contracts outstanding
at December 31, 2001, representing share repurchases of 7.6 million at prices
between $45.55 and $82.26 per share. The GSE is rated AAA at December 31, 2001
by both S&P and Moody's.
Lastly, the Company has negotiated with each of its equity forward
counterparties a limit on the total number of shares that can be required to be
delivered to the counterparty in settlement of the transactions. As of
December 31, 2001 and 2000, the aggregate maximum number of shares that the
Company could be required to deliver was 67.2 million and 55.9 million,
respectively.
F-40
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
15. COMMON STOCK (CONTINUED)
The following table summarizes the Company's common share repurchase and
equity forward activity for the years ended December 31, 2001 and 2000. (All
amounts in the tables are common shares in millions.)
YEARS ENDED
DECEMBER 31,
-------------------
2001 2000
-------- --------
Common shares repurchased:
Open market.......................................... 2.7 2.1
Equity forwards...................................... 16.7 4.9
------- ------
Total shares repurchased................................... 19.4 7.0
======= ======
Average purchase price per share........................... $ 44.32 $44.26
======= ======
Equity forward contracts:
Outstanding at beginning of year........................... 18.2 21.4
New contracts.............................................. 9.7 1.7
Exercises.................................................. (16.7) (4.9)
------- ------
Outstanding at end of year................................. 11.2 18.2
======= ======
Remaining board of director authority at end of year....... 2.3 4.8
======= ======
As of December 31, 2001, the expiration dates and range of purchase prices
for outstanding equity forward contracts are as follows:
OUTSTANDING RANGE OF MARKET
YEAR OF MATURITY CONTRACTS PRICES
- ---------------- ----------- ---------------
2003.............................................. 6.7 45.56 - 80.97
2004.............................................. 4.0 68.61 - 82.26
2005.............................................. 0.5 86.11
----
11.2
====
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
F-41
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
15. 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 EARNINGS
TO COMMON AVERAGE PER
STOCK SHARES SHARE
------------ ----------- --------
(THOUSANDS) (THOUSANDS)
YEAR ENDED DECEMBER 31, 2001
Basic EPS................................... $372,495 159,078 $ 2.34
Dilutive effect of stock options, warrants
and equity forwards....................... -- 4,322 (.06)
-------- -------- -------
Diluted EPS................................. $372,495 163,400 $ 2.28
======== ======== =======
YEAR ENDED DECEMBER 31, 2000
Basic EPS................................... $453,495 159,482 $ 2.84
Dilutive effect of stock options, warrants
and equity forwards....................... -- 4,873 (.08)
-------- -------- -------
Diluted EPS................................. $453,495 164,355 $ 2.76
======== ======== =======
YEAR ENDED DECEMBER 31, 1999
Basic EPS................................... $499,393 160,577 $ 3.11
Dilutive effect of stock options, warrants
and equity forwards....................... -- 2,581 (.05)
-------- -------- -------
Diluted EPS................................. $499,393 163,158 $ 3.06
======== ======== =======
16. STOCK OPTION PLANS
USA Education, Inc. maintains stock option plans for its employees that
permit grants of stock options for the purchase of common stock with exercise
prices equal to or greater than the market value on the date of grant.
After the change in management control in August 1997, the Board of
Directors granted options, which have ten-year terms and vest in one-third
increments, to officers and key employees under the 1993-1998 Stock Option Plan.
Options granted to executive management under this plan vest no earlier than one
year from grant date and upon the occurrence of (1) one-third on the date that
the Company's common stock closes above $42.86 per share for five business days;
(2) one-third on the date that the Company's common stock closes above $57.14
per share for five business days; and (3) one-third on the date that the
Company's common stock price closes above $71.43 per share for five business
days. Options granted in November 1997 to officers and key employees vest:
(1) one-third, one year from the date of grant; (2) one-third on the later of
one year or the date that the Company's common stock closes above $57.14 per
share for five business days; and (3) one-third on the later of one year or the
date that the Company's common stock price closes above $71.43 per share for
five business days. In the event that the Company's common stock price does not
close above the predetermined prices, all outstanding options will vest on the
eighth anniversary of the grant. Under
F-42
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
16. STOCK OPTION PLANS (CONTINUED)
this plan, the Company was originally authorized to grant up to 17.8 million
shares. Options granted by prior Boards of Directors generally have ten-year
terms and fully vest one year after the date of grant.
In May 1998, shareholders approved a Management Incentive Plan, which
replaced the 1993-1998 Stock Option Plan. Under this plan, the Board may confer
certain awards to officers and employees, which may be in the form of stock
options, performance stock, and incentive bonuses. The Board authorized up to
11.5 million shares of the Company's common stock that could be issued under
such awards and at December 31, 2001, this plan had remaining authority of
4.2 million shares. In 2001 and 2000, options granted under this plan have
ten-year terms and vest the latter of one year from date of issuance or when the
closing stock price equals 120 percent of the strike price of the option. In
1999 and 1998, options granted under this plan have ten-year terms and vest in
one-third increments identical to those of the options granted in November 1997
to officers and key employees. In the event that the Company's common stock
price does not close above the predetermined prices, all outstanding options
will vest on the eighth anniversary of the grant, except options granted in 2001
which will vest on the fifth anniversary of the grant.
The Company's Board of Directors authorized up to 19 million shares of
common stock to be issued under the Employee Stock Option Plan, of which there
is remaining authority of 5.4 million shares at December 31, 2001. Stock options
were granted under this plan to all non-officer employees of the Company and
have ten-year terms with one-half of the options vesting one year from the date
of grant and one-half vesting two years from the date of grant.
In order to encourage option holders to convert their interest in the
Company's common stock to share ownership, the Company has adopted a replacement
option program. The program applies to directors as well as officers. The
replacement option program recognizes the fact that option holders typically
must sell shares received through the exercise of an option to cover the
exercise price. The net result of an option exercise may be that option holders'
total potential investment in the Company's common stock is less after an
exercise than before, causing the option holder to forego further appreciation
on the sold shares and discouraging the option holder from converting his or her
option position into an ownership position. Under the replacement program, the
Company intends to grant new options to directors and officers upon their
exercise of existing in-the-money options in an amount equal to the number of
shares needed to pay the exercise price for the option, approximately bringing
the director or officer's total potential investment in the Company's common
stock back to the level in place before the exercise. Replacement options carry
an exercise price equal to the fair market value of the Company's common stock
on the date of their grant and vest one year from the grant date. The term of
the replacement option equals the remaining term of the underlying option.
F-43
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
16. STOCK OPTION PLANS (CONTINUED)
The following table summarizes the employee stock option plans for the years
ended December 31, 2001, 2000 and 1999. The weighted average fair value of
options granted during the year is based on an option pricing model.
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------
2001 2000 1999
---------------------- --------------------- ---------------------
AVERAGE AVERAGE AVERAGE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
----------- -------- ---------- -------- ---------- --------
Outstanding at beginning of
year........................... 14,334,901 $40.73 11,243,895 $41.04 9,666,906 $39.58
Direct options granted........... 5,607,874 71.77 8,226,105 39.16 3,643,226 43.25
Replacement options granted...... 2,316,670 71.11 475,388 55.38 -- --
Exercised........................ (10,386,258) 41.73 (3,360,197) 39.73 (1,100,933) 35.69
Canceled......................... (433,765) 52.66 (2,250,290) 41.14 (965,304) 40.85
----------- ------ ---------- ------ ---------- ------
Outstanding at end of year....... 11,439,422 $60.74 14,334,901 $40.73 11,243,895 $41.04
=========== ====== ========== ====== ========== ======
Exercisable at end of year....... 2,871,307 $42.80 4,099,257 $41.05 3,869,624 $38.87
=========== ====== ========== ====== ========== ======
Weighted-average fair value per
share of options granted during
the year....................... $31.27 $18.85 $19.49
====== ====== ======
The following table summarizes the number, average exercise prices (which
ranged from $11 per share to $87 per share) and average remaining contractual
life of the employee stock options outstanding at December 31, 2001.
AVERAGE AVERAGE REMAINING
EXERCISE PRICES OPTIONS PRICE CONTRACTUAL LIFE
- --------------- ---------- -------- -----------------
Under $40................................ 2,322,463 $37.52 7.8 Yrs.
$40-$60.................................. 1,809,007 45.59 7.8
Above $60................................ 7,307,952 71.86 9.4
---------- ------ --------
Total.................................... 11,439,422 $60.74 8.8 Yrs.
========== ====== ========
In May 1996, shareholders approved the Board of Directors Stock Option Plan,
which authorized the grant of options to acquire up to 700,000 shares of common
stock. Options under this plan have ten-year terms. In May 1998, the
shareholders approved a Directors Stock Plan, which replaced the Board of
Directors Stock Option Plan. Under the Directors Stock Plan, the Board
authorized the grant of options to acquire up to 3.5 million shares of common
stock, of which there is remaining authority of 1.3 million shares at
December 31, 2001. Options granted under this plan have ten-year terms and are
subject to the same price-vesting schedules that apply to options granted to
officers under the Management Incentive Plan, except there is no one-year
minimum vesting requirement and all outstanding options will vest on the eighth
anniversary of the date of grant.
F-44
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
16. STOCK OPTION PLANS (CONTINUED)
The following table summarizes the Board of Directors Stock Option Plans for
the years ended December 31, 2001, 2000 and 1999.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------
2001 2000 1999
--------------------- -------------------- --------------------
AVERAGE AVERAGE AVERAGE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------- -------- --------- -------- --------- --------
Outstanding at beginning of year.... 1,954,371 $41.02 1,645,866 $38.67 1,622,366 $38.48
Direct options granted.............. 235,000 61.99 415,000 42.34 52,500 43.31
Replacement options granted......... 628,635 72.15 239,205 53.81 -- --
Exercised........................... (1,255,791) 41.16 (345,700) 40.23 (29,000) 36.79
Canceled............................ -- -- -- -- -- --
---------- ------ --------- ------ --------- ------
Outstanding at end of year.......... 1,562,215 $56.59 1,954,371 $41.02 1,645,866 $38.67
========== ====== ========= ====== ========= ======
Exercisable at end of year.......... 933,580 $46.12 1,192,730 $39.14 601,275 $37.26
========== ====== ========= ====== ========= ======
Weighted-average fair value per
share of options granted during
the year.......................... $28.83 $21.55 $18.73
====== ====== ======
At December 31, 2001, the outstanding Board of Directors options had a
weighted-average remaining contractual life of 8.1 years.
USA Education, Inc. accounts for its stock option plans in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," which results in no compensation expense for stock options granted
under the plans. The following table summarizes pro-forma disclosures for the
years ended December 31, 2001, 2000 and 1999, as if the Company had accounted
for employee and Board of Directors stock options granted subsequent to
December 31, 1994 under the fair market value method as set forth in SFAS
No. 123, "Accounting for Stock-Based Compensation." The fair value for these
options was estimated at the date of grant using an option pricing model, with
the following weighted average assumptions for the years ended December 31,
2001, 2000 and 1999, respectively: risk-free interest rate of 5 percent,
6 percent and 6 percent; volatility factor of the expected market price of the
Company's common stock of 35 percent, 34 percent and 34 percent; expected
dividend rate of 1 percent, 2 percent and 2 percent; and the time of the
expected
F-45
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
16. STOCK OPTION PLANS (CONTINUED)
life of the option of ten years. Vesting for options with vesting periods tied
to the Company's stock price is assumed to occur annually in one-third
increments.
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
Net income attributable to common stock....... $372,495 $453,495 $499,393
======== ======== ========
Pro-forma net income attributable to common
stock....................................... $266,523 $406,484 $473,386
======== ======== ========
Basic earnings per share...................... $ 2.34 $ 2.84 $ 3.11
======== ======== ========
Pro-forma basic earnings per share............ $ 1.68 $ 2.55 $ 2.95
======== ======== ========
Diluted earnings per share.................... $ 2.28 $ 2.76 $ 3.06
======== ======== ========
Pro-forma diluted earnings per share.......... $ 1.63 $ 2.47 $ 2.90
======== ======== ========
17. BENEFIT PLANS
PENSION PLANS
Under the Company's regular and supplemental pension plans, participants
accrue benefits under a cash balance formula. Under the formula, each
participant has an account, for record keeping purposes only, to which credits
are allocated each payroll period based on a percentage of the participant's
compensation for the current pay period. The applicable percentage is determined
by the number of years of service the participant has with the Company. If an
individual participated in the Company's prior pension plan as of September 30,
1999 and met certain age and service criteria, the participant ("grandfathered
participant") will receive the greater of the benefits calculated under the
prior plan, which uses a final average pay plan method, or under the cash
balance formula.
F-46
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
17. BENEFIT PLANS (CONTINUED)
The following tables provide a reconciliation of the changes in the plan's
benefit obligations and fair value of assets over the two-year period ending
December 31, 2001, and a statement of the funded status as of December 31 of
both years:
DECEMBER 31,
-------------------
2001 2000
-------- --------
CHANGE IN BENEFIT OBLIGATION
Projected benefit obligation at beginning of year........... $126,094 $103,641
Service cost................................................ 9,401 7,108
Interest cost............................................... 9,813 7,983
Acquisitions................................................ -- 22,580
Actuarial gain.............................................. (1,376) (7,781)
Benefits paid............................................... (18,284) (7,437)
-------- --------
Benefit obligation at end of year........................... 125,648 126,094
-------- --------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year.............. 164,407 130,108
Actual return on plan assets................................ 21,721 23,670
Acquisitions................................................ -- 19,407
Benefits paid............................................... (18,284) (7,437)
Administrative payments..................................... (1,605) (1,341)
-------- --------
Fair value of plan assets at end of year.................... 166,239 164,407
-------- --------
FUNDED STATUS
Funded status at end of year................................ 40,591 38,313
Unrecognized net actuarial gain............................. (54,192) (50,994)
Unrecognized prior service cost and transition asset........ (1,628) (1,891)
-------- --------
Accrued pension cost........................................ $(15,229) $(14,572)
======== ========
DECEMBER 31,
-------------------
2001 2000
-------- --------
WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31
Discount rate............................................... 7.00% 7.75%
Expected return on plan assets.............................. 10.00% 10.00%
Rate of compensation increase............................... 5.50% 5.50%
Net periodic pension cost included the following components:
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
Service cost--benefits earned during the
period....................................... $ 9,401 $ 7,108 $ 5,033
Interest cost on project benefit obligations... 9,813 7,983 6,651
Expected return on plan assets................. (16,111) (13,593) (11,606)
Net amortization and deferral.................. (2,446) (2,922) (1,805)
-------- -------- --------
Net periodic pension cost (benefit)............ $ 657 $ (1,424) $ (1,727)
======== ======== ========
F-47
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
17. BENEFIT PLANS (CONTINUED)
The Company maintains a nonqualified pension plan for certain key employees
as designated by the Board of Directors and a nonqualified pension plan for its
Board of Directors. The nonqualified pension plans were the only pension plans
with an accumulated benefit obligation in excess of plan assets. There are no
plan assets in the nonqualified plans due to the nature of the plans. The
accumulated benefit obligations for these plans at December 31, 2001 and 2000
was $14 million.
401(K) PLANS
The Company's 401(k) Savings Plan ("the Plan") is a defined contribution
plan that is intended to qualify under section 401(k) of the Internal Revenue
Code. The Plan covers substantially all employees of the Company. Participating
employees may contribute up to 10 percent of compensation. Up to 6 percent of
these contributions are matched 100 percent by the Company after one year of
service.
During 2001 and 2000, the Company provided an additional discretionary
employer contribution to the Plan for employees who were not in other Company
incentive plans. In 2001, 401(k) expense increased due to the determination
prior to year-end 2001 that this discretionary award would also be provided;
therefore, an accrual was made at year-end. In prior years this discretionary
contribution was not determined to be available until after the close of the
fiscal year. The Company also acquired USA Group, Inc. in August 2000, whose
employees were immediately eligible for participation in the plan.
The Company also maintains a non-qualified plan to ensure that designated
participants receive the full amount of benefits to which they would have been
entitled under the 401(k) Plan except for limits on compensation and
contribution levels imposed by the Internal Revenue Code.
Total expenses related to the 401(k) plans were $21 million, $9 million and
$5 million in 2001, 2000 and 1999, respectively.
18. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax
F-48
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
18. INCOME TAXES (CONTINUED)
purposes. Significant components of the Company's deferred tax liabilities and
assets as of December 31, 2001 and 2000 are as follows:
DECEMBER 31,
-------------------
2001 2000
-------- --------
Deferred tax liabilities:
Leases............................................ $292,456 $295,018
Unrealized investment gains....................... 210,356 246,811
Other............................................. 21,963 28,069
-------- --------
524,775 569,898
-------- --------
Deferred tax assets:
Loan origination services......................... 92,018 74,245
Student loan reserves............................. 64,400 48,800
In-substance defeasance transactions.............. 27,124 27,446
Asset valuation allowances........................ 15,049 8,093
Securitization transactions....................... 148,505 60,834
Partnership income................................ 26,791 31,311
Other............................................. 83,160 62,298
-------- --------
457,047 313,027
-------- --------
Net deferred tax liabilities............................ $ 67,728 $256,871
======== ========
The GSE is exempt from all state, local and District of Columbia taxes
except for real property taxes. USA Education, Inc. and its other subsidiaries
are subject to state and local taxes that increased the effective tax rate by
3.3 and 1.5 percent in 2001 and 2000, respectively, and were immaterial in 1999.
Deferred tax assets on in-substance defeasance transactions resulted from
premiums on the debt extinguished. These premiums are capitalized and amortized
over the life of the defeasance trust for tax purposes. As of December 31, 2001,
2000 and 1999, all of the state tax expense is classified as current.
Reconciliations of the statutory U.S. federal income tax rates to the
Company's effective tax rate follow:
YEARS ENDED
DECEMBER 31,
------------------------------------
2001 2000 1999
-------- -------- --------
Statutory rate.......................................... 35.0% 35.0% 35.0%
Tax exempt interest and dividends received deduction.... (1.8) (2.2) (2.8)
State tax, net of federal............................... 3.3 1.5 .7
Goodwill................................................ 1.1 .4 .2
Credits................................................. (1.5) (1.1) (1.1)
Other, net.............................................. .1 (.4) (.1)
---- ---- ----
Effective tax rate...................................... 36.2% 33.2% 31.9%
==== ==== ====
F-49
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
18. INCOME TAXES (CONTINUED)
Deferred income taxes are recorded using enacted tax laws and rates for the
years in which taxes are expected to be paid. In addition, deferred tax assets
are recognized for tax loss and tax credit carryforwards, to the extent that
realization of such assets is more likely than not.
The current and deferred portions of the income tax provision were as
follows:
DECEMBER 31,
--------------------------------
2001 2000 1999
--------- -------- ---------
Current provision (benefit):
Federal................................................. $ 431,619 $256,883 $ 355,551
State................................................... 20,335 10,954 4,943
--------- -------- ---------
Total current provision..................................... 451,954 267,837 360,494
Deferred provision (benefit):
Federal................................................. (228,632) (31,957) (120,367)
--------- -------- ---------
Total deferred position..................................... (228,632) (31,957) (120,367)
--------- -------- ---------
Provision for income tax expense............................ $ 223,322 $235,880 $ 240,127
========= ======== =========
F-50
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
19. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
2001
------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- --------- --------
Net interest income................................ $179,808 $227,403 $ 197,619 $268,586
Less: provision for losses......................... 13,599 13,271 15,299 23,822
-------- -------- --------- --------
Net interest income after provision for losses..... 166,209 214,132 182,320 244,764
Derivative market value adjustment................. (168,164) 116,884 (552,832) 151,687
Other income....................................... 222,642 279,336 265,097 202,967
Operating expenses................................. 167,373 170,267 184,113 185,901
Income taxes....................................... 20,839 155,617 (98,656) 145,522
Minority interest in net earnings of subsidiary.... 2,674 2,673 2,673 2,050
-------- -------- --------- --------
Net income......................................... 29,801 281,795 (193,545) 265,945
Preferred stock dividends.......................... 2,875 2,875 2,875 2,875
-------- -------- --------- --------
Net income attributable to common stock............ $ 26,926 $278,920 $(196,420) $263,070
======== ======== ========= ========
Basic earnings per common share.................... $ .17 $ 1.74 $ (1.25) $ 1.69
======== ======== ========= ========
Diluted earnings per common share.................. $ .16 $ 1.68 $ (1.25) $ 1.69
======== ======== ========= ========
2000
-----------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
Net interest income................................. $161,869 $161,641 $160,333 $157,945
Less: provision for losses.......................... 9,438 7,900 5,428 9,354
-------- -------- -------- --------
Net interest income after provision for losses...... 152,431 153,741 154,905 148,591
Other income........................................ 175,591 125,314 205,916 180,812
Operating expenses.................................. 96,238 95,044 220,116 174,312
Income taxes........................................ 75,461 60,844 45,813 53,762
Minority interest in net earnings of subsidiary..... 2,674 2,673 2,674 2,673
-------- -------- -------- --------
Net income.......................................... 153,649 120,494 92,218 98,656
Preferred stock dividends........................... 2,907 2,886 2,865 2,864
-------- -------- -------- --------
Net income attributable to common stock............. $150,742 $117,608 $ 89,353 $ 95,792
======== ======== ======== ========
Basic earnings per common share..................... $ .96 $ .75 $ .56 $ .58
======== ======== ======== ========
Diluted earnings per common share................... $ .93 $ .73 $ .55 $ .56
======== ======== ======== ========
F-51
USA EDUCATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
19. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (CONTINUED)
1999
-----------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
Net interest income................................. $157,652 $172,706 $184,358 $179,074
Less: provision for losses.......................... 7,636 13,029 6,545 7,148
-------- -------- -------- --------
Net interest income after provision for losses...... 150,016 159,677 177,813 171,926
Other income........................................ 106,639 111,631 95,310 137,210
Operating expenses.................................. 86,268 86,410 91,520 94,372
Income taxes........................................ 53,905 58,561 57,524 70,137
Minority interest in net earnings of subsidiary..... 2,673 2,674 2,674 2,673
-------- -------- -------- --------
Net income.......................................... 113,809 123,663 121,405 141,954
Preferred stock dividends........................... -- -- -- 1,438
-------- -------- -------- --------
Net income attributable to common stock............. $113,809 $123,663 $121,405 $140,516
======== ======== ======== ========
Basic earnings per common share..................... $ .70 $ .77 $ .76 $ .89
======== ======== ======== ========
Diluted earnings per common share................... $ .69 $ .76 $ .75 $ .87
======== ======== ======== ========
F-52
APPENDIX A
FEDERAL FAMILY EDUCATION LOAN PROGRAM
GENERAL
The Federal Family Education Loan Program, known as FFELP, under Title IV of
the Higher Education Act, provides for loans to students who are enrolled in
eligible institutions, or to parents of dependent students, to finance their
educational costs. As further described below, payment of principal and interest
on the student loans is guaranteed by a state or not-for-profit guarantee agency
against:
- default of the borrower;
- the death, bankruptcy or permanent, total disability of the borrower;
- closing of the borrower's school prior to the end of the academic period;
- false certification by the borrower's school of his eligibility for the
loan; and
- an unpaid school refund.
In addition to the guarantee, the holder of student loans is entitled to
receive interest subsidy payments and special allowance payments from the U.S.
Department of Education on eligible student loans. Special allowance payments
raise the yield to student loan lenders when the statutory borrower interest
rate is below an indexed market value. Subject to conditions, a program of
federal reinsurance under the Higher Education Act entitles guarantee agencies
to reimbursement from the Department of Education for between 75% and 100% of
the amount of each guarantee payment.
Four types of FFELP student loans are currently authorized under the Higher
Education Act:
- Subsidized Stafford Loans to students who demonstrate requisite financial
need;
- Unsubsidized Stafford Loans to students who either do not demonstrate
financial need or require additional loans to supplement their Subsidized
Stafford Loans;
- Parent Loans for Undergraduate Students, known as "PLUS Loans," to parents
of dependent students whose estimated costs of attending school exceed
other available financial aid; and
- Consolidation Loans, which consolidate into a single loan a borrower's
obligations under various federally authorized student loan programs.
Before July 1, 1994, the Higher Education Act also authorized loans called
"Supplemental Loans to Students" or "SLS Loans" to independent students and,
under some circumstances, dependent undergraduate students, to supplement their
Subsidized Stafford Loans. The SLS program was replaced by the Unsubsidized
Stafford Loan program.
This appendix describes or summarizes the material provisions of Title IV of
the Higher Education Act, the FFELP and related statutes and regulations. It,
however, is not complete and is qualified in its entirety by reference to each
actual statute and regulation. Both the Higher Education Act and the related
regulations have been the subject of extensive amendments over the years. The
Company cannot predict whether future amendments or modifications might
materially change any of the programs described in this appendix or the statutes
and regulations that implement them.
LEGISLATIVE MATTERS
The FFELP is subject to comprehensive reauthorization every 6 years and to
frequent statutory and regulatory changes. The most recent reauthorization was
the Higher Education Amendments of 1998. Since the 1998 reauthorization, the
Higher Education Act has been amended by the Ticket to
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Work and Work Incentives Improvement Act of 1999, the Consolidated
Appropriations Act of 2001 and by Public Law 107-139, which President Bush
signed on February 8, 2002.
In 1993 Congress created the William D. Ford Federal Direct Loan Program
("FDLP") under which Stafford, PLUS and Consolidation Loans are funded directly
by the U.S. Department of Treasury. The school determines whether it will
participate in the FFELP or FDLP.
The 1998 reauthorization extended the principal provisions of the FFELP and
the FDLP to October 1, 2003. This legislation, as modified by the 1999 act and
made permanent by the 2002 legislation, lowered both the borrower interest rate
on Stafford Loans to a formula based on the 91-day Treasury bill rate plus
2.3 percent (1.7 percent during in-school and grace periods) and the lender's
rate after special allowance payments to the 91-day Treasury bill rate plus
2.8 percent (2.2 percent during in-school and grace periods) for loans
originated on or after October 1, 1998. The borrower interest rate on PLUS loans
originated during this period is equal to the 91-day Treasury bill rate plus
3.1 percent.
The 1999 and 2001 acts changed the financial index on which special
allowance payments are computed on new loans from the 91-day Treasury bill rate
to the three-month commercial paper rate (financial) for FFELP loans disbursed
on or after January 1, 2000. For these FFELP loans, the special allowance
payments to lenders are based upon the three-month commercial paper (financial)
rate plus 2.34% (1.74% during in-school and grace periods). The 1999 act did not
change the rate that the borrower pays on FFELP loans.
The 2001 act changed the financial index on which the interest rate for some
borrowers of SLS and PLUS loans are computed. The index was changed from the
1-year Treasury bill rate to the weekly average one-year constant maturity
Treasury yield. The 2002 act changed the interest rate paid by borrowers
beginning in fiscal year 2006 to a fixed rate of 6.8% for Stafford loans and
7.9% for PLUS loans.
The 1998 reauthorization maintained interest rates for borrowers of Federal
Direct Consolidation Loans whose applications were received prior to
February 1, 1999 at 7.46 percent, which rates are adjusted annually based on a
formula equal to the 91-day Treasury bill rate plus 2.3 percent. The borrower
interest rates on Federal Direct Consolidation Loans for borrowers whose
applications are received on or after February 1, 1999 and before July 1, 2003
(extended by P.L. 107-139) is a fixed rate equal to the lesser of the weighted
average of the interest rates of the loans consolidated, adjusted up to the
nearest one-eighth of one percent, and 8.25%. This is the same rate that the
1998 legislation set on FFELP Consolidation Loans for borrowers whose
applications are received on or after October 1, 1998 and before July 1, 2003
(extended by P.L. 107-139). The 1998 legislation, as modified by the 1999 and
2002 acts, sets the special allowance payment rate for FFELP loans at the
three-month commercial paper rate plus 2.64% for loans disbursed on or after
January 1, 2000. Lenders of FFELP Consolidation Loans pay a rebate fee of 1.05%
per annum to the U.S. Department of Education. All other guaranty fees may be
passed on to the borrower.
ELIGIBLE LENDERS, STUDENTS AND EDUCATIONAL INSTITUTIONS
Lenders eligible to make loans under the FFELP generally include banks,
savings and loan associations, credit unions, pension funds and, under some
conditions, schools and guarantors. A student loan may be made to, or on behalf
of, a "qualified student." A "qualified student" is an individual who
- is a United States citizen, national or permanent resident;
- has been accepted for enrollment or is enrolled and is maintaining
satisfactory academic progress at a participating educational institution;
and
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- is carrying at least one-half of the normal full-time academic workload
for the course of study the student is pursuing.
A student qualifies for a subsidized Stafford loan if his family meets the
financial need requirements for the particular loan program. Only PLUS loan
borrowers have to meet credit standards.
Eligible schools include institutions of higher education, including
proprietary institutions, meeting the standards provided in the Higher Education
Act. For a school to participate in the program, the Department of Education
must approve its eligibility under standards established by regulation.
FINANCIAL NEED ANALYSIS
Subject to program limits and conditions, student loans generally are made
in amounts sufficient to cover the student's estimated costs of attending
school, including tuition and fees, books, supplies, room and board,
transportation and miscellaneous personal expenses as determined by the
institution. Each Stafford Loan applicant (and parents in the case of a
dependent child) must undergo a financial need analysis. This requires the
applicant (and parents in the case of a dependent child) to submit financial
data to a federal processor. The federal processor evaluates the parents' and
student's financial condition under federal guidelines and calculates the amount
that the student and the family are expected to contribute towards the student's
cost of education. After receiving information on the family contribution, the
institution then subtracts the family contribution from the student's costs to
attend the institution to determine the student's need for financial aid. Some
of this need is met by grants, scholarships, institutional loans and work
assistance. A student's "unmet need" is further reduced by the amount of
Stafford Loans for which the borrower is eligible.
SPECIAL ALLOWANCE PAYMENTS
The Higher Education Act provides for quarterly special allowance payments
to be made by the Department of Education to holders of student loans to the
extent necessary to ensure that they receive at least specified market interest
rates of return. The rates for special allowance payments depend on formulas
that vary according to the type of loan, the date the loan was made and the type
of funds, tax-exempt or taxable, used to finance the loan. The Department makes
a special allowance payment for each calendar quarter.
The special allowance payment equals the average unpaid principal balance,
including interest which has been capitalized, of all eligible loans held by a
holder during the quarterly period multiplied by the special allowance
percentage.
For student loans disbursed before January 1, 2000, the special allowance
percentage is computed by:
(1) determining the average of the bond equivalent rates of 91-day Treasury
bills auctioned for that quarter;
(2) subtracting the applicable borrower interest rate;
(3) adding the applicable special allowance margin described in the table
below; and
(4) dividing the resultant percentage by 4.
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If the result is negative, the special allowance payment is zero.
DATE OF FIRST DISBURSEMENT SPECIAL ALLOWANCE MARGIN
- -------------------------- ------------------------------------------------------------
Before 10/17/86................. 3.50%
From 10/17/86 through
09/30/92...................... 3.25%
From 10/01/92 through
06/30/95...................... 3.10%
From 07/01/95 through
06/30/98...................... 2.50% for Stafford Loans that are in In--School, Grace or
Deferment
3.10% for Stafford Loans that are in Repayment and all other
loans
From 07/01/98 through
12/31/99...................... 2.20% for Stafford Loans that are in In--School,Grace or
Deferment
2.80% for Stafford Loans that are in Repayment
3.10% for PLUS, SLS and Consolidation loans
For student loans disbursed after January 1, 2000, the special allowance
percentage is computed by:
(1) determining the average of the bond equivalent rates of 3-month
commercial paper (financial) rates quoted for that quarter;
(2) subtracting the applicable borrower interest rate;
(3) adding the applicable special allowance margin described in the table
below; and
(4) dividing the resultant percentage by 4.
If the result is negative, the special allowance payment is zero.
DATE OF FIRST DISBURSEMENT SPECIAL ALLOWANCE MARGIN
- -------------------------- ------------------------------------------------------------
From 01/01/00.................... 1.74% for Stafford Loans that are in In-School, Grace or
Deferment
2.34% for Stafford Loans that are in Repayment
2.64% for PLUS and Consolidation loans
Special allowance payments are available on variable rate PLUS Loans and SLS
Loans only if the variable rate, which is reset annually, exceeds the applicable
maximum borrower rate. The variable rate is based on the weekly average one-year
constant maturity Treasury yield for loans made before July 1, 1998 and based on
the 91-day Treasury bill for loans made on or after July 1, 1998. The maximum
borrower rate for these loans is between 9% and 12%.
STAFFORD LOAN PROGRAM
For Stafford Loans, the Higher Education Act provides for:
- federal insurance or reinsurance of Stafford Loans made by eligible
lenders to qualified students;
- federal interest subsidy payments on Subsidized Stafford Loans paid by the
Department of Education to holders of the loans in lieu of the borrowers'
making interest payments; and
- special allowance payments representing an additional subsidy paid by the
Department to the holders of eligible Stafford Loans.
We refer to all three types of assistance as "federal assistance".
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INTEREST. The borrower's interest rate on a Stafford Loan can be fixed or
variable. Stafford Loan interest rates are presented below.
MAXIMUM
BORROWER
TRIGGER DATE BORROWER RATE RATE INTEREST RATE MARGIN
- ------------ -------------------------- ----------------- --------------------------
Before 01/01/81........... 7% 7% N/A
From 01/01/81 through
09/12/83................ 9% 9% N/A
From 09/13/83 through
06/30/88................ 8% 8% N/A
From 07/01/88 through
09/30/92................ 8% for 48 months; 8% for 48 months, 3.25% for loans made
thereafter, 91-day then 10% before 7/23/92 and for
Treasury + Interest Rate loans made on or before
Margin 10/1/92 to new student
borrowers; 3.10% for
loans made after 7/23/92
and before 7/1/94 to
borrowers with
outstanding FFELP loans
From 10/01/92 through
06/30/94................ 91-day Treasury + Interest 9% 3.10%
Rate Margin
From 07/01/94 through
06/30/95................ 91-day Treasury + Interest 8.25% 3.10%
Rate Margin
From 07/01/95 through
06/30/98................ 91-day Treasury + Interest 8.25% 2.50% (In-School, Grace or
Rate Margin Deferment); 3.10%
(Repayment)
From 07/01/98 through
06/30/06................ 91-day Treasury + Interest 8.25% 1.70% (In-School, Grace or
Rate Margin Deferment); 2.30%
(Repayment)
From 07/01/06............. 6.8% 6.8% N/A
The trigger date for Stafford Loans made before October 1, 1992 is the first
day of the enrollment period for which the borrower's first Stafford Loan is
made. The trigger date for Stafford Loans made on or after October 1, 1992 is
the date of the disbursement of the borrower's first Stafford Loan. All Stafford
Loans made on or after July 1, 1994 and before July 1, 2006 have a variable
interest rate regardless of the applicable rate on any prior loans.
The rate for variable rate Stafford Loans applicable for any 12-month period
beginning on July 1 and ending on June 30 is determined on the preceding June 1
and is equal to the LESSER of:
- the applicable maximum borrower rate AND
- the sum of:
- the bond equivalent rate of 91-day Treasury bills auctioned at the
final auction held before that June 1, AND
- the applicable interest rate margin.
INTEREST SUBSIDY PAYMENTS. The Department of Education is responsible for
paying interest on Subsidized Stafford Loans:
- while the borrower is a qualified student,
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- during the grace period, and
- during prescribed deferral periods.
The Department of Education makes quarterly interest subsidy payments to the
owner of a Subsidized Stafford Loan in an amount equal to the interest that
accrues on the unpaid balance of that loan before repayment begins or during any
deferral periods. The Higher Education Act provides that the owner of an
eligible Subsidized Stafford Loan has a contractual right against the United
States to receive interest subsidy and special allowance payments. However,
receipt of interest subsidy and special allowance payments is conditioned on
compliance with the requirements of the Higher Education Act, including the
following:
- satisfaction of need criteria, and
- continued eligibility of the loan for federal reinsurance.
If the loan is not held by an eligible lender in accordance with the
requirements of the Higher Education Act and the applicable guarantee agreement,
the loan may lose its federal assistance.
Lenders generally receive interest subsidy and special allowance payments
within 45 days to 60 days after submitting the applicable data for any given
calendar quarter to the Department of Education. However, there can be no
assurance that payments will, in fact, be received from the Department within
that period.
LOAN LIMITS. The Higher Education Act generally requires that lenders
disburse student loans in at least two equal disbursements. The Act limits the
amount a student can borrow in any academic year. The following chart shows
current and historic loan limits.
INDEPENDENT STUDENTS
-----------------------
ALL STUDENTS ADDITIONAL
BORROWER'S ACADEMIC LEVEL SUBSIDIZED SUBSIDIZED UNSUBSIDIZED MAXIMUM
BASE AMOUNT SUBSIDIZED ON OR AND UNSUBSIDIZED ONLY ON OR ANNUAL
AND UNSUBSIDIZED ON AFTER ON OR AFTER AFTER TOTAL
OR AFTER 10/1/93 1/1/87 10/1/93 7/1/94 AMOUNT
- ------------------------- ---------- ---------------- ------------ --------
Undergraduate (per year):
1st year....................................... $ 2,625 $ 2,625 $ 4,000 $ 6,625
2nd year....................................... $ 2,625 $ 3,500 $ 4,000 $ 7,500
3rd year and above............................. $ 4,000 $ 5,500 $ 5,000 $ 10,000
Graduate (per year).............................. $ 7,500 $ 8,500 $10,000 $ 18,500
Aggregate Limit:
Undergraduate.................................. $17,250 $23,000 $23,000 $ 46,000
Graduate (including undergraduate)............. $54,750 $65,500 $73,000 $138,500
For the purposes of the table above:
- The loan limits include both FFELP and FDLP loans.
- The amounts in the second column represent the combined maximum loan
amount per year for Subsidized and Unsubsidized Stafford Loans.
Accordingly, the maximum amount that a student may borrow under an
Unsubsidized Stafford Loan is the difference between the combined maximum
loan amount and the amount the student received in the form of a
Subsidized Stafford Loan.
Independent undergraduate students, graduate students and professional
students may borrow the additional amounts shown in the next to last column in
the chart above. Dependent undergraduate students may also receive these
additional loan amounts if their parents are unable to provide the family
contribution amount and it is unlikely that they will qualify for a PLUS Loan.
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- Students attending certain medical schools are eligible for higher annual
and aggregate loan limits.
- The annual loan limits are sometimes reduced when the student is enrolled
in a program of less than one academic year or has less than a full
academic year remaining in his program.
REPAYMENT. Repayment of a Stafford Loan begins 6 months after the student
ceases to be enrolled at least half time. In general, each loan must be
scheduled for repayment over a period of not more than 10 years after repayment
begins. New borrowers on or after October 7, 1998 who accumulate outstanding
loans under the FFELP totaling more than $30,000 are entitled to extend
repayment for up to 25 years, subject to minimum repayment amounts and
Consolidation loan borrowers may be scheduled for repayment up to 30 years
depending on the borrower's indebtedness. The Higher Education Act currently
requires minimum annual payments of $600, unless the borrower and the lender
agree to lower payments, except that negative amortization is not allowed. The
Act and related regulations require lenders to offer the choice of a standard,
graduated, income-sensitive and extended repayment schedule, if applicable, to
all borrowers entering repayment.
GRACE PERIODS, DEFERRAL PERIODS AND FORBEARANCE PERIODS. After the borrower
stops pursuing at least a half-time course of study, he must begin to repay
principal of a Stafford Loan following the grace period. However, no principal
repayments need be made, subject to some conditions, during deferment and
forbearance periods.
For borrowers whose first loans are disbursed on or after July 1, 1993,
repayment of principal may be deferred, subject to a maximum deferment of
3 years:
- while the borrower returns to school at least half-time or is enrolled in
an approved graduate fellowship program or rehabilitation program; or
- when the borrower is seeking, but unable to find, full-time employment; or
- when the lender determines that repayment will cause the borrower economic
hardship, as defined in the Act.
The Higher Education Act also permits, and in some cases requires,
"forbearance" periods from loan collection in some circumstances. Interest that
accrues during forbearance is never subsidized. Interest that accrues during
deferment periods may be subsidized.
PLUS AND SLS LOAN PROGRAMS
The Higher Education Act authorizes PLUS Loans to be made to parents of
eligible dependent students and previously authorized SLS Loans to be made to
the categories of students now served by the Unsubsidized Stafford Loan program.
Only parents who have no adverse credit history or who are able to secure an
endorser without an adverse credit history are eligible for PLUS Loans. The
basic provisions applicable to PLUS and SLS Loans are similar to those of
Stafford Loans for federal insurance and reinsurance. However, interest subsidy
payments are not available under the PLUS and SLS programs and, in some
instances, special allowance payments are more restricted.
LOAN LIMITS. PLUS and SLS Loans disbursed before July 1, 1993 were limited
to $4,000 per academic year with a maximum aggregate amount of $20,000.
The annual and aggregate amounts of PLUS Loans first disbursed on or after
July 1, 1993 are limited only to the difference between the cost of the
student's education and other financial aid received, including scholarship,
grants and other student loans.
INTEREST. The interest rate for a PLUS or SLS Loan depends on the date of
disbursement and period of enrollment. The interest rates for PLUS Loans and SLS
Loans are presented in the following
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chart. Until July 1, 2001, the 1-year index was the bond equivalent rate of
52-week Treasury bills auctioned at the final auction held prior to each
June 1. Beginning July 1, 2001, the 1-year index is the weekly average 1-year
constant maturity Treasury yield determined the preceding June 26.
MAXIMUM
TRIGGER BORROWER
DATE BORROWER RATE RATE INTEREST RATE MARGIN
- ------- ------------------------------ ------------------ --------------------
Before 10/01/81............... 9% 9% N/A
From 10/01/81 through
10/30/82.................... 14% 14% N/A
From 11/01/82 through 12% 12% N/A
06/30/87....................
From 07/01/87 through
09/30/92.................... 1-year Index + Interest Rate 12% 3.25%
Margin
From 10/01/92 through
06/30/94.................... 1-year Index + Interest Rate PLUS 10%, SLS 11% 3.10%
Margin
From 07/01/94 through
06/30/98.................... 1-year Index + Interest Rate 9% 3.10%
Margin
From 6/30/98 through
06/30/06.................... 91-day Treasury + Interest 9% 3.10%
Rate Margin
From 07/01/06................. 7.9% 7.9% N/A
For PLUS and SLS Loans made before October 1, 1992, the trigger date is the
first day of the enrollment period for which the loan was made. For PLUS and SLS
Loans made on or after October 1, 1992, the trigger date is the date of the
disbursement of the loan.
For PLUS or SLS Loans that bear a variable rate, the rate is set annually
for 12-month periods, from July 1 through June 30, on the preceding June 1 and
is equal to the lesser of:
- the applicable maximum borrower rate
and
- the sum of:
- the 1-year Index or the bond equivalent rate of 3-month Treasury bills,
as applicable,
and
- the applicable interest rate margin.
A holder of a PLUS or SLS Loan is eligible to receive special allowance
payments during any quarter if:
- the borrower rate is set at the maximum borrower rate and
- the sum of the average of the bond equivalent rates of 3-month Treasury
bills auctioned during that quarter and the applicable interest rate
margin exceeds the maximum borrower rate.
REPAYMENT, DEFERMENTS. Borrowers begin to repay principal of their PLUS and
SLS Loans no later than 60 days after the final disbursement, subject to
deferment and forbearance provisions. Borrowers may defer and capitalize
repayment of interest during periods of educational enrollment, unemployment and
economic hardship, as defined in the Act. Maximum loan repayment periods and
minimum payment amounts for PLUS and SLS Loans are the same as those for
Stafford Loans.
CONSOLIDATION LOAN PROGRAM
The Higher Education Act also authorizes a program under which borrowers may
consolidate one or more of their student loans into a single Consolidation Loan
that is insured and reinsured on a basis similar to Stafford and PLUS Loans.
Consolidation Loans are made in an amount sufficient to pay outstanding
principal, unpaid interest, late charges and collection costs on all federally
reinsured student loans incurred under the FFELP that the borrower selects for
consolidation, as well as loans
A-8
made under various other federal student loan programs and loans made by
different lenders. Under this program, a lender may make a Consolidation Loan to
an eligible borrower who requests it so long as the lender holds all the
outstanding FFELP loans of the borrower; or the borrower has multiple holders of
his outstanding student loans or his holder does not offer Consolidation loans.
Under certain circumstances, a FFELP borrower may obtain a Consolidation Loan
under the FDLP.
Consolidation Loans made on or after July 1, 1994 have no minimum loan
amount, although Consolidation Loans for less than $7,500 do not enjoy an
extended repayment period. Applications for Consolidation Loans received on or
after January 1, 1993 but before July 1, 1994 were available only to borrowers
who had aggregate outstanding student loan balances of at least $7,500. For
applications received before January 1, 1993, Consolidation Loans were available
only to borrowers who had aggregate outstanding student loan balances of at
least $5,000.
To obtain a Consolidation Loan, the borrower must be either in repayment
status or in a grace period before repayment begins. In addition, for
applications received before January 1, 1993, the borrower must not have been
delinquent by more than 90 days on any student loan payment. Married couples who
agree to be jointly and severally liable will be treated as one borrower for
purposes of loan consolidation eligibility.
Consolidation Loans bear interest at a fixed rate equal to the greater of
the weighted average of the interest rates on the unpaid principal balances of
the consolidated loans and 9% for loans originated before July 1, 1994. For
Consolidation Loans made on or after July 1, 1994 and for which applications
were received before November 13, 1997, the weighted average interest rate is
rounded up to the nearest whole percent. Consolidation Loans made on or after
July 1, 1994 for which applications were received on or after November 13, 1997
through September 30, 1998 bear interest at the annual variable rate applicable
to Stafford Loans subject to a cap of 8.25%. Consolidation Loans for which the
application is received on or after October 1, 1998 bear interest at a fixed
rate equal to the weighted average interest rate of the loans being consolidated
rounded up to the nearest one-eighth of one percent, subject to a cap of 8.25%.
Interest on Consolidation Loans accrues and, for applications received
before January 1, 1993, is paid without interest subsidy by the Department. For
Consolidation Loans for which applications were received between January 1 and
August 10, 1993, all interest of the borrower is paid during all deferral
periods. Consolidation Loans for which applications were received on or after
August 10, 1993 are only subsidized if all of the underlying loans being
consolidated were Subsidized Stafford Loans. In the case of Consolidation Loans
made on or after November 13, 1997, the portion of a Consolidation Loan that is
comprised of Subsidized Stafford Loans retains subsidy benefits during deferral
periods.
No insurance premium is charged to a borrower or a lender in connection with
a Consolidation Loan. However, lenders must pay a monthly rebate fee to the
Department at an annualized rate of 1.05% on principal and interest on
Consolidation Loans for loans disbursed on or after October 1, 1993, and at an
annualized rate of 0.62% for Consolidation Loan applications received between
October 1, 1998 and January 31, 1999. The rate for special allowance payments
for Consolidation Loans is determined in the same manner as for other FFELP
loans.
A borrower must begin to repay his Consolidation Loan within 60 days after
his consolidated loans have been discharged. For applications received on or
after January 1, 1993, repayment schedule options include graduated or
income-sensitive repayment plans, and loans are repaid over periods determined
by the sum of the Consolidation Loan and the amount of the borrower's other
eligible student loans outstanding. The lender may, at its option, include
graduated and income-sensitive repayment plans in connection with student loans
for which the applications were received before that date. The maximum maturity
schedule is 30 years for indebtedness of $60,000 or more.
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A borrower must consolidate his loans with his current lender if he has only
FFELP loans, they are all held by the same lender and that lender makes
Consolidation Loans. Otherwise, the borrower may consolidate his loans with any
lender or, if he has FDLP loans or applies for an income-sensitive repayment
plan, with the FDLP.
GUARANTEE AGENCIES UNDER THE FFELP
Under the FFELP, guarantee agencies guarantee loans made by eligible lending
institutions. Student loans are guaranteed as to 100% of principal and accrued
interest against death or discharge. The guarantor also pays 100% of the unpaid
principal and accrued interest on PLUS Loans, where the student on whose behalf
the loan was borrowed dies. Guarantee agencies also guarantee lenders against
default. For loans that were made before October 1, 1993, lenders are insured
for 100% of the principal and unpaid accrued interest. Since October 1, 1993,
lenders are insured for 98% of principal and all accrued interest.
The Secretary of Education reinsures guarantors for amounts paid to lenders
on loans that are discharged or defaulted. The reimbursement on discharged loans
is for 100% of the amount paid to the holder. The reimbursement rate for
defaulted loans decreases as a guarantor's default rate increases. The first
trigger for a lower reinsurance rate is when the amount of defaulted loan
reimbursements exceeds 5% of the amount of all loans guaranteed by the agency in
repayment status at the beginning of the federal fiscal year. The second trigger
is when the amount of defaults exceeds 9% of the loans in repayment. Guarantee
agency reinsurance rates are presented in the table below.
CLAIMS PAID DATE MAXIMUM 5% TRIGGER 9% TRIGGER
- ---------------- -------- ---------- ----------
Before October 1, 1993...................................... 100% 90% 80%
October 1, 1993 - September 30, 1998........................ 98% 88% 78%
On or after October 1, 1998................................. 95% 85% 75%
After the Secretary reimburses a guarantor for a default claim, the
guarantor attempts to collect the loan from the borrower. However, the Secretary
requires that the defaulted guaranteed loans be assigned to the Department of
Education when the guarantor is not successful. A guarantor also refers
defaulted guaranteed loans to the Secretary to "offset" any federal income tax
refunds or other federal reimbursement which may be due the borrowers. Some
states have similar offset programs.
To be eligible for federal reinsurance, guaranteed loans must be made by an
eligible lender and meet the requirements of the regulations issued under the
Higher Education Act. Generally, these regulations require that lenders
determine whether the applicant is an eligible borrower attending an eligible
institution, explain to borrowers their responsibilities under the loan, ensure
that the promissory notes evidencing the loan are executed by the borrower; and
disburse the loan proceeds as required. After the loan is made, the lender must
establish repayment terms with the borrower, properly administer deferrals and
forbearances and credit the borrower for payments made. If a borrower becomes
delinquent in repaying a loan, a lender must perform collection procedures that
vary depending upon the length of time a loan is delinquent. The collection
procedures consist of telephone calls, demand letters, skiptracing procedures
and requesting assistance from the guarantor.
A lender may submit a default claim to the guarantor after the related
student loan has been delinquent for at least 270 days. The guarantor must
review and pay the claim within 90 days after the lender filed it. The guarantor
will pay the lender interest accrued on the loan for up to 450 days after
delinquency. The guarantor must file a reimbursement claim with the Secretary
within 45 days after the guarantor paid the lender for the default claim.
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STUDENT LOAN DISCHARGES
FFELP loans are not generally dischargeable in bankruptcy. Under the United
States Bankruptcy Code, before a student loan may be discharged, the borrower
must demonstrate that repaying it would cause the borrower or his family undue
hardship. When a FFELP borrower files for bankruptcy, collection of the loan is
suspended during the time of the proceeding. If the borrower files under the
"wage earner" provisions of the Bankruptcy Code or files a petition for
discharge on the ground of undue hardship, then the lender transfers the loan to
the guarantee agency which then participates in the bankruptcy proceeding. When
the proceeding is complete, unless there was a finding of undue hardship, the
loan is transferred back to the lender and collection resumes.
Student loans are discharged if the borrower becomes totally and permanently
disabled. A physician must certify eligibility for discharge.
If a school closes while a student is enrolled, or within 90 days after the
student withdrew, loans made for that enrollment period are discharged. If a
school falsely certifies that a borrower is eligible for the loan, the loan may
be discharged. And if a school fails to make a refund to which a student is
entitled, the loan is discharged to the extent of the unpaid refund.
REHABILITATION OF DEFAULTED LOANS
The Secretary of Education is authorized to enter into agreements with the
guarantor under which the guarantor may sell defaulted loans that are eligible
for rehabilitation to an eligible lender. For a loan to be eligible for
rehabilitation, the guarantor must have received reasonable and affordable
payments for 12 months, then the borrower may request that the loan be sold.
Because monthly payments are usually greater after rehabilitation, not all
borrowers opt for rehabilitation. Upon rehabilitation, a loan is eligible for
all the benefits under the Higher Education Act for which it would have been
eligible had no default occurred and the negative credit record is expunged. No
student loan may be rehabilitated more than once.
GUARANTOR FUNDING
In addition to providing the primary guarantee on FFELP loans, guarantee
agencies are charged with responsibility for maintaining records on all loans on
which they have issued a guarantee ("account maintenance"), assisting lenders to
prevent default by delinquent borrowers ("default aversion"), post-default loan
administration and collections and program awareness and oversight. These
activities are funded by revenues from the following statutorily prescribed
sources plus earnings on investments.
SOURCE BASIS
- ------ ----------------------------------------------------------
Insurance Premium............................ Up to 1% of the principal amount guaranteed, withheld from
the proceeds of each loan disbursement.
Loan Processing and Origination Fee.......... .65% of the principal amount guaranteed, paid by the
Department of Education.
Account Maintenance Fee...................... .10% of the original principal amount of loans
outstanding, paid by the Department of Education.
Default Aversion Fee......................... 1% of the outstanding amount of loans that were reported
delinquent but did not default within 300 days
thereafter, paid by transfers out of the Student Loan
Reserve Fund.
Collection Retention......................... 24% of the amount collected on loans on which reinsurance
has been paid (18.5% collected for a defaulted loan that
is purchased by a lender for rehabilitation or
consolidation), withheld from gross receipts.
A-11
Under the Higher Education Act, the Loan Processing and Origination Fee will
decline to 0.40% and the Collection Retention will decline to 23% beginning
October 1, 2003.
The Act requires guaranty agencies to establish two funds: a Student Loan
Reserve Fund and an Agency Operating Fund. The Student Loan Reserve Fund
contains the reinsurance payments received from the Department, Insurance
Premiums and the Collection Retention. The fund is federal property and its
assets may only be used to pay insurance claims and to pay Default Aversion
Fees. The Agency Operating Fund is the guarantor's property and is not subject
to strict limitations on its use.
DEPARTMENT OF EDUCATION OVERSIGHT
The Secretary of Education has oversight powers over guarantors. If the
Department of Education determines that a guarantor is unable to meet its
insurance obligations, the holders of loans guaranteed by that guarantor may
submit claims directly to the Department and the Department is required to pay
the full guarantee payments due, in accordance with guarantee claim processing
standards no more stringent than those applied by the terminated guarantor.
However, the Department's obligation to pay guarantee claims directly in this
fashion is contingent upon its making the determination referred to above.
A-12
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report included in this Form 10-K, into USA Education, Inc.'s previously
filed Registration Statement No. 333-33577, Registration Statement No.
333-33575, Registration Statement No. 333-44425, Registration Statement No.
333-38391, Registration Statement No. 333-53631, Registration Statement No.
333-83941, Registration Statement No. 333-46056, and Registration Statement
No. 333-63164.
/s/ Arthur Andersen LLP
Vienna, VA
March 28, 2002
Exhibit 99
March 28, 2002
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Ladies and Gentlemen:
This is to confirm that our auditor, Arthur Andersen LLP ("Andersen"),
has represented to us that its audit of the consolidated financial statements
of USA Education, Inc. and subsidiaries as of December 31, 2001 and for the year
then ended was subject to Andersen's quality control system for the U.S.
accounting and auditing practice, to provide reasonable assurance that the
engagement was conducted in compliance with professional standards, that
there was appropriate continuity of Andersen personnel working on the audit,
and availability of national office consultation. Availability of personnel
at foreign affiliates of Andersen is not relevant to this audit.
Sincerely,
USA Education, Inc.
By: /s/ John F. Remondi
--------------------
John F. Remondi
