Attached files
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EX-32.1 - EXHIBIT 32.1 FOR FORM 10Q - STUDENT LOAN CORP | exhibit32_1.htm |
EX-31.1 - EXHIBIT 31.1 FOR FORM 10Q - STUDENT LOAN CORP | exhibit31_1.htm |
EX-31.2 - EXHIBIT 31.2 FOR FORM 10Q - STUDENT LOAN CORP | exhibit31_2.htm |
EX-10.101 - EXHIBIT 10.10.1 FOR FORM 10Q - STUDENT LOAN CORP | exhibit10_101.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________
FORM 10-Q
__________________
(Mark One)
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x
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended March 31, 2010
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or
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¨
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from ___ to ___
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Commission File Number: 1-11616
THE STUDENT LOAN CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
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16-1427135
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(State or other jurisdiction of
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(I.R.S. Employer Identification No.)
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incorporation or organization)
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750 Washington Blvd.
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06901
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Stamford, Connecticut
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(Zip Code)
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(Address of principal executive offices)
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(203) 975-6320
(Registrant's telephone number, including area code)
__________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes
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x
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No
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o
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Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes
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x
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No
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o
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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
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Accelerated filer x
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Non-accelerated filer o (Do not check if a smaller reporting company)
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Smaller reporting company o
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
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o
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No
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x
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On May 3, 2010, there were 20,000,000 shares of The Student Loan Corporation’s Common Stock outstanding.
Form 10-Q
TABLE OF CONTENTS
Part I
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Consolidated Financial Information
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Page
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Item 1 -
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Consolidated Financial Statements
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Consolidated Statements of Income (Unaudited) for the Three Months Ended March 31, 2010 and 2009
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2
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Consolidated Balance Sheets as of March 31, 2010 (Unaudited) and December 31, 2009
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3
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Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the Three Months Ended March 31, 2010 and 2009
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4
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Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2010 and 2009
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5
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Notes to Consolidated Financial Statements (Unaudited)
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6 – 24
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Item 2 -
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
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25 – 43
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Item 3 -
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Quantitative and Qualitative Disclosures About Market Risk
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44
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Item 4 -
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Controls and Procedures
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44
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Part II
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Other Information
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Item 1A-
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Risk Factors
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45 – 47
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Item 6 -
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Exhibits
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47
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Signature
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48
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Exhibit Index
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49
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1
PART I CONSOLIDATED FINANCIAL INFORMATION
Item 1.
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Consolidated Financial Statements
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THE STUDENT LOAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except share and per share amounts)
(Unaudited)
Three months ended
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March 31,
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2010
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2009
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NET INTEREST INCOME
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Interest income
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$ | 256,821 | $ | 204,196 | ||||
Interest expense
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(171,848 | ) | (146,118 | ) | ||||
Net interest income
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84,973 | 58,078 | ||||||
Provision for loan losses
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(43,890 | ) | (21,142 | ) | ||||
Net interest income after provision for loan losses
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41,083 | 36,936 | ||||||
OTHER INCOME
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Fee and other income
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585 | 6,958 | ||||||
Total other income
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585 | 6,958 | ||||||
OPERATING EXPENSES
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Salaries and employee benefits
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7,945 | 8,978 | ||||||
Write-off of funding commitment fee to principal stockholder
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7,500 | – | ||||||
Other expenses
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25,889 | 25,881 | ||||||
Total operating expenses
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41,334 | 34,859 | ||||||
Income before income taxes
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334 | 9,035 | ||||||
Provision for income taxes
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(125 | ) | 1,513 | |||||
NET INCOME
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$ | 459 | $ | 7,522 | ||||
DIVIDENDS DECLARED AND PAID
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$ | 7,000 | $ | 28,600 | ||||
BASIC AND DILUTED EARNINGS PER COMMON SHARE
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$ | 0.02 | $ | 0.38 | ||||
(based on 20,000,000 average shares outstanding)
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DIVIDENDS DECLARED AND PAID PER COMMON SHARE
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$ | 0.35 | $ | 1.43 |
See accompanying Notes to the unaudited Consolidated Financial Statements.
2
THE STUDENT LOAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share amounts)
March 31,
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December 31,
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2010
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2009
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(Unaudited)
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ASSETS
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Federally insured student loans
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$ | 29,153,764 | $ | 17,948,706 | ||||
Private education loans
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9,909,604 | 7,432,471 | ||||||
Deferred origination and premium costs
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748,606 | 548,083 | ||||||
Allowance for loan losses
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(173,245 | ) | (149,098 | ) | ||||
Student loans, net
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39,638,729 | 25,780,162 | ||||||
Loans held for sale
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4,293,521 | 2,409,267 | ||||||
Cash
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448,516 | 17,998 | ||||||
Residual interests in securitized loans
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– | 820,291 | ||||||
Other assets
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2,569,323 | 1,990,523 | ||||||
Total Assets
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$ | 46,950,089 | $ | 31,018,241 | ||||
LIABILITIES AND STOCKHOLDERS' EQUITY
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Liabilities
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Short-term borrowings, payable to principal stockholder
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$ | 4,211,000 | $ | 5,131,000 | ||||
Short-term secured borrowings, payable to the Department of Education
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4,034,044 | 2,066,686 | ||||||
Long-term borrowings, payable to principal stockholder
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4,391,000 | 4,391,000 | ||||||
Long-term secured borrowings
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32,464,971 | 16,999,976 | ||||||
Deferred income taxes
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170,976 | 410,546 | ||||||
Other liabilities
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377,655 | 348,612 | ||||||
Total liabilities
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45,649,646 | 29,347,820 | ||||||
Stockholders’ Equity
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Common stock, $0.01 par value; authorized 50,000,000 shares; 20,000,000 shares issued and outstanding
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200 | 200 | ||||||
Additional paid-in capital
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142,540 | 141,869 | ||||||
Retained earnings
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1,157,703 | 1,528,352 | ||||||
Total stockholders' equity
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1,300,443 | 1,670,421 | ||||||
Total Liabilities and Stockholders' Equity
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$ | 46,950,089 | $ | 31,018,241 |
The table below presents the carrying amounts of certain assets and liabilities of the Company’s consolidated variable interest entities (VIEs) which are included in the Consolidated Balance Sheet above. The assets in the table below include only those assets that can be used to settle obligations of the consolidated VIEs. The liabilities in the table below include third party liabilities of consolidated VIEs only, and exclude intercompany balances that eliminate in consolidation. The liabilities also exclude amounts for which creditors have recourse to the general credit of the Company.
CONSOLIDATED VIEs
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March 31,
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2010
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(Unaudited)
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ASSETS
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Federally insured student loans
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$ | 27,391,883 | ||
Private education loans
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5,922,500 | |||
Deferred origination and premium costs
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594,946 | |||
Allowance for loan losses
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(103,413 | ) | ||
Other assets(1)
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2,130,319 | |||
LIABILITIES
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Long-term secured borrowings
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$ | 32,464,971 | ||
Other liabilities
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173,516 |
(1)
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Amount primarily represents restricted cash and cash equivalents of $1.2 billion and accrued interest receivable of $0.8 billion
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See accompanying Notes to the unaudited Consolidated Financial Statements.
3
THE STUDENT LOAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share amounts)
(Unaudited)
Three Months Ended
March 31,
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2010
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2009
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COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL
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Balance, beginning of period
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$ | 142,069 | $ | 141,923 | ||||
Capital contributions and other changes
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671 | 10 | ||||||
Balance, end of period
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$ | 142,740 | $ | 141,933 | ||||
RETAINED EARNINGS
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Balance, beginning of period
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$ | 1,528,352 | $ | 1,452,280 | ||||
Net income
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459 | 7,522 | ||||||
Cumulative effect of adoption of accounting standard, net of taxes of $218.4 million
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(364,108 | ) | – | |||||
Common dividends declared, $0.35 and $1.43 per common share for the three months ended March 31, 2010 and 2009, respectively
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(7,000 | ) | (28,600 | ) | ||||
Balance, end of period
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$ | 1,157,703 | $ | 1,431,202 | ||||
TOTAL STOCKHOLDERS' EQUITY
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$ | 1,300,443 | $ | 1,573,135 |
See accompanying Notes to the unaudited Consolidated Financial Statements.
4
THE STUDENT LOAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Three Months Ended
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March 31,
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2010
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2009
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Cash flows from operating activities:
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Net income
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$ | 459 | $ | 7,522 | ||||
Adjustments to reconcile net income to net cash from operating activities:
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Depreciation and amortization of equipment and computer software
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2,707 | 2,571 | ||||||
Amortization of deferred loan origination and purchase costs
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33,173 | 22,087 | ||||||
Provision for loan losses
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43,890 | 21,142 | ||||||
Deferred tax provision
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(20,457 | ) | (15,455 | ) | ||||
Other changes in loans held for sale including loan origination and purchase costs
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(1,885,585 | ) | (1,088,000 | ) | ||||
Change in accrued interest receivable
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(77,056 | ) | (31,255 | ) | ||||
Proceeds from loans sold
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– | 6 | ||||||
Accreted interest on residual interests
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– | (17,792 | ) | |||||
Loss on residual interest valuation
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– | 65,659 | ||||||
Loss on servicing asset valuation
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– | 7,335 | ||||||
Cash received on residual interests in trading securitized assets
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– | 53,859 | ||||||
Change in other assets
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35,113 | 119,286 | ||||||
Change in other liabilities
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26,836 | (74,622 | ) | |||||
Other non-cash charges
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13,278 | (9,039 | ) | |||||
Net cash used in operating activities
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$ | (1,827,642 | ) | $ | (936,696 | ) | ||
Cash flows from investing activities:
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Change in loans
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$ | 186,432 | $ | (665,366 | ) | |||
Change in loan origination and purchase costs
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14,221 | (11,390 | ) | |||||
Change in restricted cash and cash equivalents
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(228,682 | ) | (13,916 | ) | ||||
Capital expenditures on equipment and computer software
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(1,474 | ) | (1,820 | ) | ||||
Net cash used in investing activities
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$ | (29,503 | ) | $ | (692,492 | ) | ||
Cash flows from financing activities:
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Net change in borrowings payable to principal stockholder with original maturities of three months or less
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$ | (920,000 | ) | $ | 4,103,000 | |||
Proceeds from other short-term borrowings
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2,055,176 | 1,137,126 | ||||||
Repayments of other short-term borrowings
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(144,818 | ) | (2,790,242 | ) | ||||
Proceeds from long-term borrowings
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2,002,334 | 546,126 | ||||||
Repayments of long-term borrowings
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(698,029 | ) | (1,338,043 | ) | ||||
Dividends paid to stockholders
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(7,000 | ) | (28,600 | ) | ||||
Net cash provided by financing activities
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$ | 2,287,663 | $ | 1,629,367 | ||||
Net increase in cash
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$ | 430,518 | $ | 179 | ||||
Cash - beginning of period
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17,998 | 595 | ||||||
Cash - end of period
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$ | 448,516 | $ | 774 | ||||
Supplemental disclosure:
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Cash paid for:
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Interest
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$ | 150,299 | $ | 212,903 | ||||
Income taxes, net
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$ | 242 | $ | 8,251 |
See accompanying Notes to the unaudited Consolidated Financial Statements.
5
THE STUDENT LOAN CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2010
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1.
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BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
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Interim Financial Information
The accompanying unaudited Consolidated Financial Statements of The Student Loan Corporation (the Company), a Delaware corporation, include the accounts of the Company and its wholly owned subsidiaries, SLC Student Loan Receivables I, Inc, SLC Conduit I LLC and its consolidated securitization trusts that are Variable Interest Entities (VIE’s) and for which the Company is the primary beneficiary. SLC Student Loan Receivables I, Inc. is a special-purpose entity formed in 2001 for the purpose of acquiring student loans originated or acquired by the Company and transferring such loans to, and depositing such loans in, securitization trusts. SLC Conduit I LLC is a limited liability company formed in 2009 for the purpose of acquiring Federal Family Education Loan (FFEL) Program loans originated or acquired by the Company and issuing funding notes to the U.S. Department of Education (the Department) sponsored student loan-backed commercial paper conduit, Straight-A Funding, LLC (the Conduit). All intercompany balances and transactions have been eliminated.
The Company, which has a trust agreement to originate loans through Citibank, N.A. (CBNA), is an originator, manager and servicer of student loans, including loans made in accordance with federally sponsored guaranteed student loan programs as well as private education loans. CBNA owns 80% of the Company’s outstanding common stock and is an indirect wholly owned subsidiary of Citigroup Inc. (Citigroup).
In the opinion of management, all adjustments, consisting of normal, recurring accruals, necessary to state fairly the Company’s financial position and results of operations in conformity with U.S. generally accepted accounting principles (GAAP) have been reflected. The results for the three months ended March 31, 2010 may not be indicative of the results for the full year ending December 31, 2010. Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, but is not required for interim reporting purposes, has been condensed or omitted. The accompanying unaudited Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and related Notes included in the Company’s 2009 Annual Report on Form 10-K.
Basis of Presentation
The Company’s accounting policies are in conformity with GAAP. The Company’s operations are a single segment for financial reporting purposes, as the Company’s operations only consist of originating, managing and servicing student loans.
Certain amounts in the prior period’s financial statements have been reclassified to conform to the current period’s presentation. Such reclassification had no effect on the Consolidated Balance Sheet and Consolidated Statements of Income as previously reported.
See Note 2 for an understanding of changes to certain previously reported amounts resulting from the correction of immaterial errors.
Use of Estimates
The preparation of the Consolidated Financial Statements in conformity with GAAP requires the Company to make estimates based on assumptions about current and future economic and market conditions (including, but not limited to, credit risk, market liquidity and interest rates) which affect reported amounts and related disclosures in the Company’s financial statements. Although current estimates reflect existing conditions and expected trends, as appropriate, it is reasonably possible that actual conditions in the future could differ from those estimates. Such differences could have a material adverse effect on the Company’s results of operations and financial position. Among other effects, such changes could result in credit losses and expenses in excess of established reserves in the Allowance for loan losses.
6
Revenue Recognition
Revenues, which include net interest income, fees and gains on loans sold, if any, are recognized as they are earned. Interest income includes special allowance payments (SAP) from and excess interest payments to the federal government as prescribed under the Higher Education Act of 1965, as amended (the Higher Education Act), and is net of amortization of premiums and origination costs. The Company accounts for premiums and origination costs in accordance with Accounting Standards Codification (ASC) 310-20. Deferred premiums and origination costs on the Company’s loan portfolio are amortized using the interest method and recognized as yield adjustments to net interest income.
Loans
The Company has a portfolio of student loans originated under the FFEL Program authorized by the Department under the Higher Education Act which are insured by guaranty agencies (guarantors). The Company recognizes student loan interest income as it is earned. SAP from and excess interest payments to the federal government, if any, are recognized as yield adjustments to interest income.
The Company also has a portfolio of private education loans primarily consisting of CitiAssist® loans. Some of those loans are insured against loss by private insurers or covered under other risk-sharing agreements with creditworthy schools. Other loans, including many higher risk loans, are neither insured nor covered under risk-sharing agreements. The Company is exposed to 100% of loss on such loans. Effective January 1, 2008, the Company elected to stop insuring new CitiAssist loan originations.
Allowance for Loan Losses
The Company has an allowance for loan losses that provides a reserve for estimated losses on: (1) the portion of the FFEL Program loan portfolio that is subject to the risk-sharing provisions of the Higher Education Act and (2) the private education loan portfolio, after considering the credit risk insurance coverage obtained from third parties on certain loans, the impact of any risk-sharing agreements with certain schools and counterparty risk ratings. Estimated losses are calculated using historical delinquency and credit loss experience adjusted for aging of the portfolio, market conditions and other factors impacting the portfolio that are not captured by historical trends. These factors include, among other things, internal policy changes, regulatory changes and general economic conditions affecting borrowers, private insurers, risk sharers, and higher education institution clients. Losses that are probable and estimable are expensed currently which increases the provision for loan losses. Actual losses are charged against the reserve as they occur, and subsequent recoveries are credited back to the reserve.
The Company ceases to accrue interest income on a student loan when one of the following events occurs: (1) a FFEL Program loan loses its guarantee, (2) an insured private education loan reaches 150 days of delinquency or (3) an uninsured private education loan reaches 90 days of delinquency. Accrual of interest is resumed if the loan guarantee is reinstated or when principal and interest become current again. Interest received on non-accruing loans is recorded directly into interest income. The Company immediately writes off the loan balance corresponding to the unguaranteed portion of FFEL Program loans at the end of the month in which the loan is at least 270 days delinquent and the uninsured portion of private education loans at the end of the month in which the loan is at least 120 days delinquent. The Company also writes off the loan balances for loans in which the guarantee claim is not received for FFEL Program and private education loans after 450 days and 240 days of delinquency, respectively. When loans or portions of loans are written off, the Company reduces interest income by the amounts of accrued, uncollected interest and unamortized deferred premiums and origination costs.
The Company’s FFEL Program and private education loans contain terms that allow the borrower to postpone payments while in school or to postpone or reduce payments if they meet certain income or financial hardship criteria. The Company continues to accrue interest income on such loans. This accrued interest increases the borrowers’ unpaid balance.
7
Transfer of Student Loans
Whole Loan Sales
The Company accounts for its whole loan sales in accordance with the provisions of ASC 860-10-40. In order for a transfer of financial assets to be considered a sale, the assets transferred by the Company must have been isolated from the seller, even in bankruptcy or other receivership, and the purchaser must have the right to pledge or exchange the assets transferred. In addition, the sale accounting rules of ASC 860-10-40-5 require the Company to relinquish effective control over the loans sold as of the sale date.
Loans Securitized
Prior to January 1, 2010, the Company used two distinct methods of accounting for its securitizations. Certain of the Company’s securitizations met the qualifications of ASC 860-10-40-5 to be accounted for as a sale. The qualifications were that the assets transferred were legally isolated from the Company, even in the event of a bankruptcy; that the holders of the beneficial interests were not constrained from pledging or exchanging their interests; and that the transferor did not maintain effective control over the transferred assets. The Company used a two-step structure with a qualifying special purpose entity (QSPE) to obtain legal isolation. For the Company’s securitizations which were accounted for as a sale, referred to as off-balance sheet securitizations, the transferred assets were removed from the consolidated balance sheet and a gain or loss was recognized. The Company’s securitizations that failed to meet the accounting requirements for a sale in accordance with ASC 860-10-40-5, referred to as on-balance sheet securitizations, were accounted for as secured borrowings and the transferred assets were consolidated in the Company’s financial statements.
As a result of changes in accounting standards effective January 1, 2010, the Company consolidated all of its former QSPE’s. In addition, all of the Company’s future securitization transactions are likely to be accounted for as secured borrowings and consolidated in the Company’s financial statements. For additional information, see Accounting Changes below.
The Company’s on-balance sheet securitization transactions are collateralized by certain of its student loans, which are recorded in Federally insured student loans and Private education loans, and by accrued interest on the student loans and restricted cash and cash equivalents, which are recorded in Other assets on the Consolidated Balance Sheets.
Historically, the Company’s off-balance sheet securitizations have resulted in gains and losses recognized at the time of securitization which were reported in Gains on loans securitized. These securitization gains and losses represent the difference between the cost basis of the assets sold and the fair value of the assets received, including, as applicable, cash and retained interests. Retained interests in off-balance sheet securitization trusts were in the form of residual interests, servicing assets, and retained notes. All of the Company’s retained interests were recorded at fair value in accordance with GAAP. Unrealized gains and losses on retained interests were reported in Fee and other income. Accreted interest on residual interests was reported in Interest income. The Company estimated the fair value of the residual interests and servicing assets using an income approach by determining the present value of expected future cash flows using modeling techniques that incorporated management's best estimates of key assumptions, including prepayment speeds, credit losses, borrower benefits and discount rates.
The Company receives cash from the trusts for servicing fee revenues, residual interest distributions and payments of principal and interest on retained notes.
Additional information on the Company's securitization activities may be found in Note 8.
Loans Financed through Department of Education Programs
The Company has funded certain of its FFEL Program loans through the Conduit. The funding received from the Conduit is accounted for as secured borrowings and the student loans pledged as collateral are recorded in Federally insured student loans on the Company’s Consolidated Balance Sheets. See Note 5 for additional information regarding the Conduit.
8
The Company also obtains debt financing through the Department’s Loan Participation Purchase Program (the Participation Program). The borrowings through the Participation Program are collateralized by FFEL Program Stafford and PLUS loans which are recorded in Loans held for sale on the Company’s Consolidated Balance Sheet. Loans funded under the Participation Program are either sold to the Department pursuant to the Department’s Loan Purchase Commitment Program (the Purchase Program) or refinanced prior to the Participation Program’s expiration. Additional information pertaining to the Company’s borrowings through the Participation Program can be found in Note 5.
Loans Held for Sale
Loans held for sale are loans that the Company plans to sell under the Purchase Program. Management continually assesses its future loan sale plans and may transfer loans or record loans directly into the held for sale portfolio to meet the Company’s anticipated near term sale requirements. These loans are recorded at the lower of cost, consisting of principal and deferred costs, or fair value. During 2010 and 2009, loans held for sale were composed of loans to be sold to the Department under the Purchase Program, which provides for a purchase price that is higher than the carrying value of the loans. For the three months ended March 31, 2010 and 2009, the fair value of loans held for sale exceeded cost and no write down was necessary.
Changes in the Company’s loans held for sale are presented in the table below:
Three Months Ended
March 31,
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||||||||
(Dollars in thousands)
|
2010
|
2009
|
||||||
Balance at beginning of period
|
$ | 2,409,267 | $ | 1,072,316 | ||||
Originations and purchases
|
2,024,010 | 1,165,172 | ||||||
Transfers back into the operating loan portfolio
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(1,331 | ) | (3,812 | ) | ||||
Loan sales
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– | (6 | ) | |||||
Other (1)
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(138,425 | ) | (77,172 | ) | ||||
Balance at end of period
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$ | 4,293,521 | $ | 2,156,498 | ||||
(1)
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Amounts include, among other things, borrower principal payments and loan cancellations.
|
Restricted Cash and Cash Equivalents
Restricted cash and cash equivalents represents amounts related to the Company’s secured borrowings. This cash must be used to make payments related to the secured borrowings and is classified as a component of Other assets. Amounts on deposit in these accounts represent reserve accounts or are the result of timing differences between when principal and interest is collected on the trust assets and when principal and interest is paid on trust liabilities.
Derivatives
The Company currently has one cross-currency swap and one interest rate swap. The cross-currency swap is intended to manage the Company’s exposure to foreign currency exchange rate fluctuations on its Euro denominated secured borrowing. The Company’s interest rate swap is intended to hedge the Company’s exposure resulting from fluctuations between prime and London Interbank Offered Rate (LIBOR) on certain of its private education loans that have been securitized.
The Company historically had derivative financial instruments including interest rate swaps and floor options which were intended to economically hedge the interest rate risk inherent in its residual interests and servicing assets in off-balance sheet securitizations. The Company closed out of these positions during the fourth quarter of 2009 in anticipation of changes in accounting standards effective January 1, 2010, which resulted in the consolidation of the Company’s previously unconsolidated securitizations and the elimination of the related retained interests. The Company’s derivative instruments do not qualify for hedge accounting under ASC 815 and are carried at fair value in Other assets and Other liabilities with changes in fair value recorded currently in Fee and other income.
9
Internally Developed Software
Certain direct costs associated with the development of internal use software are capitalized. The Company capitalizes development costs for internal use software in accordance with the provisions of ASC 350-40. These costs are included in Other assets and are amortized by the straight-line method over the service period, not to exceed ten years. Capitalization of development costs starts after the preliminary project stage is completed and ends when the project is substantially complete and ready for its intended use. Capitalized internally developed software costs are periodically reviewed for impairment. Capitalized costs of projects deemed to be obsolete or abandoned are written off as operating expenses.
Accounting Changes
Subsequent Events: Amendments to Certain Recognition and Disclosure Requirements
In February 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-09, Subsequent Events: Amendments to Certain Recognition and Disclosure Requirements. This ASU clarifies that an entity that is an SEC filer is required to evaluate subsequent events through the date that the financial statements are issued. However, an entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. This ASU is effective for the Company for the quarter ended March 31, 2010.
Additional Disclosures Regarding Fair Value Measurements
In January 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair Value Measurements. The ASU requires disclosing the amounts of significant transfers in and out of Level 1 and 2 of the fair value hierarchy and describing the reasons for the transfers. The disclosures are effective for reporting periods beginning after December 15, 2009. The Company adopted ASU 2010-06 as of January 1, 2010. The required disclosures are included in Note 11. Additionally, disclosures of the gross purchases, sales, issuances and settlements activity in the Level 3 of the fair value measurement hierarchy will be required for fiscal years beginning after December 15, 2010.
Elimination of QSPEs and Changes in the Consolidation Model for Variable Interest Entities
In June 2009, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 166, Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140 (SFAS 166, now incorporated into ASC Topic 860) and SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167, now incorporated into ASC Topic 810). The Company adopted both standards on January 1, 2010 and has elected to apply both standards prospectively. Accordingly, prior periods have not been restated.
SFAS 166 eliminated QSPEs. SFAS 167 details three key changes to the consolidation model. First, former QSPEs are now included in the scope of SFAS 167. In addition, the FASB has changed the method of analyzing which party to a VIE should consolidate the VIE (known as the primary beneficiary) to a qualitative determination of which party to the VIE has “power” combined with potentially significant benefits or losses, instead of the previous quantitative risks and rewards model. The party that has “power” has the ability to direct the activities of the VIE that most significantly impact the VIE’s economic performance. Finally, the new standard requires that the primary beneficiary analysis be re-evaluated whenever circumstances change. The previous rules required reconsideration of the primary beneficiary only when specified reconsideration events occurred.
Based on the qualitative analysis performed, the Company has determined that it is the primary beneficiary of all of its previously off-balance sheet securitizations because the Company was determined to be the variable interest holder with the power to most significantly influence the economic performance of the trusts. In addition, through its residual interest, the Company was determined to have the obligation to absorb losses and the right to receive benefits of the VIE that could potentially be significant to the VIE. This resulted in the consolidation of all of the Company’s previously off-balance sheet securitizations on January 1, 2010. The Company consolidated all of the former QSPEs by initially measuring the assets and liabilities of the former QSPEs at their carrying values (the amounts at which the assets and liabilities would have been carried in the Consolidated Financial Statements if the Company had always consolidated these former QSPEs).
10
The consolidation of the Company’s previously unconsolidated securitization trusts on January 1, 2010 had the following impact on the Company’s Consolidated Balance Sheet:
January 1,
|
||||
(Dollars in thousands)
|
2010
|
|||
(Unaudited)
|
||||
Assets:
|
||||
Federally insured student loans
|
$ | 11,825,513 | ||
Private education loans
|
2,064,716 | |||
Deferred origination and premium costs
|
247,902 | |||
Allowance for loan losses
|
(6,987 | ) | ||
Student loans, net
|
14,131,144 | |||
Residual interest in securitized loans
|
(820,291 | ) | ||
Other assets
|
274,666 | |||
Total Assets
|
$ | 13,585,519 | ||
Liabilities and Stockholders’ Equity:
|
||||
Long-term secured borrowings
|
$ | 14,165,862 | ||
Deferred income taxes
|
(219,113 | ) | ||
Other liabilities
|
2,878 | |||
Total Liabilities
|
13,949,627 | |||
Retained earnings
|
(364,108 | ) | ||
Total Liabilities and Stockholders' Equity
|
$ | 13,585,519 |
|
2. CORRECTION OF IMMATERIAL ERRORS
The Company previously identified certain errors in the tax provision and related accounts from prior periods. The errors primarily related to accounting for state and local income taxes, deferred tax amounts for loan securitizations, and accounting for uncertain tax positions. Certain of these errors were recorded as out of period immaterial adjustments in prior periods. The Company assessed the materiality of these errors and concluded that they are immaterial to amounts reported in prior period financial statements. The correction of these immaterial amounts will continue to be reflected in the Company’s current and future Exchange Act reports. The impact of the correction on the Company’s previously reported Consolidated Statements of Income is provided below.
Three Months Ended
March 31, 2009
|
||||||||
(Dollars in thousands)
|
As
Reported
|
As Corrected
|
||||||
Income Taxes
|
$ | 1,507 | $ | 1,513 | ||||
Net Income
|
7,528 | 7,522 | ||||||
Basic and Diluted Earnings Per Share
|
$ | 0.38 | $ | 0.38 |
11
3. STUDENT LOANS
The Company’s portfolio of student loans consists primarily of loans originated under government guaranteed loan programs, principally the FFEL Program, and private education loans, primarily CitiAssist loans.
The Company’s loans are summarized by program type as follows:
March 31,
|
December 31,
|
|||||||
(Dollars in thousands)
|
2010
|
2009
|
||||||
Federal Stafford Loans
|
$ | 11,496,774 | $ | 10,414,533 | ||||
Federal Consolidation Loans
|
15,904,297 | 5,864,695 | ||||||
Federal SLS/PLUS/HEAL Loans
|
1,752,693 | 1,669,478 | ||||||
Private education loans
|
9,909,604 | 7,432,471 | ||||||
Total student loans held, excluding deferred costs
|
39,063,368 | 25,381,177 | ||||||
Deferred origination and premium costs
|
748,606 | 548,083 | ||||||
Student loans held
|
39,811,974 | 25,929,260 | ||||||
Less: allowance for loan losses
|
(173,245 | ) | (149,098 | ) | ||||
Student loans held, net
|
39,638,729 | 25,780,162 | ||||||
Loans held for sale, excluding deferred costs
|
4,245,158 | 2,381,026 | ||||||
Deferred origination and premium costs
|
48,363 | 28,241 | ||||||
Loans held for sale
|
4,293,521 | 2,409,267 | ||||||
Other loans and lines of credit (1)
|
1,808 | 5,616 | ||||||
Total loan assets
|
$ | 43,934,058 | $ | 28,195,045 |
|
(1)
|
Recorded in Other Assets and included in Other in Note 4.
|
4.OTHER ASSETS
Other assets are summarized as follows:
March 31,
|
December 31,
|
|||||||
(Dollars in thousands)
|
2010
|
2009
|
||||||
Accrued interest receivable:
|
||||||||
from student loan borrowers
|
$ | 1,106,855 | $ | 889,461 | ||||
from federal government
|
5,602 | 1,607 | ||||||
Restricted cash and cash equivalents
|
1,207,877 | 690,536 | ||||||
Deferred financing fees
|
106,509 | 39,667 | ||||||
Income taxes receivable
|
96,496 | 114,077 | ||||||
Equipment and computer software (1)
|
23,512 | 24,745 | ||||||
Servicing asset from securitization activity
|
– | 176,587 | ||||||
Retained notes from securitization activities
|
– | 19,750 | ||||||
Other
|
22,472 | 34,093 | ||||||
Total other assets
|
$ | 2,569,323 | $ | 1,990,523 |
|
(1)
|
Amounts are reflected net of accumulated depreciation and software amortization of $69.8 million and $67.0 million at March 31, 2010 and December 31, 2009, respectively.
|
12
|
5.
|
SHORT- AND LONG-TERM BORROWINGS
|
The following table summarizes the Company’s total borrowings:
March 31, 2010
|
December 31, 2009
|
||||||||||
(Dollars in thousands)
|
Interest Rates
|
Ending Balance
|
Ending Balance
|
||||||||
Unsecured borrowings:
|
|||||||||||
Short-term borrowings, payable to principal stockholder
|
1.99% to 2.90
|
% | $ | 4,211,000 | $ | 5,131,000 | |||||
Long-term borrowings, payable to principal stockholder
|
2.38% to 5.39
|
% | 4,391,000 | 4,391,000 | |||||||
Total unsecured borrowings
|
$ | 8,602,000 | $ | 9,522,000 | |||||||
Secured borrowings:
|
|||||||||||
Short-term secured borrowings
|
0.71 | % | $ | 4,034,044 | $ | 2,066,686 | |||||
Senior notes on long-term secured borrowings from on-balance sheet securitizations(1)
|
0.25% to 4.75
|
% | 21,247,215 | 6,812,894 | |||||||
Subordinated notes on long-term secured borrowings from on-balance sheet securitizations(1)
|
0.45% to 2.01
|
% | 790,900 | – | |||||||
Long-term secured borrowings from the Conduit(2)
|
0.56 | % | 10,426,856 | 10,187,082 | |||||||
Total secured borrowings
|
$ | 36,499,015 | $ | 19,066,662 | |||||||
Total Borrowings:
|
$ | 45,101,015 | $ | 28,588,662 |
(1)
|
Interest due on secured borrowings from the Company’s on-balance sheet securitizations is variable based on either 3-Month LIBOR, 1-Month LIBOR or prime plus a fixed premium.
|
(2)
|
Interest due on secured borrowings from the Conduit is variable based on the rate at which the Conduit is able to issue the 90-day Commercial Paper rate as published by the Department (CP), plus fixed costs associated with the Conduit.
|
The Company’s Amended and Restated Omnibus Credit Agreement as executed provided up to $6.6 billion in aggregate credit for new borrowings, including separate tranches (with their own sublimits and pricing) for overnight funding, FFEL Program loan funding, private education loan funding and illiquid asset funding. After completing two private education loan securitizations in the first quarter of 2010, the Company reduced the aggregate commitment amount under the credit agreement by $1.0 billion to $5.6 billion. The initial term of the Amended and Restated Omnibus Credit Agreement expires on December 30, 2010 and all new borrowings will be due and payable on or before this date. At March 31, 2010, the Company did not have any new borrowings outstanding under the Amended and Restated Omnibus Credit Agreement.
The $8.6 billion of borrowings outstanding at March 31, 2010 under the terms of the Omnibus Credit Agreement dated November 30, 2000, between the Company and CBNA (Original Omnibus Credit Agreement) will continue to mature based on their originally contracted maturities, unless a change of control or an event of default, as defined by the Amended and Restated Omnibus Credit Agreement, occurs. A change of control is defined as any event that results in an entity other than CBNA or its affiliates owning more than 50% of the voting equity interest in the Company. If a change of control or an event of default (certain of which require explicit action by CBNA to effect an acceleration) under the Amended and Restated Omnibus Credit Agreement were to occur, all outstanding borrowings under the Original Omnibus Credit Agreement and all new borrowings under the Amended and Restated Omnibus Credit Agreement would become due and payable immediately. The borrowings outstanding under the Original Omnibus Credit Agreement are also subject to the representations, warranties, conditions, covenants (including a borrowing base and various other financial covenants) and events of default contained in the Amended and Restated Omnibus Credit Agreement.
13
At March 31, 2010, $3.0 billion of the Company’s outstanding unsecured borrowings under the Original Omnibus Credit Agreement and $2.2 billion of the Company’s secured borrowings from certain of its private education loan securitizations included derivatives embedded in the respective debt instruments. These embedded options have been determined to be clearly and closely related to the debt instruments as these terms are defined in ASC 815 and, therefore, do not require bifurcation.
Secured borrowings increased by $17.4 billion at March 31, 2010 from December 31, 2009 primarily due to changes in accounting standards which resulted in the consolidation of the Company’s previously unconsolidated securitization trusts. This increased secured borrowings by $14.2 billion. The Company also completed two securitizations, which contributed $1.5 billion, obtained an additional $0.5 billion of funding from the Conduit and had a net increase in short-term secured borrowings from the Department under the Participation Program of $2.0 billion. Proceeds from the long-term secured borrowings were primarily used to pay down short- and long-term unsecured borrowings. Of the secured borrowings at March 31, 2010 and December 31, 2009, $0.2 billion is denominated in Euros and an additional $0.1 billion of notes remains available for issuance. At March 31, 2010, the total authorized long-term secured borrowings of $32.5 billion were collateralized by $27.4 billion of FFEL Program loans and $5.9 billion of private education loans. Principal payments on the secured borrowings are made as principal amounts are collected on the collateralized loans. The secured borrowings related to the Company’s on-balance sheet securitizations mature from March 2013 through February 2045. Secured borrowings related to the Conduit will mature before the expiration of the Conduit Program in January 2014.
See the Consolidated Balance Sheet for additional information regarding collateralized assets related to the Company’s long-term secured borrowings.
The Conduit provides additional liquidity support to eligible student lenders by providing funding for FFEL Program Stafford and PLUS loans first disbursed on or after October 1, 2003 and before July 1, 2009, and fully disbursed by September 30, 2009. In addition to providing financing at a cost based on market rates, a significant benefit to lenders is that eligible loans are permitted to have borrower benefits, which are currently not permitted under the Participation and Purchase Programs. Funding from the Conduit is provided indirectly by the capital markets through the sale to private investors of government back-stopped asset-backed commercial paper. The Company receives funding equal to 97% of the principal and interest to be capitalized of the pledged student loans. The commercial paper issued by the Conduit has short-term maturities generally ranging up to 90 days. In the event the commercial paper issued by the Conduit cannot be reissued at maturity and the Conduit does not have sufficient cash to repay investors, the Federal Financing Bank (FFB) has committed to provide short-term liquidity to the Conduit. If the Conduit is not able to issue sufficient commercial paper to repay its investors or liquidity advances from the FFB, the Company can either secure alternative financing and repay its Conduit borrowings or sell the pledged student loans to the Department at a predetermined price equal to either 97% or 100% of the accrued interest and outstanding principal of pledged loans, based on first disbursement date and certain other loan criteria. If the Company were to sell the pledged loans to the Department, this would likely result in a significant loss to the Company.
|
6.
|
FEE AND OTHER INCOME
|
Fee and other income is summarized as follows:
Three Months Ended
March 31,
|
||||||||
(Dollars in thousands)
|
2010
|
2009
|
||||||
Late fees
|
$ | 4,902 | $ | 1,684 | ||||
Net mark-to-market loss on interest rate derivative
|
(4,340 | ) | – | |||||
(Losses) gains on foreign currency translation net of mark-to-market (losses) gains on foreign currency swap
|
(821 | ) | 2,251 | |||||
Other origination and servicing fees from CBNA
|
524 | 2,148 | ||||||
Net gains from securitization retained interests and related derivatives
|
– | 527 | ||||||
Other income
|
320 | 348 | ||||||
Total fee and other income
|
$ | 585 | $ | 6,958 |
14
|
7.
|
RELATED PARTY TRANSACTIONS
|
CBNA, an indirect wholly owned subsidiary of Citigroup, owns 80% of the outstanding common stock of the Company. Pursuant to various intercompany agreements, a number of significant transactions are carried out between the Company and Citigroup, CBNA and/or their affiliates. Related party agreements with CBNA include the Amended and Restated Omnibus Credit Agreement, entered into on January 29, 2010 (Amended and Restated Omnibus Credit Agreement), a tax-sharing agreement and student loan originations and servicing agreements. In addition, the Company maintains a trust agreement with CBNA through which it originates FFEL Program loans. Also, the Company has an agreement for education loan servicing with Citibank (South Dakota), National Association. Management believes that the terms under which these transactions and services are provided are no less favorable to the Company than those that could be obtained from unaffiliated third parties.
The Company is part of a group of businesses within Citigroup, referred to as Citi Holdings. Citigroup intends to exit these businesses as quickly as practicable in an economically rational manner through business divestitures, portfolio run-off and asset sales. The Company’s management is currently working with Citi Holdings to provide information necessary to support Citi Holdings’ efforts to explore possible disposition and combination alternatives with regard to its ownership in the Company.
Detailed below is a summary of the Company’s transactions with either CBNA or other Citigroup affiliates which are included in the accompanying Consolidated Statements of Income:
Three Months Ended
March 31,
|
||||||||
(Dollars in thousands)
|
2010
|
2009
|
||||||
Revenues:
|
||||||||
Interest income
|
$ | 40 | $ | 150 | ||||
Interest expense
|
86,718 | 116,874 | ||||||
Fee and other (loss) income:
|
||||||||
Derivative valuation (loss) gain
|
(267 | ) | 53,578 | |||||
Other origination and servicing fees
|
524 | 2,148 | ||||||
Operating Expenses:
|
||||||||
Salaries and employee benefits
|
||||||||
Employee benefits and administration
|
$ | 1,551 | $ | 1,696 | ||||
Stock-based compensation
|
315 | (17 | ) | |||||
Other expenses
|
||||||||
Servicing, professional and other fees paid
|
14,963 | 15,822 | ||||||
Data processing and communications
|
2,449 | 1,959 | ||||||
Premises
|
525 | 555 | ||||||
Write-off of funding commitment fee
|
7,500 | – | ||||||
Other
|
848 | 649 |
Funding Agreements
On January 29, 2010, the Company entered into an Amended and Restated Omnibus Credit Agreement with CBNA. The Amended and Restated Omnibus Credit Agreement supersedes and replaces in its entirety the Original Omnibus Credit Agreement and is effective as of January 1, 2010. The Company’s unsecured borrowings at December 31, 2009 represent borrowings outstanding under the terms of Original Omnibus Credit Agreement. The Amended and Restated Omnibus Credit Agreement, as executed, provided up to $6.6 billion in aggregate credit for new borrowings, including separate tranches (with their own sublimits and pricing) for overnight funding, FFEL Program loan funding, private education loan funding and illiquid asset funding. After completing two private education loan securitizations in the first quarter of 2010, the Company reduced the aggregate commitment amount under the credit agreement by $1.0 billion to $5.6 billion. The initial term of the Amended and Restated Omnibus Credit Agreement expires on December 30, 2010 and all new borrowings will be due and payable on or before this date.
15
All of the Company’s outstanding short- and long-term unsecured borrowings were incurred under the terms of the Original Omnibus Credit Agreement. At March 31, 2010 the Company had outstanding short- and long-term unsecured borrowings with CBNA of $4.2 billion and $4.4 billion, respectively, and $5.1 billion and $4.4 billion, respectively, at December 31, 2009.
When the Amended and Restated Omnibus Credit Agreement was executed, the Company paid an upfront funding commitment fee of $57 million to secure the funding commitment. For the three months ended March 31, 2010, the Company recognized amortization of the upfront funding commitment fee of $14.2 million, which is included in Interest expense. The Company also recorded a $7.5 million write down of the upfront funding commitment fee in conjunction with the loan commitment reduction, which is included as a component of Operating expense. Under this agreement, CBNA also charges a monthly fee on the undrawn balance, for which the Company recognized $14.9 million for the three months ended March 31, 2010 in Interest expense.
For further information on the Company’s borrowings with CBNA, see Note 5.
Interest Rate Swap and Option Agreements
Historically, the Company maintained interest rate derivative and option agreements with CBNA, an investment-grade counterparty. The interest rate derivative agreements were used in an effort to manage the interest rate risk inherent in the retained interests in the Company’s off-balance sheet securitizations. The option agreements were designated as economic hedges to the floor income component of the residual interests. The Company closed out of these derivative positions during the fourth quarter of 2009 in anticipation of changes in accounting standards effective January 1, 2010, which resulted in the consolidation of the Company’s previously unconsolidated securitizations and elimination of the related retained interests being hedged.
Student Loan Origination Agreement and Servicing Fees Earned
CitiAssist loans are originated and serviced under an intercompany agreement with CBNA. After final disbursement by CBNA, the Company purchases all qualified private education loans at CBNA’s carrying value at the time of purchase, plus a contractual premium. Total principal balances of CitiAssist loans purchased by the Company were $0.6 billion and $0.1 billion for the three months ended March 31, 2010 and 2009, respectively. Total premiums paid by the Company related to CitiAssist loan purchases were $3.8 million and $0.6 million for the three months ended March 31, 2010 and 2009, respectively. At March 31, 2010, the Company was committed to purchase CitiAssist loans of $0.2 billion.
Servicing, Professional and Other Fees Paid
The majority of the loan originations and servicing work on the Company’s FFEL Program and CitiAssist loan portfolios was performed under the provisions of intercompany agreements with affiliates of the Company, including Citibank (South Dakota), National Association.
Stock-based Compensation
The Company participates in various Citigroup stock-based compensation programs under which Citigroup stock or stock options are granted to certain of the Company’s employees. The Company has no stock-based compensation programs in which its own stock is granted. The Company pays Citigroup directly for participation in certain of its stock-based compensation programs, but receives a capital contribution for those awards related to participation in the employee incentive stock option program.
CBNA Tax-sharing Agreement
The Company is included in the consolidated federal income tax return of Citigroup, as well as certain combined or unitary state/local income or franchise tax returns of Citigroup or its subsidiaries. As such, the Company pays its income taxes through CBNA. The taxes paid by the Company are based on an effective tax rate that approximates the tax expense that would be recognized if the Company were to file such income tax returns on a stand-alone basis.
16
Other Intercompany Arrangements
Citigroup and its subsidiaries engage in other transactions and servicing activities with the Company, including cash management, data processing, telecommunications, payroll processing and administration, facilities procurement, underwriting, and others.
|
8.
|
STUDENT LOAN SECURITIZATIONS AND VARIABLE INTEREST ENTITIES
|
The Company maintains programs to securitize certain portfolios of student loan assets. Prior to January 1, 2010, the Company’s securitization transactions qualifying as sales under ASC 860-10-40-5 were off-balance sheet transactions in which the loans were removed from the Consolidated Financial Statements of the Company and sold to an independent trust. In order to pay for the loan assets, the trust sold debt securities, collateralized primarily by the student loan assets, to outside investors. For off-balance sheet securitizations, the Company generally retained interests in the form of subordinated residual interests (i.e., interest-only strips) and servicing rights.
The Company also entered into similar securitization transactions that did not qualify for sale treatment and, accordingly, were accounted for as secured borrowings. These transactions do not give rise to a gain or loss on sale. Student loan assets sold to these securitization trusts, along with other assets and liabilities of the trusts, remain on-balance sheet. The Company’s FFEL Program loans that are funded through the Conduit are funded indirectly through the sale of asset-backed commercial paper to private investors and are also accounted for as secured borrowings with the transferred assets remaining on-balance sheet. See Notes 1 and 5 for additional details regarding the Conduit.
As a result of changes in accounting standards effective January 1, 2010, the Company has consolidated all of its previously off-balance sheet securitization transactions. In addition, all of the Company’s future securitization transactions will likely be accounted for as secured borrowings and consolidated in the Company’s financial statements. For additional information about the changes in accounting standards and the impact of the consolidation on the Company’s Consolidated Balance Sheet, see Accounting Changes in Note 1.
For an understanding of the carrying amount of assets pledged as collateral for secured borrowings through securitizations and the related liabilities at March 31, 2010, refer to the table included on the Consolidated Balance Sheet. The assets of the Company’s consolidated VIE’s are restricted from being sold or pledged as collateral for other borrowings and the cash flows from these restricted assets may be used only to pay obligations of the trust.
Under terms of all the trust arrangements, the Company has the option, but not the obligation, to provide financial support, but has never provided such support. A substantial portion of the credit risk associated with the securitized loans has been transferred to third party guarantors or insurers either under the FFEL Program or private credit insurance.
17
The following table summarizes the Company’s securitization activity:
Three Months Ended
March 31,
|
||||||||
(Dollars in thousands)
|
2010
|
2009
|
||||||
Securitization financings:
|
||||||||
Student loans securitized (1)
|
$ | 1,899,710 | $ | 587,285 | ||||
Student loans funded through the Conduit (1)
|
547,541 | – | ||||||
Total student loans funded through securitization financings (1)
|
$ | 2,447,251 | $ | 587,285 | ||||
Net proceeds from student loans securitized (2)
|
$ | 1,459,441 | $ | 546,126 | ||||
Net proceeds from student loans funded through the Conduit during the current period (2)
|
533,632 | – | ||||||
Total net proceeds from securitization financings(2)
|
$ | 1,993,073 | $ | 546,126 |
(1)
|
Amounts represent the carrying value of the student loans securitized as of the securitization date.
|
(2)
|
Amounts represent net proceeds from loans securitized or funded through the Conduit as of the securitization / funding date.
|
The difference between student loans securitized or loans funded through the Conduit and net proceeds received is largely a result of required overcollateralization, but also reflects issuance costs.
The following table summarizes the principal amounts and fair values of retained interests in the Company’s off-balance sheet loan securitizations at December 31, 2009:
December 31, 2009
|
||||||||
(Dollars in thousands)
|
FFEL
Program
Loans
|
Private
Education
Loans
|
||||||
Principal amounts
|
$ | 11,830,320 | $ | 2,066,492 | ||||
Retained interests
|
868,529 | 148,099 |
The following table reflects amounts received from previously off-balance sheet securitization trusts:
Three Months Ended
|
||||
March 31,
|
||||
(Dollars in thousands)
|
2009
|
|||
Cash received for servicing
|
$ | 20,066 | ||
Cash received on residual interests
|
53,859 | |||
Cash received on retained notes
|
781 |
During the three months ended March 31, 2009, the Company earned $19.9 million of contractually specified servicing fees and $0.7 million of interest on retained notes.
Changes in the Company’s servicing assets are presented in the table below:
Three Months Ended
|
||||||||
March 31,
|
||||||||
(Dollars in thousands)
|
2010
|
2009
|
||||||
Balance at beginning of period
|
$ | 176,587 | $ | 208,133 | ||||
Changes in fair value due to changes in inputs and assumptions
|
1,212 | |||||||
Other changes (1)
|
(176,587 | ) | (8,547 | ) | ||||
Balance at end of period
|
$ | – | $ | 200,798 |
(1)
|
Amount for the three months ended March 31, 2010 represents the elimination of residual interests and servicing assets as the Company consolidated previously off-balance sheet securitization trusts as a result of changes in accounting standards. Amount for the three months ended March 31, 2009 represents the effects of excess servicing income received and the passage of time.
|
18
The following table reflects net gains from securitization retained interests and related derivatives from off-balance sheet securitization trusts, which are recorded in Fee and other income:
Three Months Ended
March 31,
|
||||
(Dollars in thousands)
|
2009
|
|||
Losses related to residual interests
|
$ | (65,659 | ) | |
Servicing revenue net of valuation gains and losses on servicing assets
|
12,608 | |||
Mark-to-market gains on derivatives
|
53,578 | |||
Net gains from securitization retained interests and related derivatives
|
$ | 527 |
The Company utilized discounted cash flow models to measure the fair value of its residual interests and servicing assets. These models require management to make certain assumptions which, while based on relevant internal and external data, inherently involve significant judgment and uncertainty. The discount rates, basis spreads, anticipated net credit loss rates, anticipated prepayment rates and projected borrower benefit utilization rates are key assumptions utilized to measure the fair value of these retained interests. The Company’s discount rate was the sum of a risk-free rate and a risk premium, which reflected the prevailing economic and market conditions at the balance sheet date.
The key assumptions used to value the residual interests of securitized trusts were as follows:
December 31, 2009
|
||||
Discount rates:
|
||||
FFEL Program Consolidation Loans
|
11.10 | % | ||
FFEL Program Stafford and PLUS loan
|
11.10 | % | ||
Private education loans
|
16.85 | % | ||
Constant prepayment rates:
|
||||
FFEL Program Consolidation Loans
|
0.16% to 0.58%
|
|||
FFEL Program Stafford and PLUS loan
|
4.44 | % | ||
Private education loans
|
3.45 | % | ||
Anticipated credit losses, net of insurance and guarantees:
|
||||
FFEL Program Consolidation Loans
|
0.27 | % | ||
FFEL Program Stafford and PLUS loan
|
0.57 | % | ||
Private education loans
|
0.90 | % | ||
Basis spread between LIBOR and CP rates
|
16 basis points
|
|||
Utilization rates of borrower benefits:
|
||||
Automated clearing house
|
2.6% to 38.1
|
% | ||
On time payments
|
0% to 34.5
|
% |
The key assumptions used to value the servicing assets of trusts related to securitization sales were as follows:
December 31, 2009
|
||||
Discount rates:
|
||||
FFEL Program Consolidation Loans
|
5.39 | % | ||
Private education loans
|
5.89 | % | ||
Constant prepayment rates:
|
||||
FFEL Program Consolidation Loans
|
0.16% to 0.58
|
% | ||
Private education loans
|
3.45 | % | ||
Weighted average servicing margin
|
20 basis points
|
There was no servicing asset associated with the FFEL Program Stafford and PLUS loan securitization.
19
Principal amounts of off-balance sheet securitized loans and the related loan delinquencies (loans which are 90 days or more past due) are presented in the following table:
(Dollars in thousands)
|
December 31, 2009
|
|||
Principal amounts
|
$ | 13,896,812 | ||
Delinquencies
|
553,463 |
Credit losses, net of recoveries, for the Company’s off-balance sheet securitized loans are presented in the table below:
Three Months Ended
|
||||
(Dollars in thousands)
|
March 31, 2009
|
|||
Credit losses, net of recoveries:
|
$ | 2,778 |
|
9.
|
DERIVATIVE AGREEMENTS
|
The Company currently has one cross-currency swap and one interest rate swap. The cross-currency swap is intended to manage the Company’s exposure to foreign currency exchange rate fluctuations on its Euro denominated secured borrowing and matures at the earlier of the date at which the respective notes mature, the trust loan assets have been liquidated or 2032. The Company’s interest rate swap relates to one of the Company’s securitization trusts that was consolidated as a result of changes in accounting standards and was included within the Company’s financial statements beginning in the first quarter of 2010. The interest rate swap is intended to hedge the trusts’ risk resulting from fluctuations between prime and LIBOR and matures in 2017.
Historically, the Company maintained interest rate derivative and option agreements with CBNA, an investment-grade counterparty. The interest rate derivative agreements were used in an effort to manage the interest rate risk inherent in the retained interests in the Company’s off-balance sheet securitizations. The option agreements were designated as economic hedges to the floor income component of the residual interests. The Company closed out of these derivative positions during the fourth quarter of 2009 in anticipation of changes in accounting standards effective January 1, 2010, which resulted in the consolidation of the Company’s previously unconsolidated securitizations and elimination of the related retained interests being hedged.
The Company’s derivative instruments do not qualify for hedge accounting under ASC 815.
The fair values of the Company’s derivatives are included in Other Assets and Other Liabilities, respectively, and are provided in the table below:
March 31, 2010
|
December 31, 2009
|
|||||||||||||||||||||||
Fair Value
|
Fair Value
|
|||||||||||||||||||||||
(Dollars in thousands)
|
Notional
|
Asset
|
Liability
|
Notional
|
Asset
|
Liability
|
||||||||||||||||||
Prime-LIBOR swap
|
$ | 1,949,837 | $ | 12,972 | $ | – | $ | – | $ | – | $ | – | ||||||||||||
Foreign currency swap
|
232,050 | – | 30,368 | 232,050 | – | 17,381 |
Gains and losses on the Company’s derivatives are recorded in Fee and Other Income and are provided in the table below:
Three Months Ended
March 31,
|
||||||||
(Dollars in thousands)
|
2010
|
2009
|
||||||
Losses on foreign currency swap
|
$ | (12,986 | ) | $ | (7,349 | ) | ||
Losses on prime-LIBOR swap
|
(4,340 | ) | – | |||||
Gains on LIBOR-based swaps
|
– | 6,569 | ||||||
Gains on interest rate floor options
|
– | 47,009 | ||||||
Net (losses) gains on derivatives
|
$ | (17,326 | ) | $ | 46,229 |
20
10. FAIR VALUE OF FINANCIAL INSTRUMENTS (ASC 825-10)
The estimated fair value of the Company’s financial instruments is presented in the following table:
March 31, 2010
|
December 31, 2009
|
|||||||||||||||
(Dollars in thousands)
|
Carrying Value
|
Estimated Fair Value
|
Carrying Value
|
Estimated Fair Value
|
||||||||||||
Financial Assets:
|
||||||||||||||||
Federally insured student loans
|
$ | 33,943,364 | $ | 33,540,001 | $ | 20,719,055 | $ | 20,368,741 | ||||||||
Private education loans | 9,990,694 | 7,208,702 | 7,475,990 | 5,014,558 | ||||||||||||
Cash and restricted cash and cash equivalents
|
1,656,393 | 1,656,393 | 708,534 | 708,534 | ||||||||||||
Accrued interest receivable
|
1,112,457 | 1,008,702 | 891,069 | 776,524 | ||||||||||||
Derivative assets
|
12,972 | 12,972 | – | – | ||||||||||||
Residual interests in loans securitized
|
– | – | 820,291 | 820,291 | ||||||||||||
Servicing assets
|
– | – | 176,587 | 176,587 | ||||||||||||
Retained notes from securitization sales
|
– | – | 19,750 | 19,750 | ||||||||||||
Financial Liabilities:
|
||||||||||||||||
Short-term borrowings
|
$ | 8,245,044 | $ | 8,254,756 | $ | 7,197,686 | $ | 7,219,301 | ||||||||
Long-term borrowings
|
36,855,971 | 35,865,703 | 21,390,976 | 21,412,849 | ||||||||||||
Derivative liabilities
|
30,368 | 30,368 | 17,381 | 17,381 | ||||||||||||
Interest payable
|
74,062 | 74,062 | 63,898 | 63,898 |
In accordance with ASC 825-10, the estimated fair values have been determined by the Company using available market information and other valuation methodologies that are described below. The fair value approximates the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. These estimates are subjective in nature and involve uncertainties and matters of significant judgment. Accordingly, the estimates may not be indicative of the amounts that the Company could realize in a current market exchange. Changes in assumptions could materially affect the estimates.
The difference between fair value and carrying value may vary from period to period based on changes in a wide range of factors, including returns required by investors in financial instruments, LIBOR and CP interest rates, portfolio mix of variable and fixed rate loans, growth of the portfolio, timing of contractual repricing, portfolio age, default rates and maturity or contractual settlement dates.
Total Loan Assets
The fair value of loans was calculated by discounting cash flows through expected maturity using the estimated current relevant yield curve for the interest rates. The carrying value is presented net of the allowance for loan losses.
Cash, Restricted Cash and Cash Equivalents and Accrued Interest Payable
Due to the short-term nature of these instruments, carrying value approximates fair value.
Accrued Interest Receivable
Most of the Company’s accrued interest receivable relates to loans that are not currently in repayment. This accrued interest will be added to the borrowers’ principal balances when the loans enter repayment. Accordingly, the fair value of accrued interest receivable that is expected to be capitalized was calculated using the same methodology used for the related loan assets. Accrued interest receivable on loans in repayment is considered short-term and, accordingly, carrying value approximates fair value.
21
Residual Interests in Loans Securitized, Servicing Assets and Retained Notes
The fair value of the residual interests in the loans securitized, servicing assets, and retained notes (collectively, retained interests) at December 31, 2009 were determined using a discounted cash flow model. At December 31, 2009, retained interests from securitization were recorded at fair value in the Consolidated Financial Statements. For more information on student loan securitizations, see Note 8.
Short-Term and Long-Term Borrowings
The Company pays interest on its short- and long-term borrowings based on CP, LIBOR or prime rates. These borrowings generally have variable interest rates with reset periods ranging from one day to every three months, depending on the specific terms of each borrowing. Many of the Company’s borrowings are based on a base index plus a credit premium. These credit premiums are fixed over the life of the related borrowing. The fair value of the Company’s borrowings from the Original Omnibus Credit Agreement, the Conduit and from its on-balance sheet securitization trusts was calculated by discounting cash flows using, among other things, estimated assumptions including maturity and market discount rates.
Derivatives
Derivatives are used in an effort to manage interest rate and foreign currency exchange rate risk. The fair value of derivative instruments was based upon quotes received from counterparties. These quotes are based on the counterparties’ proprietary models utilizing specific terms and conditions of the derivatives and other market observable inputs. Derivatives are recorded at fair value in the Consolidated Financial Statements.
|
11.
|
FAIR VALUE (ASC 860-50-35 and 50, ASC 820-10 AND ASC 825-10)
|
The Company determines fair value using valuation techniques that are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs create the following fair value hierarchy:
Level 1 –
|
Quoted prices for identical instruments in active markets.
|
Level 2 –
|
Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations whose inputs are observable or whose primary value drivers are observable.
|
Level 3 –
|
Instruments whose primary value drivers are unobservable.
|
Items Measured at Fair Value on a Recurring Basis
The following table presents the Company’s financial assets and liabilities that are measured at fair value on a recurring basis for each of these hierarchy levels:
March 31, 2010
|
December 31, 2009
|
|||||||||||||||
(Dollars in thousands)
|
Level 2
|
Level 3
|
Level 2
|
Level 3
|
||||||||||||
Assets:
|
||||||||||||||||
Residual interests in securitized loans
|
$ | – | $ | – | $ | – | $ | 820,291 | ||||||||
Other assets (1)
|
12,972 | – | – | 196,337 | ||||||||||||
Total Assets
|
$ | 12,972 | $ | – | $ | – | $ | 1,016,628 | ||||||||
Liabilities:
|
||||||||||||||||
Other liabilities
|
$ | 30,368 | $ | – | $ | 17,381 | $ | – |
(1)
|
Amount reported in Level 2 at March 31, 2010 represents an interest rate swap from one of the Company’s securitization trusts that was consolidated as a result of changes in accounting standards, effective January 1, 2010.
|
22
Derivatives
Derivatives are used in an effort to manage interest rate and foreign currency exchange rate risk. Fair value was based upon quotes received from counterparties. These quotes are based on the counterparties' proprietary models utilizing specific terms and conditions of the derivatives and other market observable inputs. Derivatives are recorded at fair value and are included in Other assets and Other liabilities in the table above and in the Consolidated Financial Statements. For more information on derivatives, see Note 9.
Retained Interests in Securitized Loans
The Company classified its residual interests, servicing assets and retained notes in its off balance-sheet securitizations as Level 3 instruments and utilized discounted cash flow models to measure the fair value. These models required management to make certain assumptions which, while based on relevant internal and external data, inherently involve significant judgment and uncertainty. The market for subordinated notes similar to those retained by the Company is not currently active. All of the Company’s retained interests in off-balance sheet securitizations were recorded at fair value in the Consolidated Financial Statements at December 31, 2009. For more information on loan securitizations, see Note 8.
The following table presents the changes in the Level 3 fair value category:
Three Months Ended
March 31,
|
||||||||
(Dollars in thousands)
|
2010
|
2009
|
||||||
Residual interests in securitized loans:
|
||||||||
Balance at beginning of period
|
$ | 820,291 | $ | 942,807 | ||||
Total gains and losses (realized/unrealized) included in earnings:
|
||||||||
Interest income
|
– | 17,792 | ||||||
Fee and other income
|
– | (65,659 | ) | |||||
Purchases, issuances and settlements (1)
|
(820,291 | ) | (53,859 | ) | ||||
Balance at end of period
|
$ | – | $ | 841,081 | ||||
Unrealized (losses) gains relating to assets still held at the reporting date (2)
|
$ | – | $ | (65,659 | ) | |||
Servicing assets and retained notes included in Other assets:
|
||||||||
Balance at beginning of period
|
$ | 196,337 | $ | 274,620 | ||||
Total gains (realized/unrealized) included in earnings:
|
||||||||
Fee and other income
|
– | 3,358 | ||||||
Purchases, issuances and settlements (1)
|
(196,337 | ) | (10,693 | ) | ||||
Balance at end of period
|
$ | – | $ | 267,285 | ||||
Unrealized gains relating to assets still held at the reporting date (2)
|
$ | – | $ | 1,212 |
|
(1)
|
Amount reported for March 31, 2010 represents the elimination of residual interests and servicing assets as the Company consolidated previously off-balance sheet securitization trusts as a result of changes in accounting standards.
|
|
(2)
|
The difference between total gains and losses (realized /unrealized) included in earnings and unrealized gains relating to assets still held at the reporting date represents accreted yield.
|
23
Items Measured at Fair Value on a Non-recurring Basis
Certain assets and liabilities are measured at fair value on a non-recurring basis and therefore are not included in the table above. These include assets such as loans held for sale that are measured at the lower of cost or fair value.
The fair value of loans measured at the lower of cost or fair value is determined using discounted cash flow models or contractual sales price when applicable. Such loans are generally classified in Level 3 of the fair value hierarchy as these discounted cash flow models utilize unobservable inputs, including discount rate, expected prepayment rates and expected credit losses.
At March 31, 2010 and December 31, 2009, the fair value of loans held for sale exceeded the cost basis of $4.3 billion and $2.4 billion, respectively.
|
12.
|
COMMITMENTS AND CONTINGENCIES
|
In the ordinary course of business, the Company is involved in various litigation proceedings incidental to and typical of the business in which it is engaged. In the opinion of the Company’s management, the ultimate resolution of these matters would not be likely to have a material adverse effect on the results of the Company’s operations, financial condition or liquidity.
24
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
Certain statements contained in this report that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are typically identified by the words or phrases “believe”, “expect”, “anticipate”, “intend”, “estimate”, “may increase”, “may result in”, “may fluctuate”, and similar expressions or future or conditional verbs such as “will”, “should”, “would” and “could”. These forward-looking statements involve risks and uncertainties, which could cause The Student Loan Corporation’s (the Company) actual results to differ materially from those the Company expects, including, but not limited to:
·
|
the amount, availability, and cost of future short- and long-term financing to the Company from Citibank, N.A. (CBNA), securitizations, whole loan sales, and other sources;
|
·
|
the Company’s ability to acquire or originate a sufficient volume of private education loans in the amounts anticipated and with interest rates that generate sufficient yields and margins;
|
·
|
the effects of legislative and regulatory changes that affect the demand for, collectibility of and interest rates on student loans, especially the establishment of certain fixed rates of interest on Federal Family Education Loan (FFEL) Program loans, as well as the Health Care and Education Reconciliation Act of 2010 which eliminates the origination of new FFEL Program loans as of July 1, 2010;
|
·
|
the success of the Company’s strategic repositioning efforts, including a more refined origination strategy and pricing changes on its private education loan originations;
|
·
|
the success of the Company’s marketing and sales efforts to grow and improve the profitability of its private education loan business;
|
·
|
actual credit losses, loan collection strategies and their impact on delinquency rates, and the adequacy of loan loss reserves;
|
·
|
any change in ownership of the Company that could result from the potential disposition by CBNA;
|
·
|
fluctuations in interest rates and between various interest rate indices, particularly the manner in which short-term rates affect the Company’s funding costs, consolidation rates, the rates at which interest accrues on its loan portfolio and the effects of interest rate fluctuations on the demand for student loans;
|
·
|
the availability and amount of loan subsidies and any effect on the Company’s net interest margin;
|
·
|
general economic conditions, including, without limitation, the performance of financial markets and unemployment rates;
|
·
|
the availability of alternative financing options to students and their parents, including competitive products offered by other lenders;
|
·
|
the adequacy of the Company’s capital expenditures and of funds allocated for future capital expenditures;
|
·
|
the amount of financial aid available to students and their parents and the cost of education;
|
·
|
prepayment rates on student loans and the quality and profitability of those loans that move into repayment status, as well as actual experience with the repayment cycle of the loan portfolio; |
·
|
the performance of the Company’s loan portfolio servicers, insurers, risk-sharers and higher education institution clients; |
25
·
|
the Company’s and other servicers’ ability to continue to service the loan portfolio in accordance with their contractual obligations; and
|
·
|
loan origination costs.
|
The following discussion should be read in conjunction with the accompanying unaudited Consolidated Financial Statements and Notes and the Company’s 2009 Annual Report on Form 10-K.
Management’s Discussion and Analysis provides the Company’s perspective on its operations and business environment, including the following:
Business Overview – a general description of the Company’s business as well as the impacts of market conditions on the business and business trends.
Business Highlights – a review of key events affecting the Company’s historical and future operating results.
Critical Accounting Estimates – an overview of accounting policies that require critical judgments and estimates.
Financial Condition – a discussion and analysis of the Company’s loan portfolio, disbursement and procurement activity and allowance for loan losses.
Results of Operations – a review of the Company’s results of operations for the three months ended March 31, 2010 and 2009 and discussion of the key factors impacting those results.
Liquidity and Capital Resources – an analysis of the Company’s sources and uses of cash and capital obligations.
Legislation and Regulations – a discussion of legislative activities that affect the student loan industry.
Business Overview
The Company is one of the nation’s leading originators and holders of student loans providing a full range of education financing products and services to meet the needs of students, parents, schools and lenders. The Company was incorporated in 1992 under the laws of the State of Delaware. CBNA owns 80% of the Company’s outstanding common stock and is an indirect wholly owned subsidiary of Citigroup Inc. (Citigroup). The majority of the Company’s loans have been originated and guaranteed under the FFEL Program, authorized by the U.S. Department of Education (the Department) under the Higher Education Act of 1965, as amended (the Higher Education Act). The Company, which has a trust agreement to originate loans through CBNA, is an originator, manager and servicer of loans made in accordance with federally sponsored guaranteed student loan programs as well as private education loans. The Company is committed to providing exceptional service to borrowers and schools, offering competitive and innovative products with solutions that allow students and their families to finance the education of their choice.
On March 30, 2010, President Obama signed into law H.R. 4872, the Health Care and Education Reconciliation Act of 2010, which eliminated new FFEL Program loan originations. Effective July 1, 2010, all federally sponsored guaranteed student loans will be originated through the Federal Direct Loan Program. In compliance with this regulatory change, the Company will cease originating new FFEL Program loans.
While the elimination of the FFEL Program affects a portion of the Company’s strategy, since 2007, management has pro-actively repositioned the Company away from FFEL Program loan originations towards an increased focus on its CitiAssist product. Strategic repositioning activities include, among other things, significant changes in the private education loan underwriting process and a more sophisticated approach to risk-based pricing. The Company has also taken initiatives to reduce its expense base and has continued to use the capital markets for long-term liquidity. Management believes these actions well position the Company to continue its mission to assist students with financing the education of their choice through its private education loan product. The CitiAssist product is one of the longest standing private education loan products in the industry. With over 50 years of experience, the Company will continue to offer competitively priced private loans for undergraduate, graduate, and professional students.
26
The earnings of the Company are primarily generated by the spread between the interest earned on its loan assets and the interest paid on its borrowings. Net interest income is impacted by, among other things: spread changes between the 90-day Commercial Paper rate as published by the Department (CP), the prime rate or the 91-day Treasury Bill rate and London Interbank Offered Rate (LIBOR); credit premiums on the Company’s debt; legislative changes that impact FFEL Program subsidies; utilization rates of borrower benefits; and portfolio growth or contraction.
The Company utilizes funding from various sources for liquidity and to fund new loan originations including, securitizations, government sponsored programs and borrowings from CBNA. The Department sponsored student loan-backed commercial paper conduit, Straight-A Funding, LLC (the Conduit) provides funding to the Company for certain of its FFEL Program Stafford and PLUS loans which were fully disbursed by September 30, 2009. In addition, since December 2008 the Company has been utilizing the Department’s Loan Participation Purchase Program (the Participation Program) and Loan Purchase Commitment Program (the Purchase Program) available through the Ensuring Continued Access to Student Loans Act (ECASLA). These programs are only available for FFEL Program loans disbursed for the remainder of the 2009 – 2010 academic year.
Gains on sales of loans through the Purchase Program, whole loan sales and off-balance sheet securitizations have contributed significantly to the Company’s historical earnings. Future gains on sales of loans will depend on market conditions and the Company’s operational strategies. In addition, as a result of changes in accounting standards effective January 1, 2010, the Company does not expect to recognize gains or losses on future securitization transactions when they are executed. See Note 1 to the Consolidated Financial Statements for additional information related to these changes in accounting standards.
Business Highlights
Net interest income of $85.0 million for the quarter ended March 31, 2010 was $26.9 million, or 46%, higher than the same quarter of 2009. This increase reflects a net increase of $41.3 million related to the adoption of the new accounting standards which resulted in the consolidation of the Company’s previously unconsolidated securitization trusts, $25.4 million for the impact of favorable changes in the spreads between CP and LIBOR and prime and LIBOR, $9.9 million for pricing changes on the Company’s private education loans, and $11.7 million for higher loan balances. These increases were partially offset by higher funding costs which decreased net interest income by $30.1 million, amortization of the funding commitment fee to the Company’s principal stockholder on the Company’s Amended and Restated Omnibus Credit Agreement, executed on January 29, 2010 (Amended and Restated Omnibus Credit Agreement) of $14.2 million and fees on the undrawn balance of $14.9 million.
Net interest margin of 0.79% was four basis points lower than the same period of 2009. Net interest margin for the first quarter of 2010 would have been 27 basis points higher without amortization of the funding commitment fee and fees on the undrawn balance of the Company’s Amended and Restated Omnibus Credit Agreement. Net interest margin also includes the positive impact of the Company’s continued strategic realignment towards risk-based pricing supporting future earnings growth.
During the first quarter of 2010, the Company continued to focus on securing additional long-term structural liquidity. These efforts resulted in the completion of two private education loan securitizations, including one executed under the Term Asset-Backed Securities Loan Facility, which contributed $1.5 billion of funding. The Company also accessed an additional $0.5 billion of funding from the Conduit.
During the twelve-month period ended March 31, 2010, the Company’s managed student loan portfolio increased by $0.5 billion (1%) to $44.5 billion. The managed portfolio includes $44.1 billion of the Company’s owned loan assets of which $38.1 billion has been pledged as collateral against secured borrowings. Originations for the quarter ended March 31, 2010 included FFEL Program Stafford and PLUS loan originations of $2.0 billion, a decrease of 8% compared to the $2.2 billion originated in the first quarter of 2009. The Company also made new CitiAssist® loan commitments of $0.3 billion during the first quarter of 2010, which was 49% lower than the same period in 2009, reflecting the Company’s refined origination strategy.
27
Impacts of Changes in Accounting Standards on the Company’s Financial Statements
Changes in accounting standards that were effective January 1, 2010 have significantly impacted the Company’s balance sheet and results of operations as of and for the period ended March 31, 2010. These changes resulted in the consolidation of assets previously sold to unconsolidated securitization trusts and the debt issued by those trusts. This also resulted in the elimination of retained interests related to those securitizations along with the related mark-to-market gains and losses. The cumulative effect of adopting these new accounting standards on January 1, 2010 resulted in an aggregate after tax charge to retained earnings of $364.1 million. For additional information about the adoption on January 1, 2010, see Note 1 to the Consolidated Financial Statements.
In addition, the Company now recognizes in its financial statements the net interest income of these trusts along with loan loss provisions, mark-to-market gains and losses on derivatives held by the trusts and trust operating expenses. The tables below highlight the consolidating balance sheet and income statement as of and for the three months ended March 31, 2010:
Balance Sheet
March 31, 2010
|
||||||||||||
(Unaudited)
|
||||||||||||
(Dollars in thousands)
|
SLC and Previously Consolidated Subsidiaries(1)
|
Subsidiaries Consolidated on 1/1/2010(2)
|
Total Consolidated(3)
|
|||||||||
Assets:
|
||||||||||||
Federally insured student loans
|
$ | 17,564,239 | $ | 11,589,525 | $ | 29,153,764 | ||||||
Private education loans
|
7,907,674 | 2,001,930 | 9,909,604 | |||||||||
Deferred origination and premium costs
|
512,934 | 235,672 | 748,606 | |||||||||
Allowance for loan losses
|
(166,964 | ) | (6,281 | ) | (173,245 | ) | ||||||
Student loans held for sale
|
4,293,521 | – | 4,293,521 | |||||||||
Cash
|
448,516 | – | 448,516 | |||||||||
Other assets
|
2,072,354 | 496,969 | 2,569,323 | |||||||||
Total Assets
|
$ | 32,632,274 | $ | 14,317,815 | $ | 46,950,089 | ||||||
Liabilities and stockholders’ equity:
|
||||||||||||
Short- and long-term borrowings, payable to principal stockholder
|
$ | 8,602,000 | $ | – | $ | 8,602,000 | ||||||
Short-term secured borrowings, payable to Department of Education
|
4,034,044 | – | 4,034,044 | |||||||||
Long-term secured borrowings
|
18,594,437 | 13,870,534 | 32,464,971 | |||||||||
Deferred income taxes
|
170,976 | – | 170,976 | |||||||||
Other liabilities
|
348,137 | 29,518 | 377,655 | |||||||||
Net intercompany payables and receivables
|
(417,763 | ) | 417,763 | – | ||||||||
Common stock and Additional Paid-in Capital
|
142,740 | – | 142,740 | |||||||||
Retained earnings
|
1,157,703 | – | 1,157,703 | |||||||||
Total Liabilities and Stockholders’ Equity
|
$ | 32,632,274 | $ | 14,317,815 | $ | 46,950,089 |
(1)
|
Represents the Student Loan Corporation and its subsidiaries that were consolidated under accounting standards in effect prior to the adoption of accounting standards on January 1, 2010, which resulted in the consolidation of the Company’s previously off-balance sheet securitizations.
|
(2)
|
Represents the Company’s subsidiaries that were consolidated upon adoption of accounting standards on January 1, 2010, which resulted in the consolidation of the Company’s previously off-balance sheet securitization trusts.
|
(3)
|
Represents the Company’s Consolidated Balance Sheet at March 31, 2010.
|
28
Statement of Income
Three Months Ended March 31, 2010
|
||||||||||||
(Unaudited)
|
||||||||||||
(Dollars in thousands)
|
Impact from SLC and Previously Consolidated Subsidiaries(1)(4)
|
Impact from Subsidiaries Consolidated on 1/1/2010(2)(4)
|
Total Consolidated(3)
|
|||||||||
Interest income
|
$ | 179,159 | $ | 77,662 | $ | 256,821 | ||||||
Interest expense
|
(153,285 | ) | (18,563 | ) | (171,848 | ) | ||||||
Net interest income
|
25,874 | 59,099 | 84,973 | |||||||||
Provision for loan losses
|
(41,475 | ) | (2,415 | ) | (43,890 | ) | ||||||
Fee and other income (loss)
|
3,388 | (2,803 | ) | 585 | ||||||||
Salaries and employee benefits
|
(7,945 | ) | – | (7,945 | ) | |||||||
Write-off of funding commitment fee to principal stockholder
|
(7,500 | ) | – | (7,500 | ) | |||||||
Other expenses
|
(25,852 | ) | (37 | ) | (25,889 | ) | ||||||
Provision for income taxes
|
125 | – | 125 | |||||||||
Total Net (Loss) Income
|
$ | (53,385 | ) | $ | 53,844 | $ | 459 |
(1)
|
Represents the Student Loan Corporation and its subsidiaries that were consolidated under accounting standards in effect prior to the adoption of accounting standards on January 1, 2010, which resulted in the consolidation of the Company’s previously off-balance sheet securitizations.
|
(2)
|
Represents the Company’s subsidiaries that were consolidated upon adoption of accounting standards on January 1, 2010, which resulted in the consolidation of the Company’s previously off-balance sheet securitization trusts.
|
(3)
|
Represents the Company’s Consolidated Income Statement for the three months ended March 31, 2010.
|
(4)
|
All intercompany income and expense including, among other things, servicing fee revenue and expense have been excluded.
|
In 2009, the Company’s statement of income included certain income items which were not recorded in 2010 due to the consolidation of the previously unconsolidated securitization trusts. Interest income for the first quarter of 2009 included accreted interest of $17.8 million on the Company’s residual interests in its off-balance sheet securitization trusts. Fee and other income for the same period included net mark-to-market losses on the retained interests and related derivatives of $19.4 million, and servicing fee revenue of $19.9 million.
Critical Accounting Estimates
Certain accounting estimates made by management are considered to be important to the portrayal of the Company’s consolidated financial condition. Since management is required to make difficult, complex or subjective judgments and estimates, actual results could differ, possibly materially, from those estimates. The most significant of these critical estimates and judgments are those used to account for allowance for loan losses and loans held for sale, which are more fully described in the Company’s 2009 Annual Report on Form 10-K. See the Notes to the Consolidated Financial Statements for more information on the Company’s accounting estimates.
29
Financial Condition
Loans
At March 31, 2010, the Company’s student loan assets were composed of FFEL Program loans, private education loans, a portfolio of loans held for sale and related deferred costs.
See Note 3 to the Consolidated Financial Statements for a presentation of the loan portfolio by program type.
At March 31, 2010, the Company had $44.1 billion of owned loan assets as compared to $28.3 billion at December 31, 2009. This increase primarily reflects $13.8 billion of student loan assets from the Company’s previously off-balance sheet securitization trusts that were consolidated as a result of changes in accounting standards effective January 1, 2010. At December 31, 2009, these student loan assets were included in the Company’s managed loans of $42.9 billion. See Impacts of Changes in Accounting Standards on the Company’s Financial Statements on page 28 for more information regarding the impact of the change in accounting standard on the Company’s Balance Sheet at March 31, 2010.
The Company makes loans through the retail and wholesale channels. The retail channel represents loan activity initiated through the Company’s relationships with colleges and universities. The majority of the Company’s new FFEL Program Stafford and PLUS loan and school-certified private education loan originations are initiated through the efforts of the Company’s retail sales force. The Company originates the remaining portion of such originations by marketing directly to students and their families, for example, through email and online advertising campaigns. The wholesale channel, which accounts for a small fraction of the Company’s new loan originations, represents loan activity initiated outside of the retail channel, such as purchases of loans originated by other lenders under existing loan purchase commitments.
Details of the Company’s origination activity are presented in the table below:
Three Months Ended
|
||||||||
March 31,
|
||||||||
(Dollars in millions)
|
2010
|
2009
|
||||||
Retail:
|
||||||||
FFEL Program Stafford and PLUS Loan originations
|
$ | 2,008 | $ | 2,192 | ||||
CitiAssist loans disbursed under commitments to purchase (1)
|
329 | 643 | ||||||
Total Retail
|
2,337 | 2,835 | ||||||
Wholesale:
|
||||||||
Loan Consolidation and other secondary market volume
|
7 | 30 | ||||||
Total Originations
|
$ | 2,344 | $ | 2,865 |
(1)
|
Represents CitiAssist loans disbursed by CBNA. These loans have been or will be purchased by the Company after final disbursement.
|
The Company’s FFEL Program loan originations decreased by 8% for the three months ended March 31, 2010 as compared to the same period in 2009. This decrease is largely due to schools moving from the FFEL Program to the Department’s Direct Lending Program. This decrease was partially absorbed by overall growth in the marketplace. As a result of H.R. 4872, the Health Care and Education Reconciliation Act of 2010, the Company will cease originating FFEL Program loans before July 1, 2010.
The Company’s CitiAssist loan commitments are significantly lower than the same period in 2009, primarily reflecting the Company’s refined origination strategy which included, among other things, changes to its underwriting standards and pricing structure. These changes resulted in the discontinuation of Uninsured CitiAssist Custom Loan programs and significantly reduced the volume of originations at certain schools. The Company continuously enhances its private loan product to optimize profitability and ensure that it is competitive in the most attractive market segments. In addition, as the Company shifts its business model to position SLC as the private student loan lender of choice, direct marketing to students and their families will take on greater focus.
30
In order to comply with certain legal and regulatory requirements, private education loans are originated by CBNA through an intercompany agreement. After final disbursement, the Company purchases all private education loans from CBNA. At March 31, 2010 and December 31, 2009, the private education loans disbursed and still held by CBNA were $0.1 billion and $0.4 billion, respectively.
Historically, loans were not specifically purchased or originated for resale, and accordingly were recorded in the Company’s portfolio. However, certain loans originated since the fourth quarter of 2008 have been originated with the intent of selling to the Department under the Purchase Program and, accordingly, have been recorded directly into the held for sale portfolio. At March 31, 2010, $4.3 billion of loans were classified as held for sale.
Allowance for loan losses
The Company develops its allowance for loan losses using four segments: FFEL Program, Insured CitiAssist, Uninsured CitiAssist Standard, and Uninsured CitiAssist Custom. Uninsured CitiAssist Standard is primarily composed of CitiAssist loans that have been approved based on standard underwriting criteria similar to Insured CitiAssist and were originated on or after January 1, 2008. Uninsured CitiAssist Custom is primarily composed of loans made to non-traditional students or loans with less stringent underwriting standards. The Company stopped originating new Uninsured CitiAssist Custom loans in November 2008.
Although the Company evaluates the adequacy of its allowance for loan losses using four segments, the entire allowance for loan losses is available to absorb credit losses from any segment of the Company’s owned loans. The allowance for loan losses includes all losses at each reporting period that are both probable and estimable. However, no assurance can be provided that the allowance for loan losses will be adequate to cover all losses that may in fact be realized in the future, or that a higher reserve for loan losses will not be required. For a full understanding of the methodology used to estimate the allowance for loan losses, see Note 1 to the Consolidated Financial Statements.
The Company’s allowance for loan losses at March 31, 2010 was $173.2 million, an increase of $24.1 million compared to $149.1 million at December 31, 2009. This increase reflects continued performance deterioration from the economic environment and seasoning of the uninsured CitiAssist Standard portfolio. The allowance for loan losses also reflects $6.3 million of additional reserves for newly consolidated securitization loan assets. In addition, there was a build of $5.1 million associated with private education loan forbearance policy changes. These policy changes will result in the Company limiting its borrower assistance programs and are expected to materially increase credit losses beginning in the fourth quarter of 2010. Charge-offs, net of recoveries, increased by $6.6 million, or 33%, during the first quarter as compared to the same period in 2009 primarily due to seasoning of the Uninsured CitiAssist Standard portfolio.
31
An analysis of the allowance for loan losses and its components is presented in the table below:
Three Months Ended
March 31,
|
||||||||
(Dollars in thousands)
|
2010
|
2009
|
||||||
Balance at beginning of period(1)
|
||||||||
FFEL Program
|
$ | 26,080 | $ | 14,445 | ||||
Insured CitiAssist
|
17,554 | 8,512 | ||||||
Uninsured CitiAssist Standard
|
35,840 | 11,891 | ||||||
Uninsured CitiAssist Custom
|
76,611 | 75,481 | ||||||
$ | 156,085 | $ | 110,329 | |||||
Provision for loan losses
|
||||||||
FFEL Program
|
$ | 3,328 | $ | 3,371 | ||||
Insured CitiAssist
|
1,870 | 3,858 | ||||||
Uninsured CitiAssist Standard
|
21,754 | 3,082 | ||||||
Uninsured CitiAssist Custom
|
16,938 | 10,831 | ||||||
$ | 43,890 | $ | 21,142 | |||||
Charge offs
|
||||||||
FFEL Program
|
$ | (5,001 | ) | $ | (2,973 | ) | ||
Insured CitiAssist
|
(3,377 | ) | (2,420 | ) | ||||
Uninsured CitiAssist Standard
|
(4,521 | ) | (636 | ) | ||||
Uninsured CitiAssist Custom
|
(17,713 | ) | (16,896 | ) | ||||
$ | (30,612 | ) | $ | (22,925 | ) | |||
Recoveries
|
||||||||
FFEL Program
|
$ | – | $ | – | ||||
Insured CitiAssist
|
– | – | ||||||
Uninsured CitiAssist Standard
|
238 | – | ||||||
Uninsured CitiAssist Custom
|
3,644 | 2,831 | ||||||
$ | 3,882 | $ | 2,831 | |||||
Balance at end of period
|
||||||||
FFEL Program
|
$ | 24,407 | $ | 14,843 | ||||
Insured CitiAssist
|
16,047 | 9,950 | ||||||
Uninsured CitiAssist Standard
|
53,311 | 14,337 | ||||||
Uninsured CitiAssist Custom
|
79,480 | 72,247 | ||||||
$ | 173,245 | $ | 111,377 |
(1)
|
Beginning balance for the three months ended March 31, 2010 includes $7.0 million for the consolidation of loans from the Company’s previously off-balance sheet securitizations on January 1, 2010.
|
32
Private Education Loans
The Company’s private education loan portfolio is not guaranteed by the federal government. Although private education loans do not carry a federal government guarantee, 53% of the outstanding balances of these loans carry private insurance through United Guaranty Commercial Insurance Company of North Carolina and New Hampshire Insurance Company (UGCIC/NHIC), and 10% of the outstanding balances are insured through Arrowood Indemnity Company (Arrowood). UGCIC/NHIC are subsidiaries of American International Group (AIG). Arrowood is a wholly owned subsidiary of Arrowpoint Capital Corporation (Arrowpoint).
These insurance providers insure the Company against a portion of losses arising from borrower loan default, bankruptcy or death. Under the Arrowood program, private education loans submitted for default claim are generally subject to a risk-sharing deductible of 5% of the outstanding principal and accrued interest balances. Under the UGCIC/NHIC program, default claims are generally subject to risk-sharing deductibles between 10% and 20% of the outstanding principal and accrued interest balances.
From 2003 through 2007, UGCIC/NHIC insured the Company for maximum portfolio losses ranging from 12.5% to 13.5% over the life of the loans. The Company is exposed to 100% of losses that exceed these thresholds. While these losses are not currently forecast to exceed these thresholds, if deterioration in market conditions continues, losses could be higher than expected. For loans insured during 2005 and 2006, the insurance premium is calculated under an experience-rated plan, which may require additional premium payments of up to $58.2 million in order to maintain insurance coverage for these loans if the loss limits exceed the established parameters. If parameters are exceeded in 2010, payments would be required beginning in 2011. The Company ceased insuring new CitiAssist Standard loans in January 2008.
At March 31, 2010, NHIC was rated A+/ Negative by Standard & Poor’s and Aa3/Negative by Moody’s. UGCIC is no longer rated. On February 24, 2009, Moody’s withdrew its rating of both UGCIC and its parent citing business reasons, which Moody’s defines as reasons unrelated to bankruptcy, reorganization status or adequacy of information. Previously, UGCIC was rated a Baa2. Both NHIC and UGCIC generally continue to make claim payments as agreed.
33
Information on private education loans, including delinquency and insurance coverage, is shown in the tables below:
March 31, 2010(1)
|
December 31, 2009
|
|||||||||||||||||||||||||||||||
(Dollars in thousands)
|
Insured
|
Uninsured Standard
|
Uninsured Custom
|
Total
|
Insured
|
Uninsured Standard
|
Uninsured Custom
|
Total
|
||||||||||||||||||||||||
Total private education loans
|
$ | 6,266,917 | $ | 2,560,235 | $ | 1,082,452 | 9,909,604 | $ | 4,408,479 | $ | 2,000,260 | $ | 1,023,732 | $ | 7,432,471 | |||||||||||||||||
Private education loans in repayment
|
4,395,427 | 592,029 | 756,168 | 5,743,624 | 2,752,005 | 501,365 | 694,630 | 3,948,000 | ||||||||||||||||||||||||
Private education loans in forbearance
|
386,613 | 137,517 | 64,872 | 589,002 | 273,839 | 84,470 | 56,978 | 415,287 | ||||||||||||||||||||||||
Percent of private education loans that are delinquent 30 - 89 days
|
2.4 | % | 2.2 | % | 4.4 | % | 2.6 | % | 2.3 | % | 1.9 | % | 4.1 | % | 2.5 | % | ||||||||||||||||
Percent of private education loans that are delinquent 90 days or more
|
1.9 | % | 1.1 | % | 2.0 | % | 1.8 | % | 1.9 | % | 0.4 | % | 1.2 | % | 1.6 | % | ||||||||||||||||
Allowance for loan losses
|
$ | 16,047 | $ | 53,311 | $ | 79,479 | $ | 148,837 | $ | 17,182 | $ | 31,217 | $ | 78,509 | $ | 126,908 | ||||||||||||||||
Private education loans covered by risk-sharing agreements with schools
|
– | – | 468,008 | 468,008 | – | – | 482,423 | 482,423 | ||||||||||||||||||||||||
Year-to-date average of private education loans in repayment
|
4,425,557 | 547,997 | 766,127 | 5,739,681 | 2,372,212 | 273,478 | 600,392 | 3,246,082 | ||||||||||||||||||||||||
Year-to-date average of private education loans in repayment and forbearance
|
4,798,236 | 658,515 | 829,310 | 6,286,061 | 2,655,263 | 319,543 | 656,031 | 3,630,837 | ||||||||||||||||||||||||
Year-to-date net credit losses as a percentage of average loans in repayment
|
0.1 | % | 0.8 | % | 1.8 | % | 0.4 | % | 0.7 | % | 3.4 | % | 10.7 | % | 2.8 | % | ||||||||||||||||
Year-to-date net credit losses as a percentage of average loans in repayment and forbearance
|
0.1 | % | 0.7 | % | 1.7 | % | 0.4 | % | 0.6 | % | 2.9 | % | 9.8 | % | 2.5 | % | ||||||||||||||||
Allowance as a percentage of total loan balance
|
0.3 | % | 2.1 | % | 7.3 | % | 1.5 | % | 0.4 | % | 1.6 | % | 7.7 | % | 1.7 | % | ||||||||||||||||
Allowance as a percentage of total loans in repayment
|
0.4 | % | 9.0 | % | 10.5 | % | 2.6 | % | 0.6 | % | 6.2 | % | 11.3 | % | 3.2 | % | ||||||||||||||||
Allowance coverage of annualized year-to-date net credit losses (in years)
|
1.2 | 3.1 | (2) | 1.4 | 1.7 | 1.1 | 3.3 | (2) | 1.2 | 1.4 |
(1)
|
Amounts presented above for March 31, 2010 include the impact of changes in accounting standards, effective January 1, 2010, which resulted in the consolidation of the Company’s previously unconsolidated private education loan securitization trust.
|
(2)
|
The Company began originating loans in this portfolio in January 2008, so few loans have entered repayment. Accordingly, the amount of net credit losses is disproportionately low relative to the allowance for loan losses, which includes an allowance for loans not yet in repayment.
|
34
March 31, 2010(1)
|
March 31, 2009
|
|||||||||||||||||||||||||||||||
(Dollars in thousands)
|
Insured
|
Uninsured Standard
|
Uninsured Custom
|
Total
|
Insured
|
Uninsured Standard
|
Uninsured Custom
|
Total
|
||||||||||||||||||||||||
Total private education loans
|
$ | 6,266,917 | $ | 2,560,235 | $ | 1,082,452 | 9,909,604 | $ | 4,542,484 | $ | 484,534 | $ | 899,553 | $ | 5,926,571 | |||||||||||||||||
Private education loans in repayment
|
4,395,427 | 592,029 | 756,168 | 5,743,624 | 2,250,303 | 212,250 | 588,494 | 3,051,047 | ||||||||||||||||||||||||
Private education loans in forbearance
|
386,613 | 137,517 | 64,872 | 589,002 | 311,153 | 35,804 | 57,444 | 404,401 | ||||||||||||||||||||||||
Percent of private education loans that are delinquent 30 - 89 days
|
2.4 | % | 2.2 | % | 4.4 | % | 2.6 | % | 2.6 | % | 1.2 | % | 5.1 | % | 3.0 | % | ||||||||||||||||
Percent of private education loans that are delinquent 90 days or more
|
1.9 | % | 1.1 | % | 2.0 | % | 1.8 | % | 2.2 | % | 0.5 | % | 1.9 | % | 2.0 | % | ||||||||||||||||
Allowance for loan losses
|
$ | 16,047 | $ | 53,311 | $ | 79,479 | $ | 148,837 | $ | 9,950 | $ | 14,337 | $ | 72,247 | $ | 96,534 | ||||||||||||||||
Private education loans covered by risk-sharing agreements with schools
|
– | – | 468,008 | 468,008 | – | – | 465,644 | 465,644 | ||||||||||||||||||||||||
Year-to-date average of private education loans in repayment
|
4,425,557 | 547,997 | 766,127 | 5,739,681 | 2,219,856 | 198,379 | 587,671 | 3,055,906 | ||||||||||||||||||||||||
Year-to-date average of private education loans in repayment and forbearance
|
4,798,236 | 658,515 | 829,310 | 6,286,061 | 2,482,019 | 227,490 | 637,393 | 3,346,902 | ||||||||||||||||||||||||
Year-to-date net credit losses as a percentage of average loans in repayment
|
0.1 | % | 0.8 | % | 1.8 | % | 0.4 | % | 0.1 | % | 0.3 | % | 2.4 | % | 0.6 | % | ||||||||||||||||
Year-to-date net credit losses as a percentage of average loans in repayment and forbearance
|
0.1 | % | 0.7 | % | 1.7 | % | 0.4 | % | 0.1 | % | 0.3 | % | 2.2 | % | 0.5 | % | ||||||||||||||||
Allowance as a percentage of total loan balance
|
0.3 | % | 2.1 | % | 7.3 | % | 1.5 | % | 0.2 | % | 3.0 | % | 8.0 | % | 1.6 | % | ||||||||||||||||
Allowance as a percentage of total loans in repayment
|
0.4 | % | 9.0 | % | 10.5 | % | 2.6 | % | 0.4 | % | 6.8 | % | 12.3 | % | 3.2 | % | ||||||||||||||||
Allowance coverage of annualized year-to-date net credit losses (in years)
|
1.2 | 3.1 | (2) | 1.4 | 1.7 | 1.0 | 5.6 | (2) | 1.3 | 1.4 |
(1)
|
Amounts presented above for March 31, 2010 include the impact of changes in accounting standards, effective January 1, 2010, which resulted in the consolidation of the Company’s previously unconsolidated private education loan securitization trust.
|
(2)
|
The Company began originating loans in this portfolio in January 2008, so few loans have entered repayment. Accordingly, the amount of net credit losses is disproportionately low relative to the allowance for loan losses, which includes an allowance for loans not yet in repayment.
|
35
Forbearance usage and delinquency rates generally increased between December 31, 2009 and March 31, 2010. This increase primarily reflects continued seasoning of the Uninsured CitiAssist Standard portfolio.
Forbearance is a key collection tool for borrowers experiencing temporary financial difficulties who need a little more time to resolve the difficulties and are willing to resume making payments. The Company also offers an interest only payment plan as another default prevention tool. As of March 31, 2010, approximately $1.2 billion, or 21% of CitiAssist loans that are in repayment are using this payment option.
Private education student loan forbearance policies at banks and other financial institutions, including The Student Loan Corporation, are subject to various regulatory requirements. In review of the current regulatory environment, the Company is likely to implement changes to the Company’s private education loan loss mitigation programs including, among other things, that participation by borrowers in private education loan forbearance and loss mitigation programs be subject to more rigorous requirements, that shorter forbearance periods be granted and that minimum periods of payment performance be required between grants of forbearance. The Company expects that these changes, when implemented, will materially increase net credit losses attributable to private education loans.
The Company stopped originating new Uninsured Custom loans in November 2008. The increase in the loan balance to $1.1 billion at March 31, 2010 from $1.0 billion at December 31, 2009 is due to the purchase of loans from CBNA in 2010 after final disbursements. The Uninsured Custom loans at March 31, 2010 include $205.9 million of higher risk loans made to students attending proprietary schools. Most of these Uninsured Custom loans did not follow the Company’s standard underwriting process. Approximately 50% of the Uninsured Custom loans are covered by risk-sharing agreements with higher education institutions. Under these programs, the institution assumes a portion of the Company’s credit exposure for the covered loans. The risk-sharing agreements generally take one of two forms: i) the school reimburses the Company for a specified percentage of losses of 50% to 100% when the losses exceed an agreed upon threshold ranging from 0% to 100%, or ii) the school pays 8% to 50% of the total disbursed amount to compensate for future expected losses. Although this reduces the Company’s overall risk, these programs generally transfer less risk away from the Company than private insurance coverage.
Results of Operations
Factors Affecting Net Interest Income
Net Interest Margin Spread Analysis
The following table analyzes the components of net interest margin for the Company’s student loan portfolio:
Three Months Ended
|
||||||||
March 31,
|
||||||||
2010
|
2009
|
|||||||
Student loan yield
|
2.65 | % | 2.94 | % | ||||
Floor income
|
0.43 | % | 0.32 | % | ||||
Consolidation loan rebate fees
|
(0.39 | )% | (0.24 | )% | ||||
Accreted interest on residual interests
|
– | 0.25 | % | |||||
Amortization of deferred loan origination and purchase costs
|
(0.31 | )% | (0.32 | )% | ||||
Net yield
|
2.38 | % | 2.95 | % | ||||
Cost of funds (1)
|
(1.59 | )% | (2.12 | )% | ||||
Net interest margin
|
0.79 | % | 0.83 | % |
(1) Cost of funds was calculated by dividing interest expense by average interest bearing assets.
36
The Company’s net interest margin is affected by a variety of factors, including the interest rate environment, regulatory actions and competition. The Company’s student loan yield is either based on CP or Treasury rates (FFEL Program loans) or prime or LIBOR rates (private education loans) plus an incremental credit premium. The Company has the ability to set credit premiums on its private education loans to reflect current market conditions at origination. However, credit premiums earned on FFEL Program loans are prescribed under the Higher Education Act. The College Cost Reduction and Access Act (CCRA Act) reduced the yield on new loans originated on or after October 1, 2007. In addition, net interest margin is impacted by the relative profitability of the Company’s FFEL Program and private education loan products, and by the weighting of these products within the Company’s loan portfolio. For the quarter ended March 31, 2010, the Company earned $230.0 million and $102.3 million in student loan interest from its FFEL Program and private education loan portfolios, respectively.
In contrast, the Company’s cost of funds is primarily based on three month LIBOR plus an incremental credit premium. Increasing or decreasing LIBOR rates combined with increasing or decreasing credit premiums affect the Company’s overall interest expense. LIBOR rates on the Company’s debt reset periodically while credit premiums are fixed based on market rates at the time of borrowing.
The Company’s student loan yield is also impacted by floor income earned on its FFEL Program loans that were originated prior to April 1, 2006. The Company determines floor income to be the amount of additional interest income generated when net interest margin exceeds the minimum expected spreads. Floor income is defined as the difference between the income earned at the borrower payment rate less the Department-stipulated asset spread and the funding cost of the asset. Floor income, as determined by the Company, is a financial measure that is not defined by U.S. generally accepted accounting principles (GAAP). The 11 basis point increase in net interest margin from floor income primarily reflects the consolidation of loans from the Company’s previously off-balance sheet securitizations, a significant amount of which are loans that were originated prior to April 1, 2006 and generate floor income.
The decrease in net interest margin of four basis points is impacted by several factors. In the first quarter of 2010, the Company recognized in interest expense $29.1 million for amortization of the upfront commitment fee on the Amended and Restated Omnibus Credit Agreement and fees on the undrawn balance. This reduced net interest margin by 27 basis points over the same period of the prior year. In addition, changes in accounting standards resulted in the consolidation of previously off-balance sheet securitization trusts which eliminated the related residual interests and associated accretion, which had contributed 25 basis points to net interest margin in the first quarter of 2009. If these factors were excluded, the adjusted net interest margin in 2010 would be 48 basis points higher than the same period of 2009. The consolidation of the previously off-balance sheet securitization trusts contributed to this overall increase in net interest margin largely because the cost of funds for these trusts is lower than that of other borrowings of the Company due to favorable market conditions existing at the time of securitization.
Net interest margin also benefited from favorable changes in the spreads between the indices used to calculate a significant amount of the Company’s interest revenue (CP and Prime) and LIBOR, the index used to determine most of the Company’s interest expense. However, this was offset by higher credit premiums as the Company has refinanced a significant amount of its borrowings that matured with new long-term borrowings. Because pricing on the asset portfolio is fixed at origination, these term funding transactions, as well as any future funding transactions executed, will continue to have an adverse impact on net interest margin for the life of the borrowings
In an effort to mitigate net interest margin compression, the Company continuously refines its product pricing to reflect current market conditions. In addition, the Company has accessed several sources of funding for FFEL Program loans including the Participation Program and the Conduit. These sources provide funding that better matches the tenor of the Company’s assets at more favorable credit premiums than alternative sources. See Legislation and Regulations on page 43 and Liquidity and Capital Resources on page 41, for further details.
At March 31, 2010 and 2009, the Company’s outstanding borrowings had contractual weighted average interest rates of 1.3% and 2.0%, respectively.
37
Rate/Volume Analysis
The following table shows the factors contributing to changes in net interest income (interest income less interest expense) year-over-year, due to changes in both the weighted average balances and interest rates of loan assets and funding liabilities:
For the three months ended March 31, 2010 vs. the three months ended March 31, 2009
|
||||||||||||
Increase (decrease) due to change in:
|
||||||||||||
(Dollars in millions)
|
Volume
|
Rate
|
Net
|
|||||||||
Interest earning assets
|
$ | 115.7 | $ | (63.1 | ) | $ | 52.6 | |||||
Interest bearing liabilities
|
93.6 | (67.9 | ) | 25.7 | ||||||||
Net interest income
|
$ | 22.1 | $ | 4.8 | $ | 26.9 |
Three Months Ended March 31, 2010
The Company’s comparisons of financial highlights are as follows:
Three Months Ended
|
Favorable
|
Favorable
|
||||||||||||||
March 31,
|
(Unfavorable)
|
(Unfavorable)
|
||||||||||||||
(Dollars in thousands)
|
2010
|
2009
|
Change
|
% Change
|
||||||||||||
Net interest income
|
$ | 84,973 | $ | 58,078 | $ | 26,895 | 46 | % | ||||||||
Provision for loan losses
|
(43,890 | ) | (21,142 | ) | (22,748 | ) | (108 | )% | ||||||||
Fee and other income
|
585 | 6,958 | (6,373 | ) | (92 | )% | ||||||||||
Operating expenses
|
(41,334 | ) | (34,859 | ) | (6,475 | ) | (19 | )% | ||||||||
Provision for income taxes
|
125 | (1,513 | ) | 1,638 | 108 | % | ||||||||||
Net income
|
$ | 459 | $ | 7,522 | $ | (7,063 | ) | (94 | )% | |||||||
Total operating expenses as a percentage of average managed student loans
|
0.38 | % | 0.32 | % | (0.06 | )% | ||||||||||
Return on average equity
|
0.1 | % | 1.9 | % | (0.02 | )% | ||||||||||
Effective tax rate
|
(37.4 | )% | 16.7 | % | 54.1 | % |
Net interest income
Net interest income of $85.0 million for the quarter ended March 31, 2010 was $26.9 million (46%) higher than the same quarter of 2009. This increase reflects a net increase of $41.3 million related to the adoption of the new accounting standards which resulted in the consolidation of the Company’s previously unconsolidated securitization trusts, $25.4 million for the impact of favorable changes in the spreads between CP and LIBOR and prime and LIBOR, $9.9 million for pricing changes on the Company’s private education loans, and $11.7 million for higher loan balances. These increases were partially offset by higher funding costs which decreased net interest income by $30.1 million, amortization of the funding commitment fee on the Company’s Amended and Restated Omnibus Credit Agreement of $14.2 million and fees on the undrawn balance of $14.9 million. Net interest margin of 0.79% was four basis points lower than the same period of 2009. Net interest margin excluding the amortization of the funding commitment fee and excluding fees on the undrawn balance was 1.06% for the first quarter of 2010, 23 basis points higher than the first quarter of 2009.
Net interest income includes floor income of $46.0 million and $21.7 million for the three months ended March 31, 2010 and 2009, respectively. This increase primarily reflects the consolidation of loans from the Company’s previously off-balance sheet securitizations, a significant amount of which are loans that were originated prior to April 1, 2006 and generate floor income.
38
Fee and other income
The Company’s other income of $0.6 million for the quarter ended March 31, 2010 was $6.4 million, or 92% lower than the same period in 2009. This decrease primarily reflects changes in the Company’s fee and other income related to the Company’s securitization activities largely as a result of changes in accounting standards which resulted in the consolidation of previously unconsolidated securitization trusts. See Note 1 to the Consolidated Financial Statements for further information regarding the change in accounting for securitizations.
The Company’s derivative instruments are designed to minimize cash flow volatility for the securitization trusts in which they are embedded, but they are not designated as hedges under ASC 815 and, accordingly, the derivatives are marked to fair value each period. The fair value of the Company’s derivative instruments is driven by market participants’ expectations of future changes in the relevant interest and foreign exchange rates over the life of the instruments. In contrast, the assets and liabilities of the trusts are recorded at amortized cost. This dissimilar accounting treatment may give rise to earnings volatility.
Changes in the fair value of the foreign currency swap within the Company’s 2008-1 securitization trust have historically been largely offset by foreign currency translation adjustments on the Euro denominated debt. In the future, however, any significant fluctuations between the then current exchange rate and the market’s expectation of future exchange rates could give rise to material gains or losses. In addition, changes in the fair value of the prime-LIBOR swap within the Company’s 2006-A securitization trust, which was consolidated as of January 1, 2010, could be material and are not offset by any changes in the carrying value of the securitization trust’s other assets or liabilities. For more information on the Company’s derivative agreements, see Note 9 to the Consolidated Financial Statements.
Operating expenses
Total operating expenses of $41.3 million for the quarter ended March 31, 2010 were $6.5 million (19%) higher than the same period in 2009. Operating expenses during the first quarter of 2010 included a $7.5 million write-off of funding commitment fees on the Company’s Amended and Restated Omnibus Credit Agreement. After completing two private education loan securitizations in the latter half of the quarter, the Company reduced the aggregate commitment amount under the agreement. While this resulted in a write-off in the current quarter, it will lower future fees on the undrawn balance for the remainder of the year. The Company’s salaries and employee benefits expenses were $1.0 million lower than the same period in 2009, reflecting the benefits of the Company’s strategic repositioning efforts. The Company’s operating expense ratio (total operating expenses less the write-off of Omnibus Credit Agreement funding commitment fees as a percentage of average managed student loans) for the first quarter of 2010 was 0.31%, one basis point lower than the same quarter of 2009.
Provision for loan losses
The provision for loan losses increased by $22.7 million for the three months ended March 31, 2010 as compared to the same period in 2009 reflecting the significant build in the allowance for loan losses as well as higher net credit losses driven mainly by the Uninsured CitiAssist Standard portfolio as more loans enter repayment. For a full discussion of trends in the Company’s loan losses, see Allowance for Loan Losses on page 31.
Provision for income taxes
The Company’s provision for income taxes for first quarter of 2010 reflects the favorable impact of $0.3 million of the revaluation of deferred tax items for changes in the effective tax rate.
Securitization Activity and Off-Balance Sheet Transactions
Securitization Activity
The Company securitizes student loans through the establishment of trusts, which purchase loans from the Company and sell notes backed by those loans. The Company has historically relied on securitizations to assist in funding new loan origination activities. Securitizations that qualify for sale treatment are referred to as off-balance sheet transactions and those that do not qualify for sale treatment are included in the Company’s Consolidated Balance Sheets. The Company generally retains a residual interest in, as well as the servicing rights on, its off-balance sheet transactions.
As a result of changes in accounting standards, effective January 1, 2010, all of the Company’s future securitization transactions are likely to be accounted for as secured borrowings. The changes have also resulted in the consolidation of assets previously sold to unconsolidated securitization entities as well as the associated notes issued by these securitization entities and the elimination of retained interests, all of which will affect the Company’s financial position in 2010. See Note 1 to the Consolidated Financial Statements for additional information on the changes in accounting standards.
39
The Company completed two securitization financings during the three months ended March 31, 2010, as compared to one securitization financing for the same period in 2009. The Company’s FFEL Program loans funded through the Conduit were also accounted for as secured borrowings.
Three Months Ended
March 31,
|
||||||||
(Dollars in thousands)
|
2010
|
2009
|
||||||
Securitization financings:
|
||||||||
Student loans securitized (1)
|
$ | 1,899,710 | $ | 587,285 | ||||
Student loans funded through the Conduit (1)
|
547,541 | – | ||||||
Total student loans funded through securitization financings (1)
|
$ | 2,447,251 | $ | 587,285 | ||||
Net proceeds from student loans securitized (2)
|
$ | 1,459,441 | $ | 546,126 | ||||
Net proceeds from student loans funded through the Conduit during the current period (2)
|
533,632 | – | ||||||
Total net proceeds from securitization financings(2)
|
$ | 1,993,073 | $ | 546,126 |
(1)
|
Amounts represent the carrying value of the student loans securitized as of the securitization date.
|
(2)
|
Amounts represent net proceeds of loans securitized or funded through the Conduit as of the securitization / funding date.
|
The difference between student loans securitized or funded through the Conduit and the net proceeds received is largely a result of required overcollateralization, but also reflects issuance costs.
The following table reflects balances related to all of the Company’s securitization transactions and other long-term secured borrowings:
(Dollars in thousands)
|
March 31, 2010
|
December 31, 2009
|
||||||
Total on-balance sheet student loans securitized (1)
|
$ | 23,023,331 | $ | 7,649,159 | ||||
Total on-balance sheet student loans funded through the Conduit
|
10,291,052 | 10,060,877 | ||||||
Total off-balance sheet student loans securitized (2)
|
– | 13,896,812 | ||||||
Total long-term secured borrowings(3)
|
32,464,971 | 16,999,976 | ||||||
Residual interests from off-balance sheet student loans securitized
|
– | 820,291 | ||||||
Servicing assets from off-balance sheet student loans securitized
|
– | 176,587 |
(1)
|
Amounts include securitized loan balances from seventeen on-balance sheet securitizations as of March 31, 2010 and five as of December 31, 2009.
|
(2)
|
Amounts include securitized loan balances from ten off-balance sheet securitizations as December 31, 2009.
|
(3)
|
Amounts include secured borrowings from the Company’s on-balance sheet securitizations and the Conduit.
|
For further information on the Company’s other long-term secured borrowings and student loan securitizations, see Notes 1, 5 and 8 to the Consolidated Financial Statements.
Other Off-Balance Sheet Arrangements
The Company also has credit commitments with schools and institutions which are detailed in Sources and Uses of Cash below, as well as one foreign currency swap and one interest rate swap which are described in Note 9 to the Consolidated Financial Statements.
40
Liquidity and Capital Resources
Sources and Uses of Cash
In determining the appropriate mix of funding, the Company strives to balance the competing objectives of maximizing net interest income and minimizing risk. In an effort to manage risk, the Company seeks to match the terms of its funding with the terms of its revenue producing assets, particularly the interest rate characteristics (including the index on which the rate is based and the timing of rate resets) and weighted average lives. The Company largely relies on two primary sources of funding, funding from CBNA and securitizations. However, during 2009 and 2010 the Company further diversified its sources of funding through various programs and facilities supported by the Department.
Funding Arrangements with CBNA
On January 29, 2010, the Company entered into the Amended and Restated Omnibus Credit Agreement with CBNA. The Amended and Restated Omnibus Credit Agreement, as executed, provided up to $6.6 billion in aggregate credit for new borrowings, including separate tranches (with their own sublimits and pricing) for overnight funding, FFEL Program loan funding, private education loan funding and illiquid asset funding. After completing two private education loan securitizations in the first quarter of 2010, the Company reduced the aggregate commitment amount under the credit agreement by $1.0 billion to $5.6 billion. The initial term of the Amended and Restated Omnibus Credit Agreement expires on December 30, 2010 and all new borrowings will be due and payable on or before this date. At March 31, 2010, the Company had $8.6 billion of borrowings outstanding under the Omnibus Credit Agreement dated November 30, 2000, between the Company and CBNA (Original Omnibus Credit Agreement). In addition to proceeds from the Company’s operations, to the extent needed, overnight borrowings available through the Amended and Restated Omnibus Credit Agreement may be utilized to fund the Company’s business operations for the remainder of the year.
Securitizations
The Company continues to access funding directly with investors through the capital markets. During the quarter ended March 31, 2010, the Company completed two private education loan securitizations, including one executed under The Term Asset-Backed Securities Loan Facility (TALF).
Other Funding Programs
During 2009 and 2010 the Company utilized the following programs and facilities supported by the Department:
·
|
The Conduit: This program provides additional liquidity support to eligible student lenders by providing funding for FFEL Program Stafford and PLUS loans first disbursed on or after October 1, 2003 and before July 1, 2009, and fully disbursed by September 30, 2009. The Company receives funding equal to 97% of the principal and interest to be capitalized of the pledged student loans through the issuance of a funding note which is purchased by the Conduit. The funding notes mature no later than January 2014. As of March 31, 2010, the Company does not expect to fund any additional loans through the Conduit.
|
|
·
|
The TALF: This facility provides additional liquidity support to the asset-backed securities market. The Company completed two private education loan securitizations under this facility during the period it was available. This facility expired on March 31, 2010. Prior to the expiration of this facility the Company also executed a private education loan securitization with investors directly through the capital markets. In addition, one of its TALF securitizations included investors that did not utilize funding from the facility.
|
|
·
|
The Participation Program and Purchase Programs: The Participation Program provides lenders with short-term liquidity for new FFEL Program loan originations. Under the Purchase Program, the Department purchases eligible FFEL Program loans at a price that exceeds the outstanding principal, accrued interest and origination fees, resulting in gains on the sale of loans. These programs are currently only available for FFEL Program loans disbursed for the remainder of the 2009 – 2010 academic year, and will only be used for FFEL Program loan originations made prior to the elimination of the FFEL Program on July 1, 2010.
|
41
The Company has and will continue to shift its use of its available sources or augment funding with additional funding sources in response to changing market conditions.
The following table summarizes the Company’s primary sources and uses of cash:
Three Months Ended
March 31,
|
||||||||
(Dollars in billions)
|
2010
|
2009
|
||||||
Sources of Cash:
|
||||||||
Proceeds from securitizations, net of principal repayments
|
$ | 1.1 | $ | 0.5 | (1) | |||
Proceeds from secured borrowings related to the Conduit, net of principal repayments
|
0.2 | – | ||||||
Proceeds related to the Participation and Purchase Programs, net of principal repayments
|
2.0 | 1.1 | ||||||
Proceeds from borrowings with CBNA, net of principal repayments
|
– | 0.1 | ||||||
Borrower repayments on student loans and other loan reductions
|
0.9 | 0.6 | ||||||
Uses of Cash:
|
||||||||
Loan disbursements and other procurement activities
|
$ | (2.6 | ) | $ | (2.2 | ) | ||
Repayments of borrowings with CBNA, net of proceeds
|
(0.9 | ) | – | |||||
Payment of funding commitment fee and fee on undrawn balance to CBNA under the Amended and Restated Omnibus Credit Agreement
|
(0.1 | ) | ||||||
Increases in cash during the period:
|
$ | 0.4 | – |
|
(1)
|
Includes proceeds from whole loan sales
|
The Company had cash expenditures for equipment and computer software which were primarily composed of software developed for internal use. Cash expenditures for equipment and computer software totaled $1.5 million and $1.8 million for the three months ended March 31, 2010 and 2009, respectively.
Future Funding Expectations
The Company’s future cash needs will depend primarily on the volume of new loan disbursements as well as the cash provided by, or used in, operating activities. The Company currently expects new loan disbursement volumes to be funded primarily via the capital markets and from the Amended and Restated Omnibus Credit Agreement. However, under the terms of the Amended and Restated Agreement, any future securitizations will require approval from Citigroup. In addition, the Company will continue to evaluate alternative funding sources. However, there can be no assurance that any such alternatives will provide terms that are comparable to or more favorable than those currently available to the Company. Management believes liquidity and capital will be sufficient to meet the Company's anticipated requirements until the expiration of the term of the Amended and Restated Omnibus Credit Agreement on December 30, 2010 utilizing funding available from the Amended and Restated Omnibus Credit Agreement and via the securitization market and government programs. This is dependent upon, among other things, the capital markets providing uninterrupted and cost effective funding. In addition, any disposition of its ownership in the Company by Citigroup which results in a change of control whereby an entity other than CBNA or its affiliates owns more than 50% of the voting equity interest in the Company, or other event that results in the early termination of the Amended and Restated Omnibus Credit Agreement, could materially and adversely impact the Company’s liquidity and capital requirements.
42
Legislation and Regulations
Current Legislative and Regulatory Impacts
FFEL Program
On March 30, 2010, President Obama signed into law H.R. 4872, the Health Care and Education Reconciliation Act of 2010, which included a provision to eliminate new FFEL Program loan originations effective July 1, 2010, and will have all schools use the Federal Direct Loan Program. In compliance with this regulatory change the Company will cease originating new FFEL Program loans.
Other Developments
In July 2009, the Private Student Loan Debt Swap Act of 2009 (S. 1541) was introduced into the Senate. As proposed, this act would allow certain private education loan borrowers, who, at the time of taking out the private education loan, were eligible for loans through federally guaranteed student loan programs, to refinance their private education loans under the Federal Direct Loan Program. A House version of the bill is expected to be introduced in April 2010. The Company cannot predict whether this legislation will be enacted in this form, if at all, or the potential impact on the Company’s financial condition or results of operations.
Congress is considering a number of financial institution regulatory changes which, if enacted into law, would have material effects on how consumer credit products are offered, advertised, and regulated. A key component of the proposed regulatory changes is the creation of an independent Consumer Financial Protection Agency (CFPA), or a Consumer Financial Protection Bureau (CFPB) within the Federal Reserve Board, which would be granted authority to both regulate providers of credit, savings, payment, and other consumer financial products and services and to set minimum standards for such products and services. However, the current proposals would also allow state consumer protection laws to apply, even if they provide greater protection than the CFPA or CFPB, as long as they are not in conflict with requirements imposed by the proposed act or the rules that the CFPA or CFPB adopts. This type of regulatory framework is materially different from that which currently exists for financial institutions such as the Company, whose principal regulator is the Office of the Comptroller of the Currency (OCC), with state enforcement and visitation deemed preempted by the authority of the OCC. At this time it is difficult to predict what regulatory changes will look like in their final form. However, if the proposed or similar regulatory framework is enacted into law, this could have a material effect on the Company by substantially increasing the complexity of its operations.
The U.S. Supreme Court, in a recent case, Cuomo v. The Clearing House Association, L.L.C. and Office of the Comptroller of the Currency, ruled in favor of the authority of states to enforce their own laws when they are not otherwise preempted. While the scope of the impact this decision will have is yet to be determined, it appears likely to increase the regulatory burden on the Company.
Certain members of Congress have indicated that they wish to introduce legislation which would eliminate the exemption of qualifying private student loans from being discharged in bankruptcy. Current law provides that qualifying private student loans, such as most of the Company's CitiAssist loans, cannot be discharged unless the debtor can prove the payment of the debt will impose an undue hardship. If such legislation were to be enacted into law, this could have a material effect on the Company by substantially increasing credit losses.
Pending Litigation
The Company is subject to various claims, lawsuits and other actions that arise in the normal course of business. Most of these matters are claims by borrowers disputing the manner in which their loans have been processed, the accuracy of the Company’s reports to credit bureaus, or actions taken with respect to collecting on delinquent or defaulted loans. Management believes that ultimate resolutions of these claims, lawsuits and other actions will not have a material adverse effect on the Company’s business, financial condition or results of operations.
43
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company’s principal measure of market risk due to interest rate changes is Interest Rate Exposure (IRE). IRE measures the change in expected net interest margin that results solely from unanticipated, instantaneous changes in market rates of interest. Other factors such as changes in volumes, premiums, margins and the impact of prior period pricing decisions can also change current period interest income, but are not captured by IRE. While IRE assumes that the Company makes no additional changes in pricing or balances in response to the unanticipated rate changes, in practice, the Company may alter its portfolio mix, customer pricing or hedge positions, which could significantly impact reported net interest margin. IRE does not measure the impact that market rate changes would have on the Company’s earnings related to instruments classified as trading.
IRE is calculated by multiplying the gap between interest sensitive items, including loan assets, borrowings and certain derivative instruments, by a 100 basis point instantaneous change in the yield curve. The exposures in the table below represent the approximate change in net interest margin for the next 12 months based on current balances and pricing that would result from specific unanticipated changes in interest rates:
March 31,
|
||||||||||||||||
(Dollars in millions)
|
2010
|
2009
|
||||||||||||||
100 basis points
|
Increase
|
Decrease
|
Increase
|
Decrease
|
||||||||||||
Change in interest income
|
$ | (38.5 | ) | $ | 64.2 | $ | (10.7 | ) | $ | 22.1 |
In addition, the Company has exposure to uneven shifts in interest rate curves, primarily shifts in the spread between CP and LIBOR. The Company, through its Asset/Liability Management Committee, actively manages these risks by setting IRE limits and takes action in response to interest rate movements against the existing structure.
Item 4. Controls and Procedures
(a)
|
Disclosure Controls and Procedures
|
The Company's management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.
(b)
|
Internal Control Over Financial Reporting
|
There has not been any change in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
44
PART II OTHER INFORMATION
Item 1A. Risk Factors
Certain of the statements below are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. See Forward-Looking Statements on page 25.
The following discussion sets forth certain risks that the Company believes could cause its actual future results to differ materially from expected or historical results. However, the discussion below is not exhaustive, and other factors could have a material adverse impact on the Company’s results. These factors include, natural disasters, acts of terrorism and epidemics and the factors listed under Forward-Looking Statements on page 25, among others.
Liquidity is essential to the Company’s business, and the Company relies on external sources, including the Amended and Restated Omnibus Credit Agreement, capital markets, and government programs to fund its balance sheet. Failure to secure cost-effective funding would adversely impact the Company’s ability to fund student loan originations and could materially increase the Company’s cost of funds.
Uninterrupted access to liquidity is essential to the Company’s business. The Company’s liquidity and funding has been, and could continue to be, materially adversely affected by factors the Company cannot control, such as the continued general disruption of the financial markets or negative views about the financial services industry in general.
The Company’s Amended and Restated Omnibus Credit Agreement provides funding through December 30, 2010. As executed, this agreement provided up to $6.6 billion in aggregate credit for new borrowings. After completing two private education loan securitizations in the first quarter of 2010, the Company reduced the aggregate commitment amount under the credit agreement by $1.0 billion to $5.6 billion. However, the costs of funding, including the interest rates on any borrowings, the funding commitment fee and the fee on the undrawn balance, under this agreement are significantly higher than the borrowings that are expected to mature over the next twelve months. This will further compress the Company’s net interest margin. Unless the Company is able to identify and implement other funding alternatives, maturing borrowings will need to be replaced with new borrowings under this agreement at higher rates. However, under the terms of this agreement, any future securitizations require CBNA’s approval. In addition, before the end of 2010, the Company will need to negotiate an extension to this agreement with CBNA or enter into one or more alternative funding arrangements in order to maintain adequate liquidity in 2011.
The Amended and Restated Omnibus Credit Agreement also requires a comprehensive package of representations, warranties, conditions, covenants (including a borrowing base and various other financial covenants) and events of default.
The Amended and Restated Omnibus Credit Agreement supersedes and replaces in its entirety the Original Omnibus Credit Agreement. At March 31, 2010, the Company had $8.6 billion of outstanding borrowings made under the Original Omnibus Credit Agreement which will continue to mature based on their originally contracted maturities, unless a change of control or an event of default, as defined by the Amended and Restated Omnibus Credit Agreement, occurs. A change of control is defined as any event that results in an entity other than CBNA or its affiliates owning more than 50% of the voting equity interest in the Company. The Company is part of a group of businesses within Citigroup, referred to as Citi Holdings. Citigroup intends to exit these businesses as quickly as practicable in an economically rational manner through business divestitures, portfolio run-off and asset sales. The Company’s management is currently working with Citi Holdings to provide information necessary to support Citi Holdings’ efforts to explore possible disposition and combination alternatives with regard to the Company. If a change of control or an event of default (certain of which require explicit action by CBNA to effect an acceleration) under the Amended and Restated Omnibus Credit Agreement were to occur, all outstanding borrowings under the Original Omnibus Credit Agreement and all new borrowings under the Amended and Restated Omnibus Credit Agreement would become due and payable immediately. In either event, the Company would no longer have a guaranteed funding source, which would have a material adverse effect on, among other things, the Company's ability to originate new loans, repay its debt obligations, fund business operations and maintain the current level of profitability.
45
In addition to funding available to the Company under the Amended and Restated Omnibus Credit Agreement and through loan securitizations, the Company has further diversified its sources of funding, and continues to seek additional alternative sources of funding. Since December 2008, the Company has been utilizing funding available under the Participation Program. In the second quarter of 2009, the Company began selling eligible loans to the Department under the Purchase Program. These programs are only approved through the remainder of the 2009-2010 academic year. The Company will continue to utilize these programs to fund FFEL Program loan originations that it originates before the elimination of the FFEL Program on July 1, 2010.
Since the second quarter of 2009, the Company also accessed additional funding through the Conduit. Funding for the Conduit will be provided by the capital markets. In the event the commercial paper issued by the Conduit cannot be reissued or “rolled” at maturity and the Conduit does not have sufficient cash to repay investors, the Department has committed to provide liquidity to the Conduit by entering into forward purchase agreements to purchase the eligible student loans backing the Conduit at a predetermined price. The predetermined price represents a discount to the principal balance of the loans. Accordingly, a sale of loans to the Department would result in a loss to the Company and negatively impact its results of operations.
Our business is subject to extensive regulation and recent market disruptions have led to proposals for new laws and regulations, or changes to existing laws and regulations.
As a participant in the financial services industry, the Company is subject to extensive regulation. In addition, as a result of the current economic and market downturn, there has been increased discussion of, and calls for, additional legislative changes and increased scrutiny from a variety of regulators. New laws or regulations, or changes in enforcement of existing laws or regulations applicable to the Company’s business, may adversely affect the Company. Legislative or regulatory changes could lead to business disruptions, impact the value of assets that the Company holds or the scope or profitability of its business activities, require the Company to change certain of its business practices and expose the Company to additional costs (including compliance costs) and liabilities. For example, private student loan forbearance policies at banks and other financial institutions, including The Student Loan Corporation, are subject to various regulatory requirements. In view of the current regulatory environment, the Company is likely to implement changes to the Company’s private education loan loss mitigation programs including, amount other things, that participation by borrowers in private education loan forbearance and loss mitigation programs are subject to more rigorous requirements, that shorter forbearance periods be granted and that minimum periods of payment performance be required between grants of forbearance. The Company expects that these changes, when implemented, will materially increase net credit losses attributable to private education loans.
Other regulatory changes currently being considered include financial institution regulatory changes by Congress, which, if enacted into law, would have material effects on how consumer credit products are offered, advertised, and regulated, and changes by the Department to rules and regulations over the Higher Education Act.
In addition, legislation that would allow private student loan borrowers to once again discharge their private student loans in bankruptcy has been introduced. Since 2005, private student loans have not been dischargeable in bankruptcy. If enacted into law, this would have a material effect on the Company’s results of operations by significantly increasing its provision for loan losses.
The Company’s business and earnings are affected by the fiscal policies adopted by regulatory authorities of the United States. For example, policies of the Federal Reserve Board directly influence the rate of interest paid by commercial banks, including CBNA, the Company’s primary funding source, on its interest-bearing deposits. This may affect the Company’s cost of borrowing from CBNA, and also may affect the value of financial instruments, including retained interests in securitizations and assets held for sale by the Company. In addition, such changes in fiscal policy may adversely affect the ability of the Company’s borrowers to repay their loans on a timely basis and the ability of prospective borrowers to qualify for loans.
If any of these or similar types of regulatory changes were to be adopted, they could have an adverse effect on the Company’s financial condition and results of operations. For further information on the impact of other recent legislative and regulatory activities, see Legislation and Regulations on page 43.
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Recent legislative changes, which resulted in the elimination of the FFEL Program, will have a material adverse effect on the Company’s business.
On March 30, 2010, President Obama signed into law H.R. 4872, the Health Care and Education Reconciliation Act of 2010, which eliminated new FFEL Program loan originations. Effective July 1, 2010, all federally sponsored guaranteed student loans will be originated through the Federal Direct Loan Program. In compliance with this regulatory change, the Company will cease originating new FFEL Program loans. This legislative change will eliminate the primary sources of the Company’s historical originations and interest income.
Over the past year, the Company has transitioned its focus away from FFEL Program originations towards an increased focus on its private education loan product in preparation of this outcome. This transition includes the Company’s strategic repositioning activities, including, among other things, significant changes in the private education loan underwriting process and a more sophisticated approach to risk-based pricing. The Company has also taken initiatives to reduce its expense base and has continued to use the capital markets for long-term liquidity. These efforts are intended to create a business model that supports future earnings growth. However, there can be no assurance that the measures the Company has taken to transition its strategy to one more focused on the Company’s private education loan business will be successful.
For further information on the impact of these recent legislative activities and other developments, see Legislation and Regulations on page 43.
See Exhibit Index.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: May 10, 2010
The Student Loan Corporation
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By:
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/s/ Joseph P. Guage
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Joseph P. Guage
Chief Financial Officer and Duly Authorized Officer
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(Principal Financial Officer)
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EXHIBIT INDEX
Exhibit
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Number
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Description of Exhibit
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3.1
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Restated Certificate of Incorporation of the Company, incorporated by reference to Exhibit 3.1 to the Company’s 1992 Annual Report on Form 10-K (File No. 1-11616).
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3.2
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By-Laws of the Company, as amended, incorporated by reference to Exhibit 3.2 to the Company’s 1994 Annual Report on Form 10-K (File No. 1-11616).
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10.10.1*
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Amendment No. 1, dated as of March 23, 2010, to the Amended and Restated Omnibus Credit Agreement between the Company and CBNA.
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31.1 *
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Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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31.2 *
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Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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32.1 *
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Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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* Filed herewith
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