UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X Quarterly Report Pursuant to Section 13 or 15(d)
of
The Securities Exchange Act of 1934
For the quarterly period ended September 30, 2003
or
Transition Report Pursuant to Section 13 or 15(d)
of
The Securities Exchange Act of 1934
For the transition period from to
Commission File Number: 1-11616
THE STUDENT LOAN CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 16-1427135 |
(State or other jurisdiction of | (I.R.S. Employer Identification No.) |
incorporation or organization) | |
750 Washington Blvd. | 06901 |
Stamford, Connecticut | (Zip Code) |
(Address of principal executive offices) |
(203) 975-6237
(Registrant's telephone
number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes X No
On November 10, 2003, there were 20,000,000 shares of The Student Loan Corporation's Common Stock outstanding.
Available on the WorldWide Web at studentloan.com
Form 10-Q
Part I Financial
Information
Page
Item 1 - Financial Statements
Statement
of Income (Unaudited) for the Three- and Nine-Month
Periods
Ended September 30, 2003 and 2002
...................................................................
3
Balance
Sheet as of September 30, 2003
(Unaudited)
and December 31, 2002
(Audited).......................................................................
4
Statement
of Cash Flows (Unaudited) for the Nine-Month Periods
Ended
September 30, 2003 and
2002..............................................................................
5
Statement
of Changes in Stockholders' Equity (Unaudited) for
the
Nine-Month Periods Ended September 30, 2003 and
2002.................................
6
Notes to Financial Statements (Unaudited)............................................................. 7-13
Item 2
- Management's Discussion and Analysis of Financial
Condition
and Results of
Operations.............................................................................
14-20
Item 3 - Quantitative and Qualitative Discussion About Market Risk................................ 21
Item 4 - Controls and Procedures........................................................................................ 22
Part II Other Information
Item 6 - Exhibits and Reports on Form 8-K........................................................................ 23
Signature........................................................................................................................................ 24
PART I. FINANCIAL INFORMATION |
Item 1. Financial Statements |
THE STUDENT LOAN CORPORATION STATEMENT OF INCOME (Dollars in thousands, except per share amounts) (Unaudited) |
Three months ended | Nine months ended | ||
September 30, | September 30, | ||
2003 2002 | 2003 2002 | ||
REVENUE | |||
---|---|---|---|
Interest income | $204,748 $222,968 | $630,314 $752,129 | |
Interest expense | 90,108 129,679 | 287,574 458,832 | |
Net interest income | 114,640 93,289 | 342,740 293,297 | |
Less: provision for loan losses | (3,572) (3,313) | (10,246) (8,608) | |
Net interest income after provision for loan losses | 111,068 89,976 | 332,494 284,689 | |
Fee and other income | 5,498 4,968 | 14,421 17,313 | |
Total revenue, net | 116,566 94,944 | 346,915 302,002 | |
OPERATING EXPENSES | |||
Salaries and employee benefits | 7,418 6,526 | 21,318 19,820 | |
Other expenses | 22,215 19,821 | 64,526 59,292 | |
Total operating expenses | 29,633 26,347 | 85,844 79,112 | |
Income before income taxes | 86,933 68,597 | 261,071 222,890 | |
Income taxes | 35,412 28,001 | 101,918 90,447 | |
NET INCOME | $51,521 $40,596 | $159,153 $132,443 | |
DIVIDENDS DECLARED | $15,400 $14,000 | $ 46,200 $42,000 | |
BASIC AND DILUTED EARNINGS PER COMMON SHARE | |||
(based on 20 million average shares outstanding) | $ 2.58 $ 2.03 | $ 7.96 $ 6.62 | |
DIVIDENDS DECLARED PER COMMON SHARE | $ 0.77 $ 0.70 | $ 2.31 $ 2.10 | |
OPERATING RATIOS | |||
Net interest margin | 2.02% 1.87% | 2.08% 2.05% | |
Operating expense as a percentage of average student | |||
loans | 0.52% 0.53% | 0.52% 0.55% | |
Return on Equity | 23.40% 22.26% | 25.56% 25.40% | |
See accompanying notes to financial statements.
THE STUDENT LOAN CORPORATION |
BALANCE SHEET |
(Dollars in thousands) |
September 30, | December 31, | |
2003 | 2002 | |
(Unaudited) | (Audited) | |
ASSETS | ||
---|---|---|
Student loans | $ 20,444,808 | $ 19,173,992 |
Less: allowance for loan losses | (6,884) | (5,484) |
Student loans, net | 20,437,924 | 19,168,508 |
Loans available for sale | 2,443,412 | 1,361,874 |
Cash | 287 | 383 |
Other assets | 524,669 | 474,839 |
Total Assets | $ 23,406,292 | $ 21,005,604 |
LIABILITIES AND STOCKHOLDERS' EQUITY | ||
Short-term borrowings | $ 11,772,700 | $ 15,789,900 |
Long-term borrowings | 10,350,000 | 4,000,000 |
Payable to principal stockholder | 5,189 | 6,247 |
Deferred income taxes | 129,328 | 105,897 |
Other liabilities | 256,564 | 338,524 |
Total Liabilities | 22,513,781 | 20,240,568 |
Common stock, $.01 par value; authorized 50,000,000 | ||
shares; 20,000,000 shares issued and outstanding | 200 | 200 |
Additional paid-in capital | 135,811 | 135,205 |
Retained earnings | 749,095 | 636,142 |
Accumulated other changes in equity
from nonowner sources |
7,405 | (6,511) |
Total Stockholders' Equity | 892,511 | 765,036 |
Total Liabilities and Stockholders' Equity | $ 23,406,292 | $ 21,005,604 |
AVERAGE STUDENT LOANS | $ 22,008,199 | $ 19,481,147 |
(year-to-date) | ||
See accompanying notes to financial statements.
THE STUDENT LOAN CORPORATION |
STATEMENT OF CASH FLOWS |
(Dollars in thousands) |
(Unaudited) |
Nine months ended | |||
September 30, | |||
2003 | 2002 | ||
Cash flows from operating activities: | |||
Net income | $ 159,153 | $ 132,443 | |
Adjustments to reconcile net income to | |||
net cash from operating activities: | |||
Depreciation and amortization | 82,365 | 48,856 | |
Provision for loan losses | 10,246 | 8,608 | |
Deferred tax provison | 13,898 | 5,978 | |
Loss on disposal of assets | - | 1,678 | |
Realized gains on securitized loans | (312) | (3,121) | |
(Increase) in accrued interest receivable | (24,622) | (21,259) | |
Decrease/(increase) in other assets | 3,469 | (31,155) | |
(Decrease) in other liabilities | (73,767) | (84,081) | |
Net cash provided by operating activities | 170,430 | 57,947 | |
Cash flows from investing activities: | |||
Disbursements of loans | (2,162,986) | (1,834,346) | |
Loan portfolio purchases | (1,990,846) | (1,769,474) | |
Loan purchases held for sale | (1,103,838) | (1,052,464) | |
Loan reductions | 2,930,351 | 2,526,410 | |
Net (increase) in deferred loan origination and purchase costs | (112,638) | (141,516) | |
Proceeds from loans securitized | - | 249,317 | |
Capital expenditures on equipment and computer software | (17,169) | (7,583) | |
Net cash used in investing activities | (2,457,126) | (2,029,656) | |
Cash flows from financing activities: | |||
Net (decrease) in borrowings with original | |||
maturities of one year or less | (4,617,200) | (2,079,700) | |
Repayments of long-term borrowings | (2,200,000) | (57,000) | |
Proceeds from long-term borrowings | 9,150,000 | 4,150,000 | |
Dividends paid to stockholders | (46,200) | (42,000) | |
Net cash provided by financing activities | 2,286,600 | 1,971,300 | |
Net decrease in cash | (96) | (409) | |
Cash - beginning of period | 383 | 1,222 | |
Cash - end of period | $ 287 | $ 813 | |
Supplemental disclosure of cash flow information: | |||
Cash paid for: | |||
Interest | $ 345,610 | $ 606,923 | |
Income taxes paid, net of refunds | $ 115,584 | $ 70,872 | |
See accompanying notes to financial statements.
THE STUDENT LOAN CORPORATION | ||
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY | ||
(Dollars in thousands, except per share amounts) | ||
(Unaudited) | ||
Nine months ended September 30, | ||
2003 | 2002 | |
COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL | ||
Balance, beginning of period | $ 135,405 | $ 135,051 |
Other | 606 | 354 |
Balance, end of period | $ 136,011 | $ 135,405 |
RETAINED EARNINGS | ||
Balance, beginning of period | $ 636,142 | $ 516,651 |
Net income | 159,153 | 132,443 |
Common dividends declared, $0.77 per common share in 2003; | ||
$0.70 per common share in 2002 | (46,200) | (42,000) |
Balance, end of period | $ 749,095 | $ 607,094 |
ACCUMULATED OTHER CHANGES IN EQUITY FROM NONOWNER SOURCES | ||
Balance, beginning of period | $ (6,511) | $ - |
Net change in cash flow hedges, net of taxes of $3,505 in 2003 and | ||
$(5,496) in 2002 | 5,016 | (7,977) |
Net change in unrealized gains on investment securities, | ||
net of taxes of $5,904 in 2003 and $242 in 2002 | 8,900 | 351 |
Balance, end of period | $ 7,405 | $ (7,626) |
TOTAL STOCKHOLDERS' EQUITY | $892,511 | $734,873 |
SUMMARY OF CHANGES IN EQUITY FROM NONOWNER SOURCES | ||
Net Income | $ 159,153 | $ 132,443 |
Changes in equity from nonowner sources, net of taxes | 13,916 | (7,626) |
Total changes in equity from nonowner sources | $ 173,069 | $ 124,817 |
See accompanying notes to financial statements.
THE STUDENT LOAN CORPORATION
Notes to Financial Statements
(Unaudited)
September 30, 2003
1. Significant Accounting Policies
Interim Financial Information
The financial information of The Student Loan Corporation (the Company) as of September 30, 2003 and for the three- and nine-month periods ended September 30, 2003 and 2002 is unaudited and includes all adjustments (consisting of normal recurring accruals) which, in the opinion of management, are necessary to fairly state the Company's financial position and results of operations in conformity with accounting principles generally accepted in the United States of America. The results for the three- and nine-month periods ended September 30, 2003 may not be indicative of the results for the full year ended December 31, 2003. The accompanying financial statements should be read in conjunction with the financial statements and related notes included in the Company's 2002 Annual Report and Form 10-K. |
Certain amounts in the prior year's financial statements have been reclassified to conform with the current year's presentation. Such reclassifications had no effect on the results of operations as previously reported. |
Use of Estimates
In preparing the financial statements in conformity with accounting principles generally accepted in the United States of America, management has used a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions. |
Revenue Recognition
Revenues, which include interest, fees, and gains on loans securitized, if any, are recognized as earned. Interest income may include special allowance payments and other interest subsidies made by the federal government as prescribed under the Federal Higher Education Act of 1965, as amended (the Act). |
Premiums and discounts on loan portfolio purchases and loan origination and lender fees paid on disbursements are deferred and amortized to interest income on a level yield basis over the expected average life of the student loans in those portfolios. Expected average life is determined based upon a periodic consideration of a variety of factors, including market and borrower interest rates, customer prepayments and guarantor payments received through the claims process. A student loan's expected average life, which is initially determined and may be subsequently revised, may be different from one portfolio to another based upon loan type, year of origination or purchase or other factors. Therefore, different lives are used for different portfolio types based upon these underlying loan characteristics and historical performance. The expected average lives of these loans are reviewed periodically and compared to actual loan run off. If the actual loan run off is different from the anticipated prepayments reflected in the amortization tables, the Company makes a current period adjustment to interest income to arrive at the investment balance that would have been remaining had the new effective yield been applied since loan inception and the amortization rates for future periods are appropriately adjusted. |
Loans
Loans primarily consist of student loans originated under the Federal Family Education Loan (FFEL) Program authorized by the U.S. Department of Education (the Department) under the Act, and are insured by guaranty agencies (guarantors). Student loan interest, inclusive of special allowance payments and floor income, if any, is recognized as it is earned. Federally mandated loan origination or lender fees paid on disbursements, as well as other loan origination costs and premiums and discounts on loan portfolio purchases, are deferred and amortized to interest income on a level yield basis over the expected average lives of the student loans in those portfolios. The determination of the expected average life is based upon a consideration of a variety of factors, including customer prepayments and guarantor payments received through the claims process. (See Revenue Recognition). |
The Company also has a portfolio of alternative loans, primarily CitiAssist Loans. Generally, such loans are insured against loss by private insurers or are covered under risk-sharing agreements with creditworthy universities. |
Allowance for Loan Losses
An allowance for loan losses provides a reserve for estimated losses on the Company's FFEL Program loan portfolio under the risk-sharing provisions of the Act, which provide for lender risk-sharing of 2% of the principal and accrued interest on most claims of FFEL Program defaulted loans. The allowance also reserves for estimated losses on CitiAssist Loans. Most of the Company's CitiAssist Loan portfolio is insured by Guaranty National Insurance Company (GNIC) and Globe Indemnity Company (GIC), subsidiaries of Royal & SunAlliance Insurance Group PLC (RSA). During the third quarter of 2003, the financial strength ratings of GNIC and GIC were downgraded to below investment grade. These loans, and the portion of these loans reinsured by other investment-grade private third party insurers, are generally subject to risk-sharing losses of 5% of the claimed amount. Effective April 1, 2003, the Company began to insure substantially all new CitiAssist Loan originations and purchases through a subsidiary of American International Group (AIG). Under the new insurer, defaults on new loan originations are generally subject to risk-sharing losses of 10% - 20%. The allowance also provides a reserve for certain CitiAssist Loans that are not insured against loss. |
The allowance is established based on estimates of probable losses inherent in the FFEL Program and CitiAssist Loan portfolios and is determined through various statistical analyses. These include migration analyses, in which historical delinquency and credit loss experience is applied to the current aging of the portfolio, together with analyses that reflect current trends and conditions. The estimated losses (net of any third party risk-sharing) are accrued to the allowance when the student loans reach 90 days of delinquency for FFEL Program loans and 30 days of delinquency for CitiAssist Loans. Actual losses, including those that arise from claims with guarantors and private insurers, are charged against the allowance as they occur. |
Student Loan Securitizations
The Company accounts for its securitization transactions in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement No. 125". Under the Company's program to securitize student loans, the loans are removed from the financial statements of the Company and ultimately sold to an independent trust. In turn, the trust sells securities, backed by the student loan assets, to outside investors. Since the securitizations meet the SFAS No. 140 criteria for sale recognition, gains or losses on the sale of the student loans are recorded at the time of securitization. Residual interests that are retained in the loans securitized are accounted for as investments in available-for-sale debt securities. Initial and subsequent measurements of the fair value of the residual retained interests are performed using a discounted cash flow model. |
Loans Available for Sale
Loans available for sale represent loans originated or purchased by the Company for future securitization. These loans are recorded at the lower of cost or market value. Net credit losses on these loans are charged to other expense as incurred. |
Hedging Transactions
The Company's interest rate swap agreements are accounted for in accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended, which requires that all derivatives be recorded at fair value on the balance sheet. Fair value is determined by discounting the cash flows using market interest rates through the contractual maturity dates. These derivatives, which have been designated and are effective as cash flow hedges, are recorded in other liabilities. Changes in these derivatives' fair values, net of taxes, are recorded in the accumulated other changes in equity from nonowner sources component of stockholders' equity. These changes in fair value will be included in earnings of future periods when earnings are also affected by the variability of the hedged cash flows. Accrued interest receivable or payable related to the interest rate swap agreements is recorded in interest expense. |
On July 1, 2003, the Company adopted SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. In particular, this Statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative and when a derivative contains a financing component that warrants special reporting in the statement of cash flows. This Statement is generally effective for contracts entered into or modified after June 30, 2003 and its adoption did not have a material impact on the Company's financial condition or results of operations. |
2. Accounting Changes
The Company participates in various stock-based compensation plans under which Citigroup stock or stock options are granted to certain of the Company's employees. On January 1, 2003, the Company adopted the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation", prospectively to all awards granted, modified, or settled after December 31, 2002. The prospective method is one of the adoption methods provided for under SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure", issued in December 2002. The fair value recognition provisions of SFAS No. 123 require that compensation cost for all stock awards be calculated and recognized over the service period. This compensation cost is determined using option pricing models, intended to estimate the fair value of the awards at the grant date. Prior to January 1, 2003, the Company applied Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", application of which generally results in no charge to earnings for employee stock option awards because the options granted under these plans have an exercise price equal to the market value of the underlying stock at the grant date. Effective January 1, 2003, the Company began recording an expense for these awards. The adoption of SFAS No. 123 did not have a material impact on the Company's financial condition or results of operations. Changes have been made to various stock-based compensation plan provisions for awards granted in 2003. Other changes also may be made that may impact the expense recognized under SFAS No. 123. | |
Also, in January 2003, the FASB released FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46). The provisions of FIN 46 applied immediately to variable interest entities (VIEs) created after January 31, 2003, and to VIEs in which an enterprise obtains an interest after that date. In October 2003, the FASB announced that the effective date of FIN 46 was deferred from July 1, 2003 to periods ending after December 15, 2003 for VIEs created prior to February 1, 2003. The Company elected to adopt the provisions of FIN 46 in the third quarter of 2003. FIN 46 changes the method of determining whether certain entities, including securitization entities, should be included in consolidated financial statements. An entity is subject to FIN 46 and is called a VIE if it has : (1) equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or (2) equity investors that cannot make significant decisions about the entity's operations, or that do not absorb the expected losses or receive the expected returns of the entity. A VIE is consolidated by its primary beneficiary, which is the party involved with the VIE that absorbs a majority of the expected losses, receives a majority of the expected residual returns, or both. Certain entities, including transferors to qualifying special-purpose entities (QSPEs) meeting the reporting requirements of SFAS No. 140, are specifically exempted from the scope of FIN 46. Since the Company's securitizations use trust arrangements that meet the QSPE conditions of SFAS No. 140, its QSPE's financial statements are not consolidated with the financial statements of the Company. Therefore, the impact of adopting FIN 46 on July 1, 2003 was not material to the Company's financial condition or results of operations. |
The Financial Accounting Standards Board (FASB) continues to provide additional guidance on implementing FIN 46 through FASB staff positions. In addition, a draft interpretation of FIN 46 has been issued for comment. As this guidance is finalized, the Company will continue to review the status of VIEs with which it is involved. |
On July 1, 2003, the Company adopted SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150 establishes standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity. It requires that a financial instrument that falls within the scope of this Statement be classified as a liability (or an asset in some circumstances) when that financial instrument embodies an obligation of the issuer. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective July 1, 2003, and its adoption did not have a material impact on the Company's financial statements. |
3. Related Party Transactions
As of August 30, 2003, Citibank, N.A. (CBNA), an indirect wholly owned subsidiary of Citigroup Inc. (Citigroup), owns 80% of the outstanding common stock of the Company. Previously, Citibank New York State (CNYS) had owned such stock, which was transferred to CBNA as a result of the August 2003 merger of CBNA and CNYS. The merger did not have a material effect on the financial condition or results of operations of the Company. |
A number of significant transactions are carried out between the Company and Citigroup and its affiliates. At the effective date of the CBNA-CNYS merger, CBNA became a party to all intercompany agreements that the Company had previously entered into with CNYS, including the Omnibus Credit Agreement (the Omnibus Agreement), the tax-sharing agreement and the CitiAssist loan originations and servicing agreements. In addition, following the merger, FFEL Program loans, which had previously been originated through a trust agreement with CNYS, are originated through a trust agreement with CBNA. CBNA succeeded to all of the rights and assumed all of the obligations of CNYS under such intercompany agreements. |
The majority of the Company's loan originations and servicing is performed through the provisions of intercompany agreements with affiliates of Citigroup. Expenses related to these agreements were $22.7 million and $23.7 million for the nine-month periods ended September 30, 2003 and 2002, respectively. In addition, the Company recorded loan origination and servicing revenue of $5.8 million and $4.8 million for the first nine months of 2003 and 2002, respectively, for work performed by the Company on CitiAssist Loans held by CNYS and CBNA prior to purchase by the Company. |
The Company had outstanding short- and long-term unsecured borrowings with CBNA, pursuant to the terms of the Omnibus Agreement, of $11.8 billion and $10.3 billion, respectively, at September 30, 2003. At September 30, 2003 and 2002, the total outstanding borrowings had contracted weighted average interest rates of 1.6% and 2.4%, respectively, based on LIBOR at the time the borrowings were established or rates reset. For the nine-month periods ended September 30, 2003 and 2002, the Company incurred $278.5 million and $457.7 million, respectively, in interest expense payable to CBNA or CNYS related to these borrowings. |
The Company has a number of interest rate swap agreements outstanding with a subsidiary of Citigroup. At September 30, 2003, the agreements had notional amounts totaling $3.0 billion and contractual terms of between six and twenty-four months. For the three- and nine-month periods ended September 30, 2003, the Company realized $1.0 million and $9.1 million, respectively, in interest expense related to these swap agreements. For 2002, interest expense of $1.2 million was realized on the swap agreements during the third quarter. This was also the amount realized for the first nine months of 2002. |
In addition, Citigroup and its subsidiaries engage in other transactions and servicing activities with the Company, including cash management, data processing, income tax payments, loan servicing, employee benefits, payroll administration and facilities management. Also, certain of the Company's employees perform services on behalf of other Citigroup entities, which are unrelated to the business of education financing, and for which the Company receives compensation. Management believes that the terms under which these transactions and services are provided are, in the aggregate, no less favorable to the Company than those that could be obtained from unaffiliated parties. |
4. Interest Rate Swap Agreements
To better match the interest rate characteristics of its borrowings with its loan assets, the Company, from time to time, enters into interest rate swap agreements on portions of its portfolio. The swap agreements are intended to reduce the basis risk caused by differences between the Company's borrowing rates (based on LIBOR) and the student loan lending rates (based primarily on the 91-day Treasury Bill Rate). The Company's hedges are in compliance with the hedge accounting provisions of SFAS No. 133, as amended, and management expects the Company's hedge program to be effective in offsetting changes in cash flows for the risk being hedged. |
At September 30, 2003 the Company had a number of interest rate swap agreements outstanding with a subsidiary of Citigroup to receive payments based on LIBOR and make payments based on the 91-day Treasury Bill Rate. These agreements, which have been designated and are effective as cash flow hedges, have notional amounts totaling $3.0 billion and contractual terms of between six and twenty-four months. Swap agreements with notional amounts totaling $1.3 billion matured on July 1, 2003. New swap agreements with notional amounts totaling $1.1 billion were entered into during September 2003. |
The fair value of the outstanding swaps at September 30, 2003 was a $3.3 million liability and is reflected in other liabilities on the balance sheet with a corresponding amount, net of taxes of $1.3 million, recorded in the accumulated other changes in equity from nonowner sources component of stockholders' equity. Substantially all of this balance in accumulated other changes in equity from nonowner sources is expected to be reclassified into earnings within the next twelve months. No amounts have been excluded from the assessment of effectiveness and no hedge ineffectiveness has been recognized in earnings pursuant to these swap agreements. Net amounts reclassified from accumulated other changes in equity from nonowner sources are reported in interest expense. |
Accumulated other changes in equity from nonowner sources from cash flow hedges, net of tax, are summarized as follows: |
Three-Month Period | Nine-Month Period | |||
Ended September 30, | Ended September 30, | |||
(Dollars in thousands) | 2003 | 2002 | 2003 | 2002 |
Beginning balance | $(1,437) | $(838) | $(7,010) | $--- |
Net unrealized loss from cash flow hedges | (1,181) | (7,833) | (463) | (8,671) |
Net amounts reclassified to earnings | 623 | 694 | 5,478 | 694 |
Ending balance | $(1,995) | $(7,977) | $(1,995) | $(7,977) |
5. 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 proceedings would not be likely to have a material adverse effect on the results of the Company's operations, financial condition or liquidity. |
Amendments to the Act have reduced the net interest spread earned on the FFEL Program guaranteed student loan portfolio as new loans with lower yields are added to the portfolio and older, more profitable loans are repaid. Despite reductions in funding costs and their expected effects on net income, pressure on margins will continue as more loans are originated with lower yields. Also, the Act may be amended by Congress at any time, possibly resulting in further reductions in FFEL Program loan subsidies and reduced lender net interest margins, in addition to influencing customer prepayments. Any such amendments, in part or in combination, could adversely affect the Company's business and prospects. |
6. Student Loan Securitization
In 2002, the Company commenced a program to securitize certain portfolios of FFEL Program student loan assets. The Company accounts for its securitization transactions in accordance with the provisions of SFAS No. 140. Under the Company's program to securitize student loans, the loans are sold, through a wholly owned special purpose subsidiary, to an independent trust that was established for that purpose. The trust, in turn, sells debt securities, backed by the student loan assets, to outside investors. The Company has retained the servicing relationship on the transferred portfolios and receives servicing and administrative fees from the trust. Failure to service the loans in accordance with contractual obligations could lead to a termination of the servicing rights and the loss of future servicing revenue. |
At September 30, 2003, total student loan assets held by the trust were approximately $421.5 million. At that time, the Company maintained an ownership interest in the assets securitized of approximately $30.4 million in the form of residual retained interests. The Company accounts for the retained interests as investments in available-for-sale debt securities and records them in other assets in the Company's financial statements. At September 30, 2003, the retained interests were composed of a junior certificate of $2.2 million and other retained interests of $28.2 million. The junior certificate balance of $2.2 million is reflective of a $6.3 million principal payment received in the second quarter of 2003. In addition, the payment resulted in the recognition of a $0.3 million pretax gain that was included in net income in the second quarter of 2003. At September 30, 2003, the Company had an unrealized holding gain on its retained interests of $9.4 million, net of taxes of $6.2 million, recorded in accumulated other changes in equity from nonowner sources. Of this unrealized gain, $2.7 million, net of taxes, was recorded in the third quarter of 2003. |
The Company also received cash flows of $0.4 million and $0.1 million from the trust during the first nine months of 2003 and 2002, respectively, for loan servicing and administrative fees as the master servicer. Receivables of $0.02 million were due from the trust for portfolio servicing fees and accrued interest on the junior certificate at both September 30, 2003 and 2002. No amounts were paid or payable to the trust during the third quarter of 2003. At September 30, 2002, $0.6 million was payable to the trust for customer payments collected. No new securitization transactions were entered into during the first nine months of 2003. |
As required by SFAS No. 140, the effect of two negative changes in each of the key assumptions used to determine the fair value of retained interests are disclosed. The negative effect of the change in each assumption must be calculated independently, holding all other assumptions constant. Because the key assumptions may not be independent, the net effect of simultaneous adverse changes in the key assumptions may be different from the sum of the individual effects shown below. |
At September 30, 2003, the key assumptions used to value retained interests were as follows:
Discount Rate | 5.0% |
Constant prepayment rate | 3.0% |
Anticipated net credit losses | 0.24% |
Sensitivity of the fair value to adverse changes in the key assumptions were as follows at September 30, 2003:
(Dollars in thousands) Carrying value of retained interests $ 30,362.7 | |
Discount Rate 5.0% +10% $ (718.3) +20% $(1,404.7) Constant prepayment rate 3.0% +10% $ (238.6) +20% $ (472.5) Anticipated net credit losses 0.24% +10% $ (65.6) +20% $ (131.4) |
These estimates and assumptions, based upon the collateral held by the trust, are subject to change and, therefore, the fair values of the retained interests as presented in the financial statements are subject to possible impairment and may not be fully recoverable.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies
There were no material changes to the Company's critical accounting policies during the third quarter of 2003. The Company considers its accounting policies on revenue recognition, allowance for loan losses, student loan securitizations, and hedging transactions to be its critical accounting policies. For a description of these and other significant accounting policies, see Note 1 to the financial statements and the Company's 2002 Annual Report and Form 10-K. |
Accounting Changes
For accounting changes adopted during 2003, see Note 2 to the financial statements. |
Financial Condition
As of August 30, 2003, Citibank, N.A. (CBNA), an indirect wholly owned subsidiary of Citigroup, Inc. (Citigroup), owns 80% of the outstanding common stock of the Company. Previously, Citibank (New York State)(CNYS) had owned such stock, which was transferred to CBNA as a result of the August 2003 merger of CBNA and CNYS. The merger did not have a material effect on the financial condition or results of operations of the Company. |
At the effective date of the merger, CBNA became a party to all intercompany agreements that the Company had previously entered into with CNYS, including the Omnibus Credit Agreement, the tax-sharing agreement and the CitiAssist Loan originations and servicing agreements. In addition, following the merger, FFEL Program loans, which had previously been originated through a trust agreement with CNYS, are currently originated through a trust agreement with CBNA. CBNA succeeded to all of the rights and assumed all of the obligations of CNYS under such intercompany agreements. |
At September 30, 2003, the Company's student loan assets were composed of a $20.5 billion portfolio of loans held and a $2.4 billion inventory of loans available for sale. The combined $22.9 billion of loan assets, composed primarily of loans originated under the Federal Family Education Loan (FFEL) Program, increased by $2.4 billion (11%) from $20.5 billion at December 31, 2002. This growth was attributable to FFEL Program loan disbursements totaling $2,163 million and loan purchases of $3,095 million in the first nine months of 2003, partially offset by $2,930 million in loan reductions (attributable to borrower principal payments, loan consolidations and claims paid by guarantors), and other adjustments of $24 million. During the nine months ended September 30, 2002, the Company had FFEL Program loan disbursements of $1,834 million, loan purchases of $2,822 million, loan securitizations of $249 million, loan reductions of $2,526 million and other adjustments of $80 million. |
The Company's loan disbursements and loan commitments to finance education for the first nine months of 2003 and 2002 are presented below: |
(Dollars in millions) | 2003 | 2002 | Difference | % Change |
FFEL Program Stafford and PLUS Loan disbursements | $2,163 | $1,834 | $329 | 18% |
CitiAssist Loans under commitments to purchase | 899* | 697** | 202 | 29% |
Total loan disbursements and commitments | $3,062 | $2,531 | $531 | 21% |
* These disbursements are composed of $479 million of loans originated and disbursed by CBNA and CNYS in 2003 and purchased by the Company in the first nine months of 2003 (and included in loan purchases) and $420 million originated and disbursed by CBNA and CNYS in 2003 and committed by the Company for purchase in the future. | |
** These disbursements are composed of $347 million of loans originated and disbursed by CNYS in 2002 and purchased by the Company in the first nine months of 2002 (and included in loan purchases) and $350 million originated and disbursed by CNYS in 2002 and purchased by the Company in subsequent periods. | |
The $329 million increase in loan disbursements for the first nine months of 2003, compared to the same period last year, is primarily attributable to ongoing sales and electronic commerce initiatives. |
In order to comply with certain regulatory requirements, CitiAssist Loans are originated by Citibank, N.A. (CBNA) through an intercompany agreement. Following full disbursement, the Company purchases all qualified CitiAssist Loans at their current value at the time of purchase, including contractual fees. At September 30, 2003, CitiAssist Loans of $420 million had been disbursed by CBNA or CNYS, but had not yet been purchased by the Company. These loans are not included in the Company's September 30, 2003 loan portfolio. CitiAssist Loans are originated through an alternative loan program and do not carry federal government guarantees. |
The Company's secondary market loan activities for the first nine months of 2003 and 2002 are shown in the table below: | |
(Dollars in millions) | 2003 | 2002 | Difference | % Change |
FFEL Program Consolidation Loan purchases | $2,134 | $2,018 | $ 116 | 6% |
CitiAssist Loan purchases | 885 | 636 | 249 | 39% |
Other loan purchases | 76 | 168 | (92) | (55%) |
Total loan purchases | $3,095 | $2,822 | $ 273 | 10% |
From time to time, the Company makes student loan purchases. For the first nine months of 2003, the Company's loan purchases increased by $273 million compared to the same period last year. The increase in loan purchases is primarily attributable to new CitiAssist and Consolidation Loan volume. The Federal Consolidation Loans were purchased primarily for the Company's available for sale inventory, which was established to create a portfolio of loans available for future securitization. The size of the available for sale portfolio is dependent upon the needs of the securitization program. The Company's participation in securitization and secondary market loan activities is dependent upon market conditions. Of the Consolidation Loans purchased in the first nine months of 2003 and 2002, $920 million and $631 million, respectively, were consolidations of federally guaranteed student loans already held in the Company's loan portfolios. For the first nine months of 2003, the Company's student loan purchases included $1,991 million purchased for its portfolio and $1,104 million purchased for its resale inventory. During the nine months ended September 30, 2002, the Company purchased $1,770 million of student loans for its portfolio and $1,052 million for its resale inventory. |
In 2002, the Company commenced a program to securitize certain portfolios of FFEL Program student loan assets. The Company accounts for its securitization transactions in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement No. 125." Under the Company's program to securitize student loans, the loans are sold, through a wholly owned special purpose subsidiary, to an independent trust that was established for that purpose. The trust, in turn, sells debt securities, backed by the student loan assets, to outside investors. The Company has retained the servicing relationship on the transferred portfolios and receives servicing and administrative fees from the trust. Failure to service the loans in accordance with contractual obligations could lead to a termination of the servicing rights and the loss of future servicing revenue. |
At September 30, 2003, total student loan assets held by the trust were approximately $421.5 million. At that time, the Company maintained an ownership interest in the assets securitized of approximately $30.4 million in the form of residual retained interests. The Company accounts for the retained interests as investments in available-for-sale debt securities and records them in other assets in the Company's financial statements. At September 30, 2003, the retained interests were composed of a junior certificate of $2.2 million and other retained interests of $28.2 million. The junior certificate balance of $2.2 million is reflective of a $6.3 million principal payment received in the second quarter of 2003. In addition, the payment resulted in the recognition of a $0.3 million pretax gain that was included in net income in the second quarter of 2003. At September 30, 2003, the Company had an unrealized holding gain on its retained interests of $9.4 million, net of taxes of $6.2 million, recorded in accumulated other changes in equity from nonowner sources. Of this unrealized gain, $2.7 million, net of taxes, was recorded in the third quarter of 2003. |
The Company received cash flows of $0.4 million and $0.1 million from the trust during the first nine months of 2003 and 2002, respectively, for loan servicing and administrative fees as the master servicer. Receivables of $0.02 million were due from the trust for portfolio servicing fees and accrued interest on the junior certificate at both September 30, 2003 and 2002. No amounts were paid or payable to the trust during the third quarter of 2003. At September 30, 2002, $0.6 million was payable to the trust for customer payments collected. No new securitization transactions were entered into during the first nine months of 2003. |
To better match the interest rate characteristics of its borrowings with its loan assets, the Company, from time to time, enters into interest rate swap agreements on portions of its portfolio. The swap agreements are intended to reduce the basis risk caused by differences between the Company's borrowing rates (based on LIBOR) and the student loan lending rates (based primarily on the 91-day Treasury Bill Rate). The Company's hedges are in compliance with the hedge accounting provisions of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended, and management expects the Company's hedge program to be effective in offsetting changes in cash flows for the risk being hedged. |
At September 30, 2003, the Company had a number of interest rate swap agreements outstanding with a subsidiary of Citigroup to receive payments based on LIBOR and make payments based on the 91-day Treasury Bill Rate. These agreements, which have been designated and are effective as cash flow hedges, have notional amounts totaling $3.0 billion and contractual terms of between six and twenty-four months. Swap agreements with notional amounts totaling $1.3 billion matured on July 1, 2003. New swap agreements with notional amounts totaling $1.1 billion were entered into during September 2003. |
The fair value of the outstanding swaps at September 30, 2003 was a $3.3 million liability and is reflected in other liabilities on the balance sheet with a corresponding amount, net of taxes of $1.3 million, recorded in the accumulated other changes in equity from nonowner sources component of stockholders' equity. Substantially all of this balance in accumulated other changes in equity from nonowner sources is expected to be reclassified into earnings within the next twelve months. No amounts have been excluded from the assessment of effectiveness and no hedge ineffectiveness has been recognized in earnings pursuant to these swap agreements. For additional information on the Company's interest rate swap agreements, see Note 4 to the financial statements. |
Pursuant to federal tax regulations, the Company has elected to be included in the consolidated federal income tax return of Citigroup, and is also included in certain combined or unitary state/local income or franchise tax returns of Citicorp/Citigroup or its subsidiaries. In the first nine months of 2003, the Company paid income taxes, net of refunds, of $116 million, primarily pursuant to a tax-sharing agreement with its majority shareholder, compared to $71 million paid in the same period last year. The increase in taxes paid is primarily attributable to the timing of the majority owner's requests for tax payments and is not reflective of any significant changes in the tax provision. |
The Company's short- and long-term debt was procured primarily through an Omnibus Credit Agreement with its majority shareholder, which provides for a maximum aggregate credit limit of $25 billion. Short-term debt decreased by $4.0 billion to $11.8 billion at September 30, 2003, compared to that outstanding at December 31, 2002. The decrease was primarily attributable to $37.8 billion in repayments of rolling short-term borrowings in the first nine months of 2003, partially offset by new rolling short-term borrowings of $31.0 billion and a $2.8 billion reclassification of maturing long-term debt to short-term debt. The $6.4 billion increase in long-term borrowings at September 30, 2003, compared to December 31, 2002, was primarily due to the procurement of $9.2 billion of new long-term borrowings, partially offset by the reclassification of $2.8 billion of maturing long-term debt to short-term debt. The new long-term borrowings were used primarily to fund new loan disbursements and purchases and reflects the replacement of maturing short-term debt with long-term debt in order to lock in lower interest rates for an extended period of time. |
At September 30, 2003 and 2002, the total outstanding borrowings had weighted average interest rates of 1.6% and 2.4%, respectively, based on LIBOR at the time the borrowings were established or rates reset. For the nine-month periods ended September 30, 2003 and 2002, the Company incurred $278.5 million and $457.7 million, respectively, in interest expense payable to CBNA or CNYS related to these borrowings. The $179.2 million decrease in interest expense was primarily attributable to the decline in interest rates. During the first nine months of 2003, the Company made $346 million in interest payments to CBNA and CNYS, compared to $607 million for the same period in 2002. The difference in interest payments between the two periods resulted primarily from differences in the contractual interest due dates and the lower interest rates on the Company's borrowings. |
The Company paid a quarterly dividend of $0.77 per common share on September 2, 2003. On October 16, 2003, the Board of Directors declared a regular quarterly dividend on the Company's common stock of $0.77 per share to be paid December 1, 2003 to stockholders of record on November 14, 2003. |
Results of Operations
Quarter Ended September 30, 2003
Net income was $51.5 million ($2.58 basic and diluted earnings per share) for the third quarter of 2003. This was an increase of $10.9 million (27%) compared to earnings for the same period last year. The improvement is primarily attributable to portfolio growth of 13% over the previous twelve months and increased floor income earned on both Consolidation and Stafford Loan assets. |
The net interest margin for the third quarter of 2003 was 2.02%, up 15 basis points from the third quarter 2002 margin of 1.87%. The improvement was due to a $12.2 million increase in floor income resulting from the Company's ability to take advantage of favorable funding opportunities, partially offset by an increase in loan fee amortizations of $9.5 million, of which $7.4 million is attributable to principal prepayments. Should short-term interest rates increase above the September 30, 2003 level, the floor income benefit could decline materially. |
Total operating expenses for the third quarter of 2003 were $29.6 million, an increase of $3.3 million (12%) from the same period last year, reflecting both the incremental costs incurred to originate, service and administer the larger loan portfolio and ongoing infrastructure investments. For the third quarter of 2003, the Company's expense ratio, operating expenses as a percentage of average student loan assets, was 0.52%, reflecting a one basis point improvement from the third quarter of 2002. |
An allowance for loan losses provides a reserve for estimated losses on the Companys FFEL Program loan portfolio under the risk-sharing provisions of the Act, which provide for lender risk-sharing of 2% of the principal and accrued interest on most claims of FFEL Program defaulted loans. The allowance also provides a reserve for estimated losses on CitiAssist Loans. Most of the Company's CitiAssist Loan portfolio is insured by Guaranty National Insurance Company (GNIC) and Globe Indemnity Company (GIC), subsidiaries of Royal & SunAlliance Insurance Group PLC (RSA). During the third quarter of 2003, the financial strength ratings of GNIC and GIC were downgraded to below investment grade. These loans, and the portion of these loans reinsured by other investment-grade private insurers, are generally subject to risk-sharing losses of 5% of the claimed amount. Effective April 1, 2003, the Company began to insure substantially all new CitiAssist Loan originations and purchases through a subsidiary of American International Group (AIG). Under the new insurer's program, defaults on new loan originations are generally subject to risk-sharing losses of 10% - 20%. However, since the increase in risk-sharing expense is generally expected to be offset by a decrease in insurance premiums, the Company does not expect a material change in overall costs related to the CitiAssist Loan program. The allowance also provides a reserve for certain CitiAssist Loans that are not insured against loss. In the third quarter of 2003, the provision for loan losses increased by $0.3 million, compared to the same period in 2002. This increase is due to changes in product mix and an increase in loans moving into repayment over the previous twelve-month period. |
The Company's return on equity was 23.4% for the third quarter of 2003, up 1.1% compared to 22.3% for the same period of 2002. |
The Company's effective tax rate for the third quarter of 2003 was approximately 40.7%, compared to 40.8% for the same period in the prior year. The decrease in the effective tax rate was primarily attributable to a change in certain 2003 state tax estimates. |
Nine Months Ended September 30, 2003
The Company earned net income of $159.2 million ($7.96 basic earnings per share) for the nine months ended September 30, 2003, an increase of 20% from the $132.4 million ($6.62 basic earnings per share) for the same period of 2002. Increased floor income and portfolio growth accounted for substantially all of this improvement. | |
The net interest margin for the nine months ended September 30, 2003 was 2.08%, up three basis points from the margin of 2.05% for the same period last year. The improvement was due to a $37.2 million increase in floor income resulting from the Company's ability to take advantage of favorable funding opportunitues, partially offset by an increase in loan fee amortizations of $32.9 million, of which $24.7 million is attributable to principal prepayments. | |
Total operating expenses for the first nine months of 2003 were $85.8 million, $6.7 million (9%) higher than the same period last year. The increase reflects the incremental costs incurred to originate, service and administer the larger loan portfolio and ongoing technology infrastructure investments. Operating expenses as a percentage of average student loans for the first nine months of 2003 was 0.52%, compared to 0.55% for the first nine months of 2002. | |
The Company's return on equity was 25.6% for the first nine months of 2003, 0.2% higher than the 25.4% return for the same period of 2002. | |
The Company's effective tax rate was approximately 39.0% for the first nine months of 2003, compared to 40.6% for the same period in the prior year. The decrease in the effective tax rate was primarily attributable to a change in certain 2003 state tax estimates and its impact on the Company's existing deferred tax assets and liabilities. |
Special Allowance and Floor Income
Most FFEL Program Stafford and Parent Loans to Undergraduate Students (PLUS) Loans originated subsequent to July 23, 1992 have variable interest rates and qualify for the federal government's special allowance payment (SAP). Whenever the stated interest rates on these FFEL Program loans provide less than prescribed rates of return, as defined by the Act, the federal government makes a SAP, which increases the lender's loan yield by markups ranging between 1.74 and 3.50 percentage points per annum, over a base rate tied to either the 91-day Treasury Bill auction yield or the 90-day Commercial Paper rate, depending on the loan's origination date. | |
The variable borrower rates on most of the Company's FFEL Program Stafford and PLUS Loans are generally subject to annual reset provisions. In periods of declining interest rates, the stated borrower rates become, in effect, interest rate floors. Floor income is generally earned in declining short-term interest rate environments when the Company's cost of funds declines while the borrower interest rate remains fixed, generating net interest margin in excess of the expected spread. Floor income may also be earned on certain Federal Consolidation Loans since the borrower interest rate for these loans is fixed for the life of the loan. Depending on the manner in which the Company's assets are funded, the Company may earn higher interest margin spreads, which include floor income, on portions of its portfolio until the borrower interest reset date, which occurs annually for the majority of the Company's loans. During the three- and nine-month periods ended September 30, 2003, the Company earned $30.4 million and $94.9 million, respectively, of floor income. During the three- and nine-month periods ended September 30, 2002, the Company earned $18.2 million and $57.7 million, respectively, of floor income. The increase in the 2003 floor income, compared to that earned for the same periods in 2002, was primarily a result of growth in Consolidation Loans, which is the largest contributor to the Company's floor income. This increase was partially offset by lower floor income earned on Stafford Loans compared to the prior year. |
Off-Balance Sheet Transactions
The Company entered into two off-balance sheet transactions in 2002 in which certain FFEL Program portfolios of student loan assets were securitized, a process by which the loans are transferred to a special purpose entity (SPE), thereby converting the loans into cash before they would have been realized in the normal course of business. The securitized loans are removed from the financial statements of the Company and ultimately sold to an independent trust that was established for that purpose. In turn, the trust sells debt securities, backed by the student loan assets, to outside investors in order to provide the cash to pay for the transferred loans. Investors have recourse to the assets in the trust and benefit from other credit enhancements, such as a cash collateral account and other specified enhancements. After securitization, the Company continues to provide servicing for the loans sold to the trust. As a result, the Company earns administrative and servicing fees on the securitized portfolio. The Company can use the cash proceeds from the loan sale to retire debt, fund new loan originations, purchase loans or for other business purposes. During the first nine months of 2003, there were no new securitizations of loan assets. For additional information on the Company's student loan securitization activities, see Note 6 to the financial statements. |
Regulatory Impacts
Amendments to the Act that governs the FFEL Program have reduced the interest spread earned on the FFEL Program guaranteed student loan portfolio as new loans with lower yields are added to the portfolio and older, more profitable loans are repaid. Despite reductions in funding costs and their expected effects on net income, pressure on margins is expected to continue as more loans are originated with lower lender yields. Amendments to the Act also introduced a competitor program, the Federal Direct Student Loan Program (Direct Lending), in which private lenders, such as the Company, do not participate. Direct Lending accounts for approximately 20-30%, on a national basis, of all student loans originated under federally sponsored programs. Also, the Act may be amended by Congress at any time, possibly resulting in further reductions in FFEL Program loan subsidies and reduced lender net interest margins, in addition to influencing customer prepayments. Any such amendments, in part or in combination, could adversely affect the Company's business and prospects. | |
The Company continues to search for ways to take advantage of greater economies of scale. It is pursuing both new and existing marketing programs, including electronic commerce, and continues to expand its guarantor relationships and pursue alternative loan products, such as CitiAssist, that are not dependent on federal funding and program authorization. |
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. The Company's actual results may differ materially from those suggested by the forward-looking statements, which are typically identified by the words or phrases "believe", "expect", "anticipate", "intend", "estimate", "may increase", "may result in", and similar expressions or future or conditional verbs such as "will", "should", "would" and "could". These forward-looking statements involve risks and uncertainties including, but not limited to, the following: the effects of legislative changes, including those affecting the interest rates borrowers pay on certain loans, the magnitude of certain loan subsidies and the related introduction of competitive loan programs by other lenders; the effects of changes in accounting standards; actual credit losses experienced by the Company in future periods compared to the estimates used in calculating reserves; fluctuations in the interest rates paid by the Company for its funding and received on its loan portfolio, and the effect of such rates on floor income; the Company's ability to service its loan portfolio in accordance with its contractual obligations; the actual cost of employee stock option awards and the effects of changes made to various stock-based compensation programs; the success of the Company's hedging policies; the Company's ability to acquire or originate loans in the amounts anticipated and with interest rates adequate to generate sufficient yields and margins; the Company's ability to continue to develop its electronic commerce initiatives; the Company's success in expanding its guarantor relationships and products; whether risk-sharing expenses for defaults on new loan originations are offset by lower insurance premiums; the Company's ability to utilize alternative sources of funding, including its ability to continue to securitize loan portfolios; the Company's ability to derive incremental economic benefits from greater economies of scale as its portfolio grows; as well as general economic conditions, including the performance of financial markets and the implementation of regulatory changes. |
Item 3. Quantitative and Qualitative Discussion About Market Risk
The Company's primary market risk exposure results from fluctuations in the spreads between the Company's borrowing and lending rates, which may be impacted by shifts in market interest rates. Market risk is measured using various tools, including Earnings-at-Risk. The Earnings-at-Risk calculation seeks to determine the effect that shifts in interest rates are expected to have on net interest margin in future periods. The Company prepares Earnings-at-Risk calculations to measure the discounted pre-tax earnings impact over a preset time span of a specific upward and downward shift in the interest rate yield curve. The Earnings-at-Risk calculation, a static and passive measurement that excludes management's responses to prospective changes in market interest rates, reflects the repricing gaps in the position as well as option positions, both explicit and embedded, in the loan portfolio. Earnings-at-Risk is calculated by multiplying the gap between interest sensitive items, including assets, liabilities and derivative instruments, by a 100 basis point change in the yield curve. |
The Earnings-at-Risk calculation measures the Company's position at one point in time. As indicated in the table below, as of September 30, 2003, a 100 basis point increase in the interest yield curve would have a potential negative impact on the Company's pre-tax earnings of approximately $18.3 million for the next twelve months and approximately $182.8 million thereafter. A 100 basis point decrease in the interest yield curve as of September 30, 2003 would have a potential positive impact on the Company's pre-tax earnings of approximately $70.9 million for the next twelve months and approximately $180.4 million thereafter. The increase in the September 30, 2003 Earnings-at-Risk calculations, compared to those at September 30, 2002, was due to the interest rate environment at September 30, 2003 and its impact on floor income. |
Earnings-at-Risk (effect on pre-tax earnings) | September 30, 2003 | September 30, 2002 |
(Dollars in millions) | Next 12 Mos. Thereafter Total |
Next 12 Mos. Thereafter Total |
One hundred basis point increase | $(18.3) $(182.8) $(201.1) | $(7.7) $(149.3) $(157.0) |
One hundred basis point decrease | $70.9 $180.4 $251.3 | $52.9 $149.3 $202.2 |
In addition, the Company has significantly greater exposure to uneven shifts in interest rate curves (i.e., the Treasury Bill to LIBOR rate spreads). The Company, through its Asset/Liability Management Committee, actively manages these risks by setting Earnings-at-Risk limits and takes actions 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 have not been any changes 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 have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. |
PART II. OTHER INFORMATION | ||
Item 6. | Exhibits and Reports on Form 8-K | |
a) Exhibits | ||
Exhibit Number | Description | |
31.1 | Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certification of Principal Financial and Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | 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 | |
b) Reports on Form 8-K | ||
On July 21, 2003, the Company filed a Current Report on Form 8-K, dated July 21, 2003, reporting under Items 7 and 12 thereof its results of operations for the quarter ended June 30, 2003 and filing therewith a copy of the related press release. Also, on October 16, 2003, the Company filed a Current Report on Form 8-K, dated September 30, 2003, reporting under Items 7 and 12 thereof its results of operations for the quarter ended September 30, 2003 and filing therewith a copy of the related press release. |
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: November 13, 2003
The Student Loan Corporation
By /s/ Steven J. Gorey
Steven J.
Gorey
Vice
President and Principal
Financial
and
Accounting
Officer