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NELNET INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) (Management's Discussion and Analysis of Financial Condition and Results of Operations is for the three months ended March 31, 2013 and 2012. All dollars are in thousands, except per share amounts, unless otherwise noted.) The following discussion and analysis provides information that the Company's management believes is relevant to an assessment and understanding of the consolidated results of operations and financial condition of the Company. The discussion should be read in conjunction with the Company's consolidated financial statements included in the 2012 Annual Report. Forward-looking and cautionary statements This report contains forward-looking statements, including statements about the Company's plans and expectations for future financial condition, results of operations, or economic performance, or that address management's plans and objectives for future operations, and statements that assume or are dependent upon future events. The words "may," "should," "could," "would," "predict," "potential," "continue," "expect," "anticipate," "future," "intend," "plan," "believe," "estimate," "assume," "forecast," "will," and similar expressions, as well as statements in future tense, are intended to identify forward-looking statements. These statements are subject to known and unknown risks, uncertainties, and other factors that may cause actual results and performance to be materially different from any future results or performance expressed or implied by such statements. These factors include, among others, the risks and uncertainties set forth in the "Risk Factors" section of the 2012 Annual Report and elsewhere in this report, in particular such risks and uncertainties as: • student loan portfolio risks such as interest rate basis and repricing risk resulting from the fact that the interest rate characteristics of the student loan assets do not match the interest rate characteristics of the funding for those assets, the risk of loss of floor income on certain student loans originated under the FFEL Program, risks related to the use of derivatives to manage exposure to interest rate fluctuations, and risks from changes in levels of student loan prepayment or default rates (including recent increases in default rates associated with adverse general economic conditions); 22--------------------------------------------------------------------------------• financing and liquidity risks, including risks of changes in the general interest rate environment and in the securitization and other financing markets for student loans, which may increase the costs or limit the availability of financings necessary to purchase, refinance, or continue to hold student loans; • risks from changes in the educational credit and services markets resulting from changes in applicable laws, regulations, and government programs, such as the expected decline over time in FFELP loan interest income and fee-based revenues due to the discontinuation of new FFELP loan originations in 2010 and potential government initiatives to consolidate existing FFELP loans to the Federal Direct Loan Program, and the Company's ability to maintain or increase volumes under its loan servicing contract with the Department and to comply with agreements with third-party customers for the servicing of FFELP and Federal Direct Loan Program loans; • risks related to a breach of or failure in the Company's operational or information systems or infrastructure, or those of third-party vendors; and • uncertainties inherent in forecasting future cash flows from student loan assets and related asset-backed securitizations. All forward-looking statements contained in this report are qualified by these cautionary statements and are made only as of the date of this document. Although the Company may from time to time voluntarily update its prior forward-looking statements, it disclaims any commitment to do so except as required by securities laws. OVERVIEW The Company is an education services company focused primarily on providing fee-based processing services and quality education-related products and services in four core areas: loan financing, loan servicing, payment processing, and enrollment services. These products and services help students and families plan, prepare, and pay for their education and make the administrative and financial processes more efficient for schools and financial organizations. In addition, the Company earns net interest income on a portfolio of federally insured student loans. The Company earned GAAP net income of $68.1 million, or $1.46 per share, for the first quarter of 2013, compared with GAAP net income of $43.1 million, or $0.91 per share, for the same period a year ago. Included in the Company's results of operations for the first quarter of 2013 and 2012 was income of $5.8 million after tax, or $0.12 per share, and an expense of $9.6 million after tax, or $0.20 per share, respectively, as a result of derivative market value and foreign currency adjustments. Derivative market value and foreign currency adjustments include (i) the unrealized gains and losses that are caused by changes in fair values of derivatives which do not qualify for "hedge treatment" under GAAP; and (ii) the foreign currency transaction gains or losses caused by the re-measurement of the Company's Euro-denominated bonds to U.S. dollars. Excluding the derivative market value and foreign currency adjustments, net income was $62.3 million, or $1.34 per share, for the first quarter of 2013 compared with $52.7 million, or $1.11 per share, for the same period in 2012. The Company provides net income excluding the derivative market value and foreign currency adjustments because management believes the point-in time estimates of asset and liability values related to these financial instruments that are subject to interest and currency rate fluctuations affect the period-to-period comparability of the results of operations. The increase in earnings for the first quarter of 2013 compared to the first quarter of 2012 was due to an increase in net interest income earned from the Company's student loan portfolio, an increase in revenue from the Company's fee-based operating segments, and a decrease in operating expenses. The Company earns fee-based revenue through the following reportable operating segments: • Student Loan and Guaranty Servicing ("LGS") - referred to as Nelnet Diversified Solutions ("NDS") • Tuition Payment Processing and Campus Commerce ("TPP&CC") - referred to as Nelnet Business Solutions ("NBS") • Enrollment Services - commonly called Nelnet Enrollment Solutions ("NES") As shown in the following table, revenue and net income earned from the Company's reportable fee-based operating segments was $122.9 million and $17.5 million, respectively, for the first quarter of 2013 compared to $120.0 million and $10.6 million, respectively, for the same period a year ago. 23 -------------------------------------------------------------------------------- In addition, the Company earns net interest income on its FFELP student loan portfolio in its Asset Generation and Management ("AGM") operating segment. This segment is expected to generate a stable net interest margin and significant amounts of cash as the FFELP portfolio amortizes. As of March 31, 2013, the Company had a $24.9 billion student loan portfolio that will amortize over the next approximately 20 years. The Company actively seeks to acquire additional FFELP loan portfolios to leverage its servicing scale and expertise to generate incremental earnings and cash flow. The information below provides the operating results for each reportable operating segment for the three months ended March 31, 2013 and 2012 (dollars in millions). [[Image Removed]] (a) Revenue includes intersegment revenue of $15.0 million and $17.0 million for the three months ended March 31, 2013 and 2012, respectively, earned by LGS as a result of servicing loans for AGM. (b) Total revenue includes "net interest income after provision for loan losses" and "total other income" from the Company's segment statements of income, excluding the impact from changes in fair values of derivatives and foreign currency transaction adjustments, which was income of $5.3 million for the three months ended March 31, 2013 and an expense of $21.6 million for the three months ended March 31, 2012. Net income excludes changes in fair values of derivatives and foreign currency transaction adjustments, net of tax, which was income of $3.3 million for the three months ended March 31, 2013 and an expense of $13.4 million for the three months ended March 31, 2012. (c) Computed as income before income taxes divided by total revenue. Student Loan and Guaranty Servicing • Excluding intersegment revenue, revenue increased 12 percent, or $6.1 million, to $55.6 million for the first quarter of 2013, up from $49.5 million for the same period in 2012. The increase in revenue is the result of growth in servicing volume under the Company's contract with the Department and an increase in collection revenue from getting defaulted FFELP loan assets current on behalf of guaranty agencies. These increases were partially offset by decreases in traditional FFELP and guaranty servicing revenue. • As of March 31, 2013, the Company was servicing $84.6 billion of loans for 4.3 million borrowers on behalf of the Department, compared with $51.8 billion of loans for 3.1 million borrowers as of March 31, 2012. Revenue from this contract increased to $20.3 million for the first quarter of 2013, up from $14.8 million for the same period in 2012. • The Company achieved the first place ranking in the most recent annual survey results related to the servicing contract with the Department. The Company is being allocated 30 percent of new loan volume for the fourth year of this contract (the period from August 15, 2012 through August 14, 2013). The servicing contract with the Department spans five years (through June 2014), with a five-year renewal at the option of the Department. Although the Company currently anticipates that the Department will exercise its option to renew the servicing contract for five years at the end of the current term in 2014, there can be no assurance of such renewal. • Before tax operating margin increased to 26.9% in the first quarter of 2013 compared to 17.2% in the first quarter of 2012. The Company made investments and incurred certain costs in 2012 to improve performance metrics under the government servicing contract and to implement and comply with the Department's special direct consolidation loan 24-------------------------------------------------------------------------------- initiative. In addition, intangible assets for this segment were fully amortized in 2012. Excluding the amortization of intangible assets, before tax operating margin was 20.5% for the first quarter of 2012. Tuition Payment Processing and Campus Commerce • Revenue increased 7 percent, or $1.5 million, to $23.4 million for the first quarter of 2013, up from $21.9 million for the same period in 2012. The increase in revenue is the result of an increase in the number of managed tuition payment plans and campus commerce customers. • Before tax operating margin increased to 37.9% for the first quarter of 2013 compared to 31.5% in for the first quarter of 2012. The increase in margin was the result of efficiencies gained in the operations of the business and a decrease in amortization expense related to intangible assets. These decreases in expenses in 2013 compared to 2012 were partially offset by an increase in salaries and benefits due to adding personnel to support the increase in the number of tuition payment plans and campus commerce customers. • This segment is subject to seasonal fluctuations. Based on the timing of when revenue is recognized and when expenses are incurred, revenue and operating margin are higher in the first quarter as compared to the remainder of the year. Enrollment Services • Revenue decreased 9 percent, or $2.7 million, to $29.0 million for the first quarter of 2013, down from $31.7 million for the same period in 2012. The decrease in revenue is due to a decrease in inquiry generation and management revenue as a result of the regulatory uncertainty regarding recruiting and marketing to potential students in the for-profit college industry, which has caused schools to decrease spending on marketing efforts. • The Company is focused on increasing revenue and gross margin in this segment by increasing quality inquiries and volume and expanding products and services. In addition, the Company is focused on modifying operating expenses to increase margin. Excluding the costs to provide enrollment services (costs directly related to revenue) and the amortization of intangible assets (which were fully amortized in 2012), operating expenses for the first quarter of 2013 decreased $1.1 million, or 11 percent, compared to the same period in 2012. • During the first quarter of 2013, the Company contributed its student list and marketing operations (Student Marketing Group) to a third-party and received a minority interest in a new student list and marketing partnership. Asset Generation and Management • The Company acquired $743.8 million of FFELP student loans during the first three months of 2013. • Core student loan spread increased to 1.50% for the first quarter of 2013, compared to 1.44% for the three months ended December 31, 2012. This increase was due to the tightening between the interest rate paid by the Company on its liabilities funding student loan assets and the rate earned by the Company on such student loan assets. • Due to historically low interest rates, the Company continues to earn significant fixed rate floor income. During the first quarter of 2013, the Company earned $35.7 million of fixed rate floor income (net of $8.3 million of derivative settlements used to hedge such loans), compared to $38.1 million (net of $3.1 million of derivative settlements) for the same period in 2012. Liquidity and Capital Resources • As of March 31, 2013, the Company had cash and investments of $209.6 million. • For the first quarter of 2013, the Company generated $85.0 million in net cash provided by operating activities. • Forecasted future cash flows from the Company's FFELP student loan portfolio financed in asset-backed securities transactions are estimated to be approximately $2.11 billion as of March 31, 2013. • During the first quarter 2013, the Company repurchased: 213,535 shares of Class A common stock for $6.7 million (at an average price of $31.40 per share) $13.0 million (notional amount) of its own asset-backed debt securities for a gain totaling $1.4 million 25-------------------------------------------------------------------------------- • During the first quarter 2013, the Company paid a cash dividend of $0.10 per share. • The Company intends to use its strong liquidity position to capitalize on market opportunities, including FFELP student loan acquisitions; strategic acquisitions and investments in its core business areas of loan financing, loan servicing, payment processing, and enrollment services; and capital management initiatives, including stock repurchases, debt repurchases, and dividend distributions. CONSOLIDATED RESULTS OF OPERATIONS The components of the Company's consolidated financial statements are summarized below. The Company's operating results are primarily driven by the performance of its existing portfolio and the revenues generated by its fee-based businesses and the costs to provide such services. The performance of the Company's portfolio is driven by net interest income (which includes financing costs) and losses related to credit quality of the assets, along with the cost to administer and service the assets and related debt. The Company operates as four distinct operating segments as described previously. For a reconciliation of the segment operating results to the consolidated results of operations, see note 7 of the notes to consolidated financial statements included under Part I, Item 1 of this report. Since the Company monitors and assesses its operations and results based on these segments, the discussion following the consolidated results of operations is presented on a segment basis. Consolidated Net Interest Income after Provision for Loan Losses (net of settlements on derivatives) Three months ended March 31, Change 2013 2012 $ % Interest income: Loan interest $ 155,539 153,058 2,481 1.6 % Investment interest 1,617 1,095 522 47.7 Total interest income 157,156 154,153 3,003 1.9 Interest expense: Interest on bonds and notes payable 58,358 69,297 (10,939 ) (15.8 ) Net interest income 98,798 84,856 13,942 16.4 Provision for loan losses 5,000 6,000 (1,000 ) (16.7 ) Net interest income after provision for loan losses 93,798 78,856 14,942 18.9 Derivative settlements, net (a) (8,184 ) 227 (8,411 ) (3,705.3 ) Net interest income after provision for loan losses (net of settlements on derivatives) $ 85,614 79,083 6,531 8.3 % (a) The Company maintains an overall risk management strategy that incorporates the use of derivative instruments to reduce the economic effect of interest rate volatility. Management has structured the majority of the Company's derivative transactions with the intent that each is economically effective; however, the Company's derivative instruments do not qualify for hedge accounting. Derivative settlements for each applicable period should be evaluated with the Company's net interest income. 26--------------------------------------------------------------------------------Net interest income after provision for loan losses, net of settlements on derivatives, includes the following items: Three months ended March 31, Change 2013 2012 $ % Variable student loan interest margin, net of settlements on derivatives (a) $ 55,621 47,335 8,286 17.5 % Fixed rate floor income, net of settlements on derivatives (b) 35,716 38,092 (2,376 ) (6.2 ) Investment interest (c) 1,617 1,095 522 47.7 Non-portfolio related derivative settlements (645 ) - (645 ) - Corporate debt interest expense (d) (1,695 ) (1,439 ) (256 ) 17.8 Provision for loan losses (e) (5,000 ) (6,000 ) 1,000 (16.7 ) Net interest income after provision for loan losses (net of settlements on derivatives) $ 85,614 79,083 6,531 8.3 % (a) The Company generates a significant portion of its earnings from the spread, referred to as its student loan spread, between the yield the Company receives on its student loan portfolio and the cost of funding these loans. Because the Company generates a significant portion of its earnings from its student loan spread, the interest rate sensitivity of the Company's balance sheet is important to its operations. The current and future interest rate environment can and will affect the Company's net interest income. The effects of changing interest rate environments are further outlined in Item 3, "Quantitative and Qualitative Disclosures about Market Risk - Interest Rate Risk." Variable student loan spread is also impacted by the amortization/accretion of loan premiums and discounts, the 1.05% per year consolidation loan rebate fee paid to the Department, and yield adjustments from borrower benefit programs. See "Asset Generation and Management Operating Segment - Results of Operations" in this Item 2 below for additional information. (b) The Company has a portfolio of student loans that are earning interest at a fixed borrower rate which exceeds the statutorily defined variable lender rates, generating fixed rate floor income. See Item 3, "Quantitative and Qualitative Disclosures about Market Risk - Interest Rate Risk" for additional information. (c) Investment interest income includes income from unrestricted interest-earning deposits and investments and funds in the Company's special purpose entities which are utilized for its asset-backed securitizations. Investment interest increased in the first quarter of 2013 compared to the first quarter of 2012 due to an increase in the average investment balance. (d) Corporate debt interest expense includes interest expense incurred on the Company's Junior Subordinated Hybrid Securities and its unsecured and secured lines of credit. The average outstanding corporate debt during the first quarter of 2013 and the first quarter of 2012 was approximately $243.8 million and $156.8 million, respectively. (e) The provision for loan losses represents the periodic expense of maintaining an allowance sufficient to absorb losses inherent in the Company's portfolio of loans. 27--------------------------------------------------------------------------------Consolidated Other Income The Company also earns fees and generates revenue from other sources as summarized below. Three months ended March 31, Change 2013 2012 $ % Loan and guaranty servicing revenue (a) $ 55,601 49,488 6,113 12.4 % Tuition payment processing and campus commerce revenue (b) 23,411 21,913 1,498 6.8 Enrollment services revenue (c) 28,957 31,664 (2,707 ) (8.5 ) Other income (d) 9,416 10,954 (1,538 ) (14.0 ) Gain on sale of loans and debt repurchases (e) 1,407 - 1,407 100.0 Derivative market value and foreign currency adjustments (f) 9,256 (15,407 ) 24,663 (160.1 ) Derivative settlements, net (g) (8,184 ) 227 (8,411 ) (3,705.3 ) Total other income $ 119,864 98,839 21,025 21.3 % (a) Consists of revenue generated by the LGS operating segment. See "Student Loan and Guaranty Servicing Operating Segment - Results of Operations" in this Item 2 below for additional information. (b) Consists of revenue generated by the TPP&CC operating segment. See "Tuition Payment Processing and Campus Commerce - Results of Operations" in this Item 2 below for additional information. (c) Consists of revenue generated by the NES operating segment. See "Enrollment Services Operating Segment - Results of Operations" in this Item 2 below for additional information. (d) The following table summarizes the components of "other income." Three months ended March 31, 2013 2012 Borrower late fee income (1) $ 3,505 3,703 Investment advisory fees (2) 2,158 3,155 Investments - realized gains/(losses), net 957 1,186 Other 2,796 2,910 Other income $ 9,416 10,954 (1) Borrower late fee income is earned by the education lending subsidiaries (in the AGM operating segment) and is recognized when payments are collected from the borrower. (2) The Company provides investment advisory services under various arrangements and earns annual fees of 25 basis points on the outstanding balance of investments and up to 50 percent of the gains from the sale of securities for which it provides advisory services. As of March 31, 2013, the outstanding balance of investments subject to these arrangements was $713.0 million. (e) During the three months ended March 31, 2013, the Company recognized a gain of $1.4 million from the repurchase of its own debt of $13.0 million (notional amount) of the Company's asset-backed debt securities. 28--------------------------------------------------------------------------------(f) The change in "derivative market value and foreign currency adjustments" is the result of the change in the fair value of the Company's derivative portfolio and translation gains/losses resulting from the re-measurement of the Company's Euro-denominated bonds to U.S. dollars. These changes are summarized below. Valuations of derivative instruments vary based upon many factors, including changes in interest rates, credit risk, foreign currency fluctuations, and other market factors. As a result, net gains and losses on derivatives and hedging activities may vary significantly from period to period. Three months ended March 31, 2013 2012Change in fair value of derivatives - income (expense) $ (19,507 ) 16,835 Foreign currency transaction adjustment - income (expense) 28,763 (32,242 ) Derivative market value and foreign currency adjustments - income (expense) $ 9,256 (15,407 ) (g) As discussed in footnote (a) to the "Consolidated Net Interest Income after Provision for Loan Losses (net of settlements on derivatives)" table above, derivative settlements should be evaluated with the Company's net interest income. Consolidated Operating Expenses Operating expenses are summarized below. Three months ended March 31, Change 2013 2012 $ % Salaries and benefits $ 47,905 49,095 (1,190 ) (2.4 )% Cost to provide enrollment services 19,642 21,678 (2,036 ) (9.4 ) Depreciation and amortization 4,377 8,136 (3,759 ) (46.2 ) Other expenses 34,941 32,263 2,678 8.3 Total operating expenses $ 106,865 111,172 (4,307 ) (3.9 )% Operating expenses decreased in the first quarter of 2013 compared to the first quarter of 2012 due to the following: • A decrease in salaries and benefits due to ongoing cost saving measures by the Company and because higher costs were incurred during 2012 to support initiatives to improve performance metrics under the government servicing contract and to implement and comply with the Department's special direct consolidation loan initiative. • A decrease in the cost to provide enrollment services as a direct result of the decrease in enrollment services revenue. See "Enrollment Services Operating Segment - Results of Operations" in this Item 2 below for additional information. • A decrease in amortization expense as a result of a number of intangible assets becoming fully amortized during 2012. The decrease in operating expenses was partially offset by the following: • An increase in expenses as a result of adding resources and incurring other expenses to support the increase in the number of managed tuition payment plans and campus commerce customers and the Company's continued investment in new products and services to meet customer needs and expand product and service offerings. • An increase in third party servicing fees related to a significant amount of recent loan purchases being serviced by third parties. Consolidated Income Taxes The Company's effective tax rate was 36.0 percent and 35.0 percent for the three months ended March 31, 2013 and 2012, respectively. The effective tax rate during 2013 increased compared to 2012 due to various state tax law changes that reduced the 2012 income tax expense and changes in the Company's gross unrecognized tax benefits liability. 29 --------------------------------------------------------------------------------STUDENT LOAN AND GUARANTY SERVICING OPERATING SEGMENT - RESULTS OF OPERATIONS Student Loan Servicing Volumes (dollars in millions) [[Image Removed]] Company owned $23,139 $23,727 $22,650 $22,277 $21,926 $21,504 $21,237 $20,820 % of total 61.6% 38.6% 29.8% 27.1% 25.6% 23.2% 21.8% 18.5% Number of servicing borrowers: Government servicing: 441,913 2,804,502 3,036,534 3,096,026 3,137,583 3,588,412 3,892,929 4,261,637 FFELP servicing: 2,311,558 1,912,748 1,799,484 1,779,245 1,724,087 1,659,020 1,626,146 1,586,312 Private servicing: 152,200 155,947 164,554 163,135 161,763 175,070 173,331 170,224 Total: 2,905,671 4,873,197 5,000,572 5,038,406 5,023,433 5,422,502 5,692,406 6,018,173 Number of remote hosted borrowers 684,996 545,456 9,566,296 8,645,463 7,909,300 7,505,693 6,912,204 5,001,695 30--------------------------------------------------------------------------------Summary and Comparison of Operating Results Three months ended March 31, Change 2013 2012 $ % Net interest income $ 10 20 (10 ) (50.0 )% Loan and guaranty servicing revenue 55,601 49,488 6,113 12.4 Intersegment servicing revenue 14,953 16,954 (2,001 ) (11.8 ) Total other income 70,554 66,442 4,112 6.2 Salaries and benefits 28,444 29,042 (598 ) (2.1 ) Depreciation and amortization 2,789 4,413 (1,624 ) (36.8 ) Other expenses 18,390 18,666 (276 ) (1.5 ) Intersegment expenses, net 935 1,385 (450 ) (32.5 ) Total operating expenses 50,558 53,506 (2,948 ) (5.5 ) Income before income taxes and corporate overhead allocation 20,006 12,956 7,050 54.4 Corporate overhead allocation (997 ) (1,503 ) 506 (33.7 ) Income before income taxes 19,009 11,453 7,556 66.0 Income tax expense (7,223 ) (4,352 ) (2,871 ) 66.0 Net income $ 11,786 7,101 4,685 66.0 % Before tax operating margin 26.9 % 17.2 % Loan and guaranty servicing revenue. Three months ended March 31, Change 2013 2012 $ % FFELP servicing (a) $ 5,322 6,428 (1,106 ) (17.2 )% Private servicing 2,220 2,268 (48 ) (2.1 ) Government servicing (b) 20,322 14,810 5,512 37.2 FFELP guaranty collection (c) 17,067 14,256 2,811 19.7 FFELP guaranty servicing (d) 3,114 3,773 (659 ) (17.5 ) Software services (e) 7,278 7,667 (389 ) (5.1 ) Other 278 286 (8 ) (2.8 ) Loan and guaranty servicing revenue $ 55,601 49,488 6,113 12.4 % (a) FFELP servicing revenue decreased due to third-party customers' FFELP portfolios decreasing in size due to runoff. (b) Government servicing revenue increased due to an increase in the number of borrowers serviced under the government servicing contract. (c) The Company earns revenue from getting defaulted FFELP loan assets current on behalf of FFELP guaranty agencies. This revenue has increased based on an increase in defaulted loan volume. However, over time, this FFELP-related revenue source will decrease as FFELP portfolios continue to run off. (d) FFELP guaranty servicing revenue will continue to decrease as FFELP portfolios run off and guaranty volume decreases. (e) A contract with a significant remote hosted customer expires in December 2013. The number of remote hosted borrowers and related revenue has decreased from this customer for the three months ended March 31, 2013 compared to the same period in 2012 as this customer's loan volume is transferred to other servicers. The Company is receiving a portion of these transfers which has increased the number of full-service borrowers under the Department's servicing contract. For the three months ended March 31, 2013 and 2012, $2.3 million and $4.0 million in software services revenue was earned 31--------------------------------------------------------------------------------from this customer. Excluding revenue from this customer, software services revenue increased due to an increase in the number of borrowers from other remote hosted customers. Intersegment servicing revenue. Intersegment servicing revenue includes servicing revenue earned by the LGS operating segment as a result of servicing loans for the AGM operating segment. Operating expenses. Operating expenses decreased for the first quarter of 2013 compared to the same period in 2012. In 2012, the Company made investments and incurred certain costs to improve performance metrics under the government servicing contract and to implement and comply with the Department's special direct consolidation loan initiative. In addition, intangible assets were fully amortized during 2012. These costs were offset by an increase in costs incurred in 2013 to support the increase in volume under the government servicing contract. Excluding the amortization of intangible assets, before tax operating margin was 20.5% for the first quarter of 2012. TUITION PAYMENT PROCESSING AND CAMPUS COMMERCE OPERATING SEGMENT - RESULTS OF OPERATIONS This segment of the Company's business is subject to seasonal fluctuations which correspond, or are related to, the traditional school year. Tuition management revenue is recognized over the course of the academic term, but the peak operational activities take place in summer and early fall. Higher amounts of revenue are typically recognized during the first quarter due to fees related to financial aid applications. The Company's operating expenses do not follow the seasonality of the revenues. This is primarily due to generally fixed year-round personnel costs and seasonal marketing costs. Based on the timing of revenue recognition and when expenses are incurred, revenue and pre-tax operating margin are higher in the first quarter as compared to the remainder of the year. Summary and Comparison of Operating Results Three months ended March 31, Change 2013 2012 $ % Net interest income $ - 4 (4 ) (100.0 )% Tuition payment processing and campus commerce revenue 23,411 21,913 1,498 6.8 Salaries and benefits 9,359 8,618 741 8.6 Depreciation and amortization 1,138 1,740 (602 ) (34.6 ) Other expenses 2,287 2,816 (529 ) (18.8 ) Intersegment expenses, net 1,425 1,333 92 6.9 Total operating expenses 14,209 14,507 (298 ) (2.1 ) Income before income taxes and corporate overhead allocation 9,202 7,410 1,792 24.2 Corporate overhead allocation (332 ) (501 ) 169 (33.7 ) Income before income taxes 8,870 6,909 1,961 28.4 Income tax expense (3,371 ) (2,625 ) (746 ) 28.4 Net income $ 5,499 4,284 1,215 28.4 % Before tax operating margin 37.9 % 31.5 % Tuition payment processing and campus commerce revenue. Tuition payment processing and campus commerce revenue increased for the three months ended March 31, 2013 compared to the same period in 2012 as a result of an increase in the number of managed tuition payment plans, as well as an increase in campus commerce customers. Operating expenses. Operating expenses decreased for the three months ended March 31, 2013 compared to the same period in 2012 as a result of the following factors: • A decrease of $0.7 million in amortization of intangible assets. • A decrease in other expenses due to increases in electronic communications and processes that resulted in reductions in paper forms and freight. 32 --------------------------------------------------------------------------------• The decreases in expenses noted above were partially offset by an increase in salaries and benefits due to adding personnel to support the increase in the number of managed tuition payment plans and campus commerce customers. In addition, the Company continues to invest in new products and services to meet customer needs and expand product and service offerings. ENROLLMENT SERVICES OPERATING SEGMENT - RESULTS OF OPERATIONS Summary and Comparison of Operating Results Three months ended March 31, Change 2013 2012 $ % Enrollment services revenue $ 28,957 31,664 (2,707 ) (8.5 )% Salaries and benefits 5,767 6,279 (512 ) (8.2 ) Cost to provide enrollment services 19,642 21,678 (2,036 ) (9.4 ) Depreciation and amortization 61 1,617 (1,556 ) (96.2 ) Other expenses 1,651 1,956 (305 ) (15.6 ) Intersegment expenses, net 1,149 848 301 35.5 Total operating expenses 28,270 32,378 (4,108 ) (12.7 ) Income (loss) before income taxes and corporate overhead allocation 687 (714 ) 1,401 (196.2 ) Corporate overhead allocation (332 ) (501 ) 169 (33.7 ) Income (loss) before income taxes 355 (1,215 ) 1,570 (129.2 ) Income tax (expense) benefit (135 ) 462 (597 ) (129.2 ) Net income (loss) $ 220 (753 ) 973 (129.2 )% Before tax operating margin 1.2 % (3.8 )% Enrollment services revenue, cost to provide enrollment services, and gross profit. Three months ended March 31, 2013 Inquiry Inquiry Inquiry management management Digital Content generation (a) (agency) (a) (software) marketing solutions TotalEnrollment services revenue $ 4,427 18,017 1,095 1,086 4,332 28,957 Cost to provide enrollment services 2,756 16,097 - 86 703 19,642 Gross profit $ 1,671 1,920 1,095 1,000 3,629 9,315 Gross profit % 37.7% 10.7% Three months ended March 31, 2012 Inquiry Inquiry Inquiry management management Digital Content generation (a) (agency) (a) (software) marketing solutions Total Enrollment services revenue $ 4,552 20,184 1,075 1,197 4,656 31,664 Cost to provide enrollment services 2,700 18,214 - 58 706 21,678 Gross profit $ 1,852 1,970 1,075 1,139 3,950 9,986 Gross profit % 40.7% 9.8% (a) Inquiry generation revenue decreased $0.1 million (2.7%) and inquiry management (agency) revenue decreased $2.2 million (10.7%) for the three months ended March 31, 2013 compared to the same period in 2012. Revenues from these services have been affected by the ongoing regulatory uncertainty regarding recruiting and marketing to potential students in the for-profit college industry, which has caused schools to decrease spending on marketing efforts. 33--------------------------------------------------------------------------------Operating expenses. Excluding the cost to provide enrollment services and amortization of intangible assets (which were fully amortized in 2012), operating expenses for the three months ended March 31, 2013 decreased $1.1 million (10.9%) compared to the same period in 2012 due to cost saving measures in reaction to the ongoing decline in revenue in this segment. ASSET GENERATION AND MANAGEMENT OPERATING SEGMENT - RESULTS OF OPERATIONS Student Loan Portfolio For a summary of the Company's student loan portfolio as of March 31, 2013 and December 31, 2012, see note 2 of the notes to consolidated financial statements included under Part I, Item 1 of this report. Loan Activity The following table sets forth the activity of loans: Three months ended March 31, 2013 2012 Beginning balance $ 24,995,880 24,359,625 Loan acquisitions 743,766 183,293 Repayments, claims, capitalized interest, participations, and other (554,250 ) (437,039 ) Consolidation loans lost to external parties (143,151 ) (165,908 ) Loans sold (11,648 ) (33,663 ) Ending balance $ 25,030,597 23,906,308 Allowance for Loan Losses, Loan Repurchase Obligations, and Loan Delinquencies The provision for loan losses represents the periodic expense of maintaining an allowance sufficient to absorb losses, net of recoveries, inherent in the portfolio of student loans. In addition, the Company's servicing operations are obligated to repurchase certain non-federally insured loans subject to participation interests in the event such loans become 60 or 90 days delinquent, and the Company has also retained credit risk related to certain non-federally insured loans sold and will pay cash to purchase back any of these loans which become 60 days delinquent. The Company's estimate related to its obligation to repurchase these loans is included in "other liabilities" in the Company's consolidated balance sheets. Delinquencies have the potential to adversely impact the Company's earnings through increased servicing and collection costs and account charge-offs. For a summary of the activity in the allowance for loan losses and accrual related to the Company's loan repurchase obligations for the three months ended March 31, 2013 and 2012 and a summary of the Company's student loan delinquency amounts as of March 31, 2013, December 31, 2012, and March 31, 2012, see note 2 of the notes to consolidated financial statements included under Part I, Item 1 of this report. 34--------------------------------------------------------------------------------Student Loan Spread Analysis The following table analyzes the student loan spread on the Company's portfolio of student loans, which represents the spread between the yield earned on student loan assets and the costs of the liabilities and derivative instruments used to fund the assets. Three months ended March 31, December 31, March 31, 2013 2012 2012 Variable student loan yield, gross 2.57 % 2.61 % 2.63 % Consolidation rebate fees (0.77 ) (0.76 ) (0.75 ) Discount accretion, net of premium and deferred origination costs amortization 0.03 0.03 (0.02 ) Variable student loan yield, net 1.83 1.88 1.86 Student loan cost of funds - interest expense (0.93 ) (1.05 ) (1.13 ) Student loan cost of funds - derivative settlements 0.01 0.01 0.06 Variable student loan spread 0.91 0.84 0.79 Fixed rate floor income, net of settlements on derivatives 0.59 0.60 0.64 Core student loan spread 1.50 % 1.44 % 1.43 % Average balance of student loans $ 24,781,426 23,766,653 24,118,892 Average balance of debt outstanding 24,823,397 24,086,770 24,236,068 A trend analysis of the Company's core and variable student loan spreads is summarized below. [[Image Removed]] (a) The interest earned on the majority of the Company's FFELP student loan assets is indexed to the one-month LIBOR rate. The Company funds the majority of its assets with three-month LIBOR indexed floating rate securities. The relationship between the indices in which the Company earns interest on its loans and funds such loans has a significant impact on student loan spread. This table (the right axis) shows the difference between the Company's liability base rate and the one-month LIBOR rate by quarter. Variable student loan spread increased during the three months ended March 31, 2013 as a result of the tightening of the Asset/Liability Base Rate Spread as reflected in the previous table. 35 -------------------------------------------------------------------------------- The primary difference between variable student loan spread and core student loan spread is fixed rate floor income, net of settlements on derivatives. A summary of fixed rate floor income and its contribution to core student loan spread follows: Three months ended December 31, March 31, 2013 2012 March 31, 2012 Fixed rate floor income, gross $ 44,020 42,566 41,229 Derivative settlements (a) (8,304 ) (7,033 ) (3,137 ) Fixed rate floor income, net $ 35,716 35,533 38,092 Fixed rate floor income contribution to spread, net 0.59 % 0.60 % 0.64 % (a) Includes settlement payments on derivatives used to hedge student loans earning fixed rate floor income. The high levels of fixed rate floor income earned during 2013 and 2012 are due to historically low interest rates. If interest rates remain low, the Company anticipates continuing to earn significant fixed rate floor income in future periods. See Item 3, "Quantitative and Qualitative Disclosures about Market Risk," which provides additional detail on the Company's portfolio earning fixed rate floor income and the derivatives used by the Company to hedge these loans. Summary and Comparison of Operating Results Three months ended March 31, Change 2013 2012 $ % Net interest income after provision for loan losses $ 93,172 78,683 14,489 18.4 % Other income 4,196 5,000 (804 ) (16.1 ) Gain on sale of loans and debt repurchases 1,407 - 1,407 100.0 Derivative market value and foreign currency adjustments, net 5,275 (21,604 ) 26,879 124.4 Derivative settlements, net (7,539 ) 227 (7,766 ) (3,421.1 ) Total other income 3,339 (16,377 ) 19,716 (120.4 ) Salaries and benefits 562 719 (157 ) (21.8 ) Other expenses 7,513 3,632 3,881 106.9 Intersegment expenses, net 15,142 17,143 (2,001 ) (11.7 ) Total operating expenses 23,217 21,494 1,723 8.0 Income before income taxes and corporate overhead allocation 73,294 40,812 32,482 79.6 Corporate overhead allocation (712 ) (1,392 ) 680 (48.9 ) Income before income taxes 72,582 39,420 33,162 84.1 Income tax expense (27,581 ) (14,979 ) (12,602 ) 84.1 Net income $ 45,001 24,441 20,560 84.1 % Additional information: Net income $ 45,001 24,441 20,560 84.1 % Derivative market value and foreign currency adjustments, net (5,275 ) 21,604 (26,879 ) (124.4 ) Tax effect 2,005 (8,210 ) 10,214 (124.4 ) Net income, excluding derivative market value and foreign currency adjustments $ 41,731 37,835 3,896 10.3 % 36-------------------------------------------------------------------------------- Net interest income after provision for loan losses (net of settlements on derivatives). Three months ended March 31, Change 2013 2012 $ % Variable interest income, net of settlements on derivatives (a) $ 157,548 161,142 (3,594 ) (2.2 )% Consolidation rebate fees (b) (47,208 ) (44,889 ) (2,319 ) 5.2 Discount accretion, net of premium and deferred origination costs amortization (c) 1,943 (1,060 ) 3,003 (283.3 ) Interest on bonds and notes payable (d) (56,662 ) (67,858 ) 11,196 (16.5 ) Variable student loan interest margin, net of settlements on derivatives 55,621 47,335 8,286 17.5 Fixed rate floor income, net of settlements on derivatives (e) 35,716 38,092 (2,376 ) (6.2 ) Investment interest 115 454 (339 ) (74.7 ) Intercompany interest (819 ) (971 ) 152 (15.7 ) Provision for loan losses - federally insured (6,000 ) (6,000 ) - - Provision for loan losses - nonfederally insured 1,000 - 1,000 - Net interest income after provision for loan losses (net of settlements on derivatives (f)) $ 85,633 78,910 6,723 8.5 % (a) Variable interest income, net of settlements on derivatives, decreased for the three months ended March 31, 2013 compared to the same period in 2012 as a result of a decrease in the yield earned on student loans, net of settlements on derivatives, which decreased to 2.58% for the three months ended March 31, 2013 from 2.69% for the same period in 2012. The decrease was partially offset by an increase in the average student loan portfolio of $0.7 billion (2.7%). (b) Consolidation rebate fees increased for the three months ended March 31, 2013 compared to the same period in 2012 due to an increase in the average consolidation loan balance in 2013 as compared to 2012. (c) The accretion of loan discounts (net of amortization of loan premiums) increased as a result of the ongoing purchase of loans at a discount. (d) Interest on bonds and notes payable decreased as a result of a decrease in the Company's cost of funds to 0.93% for the three months ended March 31, 2013 from 1.13% for the same period in 2012. The decrease was partially offset by an increase in average debt outstanding of $0.6 billion (2.4%) for the three months ended March 31, 2013, compared to the same period in 2012. (e) The high levels of fixed rate floor income earned during the three months ended March 31, 2013 and 2012 are due to historically low interest rates. (f) The Company maintains an overall risk management strategy that incorporates the use of derivative instruments to reduce the economic effect of interest rate volatility. Derivative settlements for each applicable period should be evaluated with the Company's net interest income. Other income. The following table summarizes the components of "other income." Three months ended March 31, 2013 2012 Borrower late fee income $ 3,505 3,703 Realized and unrealized gains (losses) on investments, net 88 578 Other 603 719 Other income $ 4,196 5,000 Gain on sale of loans and debt repurchases. During the first quarter of 2013, the Company repurchased its own asset-backed debt securities of $13.0 million (notional amount), resulting in a gain of $1.4 million. 37 -------------------------------------------------------------------------------- Derivative market value and foreign currency adjustments, net. The Company maintains an overall interest rate risk management strategy that incorporates the use of derivative instruments to reduce the economic effect of interest rate volatility. Derivative instruments primarily used by the Company to manage interest rate risk includes interest rate swaps and basis swaps. Management has structured the majority of the Company's derivative transactions with the intent that each is economically effective. However, the Company's derivatives do not qualify for hedge accounting treatment, and the stand-alone derivatives must be marked-to-market, the adjustments for which are included in "derivative market value and foreign currency adjustments, net" in the statements of income. In addition, the Company has Euro-denominated bonds of which the principal and accrued interest are re-measured at each reporting period to U.S. dollars. Changes in the principal and accrued interest amounts as a result of foreign currency exchange rate fluctuations are included in "derivative market value and foreign currency adjustments, net." In connection with the issuance of the Euro-denominated bonds, the Company has entered into cross-currency interest rate swaps which do not qualify for hedge accounting treatment. The re-measurement of the Euro-denominated bonds generally correlates with the change in fair value of the cross-currency interest rate swaps. However, the Company will experience unrealized gains or losses related to the cross-currency interest rate swaps if the two underlying indices (and related forward curve) do not move in parallel. The gains and/or losses included in "derivative market value and foreign currency adjustments, net" in the Company's statements of income are primarily caused by interest rate and currency exchange rate volatility, as well as the volume and terms of derivatives not receiving hedge accounting treatment. Included in the table of operating results above is additional information which reflects the operating results of this segment excluding the unrealized gains and losses from the Company's derivative portfolio and the foreign currency transaction adjustments. The Company believes these point-in-time estimates of asset and liability values related to these financial instruments that are subject to interest and currency rate fluctuations affect the period-to-period comparability of the results of operations. Salaries and benefits. Salaries and benefits have decreased during the three months ended March 31, 2013 compared to the first quarter of 2012 due to a reduction of employees as a result of continued focus by the Company on managing costs. Other expenses. Other expenses increased during the three months ended March 31, 2013 compared to the first quarter of 2012 due to an increase in third party servicing fees related to a significant amount of recent loan purchases being serviced at third parties. Intersegment expenses, net. Intersegment expenses primarily include fees paid to the LGS operating segment for the servicing of the Company's student loan portfolio. LIQUIDITY AND CAPITAL RESOURCES The Company's fee generating businesses are non-capital intensive and all produce positive operating cash flows. As such, a minimal amount of debt and equity capital is allocated to the fee-based segments and any liquidity or capital needs are satisfied using cash flow from operations. Therefore, the Liquidity and Capital Resources discussion is concentrated on the Company's liquidity and capital needs to meet existing debt obligations in the Asset Generation and Management operating segment. Sources of Liquidity Currently Available As of March 31, 2013, the Company had cash and investments of $209.6 million. In addition, the Company has historically generated positive cash flow from operations. For the three months ended March 31, 2013 and the year ended December 31, 2012, the Company had net cash flow from operating activities of $85.0 million and $299.3 million, respectively. On March 28, 2013, the Company amended its unsecured line of credit to increase the line of credit to $275.0 million and extend the maturity date from February 17, 2016 to March 28, 2018. As of March 31, 2013, the unsecured line of credit had $115.0 million outstanding and $160.0 million was available for future use. As part of certain of the Company's asset-backed securitizations, the Company has purchased the Class B subordinated note tranches in the total amount of $138.1 million (par value). In addition, the Company has repurchased certain of its own asset-backed securities (bonds and notes payable) in the open market in the total amount of $59.2 million (par value). For accounting purposes, these notes are effectively retired and are not included on the Company's consolidated balance sheet. However, these securities are legally outstanding at the trust level and the Company could sell these notes to third parties or redeem the notes at par as cash is generated by the trust estate. Upon a sale of these notes to third parties, the Company would obtain cash proceeds equal to the market value of the notes on the date of such sale. 38 -------------------------------------------------------------------------------- The Company intends to use its strong liquidity position to capitalize on market opportunities, including FFELP student loan acquisitions; strategic acquisitions and investments, including continued investments in its core business areas of asset management and finance, loan servicing, payment processing, and enrollment services; and capital management initiatives, including stock repurchases, debt repurchases, and dividend distributions. Liquidity Needs and Sources of Liquidity Available to Satisfy Debt Obligations Secured by Student Loan Assets and Related Collateral The following table shows the Company's debt obligations outstanding that are secured by student loan assets and related collateral. As of March 31, 2013 Carrying amount Final maturity Bonds and notes issued in asset-backed securitizations $ 23,078,816 11/25/15 - 8/25/52 FFELP warehouse facilities 1,942,239 4/2/15 - 2/28/16 Other borrowings 61,878 11/14/13 - 11/11/15 $ 25,082,933 Bonds and Notes Issued in Asset-backed Securitizations The majority of the Company's portfolio of student loans is funded in asset-backed securitizations that are structured to substantially match the maturity of the funded assets, thereby minimizing liquidity risk. In addition, due to (i) the difference between the yield the Company receives on the loans and cost of financing within these transactions, and (ii) the servicing and administration fees the Company earns from these transactions, the Company has created a portfolio that will generate earnings and significant cash flow over the life of these transactions. As of March 31, 2013, based on cash flow models developed to reflect management's current estimate of, among other factors, prepayments, defaults, deferment, forbearance, and interest rates, the Company currently expects future undiscounted cash flows from its portfolio to be approximately $2.11 billion as detailed below. The $2.11 billion includes approximately $465.9 million (as of March 31, 2013) of overcollateralization included in the asset-backed securitizations. These excess net asset positions are reflected variously in the following balances in the consolidated balance sheet: "student loans receivable," "restricted cash and investments," and "accrued interest receivable." The forecasted cash flow presented below includes all loans funded in asset-backed securitizations as of March 31, 2013. As of March 31, 2013, the Company had $23.0 billion of loans included in asset-backed securitizations, which represented 92.1 percent of its total FFELP student loan portfolio. The forecasted cash flow does not include cash flows that the Company expects to receive related to loans funded in its warehouse facilities or loans acquired subsequent to March 31, 2013. 39-------------------------------------------------------------------------------- FFELP Asset-backed Securitization Cash Flow Forecast (a) $2.11 billion (dollars in millions) [[Image Removed]](a) The Company uses various assumptions, including prepayments and future interest rates, when preparing its cash flow forecast. These assumptions are further discussed below. Prepayments: The primary variable in establishing a life of loan estimate is the level and timing of prepayments. Prepayment rates equal the amount of loans that prepay annually as a percentage of the beginning of period balance, net of scheduled principal payments. A number of factors can affect estimated prepayment rates, including the level of consolidation activity and default rates. Should any of these factors change, management may revise its assumptions, which in turn would impact the projected future cash flow. The Company's cash flow forecast above assumes prepayment rates that are generally consistent with those utilized in the Company's recent asset-backed securities transactions. If management used a prepayment rate assumption two times greater than what was used to forecast the cash flow, the cash flow forecast would be reduced by approximately $220 million to $280 million. Interest rates: The Company funds the majority of its student loans with three-month LIBOR indexed floating rate securities. Meanwhile, the interest earned on the Company's student loan assets are indexed primarily to a one-month LIBOR rate. The different interest rate characteristics of the Company's loan assets and liabilities funding these assets result in basis risk. The Company's cash flow forecast assumes three-month LIBOR will exceed one-month LIBOR by 12 basis points for the life of the portfolio, which approximates the historical relationship between these indices. If the forecast is computed assuming a spread of 24 basis points between three-month and one-month LIBOR for the life of the portfolio, the cash flow forecast would be reduced by approximately $90 million to $130 million. The Company uses the current forward interest rate yield curve to forecast cash flows. A change in the forward interest rate curve would impact the future cash flows generated from the portfolio. An increase in future interest rates will reduce the amount of fixed rate floor income the Company is currently receiving. The Company attempts to mitigate the impact of a rise in short-term rates by hedging interest rate risks. As of March 31, 2013, the net fair value of the Company's interest rate derivatives used to hedge loans earning fixed rate floor income was a liability of $36.5 million. See Item 3, "Quantitative and Qualitative Disclosures about Market Risk - Interest Rate Risk." 40 --------------------------------------------------------------------------------FFELP Warehouse Facilities The Company funds a portion of its FFELP loan acquisitions using its FFELP warehouse facilities. Student loan warehousing allows the Company to buy and manage student loans prior to transferring them into more permanent financing arrangements. As of March 31, 2013, the Company had four FFELP warehouse facilities with an aggregate maximum financing amount available of $2.0 billion, of which $1.9 billion was outstanding and $57.8 million was available for additional funding. Two of the warehouse facilities provide for formula-based advance rates, depending on FFELP loan type, up to a maximum of the principal and interest of loans financed. The advance rates for collateral may increase or decrease based on market conditions. The other two FFELP warehouse facilities have static advance rates that require initial equity for loan funding, but do not require increased equity based on market movements. As of March 31, 2013, the Company had $130.7 million advanced as equity support on its FFELP warehouse facilities. For further discussion of the Company's FFELP warehouse facilities outstanding at March 31, 2013, see note 3 of the notes to consolidated financial statements included under Part I, Item 1 of this report. Upon termination or expiration of the warehouse facilities, the Company would expect to access the securitization market, obtain replacement warehouse facilities, use operating cash, rely on sale of assets, or transfer collateral to satisfy any remaining obligations. Other Uses of Liquidity Effective July 1, 2010, no new loan originations can be made under the FFEL Program and all new federal loan originations must be made through the Federal Direct Loan Program. As a result, the Company no longer originates new FFELP loans. The Company believes there will continue to be opportunities to purchase FFELP loan portfolios from current FFELP participants looking to adjust their FFELP businesses. The Company plans to fund FFELP student loan acquisitions from third parties using its Union Bank participation agreement (as described below); using its FFELP warehouse facilities (as described above); and continuing to access the asset-backed securities market. Union Bank Participation Agreement The Company maintains an agreement with Union Bank, as trustee for various grantor trusts, under which Union Bank has agreed to purchase from the Company participation interests in student loans. As of March 31, 2013, $368.6 million of loans were subject to outstanding participation interests held by Union Bank, as trustee, under this agreement. The agreement automatically renews annually and is terminable by either party upon five business days notice. This agreement provides beneficiaries of Union Bank's grantor trusts with access to investments in interests in student loans, while providing liquidity to the Company. The Company can participate loans to Union Bank to the extent of availability under the grantor trusts, up to $750 million or an amount in excess of $750 million if mutually agreed to by both parties. Loans participated under this agreement have been accounted for by the Company as loan sales. Accordingly, the participation interests sold are not included in the Company's consolidated balance sheets. Asset-backed Securities Transactions Depending on market conditions, the Company anticipates continuing to access the asset-backed securities market. Asset-backed securities transactions would be used to refinance student loans included in the FFELP warehouse facilities and/or existing asset-backed securities transactions. On April 30, 2013, the Company completed an asset-backed securities transaction totaling $765.0 million. The Company used the proceeds from the sale of these notes to purchase student loans, including loans previously financed in the FFELP warehouse facilities. 41 --------------------------------------------------------------------------------Liquidity Impact Related to Hedging Activities The Company utilizes derivative instruments to manage interest rate sensitivity. By using derivative instruments, the Company is exposed to market risk which could impact its liquidity. Based on the derivative portfolio outstanding as of March 31, 2013, the Company does not currently anticipate any movement in interest rates having a material impact on its capital or liquidity profile, nor does the Company expect that any movement in interest rates would have a material impact on its ability to meet potential collateral deposits with its counterparties. However, if interest rates move materially and negatively impact the fair value of the Company's derivative portfolio or if the Company enters into additional derivatives for which the fair value becomes negative, the Company could be required to deposit additional collateral with its derivative instrument counterparties. The collateral deposits, if significant, could negatively impact the Company's liquidity and capital resources. As of March 31, 2013, the fair value of the Company's derivatives, which had a negative fair value (a liability in the Company's balance sheet), was $54.0 million, and the Company had $47.1 million posted as collateral to derivative counterparties. Other Debt Facilities As previously discussed, the Company has a $275.0 million unsecured line of credit with a maturity date of March 28, 2018. As of March 31, 2013, the unsecured line of credit had an outstanding balance of $115.0 million and $160.0 million was available for future use. The Company has issued Junior Subordinated Hybrid Securities ("Hybrid Securities") that have a final maturity of September 15, 2061. The Hybrid Securities are unsecured obligations of the Company. As of March 31, 2013, $99.2 million of Hybrid Securities were outstanding. Debt Repurchases Due to the Company's positive liquidity position and opportunities in the capital markets, the Company has repurchased its own debt over the last several years. Gains recorded by the Company from the repurchase of debt are included in "gain on sale of loans and debt repurchases" on the Company's consolidated statements of income. For the three months ended March 31, 2013, the Company recognized a gain of $1.4 million from the repurchase of $13.0 million (notional amount) of its own asset-backed debt securities. Stock Repurchases The Board of Directors has authorized a stock repurchase program to repurchase up to a total of five million shares of the Company's Class A common stock during the three-year period ending May 24, 2015. Shares may be repurchased from time to time depending on various factors, including share prices and other potential uses of liquidity. For the three month period ended March 31, 2013, the Company repurchased 213,535 shares for $6.7 million (at an average price of $31.40 per share). Certain of these share repurchases were made pursuant to a trading plan adopted by the Company in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934. As of March 31, 2013, 4,047,958 shares remain authorized for purchase under the Company's repurchase program. Dividends On March 15, 2013, the Company paid a first quarter 2013 cash dividend on the Company's Class A and Class B common stock of $0.10 per share. In addition, the Company's Board of Directors declared a second quarter cash dividend on the Company's outstanding shares of Class A and Class B common stock of $0.10 per share. The second quarter cash dividend will be paid on June 14, 2013, to shareholders of record at the close of business on May 31, 2013. The Company currently plans to continue making regular quarterly dividend payments, subject to future earnings, capital requirements, financial condition, and other factors. In addition, the payment of dividends is subject to the terms of the Company's outstanding Hybrid Securities, which generally provide that if the Company defers interest payments on those securities it cannot pay dividends on its capital stock. RECENT ACCOUNTING PRONOUNCEMENTS In January 2013, the Company adopted the provisions of Accounting Standards Update ("ASU") No. 2013-01, issued by the Financial Accounting Standards Board ("FASB"), which requires new asset and liability offsetting disclosures for derivatives, repurchase agreements, and security lending transactions to the extent that they are: (1) offset in the financial statements; or (2) 42 -------------------------------------------------------------------------------- subject to an enforceable master netting arrangement or similar agreement. The Company does not have any repurchase agreements and does not participate in security lending transactions. The Company records the fair value of its derivatives gross in its consolidated balance sheets; however, certain of the Company's derivative instruments are subject to right of offset provisions with counterparties. The new asset and liability offsetting disclosures required by this ASU are included in note 4 of the notes to consolidated financial statements included under Part I, Item 1 of this report. In February 2013, the FASB amended the Accounting Standards Codification related to comprehensive income. This amendment requires companies to report, in one place, information about reclassifications (by component) out of accumulated other comprehensive income. In addition, this amendment requires companies to present the related line item effect of significant reclassifications on the statement where income is presented. The Company adopted the provisions of this amendment during the first quarter 2013, which affects only the display of information and does not change existing recognition and measurement requirements in the consolidated financial statements. The information required by this amendment is included in note 5 of the notes to consolidated financial statements included under Part I, Item 1 of this report. Issued but not yet effective accounting pronouncements are not expected to have a material impact on the Company's consolidated financial statements. |