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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
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) 975-6292
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
On August 5, 2002, there were 20,000,000 shares of The Student Loan
Corporation's Common Stock outstanding.
Form 10-Q
Page
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Part I Financial Information
Item 1 - Financial Statements
Statements of Income (Unaudited) for the Three- and Six-Month Periods
Ended June 30, 2002 and 2001 ............................................. 3
Balance Sheets as of June 30, 2002 (Unaudited)
and December 31, 2001 (Audited) .......................................... 4
Statements of Cash Flows (Unaudited) for the Six-Month Periods Ended
June 30, 2002 and 2001 ................................................... 5
Statements of changes in Stockholders' Equity (Unaudited) for the
Six-Month Periods Ended June 30, 2002 and 2001 ........................... 6
Notes to Financial Statements (Unaudited) ................................ 7-10
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................................ 11-15
Item 3 - Quantitative and Qualitative Discussion About Market Risk ................ 16
Part II Other Information
Item 4 - Submissions of Matters to a Vote of Security Holders ..................... 17
Item 6 - Exhibits and Reports on Form 8-K ......................................... 17
Signature ..................................................................................... 18
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
THE STUDENT LOAN CORPORATION
STATEMENTS OF INCOME
(Dollars in thousands, except per share amounts)
(Unaudited)
Three months ended Six months ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
---- ---- ---- ----
REVENUE
Interest income $ 266,350 $ 315,364 $ 529,234 $ 622,395
Interest expense 165,877 225,710 329,153 475,440
--------- --------- --------- ---------
NET INTEREST INCOME 100,473 89,654 200,081 146,955
Provision for loan losses (3,294) (1,751) (5,295) (3,565)
--------- --------- --------- ---------
Net interest income after provision for loan losses 97,179 87,903 194,786 143,390
Gain on student loan securitization -- -- 3,121 --
Fee and other income 3,183 2,165 9,151 4,462
--------- --------- --------- ---------
TOTAL REVENUE, NET 100,362 90,068 207,058 147,852
--------- --------- --------- ---------
OPERATING EXPENSES
Salaries and employee benefits 7,135 6,051 13,294 10,738
Other expenses 21,926 17,814 39,471 34,368
--------- --------- --------- ---------
TOTAL OPERATING EXPENSES 29,061 23,865 52,765 45,106
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 71,301 66,203 154,293 102,746
Income taxes 29,106 27,231 62,446 41,507
--------- --------- --------- ---------
NET INCOME $ 42,195 $ 38,972 $ 91,847 $ 61,239
========= ========= ========= =========
DIVIDENDS DECLARED $ 14,000 $ 14,000 $ 28,000 $ 28,000
========= ========= ========= =========
BASIC AND DILUTED EARNINGS PER COMMON SHARE -
(based on 20 million average shares outstanding) $ 2.11 $ 1.95 $ 4.59 $ 3.06
========= ========= ========= =========
DIVIDENDS DECLARED PER COMMON SHARE $ 0.70 $ 0.70 $ 1.40 $ 1.40
========= ========= ========= =========
OPERATING RATIOS
Net interest margin 2.12% 2.10% 2.14% 1.77%
Operating expense as a percentage of
average student loans 0.61% 0.56% 0.56% 0.54%
Return on equity 24.11% 26.37% 27.04% 21.14%
See accompanying notes to financial statements.
3
THE STUDENT LOAN CORPORATION
BALANCE SHEETS
(Dollars in thousands)
June 30, December 31,
2002 2001
(Unaudited) (Audited)
----------- ---------
ASSETS
Student loans $ 18,480,295 $ 18,236,966
Less: Allowance for loan losses (4,484) (3,584)
------------ ------------
Student loans, net 18,475,811 18,233,382
Loans available for sale 773,138 --
Cash 585 1,222
Other assets 543,384 482,492
------------ ------------
TOTAL ASSETS $ 19,792,918 $ 18,717,096
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings $ 18,085,460 $ 15,383,800
Long-term notes 250,000 2,200,000
Payable to principal stockholder 6,952 7,282
Deferred income taxes 99,011 93,908
Other liabilities 636,079 380,404
------------ ------------
Total Liabilities 19,077,502 18,065,394
------------ ------------
Common stock, $.01 par value; authorized 50,000,000
shares; 20,000,000 shares issued and outstanding 200 200
Additional paid-in capital 135,205 134,851
Retained earnings 580,498 516,651
Accumulated other changes in equity from nonowner sources (487) --
------------ ------------
Total Stockholders' Equity 715,416 651,702
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 19,792,918 $ 18,717,096
============ ============
AVERAGE STUDENT LOANS
(year-to-date) $ 18,864,986 $ 17,296,907
============ ============
See accompanying notes to financial statements.
4
THE STUDENT LOAN CORPORATION
STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Six months ended
June 30,
--------
2002 2001
---- ----
Cash flows from operating activities:
Net income $ 91,847 $ 61,239
Adjustments to reconcile net income to
net cash from operating activities:
Gain on securitization of loans (3,121) --
Depreciation and amortization 31,476 24,785
Provision for loan losses 5,295 3,565
Deferred tax provision 5,439 22,094
(Increase) in accrued interest receivable (28,384) (59,667)
(Increase)/decrease in other assets (18,952) 7,995
Increase in other liabilities 255,700 140,731
----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 339,300 200,742
----------- -----------
Cash flows from investing activities:
Disbursement of loans (1,412,025) (1,147,139)
Portfolio loan purchases (813,414) (1,578,765)
Loan purchases available for sale (553,762) --
Repayment of loans 1,242,432 968,752
Proceeds on loan securitization 249,317 --
Sale of loans 227,729 142,645
Capital expenditures on equipment and computer software (3,874) (3,773)
----------- -----------
NET CASH (USED IN) INVESTING ACTIVITIES (1,063,597) (1,618,280)
----------- -----------
Cash flows from financing activities:
Net increase in borrowings with original
maturities of one year or less 501,660 1,446,566
New long-term borrowings 250,000 --
Dividends paid to stockholders (28,000) (28,000)
----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 723,660 1,418,566
----------- -----------
NET INCREASE IN CASH (637) 1,028
CASH - BEGINNING OF PERIOD 1,222 323
----------- -----------
CASH - END OF PERIOD $ 585 $ 1,351
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Interest $ 30,855 $ 336,048
Net income taxes paid, net of refunds $ 70,445 $ (11,828)
See accompanying notes to financial statements.
5
THE STUDENT LOAN CORPORATION
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share amounts)
(Unaudited)
Six Months Ended June 30,
-------------------------
2002 2001
---- ----
COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL
Balance, beginning of period $ 135,051 $ 134,972
Other 354 79
--------- ---------
Balance, end of period $ 135,405 $ 135,051
--------- ---------
RETAINED EARNINGS
Balance, beginning of period $ 516,651 $ 437,290
Net income 91,847 61,239
Common dividends declared, $1.40 per common share (28,000) (28,000)
--------- ---------
Balance, end of period $ 580,498 $ 470,529
--------- ---------
ACCUMULATED OTHER CHANGES IN EQUITY FROM NONOWNER SOURCES
Balance, beginning of period $ -- --
Net change for cash flow hedges, net of tax (838) --
Net change for investments, net of tax 351 --
--------- ---------
Balance, end of period $ (487) $ --
--------- ---------
See accompanying notes to financial statements.
6
THE STUDENT LOAN CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2002
1. SIGNIFICANT ACCOUNTING POLICIES
INTERIM FINANCIAL INFORMATION
The financial information of The Student Loan Corporation (the
"Company") as of June 30, 2002 and for the three- and six-month periods
ended June 30, 2002 and 2001 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
accompanying financial statements should be read in conjunction with
the financial statements and related notes included in the Company's
2001 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.
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 and net credit losses are charged to
other expense as incurred.
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS
On January 1, 2002, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets" (SFAS No. 144), when the rule became
effective for calendar year companies. SFAS No. 144 established
additional criteria for determining when a long-lived asset is
held-for-sale. It also requires that an impairment loss be recognized
only if the carrying amount of a long-lived asset is not recoverable
from its undiscounted cash flows and it measures an impairment loss as
the difference between the carrying amount and fair value of the
asset. The provisions of the new standard are to be applied
prospectively. It is not expected that SFAS No. 144 will materially
affect the financial statements.
INTEREST RATE SWAP AGREEMENTS
The Company's interest rate swap agreements are accounted for in
accordance with SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities", which requires that all derivatives be
recorded on the balance sheet at their fair value. Fair value changes
for cash flow hedges that have been designated and are effective as
cash flow hedges are reflected on the financial statements with a
corresponding amount, net of taxes, reflected in the accumulated other
changes in equity from nonowner sources component of stockholders'
equity.
USE OF ESTIMATES
In preparing the financial statements in conformity with GAAP,
management has used a number of estimates and assumptions relating to
the reporting of assets and liabilities, the disclosure of contingent
7
assets and liabilities and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates and assumptions.
2. RELATED PARTY TRANSACTIONS
Citibank (New York State) ("CNYS"), an indirect wholly owned subsidiary
of Citigroup Inc., owns 80% of the outstanding common stock of the
Company. A number of significant transactions are carried out between
the Company and Citigroup and its affiliates. At June 30, 2002, the
Company had outstanding short- and long-term unsecured borrowings with
CNYS of $18.1 billion and $0.3 billion, respectively, compared to $15.4
billion and $2.2 billion, respectively, at December 31, 2001. For the
three- and six-month periods ended June 30, 2002, the Company incurred
$165.9 million and $329.2 million, respectively, in interest expense
payable to CNYS and its affiliates, compared to $225.7 million and
$475.4 million, respectively, for the same periods in 2001. Also,
during the first six months of 2002 the Company entered into a number
of forward-starting interest rate swap agreements with a subsidiary of
Citigroup. At June 30, 2002, the agreements had notional amounts
totaling $2.7 billion and terms of between twelve and eighteen months.
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.
Management believes that the terms of these transactions are, in the
aggregate, no less favorable to the Company than those which could be
obtained from unaffiliated parties.
3. 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 borrowing rates (based primarily on the 91-day Treasury Bill)
and lending rates (based on LIBOR). Consistent with the requirements of
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", as amended, management expects the Company's hedge program
to be highly effective in offsetting changes in cash flows for the risk
being hedged.
In 2002, the Company entered into a number of forward-starting interest
rate swap contracts with an affiliate of Citigroup to receive payments
based on LIBOR and make payments based on the 91-day Treasury Bill
rate. For the three- and six-month periods ended June 30, 2002, the
Company entered into new contracts with notional amounts of $2.3
billion and $2.7 billion, respectively. They have been designated and
are effective as cash flow hedges. The swap agreements have terms of
between 12 and 18 months. The fair value of the swaps at June 30, 2002
was a $1.4 million liability and is reflected in other liabilities on
the June 30, 2002 financial statements with a corresponding amount net
of taxes reflected in the accumulated other changes in equity from
nonowner sources component of stockholders' equity (see below).
Substantially all of the $1.4 million liability, net of taxes, is
expected to be reclassified from accumulated other changes in equity
from nonowner sources within the next twelve months. No amounts have
been excluded from the assessment of effectiveness and no hedge
ineffectiveness has been recognized in earnings related to these swap
agreements.
Accumulated other changes in equity from nonowner sources from cash
flow hedges for the six months ended June 30, 2002 is summarized
(net of tax) as follows:
Six Months Ended June 30, 2002
------------------------------
(Dollars in thousands)
Beginning Balance $ --
Net loss from cash flow hedges (838)
Net amounts reclassified to earnings --
------
Ending Balance $ (838)
------
8
4. COMMITMENTS AND CONTINGENCIES
In February 2000, three stockholders' derivative complaints, captioned
"Alan Kahn v. Citigroup Inc.", "Kenneth Steiner v. Citigroup Inc.",
and "Katherine F. Petty v. Citigroup Inc.", were filed in the Delaware
Court of Chancery against the Company and its directors (as well as
Citigroup and certain subsidiaries). In April 2000, the Delaware Court
of Chancery consolidated the three complaints for all purposes under
the caption "In re The Student Loan Corp. Derivative Litigation", and
designated the "Alan Kahn v. Citigroup Inc". complaint as the
operative pleading. The action remains pending. For further
information, see "Legal Proceedings" in the Company's Annual Report on
Form 10-K for the year ended December 31, 2001.
In the ordinary course of business, the Company is also involved in
various legal 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 Higher Education Act of 1965 (the "Act") have
significantly reduced the net interest spreads earned on the Federal
Family Education Loan ("FFEL") Program guaranteed student loan
portfolio as new loans with lower yields were added to the portfolio
and older, more profitable loans were repaid. As the funding costs have
not been similarly reduced, pressure on margins will continue as more
loans are originated with lower yields. In addition, Congress may amend
the Act at any time, possibly resulting in further reductions in FFEL
Program loan subsidies, which could occur in the form of increased
risk-sharing costs or reduced margins. Any such amendment could
adversely affect the Company's business and prospects.
5. LOAN SECURITIZATION
In the first quarter of 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 FASB Statement 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.
The trust, in turn, sells securities, backed by the student loan
assets, to investors.
In the first quarter of 2002, the Company securitized approximately
$249 million of Federal Consolidation Loans, selling them to a trust
that was established to purchase the loans. The Company recognizes the
securitization as a sale for financial statement purposes and the
securitization qualifies as a financing for tax purposes. The Company
sold the loans to the trust through a wholly owned, special purpose
subsidiary formed to acquire the Company's loans at par value. A
pre-tax gain of $3.1 million was recorded as a result of the
securitization. The gain was reflective of the difference between the
carrying value of the assets sold to the trust by the Company's wholly
owned special purpose subsidiary and the fair value of the assets
received from the trust. As a result of the securitization
transaction, the Company recorded approximately $12.6 million in
residual trust investments (composed of a note receivable of $8.5
million and residual trust equity of $4.1 million), which are included
in other assets on the Company's financial statements. The Company
regularly reviews these residual trust investments for impairment and
accounts for them as investments in available-for-sale debt
securities. At June 30, 2002, the fair values of these assets
approximated their carrying values. The Company receives
administrative and servicing fees on the securitized portfolio and
investment income on the note receivable. Approximately $0.3 million
(net of taxes) related to the securitization investments is reflected
as an increase to accumulated other changes in equity from nonowner
sources in the stockholders' equity component of the financial
statements at June 30, 2002.
9
At June 30, 2002, total student loan assets held by the trust were
approximately $249.7 million. At that time, receivables due from the
trust were $0.07 million and payables to the trust were $0.4 million.
During the quarter ended June 30, 2002, the Company received cash flows
from the trust related to the securitization of $.05 million for loan
servicing fees as the master servicer. Also, consistent with terms
described in the prospectus, $1.9 million was paid to the Company by
the trust to acquire additional eligible add-on loan assets. There were
no new securitizations of student loans in the second quarter of 2002.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FINANCIAL CONDITION
During the six months ended June 30, 2002, the Company's student loan
portfolio, composed primarily of loans originated under the Federal
Family Education Loan ("FFEL") Program, increased by $0.3 billion (1%)
to $18.5 billion from $18.2 billion at December 31, 2001. This growth
was attributable to loan disbursements totaling $1,412 million and loan
purchases of $813 million in the first two quarters of 2002, partially
offset by $228 million in loan sales, $1,242 million in loan reductions
(attributable to borrower principal payments and claims paid by
guarantors), $490 million in loans conveyed in a noncash transfer to
an available-for-sale inventory that was established in the first
quarter of 2002, and other adjustments of $22 million. During the six
months ended June 30, 2001, the Company made loan disbursements of
$1,147 million, loan purchases of $1,579 million, loan sales of $143
million, loan reductions of $969 million and other adjustments of $27
million.
As mentioned above, during the first quarter of 2002, the Company
established an inventory of loans available for sale. At June 30,
2002, this inventory had a balance of $773 million, composed of $490
million of loans conveyed in a noncash transfer from the Company's
loan portfolio and $554 million of loans purchased in the first six
months of 2002, partially offset by a loan securitization of
approximately $249 million, loan reductions of $13 million and other
adjustments of $9 million.
From time to time, the Company makes guaranteed student loan purchases,
composed primarily of secondary market and Federal Consolidation Loan
purchases. For the first six months of 2002, the Company's student loan
purchases included $813 million purchased for its portfolio and $554
million purchased for its resale inventory. This is a decrease of $212
million (13%) in loan purchases compared to the same period in 2001.
The Company's participation in the secondary market is dependent upon
market conditions.
The Company's loan disbursements and new CitiAssist Loan commitments
for the first half of 2002 and 2001 are shown in the table below:
(Dollars in millions) 2002 2001 Difference % Change
---- ---- ---------- --------
CitiAssist Loan Commitments $ 339 $ 234 $ 105 45%
FFEL Program Stafford and PLUS Loans 1,046 929 117 13%
Federal Consolidation Loans 366 218 148 68%
------ ------ ------
Total $1,751 $1,381 $ 370 27%
====== ====== ======
CitiAssist Loans are originated through an alternative loan program and
do not carry federal government guarantees. The Federal Consolidation
Loan originations reflected in the above table do not include
Consolidation Loans generated through third party marketing
relationships. Loans generated through these relationships are reported
as purchases since unconsolidated loan balances held by other lenders
must be purchased at face value from the other lenders prior to loan
consolidation.
In the first quarter of 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 removed from the financial statements of the Company and
ultimately sold to an independent trust. The trust, in turn, sells
securities, backed by the student loan assets, to investors.
In the first quarter of 2002, the Company securitized approximately
$249 million of Federal Consolidation Loans, selling them to a trust
that was established to purchase the loans. The Company recognizes the
securitization as a sale for financial statement purposes and the
securitization qualifies as a financing for tax purposes. The Company
sold the loans to the trust through a wholly owned, special
11
purpose subsidiary formed to acquire the Company's loans at par value.
A pre-tax gain of $3.1 million was recorded as a result of the
securitization. The gain was reflective of the difference between the
carrying value of the assets sold to the trust by the Company's wholly
owned special purpose subsidiary and the fair value of the assets
received from the trust. As a result of the securitization transaction,
the Company recorded approximately $12.6 million in residual trust
investments (composed of a note receivable of $8.5 million and residual
trust equity of $4.1 million), which are included in other assets on
the Company's financial statements. The Company receives administrative
and servicing fees on the securitized portfolio and investment income
on the note receivable. Approximately $0.3 million (net of taxes)
related to the securitization investments is reflected as an increase
to accumulated other changes in equity from nonowner sources in the
stockholders' equity component of the financial statements at June 30,
2002.
At June 30, 2002, total student loan assets held by the trust were
approximately $249.7 million. At that time, receivables due from the
trust were $0.07 million and payables to the trust were $0.4 million.
During the quarter ended June 30, 2002, the Company received cash flows
from the trust related to the securitization of $.05 million for loan
servicing fees as the master servicer. Also, consistent with terms
described in the prospectus, $1.9 million was paid to the Company by
the trust to acquire additional eligible add-on loan assets. There were
no new securitizations of student loans in the second quarter of 2002.
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 borrowing rates (based primarily on the 91-day Treasury Bill)
and lending rates (based on LIBOR). Consistent with the requirements of
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", as amended, management expects the Company's hedge program
to be highly effective in offsetting changes in cash flows for the risk
being hedged.
In 2002, the Company entered into a number of forward-starting interest
rate swap contracts with an affiliate of Citigroup to receive payments
based on LIBOR and make payments based on the 91-day Treasury Bill
rate. For the three- and six-month periods ended June 30, 2002, the
Company entered into new contracts with notional amounts of $2.3
billion and $2.7 billion, respectively. They have been designated and
are effective as cash flow hedges. The swap agreements have terms of
between 12 and 18 months. The fair value of the swaps at June 30, 2002
was a $1.4 million liability and is reflected in other liabilities on
the June 30, 2002 financial statements with a corresponding amount net
of taxes reflected in the accumulated other changes in equity from
nonowner sources component of stockholders' equity. Substantially all
of the $1.4 million liability, net of taxes, is expected to be
reclassified from accumulated other changes in equity from nonowner
sources within the next twelve months. No amounts have been excluded
from the assessment of effectiveness and no hedge ineffectiveness has
been recognized in earnings related to these swap agreements.
During the first half of 2002, the Company made $31 million in interest
payments, principally to CNYS, compared to $336 million for the same
period in 2001. The decrease is attributable to changes in both the
size of the borrowings and timing of interest payments.
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. The
Company paid income taxes, net of refunds, of $70 million, primarily to
CNYS, in the first half of 2002. The Company's income taxes were
overfunded at December 31, 2000, generating a $12 million federal tax
refund from CNYS, which was received in the first half of 2001.
Deferred income taxes increased by $5.1 million during the first six
months of 2002, composed of $5.4 million of deferred tax provision and
$0.2 million in non-provision-related deferred taxes resulting from the
securitization investments, partially offset by $0.5 million in
non-provision-related deferred taxes related to recording the fair
value on the interest rate swaps. The increase in deferred taxes during
the
12
first half of 2002 was primarily attributable to both the temporary
differences for deferred loan origination costs and the gain on sale
recorded in conjunction with securitization activity.
In the first six months of 2002, short-term debt increased by $2.7
billion to $18.1 billion. The increase was primarily attributable to
the reclassification of maturing long-term debt to short-term debt. The
$1.9 billion decrease in long-term borrowings at June 30, 2002 was due
to the reclassification of $2.2 billion of maturing long-term debt to
short-term debt and the procurement of $0.3 billion of new long-term
borrowings. The new borrowings were used primarily to fund new loan
disbursements and purchases. At June 30, 2002, accrued interest on the
Company's borrowings was $558 million, compared to accrued interest of
$345 million at December 31, 2001. The June 30, 2002 increase in
accrued interest, which is reflected in other liabilities on the
financial statements, results from the structure of the interest
payment terms on a substantial portion of the Company's debt. These
terms required that interest accumulate for periods of up to one year
ending July 2002, when interest in the amount of $490 million was
due and paid.
The Company paid a quarterly dividend of $0.70 per common share on June
1, 2002. On July 18, 2002, the Board of Directors declared a regular
quarterly dividend on the Company's common stock of $0.70 per share to
be paid September 3, 2002 to stockholders of record on August 15, 2002.
RESULTS OF OPERATIONS
QUARTER ENDED JUNE 30, 2002
Net income was $42.2 million ($2.11 basic and diluted earnings per
share) for the second quarter of 2002. This was an increase of $3.2
million (8.3%) compared to earnings for the same period last year. The
increase in net income was primarily attributable to increased interest
income generated by both portfolio growth and increased floor income.
The net interest margin for the second quarter of 2002 was 2.12%, up 2
basis points from the second quarter 2001 margin of 2.10%. The
improvement in net interest margin was primarily attributable to
increased floor income in the second quarter of 2002. Management
expects the majority of the current floor income benefit to decline
significantly for periods after July 1, 2002, when borrower interest
rates on most FFEL Program loans were reset.
Total operating expenses for the second quarter of 2002 increased $5.2
million (22%) from the same period last year, primarily reflecting the
incremental costs incurred to service the larger loan portfolio. In
addition, during the second quarter of 2002 the Company recognized a
one-time pre-tax expense of $1.7 million to write down the value of
certain previously capitalized internally developed software that is
being replaced through new systems development. For the second quarter
of 2002, the Company's expense ratio, operating expenses as a
percentage of average student loan assets, was 0.61% compared to 0.56%
for the second quarter of 2001. The increase reflects the incremental
costs incurred to service the larger loan portfolio, technology
infrastructure costs (as noted above), and growth in the Company's
sales force.
In the second quarter of 2002, the provision for loan losses increased
by $1.5 million, compared to the same period in 2001. This increase is
attributable primarily to the growth in the portfolio and is not
indicative of any specific changes in delinquency between the two
periods.
The Company's return on equity was 24.1% for the second quarter of
2002, compared to 26.4% for the same period of 2001.
SIX MONTHS ENDED JUNE 30, 2002
The Company earned net income of $91.8 million ($4.59 basic earnings
per share) for the six months ended June 30, 2002, an increase of $30.6
million (50%) from the first half of 2001. The increase was
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primarily attributable to the higher interest income generated by both
loan portfolio growth and increased floor income.
Total operating expenses for the first half of 2002 were $52.8 million,
$7.7 million (17%) higher than the same period last year. The increase
reflects the incremental costs incurred to service the larger
portfolio, technology infrastructure costs (as noted above), and growth
in the Company's sales force. Operating expenses as a percentage of
average student loans for the first half of 2002 were 0.56%, compared
to 0.54% for the first half of 2001.
The Company's return on equity was 27.0% for the first six months of
2002, 5.9% higher than the 21.1% return for the same period of 2001.
The improvement was primarily attributable to increased net interest
income resulting from higher floor income. Management expects the
majority of the current floor income benefit to decline significantly
for periods after July 1, 2002, when borrower interest rates on most
FFEL Program loans were reset.
The Company's effective tax rate was approximately 40.5% for the first
six months of 2002, compared to 40.4% for the same period of 2001.
SPECIAL ALLOWANCE AND FLOOR INCOME
Most FFEL Program loans originated prior to July 23, 1992 have fixed
interest rates. Those issued subsequent to July 23, 1992 generally have
variable rates. Most FFEL Program loans also 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.
As indicated above, whenever the stated interest rates on qualifying
FFEL Program loans provide less than prescribed rates of return, as
defined by the Act, the federal government pays a SAP, which increases
the loan yield to lenders. In periods of declining interest rates, the
stated fixed borrower rates, which are subject to various annual reset
provisions, become, in effect, interest rate floors. Floor income is
generally available in declining short-term interest rate environments
when the Company's cost of funds declines while this borrower interest
rate remains fixed, generating net interest margin in excess of the
expected spread. Depending on the manner in which the Company's assets
are funded, the Company may earn net interest margin spreads, which
include floor income, on portions of its portfolio until the date the
borrower interest rate is reset, which occurs annually for the majority
of the Company's loans. The Company earned $39.4 million of floor
income for the first six months of 2002, compared to $21.4 million for
the same period of 2001. Management expects the majority of the current
floor income benefit to decline significantly for periods after July
1, 2002, when borrower interest rates on FFEL Program loans were
reset.
OFF-BALANCE SHEET ARRANGEMENTS
In the first quarter of 2002, the Company entered into an off-balance
sheet arrangement in which a $249 million portfolio of student loans
was securitized, a process by which the loans were 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 SPE obtained the cash needed to pay the Company for the loan assets
received by issuing securities to investors in the form of debt
instruments (asset-backed securities). Investors have recourse to the
assets in the SPE and benefit from other credit enhancements, such as a
cash collateral account and other specified enhancements. The Company
can use the cash proceeds from the loan sale to fund new loan
originations, purchase loans or for other business purposes.
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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.
REGULATORY IMPACTS
Amendments to the Act, which 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. As the funding costs have not
been similarly reduced, 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
one-third, on a national basis, of all student loans originated under
federally sponsored programs.
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 e-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 Student Loan Corporation's (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 future legislative changes and 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; 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 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; the Company's ability to utilize
alternative sources of funding, including securitization; the
successful resolution of legal proceedings; as well as general economic
conditions, including the performance of financial markets and the
implementation of regulatory changes.
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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 future 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 June 30, 2002, a
100 basis point increase in the interest yield curve would have a
potential positive impact on the Company's pre-tax earnings of
approximately $10.5 million for the next twelve months and a potential
negative impact of approximately $117.0 million thereafter. A 100 basis
point decrease in the interest yield curve as of June 30, 2002 would
have a potential positive impact on the Company's pretax earnings of
approximately $28.0 million for the subsequent twelve-month period and
approximately $117.0 million thereafter.
Earnings-at-Risk (effect on pre-tax earnings) June 30, 2002 June 30, 2001
------------- -------------
Next Next
(Dollars in millions) 12 Mos. Thereafter Total 12 Mos. Thereafter Total
------- ---------- ----- ------- ---------- -----
One hundred basis point increase $ 10.5 $ (117.0) $ (106.5) $ 30.2 $ (99.2) $ (69.0)
One hundred basis point decrease $ 28.0 $ 117.0 $ 145.0 $ 22.9 $ 99.5 $ 122.4
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.
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PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS
At the Company's 2002 Annual Meeting of Stockholders, held May 9, 2002, the
Company's stockholders took the following actions:
1. Three directors were elected to the Board of Directors: Gina
Doynow (with holders of 18,274,222 shares voting in favor, 307,717
shares withheld and none abstaining); Jill Fadule (with holders of
18,504,668 shares voting in favor, 77,271 shares withheld and none
abstaining); David Young (with holders of 18,274,572 shares voting
in favor, 307,367 shares withheld and none abstaining). Ms. Gina
Doynow, Ms. Jill Fadule and Mr. David Young will each serve until
the year 2005 annual meeting of stockholders. The terms of office
of the other existing directors did not change.
2. The selection of KPMG LLP as the Company's independent auditors
for the 2002 fiscal year was ratified (with holders of 18,537,590
shares voting in favor, 41,399 shares voting against and 2,950
abstaining).
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
Exhibit Number Description
- -------------- -----------
99.01 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.02 Certification of 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 April 19, 2002, the Company filed a Current Report on Form 8-K,
dated March 27, 2002. Under Item 5 thereof, the Company described
the terms of the initial sale of student loan asset-backed notes
under the Company's loan securitization program.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Date: August 9, 2002
The Student Loan Corporation
By /s/ Steven Gorey
----------------------------------------
Steven Gorey
Vice President and Principal
Financial and Accounting Officer
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