Back to GetFilings.com
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------
FORM 10-K
(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBERS 001-13251
SLM HOLDING CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 52-2013874
(State of Other Jurisdiction (I.R.S. Employer
of Identification
Incorporation or Organization) No.)
11600 SALLIE MAE DRIVE, 20193
RESTON, VIRGINIA (Zip Code)
(Address of Principal
Executive Offices)
(703) 810 3000
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: Common Stock, par
value $.20 per share Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
The aggregate market value of voting stock held by non-affiliates of the
registrant as of February 28, 1999 was approximately $6,985,647,589 (based on
closing sale price of $42.875 per share as reported for the New York Stock
Exchange--Composite Transactions). On that date there were 162,930,556 shares of
Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement relating to the registrant's Annual Meeting
of Shareholders scheduled to be held May 20, 1999 are incorporated by reference
into Part III of this Report.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
This Report contains forward-looking statements and information that are
based on management's current expectations as of the date of this document. When
used herein, the words "anticipate," "believe," "estimate," "intend" and
"expect" and similar expressions are intended to identify forward-looking
statements. Such forward-looking statements are subject to risks, uncertainties,
assumptions and other factors that may cause the actual results to be materially
different from those reflected in such forward-looking statements. Such factors
include, among others, changes in the terms of student loans and the educational
credit marketplace arising from the implementation of applicable laws and
regulations and from changes in such laws and regulations, which may reduce the
volume, average term and costs of yields on student loans under the Federal
Family Education Loan Program ("FFELP") or result in loans being originated or
refinanced under non-FFELP programs or may affect the terms upon which banks and
others agree to sell FFELP loans to the Company. The Company could also be
affected by changes in the demand for educational financing or in financing
preferences of lenders, educational institutions, students and their families;
and changes in the general interest rate environment and in the securitization
markets for student loans, which may increase the costs or limit the
availability of financings necessary to initiate, purchase or carry student
loans; and interruptions of the Company's or others' operations resulting from
the inability of computer or other systems to process Year 2000-related
information, which may impact the Company's liquidity and its ability to obtain,
generate or process documents or payments received from or due to others.
PART I.
ITEM 1. BUSINESS
Industry data on the FFELP and the Federal Direct Student Loan Program (the
"FDSLP") contained in this report are based on sources that the Company believes
to be reliable and to represent the best available information for these
purposes, including published and unpublished U.S. Department of Education
("DOE") data and industry publications.
GENERAL
SLM Holding Corporation, a Delaware Corporation (the "Company"), is the
nation's largest private source of funding and servicing support for higher
education loans for students and their parents. The Company provides a wide
range of financial services, processing capabilities and information technology
to meet the needs of educational institutions, lenders, students and guarantee
agencies. The Company was formed in 1997 in connection with the reorganization
(the "Reorganization") of the Student Loan Marketing Association, a
government-sponsored enterprise (the "GSE"), pursuant to the Student Loan
Marketing Association Reorganization Act of 1996 (the "Privatization Act"). The
Privatization Act required the GSE to propose to shareholders a plan of
reorganization under which their share ownership would convert to an equivalent
share ownership in a state-chartered holding company that would own all of the
stock of the GSE. Pursuant to the Privatization Act, the Reorganization was
approved by the GSE's shareholders on July 31, 1997 and effected on August 7,
1997. The Privatization Act requires the GSE to transfer its business to the
Company and dissolve on or before September 30, 2008. During the period prior to
the dissolution of the GSE (the "Wind-Down Period"), the GSE is subject to
various limitations on its business and activities. See "--Operations During the
Wind-Down Period" and "Regulation--The Privatization Act."
Chartered by an act of Congress in 1972, the GSE's stated mission was to
enhance access to education by providing a national secondary market and
financing for guaranteed student loans. As of December 31, 1998, the Company's
managed portfolio of student loans totaled approximately $46.2 billion
(including loans owned, loans securitized and loan participations). The Company
also had commitments to purchase $17.1 billion of additional student loans or
participations therein as of December 31, 1998. While the Company continues to
be the leading purchaser of student loans, its business has expanded over its
first quarter of a century, reflecting changes in both the education sector and
the financial markets.
2
Primarily a wholesale provider of credit and a servicer of student loans,
the Company serves a diverse range of clients, including approximately 5,000
financial and educational institutions and state agencies. Through its four
regional loan servicing centers, the Company processes student loans for
approximately five million borrowers and is recognized as the nation's
pre-eminent servicer of student loans. The Company also provides and arranges
infrastructure finance for colleges and universities. See "--Specialized
Financial Services--Academic Facilities Financings and Student Loan Revenue
Bonds."
The Company believes that it has successfully fulfilled the GSE's original
mandate by fostering a thriving, competitive student loan market and has
maintained its leadership position in the education finance industry due to its
focus on customer relationships, value-added products and services, superior
loan servicing capabilities and a sound financial management strategy. In
recognition of the increasingly important role that college and university
administrators play in the student loan process, the Company has adopted a
school-based growth strategy. The Company's core marketing strategy is to
provide schools and their students with simple, flexible and cost-effective
products and services so that schools will choose to work with the Company. This
strategy, combined with superior servicing and technology capabilities, has
helped the Company to build valuable partnerships with schools, lenders,
guarantee agencies and others.
INDUSTRY OVERVIEW
The student loan industry provides affordable financing to students and
their families to fund education. The large majority of student loans is made to
finance post-secondary education under federally sponsored programs, although
many students and parents secure education credit through private student loan
programs. The federally sponsored student loans programs are highly regulated.
Under programs sponsored by the federal government, banks and other lenders that
satisfy statutory eligibility requirements can make student loans at
below-market rates due to subsidies and guarantees. The largest student loan
program, formerly called the Guaranteed Student Loan Program and now known as
the FFELP, was created in 1965 to ensure low-cost access by families to a full
range of post-secondary educational institutions. In 1972, to encourage further
bank participation in the Guaranteed Student Loan Program, Congress established
the GSE as a for-profit, stockholder-owned national secondary market for student
loans. The FFELP industry currently includes a network of approximately 4,200
originators and 6,300 educational institutions and is collectively guaranteed
and administered by 36 state-sponsored or non-profit guarantee agencies under
contract with the DOE. In addition to the Company, a number of non-profit
entities, banks and other financial intermediaries operate as secondary markets
for student loans. The Company believes that lender participation in the FFELP
is relatively concentrated, with an estimated 95 percent of outstanding loans
held by the top 100 participants, including approximately one-third owned or
managed by the Company as of December 31, 1998.
The Higher Education Act of 1965, as amended (the "Higher Education Act"),
is reauthorized by Congress approximately every six years. The Higher Education
Act was last reauthorized on October 7, 1998 in the form of the Higher Education
Amendments of 1998 (the "Reauthorization Legislation"), legislation that lowered
both the borrower interest rate on Stafford loans and the lender's rate after
special allowance payments. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation--Other Related
Information--Legislative Developments." The provisions of the FFELP are also
subject to revision from time to time by Congress.
Demand for student loans has risen substantially over the last several
years. Higher education tuition cost and fee increases continue to exceed the
inflation rate. Over half of all full-time college students today depend on some
form of borrowing, compared to just over 35 percent in 1985. In addition,
federal legislation enacted in late 1992 expanded loan limits and borrower
eligibility. All of these factors contributed to annual federally sponsored
student loan volume more than doubling ($29.5 billion in the 1997-98 academic
year (including FDSLP volume) from $12.6 billion in the 1991-92 academic year).
Estimated future increases in tuition costs and college enrollments are expected
to prompt continued growth in the student loan market.
3
In 1993, Congress expanded a previously established pilot program into the
FDSLP, which is administered by the DOE. Established as an alternative to the
private sector-based FFELP, the FDSLP accounted for approximately one-third of
all new federally sponsored student loans issued in academic year 1997-98. Under
the FDSLP, the federal government contracts with third parties for loan
administration and collections services while financing its lending activity
through U.S. Treasury borrowings.
PRODUCTS AND SERVICES
LOAN PURCHASES. The Company's student loan purchases primarily involve two
federally sponsored programs. The Company principally purchases Stafford loans,
PLUS loans and SLS loans originated under the FFELP, all of which are insured by
state-related or non-profit guarantee agencies and are reinsured by the DOE. The
Company also purchases student loans originated under the Health Education
Assistance Loan program ("HEAL") that are insured directly by the United States
Department of Health and Human Services. (HEAL loans have been discontinued and
new borrowers are directed to unsubsidized Stafford Loans). As of December 31,
1998, the Company's managed portfolio of student loans totaled $46.2 billion,
including $43.8 billion of FFELP loans (including loans owned, loans securitized
and loan participations) and $2.5 billion of HEAL loans.
The Company purchases student loans primarily from commercial banks. The
Company also purchases student loans from other eligible FFELP lenders,
including savings and loan associations, mutual savings banks, credit unions and
insurance companies, educational institutions and state and private non-profit
loan originating and secondary market agencies.
Most lenders using the secondary market hold loans while borrowers are in
school and sell loans shortly before conversion to repayment status, when
servicing costs increase significantly. Traditionally, the Company has purchased
most of its loans just before their conversion to repayment status, although the
Company also buys "in-school" loans and loans in repayment. The Company
purchases loans primarily through commitment contracts, but also makes "spot"
purchases. Approximately 84 percent and 60 percent of the Company's new loan
purchases were made pursuant to purchase commitment contracts in 1998 and 1997,
respectively. The Company enters into commitment contracts with lenders to
purchase loans up to a specified aggregate principal amount over the term of the
contract, which is usually two to three years. Under the commitment contracts,
lenders have the right, and in most cases the obligation, to sell to the Company
the loans they own over a specified period of time at a purchase price that is
based on certain loan characteristics.
In conjunction with commitment contracts, the Company frequently provides
selling institutions with operational support in the form of
PortSS-Registered Trademark-, an automated loan administration system for the
lender's use at its own offices before loan sale, or in the form of loan
origination and interim servicing provided through one of the Company's loan
servicing centers (ExportSS-Registered Trademark-). In 1998 and 1997, 80 percent
and 70 percent, respectively, of the Company's purchase commitment volume came
from users of PortSS-Registered Trademark-and ExportSS-Registered Trademark-.
The Company also offers commitment clients the ability to originate loans and
then transfer them to the Company for servicing (TransportSS-SM-).
PortSS-Registered Trademark-, ExportSS-Registered Trademark-and TransportSS-SM-
provide the Company and the lender assurance that loans will be efficiently
administered by the Company and that borrowers will have access to the Company's
repayment options and benefits. The growth in volume generated by PortSS,
ExportSS and TransportSS demonstrates the importance of the Company's investment
in these systems in past years.
In a spot purchase, the Company competes with other secondary market
participants to purchase a portfolio of eligible loans from a selling holder
when such holder decides to offer its loans for sale. The Company made
approximately 3 percent and 22 percent of its purchases of educational loans
through spot purchases in 1998 and 1997, respectively. In general, spot purchase
volume is more costly than volume purchased under commitment contracts.
The Company also offers eligible borrowers a program for consolidation of
eligible insured loans into a single new insured loan with a term of 10 to 30
years. As of December 31, 1998, the Company owned
4
approximately $8 billion of such consolidation loans, known as SMART
LOAN-Registered Trademark- Accounts. Immediately following enactment of the
Emergency Student Loan Consolidation Act in November 1997, which made
significant changes to the FFELP loan consolidation program, the Company
temporarily suspended its loan consolidation program. As a result of the
Reauthorization Legislation, the Company announced in the fourth quarter of 1998
that it will once again offer student loan borrowers the SMART
LOAN-Registered Trademark- consolidation program. The Company also introduced in
the second quarter of 1998 its Flex Repay-SM- Account as an alternative to
consolidation. See "Borrower Benefits and Program Technology Support" and
"Management's Discussion and Analysis of Financial Condition Results of
Operations--Other Related Events and Information--Legislative Developments."
PRIVATE CREDIT. In Spring of 1996 the Company introduced three private
loans under its Signature Education Loan-SM- Program. Under agreements with the
Company, lenders originated approximately $68 million in loan volume in
Signature private loans in academic year 1997-98 at more than 850 schools. The
majority of this volume represents loans made to borrowers with credit-worthy
cosigners. Signature Student-SM- Loans are available to students with
credit-worthy cosigners at all four-year colleges and universities to supplement
their federal loans. In addition, non-freshmen at some 250 schools may borrow
without a cosigner. Students may borrow as much as the costs of attendance minus
other financial aid they are eligible to receive. Signature Health-SM- Loans are
available at nearly 125 schools to credit-ready graduate students studying
allopathic medicine, dentistry, osteopathic medicine, pharmacy, veterinary
medicine, podiatry, optometry, and selected allied health fields. These loans
are designed to supplement Stafford loans and to replace the loss of HEAL
Program loans. Signature Select-SM- Loans are available at six participating
colleges. With the Signature Select-SM- Loan, participating colleges tailor loan
features to reflect the needs of their individual campuses and provide default
coverage in exchange for the program's flexibility. Depending on the
participating college, students may need cosigners to apply. Signature Loans are
insured by the Company through its HEMAR Insurance Corporation of America (HICA)
subsidiary. Most of the HICA- insured loans purchased by the Company are part of
"bundled" loan programs that include FFELP loans. The Company also purchases
loans originated under various other HICA-insured loan programs, including
particularly the private loan affinity programs MEDLOANS, LAWLOANS, and MBA
LOANS. These three programs accounted for $176 million in private and $422
million in FFELP loans during academic year 1997-98. As of December 31, 1998,
the Company owned approximately $1.6 billion of privately insured education
loans
The enhancement of the Company's private credit delivery platform was one of
the Company's key initiatives in 1998. SLM Financial, the Company's new wholly
owned subsidiary, substantially expanded the Company's private credit product
line, focusing on career training, lifelong learning and K-12 education. The
Company began offering Education Capital Professional loans directly to
borrowers and through partnerships with colleges and universities, technical and
trade schools and other adult learning centers. These loans are available to
borrowers enrolled in career training courses or a distance learning school;
attending a two-year or four-year proprietary school; attending a four-year
college less than half-time; or who need a computer loan. The Company also made
available its Education Capital K-12 Family Loan to parents and other family
members of children attending private K-12 schools, a market management believes
to be growing with approximately six million children enrolled in 26,000 schools
nationwide. Under this program, families can borrow up to the entire cost of
tuition and fees, or as little as $1,000 to finance the purchase of a computer,
musical instrument or other, high-cost, education-related items.
BORROWER BENEFITS AND PROGRAM TECHNOLOGY SUPPORT. To create customer
preferences and compete more effectively in the student loan marketplace, the
Company has developed a comprehensive set of loan programs and services for
borrowers, including numerous loan restructuring and repayment options and
programs that encourage and reward good repayment habits. The Company also
provides counseling and information programs (including a world wide web site)
that help borrowers and reinforce relationships with college and university
customers and lender partners.
5
Under the Company's Great Rewards-Registered Trademark- Program, certain
FFELP borrowers who make their first 48 scheduled monthly payments on time
receive a two percentage-point interest rate reduction for the remaining term of
the loan. Other programs credit students an amount equal to part of the loan
origination fees they pay and modestly reduce interest costs for use of
automatic debit accounts. The Company also provides financial aid administrators
at colleges and universities with innovative products and services that simplify
the lending process, including electronic funds transfer services and loan
information and management software that enables college application data to be
transferred electronically between program participants.
The Flex Repay-SM- Account, the Company's newest graduated repayment option,
allows students who are having difficulty making repayments to extend loan
repayment to make their payments more affordable while minimizing total loan
costs in comparison to loan consolidation.
In the Fourth quarter of 1998, the Company announced Laureate-SM-, a new
Internet-based student loan delivery system that the Company expects will be
available for the 1999-2000 academic year. This system is designed to provide
real-time data linkage among schools, borrowers, lenders and guarantors. With
Laureate, a student loan process that previously required multiple sessions over
several days is now expected to be completed in one on-line session.
ORIGINATIONS. In 1998, the Company began to originate a nominal amount of
FFELP loans through its wholly owned subsidiary, SLM Education Loan Corp. The
Company expects that its origination activity will increase with the
introduction of Laureate.
JOINT VENTURE WITH THE CHASE MANHATTAN BANK. In the fourth quarter of 1998,
the Company restructured its joint venture with The Chase Manhattan Bank
("Chase"), which, with an estimated market share of eight percent, is the
largest originator of student loans under the FFELP. Under the restructured
arrangement, the Company and Chase Education Holdings, Inc., a wholly owned
subsidiary of Chase, remain equal owners of Education First Finance LLC and
Education First Marketing LLC (collectively, the "Joint Venture"). Education
First Marketing LLC remains responsible for marketing education loans to be made
by Chase to schools and borrowers. Shortly after such loans are fully disbursed
by Chase, the loans are purchased on behalf of Education First Finance LLC by
the Chase/Sallie Mae Education Loan Trust (the "Trust"), but then, under the
restructured arrangement, are sold to the Company. Under the terms of the
restructuring, the Company will now purchase all loans originated by Chase.
Previously, the Joint Venture funded the student loans through sales of
participations that entitled the Company and Chase to one-half interests in the
student loans originated by Chase. As of December 31, 1998, the Trust owned
approximately $3.4 billion of federally insured education loans and in the
fourth quarter of 1998, the Trust sold $1.7 billion of federally insured
education loans to the Company of which one half represents new purchase volume.
The Trust is required to sell the balance of its existing portfolio to the
Company in the first two quarters of 1999. Substantially all loans owned by the
Trust have been serviced on behalf of the Trust by Sallie Mae Servicing
Corporation, the Company's wholly owned servicing subsidiary ("SMSC"), on a
fee-for-service basis. After the Trust's existing portfolio is sold to the
Company, the Trust's fee payments to SMSC will be negligible.
SERVICING
In 1980, the Company began servicing its own portfolios in order to better
control costs and manage risks. In late 1995, in connection with the
commencement of its securitization program, the Company transferred its
servicing operations to SMSC. Through SMSC, the Company is now the nation's
largest FFELP loan servicer, and management believes that the Company is
recognized as the premier service quality and technology provider in the student
loan industry. The Company believes that its processing capability and service
excellence are integral to its school-based growth strategy. As of December 31,
1998, the Company serviced approximately $46.5 billion of loans, including
approximately $21.4 billion of loans owned by the GSE and $17.9 billion owned by
eleven securitization trusts sponsored by the GSE,
6
$4.0 billion of loans currently owned by ExportSS-Registered Trademark-
customers and $3.2 billion owned by the Chase Joint Venture Trust.
The Company currently has four loan servicing centers, located in Florida,
Kansas, Pennsylvania and Texas. This geographic coverage, together with total
systems integration among centers, facilitates operations and customer service.
The DOE and the various guarantee agencies prescribe rules and regulations
that govern the servicing of federally insured student loans. The Company's
origination and servicing systems, internal procedures and highly trained staff
support compliance with these regulations, and are designed to promote asset
integrity and provide superior service to borrowers. The Company uses imaging
technology to further increase servicing productivity and capacity.
SPECIALIZED FINANCIAL SERVICES
The Company, principally through the GSE, engages in a number of specialty
financial services related to higher education credit, including collateralized
financing of FFELP and other education loan portfolios (warehousing advances),
credit support for student loan revenue bonds, portfolio investments in student
loan revenue and facilities bonds, underwritings of academic facilities bonds
and surety bond support for non-federally insured student loans.
WAREHOUSING ADVANCES. Warehousing advances are secured loans to financial
and educational institutions to fund FFELP and HEAL loans and other forms of
education-related credit. As of December 31, 1998, the Company held
approximately $1.5 billion of warehouse loans with an average term of four
years. These loans remain assets of the GSE, but the GSE can extend new
warehousing advances during the Wind-Down Period only pursuant to financing
commitments in place as of August 7, 1997. As of December 31, 1998, the GSE had
in place approximately $3.1 billion of such commitments. The Company does not
expect that its non-GSE affiliates will continue this line of business.
ACADEMIC FACILITIES FINANCINGS AND STUDENT LOAN REVENUE BONDS. Since 1987,
the GSE has provided facilities financing and commitments for future facilities
financing to approximately 250 educational institutions. Certain of these
financings are secured either by a mortgage on the underlying facility or by
other collateral. The GSE also invests in student loan revenue obligations. In
late 1995, the GSE established a broker-dealer subsidiary, Education Securities,
Inc. ("ESI"), which manages the GSE's municipal bond portfolio and is developing
an array of specialized underwriting and financial advisory services for the
education sector. The Company anticipates that it will reduce its investment
activity in academic facilities and student loan revenue bond products during
the Wind-Down Period. As of December 31, 1998, these portfolios totaled $1.2
billion and $123 million, respectively.
LETTERS OF CREDIT. In the past, the GSE has offered letters of credit to
guarantee issues of state and non-profit agency student loan revenue bonds.
Currently outstanding letters of credit have original terms of up to 17 years
but, in most cases, may be terminated in May 2001. As of December 31, 1998, the
GSE had approximately $4.7 billion of such commitments outstanding. During the
Wind-Down Period, letter of credit activity by the GSE will be limited to
guarantee commitments in place as of August 7, 1997.
PRIVATE STUDENT LOAN INSURANCE. In 1995, the GSE acquired HICA, a South
Dakota stock insurance company engaged exclusively in insuring lenders against
credit loss on their education-related, non-federally insured loans to students
attending post-secondary educational institutions. Loans owned by the GSE are a
significant portion of HICA's insured loan portfolio. See "--Products and
Services--Private Credit."
FINANCING/SECURITIZATION
The GSE obtains funds for its operations primarily from the sale of debt
securities in the domestic and overseas capital markets, and through public
offerings and private placements of U.S. dollar-denominated and foreign
currency-denominated debt of varying maturities and interest rate
characteristics. GSE debt
7
securities are currently rated at the highest credit rating level by Moody's
Investors Service and Standard & Poor's.
The GSE uses interest rate and currency exchange agreements (collateralized
where appropriate), U.S. Treasury securities, interest rate futures contracts
and other hedging techniques to reduce its exposure to interest rate and
currency fluctuations arising out of its financing activities and to match the
characteristics of its assets and liabilities. The GSE has also issued preferred
stock to obtain funds, including preferred stock held by the Company. Under the
Privatization Act, the GSE may issue debt with maturity dates through September
30, 2008 to fund student loan and other permitted asset purchases. Upon the
GSE's dissolution pursuant to the Privatization Act, the GSE must transfer any
remaining GSE obligations into a defeasance trust for the benefit of the holders
of such obligations together with cash or full faith and credit obligations of
the United States, or an agency thereof, in amounts sufficient, as determined by
the Secretary of the Treasury, to pay the principal and interest on the
deposited obligations. If the GSE has insufficient assets to fully fund such GSE
debt, the Company must transfer sufficient assets to the trust to account for
this shortfall. The Privatization Act requires that upon the dissolution of the
GSE on or before September 30, 2008, the GSE shall repurchase or redeem or make
proper provisions for repurchase or redemption of the GSE's outstanding
preferred stock.
Since late 1995 the Company has further diversified its funding sources,
independent of its GSE borrower status, by securitizing a portion of its student
loan assets. Securitization is an off-balance sheet funding mechanism that the
Company effects through the sale of portfolios of student loans by the GSE to
SLM Funding Corporation, a bankruptcy-remote, special-purpose, wholly owned
subsidiary of the GSE, which in turn sells the student loans to an independent
owner trust that issues securities to fund the purchase of the student loans.
The securitization trusts typically issue several classes of debt securities
rated at the highest investment grade level. The GSE has not guaranteed such
debt securities and has no obligation to ensure their repayment. Because the
securities issued by the trusts through securitization are not GSE securities,
the Company has been and in the future expects to be able to fund its student
loans to term through securitization, even for those assets with final
maturities that extend beyond the Wind-Down Period. The DOE has concurred with
the Company's position that a 30 basis point per annum offset fee imposed on
loans held by the GSE does not apply to securitized loans. The Company
anticipates that securitization will remain a primary student loan funding
mechanism for the Company when it begins to conduct student loan purchase
activity through a non-GSE subsidiary. In addition to the foregoing, the Company
obtains funding through a bank line of credit. The Company intends to secure a
credit rating for its debt securities within the first six months of 1999. The
Company expects that the credit rating on any debt securities of the Company
will be lower than that of the GSE's debt securities.
OPERATIONS DURING THE WIND-DOWN PERIOD
Privatization enables the Company to commence new business activities
without regard to restrictions in the GSE's charter. The stock of certain GSE
subsidiaries, including SMSC, HICA and ESI, was transferred to the Company.
Accordingly, the business activities of these subsidiaries are no longer subject
to restrictions contained in the GSE's charter. In addition, the GSE's employees
were transferred to Sallie Mae, Inc. (the "Management Company").
During the Wind-Down Period, the GSE generally is prohibited from conducting
new business except in connection with student loan purchases through September
30, 2007 or with other outstanding contractual commitments, and from issuing new
debt obligations that mature beyond September 30, 2008. The GSE has transferred
personnel and certain assets to the Company or other non-GSE affiliates. Student
loans, warehousing advances and other program-related or financial assets (such
as portfolio investments, letters of credit, swap agreements and forward
purchase commitments) have not been transferred and are generally not expected
to be transferred until the Wind-Down Period is close to completion. Neither the
Company nor any of its non-GSE affiliates may make secondary market purchases of
FFELP loans for so long as the GSE is actively acquiring insured student loans.
During the Wind-Down Period, GSE operations will be managed pursuant to
arm's-length service agreements between the GSE
8
and one or more of its non-GSE affiliates. The Privatization Act also provides
certain restrictions on intercompany relations between the GSE and its
affiliates during the Wind-Down Period.
COMPETITION
The Company is the major financial intermediary for higher education credit,
but is subject to competition on a national basis from several large commercial
banks and non-profit secondary market agencies and on a state or local basis
from smaller banks and state-based secondary markets. In addition, the
availability of securitization for student loan assets has created new
competitive pressures for traditional secondary market purchasers. Based on the
most recent information from the DOE and management estimates, at the end of
fiscal year 1997, the GSE's share (in dollars) of outstanding FFELP loans was 35
percent, while banks and other financial institutions held 42 percent and state
secondary market participants held 23 percent. Although Congress establishes
loan limits and interest rates on student loans, management believes that market
share in the FFELP industry is increasingly a function of school and student
desire for borrower benefits and superior customer service. FFELP providers have
been aggressively competing on the basis of enhanced products and services in
recent years.
Because the GSE historically has been confined by statute to secondary
market activity, it has depended mainly on its network of lender partners and
its school-based strategy for new loan volume. Because the Company is not
subject to the same limitations as the GSE, it intends to heighten its
visibility with consumers to position itself favorably for future new product
offerings.
The Company also faces competition for new and existing loan volume from the
FDSLP. Based on current DOE projections, the Company estimates that total
student loan originations for the academic years 1997-98, 1996-97, 1995-96, and
1994-95 were $29.5 billion, $27.5 billion, $24.7 billion, and $22.2 billion,
respectively, of which FDSLP originations represented approximately 33 percent,
32 percent 31 percent and 7 percent, respectively. The DOE projects that FDSLP
originations will represent about one third of total student loan originations
in the 1998-99 academic year.
The DOE has also begun to offer FFELP borrowers the opportunity to refinance
or consolidate FFELP loans into FDSLP loans if the borrowers also have a FDSLP
loan or upon certification that the holder of their FFELP loans does not offer
an income-sensitive payment plan acceptable to the borrower. During 1998,
approximately $432 million of the GSE's FFELP loans was consolidated into the
FDSLP. In early 1995, the Company began offering an income-sensitive payment
plan. The FDSLP, however, also provides an income-contingent option not
available under the FFELP program that may be more attractive to certain
borrowers. Under this repayment option, the government will ultimately forgive
student loan debt after 25 years. In addition, the Reauthorization Legislation
maintained borrower interest rates for FDSLP consolidation whose applications
for such loans were received prior to February 1, 1999 at preferential rates. In
the fourth quarter of 1998, the Company announced that it will once again offer
student loan borrowers the SMART LOAN-Registered Trademark- consolidation
program, which it suspended in the fourth quarter of 1997. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--Other
Related Events and Information--Legislative Developments."
REGULATION
As a government-sponsored enterprise, the GSE is organized under federal law
and its operations are restricted by its government charter. Although
privatization permits the Company's private activities to expand through non-GSE
subsidiaries, the GSE's operations continue to be subject to broad federal
regulation during the Wind-Down Period.
THE PRIVATIZATION ACT
The Privatization Act established the basic framework for the Reorganization
and imposes certain restrictions on the operations of the Company and its
subsidiaries during the Wind-Down Period. The
9
Privatization Act amends the GSE's charter to require certain enhanced
regulatory oversight of the GSE to ensure its financial safety and soundness.
See "--GSE Regulation."
REORGANIZATION. The Privatization Act required the GSE to propose to
shareholders a plan of reorganization under which their share ownership in the
GSE would be automatically converted to an equivalent share ownership in a
state-chartered holding company that would own all of the common stock of the
GSE. On July 31, 1997, the GSE's shareholders approved the Reorganization in
fulfillment of this provision. The Privatization Act requires that the GSE be
liquidated on or before September 30, 2008, upon which its federal charter will
be rescinded. During the Wind-Down Period, the Company will remain a passive
entity that supports the operations of the GSE and its other non-GSE
subsidiaries, and any new business activities will be conducted through such
subsidiaries.
The Privatization Act requires all personnel and certain assets to be
transferred to non-GSE subsidiaries of the Company in connection with the
Reorganization, including the transfer of the GSE's interest in certain
subsidiaries. The GSE's student loans and related contracts, warehousing
advances and other program-related or financial assets (such as portfolio
investments, letters of credit, swap agreements and forward purchase
commitments) and any non-material assets that the GSE Board determines to be
necessary for or appropriate to continued GSE operations, may be retained by the
GSE. Employees of the GSE were transferred to the Management Company at the
effective time of the Reorganization. Employees who were employed by non-GSE
subsidiaries of the GSE before the Reorganization continue to be employed by
such subsidiaries.
During the Wind-Down Period, the GSE is restricted in the new business
activities it may undertake. The GSE may continue to purchase student loans only
through September 30, 2007, and warehousing advance, letter of credit and
standby bond purchase activity by the GSE is limited to takedowns on contractual
financing and guarantee commitments in place at the effective time of the
Reorganization. In addition, the Company, and its non-GSE subsidiaries may not
make secondary market purchases of FFELP loans for so long as the GSE is
actively acquiring insured student loans.
In certain circumstances, the GSE will continue to serve as a lender of last
resort and will provide secondary market support for the FFELP upon the request
of the Secretary of Education. If and to the extent that the GSE performs such
functions, however, it will not be required to pay a statutorily imposed 30
basis point offset fee on such loans. The GSE may transfer assets and declare
dividends, from time to time, if it maintains a minimum capital ratio of at
least 2 percent until the year 2000. After that time, charter amendments
effected by the Privatization Act require that the GSE maintain a minimum
capital ratio of at least 2.25 percent. In the event that the GSE does not
maintain the required minimum capital ratio, the Company is required to
supplement the GSE's capital to achieve such minimum capital ratio.
The GSE's debt obligations, including debt obligations that were outstanding
at the time of the Reorganization, continue to be outstanding obligations of the
GSE and will not be transferred to any other entity (except in connection with
the defeasance trust described below). See "--GSE Dissolution After
Reorganization." The Privatization Act provides that the Reorganization does not
modify the attributes accorded to the debt obligations of the GSE by the GSE's
charter. During the Wind-Down Period, the GSE can continue to issue debt in the
government agency market to finance student loans and other permissible asset
purchases. The maturity date of such issuances, however, may not extend beyond
September 30, 2008, the GSE's final dissolution date. This restriction does not
apply to debt issued to finance any lender of last resort or secondary market
purchase activity requested by the Secretary of Education. The Privatization Act
is clear that the Reorganization (and the subsequent transfer of any remaining
GSE debt to the defeasance trust described below) will not modify the legal
status of any GSE debt obligations, whether such obligations existed at the time
of Reorganization or are subsequently issued.
OVERSIGHT AUTHORITY. During the Wind-Down Period, the Secretary of the
Treasury has extended oversight authority to monitor the activities of the GSE
and, in certain cases, the Company and its non-GSE subsidiaries to the extent
that the activities of such entities are reasonably likely to have a material
impact on the financial condition of the GSE. The U.S. Department of the
Treasury has
10
established the Office of Sallie Mae Oversight to perform these functions.
During this period, the Secretary of the Treasury may require that the GSE
submit periodic reports regarding any potentially material financial risk of its
associated persons and its procedures for monitoring and controlling such risk.
The Company is expressly prohibited from transferring ownership of the GSE or
causing the GSE to file bankruptcy without the approval of the Secretary of the
Treasury and the Secretary of Education. The Secretary of Education and the
Secretary of the Treasury have express authority to request that the Attorney
General bring an action, or may bring an action under the direction and control
of the Attorney General, in the United States District Court for the District of
Columbia, for the enforcement of any provision of the GSE's safety and soundness
requirements or the requirements of the Privatization Act in general.
RESTRICTIONS ON INTERCOMPANY RELATIONS. The Privatization Act restricts
intercompany relations between the GSE and its affiliates during the Wind-Down
Period. Specified corporate formalities must be followed to ensure that the
separate corporate identities of the GSE and its affiliates are maintained.
Specifically, the Privatization Act provides that the GSE must not extend credit
to, nor guarantee any debt obligations of, the Company or its subsidiaries. The
Privatization Act also provides that (i) the funds and assets of the GSE must at
all times be maintained separately from the funds and assets of the Company and
its subsidiaries, (ii) the GSE must maintain books and records that clearly
reflect the assets and liabilities of the GSE, separate from the assets and
liabilities of the Company or its subsidiaries, (iii) the GSE must maintain a
corporate office that is physically separate from any office of the Company and
its subsidiaries, (iv) no director of the GSE who is appointed by the President
may serve as a director of the Company and (v) at least one officer of the GSE
must be an officer solely of the GSE.
Furthermore, the Privatization Act mandates that transactions between the
GSE and the Company, including any loan servicing arrangements, shall be on
terms no less favorable to the GSE than the GSE could obtain from an unrelated
third party, and any amounts collected on behalf of the GSE by the Company
pursuant to a servicing contract or other arrangement between the GSE and the
Company shall be immediately deposited by the Company to an account under the
sole control of the GSE.
LIMITATIONS ON COMPANY ACTIVITIES. During the Wind-Down Period, the Company
must remain a passive entity that holds the stock of its subsidiaries and
provides funding and management support to such subsidiaries. The Privatization
Act contemplates that until the GSE is dissolved, the Company's business
activities will be conducted through subsidiaries. However, the Privatization
Act extends to the Company and its subsidiaries the GSE's "eligible lender"
status for loan consolidation and secondary market purchases. See "Business."
The Company and its non-GSE subsidiaries generally may not begin to make
secondary market purchases of FFELP student loans for so long as the GSE is
actively acquiring insured student loans. Subject to the foregoing, the Company
may elect, at any time, to transfer new student loan purchase activity from the
GSE to one of its non-GSE subsidiaries. In addition, the Company is permitted to
and, in the third quarter of 1998, began to originate FFELP loans. See
"Business--Products and Services-- Originations." Under the Higher Education
Act, loans acquired after August 10, 1993 and held by the GSE are subject to a
30 basis point per annum "offset fee." The offset fee does not apply to
securitized loans or to loans held or securitized by the Company or its non-GSE
subsidiaries.
Although the GSE may not finance the activities of the Company's non-GSE
subsidiaries, it may, subject to its minimum capital requirements, dividend
retained earnings and surplus capital to the Company, which in turn may use such
amounts to support its non-GSE subsidiaries. The Privatization Act further
directs that, unless and until distributed as dividends by the GSE, under no
circumstances shall the assets of the GSE be available or used to pay claims or
debts of or incurred by the Company.
In exchange for the payment of $5 million to the District of Columbia
Financial Responsibility and Management Assistance Authority (the "Control
Board"), the Company and its other subsidiaries may continue to use the name
"Sallie Mae," but not the name "Student Loan Marketing Association," as part of
their legal names or as a trademark or service mark. Interim disclosure
requirements in connection with
11
securities offerings and promotional materials are required to avoid marketplace
confusion regarding the separateness of the GSE and its affiliated entities.
During the Wind-Down Period and until one year after repayment of all
outstanding GSE debt, the "Sallie Mae" name may not be used by any Company unit
that issues debt obligations or other securities to any person or entity other
than the Company or its subsidiaries. In addition, the Privatization Act
required the Company to issue certain warrants to purchase the Company's Common
Stock (the "Warrants") to the Control Board. These provisions of the
Privatization Act were part of the terms negotiated with the Administration and
Congress in conjunction with the GSE's privatization. The Company issued the
Warrants on August 7, 1997.
GSE DISSOLUTION AFTER REORGANIZATION. The Privatization Act provides that
the GSE will liquidate and dissolve on September 30, 2008, unless an earlier
dissolution is requested by the GSE and the Secretary of Education makes no
finding that the GSE continues to be needed as a lender of last resort under the
GSE charter or to purchase loans under certain agreements with the Secretary of
Education. In connection with such dissolution, the GSE must transfer any
remaining GSE obligations into a defeasance trust for the benefit of the holders
of such obligations, along with cash or full faith and credit obligations of the
United States, or an agency thereof, in amounts sufficient, as determined by the
Secretary of the Treasury, to pay the principal and interest on the deposited
obligations. As of December 31, 1998, the GSE had $367 million in current
carrying value of debt obligations outstanding with maturities after September
30, 2008. If the GSE has insufficient assets to fund fully such GSE debt
obligations outstanding at the time of dissolution, the Company must transfer
sufficient assets to the trust to account for this shortfall. The Privatization
Act also requires that on the dissolution date, the GSE shall repurchase or
redeem, or make proper provisions for the repurchase or redemption of, any
outstanding shares of preferred stock, of which the GSE has issued Series A and
B Adjustable Rate Cumulative Preferred Stock. The Series A Preferred Stock is
carried at its liquidation value of $50.00 per share for a total of $214 million
and pays a variable dividend that has been at its minimum rate of 5 percent per
annum for the last several years. The Series B Preferred Stock is carried at its
liquidation value of $500,000 per share for a total of $100 million and pays a
variable dividend that is equal to three-month London Interbank Offered Rate
("LIBOR") plus one percent per annum divided by 1.377. Upon dissolution, the GSE
charter will terminate, and any assets that the GSE continues to hold after
establishment of the trust or that remain in the trust after full payment of the
remaining obligations of the GSE assumed by the trust will be transferred to the
Company or its affiliates, as determined by the Company's Board of Directors.
GSE REGULATION
The GSE's structure and the scope of its business activities are set forth
in its charter. The charter, which is subject to review and change by Congress,
sets forth certain restrictions on the GSE's business and financing activities
and charges the federal government with certain oversight responsibilities with
respect to these activities. The GSE's charter grants the GSE certain exemptions
from federal and state laws. The GSE's charter's primary regulatory restrictions
and exemptions, including certain provisions added by the Privatization Act, are
summarized as follows:
1. Seven members of the GSE's 21-member Board of Directors are appointed by the
President of the United States. The other 14 members are elected by the Company as
the holder of the GSE's Common Stock. The Chairman of the Board is designated by
the President of the United States from among the Board's 21 members.
2. Debt obligations issued by the GSE are exempt from state taxation to the same
extent as U.S. government obligations. The GSE is exempt from all taxation by any
state or by any county, municipality or local taxing authority except with respect
to real property taxes. The GSE is not exempt from federal corporate income taxes.
3. All stock and other securities of the GSE are deemed to be exempt securities under
the laws administered by the SEC to the same extent as obligations of the United
States.
12
4. The GSE may conduct its business without regard to any qualification or similar
statute in any state of the United States, including the District of Columbia, the
Commonwealth of Puerto Rico and the territories and possessions of the United
States (although the scope of the GSE's business is generally limited by its
federal charter).
5. The issuance of GSE debt obligations must be approved by the Secretary of the
Treasury.
6. The GSE is required to have its financial statements examined annually by
independent certified public accountants and to submit a report of the examination
to the Secretary of the Treasury. The Department of the Treasury is also authorized
to conduct audits of the GSE and to otherwise monitor the GSE's financial
condition. The GSE is required to submit annual reports of its operations and
activities to the President of the United States and Congress. The GSE must pay up
to $800,000 per year to the Department of the Treasury to cover the costs of its
oversight.
7. The GSE is subject to certain "safety and soundness" regulations, including the
requirement that the GSE maintain a 2.00 percent capital adequacy ratio (increasing
to 2.25 percent after January 1, 2000). The GSE may pay dividends only upon
certification that, at the time of a dividend declaration and after giving effect
to the payment of such dividend, the capital adequacy ratio is satisfied.
8. The Secretary of Education and the Secretary of the Treasury have certain
enforcement powers under the GSE's charter.
9. A 30 basis point annual offset fee, unique to the GSE, is payable to the Secretary
of Education on student loans purchased and held by the GSE on or after August 10,
1993.
10. In certain circumstances, at the request of the Secretary of Education, the GSE is
required to act as a lender of last resort to make FFELP loans when other private
lenders are not available. Such loans are not subject to the 30 basis point offset
fee on loans held by the GSE.
OTHER REGULATION
Under the Higher Education Act, the GSE is an "eligible lender" for purposes
only of purchasing and holding loans made by other lenders and making
consolidation and lender of last resort loans. Like other participants in
insured student loan programs, the Company is subject, from time to time, to
review of its student loan operations by the General Accounting Office, the DOE
and certain guarantee agencies. The laws relating to insured student loan
programs are subject to revision from time to time and changes to such laws are
beyond the Company's control. In addition, SMSC, as a servicer of student loans,
is subject to certain DOE regulations regarding financial responsibility and
administrative capability that govern all third party servicers of insured
student loans. Failure to satisfy such standards may result in the loss of the
government guarantee of FFELP loans. ESI is a broker-dealer registered with the
SEC and the National Association of Securities Dealers (the "NASD") and is
licensed to do business in 50 states. ESI is subject to regulation by the SEC
and the NASD as a municipal security broker-dealer. HICA, a South Dakota stock
insurance company, is subject to the ongoing regulatory authority of the South
Dakota Division of Insurance and that of comparable governmental agencies in six
other states.
NON-DISCRIMINATION AND LIMITATIONS ON AFFILIATION WITH DEPOSITORY INSTITUTIONS
The Privatization Act also amended the Higher Education Act to provide that
the GSE and any successor entity (including the Company) functioning as a
secondary market for federally insured student loans may not engage, directly or
indirectly, in any pattern or practice that results in a denial of a borrower's
access to insured loans because of the borrower's race, sex, color, religion,
national origin, age, disability status, income, attendance at a particular
institution, length of a borrower's educational program or the borrower's
academic year at an eligible institution.
The Omnibus Appropriations Act of 1998, signed into law by the President on
October 21, 1998, contains several provisions that amend the Federal Deposit
Insurance Act. These provisions provide an
13
exception to the current prohibition on affiliations between
government-sponsored entities and depository institutions contained in the
Federal Deposit Insurance Act. This exception allows SLM Holding Corporation to
become affiliated with a depository institution upon certain conditions and with
the approval of the Secretary of the Treasury. Among the conditions are: the
dissolution of the GSE cannot be adversely affected by the affiliation; the
dissolution of the GSE must occur within two years after the affiliation is
consummated subject to the ability of the Secretary to extend such deadline for
up to two one-year periods; and the GSE must be separate and distinct from the
affiliated depository institution and cannot extend credit, provide credit
enhancement or purchase any obligation of the depository institution.
As of December 31, 1998, the Company employed 3,966 employees nationwide.
ITEM 2. PROPERTIES
The following table lists the principal facilities owned by the Company:
APPROXIMATE
LOCATION FUNCTION SQUARE FEET
- ------------------------------ ---------------------------- ------------
Reston, VA Operations/Headquarters 395,000
Wilkes Barre, PA Loan Servicing Center 135,000
Killeen, TX Loan Servicing Center 133,000
Lynn Haven, FL Loan Servicing Center 133,000
Lawrence, KS Loan Servicing Center 52,000
The Company leases approximately 7,000 square feet of office space in
Washington, D.C. for its government relations group and 47,000 square feet of
additional space for its loan servicing center in Lawrence, Kansas. The GSE
leases approximately 115,600 square feet of office space in Washington, D.C. for
its former headquarters. The Company has entered into subleases through the term
of these leases, which expire in 2001, and other arrangements to terminate the
GSE's obligations under these leases. With the exception of the Pennsylvania
loan servicing center, none of the Company's facilities is encumbered by a
mortgage. The Company believes that its headquarters and loan servicing centers
are generally adequate to meet its long-term student loan and new business
goals. In the third quarter of 1998 the Company closed its satellite loan
servicing centers in Waltham, Massachusetts and Spokane, Washington.
The Company's principal office is located in owned space at 11600 Sallie Mae
Drive, Reston, Virginia, 20193.
ITEM 3. LEGAL PROCEEDINGS.
ORANGE COUNTY LITIGATION. On December 19, 1996, Orange County, California
filed an amended complaint against the Company in the U.S. Bankruptcy Court for
the Central District of California. The case is currently pending in the U.S.
District Court for the Central District of California. The complaint alleges
that the Company made fraudulent representations and omitted material facts in
offering circulars on various bond offerings purchased by Orange County, which
contributed to Orange County's market losses and subsequent bankruptcy. The
complaint seeks to hold the GSE liable for losses resulting from Orange County's
bankruptcy, but does not specify the amount of damages claimed. The complaint
against the Company is one of numerous cases filed by Orange County that have
been coordinated for discovery purposes. Other defendants include Merrill Lynch,
Morgan Stanley, KPMG Peat Marwick, Standard & Poor's and Fannie Mae. The
complaint includes a claim of fraud under Section 10(b) of the Securities
Exchange Act and Rule 10b-5 promulgated thereunder. The complaint also includes
counts under the California Corporations Code and a count of common law fraud.
After extended discovery, Merrill Lynch signed a memorandum of settlement
terms that calls for Orange County to dismiss all claims against the Company
with prejudice and without any payment by the Company to Orange County. Final
papers have been signed between Orange County and Merrill Lynch and Orange
County has signed a release of claims against Sallie Mae. The settlement
agreement, however, must be approved by the court as having been made in "good
faith" for purposes of Section 877 of the
14
California Code of Civil Procedure. A number of the non-settling defendants,
including a law firm and various broker-dealers, have objected to the good faith
settlement motion. A hearing on the motion for good faith settlement was held on
November 23, 1998. On that date, the court issued a preliminary order approving
the settlement agreement and, on March 1, 1999, the court entered a final
judgment confirming that order.
CLAIM AGAINST THE SECRETARY OF EDUCATION. By letter dated July 14, 1995,
the Office of Student Financial Assistance ("SFAP") of the Department of
Education notified Sallie Mae that it proposed to limit Sallie Mae's eligible
lender status by prohibiting Sallie Mae from continuing to implement the
servicing, purchase and financing agreements that are in place with Dr. Scholl's
School of Podiatry ("Scholl College"), and from supporting other similar school
lender programs. SFAP claimed these arrangements violate a statutory ban on
prohibited inducements contained in Section 435(d)(5)(A) of the Higher Education
Act.
After a full evidentiary hearing, an administrative law judge employed by
the Secretary of Education ruled in favor of Sallie Mae on all disputed issues.
SFAP then appealed the administrative law judge's decision to the Secretary of
Education.
On February 4, 1997, Secretary Riley issued a one-page order remanding the
case to the administrative law judge to determine (1) whether the Department has
authority under the Higher Education Act to recharacterize a party as a lender
under the FFELP based on the substance of the transactions involved and in spite
of their form; and (2) if the Department has the authority to recharacterize, is
it appropriate to do so based on the facts of this case.
On July 18, 1997, the administrative law judge again issued a decision in
Sallie Mae's favor on all issues. The administrative law judge found that
"Sallie Mae's arrangement with Scholl College is typical of the traditional loan
servicing, forward financing, and loan sale contracts used in the industry." He
further stated that "Sallie Mae should not and cannot be characterized as the
originating lender of loans to students enrolled at Scholl College." On August
8, 1997, SFAP once again appealed the administrative judge's decision.
On October 13, 1998, Secretary Riley reversed the administrative law judge's
decision and issued an order that Sallie Mae be limited from participating as a
lender in the Scholl College FFEL program. Without any analysis, Secretary Riley
concluded that Sallie Mae "performs all the functions of a lender in relation to
the loans formally made by Scholl College", and that consequently the
classification as a lender may not stand.
On December 14, 1998 the Company filed a lawsuit against the Secretary in
the United States District Court for the District of Columbia seeking to
overturn the Secretary's order. In its complaint, the Company states that the
Secretary's order is arbitrary, capricious and otherwise contrary to law under
the Administrative Procedure Act. The Secretary's answer to the complaint is due
on March 15, 1999.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
Nothing to report.
15
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed and traded on the New York Stock
Exchange under the symbol SLM. The number of holders of record of the Company's
Common Stock as of March 22, 1999 was approximately 680. The following table
sets forth the high and low sales prices for the Company's Common Stock for each
full quarterly period within the two most recent fiscal years. The prices in
this table are adjusted to reflect a 7-for-2 stock split, which was effected on
January 2, 1998 as a stock dividend of five shares for every two shares
outstanding.
COMMON STOCK PRICES
1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
1997............ High 32 41/64 39 23/64 45 55/64 47 11/64
Low 25 27/64 27 1/32 36 9/32 35 9/32
1998............ High 46 3/4 49 51 48
Low 37 15/16 37 1/8 28 30 3/8
The Company paid regular quarterly dividends of $.1257 per share on the
Common Stock for the first three quarters of 1997, $.14 for the fourth quarter
of 1997 and the first three quarters of 1998 and $.15 for the fourth quarter of
1998 and the first quarter of 1999.
16
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA 1994-1998
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
The following table sets forth selected financial and other operating
information of the Company. The selected financial data in the table is derived
from the consolidated financial statements of the Company. The data should be
read in conjunction with the consolidated financial statements, related notes,
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in the Company's Form 10-K to the Securities and Exchange
Commission.
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
OPERATING DATA:
Net interest income........................................ $ 663 $ 781 $ 894 $ 908 $ 982
Net income................................................. 501 508 409 356 410
Basic earnings per share................................... 2.99 2.80 2.10 1.51 1.47
Diluted earnings per share................................. 2.95 2.78 2.09 1.51 1.47
Dividends per share........................................ .57 .52 .47 .43 .41
Return on stockholders' equity............................. 81% 65% 50% 29% 28%
Net interest margin........................................ 1.97 1.80 1.96 1.85 2.14
Return on assets........................................... 1.41 1.12 .86 .69 .85
Dividend payout ratio...................................... 19 19 22 29 28
Average equity/average assets.............................. 1.65 1.64 1.66 2.28 2.96
BALANCE SHEET DATA:
Student loans.............................................. $ 28,283 $ 29,443 $ 33,696 $ 34,285 $ 30,571
Total assets............................................... 37,210 39,832 47,572 49,951 53,161
Total borrowings........................................... 35,399 37,717 45,124 47,530 50,335
Stockholders' equity....................................... 654 675 834 867 1,388
Book value per share....................................... 3.98 3.89 4.44 4.29 5.39
OTHER DATA:
Securitized student loans outstanding...................... $ 17,909 $ 14,104 $ 6,263 $ 954 $ --
Pro-forma results (1):
"Cash basis" net interest income......................... $ 997 $ 969 $ 982 $ 908 $ 982
"Cash basis" net income.................................. 449 345 395 356 410
"Cash basis" diluted earnings per share.................. 2.64 1.89 2.02 1.51 1.47
"Cash basis" net interest margin......................... 1.96% 1.81% 1.98% 1.85% 2.14%
"Cash basis" return on assets............................ .85 .62 .77 .69 .85
- ------------------------
(1) The pro-forma results present the Company's results of operations under the
assumption that the securitization transactions are financings and that the
securitized student loans were not sold. As such, no gain on sale or
subsequent servicing and securitization revenue is recognized. Instead, the
earnings of the student loans in the trusts and related financing costs are
reflected over the life of the underlying pool of loans. Management refers
to these pro-forma results as "cash basis" results. Management monitors the
periodic "cash basis" results of the Company's managed student loan
portfolio and believes that they assist in a better understanding of the
Company's student loan business.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996-1998
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
OVERVIEW
SLM HOLDING CORPORATION ("SLM HOLDING") WAS FORMED ON FEBRUARY 3, 1997, AS A
WHOLLY OWNED SUBSIDIARY OF THE STUDENT LOAN MARKETING ASSOCIATION (THE "GSE").
ON AUGUST 7, 1997, PURSUANT TO THE STUDENT LOAN MARKETING ASSOCIATION
REORGANIZATION ACT OF 1996 (THE "PRIVATIZATION ACT") AND APPROVAL BY
SHAREHOLDERS OF AN AGREEMENT AND PLAN OF REORGANIZATION, THE GSE WAS REORGANIZED
INTO A SUBSIDIARY OF SLM HOLDING (THE "REORGANIZATION"). SLM HOLDING IS A
HOLDING COMPANY THAT OPERATES THROUGH A NUMBER OF SUBSIDIARIES INCLUDING THE
GSE. REFERENCES HEREIN TO THE "COMPANY" REFER TO THE GSE AND ITS SUBSIDIARIES
FOR PERIODS PRIOR TO THE REORGANIZATION AND TO SLM HOLDING AND ITS SUBSIDIARIES
FOR PERIODS AFTER THE REORGANIZATION.
The Company is the largest source of financing and servicing for education
loans in the United States primarily through its participation in the Federal
Family Education Loan Program ("FFELP"), formerly the Guaranteed Student Loan
Program. The Company's products and services include student loan purchases and
commitments to purchase student loans, as well as operational support to
originators of student loans and to post-secondary education institutions and
other education-related financial services. The Company also originates and
holds unguaranteed private loans.
The following Management's Discussion and Analysis contains forward-looking
statements and information that are based on management's current expectations
as of the date of this document. Discussions that utilize the words "intends,"
"anticipate," "believe," "estimate," "intend" and "expect" and similar
expressions are intended to identify forward-looking statements. Such
forward-looking statements are subject to risks, uncertainties, assumptions and
other factors that may cause the actual results of the Company to be materially
different from those reflected in such forward-looking statements. Such factors
include, among others, changes in the terms of student loans and the educational
credit marketplace arising from the implementation of applicable laws and
regulations and from changes in such laws and regulations, which may reduce the
volume, average term and costs of yields on student loans under the FFELP or
result in loans being originated or refinanced under non-FFELP programs or may
affect the terms upon which banks and others agree to sell FFELP loans to the
Company. The Company could also be affected by changes in the demand for
educational financing or in financing preferences of lenders, educational
institutions, students and their families; and changes in the general interest
rate environment and in the securitization markets for student loans, which may
increase the costs or limit the availability of financings necessary to
initiate, purchase or carry student loans; and interruptions in the Company's or
others' operations resulting from the inability of computer or other systems to
process Year 2000-related information, which may impact the Company's liquidity
and its ability to obtain, generate or process documents or payments received
from or due to others.
18
SELECTED FINANCIAL DATA
CONDENSED STATEMENTS OF INCOME
INCREASE (DECREASE)
------------------------------------------
YEARS ENDED DECEMBER 31, 1998 VS. 1997 1997 VS. 1996
------------------------------- -------------------- --------------------
1998 1997 1996 $ % $ %
--------- --------- --------- --------- --- --------- ---
Net interest income.............................. $ 663 $ 781 $ 894 $ (118) (15)% $ (113) (13)%
Less: provision for losses....................... 29 23 28 6 22 (5) (16)
--------- --------- --------- --------- -- --------- ---
Net interest income after provision for losses... 634 758 866 (124) (16) (108) (13)
Gains on sales of student loans.................. 117 280 49 (163) (58) 231 472
Servicing and securitization revenue............. 281 151 58 130 86 93 162
Other income..................................... 79 65 33 14 23 32 96
Operating expenses............................... 361 494 405 (133) (27) 89 22
Income taxes..................................... 238 241 181 (3) (1) 60 33
Minority interest in net earnings of 11 11 11 -- -- -- --
subsidiary.....................................
--------- --------- --------- --------- -- --------- ---
Net income....................................... $ 501 $ 508 $ 409 $ (7) (1)% $ 99 24%
--------- --------- --------- --------- -- --------- ---
--------- --------- --------- --------- -- --------- ---
Basic earnings per share......................... $ 2.99 $ 2.80 $ 2.10 $ .19 7% $ .70 33%
--------- --------- --------- --------- -- --------- ---
--------- --------- --------- --------- -- --------- ---
Diluted earnings per share....................... $ 2.95 $ 2.78 $ 2.09 $ .17 6% $ .69 33%
--------- --------- --------- --------- -- --------- ---
--------- --------- --------- --------- -- --------- ---
Dividends per share.............................. $ .57 $ .52 $ .47 $ .05 10% $ .05 11%
--------- --------- --------- --------- -- --------- ---
--------- --------- --------- --------- -- --------- ---
CONDENSED BALANCE SHEETS
INCREASE (DECREASE)
------------------------------------------
DECEMBER 31, 1998 VS. 1997 1997 VS. 1996
-------------------- -------------------- --------------------
1998 1997 $ % $ %
--------- --------- --------- --- --------- ---
ASSETS
Student loans..................................... $ 28,283 $ 29,444 $ (1,161) (4)% $ (4,252) (13)%
Warehousing advances.............................. 1,543 1,869 (326) (17) (921) (33)
Academic facilities financings.................... 1,180 1,375 (195) (14) (98) (7)
Cash and investments.............................. 4,106 5,130 (1,024) (20) (2,576) (33)
Other assets...................................... 2,098 2,014 84 4 107 6
--------- --------- --------- -- --------- --
Total assets...................................... $ 37,210 $ 39,832 $ (2,622) (7)% $ (7,740) (16)%
--------- --------- --------- -- --------- --
--------- --------- --------- -- --------- --
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings............................. $ 26,589 $ 23,176 $ 3,413 15% $ 658 3%
Long-term notes................................... 8,810 14,541 (5,731) (39) (8,065) (36)
Other liabilities................................. 943 1,226 (283) (23) (174) (12)
--------- --------- --------- -- --------- --
Total liabilities................................. 36,342 38,943 (2,601) (7) (7,581) (16)
--------- --------- --------- -- --------- --
Minority interest in subsidiary................... 214 214 -- -- -- --
Stockholders' equity before treasury stock........ 1,496 1,099 397 36 (272) (20)
Common stock held in treasury at cost............. 842 424 418 99 (113) (21)
--------- --------- --------- -- --------- --
Total stockholders' equity........................ 654 675 (21) (3) (159) (19)
--------- --------- --------- -- --------- --
Total liabilities and stockholders' equity........ $ 37,210 $ 39,832 $ (2,622) (7)% $ (7,740) (16)%
--------- --------- --------- -- --------- --
--------- --------- --------- -- --------- --
19
RESULTS OF OPERATIONS
EARNINGS SUMMARY
In 1998 the Company reported net income of $501 million ($2.95 diluted
earnings per share), compared to $508 million ($2.78 diluted earnings per share)
for 1997. While reported net income changed very little there were several
significant factors impacting 1998 that are discussed below. First, the
turbulence in the global financial markets following the Russian bond default in
August caused financing spreads, relative to Treasury bill rates, to widen to
levels where term financing in the securitization market did not make economic
sense to management. As a result, the Company did not enter into securitization
transactions during the second half of 1998 and only securitized $6 billion of
student loans in 1998, which was $3 billion less than in 1997. In 1998, the
Company recorded after-tax securitization gains of $76 million, which were $45
million less than the after-tax securitization gains of $121 million in 1997
(exclusive of the $61 million one-time gain associated with the successful
outcome of the offset fee litigation discussed below). Another factor in 1998
directly related to the financial market turmoil was declining Treasury bill
rates which had the effect of increasing the spread earned on a significant
portion of the Company's portfolio of managed student loans, particularly in the
second half of the year. As Treasury bill rates declined, the cost of funds on
the Company's floating rate liabilities declined while an increasing percentage
of student loans began to earn at the minimum borrower rate and, as a result,
the rate earned on the portfolio of student loans did not decline as much as the
rate on the Company's floating rate liabilities. After-tax operating expenses of
$235 million in 1998 declined by $91 million from 1997, which included $60
million of after-tax restructuring charges.
During 1998, the Company spent $418 million to repurchase 10.1 million
common shares (or 6 percent of its outstanding shares), which enhanced
earnings-per-share growth.
In addition to reporting results of operations in accordance with generally
accepted accounting principles, the Company also presents pro-forma results of
operations, which treat securitization transactions as financings and the
securitized student loans as not sold. Management refers to these pro-forma
results as "cash basis" earnings and believes that they assist in better
understanding the Company's results of operations. The Company's "cash basis"
net income was $449 million in 1998 ($2.64 diluted earnings per share) versus
$345 million ($1.89 diluted earnings per share) in 1997. See "Pro-Forma
Statements of Income."
NET INTEREST INCOME
Net interest income is derived largely from the Company's portfolio of
student loans that remain on-balance sheet. A detailed discussion of the factors
influencing returns on student loans can be found in a later section titled
"Student Loans."
Taxable equivalent net interest income of $697 million in 1998 decreased by
$119 million from 1997. In large part the decline resulted from the $10 billion
reduction in the average balance of interest earning assets due to the
securitization of student loans and the significant downsizing of other earning
assets that occurred in the latter half of 1997. In 1998, the average balance of
student loans on-balance sheet declined by $4.4 billion while the average
balance of the portfolio of securitized student loans increased by $7.5 billion.
As the Company moves student loans off-balance sheet via its securitization
activities, the earnings from those loans are, in effect, removed from net
interest income and become elements of other income, specifically, gain on sale
of student loans and servicing and securitization revenue. The average balance
of the Company's investment portfolio and warehousing advances combined declined
by $5.5 billion in 1998 as management reduced these lower yielding assets to
better utilize capital. In total, these reductions in earning assets reduced
taxable equivalent net interest income by $150 million. The effect of the
reduction in interest earning assets was partially offset by an increase of .17
percent in the net interest margin from 1997 to 1998, which increased taxable
equivalent net interest income by $31 million in 1998 over 1997. This margin
increase was due in large part to the increased percentage of student loans
20
remaining on-balance sheet relative to other earning assets (78 percent in 1998
vs. 70 percent in 1997) as well as the increase in student loan spread of .04
percent which is discussed more fully under "Student Loans---Student Loan Spread
Analysis."
Taxable equivalent net interest income and net interest margin for the year
ended December 31, 1997, decreased by $114 million and .16 percent from 1996,
respectively. The $85 million decrease in taxable equivalent net interest income
attributable to the change in rates in 1997 versus 1996 was principally due to
the decrease in the student loan spread discussed below under "Student
Loans--Student Loan Spread Analysis." Other factors contributing to the decrease
were the write-off of $13 million of deferred hedge losses in the third quarter
of 1997 and a decrease of $12 million due to rising Treasury bill rates, which
had the effect of lowering the spread earned on a significant portion of student
loans as financing costs increased while the student loans were earning at the
minimum borrower rate. These decreases were partially offset by an increase in
income of $12 million from the amortization of upfront payments received from
floor revenue contracts and higher interest spreads on investments. The $29
million decrease in taxable equivalent net interest income attributable to the
change in volume was due mainly to the decrease in the average balance of
student loans on-balance sheet as a result of securitizations.
TAXABLE EQUIVALENT NET INTEREST INCOME
The Taxable Equivalent Net Interest Income analysis set forth below is
designed to facilitate a comparison of nontaxable asset yields to taxable yields
on a similar basis. The amounts in this table and the
following table are adjusted for the impact of certain tax-exempt and
tax-advantaged investments based on the marginal federal corporate tax rate of
35 percent.
INCREASE (DECREASE)
------------------------------------------
YEARS ENDED DECEMBER 31, 1998 VS. 1997 1997 VS. 1996
------------------------------- -------------------- --------------------
1998 1997 1996 $ % $ %
--------- --------- --------- --------- --- --------- ---
Interest income
Student loans.............................. $ 2,106 $ 2,485 $ 2,635 $ (379) (15)% $ (150) (6)%
Warehousing advances....................... 102 151 194 (49) (33) (43) (22)
Academic facilities financings............. 85 98 100 (13) (13) (2) (2)
Investments................................ 295 573 548 (278) (49) 25 4
Taxable equivalent adjustment.............. 34 35 36 (1) (3) (1) (1)
--------- --------- --------- --------- -- --------- --
Total taxable equivalent interest income..... 2,622 3,342 3,513 (720) (22) (171) (5)
Interest expense............................. 1,925 2,526 2,583 (601) (24) (57) (2)
--------- --------- --------- --------- -- --------- --
Taxable equivalent net interest income....... $ 697 $ 816 $ 930 $ (119) (15)% $ (114) (12)%
--------- --------- --------- --------- -- --------- --
--------- --------- --------- --------- -- --------- --
21
AVERAGE BALANCE SHEETS
The following table reflects the rates earned on earning assets and paid on
liabilities for the years ended December 31, 1998, 1997 and 1996.
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
BALANCE RATE BALANCE RATE BALANCE RATE
--------- --------- --------- --------- --------- ---------
AVERAGE ASSETS
Student loans....................................... $ 27,589 7.63% $ 31,949 7.78% $ 33,273 7.92%
Warehousing advances................................ 1,718 5.93 2,518 6.00 3,206 6.04
Academic facilities financings...................... 1,318 8.15 1,436 8.57 1,500 8.43
Investments......................................... 4,843 6.34 9,592 6.08 9,444 5.91
--------- --- --------- --- --------- ---
Total interest earning assets......................... 35,468 7.39% 45,495 7.35% 47,423 7.41%
--- --- ---
--- --- ---
Non-interest earning assets........................... 2,012 1,916 1,804
--------- --------- ---------
Total assets.......................................... $ 37,480 $ 47,411 $ 49,227
--------- --------- ---------
--------- --------- ---------
Average Liabilities and Stockholders' Equity
Six month floating rate notes....................... $ 2,898 5.40% $ 2,908 5.48% $ 2,485 5.42%
Other short-term borrowings......................... 21,384 5.34 23,640 5.51 18,493 5.43
Long-term notes..................................... 11,194 5.60 18,677 5.70 26,024 5.55
--------- --- --------- --- --------- ---
Total interest bearing liabilities.................... 35,476 5.43% 45,225 5.59% 47,002 5.50%
--- --- ---
--- --- ---
Non-interest bearing liabilities...................... 1,385 1,406 1,410
Stockholders' equity.................................. 619 780 815
--------- --------- ---------
Total liabilities and stockholders' equity............ $ 37,480 $ 47,411 $ 49,227
--------- --------- ---------
--------- --------- ---------
Net interest margin................................... 1.97% 1.80% 1.96%
--- --- ---
--- --- ---
RATE/VOLUME ANALYSIS
The Rate/Volume Analysis below shows the relative contribution of changes in
interest rates and asset volumes.
INCREASE
(DECREASE)
ATTRIBUTABLE
TAXABLE TO CHANGE IN
EQUIVALENT ----------------------
(DECREASE) RATE VOLUME
----------- --------- -----------
1998 VS. 1997
Taxable equivalent interest income................................................... $ (720) $ (30) $ (690)
Interest expense..................................................................... (601) (61) (540)
----- --- -----
Taxable equivalent net interest income............................................... $ (119) $ 31 $ (150)
----- --- -----
----- --- -----
1997 VS. 1996
Taxable equivalent interest income................................................... $ (171) $ (30) $ (141)
Interest expense..................................................................... (57) 55 (112)
----- --- -----
Taxable equivalent net interest income............................................... $ (114) $ (85) $ (29)
----- --- -----
----- --- -----
22
STUDENT LOANS
STUDENT LOAN SPREAD ANALYSIS
The following table analyzes the reported earnings from student loans both
on-balance sheet and those off-balance sheet in securitization trusts. The line
captioned "Adjusted Student Loan Yields" reflects contractual student-loan
yields adjusted for the amortization of premiums paid to purchase loan
portfolios and the estimated costs of borrower benefits as required by GAAP. For
student loans off-balance sheet, the Company will continue to earn servicing-fee
revenues over the life of the securitized student loan portfolios. The
off-balance sheet information presented in "Securitization Program--Servicing
and Securitization Revenue" analyzes the on-going servicing revenue and residual
interest earned on the securitized portfolios of student loans. For an analysis
of the Company's student loan spread for the entire portfolio of managed student
loans on a similar basis to the on-balance sheet analysis see "Cash Basis"
student loan spread.
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
ON-BALANCE SHEET
Adjusted student loan yields.................................................. 7.97% 8.10% 8.16%
Consolidation loan rebate fees................................................ (.23) (.20) (.12)
Offset fees................................................................... (.11) (.12) (.12)
--------- --------- ---------
Student loan income........................................................... 7.63 7.78 7.92
Cost of funds................................................................. (5.34) (5.53) (5.49)
--------- --------- ---------
Student loan spread........................................................... 2.29% 2.25% 2.43%
--------- --------- ---------
--------- --------- ---------
OFF-BALANCE SHEET
Servicing and securitization revenue.......................................... 1.65% 1.58% 1.43%
--------- --------- ---------
--------- --------- ---------
Average Balances (in millions of dollars)
Student loans................................................................. $ 27,589 $ 31,949 $ 33,273
Securitized loans............................................................. 17,006 9,542 4,020
--------- --------- ---------
Managed student loans......................................................... $ 44,595 $ 41,491 $ 37,293
--------- --------- ---------
--------- --------- ---------
The Company's portfolio of student loans originated under the FFELP has a
variety of unique interest rate characteristics. The Company earns interest at
the greater of the borrower's rate or a floating rate determined by reference to
the average of the weekly auctions of 91-day Treasury bills by the government,
plus a fixed spread which is dependent upon when the loan was originated. If the
floating rate exceeds the borrower rate, the Department of Education subsidizes
the rate paid by the borrower and makes a Special Allowance Payment ("SAP")
directly to the Company. If the floating rate is less than the rate the borrower
is obligated to pay, the Company simply earns interest at the borrower rate. In
all cases, the rate a borrower is obligated to pay sets a minimum rate for
determining the yield that the Company earns on the loan. Borrowers interest
rates are either fixed to term or are reset annually on July 1 of each year
depending on when the loan was originated.
The Company generally finances its student loan portfolio with floating rate
debt tied to the average of the 91-day Treasury bill auctions, either directly
or through the use of derivative financial instruments, to mimic the interest
rate characteristics of the student loans. Such borrowings, however, do not have
minimum rates. As a result, in periods of declining interest rates, the
portfolio of managed student loans may be earning at the minimum borrower rate
while the cost of the Company's floating rate liabilities will generally decline
along with Treasury bill rates. For loans where the borrower's interest rate is
reset annually, a low interest rate environment will only enhance student loan
spreads if Treasury bill rates fall after the loans reset and then only through
the next annual reset of the borrowers interest rates, which
23
occurs on July 1 of each year. For loans where the borrower's interest rate is
fixed to term, declining interest rates may benefit the spread earned on student
loans for extended periods of time. Assuming the decline in interest rates on
the Company's floating rate debt exactly matched the decline in Treasury bill
rates, then the effect of lower Treasury bill rates in 1998 increased the
Company's on-balance sheet student loan spread by $63 million, net of payments
under Floor Interest Contracts (discussed below), of which $40 million was
attributable to student loans with minimum borrower rates fixed to term and $23
million was attributable to student loans with minimum borrower rates adjusting
annually. In 1998, funding spreads widened by .06 percent which offset the
effect of the declining Treasury bill rates on the student loan spread by
approximately $17 million.
The following table analyzes the ability of the FFELP student loans in the
Company's managed student loan portfolio to earn at the minimum borrower
interest rate at December 31, 1998 and 1997, based on the last Treasury Bill
auction of the year (4.64 percent in 1998 and 5.43 percent in 1997).
DECEMBER 31, 1998 DECEMBER 31, 1997
----------------------------------- -----------------------------------
ANNUALLY ANNUALLY
FIXED RESET FIXED RESET
BORROWER BORROWER BORROWER BORROWER
RATE RATE TOTAL RATE RATE TOTAL
----------- ----------- --------- ----------- ----------- ---------
Student loans eligible to earn at the minimum $ 12.4 $ 25.1 $ 37.5 $ 14.2 $ 20.5 $ 34.7
borrower rate....................................
Less notional amount of floor interest contracts... (5.0) (14.7) (19.7) (7.1) (10.6) (17.7)
----- ----------- --------- ----- ----------- ---------
Net student loans eligible to earn at the minimum $ 7.4 $ 10.4 $ 17.8 $ 7.1 $ 9.9 $ 17.0
borrower rate....................................
----- ----------- --------- ----- ----------- ---------
----- ----------- --------- ----- ----------- ---------
Net student loans earning at the minimum borrower $ 6.7 $ 10.3 $ 17.0 $ 4.7 $ -- $ 4.7
rate.............................................
----- ----------- --------- ----- ----------- ---------
----- ----------- --------- ----- ----------- ---------
The .04 percent increase in the student loan spread from 1997 to 1998 was
mainly due to the lower Treasury bill rates in 1998 discussed above offset by
the higher funding spreads on the Company's debt and higher consolidation loan
rebate fees. The 1998 increase in the earnings from servicing and securitization
revenue is also due to the lower Treasury bill rates.
The decrease in the student loan spread in 1997 versus 1996 was due to the
1997 increase in Treasury bill rates, which reduced the spread earned on student
loans as financing costs increased while a significant portion of the Company's
student loan portfolio continued to earn at the minimum borrower rate. Also, the
combined impact of consolidation loan rebate fees and offset fees reduced the
1997 student loan spread by .08 percent in 1997 versus 1996. Other factors
reducing student loan spread were the relative increase in participations in
student loans owned by the Joint Venture with the Chase Manhattan Bank ("the
Joint Venture"), which contractually yield a lower rate than the underlying
student loans and lower student loan yields in the form of reduced SAP rates,
partially offset by increased revenues from the amortization of upfront payments
received from student loan Floor Interest Contracts.
STUDENT LOAN FLOOR INTEREST CONTRACTS
Periodically the Company and third parties have entered into contracts to
monetize the value of the minimum borrower interest rate feature of its
portfolio of FFELP student loans. These contracts are referred to as "Floor
Interest Contracts" under which the Company receives an upfront payment and
agrees to pay the difference between the minimum borrower interest rate less the
applicable SAP rate ("the strike rate") and the average of the 91-day Treasury
bill rates over the period of the contract. If the strike rate is less than the
average of the Treasury Bill rates, then no payment is required. These upfront
payments are being amortized over the average life of the contracts. Floor
Interest Contracts sold on loans where the borrower rate is reset annually have
historically been sold through the next reset date, a period
24
of one year or less, while Floor Interest Contracts sold on loans where the
borrower rate is fixed to term have been sold for multi-year periods. The $5.0
billion of outstanding fixed borrower rate Floor Interest Contracts at December
31, 1998 have expiration dates through the year 2003, while the $14.7 billion of
annually reset borrower rate contracts expires on June 30, 1999.
For the years ended December 31, 1998, 1997 and 1996, the amortization of
the upfront payments received from the sale of Floor Interest Contracts with
annually reset borrower rates was $24 million, $7 million and $1 million,
respectively. At December 31, 1998, unamortized payments received from the sale
of Floor Interest Contracts totaled $60 million, $40 million of which related to
contracts on fixed rate loans and $20 million of which related to contracts on
annual reset loans.
PROVISION FOR LOSSES
The provision for losses represents the periodic expense of maintaining an
allowance sufficient to absorb losses--net of recoveries--inherent in the
on-balance sheet portfolio of loans, academic facilities financings, investments
and derivatives. In evaluating the adequacy of the provision for losses, the
Company considers several factors including trends in student loan claims
rejected for payment by guarantors, default rates on non-federally insured
student loans, the amount of FFELP loans subject to two percent risk-sharing,
and the credit exposure on all other investments and derivative instruments. The
1998 provision included $10 million for potential losses on the non-federally
insured portfolio and $9 million for potential losses due to risk-sharing. Once
a student loan is charged off as a result of an unpaid claim, the Company's
policy is to continue to pursue the recovery of principal and interest. In
connection with legislation reauthorizing the Higher Education Act, the deadline
for borrowers to consolidate student loans under the Federal Direct Student Loan
Program ("FDSLP") at advantageous rates was extended to January 31, 1999.
Applications from borrowers who applied for consolidation prior to December 31,
1998 will continue to be processed through the third quarter of 1999. As a
result, the Company increased the provision for losses by $10 million to provide
for write-offs for unusual loan prepayments at amounts less than carrying value.
Management believes that the provision for loan losses is adequate to cover
anticipated losses in the student loan portfolio. However, this evaluation is
inherently subjective as it requires material estimates that may be susceptible
to significant changes.
For 1997 and 1996, the Company added $17 million and $13 million,
respectively, for potential losses on the non-federally insured portfolio, and
$17 million and $15 million in 1997 and 1996, respectively, for potential losses
due to risk sharing. The 1997 provision was reduced by $11 million due to
improved experience in recovering unpaid claims.
ON-BALANCE SHEET FUNDING COSTS
The Company's borrowings are generally variable-rate indexed principally to
the 91-day Treasury bill rate. The following table summarizes the average
balance of on-balance sheet debt (by index, after giving effect to the impact of
interest rate swaps) for the years ended December 31, 1998, 1997 and 1996
(dollars in millions).
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
INDEX BALANCE RATE BALANCE RATE BALANCE RATE
- ---------------------------------------------------- --------- ----------- --------- ----------- --------- -----------
Treasury bill, principally 91-day................... $ 27,306 5.33% $ 32,240 5.52% $ 35,375 5.48%
LIBOR............................................... 4,111 5.49 6,219 5.51 7,797 5.38
Discount notes...................................... 2,328 5.27 5,267 5.48 2,694 5.35
Fixed............................................... 622 6.95 663 7.02 720 6.81
Zero coupon......................................... 140 11.13 134 11.12 123 11.12
Other............................................... 969 5.47 702 5.20 293 4.87
--------- ----- --------- ----- --------- -----
Total............................................... $ 35,476 5.43% $ 45,225 5.59% $ 47,002 5.50%
--------- ----- --------- ----- --------- -----
--------- ----- --------- ----- --------- -----
25
The following table details the spreads for the Company's Treasury bill
indexed borrowings and London Interbank Offered Rate ("LIBOR") indexed
borrowings:
YEARS ENDED DECEMBER 31,
-------------------------------
INDEXED BORROWINGS 1998 1997 1996
- -------------------------------------------------------------------------------------- --------- --------- ---------
TREASURY BILL
Weighted average Treasury bill........................................................ 5.04% 5.28% 5.23%
Borrowing spread...................................................................... .29 .24 .25
--- --- ---
Weighted average borrowing rate....................................................... 5.33% 5.52% 5.48%
--- --- ---
--- --- ---
LIBOR
Weighted average LIBOR................................................................ 5.73% 5.75% 5.64%
Borrowing spread...................................................................... (.24) (.24) (.26)
--- --- ---
Weighted average borrowing rate....................................................... 5.49% 5.51% 5.38%
--- --- ---
--- --- ---
SECURITIZATION PROGRAM
In 1998, the Company completed two securitization transactions in which a
total of $6.0 billion of student loans were sold to a special purpose finance
subsidiary and by that subsidiary to trusts that issued asset-backed securities
to fund the student loans to term. During each of the years ended December 31,
1997 and 1996, the Company completed four securitization transactions, in which
a total of $9.4 billion and $6.0 billion of student loans, respectively, were
securitized. The Company accounts for its securitization transactions in
accordance with Statement of Financial Accounting Standards No. 125 "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities" ("SFAS 125"), which establishes the accounting for certain
financial asset transfers, including securitization transactions. Under SFAS
125, the Company records an asset (the "Interest Residual") and a gain on sale
equal to the present value of the expected net cash flows from the trust to the
Company over the life of the portfolio securitized. The gain is reduced by
write-offs of certain assets related to the portfolio sold and by transaction
costs. In addition, the Company continues to service the loans in the trusts for
a fee, and earns that fee over the life of the portfolio. When the contract
servicing fee is greater than current market servicing rates, the present value
of such excess servicing fees is recognized as a servicing asset and amortized
over the life of the portfolio serviced.
GAINS ON SALES OF STUDENT LOANS
For the years ended December 31, 1998, 1997 and 1996, the Company recorded
pre-tax securitization gains of $117 million, $280 million and $49 million,
respectively. In the third quarter of 1997, the Company resolved litigation over
whether the offset fee applied to securitized student loans, and as a result,
the Company reversed a pre-tax $97 million reserve (of which $57 million was
accrued prior to 1997 and $40 million was accrued in the first half of 1997) for
offset fees accrued previously. In the consolidated statements of income, $94
million of the reserve reversal is included in the gain on sale of student loans
for 1997 and $3 million is included in servicing and securitization revenue. If
the Company had recorded gains at the time of each securitization transaction
without reserving for the offset fee, 1997 and 1996 pre-tax gains would have
been $226 million and $95 million, respectively.
The decrease in the gains in 1998 versus 1997 was mainly due to the
securitization of $3.4 billion less student loans in 1998. In the third and
fourth quarters of 1998, the Company decided not to enter into securitization
transactions due to the turbulence in the global financial markets. During this
period, Treasury bill rates, to which the Company's asset backed securities are
indexed, fell relative to other market indices, causing the Company's financing
spreads to widen. Gains for the years ended December 31, 1998, 1997 and 1996,
measured as a percentage of the securitized portfolios, were 1.95 percent, 2.39
percent and 1.58 percent, respectively. The decrease in the 1998 gains as a
percentage of the
26
securitized portfolios versus 1997 is due mainly to the inclusion of
lower-yielding consolidation loans in the portfolios of loans securitized in
1998 and to higher cost of funds offset by lower relative servicing costs due to
the higher average balance of loans securitized. The increase in gains for the
year ended December 31, 1997 versus 1996 is mainly due to the securitization of
$3.4 billion more student loans in 1997 than in 1996. The gains, as a percentage
of the securitized portfolio, were larger in 1997 than 1996 because the
portfolios of loans securitized in 1997 had higher average borrower indebtedness
and longer average lives than the 1996 portfolios. Gains on future
securitizations will continue to vary depending on the size and the
characteristics of the loan portfolios securitized and the funding costs
prevailing in the securitization debt markets.
SERVICING AND SECURITIZATION REVENUE
The following table summarizes the components of servicing and
securitization revenue:
YEARS ENDED DECEMBER 31,
---------------------------------
1998 1997 1996
--------- --------- -----
Servicing revenue less amortization of servicing asset........... $ 156 $ 98 $ 35
Securitization revenue........................................... 125 53 23
--------- --------- ---
Total servicing and securitization revenue....................... $ 281 $ 151 $ 58
--------- --------- ---
--------- --------- ---
The increase in servicing revenue is mainly due to the increase in the
average balance of securitized student loans to $17 billion in 1998, from $10
billion in 1997 and $4 billion in 1996. The increase in securitization revenue
is mainly due to the increase in the average balance of the Interest Residual to
$616 million in 1998 from $331 million in 1997 and $145 million in 1996. Also,
the Company's securitized loan portfolio benefits from declining Treasury bill
rates in a manner similar to the on-balance sheet portfolio of student loans. In
1998, the decline in Treasury bill rates enhanced securitization revenue by $31
million which included the amortization of the upfront payments received for the
sale of Floor Interest Contracts of $4 million.
OTHER INCOME
Exclusive of gains on sales of student loans and servicing and
securitization income, other income totaled $79 million in 1998 versus $65
million in 1997 and $33 million in 1996. Other income mainly includes gains and
losses on sales of investment securities, revenue the Company receives from
servicing the portfolio of student loans held by the Company's joint venture
with Chase Manhattan Bank, commitment fees for letters of credit and late fees
earned on student loans. The increase in other income in 1998 versus 1997 and
1996 is due to higher servicing fees as the average balance of Joint Venture
student loans serviced by the Company increased to $4.9 billion, up from $3.9
billion in 1997 and $410 million in 1996. See "Student Loan Purchases Analysis"
for a discussion on the restructuring of the Joint Venture. Also, in the second
half of 1998 the Company began assessing late fees and earned $7 million in 1998
versus none in 1997 and 1996. These increases in other income are somewhat
offset by lower gains on sales of securities in 1998.
OPERATING EXPENSES
Operating expenses include costs to service the Company's managed student
loan portfolio, operational costs incurred in the process of acquiring student
loan portfolios, and general and administrative expenses. Operating expenses for
the years ended December 31, 1998, 1997 and 1996 were $361 million, $494 million
and $405 million respectively. In 1998, approximately 76 percent of operating
costs related to the acquisition and servicing of student loans. Total operating
expenses as a percentage of average managed student loans were 81 basis points,
119 basis points and 109 basis points for the years ended December 31, 1998,
1997 and 1996, respectively. Operating expenses in 1997 included one-time costs
of
27
$86 million incurred in 1997 for expenses and asset write-downs in connection
with the reorganization of the Company to a privatized entity and the change in
business strategies implemented by the new management. Together these one-time
costs account for 21 of the 119 basis points in 1997. During 1998, the Company
closed two satellite servicing centers and reconfigured the remaining centers.
The Company took a charge of $12 million (3 basis points of average managed
student loans) for the cost of these efforts. The decreases in operating
expenses in 1998 versus 1997, exclusive of the one-time charges, can be
attributed to the effect of the Company's restructuring of operations in the
second half of 1997 and to management's continued commitment to control
expenses.
In 1997, operating expenses increased by $89 million over the prior year. As
discussed above, the increase can be attributed to the one-time, non-recurring
expenses of $86 million relating to the Reorganization of the GSE and the
restructuring of operations.
STUDENT LOAN PURCHASES
The following table summarizes the components of the Company's student loan
purchase activity:
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
ExportSS origination and servicing clients........................................... $ 5,665 $ 3,830 $ 5,802
Other commitment clients............................................................. 1,411 1,611 1,504
Spot purchases....................................................................... 291 1,963 969
Consolidations....................................................................... 132 699 804
Other................................................................................ 918 937 791
--------- --------- ---------
Total................................................................................ $ 8,417 $ 9,040 $ 9,870
--------- --------- ---------
--------- --------- ---------
The decrease in the purchase volume in 1998 versus 1997 is principally
attributable to the following factors: reduced activity in the spot market, the
suspension of Sallie Mae's consolidation loan program from the fourth quarter of
1997 through the third quarter of 1998 due to legislated changes in the
profitability of consolidation loans offset by a modest increase in the amount
of loans purchased from lenders who have forward purchase commitments with
Sallie Mae.
Included in ExportSS purchase volume for 1998 is $828 million of student
loans from Chase Manhattan Bank as a result of the restructuring of the
Company's Joint Venture with Chase. Under the terms of the restructuring, the
Company will now purchase all loans originated by Chase. Previously, the Joint
Venture funded the student loans through sales of participations that entitled
the Company and Chase to one-half interests in the student loans originated by
Chase. Spot purchases in 1997 included $650 million acquired from Household Bank
and in 1996, ExportSS purchases included $1.5 billion of student loan
participations from Chase in connection with the merger with Chemical Bank.
Sallie Mae's portfolio of managed student loans totaled $46.2 billion, $43.5
billion and $40.0 billion at December 31, 1998, 1997 and 1996, respectively.
For both years ended December 31, 1998 and 1997, $4.7 billion of student
loans were originated and transferred to Sallie Mae's ExportSS system, versus
$4.2 billion in 1996. The legislative uncertainty in the first half of 1998
surrounding interest rates of student loans originated after July 1, 1998, was a
factor impacting growth in loan originations during 1998. The pipeline of loans
currently serviced and committed for purchase by Sallie Mae was $5.6 billion at
December 31, 1998 versus $4.2 billion at December 31, 1997. Included in the
pipeline at December 31, 1998 is $1.6 billion of student loans that are
currently owned by Chase and are committed for sale to the Company in connection
with the restructuring of the Joint Venture.
The Department of Education offers existing FFELP borrowers the opportunity
to refinance FFELP loans into FDLSP loans. During 1998, 1997 and 1996,
approximately $432 million, $288 million and
28
$210 million, respectively, of the Company's managed student loans were accepted
for refinancing into the FDSLP. In the fourth quarter of 1998, Sallie Mae
reinstated its loan consolidation program as a result of the Reauthorization
Legislation signed in October 1998. See "Other Related Events and Information--
Legislative Developments."
The FDSLP originated approximately 33 percent, 32 percent and 31 percent of
student loan originations for academic years 1997-98, 1996-97 and 1995-96,
respectively. Based on data provided by the Department of Education, management
estimates that FDSLP originations will continue to be approximately one-third of
student loan originations for the 1998-99 academic year and thereafter.
The following table summarizes the activity in the Company's managed
portfolio of student loans for the years ended December 31, 1998, 1997 and 1996.
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
BEGINNING BALANCE................................................................ $ 43,547 $ 39,958 $ 35,239
Purchases........................................................................ 8,417 9,040 9,870
Capitalized interest on securitized loans........................................ 418 208 66
Repayments, claims, other........................................................ (5,465) (5,316) (5,003)
Loans consolidated from SLMH..................................................... (725) (343) (214)
--------- --------- ---------
ENDING BALANCE................................................................... $ 46,192 $ 43,547 $ 39,958
--------- --------- ---------
--------- --------- ---------
PRO-FORMA STATEMENTS OF INCOME
Under generally accepted accounting principles ("GAAP"), the Company's
securitization transactions have been treated as sales. At the time of sale, in
accordance with Statement of Financial Accounting Standards 125 ("SFAS 125"),
the Company records a gain equal to the present value of the estimated future
net cash flows from the portfolio of loans sold. Interest earned on the interest
residual and fees earned for servicing the loan portfolios are recognized over
the life of the securitization transaction as servicing and securitization
revenue. Under SFAS 125, income recognition is effectively accelerated through
the recognition of a gain at the time of sale while the ultimate realization of
such income remains dependent on the actual performance, over time, of the loans
that were securitized.
Management believes that, in addition to results of operations as reported
in accordance with GAAP, another important performance measure is pro-forma
results of operations under the assumption that the securitization transactions
are financings and that the securitized student loans were not sold. The
following pro-forma statements of income present the Company's results of
operations under the assumption that the securitization transactions are treated
as financings as opposed to sales of student loans. As such, no gain on sale or
subsequent servicing and securitization revenue is recognized. Instead, the
earnings of the student loans in the trusts and the related financing costs are
reflected over the life of the underlying pool of loans. Management refers to
these pro-forma results as "cash basis" statements of income. Management
monitors the periodic "cash basis" earnings of the Company's managed student
loan portfolio and believes that they assist in a better understanding of the
Company's student loan business.
29
The following table presents the "cash basis" statements of income and a
reconciliation to net income as reflected in the Company's consolidated
statements of income.
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
"CASH BASIS" STATEMENTS OF INCOME:
Insured student loans.............................................................. $ 3,417 $ 3,244 $ 2,959
Advances/Facilities/Investments.................................................... 486 824 844
--------- --------- ---------
Total interest income.............................................................. 3,903 4,068 3,803
Interest expense................................................................... (2,905) (3,099) (2,821)
--------- --------- ---------
Net interest income................................................................ 998 969 982
Less: provision for losses......................................................... 45 30 30
--------- --------- ---------
Net interest income after provision for losses..................................... 953 939 952
--------- --------- ---------
Other Income:
Gain on sales of student loans................................................... -- -- --
Servicing and securitization revenue............................................. -- -- --
Gains/(losses) on sales of securities............................................ 11 16 5
Other............................................................................ 67 48 28
--------- --------- ---------
Total other income................................................................. 78 64 33
Total operating expenses........................................................... 361 494 405
--------- --------- ---------
Income before taxes and minority interest in earnings of subsidiary................ 670 509 580
Income taxes....................................................................... 210 153 174
Minority interest in earnings of subsidiary........................................ 11 11 11
--------- --------- ---------
"Cash basis" net income............................................................ $ 449 $ 345 $ 395
--------- --------- ---------
--------- --------- ---------
"Cash basis" diluted earnings per share............................................ $ 2.64 $ 1.89 $ 2.02
--------- --------- ---------
--------- --------- ---------
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
RECONCILIATION OF GAAP BASIS NET INCOME TO "CASH BASIS" NET INCOME:
GAAP net income.................................................................... $ 501 $ 508 $ 409
--------- --------- ---------
"Cash basis" adjustments:
Gain on sales of student loans................................................... (117) (280) (49)
Servicing and securitization revenue............................................. (281) (151) (58)
Net interest income.............................................................. 334 187 88
Provision for losses............................................................. (16) (7) (2)
--------- --------- ---------
Total "cash basis" adjustments..................................................... (80) (251) (21)
Net tax effect (A)................................................................. 28 88 7
--------- --------- ---------
"Cash basis" net income............................................................ $ 449 $ 345 $ 395
--------- --------- ---------
--------- --------- ---------
- ------------------------
(A) Such tax effect is based upon Sallie Mae's marginal tax rate for the
respective period.
The following table analyzes the reported earnings from the Company's
portfolio of managed student loans, which includes both on-balance sheet and
those off-balance sheet in securitization trusts. The line captioned "Adjusted
Student Loan Yields" reflects contractual student-loan yields adjusted for the
amortization of premiums paid to purchase loan portfolios and the estimated
costs of borrower benefits.
30
"CASH BASIS" STUDENT LOAN SPREAD
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Adjusted student loan yields..................................................... 7.85% 8.03% 8.14%
Consolidation loan rebate fees................................................... (.15) (.15) (.11)
Offset fees...................................................................... (.07) (.09) (.11)
--------- --------- ---------
Student loan income.............................................................. 7.63 7.79 7.92
Cost of funds.................................................................... (5.45) (5.61) (5.53)
--------- --------- ---------
Student loan spread.............................................................. 2.18% 2.18% 2.39%
--------- --------- ---------
--------- --------- ---------
Average Balances (in millions of dollars)
Student loans.................................................................... $ 44,595 $ 41,491 $ 37,293
--------- --------- ---------
--------- --------- ---------
The Company generally finances its student loan portfolio with floating rate
debt tied to the average of the 91-day Treasury bill auctions, either directly
or through the use of derivative financial instruments, to mimic the interest
rate characteristics of the student loans. Such borrowings, however, do not have
minimum rates. As a result, in periods of declining interest rates, the
portfolio of managed student loans may be earning at the minimum borrower rate
while the Company's funding costs will generally decline along with Treasury
bill rates. For loans where the borrower's interest rate is fixed to term,
declining interest rates may benefit the spread earned on student loans for
extended periods of time. For loans where the borrower's interest rate is reset
annually, any benefit of a low interest rate environment will only enhance
student loan spreads through the next annual reset of the borrowers interest
rates, which occurs on July 1 of each year. Assuming the decline in interest
rates on the Company's floating rate debt exactly matched the decline in
Treasury bill rates, then the effect of lower Treasury bill rates in 1998 on the
Company's "cash basis" student loan spread, net of payments under Floor Interest
Contracts, was $94 million, of which, $47 million is attributable to student
loans with minimum borrower rates fixed to term and $47 million is attributable
to student loans whose minimum borrower rate adjusts annually on July 1.
Included in the "cash basis" student loan spread from loans with minimum
borrower rates adjusting annually is the amortization of the upfront payments
received on Floor Interest Contracts discussed below.
On a "cash basis," financing spreads, relative to the Treasury bill,
increased by .09 percent in 1998 versus 1997. This was due to wider financing
spreads in both the GSE and securitization debt markets and to the higher
percentage of student loan portfolios being funded by the Company's asset-backed
securities. The Company's asset-back securities have a higher cost of funds than
the Company's GSE debt because they are term match-funded and do not benefit
from the GSE's government-sponsored status. The higher funding costs on the
Company's asset backed securities is somewhat mitigated by the absence of Offset
Fees on securitized loans. The net effect of increased funding costs and offset
fees in 1998 versus 1997 was $31 million.
The .21 percent decrease in the student loan spread in 1997 versus 1996 was
due to the increase in Treasury bill rates during that time, which reduced the
spread earned on the Company's student loans as financing costs increased while
a significant portion of the managed student loan portfolio continued to earn at
the minimum borrower rate. Also contributing to the decline in the spread were
higher funding costs, as a greater percentage of the Company's managed student
loan portfolio was being funded by the Company's asset-backed securities and
higher consolidation loan rebate fees.
For the years ended December 31, 1998, 1997 and 1996, the amortization of
the upfront payments received from the sale of Floor Interest Contracts with
annually reset borrower rates was $28 million, $7 million and $1 million,
respectively. At December 31, 1998, unamortized payments received from the sale
of Floor Interest Contracts totaled $60 million, $40 million of which related to
contracts on fixed rate loans and $20 million of which related to contracts on
annual reset loans.
31
"CASH BASIS" NET INTEREST INCOME
In 1998, net interest income, on a "cash basis," was $998 million compared
with $969 million in 1997 and $982 million in 1996. The increase in net interest
income in 1998 over 1997 is mainly due to the increase in the average balance of
managed student loans, and the increase in student loans as a percentage of
average earning assets. The reduction in the average balance of the investment
portfolio, academic facilities financings, and warehousing advances in 1998
versus 1997 and from 1997 versus 1996 reduced net interest income by $338
million and $20 million, respectively.
FEDERAL AND STATE TAXES
The Company maintains a portfolio of tax-advantaged assets principally to
support education-related financing activities. That portfolio was primarily
responsible for the decrease in the effective federal income tax rate from the
statutory rate of 35 percent to 32 percent in 1998, 32 percent in 1997 and 30
percent in 1996. The GSE is exempt from all state, local, and District of
Columbia income, franchise, sales and use, personal property and other taxes,
except for real property taxes. However, this tax exemption applies only to the
GSE and does not apply to SLM Holding or its other operating subsidiaries. Under
the Privatization Act, the Company's GSE and non-GSE activities are separated,
with non-GSE activities being subject to taxation at the state and local level.
State taxes were immaterial in 1998 as the majority of the Company's business
activities were conducted in the GSE.
As increasing business activity occurs outside of the GSE, the impact of
state and local taxes will increase accordingly. Management expects that
ultimately all business activities will occur outside of the GSE, which could
increase the Company's effective income tax rate by as much as four percent. The
loss of the GSE tax exemption for sales and use and personal property taxes
could increase operating costs by one percent.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary requirements for capital are to fund the Company's
operations, its purchases of student loans and the repayment of its debt
obligations while continuing to meet the GSE's statutory capital adequacy ratio
test. The Company's primary sources of liquidity are through the debt issuances
by the GSE, off-balance sheet financings through securitizations, cash generated
by its subsidiaries' operations and distributed through dividends to the Company
and bank borrowings.
The GSE secures financing to fund its on-balance sheet portfolio of student
loans, along with its other operations, by issuing debt securities in the
domestic and overseas capital markets, through public offerings and private
placements of U.S. dollar-denominated and foreign currency-denominated debt of
varying maturities and interest rate characteristics, and through
securitizations of its student loans. The GSE's debt securities are currently
rated at the highest credit rating level by Moody's Investors Service and
Standard & Poor's. Historically, the rating agencies' ratings of the GSE have
been largely a factor of its status as a government-sponsored enterprise. Since
the Privatization Act did not modify the attributes of debt issued by the GSE,
management anticipates that the GSE will retain its current credit ratings. In
addition to the GSE debt, student loan securitization has been an increasing
source of funding for the Company's managed student loan portfolio since 1995.
As student loans are securitized, the need for long-term financing of these
assets on-balance sheet decreases. Over the long term, securitization is
expected to provide the principal source of long term funding for the Company's
managed portfolio of student loans.
The Company's unsecured financing requirements are driven by three principal
factors: refinancing of existing liabilities as they mature; financing of
student loan portfolio growth; and the Company's level of securitization
activity. As discussed under "Securitization Program," the recent turmoil in the
global financial markets has caused financing spreads in the asset-backed market
to widen. Until market conditions improve, management intends to continue to
finance its student loan portfolio through unsecured GSE debt issuances. The
uncertainty in the financial markets has also caused funding spreads
32
on the Company's unsecured debt to widen. Management believes that the current
adverse spread environment is temporary; so, to mitigate its effect on the
Company's cost of funds, the Company has been and will continue to meet its
funding needs through short-term financings. Should these market conditions
persist over an extended period of time, the increased cost of the Company's
funding could have a material adverse effect on the Company's earnings.
During 1998, the Company used the proceeds from student loan securitizations
of $6 billion, repayments and claim payments on student loans of $3.6 billion,
and the net proceeds from sales or maturities of investments, warehousing
advances and academic facility refinancings of $1.6 billion to purchase student
loans of $8.4 billion, to reduce total debt by $2.3 billion and to repurchase
$418 million of the Company's common stock.
Operating activities provided net cash inflows of $124 million in 1998, an
increase of $65 million from the net cash inflows of $59 million in 1997. This
increase was mainly attributable to the increase in net income exclusive of
noncash gains on sale of student loans of $157 million in 1998 versus 1997.
During 1998, the GSE issued $5.5 billion of long-term notes to refund
maturing and repurchased obligations. At December 31, 1998, the GSE had $8.8
billion of outstanding long-term debt issues of which $4.1 billion had stated
maturities that could be accelerated through call provisions. The GSE uses
interest rate and foreign currency swaps (collateralized where appropriate),
purchases of U.S. Treasury securities and other hedging techniques to reduce the
exposure to interest rate and currency fluctuations that arise from its
financing activities and to match the variable interest rate characteristics of
its earning assets. (See "Interest Rate Risk Management.")
SLM Holding maintains a $600 million bank line of credit with a bank that
expires on August 8, 1999. The line is being used to meet working capital needs,
and at December 31, 1998, there was $222 million outstanding under this line.
Over the long term, securitization is expected to provide the principal source
of long-term funding for the Company's managed portfolio of student loans. To
meet the need for short-term financing for student loans prior to
securitization, the Company expects to begin implementing other forms of secured
non-GSE financing such as asset-backed commercial paper in 1999. Such financings
could require the Company to obtain a bond rating, and such ratings will not be
known until specific debt is issued. It is expected that these ratings will be
below the GSE's current credit rating levels.
Until the GSE is dissolved, the Privatization Act places a number of
limitations on the Company. Under the Privatization Act, the GSE must wind down
its operations and dissolve on or before September 30, 2008. Any GSE debt
obligations outstanding at the date of such dissolution are required to be
defeased through creation of a fully collateralized trust, consisting of U.S.
government or agency obligations with cash flows matching the interest and
principal obligations of the defeased debt. The Privatization Act requires that
on the dissolution date of September 30, 2008, the GSE shall repurchase or
redeem, or make proper provisions for repurchase or redemption of any
outstanding preferred stock. The Company has the option of effecting an earlier
dissolution of the GSE if certain conditions are met. Also upon the GSE's
dissolution, all of its remaining assets will transfer to the Company.
The Privatization Act effectively requires that the GSE maintain a minimum
statutory capital adequacy ratio (the ratio of stockholders' equity to total
assets plus 50 percent of the credit equivalent amount of certain off-balance
sheet items) of at least 2 percent until January 1, 2000 and 2.25 percent
thereafter or be subject to certain "safety and soundness" requirements designed
to restore such statutory ratio. Management anticipates being able to fund the
increase in required capital from the GSE's current and retained earnings. While
the GSE may not finance the activities of its non-GSE affiliates, it may,
subject to its minimum capital requirements, dividend retained earnings and
surplus capital to SLM Holding, which in turn may contribute such amounts to its
non-GSE subsidiaries. The Privatization Act requires management to certify to
the Secretary of the Treasury that, after giving effect to the payment of
dividends, the statutory capital ratio test would have been met at the time the
dividend was declared. At
33
December 31, 1998, the GSE's statutory capital adequacy ratio, after the effect
of the dividends to be paid in the first quarter of 1999, was 2.00 percent.
The Privatization Act imposes certain restrictions on inter-Company
relations between the GSE and its affiliates during the wind-down period. In
particular, the GSE must not extend credit to, nor guarantee, any debt
obligations of SLM Holding or its non-GSE subsidiaries.
The Privatization Act provides that the GSE may continue to issue new debt
obligations maturing on or before September 30, 2008. The legislation further
provides that the legal status and attributes of the GSE's debt obligations,
including Securities and Exchange Commission ("SEC") registration and state tax
exemptions, will be fully preserved until their respective maturities. Such debt
obligations will remain GSE debt obligations, whether such obligations were
outstanding at the time of, or issued subsequent to, the Reorganization. The
obligations of SLM Holding do not have GSE status.
SECURITIZATION
Management believes that securitization represents an efficient source of
funding. The Company's Asset-Backed Securities ("ABS") generally have a higher
cost of funds than its traditional on-balance sheet financing because the ABS
securities are term match-funded and do not benefit from the GSE's
government-sponsored enterprise status. However, the increased funding costs of
the ABS securities are mitigated by the absence of the Offset Fees on
securitized loans. Securitization also allows the Company to obtain term
financing at a lower cost than otherwise would be achievable without the GSE's
government-sponsored status. Securitizations to date have been structured to
achieve an "AAA" credit rating on over 96 percent of its securities sold (with
an "A" credit rating on the remaining subordinated securities).
In the third and fourth quarters of 1998, the Company decided not to enter
into a securitization transaction. The Company's decision to defer selling loans
through securitizations resulted from the turbulence in the global financial
markets, during which Treasury bill rates, to which the GSE's asset-backed
securities are indexed, fell relative to other market indices, and the Company's
financing spreads widened. Management remains committed to the securitization
program and will continue to securitize student loans when market conditions
improve. While Management believes that the current market conditions are
temporary, a prediction of when the securitization program will resume cannot be
made at this time.
INTEREST RATE RISK MANAGEMENT
INTEREST RATE GAP ANALYSIS
The Company's principal objective in financing its operations is to minimize
its sensitivity to changing interest rates by matching the interest rate
characteristics of its borrowings to specific assets in order to lock-in
spreads. The Company funds its floating rate managed loan assets (most of which
have weekly rate resets) with variable rate debt and fixed rate debt converted
to variable rates with interest rate swaps. The Company also uses interest rate
cap and collar agreements, foreign currency swaps, options on securities, and
financial futures contracts to further reduce interest rate risk and foreign
currency exposure on certain of its borrowings. Investments are funded on a
"pooled" approach, i.e., the pool of liabilities that funds the investment
portfolio has an average rate and maturity or reset date that corresponds to the
average rate and maturity or reset date of the investments which they fund.
In addition to term match funding, the Company's ABS securities generally
match the interest rate characteristics of the majority of the student loans in
the trusts by being indexed to the 91-day Treasury bill. However, at December
31, 1998, there were approximately $2 billion of PLUS student loans outstanding
in the trusts, which have interest rates that reset annually based on the final
auction of 52-week Treasury bills before each July 1. The Company manages this
basis risk within the trusts through its on-balance sheet financing activities.
The effect of this basis risk management is included in the following table as
the impact of securitized student loans.
34
In the table below the Company's variable rate assets and liabilities are
categorized by the reset date of the underlying index. Fixed rate assets and
liabilities are categorized based on their maturity dates. An interest rate gap
is the difference between volumes of assets and volumes of liabilities maturing
or repricing during specific future time intervals. The following gap analysis
reflects rate-sensitive positions at December 31, 1998 and is not necessarily
reflective of positions that existed throughout the period.
INTEREST RATE SENSITIVITY PERIOD
----------------------------------------------------------------------
3 MONTHS 6 MONTHS
3 MONTHS TO TO 1 TO 2 2 TO 5 OVER 5
OR LESS 6 MONTHS 1 YEAR YEARS YEARS YEARS
----------- ----------- ----------- --------- --------- ---------
ASSETS
Student loans............................. $ 26,342 $ 1,940 $ -- $ -- $ -- $ --
Warehousing advances...................... 1,526 -- -- -- 17
---
Academic facilities financings............ 32 12 35 53 388 660
Cash and investments...................... 2,115 28 42 21 82 1,819
Other assets.............................. 26 31 62 134 201 1,644
----------- ----------- ----------- --------- --------- ---------
Total assets.......................... 30,041 2,011 139 208 671 4,140
----------- ----------- ----------- --------- --------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings..................... 21,800 1,381 3,408 -- -- --
Long-term notes........................... 2,556 500 -- 3,827 1,479 449
Other liabilities......................... -- -- -- -- -- 942
Minority interest in subsidiary........... -- -- -- -- -- 214
Stockholders' equity...................... -- -- -- -- -- 654
----------- ----------- ----------- --------- --------- ---------
Total liabilities and stockholders'
equity.............................. 24,356 1,881 3,408 3,827 1,479 2,259
----------- ----------- ----------- --------- --------- ---------
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
Interest rate swaps....................... (4,329) (2,662) 3,100 3,554 1,435 (1,098)
Impact of securitized student loans....... (2,203) 2,203 -- -- -- --
----------- ----------- ----------- --------- --------- ---------
Total off-balance sheet financial
instruments............................. (6,532) (459) 3,100 3,554 1,435 (1,098)
----------- ----------- ----------- --------- --------- ---------
Period gap................................ $ (847) $ (329) $ (169) $ (65) $ 627 $ 783
----------- ----------- ----------- --------- --------- ---------
----------- ----------- ----------- --------- --------- ---------
Cumulative gap............................ $ (847) $ (1,176) $ (1,345) $ (1,410) $ (783) $ --
----------- ----------- ----------- --------- --------- ---------
----------- ----------- ----------- --------- --------- ---------
Ratio of interest-sensitive assets to
interest-sensitive liabilities.......... 123.2% 105.3% 2.3% 1.9% 31.8% 555.9%
----------- ----------- ----------- --------- --------- ---------
----------- ----------- ----------- --------- --------- ---------
Ratio of cumulative gap to total assets... 2.3% 3.2% 3.6% 3.8% 2.1% --%
----------- ----------- ----------- --------- --------- ---------
----------- ----------- ----------- --------- --------- ---------
INTEREST RATE SENSITIVITY ANALYSIS
The effect of short-term movements in interest rates on the Company's
results of operations and financial position has been limited through the
Company's risk-management activities. The Company performed a sensitivity
analysis to determine the effect of a hypothetical increase in market interest
rates of 10 percent on the Company's variable rate assets and liabilities and a
hypothetical 10 percent increase in spreads to their underlying index. Based on
this analysis an increase in rates and spreads of this magnitude would reduce
net income by approximately $48 million or $.29 diluted earnings per share. The
decline in net income would be primarily due to the reduction on the spread
earned on student loans as financing
35
costs would increase while a significant portion of the Company's student loan
portfolio would continue to earn at the minimum borrower rate.
The fair value of the Company's interest-sensitive assets and its long-term
debt and hedging instruments are also subject to change as a result of potential
changes in market rates and prices. A separate analysis was performed to
determine the effects of a hypothetical 10 percent rise in market interest rates
on the fair value of the Company's financial instruments. The effect of the 10
percent rise in rates on fair values would be a decrease in the fair market
value of student loans of approximately $118 million, and a decrease in the fair
market value of non-student loan assets of approximately $49 million. The
decrease in the fair market value of these assets would be partially offset by
an increase in the fair market value of the Company's long-term debt and hedging
instruments by $66 million. The net effect of a 10% rise in rates on fair market
values would therefore be a $101 million decrease in net assets. This decrease
in the net asset market value from a rise in rates is mainly caused by the
reduction in the student loan spread as a significant portion of the Company's
student loan portfolio would continue to earn at the minimum borrower interest
rate while the related financing costs would be rising by 10%.
These amounts have been determined after considering the impact of a
hypothetical shift in interest rates and the use of this methodology to quantify
the market risk of such instruments with no other changes in the Company's
financial structure. The analysis is limited because it does not take into
account the overall level of economic activity, other operating transactions and
other management actions that could be taken to further mitigate the Company's
exposure to risk.
AVERAGE TERMS TO MATURITY
The following table reflects the average terms to maturity for the Company's
managed earning assets and liabilities at December 31, 1998:
AVERAGE TERMS TO MATURITY
(IN YEARS)
ON- OFF-
BALANCE BALANCE
SHEET SHEET MANAGED
----------- ----------- -------------
EARNING ASSETS
Student loans................................................... 7.0 4.5 6.0
Warehousing advances............................................ 4.0 -- 4.0
Academic facilities financings.................................. 7.5 -- 7.5
Cash and investments............................................ 6.5 -- 6.5
-- -- --
Total earning assets............................................ 7.0 4.5 6.0
-- -- --
-- -- --
BORROWINGS
Short-term borrowings........................................... .5 -- .5
Long-term borrowings............................................ 3.0 4.5 4.0
-- -- --
Total borrowings................................................ 1.0 4.5 2.0
-- -- --
-- -- --
In the above table, Treasury receipts and variable rate asset-backed
securities, although generally liquid in nature, extend the weighted average
remaining term to maturity of cash and investments to 6.5 years. As student
loans are securitized, the need for long-term on-balance sheet financing will
decrease.
COMMON STOCK
On January 2, 1998, the Company effected a 7-for-2 stock split through a
stock dividend of an additional five shares for every two owned. In January of
1999, the Board of Directors increased the common share repurchase authority by
10 million shares bringing the total remaining authority to
36
12.7 million shares. The following table summarizes the Company's common share
repurchase and equity-forward activity for the years ended December 31, 1998 and
1997. (All amounts in the tables are common shares in millions.)
YEARS ENDED DECEMBER
31,
--------------------
1998 1997
--------- ---------
Common shares repurchased:
Open market.................................................................................. 5.1 18.0
Equity forwards.............................................................................. 5.0 --
--------- ---------
Total shares repurchased....................................................................... 10.1 18.0
--------- ---------
Average purchase price per share............................................................... $ 41.40 $ 37.84
--------- ---------
--------- ---------
Equity forward contracts:
Outstanding at beginning of year............................................................... 7.0 --
New contracts.................................................................................. 18.5 7.0
Exercises...................................................................................... (5.0) --
--------- ---------
Outstanding at end of year..................................................................... 20.5 7.0
--------- ---------
--------- ---------
Board of director authority remaining at end of year........................................... 2.7 6.3
--------- ---------
--------- ---------
As of December 31, 1998, the expiration dates and range of purchase prices
for outstanding equity forward contracts are as follows:
DECEMBER 31, 1998
----------------------------------
OUTSTANDING RANGE OF MARKET
YEAR OF MATURITY CONTRACTS PRICES
- ------------------------------------------------------------- --------------- -----------------
1999......................................................... 5.3 $37.20--$42.20
2000......................................................... 2.5 41.79-- 46.13
2001......................................................... 8.7 32.11-- 46.68
2002......................................................... 2.0 46.23
2003......................................................... 2.0 41.20
---
20.5
---
---
OTHER RELATED EVENTS AND INFORMATION
LEGISLATIVE DEVELOPMENTS
On October 7, 1998, the President signed into law the Higher Education
Amendments of 1998, legislation that reauthorizes federal higher education
programs for a six-year period (the "Reauthorization Legislation"). The
Reauthorization Legislation lowers both the borrower interest rate on Stafford
loans to a formula based on the 91-day Treasury bill rate plus 2.3 percent (1.7
percent during in-school and grace periods) and the lender's rate after special
allowance payments to the 91-day Treasury bill rate plus 2.8 percent (2.2
percent during in-school and grace periods) for loans originated on or after
October 1, 1998 and before July 1, 2003. The borrower interest rate on PLUS
loans originated during this period will be equal to the 91-day Treasury bill
rate plus 3.1 percent. Special allowance payments are also based on the 91-day
Treasury bill rate plus 3.1 percent. These rate reductions were first introduced
on an interim basis in temporary student loan legislation enacted into law on
June 9, 1998 and effective for loans originated from July 1, 1998 through
September 30, 1998. As a result of these earlier rate reductions, the Company
renegotiated certain contract provisions with some lenders, including,
principally, price and/or settlement timing provisions, under the student loan
forward purchase commitments it has entered into with some of its lenders and is
currently engaged in renegotiating these same contract provisions with other
lenders.
37
However, there can be no assurance that as a result of such renegotiations the
Company will realize the same overall return under any such renegotiated
commitment contracts with respect to student loans originated after July 1,
1998, as it has under the prior legislation with respect to the loans whose
first disbursements occurred before July 1, 1998.
The Reauthorization Legislation maintains interest rates for borrowers of
Federal Direct Consolidation Loans whose applications for such loans were
received prior to February 1, 1999 at 7.46 percent (6.86 percent during
in-school and grace periods), which rates are adjusted annually based on a
formula equal to the 91-day Treasury bill rate plus 2.3 percent (1.7 percent
during in-school and grace periods). The Reauthorization Legislation states that
the borrower interest rates on Federal Direct Consolidation Loans for borrowers
whose applications are received on or after February 1, 1999 and before July 1,
2003 is to be a fixed rate equal to the lesser of the weighted average of the
interest rates of the loans consolidated,
adjusted up to the nearest one eighth of one percent, and 8.25%. This is the
same rate which the Reauthorization Legislation sets on FFELP consolidation
loans for borrowers whose applications are received on or after October 1, 1998
and before July 31, 2003. The Reauthorization Legislation sets the special
allowance payment rate for FFELP consolidation loans at the 91-day Treasury bill
rate plus 3.1 percent. The annual fee paid by lenders on FFELP consolidation
loans is reduced under the Reauthorization Legislation from 1.05 percent to .62
percent of the principal plus accrued unpaid interest on any such consolidation
loans, applications for which are received on or after October 1, 1998 and
before February 1, 1999. As a result of the Reauthorization Legislation, the
Company announced in the fourth quarter of 1998 that it will once again offer
student loan borrowers the SMART LOAN-Registered Trademark- consolidation
program, which it suspended in the fourth quarter of 1997. The availability of
the comparatively lower borrower interest rates (at least prior to subsequent
annual rate adjustments) on Federal Direct Consolidation Loans made on or before
January 31, 1999 may increase the likelihood that a FFELP student loan managed
by the Company will be prepaid from the proceeds of such loans during such
four-month period. The Company believes, however, that the likelihood of any
such prepayment may be mitigated by the cost savings that borrowers may realize
over Federal Direct Consolidation Loans under certain circumstances by enrolling
in the Company's SMART REWARDS-Registered Trademark- program and Direct
Repay-SM- Plan during such four month period. In connection with this
legislation the Company increased the provision for losses by $10 million to
provide for write-offs for unusual loan prepayments at amounts less than
carrying value.
As part of legislation reauthorizing various health profession education
programs, the insurance on existing loans originated under the HEAL program was
reduced from 100 percent to 98 percent of the unpaid principal balance plus
accrued interest, unless the servicer of the HEAL loan qualifies as an
"exceptional performer," in which case claims would continue to be paid at the
100 percent level. Management does not expect that the insurance reduction will
have a material impact on the Company's future financial results or condition.
ADMINISTRATION'S FY 2000 BUDGET PROPOSAL
On February 1, 1999 President Clinton submitted his Fiscal Year 2000 budget
proposal to Congress. The budget proposes significant savings from the student
loan programs, principally from the FFELP. Among the proposals for student loans
are the following:
- Reinstatement of a lower rate for new Federal Direct Consolidation Loans.
This variable rate (the 91-day Treasury bill rate plus 2.3 during
repayment and 1.7% during in-school and grace periods) would apply for
borrowers whose applications are received before September 30, 2000. The
budget proposals would also lower the annual fee paid by lenders on FFELP
consolidation loans made during the same period from 1.05 percent to .62
percent of the principal plus accrued unpaid interest;
- Creation of a 90-day period during which interest on a highly delinquent
FFELP loan does not accrue. The Reauthorization Legislation extended the
period before lenders can submit default
38
claims from 180 days to 270 days; the budget proposes to eliminate
interest accrual during this extended period;
- Reduction by 30 basis points of special allowance payments on FFELP loans
funded with tax exempt securities; and
- Implementation of additional Guarantor reforms, including the acceleration
of recall of Guarantor reserves mandated by the Reauthorization
Legislation, recall of an additional $1.5 billion in reserves, the
reduction of the Guarantor retention rate on payments on defaulted loans
to 18.5 percent, the reduction in the share of the remaining amount that
Guarantors may retain, and an expansion of the use of voluntary flexible
agreements authorized by the Reauthorization Legislation.
All these proposals may be considered by Congress as it deliberates on the
FY 2000 budget.
YEAR 2000 ISSUE
The "Year 2000 issue" refers to a wide variety of potential computer program
processing and functionality issues that may arise from the inability of
computer programs to properly process date-sensitive information relating to the
Year 2000, years thereafter and to a lesser degree the Year 1999.
THE COMPANY'S STATE OF READINESS
During 1996, the Company commenced a Year 2000 readiness project to assess
and remediate its internal software and hardware systems to avoid or mitigate
Year 2000 problems and to evaluate Year 2000 problems that may arise from
entities with which the Company interacts. In 1997, a comprehensive project
structure was implemented and a Year 2000 project team was formed. The Year 2000
project team briefs senior executives of the Company and the Company's board of
directors on the progress of the Year 2000 effort. The Company's Year 2000
readiness project encompasses the Company's information technology (IT) systems,
as well as its non-IT systems, such as systems embedded in its office equipment
and facilities. The Company has completed the assessment of its internal
software and hardware. On December 31(st) the Company achieved Year 2000
readiness for all Sallie Mae internal applications that were scheduled to
complete by 1998. With the completion of this critical milestone, the
corporation is directing its attention to 1999 project objectives. These
objectives include the completion of 1999 exceptions. A 1999 exception refers to
those vendor supplied applications whose readiness date did not align with the
Company's December 31, 1998 readiness date. These products will be upgraded upon
the vendor distribution of any Year 2000 ready release in 1999, or, if no such
release is issued, replaced with a Year 2000 ready alternative. Additional
objectives include Year 2000 readiness testing with our external business
partners and the development of Year 2000 contingency and business continuity
plans.
The Company's Year 2000 readiness project is divided into five phases:
Awareness, Assessment, Remediation, Testing and Implementation. The Awareness
phase, which is 100 percent complete, involved the dissemination of Year 2000
information throughout the Company and the education of all levels of management
about Year 2000 issues and their potential impact on the Company's operation.
The Assessment phase, which is also 100 percent complete, involved a
comprehensive inventory of and the determination of the requirements for fixes,
upgrades and replacements for all hardware, application software, embedded
systems (e.g., the microcontrollers in the Company's elevators) and desktop
applications. The Remediation phase, the Year 2000 project phase where hardware,
systems and applications are fixed, upgraded or replaced to be Year 2000 ready,
is 100 percent complete for applications scheduled to complete in 1998. Testing,
the phase in which Year 2000 remediation is validated, is also 100 percent
complete for all applications scheduled to complete in 1998. As part of this
testing effort, the Company staged a Year 2000 disaster recovery exercise in
August 1998. Finally, production installations have been completed for all of
the Company's core applications.
39
The following describes the Company's state of readiness with respect to the
IT systems that support the Company's core business--loan delivery and
acquisition and loan servicing:
- CLASS-SM-, the Company's Consolidated Loan Administration and Servicing
System, is the system that services the Company's managed student loans
and the student loan portfolios of our PortSS-Registered Trademark- and
TransportSS-SM- clients. In July 1998, remediation of CLASS was completed
and it was installed into production. A second, full round of
comprehensive functional testing and integration testing of all internal
application interfaces with CLASS was completed in December 1998. Testing
of external interfaces is scheduled to be completed in 1999.
- SALLIENET, the Company's translation and communication system used to
electronically exchange data with our customers, completed remediation in
September 1998 and was installed into production in October 1998.
SallieNet successfully completed integration testing with CLASS in
December 1998.
- PORTSS-REGISTERED TRADEMARK- III, the Company's PC-based system used by
lenders to originate loans, was developed in 1997 to be Year 2000 ready.
Minor remediation was completed on PortSS III in mid-October 1998.
Integration testing is complete and a Year 2000 ready version of the
software has been distributed to our customers.
- LINESS-SM-, the Company's PC-based product used by colleges and
universities to process financial aid loan application information, was
developed in 1993 to be Year 2000 ready. The LineSS disbursement component
used to transmit disbursement roster information from Sallie Mae's CLASS
system to the college or university, was developed in 1995 to be Year 2000
ready. LineSS utilizes the industry approved CommonLine-SM- formats for
all communications. Minor remediation on LineSS was completed in
mid-October 1998. Integration testing is complete and a Year 2000 ready
version of the software has been distributed to our customers.
- IMDOC-REGISTERED TRADEMARK-, the Company's document imaging system, has
completed remediation and functional testing and successfully completed
integration testing with CLASS in December 1998.
In addition, certain significant financial and administrative systems,
including the Company's payroll and human resources, debt accounting, investment
management and financial accounting and control systems have all completed
remediation and have successfully completed integration testing with other
internal systems.
The Company's non-IT systems principally support the Company's facilities
and telecommunications. As of October 1998, all of the Company's headquarters
core facilities systems, including elevators, internal security and fire alarms,
were determined to be Year 2000 ready in accordance with the procedures
established by the Company to make such a determination. The Company completed
Year 2000 readiness testing of its Lucent telecommunications components in
December 1998. In addition, the Company is working closely with all of its
utility providers to make a reasonable assessment of the Company's potential
exposure to any failure on their part to resolve their Year 2000 issues.
Although the Company's Reston, Virginia headquarters building is equipped with
five emergency powered generators designed to back up building power without
refueling for a period of two weeks, there can be no assurance that such back-up
systems will adequately insulate the Company from any business interruptions
caused by any widespread power outages or power outages in any service area
where its loan servicing centers are located.
The Company has surveyed its third party service providers and business
partners and is currently reviewing these surveys. In addition to requesting
readiness information, the Company has tested all third-party developed software
that the vendor claimed was Year 2000 ready, to confirm compliance or determine
the potential impact of noncompliance. In addition, the Company plans to work
with select third party service providers and business partners to ascertain
their current Year 2000 compliance status and to coordinate testing efforts
throughout 1999. There can be no assurance that the computer systems of other
companies or counterparties on which the Company relies will be Year 2000 ready
on a timely basis,
40
or that a failure to resolve Year 2000 issues by another party, or remediation
or conversion that is incompatible with the Company's computer systems, will not
have a material adverse effect on the Company.
THE RISKS OF THE COMPANY'S YEAR 2000 ISSUES
Generally, the failure by the Company or any of its significant third-party
service providers or business partners to resolve a material Year 2000 issue
could result in the interruption in, or a failure of, certain normal business
activities or operations such as servicing loans or processing payments. Such
failures could materially and adversely affect the Company's results of
operations. For example, the Company submits claims for payment, including
special allowance payments and interest subsidy payments, directly to the U.S.
Department of Education (the "DOE"). To the extent that the DOE is unable to
timely process the payments because of its failure to remediate its Year 2000
problem, the Company's liquidity could be adversely affected, possibly to a
material extent. In addition, the Company submits claims to various state or
private nonprofit guarantee agencies for payment of all or a portion of the
unpaid principal balance on loans plus accrued interest if a borrower defaults
on a student loan and in certain other circumstances such as the death,
permanent or total disability of or the filing for bankruptcy by the borrower.
The Company has surveyed each of the guarantee agencies and [continues to make]
follow-up telephone inquiries to determine the level of their Year 2000
compliance and the potential impact of noncompliance. To the extent that any of
the larger guarantee agencies are unable to timely process the payments because
of its failure to remediate its Year 2000 problem, the Company's liquidity could
be adversely affected, possibly to a material extent.
THE COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES
Costs to modify computer systems have been, and will continue to be,
expensed as incurred and are not expected to have a material impact on the
Company's future financial results or condition. The Company spent approximately
$2 million in 1997, $8 million in 1998 and expects to spend approximately $2
million in 1999 on this project. In addition, Year 2000 readiness has been
addressed and accounted for as part of the costs of routine systems development
and modification. Moreover, there can be no guarantee that these estimates will
be achieved, and actual results could differ materially from these estimates.
Specific factors that might cause such material differences include, but are not
limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer codes and similar
uncertainties.
THE COMPANY'S CONTINGENCY PLANS
The Company has developed high level contingency plans for its core
applications and will refine these plans in 1999. In addition, the Company
intends to commit resources in 1999 to evaluate and prepare contingency plans
for systems and operations viewed as vulnerable to Year 2000-related
interruptions. There can be no assurance that the Company's remediation efforts
and contingency plans will be sufficient to avoid unforeseen business
disruptions or other problems resulting from the Year 2000 issue.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Included within Management's Discussion and Analysis of Financial Condition
and Results of Operations at pages 34 to 36.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements listed under the heading "(a)
1. Financial Statements" of Item 15 hereof, which financial statements are
incorporated by reference in response to this Item 8.
41
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information as to the directors and executive officers of the Company
set forth under the captions "PROPOSAL 1--ELECTION OF DIRECTORS--Information
Concerning Nominees" and "Executive Officers" in the Proxy Statement to be filed
on Schedule 14A relating to the Company's Annual Meeting of Stockholders
scheduled to be held on May 20, 1999 (the "Proxy Statement") is incorporated
into this Report by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the caption "Executive Compensation" in the
Proxy Statement is incorporated into this Report by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information set forth under the caption "COMMON STOCK INFORMATION--Board
and Management Ownership" and "--Principal Holders" in the Proxy Statement is
incorporated into this Report by reference thereto. There are no arrangements
known to the Company, the operation of which may at a subsequent date result in
a change in control of the Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information set forth under the caption "EXECUTIVE COMPENSATION--Certain
Transactions" in the Proxy Statement is incorporated into this Report by
reference.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The following consolidated financial statements of SLM Holding Corporation
and the Report of the Independent Auditors thereon are included in Item 8 above:
Report of Independent Auditors................................................... F--2
Consolidated Balance Sheets as of December 31, 1998 and 1997..................... F--3
Consolidated Statements of Income for the years ended December 31, 1998, 1997 and
1996............................................................................ F--4
Consolidated Statements of Charges in Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996................................................ F--5
Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997
and 1996........................................................................ F--6
Notes to Consolidated Financial Statements....................................... F--7
2. Financial Statement Schedules
42
SCHEDULE
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
XX Separate Report of Predecessor Accountant
All other schedules are omitted because they are not applicable or the
required information is shown in the consolidated financial statements or notes
thereto.
3. Exhibits
The exhibits listed in the accompanying index to exhibits are filed or
incorporated by reference as part of this annual report.
(b) Reports on Form 8-K.
The Company filed no Current Reports on Form 8-K during the fourth quarter
of 1998.
(c) Exhibits.
*2 Agreement and Plan of Reorganization by and among the Student Loan Marketing
Association, SLM Holding Corporation, and Sallie Mae Merger Company.
**3.1 Amended and Restated Certificate of Incorporation of the Registrant
**3.2 By-Laws of the Registrant
**4 Warrant Certificate No. W-2, dated as of August 7, 1997
*10.1 Board of Director's Restricted Stock Plan
*10.2 Board of Director's Stock Option Plan
*10.3 Deferred Compensation Plan for Directors
*10.4 Incentive Performance Plan
*10.5 Stock Compensation Plan
*10.6 1993-1998 Stock Option Plan
*10.7 Supplemental Pension Plan
*10.8 Supplemental Employees' Thrift & Savings Plan (Sallie Mae 401(K) Supplemental
Savings Plan)
***10.9 Directors Stock Plan
***10.10 Management Incentive Plan
+10.11 Employment Agreements
*21 Subsidiaries of the Registrant
+23.1 Consent of Ernst & Young LLP
+23.2 Consent of Arthur Andersen LLP
+27 Financial Data Schedule
- ------------------------
* Incorporated by reference to the correspondingly numbered exhibits to the
Registrant's Registration Statement on Form S-4, as amended (File No.
333-21217)
** Incorporated by reference to the correspondingly numbered exhibits to the
Registrant's Registration on Form S-1 (File No. 333-38391)
*** Incorporated by reference to the Registrant's Definitive Proxy Statement on
Schedule 14A, as filed with the Securities and Exchange Commission on April
10, 1998 (File No. 001-13251)
+ Filed with the Securities and Exchange Commission with this Form 10-K
43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned hereunto duly authorized.
Dated: March 22, 1999
SLM HOLDING CORPORATION
By: /s/ ALBERT L. LORD
-----------------------------------------
Name: Albert L. Lord
Title: Chief Executive Officer
Pursuant to the requirement of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
/s/ ALBERT L. LORD Chief Executive Officer
- ------------------------------ (Principal Executive March 22, 1999
Albert L. Lord Officer)
/s/ MARK G. OVEREND Chief Financial Officer
- ------------------------------ (Principal Financial and March 22, 1999
Mark G. Overend Accounting Officer)
/s/ EDWARD A. FOX Chairman of the Board of
- ------------------------------ Directors March 17, 1999
Edward A. Fox
/s/ JAMES E. BRANDON Director
- ------------------------------ March 17, 1999
James E. Brandon
/s/ CHARLES L. DALEY Director
- ------------------------------ March 17, 1999
Charles L. Daley
/s/ THOMAS J. FITZPATRICK Director
- ------------------------------ March 17, 1999
Thomas J. Fitzpatrick
/s/ DIANE SUITT GILLELAND Director
- ------------------------------ March 17, 1999
Diane Suitt Gilleland
/s/ ANN TORRE GRANT Director
- ------------------------------ March 17, 1999
Ann Torre Grant
44
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
/s/ RONALD F. HUNT Director
- ------------------------------ March 17, 1999
Ronald F. Hunt
/s/ BENJAMIN J. LAMBERT, III Director
- ------------------------------ March 17, 1999
Benjamin J. Lambert, III
/s/ MARIE V. MCDEMMOND Director
- ------------------------------ March 17, 1999
Marie V. McDemmond
/s/ BARRY A. MUNITZ Director
- ------------------------------ March 19, 1999
Barry A. Munitz
/s/ A. ALEXANDER PORTER Director
- ------------------------------ March 17, 1999
A. Alexander Porter
/s/ WOLFGANG SCHOELLKOPF Director
- ------------------------------ March 17, 1999
Wolfgang Schoellkopf
/s/ STEVEN L. SHAPIRO Director
- ------------------------------ March 17, 1999
Steven L. Shapiro
/s/ RANDOLPH H. WATERFIELD, Director
JR.
- ------------------------------ March 17, 1999
Randolph H. Waterfield, Jr.
45
SLM HOLDING CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
INDEX
PAGE
-----
Report of Independent Public Accountants................................................................... F-2
Consolidated Balance Sheets................................................................................ F-3
Consolidated Statements of Income.......................................................................... F-4
Consolidated Statements of Changes in Stockholders' Equity................................................. F-5
Consolidated Statements of Cash Flows...................................................................... F-6
Notes to Consolidated Financial Statements................................................................. F-7
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
SLM Holding Corporation:
We have audited the accompanying consolidated balance sheets of SLM Holding
Corporation and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of SLM Holding Corporation and
subsidiaries as of December 31, 1998 and 1997, and the consolidated results of
their operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles.
Arthur Andersen LLP
Washington, D.C.
January 14, 1999
F-2
SLM HOLDING CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
DECEMBER 31,
----------------------------
1998 1997
------------- -------------
ASSETS
Student loans...................................................................... $ 28,282,505 $ 29,443,376
Warehousing advances............................................................... 1,542,732 1,868,654
Academic facilities financings
Bonds--available-for-sale........................................................ 734,994 860,325
Loans............................................................................ 445,418 514,691
------------- -------------
Total academic facilities financings............................................... 1,180,412 1,375,016
Investments
Available-for-sale............................................................... 3,306,972 4,549,977
Held-to-maturity................................................................. 683,452 525,962
------------- -------------
Total investments.................................................................. 3,990,424 5,075,939
Cash and cash equivalents.......................................................... 115,912 54,022
Other assets, principally accrued interest receivable.............................. 2,098,024 2,014,556
------------- -------------
Total assets....................................................................... $ 37,210,009 $ 39,831,563
------------- -------------
------------- -------------
LIABILITIES
Short-term borrowings.............................................................. $ 26,588,504 $ 23,175,509
Long-term notes.................................................................... 8,810,597 14,541,316
Other liabilities.................................................................. 943,399 1,226,283
------------- -------------
Total liabilities.................................................................. 36,342,500 38,943,108
------------- -------------
Commitments and contingencies
Minority interest in subsidiary.................................................... 213,883 213,883
Stockholders' equity
Common stock, par value $.20 per share, 250,000,000 shares authorized: 184,453,866
and 183,632,694 shares issued, respectively...................................... 36,891 36,726
Additional paid-in capital......................................................... 26,871 28,838
Unrealized gains on investments (net of tax of $200,167 and $203,935,
respectively).................................................................... 371,739 378,736
Retained earnings.................................................................. 1,060,334 654,135
------------- -------------
Stockholders' equity before treasury stock......................................... 1,495,835 1,098,435
Common stock held in treasury at cost:
20,327,213 and 10,221,757 shares, respectively................................... 842,209 423,863
------------- -------------
Total stockholders' equity......................................................... 653,626 674,572
------------- -------------
Total liabilities and stockholders' equity......................................... $ 37,210,009 $ 39,831,563
------------- -------------
------------- -------------
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
SLM HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
Interest income:
Student loans......................................................... $ 2,105,854 $ 2,485,138 $ 2,634,506
Warehousing advances.................................................. 101,905 151,086 193,654
Academic facilities financings:
Taxable............................................................. 44,224 51,410 52,163
Tax-exempt.......................................................... 41,064 46,558 48,262
------------ ------------ ------------
Total academic facilities financings.................................. 85,288 97,968 100,425
Investments........................................................... 294,602 573,120 548,582
------------ ------------ ------------
Total interest income................................................. 2,587,649 3,307,312 3,477,167
Interest expense:
Short-term debt..................................................... 1,297,753 1,461,954 1,138,272
Long-term debt...................................................... 627,244 1,064,202 1,444,613
------------ ------------ ------------
Total interest expense................................................ 1,924,997 2,526,156 2,582,885
------------ ------------ ------------
Net interest income................................................... 662,652 781,156 894,282
Less: provision for losses............................................ 28,619 23,478 27,846
------------ ------------ ------------
Net interest income after provision for losses........................ 634,033 757,678 866,436
------------ ------------ ------------
Other income:
Gains on sales of student loans..................................... 117,068 280,221 48,981
Servicing and securitization revenue................................ 280,863 151,221 57,736
Gains on sales of securities........................................ 10,734 16,051 4,525
Other............................................................... 68,302 48,344 28,301
------------ ------------ ------------
Total other income.................................................... 476,967 495,837 139,543
------------ ------------ ------------
Operating expenses:
Salaries and benefits............................................... 189,917 224,554 206,347
Other............................................................... 170,952 269,213 199,305
------------ ------------ ------------
Total operating expenses.............................................. 360,869 493,767 405,652
------------ ------------ ------------
Income before income taxes and minority interest in net earnings of
subsidiary.......................................................... 750,131 759,748 600,327
------------ ------------ ------------
Income tax:
Current............................................................. 306,310 217,383 204,856
Deferred............................................................ (68,337) 23,776 (23,939)
------------ ------------ ------------
Total income taxes.................................................... 237,973 241,159 180,917
Minority interest in net earnings of subsidiary....................... 10,694 10,694 10,694
------------ ------------ ------------
Net income............................................................ $ 501,464 $ 507,895 $ 408,716
------------ ------------ ------------
------------ ------------ ------------
Basic earnings per share.............................................. $ 2.99 $ 2.80 $ 2.10
------------ ------------ ------------
------------ ------------ ------------
Average common shares outstanding..................................... 167,684 181,554 194,466
------------ ------------ ------------
------------ ------------ ------------
Diluted earnings per share............................................ $ 2.95 $ 2.78 $ 2.09
------------ ------------ ------------
------------ ------------ ------------
Average common and common equivalent shares outstanding............... 170,066 182,941 195,339
------------ ------------ ------------
------------ ------------ ------------
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
SLM HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
COMMON STOCK SHARES ADDITIONAL
----------------------------------- COMMON PAID-IN
ISSUED TREASURY OUTSTANDING STOCK CAPITAL
---------- ---------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 1995.................................. 434,426,195 (232,454,334) 201,971,861 $ 86,885 $ 475,757
Comprehensive income:
Net Income................................................
Other comprehensive income, net of tax:
Unrealized gains (losses) on investments, net of tax....
Comprehensive income........................................
Cash dividends ($.47 per share).............................
Issuance of common shares................................... 2,008,304 2,008,304 402 22,633
Tax benefit related to employee stock option and purchase
plan...................................................... 7,393
Repurchase of common shares................................. (16,063,082) (16,063,082)
Retirement of treasury shares............................... (206,500,000) 206,500,000 - (41,300) (505,783)
---------- ---------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 1996.................................. 229,934,499 (42,017,416) 187,917,083 45,987 --
Comprehensive income:
Net Income................................................
Other comprehensive income, net of tax:
Unrealized gains (losses) on investments, net of tax....
Comprehensive income........................................
Cash dividends ($.52 per share).............................
Issuance of common shares................................... 3,473,351 3,473,351 695 59,316
Issuance of warrants........................................ 12,393
Tax benefit related to employee stock option and purchase
plan...................................................... 22,879
Premiums on equity forward purchase contracts............... (18,082)
Repurchase of common shares................................. (17,979,497) (17,979,497)
Retirement of treasury shares............................... (49,775,156) 49,775,156 -- (9,956) (47,668)
---------- ---------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 1997.................................. 183,632,694 (10,221,757) 173,410,937 36,726 28,838
Comprehensive income:
Net income................................................
Other comprehensive income, net of tax:
Unrealized gains (losses) on investments, net of tax....
Comprehensive income........................................
Cash dividends ($.57 per share).............................
Issuance of common shares................................... 821,172 821,172 165 21,129
Tax benefit related to employee stock option and purchase
plan...................................................... 4,093
Premiums on equity forward purchase contracts............... (27,189)
Repurchase of common shares................................. (10,105,456) (10,105,456)
---------- ---------- ----------- ----------- -----------
BALANCE AT DECEMBER 31, 1998.................................. 184,453,866 (20,327,213) 164,126,653 $ 36,891 $ 26,871
---------- ---------- ----------- ----------- -----------
---------- ---------- ----------- ----------- -----------
UNREALIZED
RETAINED TREASURY GAINS ON STOCKHOLDERS'
EARNINGS STOCK INVESTMENTS EQUITY
----------- --------- ----------- -------------
BALANCE AT DECEMBER 31, 1995.................................. $2,728,383 $(2,794,549) $ 370,846 $ 867,322
Comprehensive income:
Net Income................................................ 408,716 408,716
Other comprehensive income, net of tax:
Unrealized gains (losses) on investments, net of tax.... (21,611) (21,611)
-------------
Comprehensive income........................................ 387,105
Cash dividends ($.47 per share)............................. (90,994) (90,994)
Issuance of common shares................................... 23,035
Tax benefit related to employee stock option and purchase
plan...................................................... 7,393
Repurchase of common shares................................. (359,914) (359,914)
Retirement of treasury shares............................... (2,070,216) 2,617,299 --
----------- --------- ----------- -------------
BALANCE AT DECEMBER 31, 1996.................................. 975,889 (537,164) 349,235 833,947
Comprehensive income:
Net Income................................................ 507,895 507,895
Other comprehensive income, net of tax:
Unrealized gains (losses) on investments, net of tax.... 29,501 29,501
-------------
Comprehensive income........................................ 537,396
Cash dividends ($.52 per share)............................. (93,630) (93,630)
Issuance of common shares................................... 60,011
Issuance of warrants........................................ 12,393
Tax benefit related to employee stock option and purchase
plan...................................................... 22,879
Premiums on equity forward purchase contracts............... (18,082)
Repurchase of common shares................................. (680,342) (680,342)
Retirement of treasury shares............................... (736,019) 793,643 --
----------- --------- ----------- -------------
BALANCE AT DECEMBER 31, 1997.................................. 654,135 (423,863) 378,736 674,572
Comprehensive income:
Net income................................................ 501,464 501,464
Other comprehensive income, net of tax:
Unrealized gains (losses) on investments, net of tax.... (6,997) (6,997)
-------------
Comprehensive income........................................ 494,467
Cash dividends ($.57 per share)............................. (95,265) (95,265)
Issuance of common shares................................... 21,294
Tax benefit related to employee stock option and purchase
plan...................................................... 4,093
Premiums on equity forward purchase contracts............... (27,189)
Repurchase of common shares................................. (418,346) (418,346)
----------- --------- ----------- -------------
BALANCE AT DECEMBER 31, 1998.................................. $1,060,334 $(842,209) $ 371,739 $ 653,626
----------- --------- ----------- -------------
----------- --------- ----------- -------------
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
SLM HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31,
-------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
Operating activities
Net income................................................. $ 501,464 $ 507,895 $ 408,716
Adjustments to reconcile net income to net cash provided by
operating activities:
Gains on sales of student loans.......................... (117,068) (280,221) (48,981)
Provision for losses..................................... 28,619 23,478 27,846
(Increase) decrease in accrued interest receivable....... 84,749 (76,561) (11,286)
(Decrease) in accrued interest payable..................... (122,053) (40,231) (109,214)
(Increase) decrease in other assets...................... (94,639) 74,591 (225,591)
Increase (decrease) in other liabilities................. (157,062) (149,901) 181,284
--------------- --------------- ---------------
Total adjustments.......................................... (377,454) (448,845) (185,942)
--------------- --------------- ---------------
Net cash provided by operating activities.................... 124,010 59,050 222,774
--------------- --------------- ---------------
Investing activities
Student loans purchased.................................... (8,417,086) (9,040,097) (9,869,704)
Reduction of student loans purchased:
Installment payments..................................... 2,781,322 2,729,071 3,127,221
Claims and resales....................................... 782,041 1,112,226 1,277,400
Proceeds from securitization of student loans............ 6,035,218 9,621,989 6,026,780
Warehousing advances made.................................. (851,837) (695,061) (1,391,590)
Warehousing advance repayments............................. 1,177,759 1,615,892 2,467,198
Academic facilities financings made........................ (4,302) (148,033) (465,596)
Academic facilities financings repayments.................. 203,936 256,420 302,557
Investments purchased...................................... (9,853,778) (16,639,867) (15,966,490)
Proceeds from sale or maturity of investments.............. 10,917,744 19,027,736 16,113,659
--------------- --------------- ---------------
Net cash provided by investing activities.................... 2,771,017 7,840,276 1,621,435
--------------- --------------- ---------------
Financing activities
Short-term borrowings issued............................... 478,111,748 685,921,616 268,027,948
Short-term borrowings repaid............................... (473,466,628) (682,026,471) (262,994,320)
Long-term notes issued..................................... 5,527,280 4,691,827 8,304,988
Long-term notes repaid..................................... (12,490,124) (15,994,000) (15,744,378)
Equity forward contracts and common stock issued........... (1,802) 64,809 30,428
Common stock repurchased................................... (418,346) (680,342) (359,914)
Dividends paid............................................. (95,265) (93,630) (90,994)
--------------- --------------- ---------------
Net cash used in financing activities........................ (2,833,137) (8,116,191) (2,826,242)
--------------- --------------- ---------------
Net increase (decrease) in cash and cash equivalents......... 61,890 (216,865) (982,033)
Cash and cash equivalents at beginning of year............... 54,022 270,887 1,252,920
--------------- --------------- ---------------
Cash and cash equivalents at end of year..................... $ 115,912 $ 54,022 $ 270,887
--------------- --------------- ---------------
--------------- --------------- ---------------
Cash disbursements made for:
Interest................................................. $ 1,868,975 $ 2,198,630 $ 2,460,870
--------------- --------------- ---------------
--------------- --------------- ---------------
Income taxes............................................. $ 339,336 $ 143,500 $ 202,200
--------------- --------------- ---------------
--------------- --------------- ---------------
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. ORGANIZATION AND PRIVATIZATION
SLM Holding Corporation ("SLM Holding") was formed on February 3, 1997 as a
wholly owned subsidiary of the Student Loan Marketing Association (the "GSE").
On August 7, 1997, pursuant to the Student Loan Marketing Association
Reorganization Act of 1996 (the "Privatization Act") and approval by
shareholders of an agreement and plan of reorganization, the GSE was reorganized
into a subsidiary of SLM Holding (the "Reorganization"). SLM Holding is a
holding Company that operates through a number of subsidiaries including the
GSE. References herein to the "Company" refer to the GSE and its subsidiaries
for periods prior to the Reorganization and to SLM Holding and its subsidiaries
for periods after the Reorganization.
Under the terms of the Reorganization each outstanding share of common
stock, par value $.20 per share, of the GSE was converted into one share of
common stock, par value $.20 per share of SLM Holding. The GSE transferred all
employees to non- GSE subsidiaries on August 7, 1997 and also transferred
certain assets, including stock in certain subsidiaries, to SLM Holding or one
of its non-GSE subsidiaries on December 31, 1997. This transfer of the
subsidiaries and assets and the related exchange of stock was accounted for at
historical cost similar to a pooling of interests and therefore all prior period
financial statements and related disclosures presented have been restated as if
the Reorganization took place at the beginning of such periods.
The GSE was chartered by Congress to provide liquidity for originators of
student loans made under federally sponsored student loan programs and otherwise
to support the credit needs of students and educational institutions. The GSE is
predominantly engaged in the purchase of student loans insured under federally
sponsored programs. The GSE also makes secured loans (warehousing advances) to
providers of education credit, and provides financing to educational
institutions for their physical plant and equipment (academic facilities
financings).
The Privatization Act provides that the GSE may continue to issue new debt
obligations maturing on or before September 30, 2008. The legislation further
provides that the legal status and attributes of the GSE's debt obligations,
including Securities and Exchange Commission ("SEC") registration and state tax
exemptions, will be fully preserved until their respective maturities. Such debt
obligations will remain GSE debt obligations, whether such obligations were
outstanding at the time of, or issued subsequent to, the Reorganization. The
obligations of SLM Holding do not have GSE status. The GSE will wind down its
operations and dissolve on or before September 30, 2008. Any GSE debt
obligations outstanding at the date of such dissolution will be defeased through
creation of a fully collateralized trust, consisting of U.S. government or
agency obligations with cash flows matching the interest and principal
obligations of the defeased debt. The Privatization Act further requires that
the GSE's outstanding adjustable rate cumulative preferred stock be redeemed on
September 30, 2008 or at such earlier time when the GSE is dissolved. Also upon
the GSE's dissolution, all of its remaining assets will transfer to the Company.
The Omnibus Appropriations Act of 1998, signed into law by the President on
October 21, 1998, amends the Federal Deposit Insurance Act by, among other
things, providing an exception to its current prohibition on affiliations
between government-sponsored entities and depository institutions. This
exception allows SLM Holding Corporation to become affiliated with a depository
institution upon satisfaction of certain conditions and with the approval of the
Secretary of the Treasury. Among the conditions are that: the dissolution of the
GSE cannot be adversely affected by the affiliation; the dissolution of the GSE
must occur within two years after the affiliation is consummated subject to the
ability of the Secretary to extend such deadline for up to two one-year periods;
and the GSE must be separate and distinct from the
F-7
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. ORGANIZATION AND PRIVATIZATION (CONTINUED)
affiliated depository institution and cannot extend credit, provide credit
enhancement or purchase any obligation of the depository institution.
2. SIGNIFICANT ACCOUNTING POLICIES
LOANS
Loans, consisting of federally insured student loans, non-federally insured
student loans, student loan participations, warehousing advances, and academic
facilities financings are carried at their purchase price which, for student
loans, are adjusted for unamortized premiums and unearned purchase discounts.
STUDENT LOAN INCOME
The Company recognizes student loan income as earned, including adjustments
for the amortization of premiums and the accretion of discounts. Interest income
earned on student loan participations is recognized in accordance with the terms
of the joint venture agreement with the Chase Manhattan Bank (the "Joint
Venture") which effectively reflects the underlying interest income earned on
the student loans less servicing costs and the general and administrative
expenses of the Joint Venture. The Company's investment in the Joint Venture is
accounted for using the equity method of accounting.
In December 1998, the Company and Chase restructured the Joint Venture,
whereby student loans originated by Chase will no longer be sold to the Joint
Venture and funded through sales of student loan participations to the Company
and Chase. Instead, the Company will purchase all loans originated by Chase. The
Company will also acquire the existing $3.2 billion of student loans in the
Joint Venture that the Company and Chase each own a 50 percent interest in the
form of student loan participations.
ALLOWANCE FOR LOSSES
The Company has established an allowance for potential losses on the
existing on-balance sheet portfolio of student loans, academic facilities
financings, investments and derivatives. In evaluating the adequacy of the
allowance for losses, the Company considers several factors including trends in
student loan claims rejected for payment by guarantors, default rates on
non-federally insured student loans, the amount of FFELP loans subject to 2
percent risk-sharing, and the credit exposure on all other investments, and
derivatives. The allowance is based on periodic evaluations of its loan
portfolios considering past experience, changes to federal student loan
programs, current economic conditions and other relevant factors. The allowance
is maintained at a level that management believes is adequate to absorb
estimated credit losses. This evaluation is inherently subjective as it requires
estimates that may be susceptible to significant changes.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents includes term federal funds and bank deposits with
terms to maturity less than three months.
F-8
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVESTMENTS
Investments are held to provide liquidity, to hedge certain financing
activities and to serve as a source of short-term income. Investments are
segregated into three categories as required under Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." Securities that are actively traded are accounted
for at fair market value with unrealized gains and losses included in investment
income. Securities that are intended to be held-to-maturity are accounted for at
amortized cost. Securities that fall outside of the two previous categories are
considered as available-for-sale. Such securities are carried at market value,
with the after-tax unrealized gain or loss, along with after-tax unrealized gain
or loss on instruments which hedge such securities, carried as a separate
component of stockholders' equity. The amortized cost of debt securities in this
category is adjusted for amortization of premiums and accretion of discounts.
INTEREST EXPENSE
Interest expense is based upon contractual interest rates adjusted for net
payments under derivative financial instruments with off-balance sheet risks,
which include interest rate swap agreements, foreign currency exchange
agreements, the amortization of debt issuance costs, and deferred gains and
losses on hedge transactions entered into to reduce interest rate risk.
INTEREST RATE SWAPS
The Company utilizes interest rate swap agreements ("interest rate swaps")
principally for hedging purposes to alter the interest rate characteristics of
its debt in order to manage interest rates. This enables the Company to match
the interest rate characteristics of borrowings to specific assets in order to
lock in spreads. The Company does not hold or issue interest rate swaps for
trading purposes.
Amounts paid or received under swaps that are used to alter the interest
rate characteristics of its interest-sensitive liabilities are accrued and
recognized as an adjustment to the interest expense on the related borrowing.
The related net receivable or payable from counterparties is included in other
assets or other liabilities. Gains and losses associated with the termination of
swaps for designated positions are deferred and amortized over the remaining
life of the designated instrument as an adjustment to interest expense.
The Company's credit exposure on swaps is limited to its unrealized gains in
the event of nonperformance by the counterparties. The Company manages the
credit risk associated with these instruments by performing credit reviews of
counterparties and monitoring market conditions to establish counterparty,
sovereign and instrument-type credit lines and, when appropriate, requiring
collateral.
FLOOR INTEREST CONTRACTS
The Company enters into Floor Interest Contracts with third parties, under
which the Company receives an up-front payment and agrees to pay the difference
between the minimum borrower interest rate less the applicable Special Allowance
Percentage ("SAP") rate ("the Strike Rate") and the average of 91-day Treasury
bill rates over the period of the contract. If the Strike Rate is less than the
average Treasury bill rate, then no payment is required. These upfront payments
are being amortized to student
F-9
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
loan income over the average life of the contracts, which is approximately eight
months for the 1998 and 1997 contracts and two years for the 1996 contracts.
INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," using the asset and liability method. Under the
asset and liability method, deferred tax assets and liabilities are determined
for temporary differences between the carrying amounts of assets or liabilities
for book purposes versus tax purposes, based on the enacted tax rates which are
expected to be in effect when the underlying items of income and expense are
expected to be realized. The Company and its eligible subsidiaries file a
consolidated U.S. federal income tax return.
EARNINGS PER COMMON SHARE
Net income per share is calculated in accordance with SFAS No. 128,
"Earnings per Share." SFAS 128 requires dual presentation of basic and diluted
earnings per share ("EPS") on the face of the income statement and a
reconciliation of the numerator and denominator used in the basic EPS
calculation to the numerator and denominator used in the diluted EPS
calculation. Basic earnings per common share were computed using the weighted
average of common shares outstanding during the year. Diluted earnings per
common share were computed using the weighted average of common and common
equivalent shares outstanding during the year. Common equivalent shares include
shares issuable upon exercise of incentive stock options, and in 1997 and 1998,
warrants for voting common stock. Equity forward transactions are included in
common equivalent shares if the average market price of the Company's stock is
less than the forward contract's exercise price.
CONSOLIDATION
The consolidated financial statements include the accounts of SLM Holding
and its subsidiaries, after eliminating significant intercompany accounts and
transactions.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, reported
amounts of revenues and expenses and other disclosures. Actual results could
differ from those estimates.
RECLASSIFICATIONS
Certain reclassifications have been made to the balances as of and for the
years ended December 31, 1997 and 1996, to be consistent with classifications
adopted for 1998.
COMPREHENSIVE INCOME
The Company adopted SFAS 130, "Accounting for Comprehensive Income," during
1998. This statement establishes standards for reporting and display of
comprehensive income and its components (including revenues, expenses, gains and
losses) in a full set of general-purpose financial statements. The
F-10
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Company's unrealized gains on investments represent the only component of
comprehensive income which is excluded from net income for 1998 and prior years.
The Company's comprehensive income has been presented in the consolidated
financial statements.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosure about
Pensions and Other Post-retirement Benefits," which standardizes the disclosure
requirements for pensions and other post-retirement benefits; requires
additional information on changes in the benefit obligations and fair values of
plan assets; and eliminates certain disclosure requirements. The standard does
not change the recognition or measurement requirements for post-retirement
benefits. SFAS No. 132 is effective for fiscal years beginning after December
15, 1997 and, accordingly, the Company adopted the standards in the fiscal year
beginning January 1, 1998.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which requires that every derivative
instrument, including derivative instruments embedded in other contracts, be
recorded in the balance sheet as either an asset or liability measured at its
fair value. SFAS 133 requires that changes in the derivative instrument's fair
value be recognized currently in earnings unless specific hedge accounting
criteria are met. Special accounting for derivative financial instruments that
qualify as fair value hedges allows a derivative instrument's gains and losses
to offset related results on the hedged item in the income statement and
requires that a Company formally document, designate and assess the
effectiveness of transactions that receive hedge accounting treatment.
Derivative financial instruments that qualify as cashflow hedges are reported as
an adjustment to stockholders' equity as a component of other comprehensive
income. The Statement could result in increased period to period volatility in
reported net income. Management is continuing to assess the potential impact of
the Statement on the Company's reported results of operations and financial
position. The Company will adopt SFAS No. 133 on January 1, 2000.
3. STUDENT LOANS
The Company purchases student loans from originating lenders, typically just
before the student leaves school and is required to begin repayment of the loan.
The Company's portfolio consists principally of loans originated under two
federally sponsored programs--the Federal Family Education Loan Program
("FFELP") and the Health Education Assistance Loan Program ("HEAL"). The Company
also originates private loans from time to time.
There are three principal categories of FFELP loans: Stafford loans, PLUS
loans, and consolidation loans. Generally, Stafford and PLUS loans have
repayment periods of between five and ten years. Consolidation loans have
repayment periods of twelve to thirty years. FFELP loans obligate the borrower
to pay interest at a stated fixed rate or an annually reset variable rate that
has a cap. However, the yield to holders is subsidized on the borrowers' behalf
by the federal government to provide a market rate of return. The formula
through which the subsidy is determined is referred to as SAP. SAP is paid
whenever the average of all of the 91-day Treasury bill auctions in a calendar
quarter, plus a spread of between 2.20 and 3.50 percentage points depending on
the loan status and when it was originated, exceeds the rate of interest which
the borrower is obligated to pay. Thus, the Company earns interest at the
greater of the borrower rate or the rate determined by the SAP formula.
F-11
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
3. STUDENT LOANS (CONTINUED)
As discussed above, if the floating rate is less than the rate the borrower
is obligated to pay, the Company earns interest at the borrower rate. The
Company generally finances its student loan portfolio with floating rate debt
tied to the average of the 91-day Treasury bill auctions, either directly or
through the use of derivative financial instruments, to mimic the interest rate
characteristics of the student loans. These borrowings, however, generally do
not have minimum rates like the student loans they finance, rather they float
over all interest rate ranges. As a result, in periods of declining interest
rates the portfolio of managed student loans may be earning at the minimum rate,
which is the rate the borrower is obligated to pay, while the Company's funding
costs continue to decline along with Treasury bill rates. For loans where the
borrower's interest rate is fixed to term, declining interest rates may benefit
the spread earned on student loans for extended periods of time. The Company's
portfolio of student loans originated under the FFELP have borrower interest
rates that are either fixed to term or are reset annually on July 1 of each
year. For loans where the borrower's interest rate is reset annually, any
benefit of declining interest rates will only benefit student loan spreads
through the next annual reset of the borrower's interest rates, which occurs on
July 1 of each year.
The Company is required to pay a 30 basis point "offset fee" on FFELP loans
purchased and held after August 10, 1993 and a 105 basis point consolidation
lender fee on all consolidation loans purchased and held after October 1, 1993.
Also, all loans acquired after October 1, 1993 are subject to risk sharing on
claim payments under which the loan is guaranteed for 98 percent of the balance
plus accrued interest. Offset fees, consolidation loan rebate fees, risk-sharing
and yield reductions continue to have an increasing adverse effect on the
Company as a higher percentage of loans originated after August 1993 and subject
to these costs become available to the Company.
The estimated average remaining term of student loans in the Company's
portfolio was approximately 7 years and 6 years at December 31, 1998 and 1997,
respectively. The following table reflects the distribution of the Company's
student loan portfolio by program.
DECEMBER 31,
----------------------------
1998 1997
------------- -------------
FFELP--Stafford................................................ $ 14,195,970 $ 13,613,173
FFELP--PLUS/SLS................................................ 2,047,635 2,539,222
FFELP--Consolidation loans..................................... 8,018,638 9,230,050
HEAL........................................................... 2,430,520 2,678,401
Non-federally insured.......................................... 1,589,742 1,382,530
------------- -------------
Total student loans............................................ $ 28,282,505 $ 29,443,376
------------- -------------
------------- -------------
As of December 31, 1998 and 1997, 84 percent and 86 percent, respectively,
of the Company's on-balance sheet student loan portfolio was in repayment.
Holders of FFELP loans are insured against the borrower's default, death,
disability or bankruptcy. Insurance on FFELP loans is provided by certain state
or non-profit guarantee agencies, which are reinsured by the federal government.
FFELP loans originated prior to October 1, 1993 are reinsured 100 percent by the
federal government, while FFELP loans originated after October 1, 1993 are
reinsured for 98 percent of their unpaid balance resulting in 2 percent
risk-sharing for holders of these loans. At December 31, 1998 and 1997, the
Company owned $9.0 billion and $12.4 billion of 100 percent reinsured
F-12
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
3. STUDENT LOANS (CONTINUED)
FFELP loans, and $15.3 billion and $13.0 billion of 98 percent reinsured loans,
respectively. HEAL loans are directly insured by the federal government. Both
FFELP and HEAL loans are subject to regulatory requirements relating to
servicing. In the event of default on a student loan or the borrower's death,
disability or bankruptcy, the Company files a claim with the insurer or
guarantor of the loan, who, provided the loan has been properly originated and
serviced, and in the case of HEAL, litigated pays the Company the unpaid
principal balance and accrued interest on the loan less risk-sharing, where
applicable.
Claims not immediately honored by the guarantor because of servicing or
origination defects are returned for remedial servicing, during which period
income is not recognized. On certain paid claims, guarantors assess a penalty
for minor servicing defects. Costs associated with claims on defaulted student
loans, which include such penalties, reduced interest income on student loans by
$10.0 million, $10.9 million and $12.8 million for the years ended December 31,
1998, 1997 and 1996, respectively.
Non-federally insured loans are education-related student loans to students
attending post-secondary educational institutions. Over 88 percent of the
Company's non-federally insured student loans are insured by the Company's
wholly-owned subsidiary, the Hemar Insurance Corporation of America ("HICA").
Accordingly, the Company bears all risk of loss on these loans.
4. ALLOWANCE FOR LOSSES
The following table summarizes changes in the allowance for losses for the
years ended December 31, 1998, 1997 and 1996, respectively.
YEARS ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
Balance at beginning of period........................... $ 273,412 $ 255,380 $ 210,241
Additions
Provisions for losses.................................. 28,619 23,478 27,846
Insurance reserves acquired............................ 19,344 22,653 19,865
Recoveries............................................. 1,703 5,961 7,235
Deductions
Reductions for sales of student loans.................. (6,249) (10,556) (3,188)
Write-offs............................................. (23,644) (23,504) (6,619)
---------- ---------- ----------
Balance at end of period................................. $ 293,185 $ 273,412 $ 255,380
---------- ---------- ----------
---------- ---------- ----------
5. INVESTMENTS
At December 31, 1998 and 1997, all investments with the exception of other
investments are classified as available-for-sale securities under SFAS No. 115
and carried at fair market values which approximate amortized costs, except for
U.S. Treasury securities which have an amortized cost of $957 million and $887
million, respectively. The fair market value of U.S. Treasury securities is
adjusted for unrealized gains and losses on $1.2 billion of interest rate swaps
(See Note 9), which are held to reduce interest rate risk related to these
securities ($125 million of unrealized losses at December 31, 1998 and $45.7
million of
F-13
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
5. INVESTMENTS (CONTINUED)
unrealized losses at December 31, 1997). A summary of investments at December
31, 1998 and 1997 follows:
DECEMBER 31, 1998
----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
------------ ----------- ----------- ------------
Available-for-sale
U.S. Treasury and other U.S.
government Agencies obligations
U.S. Treasury securities.......... $ 956,568 $ 663,756 $ (125,010) $ 1,495,314
State and political subdivisions of
the U.S.
Student loan revenue bonds........ 118,143 5,112 -- 123,255
Asset-backed and other securities
Asset-backed securities........... 1,462,883 127 (18,434) 1,444,576
Variable corporate bonds.......... 100,000 42 -- 100,042
Commercial paper.................. 134,985 -- -- 134,985
Other securities.................. 8,800 -- -- 8,800
------------ ----------- ----------- ------------
Total available-for-sale investment
securities.......................... $ 2,781,379 $ 669,037 $ (143,444) $ 3,306,972
------------ ----------- ----------- ------------
------------ ----------- ----------- ------------
Held-to-maturity
Other................................. $ 683,452 $ 246 $ -- $ 683,698
------------ ----------- ----------- ------------
------------ ----------- ----------- ------------
DECEMBER 31, 1997
----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
------------ ----------- ----------- ------------
Available-for-sale
U.S. Treasury and other U.S. government
Agencies obligations
U.S. Treasury securities........... $ 886,918 $ 583,119 $ (46,163) $ 1,423,874
State and political subdivisions of the
U.S.
Student loan revenue bonds......... 189,467 7,364 -- 196,831
Asset-backed and other securities
Asset-backed securities............ 2,613,914 2,686 (32) 2,616,568
Variable corporate bonds........... 250,589 168 -- 250,757
Commercial paper................... 52,947 -- -- 52,947
Other securities................... 9,000 -- -- 9,000
------------ ----------- ----------- ------------
Total available-for-sale investment
securities........................... $ 4,002,835 $ 593,337 $ (46,195) $ 4,549,977
------------ ----------- ----------- ------------
------------ ----------- ----------- ------------
Held-to-maturity
Other.................................. $ 525,962 $ 144 $ (110) $ 525,996
------------ ----------- ----------- ------------
------------ ----------- ----------- ------------
F-14
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
5. INVESTMENTS (CONTINUED)
The Company sold available-for-sale securities with a carrying value of $367
million, $5.6 billion and $4.6 billion for the years ended December 31, 1998,
1997 and 1996, respectively.
As of December 31, 1998, stated maturities and maturities if accelerated to
the put or call dates for investments are shown in the following table:
DECEMBER 31, 1998
-------------------------------------------
AVAILABLE-FOR-SALE
HELD-TO-MATURITY --------------------------
--------------- MATURITY TO
STATED STATED PUT OR
YEAR OF MATURITY MATURITY MATURITY CALL DATE
- ------------------------------------------------ --------------- ------------ ------------
1999............................................ $ 17,459 $ 345,922 $ 348,951
2000............................................ 98,020 34,566 43,181
2001............................................ 1,173 51,233 48,261
2002............................................ 624 143,246 159,933
2003............................................ 377 121,587 113,389
2004-2008....................................... 216,754 1,657,697 1,643,573
after 2008...................................... 349,045 952,721 949,684
--------------- ------------ ------------
$ 683,452 $ 3,306,972 $ 3,306,972
--------------- ------------ ------------
--------------- ------------ ------------
6. SHORT-TERM BORROWINGS
Short-term borrowings have an original or remaining term to maturity of one
year or less. The following tables summarize outstanding short-term notes at
December 31, 1998, 1997 and 1996, the weighted average interest rates at the end
of each period, and the related average balances, weighted average interest
rates and weighted average effective interest rates, which include the effects
of related off-balance sheet financial instruments (see Note 9) during the
periods.
YEAR ENDED DECEMBER 31, 1998
AT DECEMBER 31, 1998 ---------------------------------------
-------------------------- WEIGHTED
WEIGHTED WEIGHTED AVERAGE
AVERAGE AVERAGE EFFECTIVE
ENDING INTEREST AVERAGE INTEREST INTEREST
BALANCE RATE BALANCE RATE RATE
------------- ----------- ------------- ----------- -----------
Six month floating rate notes...................... $ 3,249,352 5.14% $ 2,898,495 5.32% 5.40%
Other floating rate notes.......................... 7,361,686 5.11 3,663,277 5.39 5.41
Discount notes..................................... 4,429,756 5.06 2,556,366 5.22 5.27
Fixed rate notes................................... 4,724,823 5.41 6,531,461 5.64 5.40
Securities sold--not yet purchased and repurchase
agreements....................................... 5,600 5.50 213,871 5.63 5.63
Short-term portion of long-term notes.............. 6,817,287 5.05 8,418,547 5.48 5.24
------------- --- ------------- --- ---
Total short-term borrowings........................ $ 26,588,504 5.14% $ 24,282,017 5.47% 5.34%
------------- --- ------------- --- ---
------------- --- ------------- --- ---
Maximum outstanding at any month end............... $ 27,142,913
-------------
-------------
F-15
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. SHORT-TERM BORROWINGS (CONTINUED)
YEAR ENDED DECEMBER 31, 1997
AT DECEMBER 31, 1997 ---------------------------------------
-------------------------- WEIGHTED
WEIGHTED WEIGHTED AVERAGE
AVERAGE AVERAGE EFFECTIVE
ENDING INTEREST AVERAGE INTEREST INTEREST
BALANCE RATE BALANCE RATE RATE
------------- ----------- ------------- ----------- -----------
Six month floating rate notes...................... $ 3,149,410 5.55% $ 2,907,533 5.39% 5.48%
Other floating rate notes.......................... 3,545,717 5.63 2,478,985 5.39 5.41
Discount notes..................................... 1,641,221 5.67 5,390,829 5.43 5.49
Fixed rate notes................................... 6,789,749 5.78 5,982,389 5.87 5.58
Securities sold--not yet purchased and repurchase
agreements....................................... -- -- 292,001 5.43 5.43
Short-term portion of long-term notes.............. 8,049,412 5.74 9,496,177 5.67 5.51
------------- --- ------------- --- ---
Total short-term borrowings........................ $ 23,175,509 5.70% $ 26,547,914 5.61% 5.51%
------------- --- ------------- --- ---
------------- --- ------------- --- ---
Maximum outstanding at any month end............... $ 29,084,281
-------------
-------------
YEAR ENDED DECEMBER 31, 1996
AT DECEMBER 31, 1996 ---------------------------------------
-------------------------- WEIGHTED
WEIGHTED WEIGHTED AVERAGE
AVERAGE AVERAGE EFFECTIVE
ENDING INTEREST AVERAGE INTEREST INTEREST
BALANCE RATE BALANCE RATE RATE
------------- ----------- ------------- ----------- -----------
Six month floating rate notes...................... $ 2,699,477 5.23% $ 2,485,322 5.32% 5.42%
Other floating rate notes.......................... 2,188,722 5.25 2,088,347 5.43 5.35
Discount notes..................................... 2,377,976 6.43 3,072,019 5.31 5.36
Fixed rate notes................................... 3,964,777 6.01 1,211,197 6.07 5.53
Securities sold--not yet purchased and repurchase
agreements....................................... -- -- 165,792 4.93 4.93
Short-term portion of long-term notes.............. 11,286,675 5.55 11,956,008 5.75 5.45
------------- --- ------------- --- ---
Total short-term borrowings........................ $ 22,517,627 5.66% $ 20,978,685 5.61% 5.43%
------------- --- ------------- --- ---
------------- --- ------------- --- ---
Maximum outstanding at any month end............... $ 25,271,494
-------------
-------------
At December 31, 1998, the short-term portion of long-term notes included
issues totaling $44 million which require the payment of interest and principal
in foreign currencies. To eliminate its exposure to the effect of currency
fluctuations on these contractual obligations, the Company had entered into
various foreign currency agreements with independent parties (see Note 9).
To match the interest rate characteristics on short-term notes with the rate
characteristics of its assets, the Company enters into interest rate swaps with
independent parties. Under these agreements, the Company makes periodic
payments, indexed to the related asset rates, in exchange for periodic payments
which generally match the Company's interest obligations on fixed or variable
rate notes (see Note 9).
7. LONG-TERM NOTES
The following tables summarize outstanding long-term notes at December 31,
1998 and 1997, the weighted average interest rates and related notional amount
of derivatives at the end of the periods, and
F-16
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
7. LONG-TERM NOTES (CONTINUED)
the related average balances and weighted average effective interest rates,
which include the effects of related off-balance sheet financial instruments
(see Note 9), during the periods.
YEAR ENDED
DECEMBER 31, 1998
AT DECEMBER 31, 1998 --------------------------
---------------------------------------- WEIGHTED
WEIGHTED NOTIONAL AVERAGE
AVERAGE AMOUNT EFFECTIVE
ENDING INTEREST OF AVERAGE INTEREST
BALANCE RATE DERIVATIVES BALANCE RATE
------------ ----------- ------------- ------------- -----------
Floating rate notes:
U.S. dollar denominated:
Interest bearing, due 2000-2003............. $ 3,055,745 5.16% $ 693,119 $ 3,328,326 5.42%
------------ ----- ------------- ------------- -----
Fixed rate notes:
U.S. dollar denominated:
Interest bearing, due 2000-2018............. 5,391,029 5.95 7,734,754 7,490,869 5.59
Zero coupon, due 2014-2022.................. 144,823 11.79 -- 150,626 10.72
Foreign currency:
Interest bearing, due 2000.................. 219,000 5.02 438,000 223,697 5.15
------------ ----- ------------- ------------- -----
Total fixed rate notes.......................... 5,754,852 6.06 8,172,754 7,865,192 5.68
------------ ----- ------------- ------------- -----
Total long-term notes........................... $ 8,810,597 5.75% $ 8,865,873 $ 11,193,518 5.60%
------------ ----- ------------- ------------- -----
------------ ----- ------------- ------------- -----
YEAR ENDED
DECEMBER 31, 1997
AT DECEMBER 31, 1997 --------------------------
----------------------------------------- WEIGHTED
WEIGHTED NOTIONAL AVERAGE
AVERAGE AMOUNT EFFECTIVE
ENDING INTEREST OF AVERAGE INTEREST
BALANCE RATE DERIVATIVES BALANCE RATE
------------- ----------- ------------- ------------- -----------
Floating rate notes:
U.S. dollar denominated:
Interest bearing, due 1999-2003........... $ 4,829,849 5.60% $ 1,296,822 $ 6,788,026 5.48%
------------- ----- ------------- ------------- ---
Fixed rate notes:
U.S. dollar denominated:
Interest bearing, due 1999-2018........... 9,289,872 6.09 14,506,256 11,184,059 5.64
Zero coupon, due 1999-2022................ 164,495 10.79 25,994 278,944 8.13
Dual currency, due 1998..................... -- -- -- 168,836 6.74
Foreign currency:
Interest bearing, due 1999-2000........... 257,100 5.72 496,210 257,100 5.45
------------- ----- ------------- ------------- ---
Total fixed rate notes........................ 9,711,467 6.16 15,028,460 11,888,939 5.82
------------- ----- ------------- ------------- ---
Total long-term notes......................... $ 14,541,316 5.97% $ 16,325,282 $ 18,676,965 5.70%
------------- ----- ------------- ------------- ---
------------- ----- ------------- ------------- ---
F-17
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
7. LONG-TERM NOTES (CONTINUED)
At December 31, 1998, the Company had outstanding long-term debt issues with
call features totaling $4.1 billion. As of December 31, 1998, the stated
maturities and maturities if accelerated to the call dates for long-term notes
are shown in the following table:
DECEMBER 31, 1998
--------------------------
STATED MATURITY TO
YEAR OF MATURITY MATURITY CALL DATE
- ------------------------------------------------------------------ ------------ ------------
1999.............................................................. $ -- $ 3,921,460
2000.............................................................. 6,341,619 4,263,192
2001.............................................................. 1,719,133 79,200
2002.............................................................. 196,020 44,320
2003.............................................................. 105,100 53,700
2004-2022......................................................... 448,725 448,725
------------ ------------
$ 8,810,597 $ 8,810,597
------------ ------------
------------ ------------
The Company issues debt with interest and/or principal payment
characteristics tied to foreign currency indices to attempt to minimize its cost
of funds. At December 31, 1998 and 1997, the Company had outstanding long-term
foreign currency notes which require the payment of principal and interest in
foreign currencies. To eliminate the Company's exposure to the effect of
currency fluctuations on these contractual obligations, the Company has entered
into various foreign currency agreements with independent parties (see Note 9).
To match the interest rate characteristics on its long-term notes with the
interest rate characteristics of its assets, the Company enters into interest
rate swaps with independent parties. Under these agreements, the Company makes
periodic payments, indexed to the related asset rates, in exchange for periodic
payments which generally match the Company's interest obligations on fixed or
variable rate borrowings (see Note 9).
8. STUDENT LOAN SECURITIZATION
For the years ended December 31, 1998, 1997 and 1996, SLM Funding
Corporation, a wholly owned special purpose finance subsidiary of the GSE,
purchased from the GSE and sold $6 billion, $9.4 billion and $6 billion,
respectively, of student loans to trusts which issued floating rate student loan
asset-backed securities in underwritten public offerings. The turbulence in the
global financial markets following the Russian bond default in August 1998
caused financing spreads, relative to Treasury bill rates, to widen to levels
where term financing in the securitization market did not make economic sense to
management. As a result, the Company did not enter into securitization
transactions during the second half of 1998. At December 31, 1998 and 1997,
securitized student loans outstanding totaled $17.9 billion and $14.1 billion,
respectively.
The Company accounts for its securitization transactions in accordance with
SFAS No. 125 "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," which establishes the accounting for certain
financial asset transfers including securitization transactions. Under SFAS 125,
the Company records a gain on sale equal to the present value of the expected
net cash flows from the trust to the Company over the life of the portfolio
sold. The resultant asset (the "Interest Residual") consists of
F-18
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
8. STUDENT LOAN SECURITIZATION (CONTINUED)
the net present value of the excess of the interest earned on the portfolio of
student loans sold to the trust less the interest paid on the asset-backed
securities, servicing and administration fees, the estimated cost of borrower
benefit programs, expected losses from risk-sharing on defaulted loans and other
student loan related costs. In addition, the Company continues to service the
loans in the trusts for a fee and earns that fee over the life of the portfolio.
When the contract servicing fee is greater than current market servicing rates,
the present value of such excess servicing fees is recognized as a servicing
asset and included in the gain on sale.
For each securitization the Company records the Interest Residual asset and
a servicing asset which represent the Company's retained interest in assets sold
to the trust. These assets are determined by allocating the previous carrying
amount of the student loans securitized among the loans sold, the retained
Interest Residual asset and the servicing asset retained based on their relative
fair market values at the time of sale. The Interest Residual asset is an
available-for-sale security as defined by SFAS 115 and is therefore
marked-to-market through equity (net of tax). Servicing assets are amortized in
proportion to, and over the period of, estimated net servicing income.
Impairment of servicing assets is evaluated periodically using discounted
cashflows and comparing them to the net carrying value of those assets with the
rate of loan prepayment being the most significant estimate involved in the
measurement process. At December 31, 1998, there was no valuation allowance on
the servicing asset. At December 31, 1998 and 1997, the Interest Residual asset
was $727 million and $451 million and the servicing asset was $44 million and
$55 million.
On July 23, 1997, the U.S. Department Education, pursuant to a court order,
decided that the 30 basis point annual Offset Fee does not apply to student
loans the GSE has securitized. The GSE initially filed suit in the U.S. District
Court for the District of Columbia in April 1995 challenging the Secretary of
Education's attempt to apply the Offset Fee to securitized loans. The GSE
prevailed, and the Court of Appeals ruled that the fee applies only to loans
that the GSE owns. In addition, the Court of Appeals upheld the
constitutionality of the Offset Fee, which applies annually with respect to the
principal amount of student loans that the Company holds on-balance sheet and
that were acquired on or after August 10, 1993. Based upon the favorable final
ruling in this matter, the reserve of approximately $97 million pre-tax was
reversed and recognized in income in the third quarter of 1997. In the
consolidated statements of income, $94 million of the reserve reversal is
included in the gain on sale of student loans for 1997 and $3 million is
included in servicing and securitization revenue for 1997. Since the third
quarter of 1997, all securitization gains are calculated without consideration
of the Offset Fee.
9. DERIVATIVE FINANCIAL INSTRUMENTS
DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR PURPOSES OTHER THAN TRADING
The Company enters into various financial instruments with off-balance sheet
risk in the normal course of business primarily to reduce interest rate risk and
foreign currency exposure on certain borrowings. These financial instruments
include interest rate swaps, interest rate cap and collar agreements, foreign
currency swaps, forward currency exchange agreements, options on currency
exchange agreements, options on securities and financial futures contracts.
The Company enters into three general types of interest rate swaps under
which it pays the following: 1) a floating rate in exchange for a fixed rate
(standard swaps); 2) a fixed rate in exchange for a floating
F-19
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
9. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
rate (reverse swaps); and 3) a floating rate in exchange for another floating
rate, based upon different market indices (basis/reverse basis swaps). At
December 31, 1998, the Company had outstanding $11.6 billion, $1.2 billion and
$17.8 billion of notional principal amount of standard swaps, reverse swaps and
basis/ reverse basis swaps, respectively. Of the Company's $30.6 billion of
interest rate swaps outstanding at December 31, 1998, $29.4 billion was related
to debt and $1.2 billion was related to investments. At December 31, 1997, the
Company had notional principal outstanding of $18.2 billion, $1.1 billion and
$16.5 billion of standard swaps, reverse swaps and basis/reverse basis swaps,
respectively. Of the Company's $35.8 billion of interest rate swaps outstanding
at December 31, 1997, $34.7 billion was related to debt and $1.1 billion was
related to investments.
The following tables summarize the ending balances of the borrowings that
have been matched with interest rate swaps and foreign currency agreements at
December 31, 1998 and 1997 (dollars in billions).
AT DECEMBER 31, 1998
--------------------------------------------------------------------------------------
SWAPS
----------------------------------------- FOREIGN
BASIS/ CURRENCY TOTAL
BORROWINGS STANDARD REVERSE REVERSE BASIS AGREEMENTS DERIVATIVES
------------- ----------- ----------- --------------- ------------- -------------
Short-term borrowings
Six month floating rate notes........... $ -- $ -- $ -- $ -- $ -- $ --
Other floating rate notes............... 3.2 -- -- 6.1 -- 6.1
Discount notes.......................... .9 -- -- .9 -- .9
Fixed rate notes........................ 4.3 4.2 -- 3.3 -- 7.5
Securities sold--not yet purchased and
repurchase agreements................. -- -- -- -- -- --
Short-term portion of long-term notes... 3.6 2.8 -- 3.4 -- 6.2
----- ----- ----- ----- ----- -----
Total short-term borrowings......... 12.0 7.0 -- 13.7 -- 20.7
----- ----- ----- ----- ----- -----
Long-term notes
Floating rate notes:
U.S. dollar denominated:
Interest bearing.................... .4 -- -- .7 -- .7
Fixed rate notes:
U.S. dollar denominated:
Interest bearing.................... 4.6 4.6 -- 3.2 -- 7.8
Zero coupon......................... -- -- -- -- -- --
Foreign currency:
Interest bearing...................... .2 -- -- .2 .2 .4
----- ----- ----- ----- ----- -----
Total long-term notes............... 5.2 4.6 -- 4.1 .2 8.9
----- ----- ----- ----- ----- -----
Total notes......................... $ 17.2 $ 11.6 $ -- $ 17.8 $ .2 $ 29.6
----- ----- ----- ----- ----- -----
----- ----- ----- ----- ----- -----
F-20
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
9. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
AT DECEMBER 31, 1997
--------------------------------------------------------------------------------------
SWAPS
----------------------------------------- FOREIGN
BASIS/ CURRENCY TOTAL
BORROWINGS STANDARD REVERSE REVERSE BASIS AGREEMENTS DERIVATIVES
------------- ----------- ----------- --------------- ------------- -------------
Short-term borrowings
Six month floating rate notes........... $ -- $ -- $ -- $ -- $ -- $ --
Other floating rate notes............... .4 -- -- .8 -- .8
Discount notes.......................... .5 -- -- .5 -- .5
Fixed rate notes........................ 6.0 6.0 -- 4.7 -- 10.7
Securities sold--not yet purchased and
repurchase agreements................. -- -- -- -- -- --
Short-term portion of long-term notes... 4.0 3.2 -- 3.5 -- 6.7
----- ----- ----- ----- ----- -----
Total short-term borrowings......... 10.9 9.2 -- 9.5 -- 18.7
----- ----- ----- ----- ----- -----
Long-term notes
Floating rate notes:
U.S. dollar denominated:
Interest bearing.................... .8 .3 -- 1.0 -- 1.3
Fixed rate notes:
U.S. dollar denominated:
Interest bearing.................... 8.7 8.7 -- 5.8 -- 14.5
Zero coupon......................... -- -- -- -- -- --
Dual currency........................... -- -- -- -- -- --
Foreign currency:
Interest bearing...................... .3 -- -- .2 .3 .5
----- ----- ----- ----- ----- -----
Total long-term notes............... 9.8 9.0 -- 7.0 .3 16.3
----- ----- ----- ----- ----- -----
Total notes......................... $ 20.7 $ 18.2 $ -- $ 16.5 $ .3 $ 35.0
----- ----- ----- ----- ----- -----
----- ----- ----- ----- ----- -----
F-21
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
9. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
The following table summarizes the activity for the Company's interest rate
swaps, foreign currency agreements and futures contracts held or issued for
purposes other than trading for the years ended December 31, 1996, 1997 and 1998
(dollars in millions).
NOTIONAL PRINCIPAL
-------------------------
INTEREST FOREIGN FUTURES
RATE CURRENCY CONTRACT
SWAPS AGREEMENTS AMOUNTS
------------ ----------- ---------
Balance, December 31, 1995.................................................. $ 36,180 $ 1,484 $ 180
Issuances/Opens........................................................... 14,571 14 2,631
Maturities/Expirations.................................................... (13,369) (310) (708)
Terminations/Closes....................................................... (300) -- (1,925)
------------ ----------- ---------
Balance, December 31, 1996.................................................. 37,082 1,188 178
Issuances/Opens........................................................... 11,890 7 4,257
Maturities/Expirations.................................................... (13,165) (938) (885)
Terminations/Closes....................................................... -- -- (2,551)
------------ ----------- ---------
Balance, December 31, 1997.................................................. 35,807 257 999
Issuances/Opens........................................................... 14,524 -- 2,737
Maturities/Expirations.................................................... (18,332) -- --
Terminations/Closes....................................................... (1,400) (38) (3,170)
------------ ----------- ---------
Balance, December 31, 1998.................................................. $ 30,599 $ 219 $ 566
------------ ----------- ---------
------------ ----------- ---------
INTEREST RATE SWAPS
Net payments related to the debt-related swaps are recorded in interest
expense. For the years ended December 31, 1998, 1997 and 1996, the Company
received net payments on debt-related swaps reducing interest expense by $74
million, $105 million and $165 million, respectively.
As of December 31, 1998, stated maturities of interest rate swaps and
maturities if accelerated to the put dates, are shown in the following table
(dollars in millions). The maturities of interest rate swaps generally coincide
with the maturities of the associated assets or borrowings.
DECEMBER 31, 1998
----------------------
STATED MATURITY TO
YEAR OF MATURITY/PUT MATURITY PUT DATE
- ---------------------------------------------------------------------- --------- -----------
1999.................................................................. $ 17,377 $ 20,237
2000.................................................................. 7,635 6,060
2001.................................................................. 4,210 3,075
2002.................................................................. 162 12
2003.................................................................. 30 30
2004-2008............................................................. 1,185 1,185
--------- -----------
$ 30,599 $ 30,599
--------- -----------
--------- -----------
F-22
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
9. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
FOREIGN CURRENCY AGREEMENTS
At December 31, 1998 and 1997, the Company had borrowings with principal
repayable in foreign currencies of $263 million and $257 million, respectively.
These borrowings were hedged by notional principal of $219 million and $257
million, respectively, of foreign currency swaps. The foreign currency
derivative agreements typically mature concurrently with the maturities of the
debt. The following table summarizes the outstanding amount of these borrowings
and their currency translation values at December 31, 1998 and 1997, using spot
rates at the respective dates (dollars in millions).
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Carrying value of outstanding foreign currency debt........................... $ 263 $ 257
Currency translation value of outstanding foreign currency debt............... $ 218 $ 191
FUTURES CONTRACTS
The Company enters into financial futures contracts to hedge the risk of
future interest rate changes. The contracts provide a better matching of
interest rate reset dates on debt with the Company's assets. They are also used
as anticipatory hedges of debt to be issued to fund the Company's assets. The
gains and losses on these hedging transactions are deferred and included in
other assets and will be recognized as an adjustment to interest expense. At
December 31, 1998 and 1997, the Company had futures contracts that hedged
approximately $566 million and $999 million of debt, respectively. Approximately
$4.7 million and $4.3 million of realized losses had been deferred at December
31, 1998 and 1997 respectively, related to futures contracts.
FLOOR INTEREST CONTRACTS
During 1998, 1997 and 1996, the Company entered into Floor Interest
Contracts with principal balances of $23 billion, $11 billion and $13 billion,
respectively, in exchange for upfront payments of $38 million, $14 million and
$128 million, respectively. For the years ended December 31, 1998, 1997 and
1996, the amortization of the upfront payments on fixed and variable Floor
Interest Contracts increased student loan income by $52 million, $41 million and
$23 million, respectively, of which $28 million, $34 million and $22 million,
respectively, related to contracts with fixed borrower rates and $24 million, $7
million and $1 million, respectively, related to contracts with annually reset
borrower rate. In addition, in 1998 the Company sold Floor Interest Contracts
related to off-balance sheet student loans, and the amortization of the upfront
payments on these contracts increased securitization revenue by $4 million. For
the years ended December 31, 1998, 1997 and 1996, payments under the contracts
totaled $58 million, $19 million and $12 million, respectively.
DERIVATIVE FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES
From time to time the Company maintains trading positions in derivative
financial instruments which are designed to generate additional income based on
market conditions. Trading results for these positions were immaterial to the
Company's financial statements for the years ended December 31, 1998, 1997 and
1996. As of December 31, 1998, the Company had no trading positions outstanding.
During December 1995, the Company entered into a derivative contract of $1.5
billion notional amount whose value is
F-23
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
9. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
determined by both the market value and the yield of certain AAA rated variable
rate asset-backed securities. The mark-to-market gain/(loss) on this contract,
which is included in gains/(losses) on sales of securities in the Consolidated
Statements of Income, was $(2) million, $3 million and $4 million for the years
ended December 31, 1998, 1997 and 1996, respectively. This contract matured on
January 15, 1998.
10. FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires estimation of the fair values of financial instruments. The following
is a summary of the assumptions and methods used to estimate those values.
STUDENT LOANS
Fair value was determined by analyzing amounts which the Company has paid
recently to acquire similar loans in the secondary market.
WAREHOUSING ADVANCES AND ACADEMIC FACILITIES FINANCINGS
The fair values of both warehousing advances and academic facilities
financings were determined through standard bond pricing formulas using current
interest rates and credit spreads.
CASH AND INVESTMENTS
For investments with remaining maturities of three months or less, carrying
value approximated fair value. Investments in U.S. Treasury securities were
valued at market quotations. All other investments were valued through standard
bond pricing formulas using current interest rates and credit spreads.
SHORT-TERM BORROWINGS AND LONG-TERM NOTES
For borrowings with remaining maturities of three months or less, carrying
value approximated fair value. Where available the fair value of financial
liabilities was determined from market quotations. If market quotations were
unavailable standard bond pricing formulas were applied using current interest
rates and credit spreads.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
The fair values of off-balance sheet financial instruments were estimated at
the amount that would be required to terminate such agreements, taking into
account current interest rates and credit spreads.
F-24
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
10. FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
The following table summarizes the fair values of the Company's financial
assets and liabilities, including off-balance sheet financial instruments
(dollars in millions):
DECEMBER 31, 1998 DECEMBER 31, 1997
--------------------------------- ---------------------------------
FAIR CARRYING FAIR CARRYING
VALUE VALUE DIFFERENCE VALUE VALUE DIFFERENCE
--------- --------- ----------- --------- --------- -----------
EARNING ASSETS
Student loans................................. $ 29,138 $ 28,283 $ 855 $ 29,773 $ 29,444 $ 329
Warehousing advances.......................... 1,529 1,543 (14) 1,864 1,869 (5)
Academic facilities financings................ 1,219 1,180 39 1,405 1,375 30
Cash and investments.......................... 4,107 4,106 1 5,130 5,130 --
--------- --------- ----- --------- --------- -----
Total earning assets.......................... 35,993 35,112 881 38,172 37,818 354
--------- --------- ----- --------- --------- -----
INTEREST BEARING LIABILITIES
Short-term borrowings......................... 26,580 26,589 9 23,161 23,176 15
Long-term notes............................... 8,931 8,810 (121) 14,553 14,541 (12)
--------- --------- ----- --------- --------- -----
Total interest bearing liabilities............ 35,511 35,399 (112) 37,714 37,717 3
--------- --------- ----- --------- --------- -----
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
Interest rate swaps........................... 75 -- 75 59 -- 59
Forward exchange agreements and foreign
currency swaps.............................. (56) -- (56) (99) -- (99)
Floor revenue contracts....................... (179) (60) (119) (59) (78) 19
Academic facilities financing commitments..... -- -- -- --
Letters of credit............................. -- -- -- --
----- -----
Excess of fair value over carrying value...... $ 669 $ 336
----- -----
----- -----
At December 31, 1998 and 1997, substantially all interest rate swaps and
foreign currency swaps were hedging liabilities.
11. COMMITMENTS AND CONTINGENCIES
The GSE has committed to purchase student loans during specified periods and
to lend funds under the warehousing advance commitments, academic facilities
financing commitments and letters of credit programs.
Letters of credit support the issuance of state student loan revenue bonds.
They represent unconditional guarantees of the GSE to repay holders of the bonds
in the event of a default. In the event that letters of credit are drawn upon,
such loans are collateralized by the student loans underlying the bonds. Under
the terms of the Privatization Act, any future activity under warehousing
advance commitments, academic facilities financing commitments and letter of
credit activity by the GSE is limited to guarantee commitments which were in
place on August 7, 1997.
F-25
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Commitments outstanding are summarized below:
DECEMBER 31,
----------------------------
1998 1997
------------- -------------
Student loan purchase commitments.............................. $ 17,103,585 $ 17,494,734
Warehousing advance commitments................................ 3,081,515 3,370,419
Academic facilities financing commitments...................... 13,200 19,577
Letters of credit.............................................. 4,691,974 4,829,089
------------- -------------
$ 24,890,274 $ 25,713,819
------------- -------------
------------- -------------
The following schedule summarizes expirations of commitments outstanding to
the earlier of call date or maturity date at December 31, 1998:
DECEMBER 31, 1998
------------------------------------------------------
ACADEMIC
STUDENT LOAN WAREHOUSING FACILITIES LETTERS OF
PURCHASES ADVANCES FINANCINGS CREDIT
------------- ------------ ----------- ------------
1999.................................. $ 3,885,721 $ 70,191 $ 13,200 $ 785,290
2000.................................. 3,133,668 1,311,323 -- 2,100,506
2001.................................. 3,275,850 -- -- 848,506
2002.................................. 6,808,346 1,700,001 -- 713,681
2003.................................. -- -- -- --
2004.................................. -- -- -- 213,151
Thereafter............................ -- -- -- 30,840
------------- ------------ ----------- ------------
Total............................. $ 17,103,585 $3,081,515 $ 13,200 $ 4,691,974
------------- ------------ ----------- ------------
------------- ------------ ----------- ------------
MINIMUM STATUTORY CAPITAL ADEQUACY RATIO
The Privatization Act effectively requires that the GSE maintain a minimum
statutory capital adequacy ratio (the ratio of stockholders' equity to total
assets plus 50 percent of the credit equivalent amount of certain off-balance
sheet items) of at least 2 percent until January 1, 2000 and 2.25 percent
thereafter or be subject to certain "safety and soundness" requirements designed
to restore such statutory ratio. Management anticipates being able to fund the
increase in required capital from the GSE's current and retained earnings. While
the GSE may not finance the activities of its non-GSE affiliates, it may,
subject to its minimum capital requirements, dividend retained earnings and
surplus capital to SLM Holding, which in turn may contribute such amounts to its
non-GSE subsidiaries. The Privatization Act now requires management to certify
to the Secretary of the Treasury that, after giving effect to the payment of
dividends, the statutory capital ratio test would have been met at the time the
dividend was declared. At December 31, 1998, the GSE's statutory capital
adequacy ratio, after the effect of the dividends to be paid in the first
quarter of 1999, was 2.00 percent.
LEGISLATIVE DEVELOPMENTS
On October 7, 1998, the President signed into law the Higher Education
Amendments of 1998, legislation that reauthorizes federal higher education
programs for a six-year period (the "Reauthorization
F-26
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Legislation"). The Reauthorization Legislation lowers both the borrower interest
rate on Stafford loans to a formula based on the 91-day Treasury bill rate plus
2.3 percent (1.7 percent during in-school and grace periods) and the lender's
rate after special allowance payments to the 91-day Treasury bill rate plus 2.8
percent (2.2 percent during in-school and grace periods) for loans originated on
or after October 1, 1998 and before July 1, 2003. The borrower interest rate on
PLUS loans originated during this period will be equal to the 91-day Treasury
bill rate plus 3.1 percent. Special allowance payments are also based on the
91-day Treasury bill rate plus 3.1 percent.
LITIGATION
On December 19, 1996, Orange County, California filed an amended complaint
against the Company in the U.S. Bankruptcy Court for the Central District of
California. The case is currently pending in the U.S. District Court for the
Central District of California. The complaint alleges that the Company made
fraudulent representations and omitted material facts in offering circulars on
various bond offerings purchased by Orange County, which contributed to Orange
County's market losses and subsequent bankruptcy. The complaint seeks to hold
the GSE liable for losses resulting from Orange County's bankruptcy, but does
not specify the amount of damages claimed.
After extended discovery, Merrill Lynch signed a memorandum of settlement
terms that calls for Orange County to dismiss all claims against the Company
with prejudice and without any payment by the Company to Orange County. Final
papers have been signed between Orange County and Merrill Lynch and Orange
County has signed a release of claims against Sallie Mae. The settlement
agreement, however, must be approved by the court as having been made in "good
faith" for purposes of Section 877 of the California Code of Civil Procedure. A
number of the non-settling defendants, including a law firm and various
broker-dealers, have objected to the good faith settlement motion. A hearing on
the motion for good faith settlement was held on November 23, 1998. On that
date, the court issued a preliminary order approving the settlement agreement
and on March 1, 1999, the court entered a final judgement confirming that order.
12. MINORITY INTEREST
Upon the Reorganization on August 7, 1997, each outstanding share of common
stock of the GSE was converted into one share of common stock of SLM Holding.
The outstanding preferred stock of the GSE was not affected by the
Reorganization and is reflected as minority interest in the consolidated
financial statements.
The GSE's preferred stock dividends are cumulative and payable quarterly at
4.50 percentage points below the highest yield of certain long-term and
short-term U.S. Treasury obligations. The dividend rate for any dividend period
will not be less than 5 percent per annum nor greater than 14 percent per annum.
For the years ended December 31, 1998, 1997 and 1996, the GSE's preferred
dividend rate was 5 percent and reduced net income by $10.7 million. The
Privatization Act requires that on the dissolution date of September 30, 2008,
the GSE shall repurchase or redeem, or make proper provisions for repurchase or
redemption of any outstanding preferred stock. The Company has the option of
effecting an earlier dissolution of the GSE if certain conditions are met.
F-27
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
13. COMMON STOCK
In November 1997, the Company announced that it would effect a 7-for-2 stock
split through a stock dividend of an additional five shares for every two
already outstanding, effective January 2, 1998, for shareholders of record on
December 12, 1997. The stock dividend did not affect the par value of the common
stock and as a result, $26.2 million was reclassified from retained earnings
($26.1 million) and additional paid-in-capital ($.1 million) to common stock to
account for the additional shares issued. In the consolidated statement of
changes in stockholders' equity the effect of the stock dividend has been
presented retroactively to the earliest period presented and the balances of
common stock, additional paid-in-capital and retained earnings as well as all
common stock activity have been restated to reflect the dividend. All share and
per share amounts have been restated to reflect the payment of that dividend.
On August 7, 1997, each outstanding share of GSE common stock, par value
$.20 per share, was converted into one share of SLM Holding common stock, par
value $.20 per share. Prior to the conversion of common stock, the GSE retired
49.8 million shares of treasury stock at an average price of $15.94 per share
resulting in decreases of $10 million to common stock, $48 million to additional
paid-in-capital and $736 million to retained earnings. In December 1996, the
Company retired 206.5 million shares of common stock held as treasury stock at
an average price of $12.67. This retirement decreased the balance in treasury
stock by $2.6 billion with corresponding decreases of $41 million in common
stock, $506 million in additional paid-in-capital and $2.1 billion to retained
earnings.
The Board of Directors has authorized and reserved 18.9 million common
shares for issuance under various compensation and benefit plans. At December
31, 1998, under these authorizations, the Company has 17.0 million shares in
reserve and a remaining authority for issuance of 11.3 million shares.
The Company has engaged in repurchases of its common stock since 1986. In
1998, the Company supplemented its open market common stock purchases by
entering into equity forward transactions to purchase 18.5 million shares on a
cash or net share settled basis. At December 31, 1998, the Company had contracts
outstanding to purchase 20.5 million shares. In January 1999, the Board of
Directors increased the Company's authority to repurchase shares through either
the open market or through equity forward contracts to 12.7 million shares.
Basic earnings per common share are calculated using the weighted average
number of shares of common stock outstanding during each period. Diluted
earnings per common share reflect the potential dilutive effect of additional
common shares that are issuable upon exercise of outstanding stock options
F-28
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
13. COMMON STOCK (CONTINUED)
and warrants, determined by the treasury stock method, and equity forwards,
determined by the reverse treasury stock method, as follows:
AVERAGE EARNINGS
NET INCOME SHARES PER SHARE
----------- ----------- -----------
(THOUSANDS) (THOUSANDS)
Year ended December 31, 1998
Basic EPS............................................... $ 501,464 167,684 $ 2.99
Dilutive effect of stock options, warrants and equity
forwards.............................................. -- 2,382 (.04)
----------- ----------- -----
Diluted EPS............................................. $ 501,464 170,066 $ 2.95
----------- ----------- -----
----------- ----------- -----
Year ended December 31, 1997
Basic EPS............................................... $ 507,895 181,554 $ 2.80
Dilutive effect of stock options and warrants........... -- 1,387 (.02)
----------- ----------- -----
Diluted EPS............................................. $ 507,895 182,941 $ 2.78
----------- ----------- -----
----------- ----------- -----
14. STOCK OPTION PLANS
SLM Holding maintains stock option plans for its employees which permit
grants of stock options for the purchase of common stock with exercise prices
equal to or greater than the market value on the date of grant.
After the change in management control in August 1997, the Board of
Directors granted options, which have 10-year terms and vest in one-third
increments, to officers and key employees under the 1993-1998 Stock Option Plan.
Options granted to executive management under this plan in August 1997 vest in
one year and (1) one-third on the date that the Company's common stock closes
above $42.86 per share for five business days; (2) one-third on the date that
the Company's common stock closes above $57.14 per share for five business days;
and (3) one-third on the date that the Company's common stock price closes above
$71.43 per share for five business days. Options granted to officers and key
employees in November 1997 vest: (1) one-third, one year from the date of grant;
(2) one-third on the later of one year or the date that the Company's common
stock closes above $57.14 per share for five business days; and (3) one-third on
the later of one year or the date that the Company's common stock price closes
above $71.43 per share for five business days. As of December 31, 1998,
one-third of these options had vested. In the event that the Company's common
stock price does not close above the predetermined prices, all outstanding
options will vest eight years after the date of grant. Under this plan, the
Company was originally authorized to grant up to 17.8 million shares. Options
granted by prior Boards of Directors generally have 10-year terms and vest one
year after the date of grant.
In May 1998, shareholders approved a Management Incentive Plan, which
replaced the 1993-1998 Stock Option Plan. Under this plan, the Board may confer
certain awards to officers and employees, which may be in the form of stock
options, performance stock, and incentive bonuses. The Board authorized up to 6
million shares of the Company's common stock that could be issued pursuant to
such awards and at December 31, 1998, this plan had remaining authority of 5.0
million shares. In 1998, options granted under this plan have ten year terms and
vest in one-third increments identical to those of the options granted in
F-29
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
14. STOCK OPTION PLANS (CONTINUED)
November 1997 to officers and key employees. In the event that the Company's
common stock price does not close above the predetermined prices, all
outstanding options will vest eight years after the date of grant.
The Company's Board of Directors authorized the grant of options for up to
5.5 million shares of common stock under the Employee Stock Option Plan, of
which there is remaining authority of 2.0 million shares at December 31, 1998.
Stock options were granted under this plan to all non-officer employees of the
Company and have ten year terms with one-half of the options vesting one year
from the date of grant and one-half vesting two years from the date of grant.
The following table summarizes the employee stock option plans for the years
ended December 31, 1998, 1997 and 1996. The weighted average fair value of
options granted during the year is based on an option-pricing model.
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------
1998 1997 1996
---------------------- ----------------------- ----------------------
AVERAGE AVERAGE AVERAGE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
----------- --------- ------------ --------- ----------- ---------
Outstanding at beginning of year........... 8,365,532 $ 37.30 3,261,500 $ 17.37 3,832,413 $ 13.94
Granted.................................... 2,935,893 43.91 13,156,252 40.64 1,139,408 20.88
Exercised.................................. (598,248) 29.89 (2,864,110) 17.53 (1,698,771) 11.97
Canceled................................... (1,036,271) 39.04 (5,188,110) 44.16 (11,550) 20.86
----------- --------- ------------ --------- ----------- ---------
Outstanding at end of year................. 9,666,906 $ 39.58 8,365,532 $ 37.30 3,261,500 $ 17.37
----------- --------- ------------ --------- ----------- ---------
----------- --------- ------------ --------- ----------- ---------
Exercisable at end of year................. 3,077,332 $ 35.88 486,465 $ 18.79 2,133,642 $ 15.51
----------- --------- ------------ --------- ----------- ---------
----------- --------- ------------ --------- ----------- ---------
Weighted-average fair value of options
granted during the year.................. $ 17.63 $ 17.96 $ 7.39
--------- --------- ---------
--------- --------- ---------
The following table summarizes the number, average exercise prices (which
ranged from $10 per share to $50 per share) and average remaining contractual
life of the employee stock options outstanding at December 31, 1998.
AVERAGE REMAINING
EXERCISE PRICES OPTIONS AVERAGE PRICE CONTRACTUAL LIFE
- ----------------------------------------------- ---------- ------------- ---------------------
Under $20...................................... 76,650 $ 11.92 5.5Yrs.
$20-$39........................................ 2,801,036 35.79 8.5
Above $39...................................... 6,789,220 41.46 9.0
---------- ------ --
Total.......................................... 9,666,906 $ 39.58 9.0Yrs.
---------- ------ --
---------- ------ --
In May 1996, shareholders approved the Board of Directors Stock Option Plan,
which authorized the grant of options to acquire up to 700,000 shares of common
stock. Options under this plan are exercisable on the date of grant and have ten
year terms. In May 1998, the shareholders approved a Directors' Stock Plan,
which replaced the Board of Directors Stock Option Plan. Under the Directors'
Stock Plan, the Board authorized the grant of options to acquire up to 3 million
shares of common stock, of which there is remaining authority of 1.5 million
shares. Options granted under this plan have ten year terms and vest in
F-30
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
14. STOCK OPTION PLANS (CONTINUED)
one-third increments identical to those of the August 1997 executive management
options except there is no one year minimum vesting requirement. In the event
that the Company's common stock price does not close above the predetermined
prices, all outstanding options will vest eight years after the date of grant.
The following table summarizes the Board of Directors Stock Option Plans for
the years ended December 31, 1998, 1997 and 1996.
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
1998 1997 1996
--------------------- --------------------- --------------------
AVERAGE AVERAGE AVERAGE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------- --------- ---------- --------- --------- ---------
Outstanding at beginning of year................ 1,657,775 $ 38.49 220,500 $ 20.86 -- $ --
Granted......................................... -- -- 1,638,000 38.96 220,500 20.86
Exercised....................................... (2,000) 30.86 (141,225) 22.34 -- --
Canceled........................................ (33,409) 39.34 (59,500) 24.39 -- --
---------- --------- ---------- --------- --------- ---------
Outstanding at end of year...................... 1,622,366 38.48 1,657,775 $ 38.49 220,500 $ 20.86
---------- --------- ---------- --------- --------- ---------
---------- --------- ---------- --------- --------- ---------
Exercisable at end of year...................... 612,775 $ 37.07 614,775 $ 37.05 220,550 $ 20.86
---------- --------- ---------- --------- --------- ---------
---------- --------- ---------- --------- --------- ---------
Weighted-average fair value of options granted
during the year............................... $ -- $ 17.79 $ 7.38
--------- --------- ---------
--------- --------- ---------
At December 31, 1998, the outstanding Board of Directors options had a
weighted-average remaining contractual life of 8.5 years.
SLM Holding accounts for its stock option plans in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," which results in no compensation expense for stock options granted
under the plans. The following table summarizes pro forma disclosures for the
years ended December 31, 1998, 1997 and 1996, as if SLM Holding had accounted
for employee and Board of Directors stock options granted subsequent to December
31, 1994 under the fair market value method as set forth in SFAS No. 123,
"Accounting for Stock-Based Compensation." The fair value for these options was
estimated at the date of grant using an option pricing model, with the following
weighted average assumptions for the years ended December 31, 1998, 1997 and
1996, respectively: risk-free interest rate of 5 percent, 6 percent and 6
percent; volatility factor of the expected market price of SLM Holding's common
stock of 32 percent, 31 percent and 29 percent; dividend growth rate of 2
percent; and the time of exercise-expiration date. Vesting for options with
vesting periods tied to the Company's stock price is
F-31
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
14. STOCK OPTION PLANS (CONTINUED)
assumed to occur in one-third increments with one-third vesting one year from
date of grant; one-third vesting three years from date of grant; and one-third
vesting five years from date of grant.
YEARS ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
Net income............................................... $ 501,464 $ 507,895 $ 408,716
---------- ---------- ----------
---------- ---------- ----------
Pro forma net income..................................... $ 469,470 $ 486,052 $ 402,420
---------- ---------- ----------
---------- ---------- ----------
Basic earnings per share................................. $ 2.99 $ 2.80 $ 2.10
---------- ---------- ----------
---------- ---------- ----------
Pro forma basic earnings per share....................... $ 2.80 $ 2.68 $ 2.07
---------- ---------- ----------
---------- ---------- ----------
Diluted earnings per share............................... $ 2.95 $ 2.78 $ 2.09
---------- ---------- ----------
---------- ---------- ----------
Pro forma diluted earnings per share..................... $ 2.76 $ 2.66 $ 2.06
---------- ---------- ----------
---------- ---------- ----------
15. BENEFIT PLANS
PENSION PLANS
The Company has a qualified noncontributory defined benefit pension plan
(the "Plan") covering substantially all employees who meet certain service
requirements. The Plan's benefits are based on years of service and the
employee's compensation. The Company computes plan benefits on 5-year highest
average base salary, a maximum service accrual period of 30 years, and normal
retirement age of 62. The Plan is funded annually based on the maximum amount
that can be deducted for federal income tax purposes. The assets of the Plan are
primarily invested in equities and fixed income securities.
F-32
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
15. BENEFIT PLANS (CONTINUED)
The following tables provide a reconciliation of the changes in the Plan's
benefit obligation and fair value of assets over the two-year period ending
December 31, 1998, and a statement of the funded status as of December 31 of
both years:
DECEMBER 31,
----------------------
1998 1997
---------- ----------
CHANGE IN BENEFIT OBLIGATION
Projected benefit obligation at beginning of year..................... $ 92,885 $ 75,106
Service cost.......................................................... 11,624 8,453
Interest cost......................................................... 5,961 5,617
Actuarial (gain)/loss................................................. (10,547) 4,111
Benefits paid......................................................... (574) (402)
---------- ----------
Benefit obligation at end of year..................................... 99,349 92,885
---------- ----------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year........................ 101,389 75,587
Actual return on plan assets.......................................... 14,165 19,203
Employer contribution................................................. 1,856 7,001
Benefits paid......................................................... (574) (402)
---------- ----------
Fair value of plan assets at end of year.............................. 116,836 101,389
---------- ----------
FUNDED STATUS
Funded status at end of year.......................................... 17,487 8,504
Unrecognized net actuarial gain....................................... (29,751) (15,461)
Unrecognized prior service cost and transition asset.................. (2,320) (2,528)
---------- ----------
Accrued pension cost.................................................. $ (14,584) $ (9,485)
---------- ----------
---------- ----------
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Weighted-average assumptions as of December 31
Discount rate.............................................................. 7.00% 7.00%
Expected return on plan assets............................................. 8.00% 8.00%
Rate of compensation increase.............................................. 6.00% 6.00%
Net periodic pension cost included the following components:
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Service cost--benefits earned during the period............... $ 11,624 $ 8,453 $ 8,369
Interest cost on project benefit obligations.................. 5,961 5,617 5,055
Expected return on plan assets................................ (9,183) (19,203) (13,009)
Net amortization and deferral................................. (1,271) 12,431 8,429
--------- --------- ---------
Net periodic pension cost..................................... $ 7,131 $ 7,298 $ 8,844
--------- --------- ---------
--------- --------- ---------
F-33
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
15. BENEFIT PLANS (CONTINUED)
The Company maintains a nonqualified pension plan for certain key employees
as designated by the Board of Directors and a nonqualified pension plan for its
Board of Directors. The nonqualified pension plans were the only pension plans
with an accumulated benefit obligation in excess of plan assets. There are no
plan assets in the nonqualified plans due to the nature of the plans. The
accumulated benefit obligations for these plans were $10.9 million at December
31, 1998 and $10.4 million at December 31, 1997.
401(K) PLANS
The Company's 401(k) Savings Plan ("the Plan") is a defined contribution
plan that is intended to qualify under section 401(k) of the Internal Revenue
Code. The Plan covers substantially all employees who have been employed by the
Company for one or more years and have completed at least a thousand hours of
service. Participating employees may contribute up to 6 percent of base salary
and these contributions are matched 100 percent by the Company.
The Company also maintains a non-qualified Plan to ensure that designated
participants receive the full amount of benefits to which they would have been
entitled under the 401(k) Plan but for limits on compensation and contribution
levels imposed by the Internal Revenue Code.
Total expenses related to the 401(k) plans were $6.5 million, $5.2 million
and $5.0 million in 1998, 1997 and 1996, respectively.
16. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax
F-34
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
16. INCOME TAXES (CONTINUED)
purposes. Significant components of the Company's deferred tax liabilities and
assets as of December 31, 1998 and 1997 are as follows:
DECEMBER 31,
----------------------
1998 1997
---------- ----------
Deferred tax liabilities:
Leases.............................................................. $ 315,763 $ 352,046
Unrealized investment gains......................................... 200,167 203,935
Securitization transactions......................................... -- 39,735
Other............................................................... 48,778 34,500
---------- ----------
564,708 630,216
---------- ----------
Deferred tax assets:
ExportSS operating costs............................................ 39,296 46,643
Student loan reserves............................................... 35,979 51,188
In-substance defeasance transactions................................ 30,294 30,520
Asset valuation allowances.......................................... 24,467 24,490
Securitization transactions......................................... 2,049 --
Other............................................................... 75,592 49,904
---------- ----------
207,677 202,745
---------- ----------
Net deferred tax liabilities.......................................... 357,031 $ 427,471
---------- ----------
---------- ----------
The GSE is exempt from all state, local and District of Columbia taxes
except for real property taxes. SLM Holding and its other subsidiaries are
subject to state and local taxes which were immaterial in 1998 and 1997.
Deferred tax assets on in-substance defeasance transactions resulted from
premiums on the debt extinguished. These premiums are capitalized and amortized
over the life of the defeasance trust for tax purposes.
Reconciliations of the statutory U.S. federal income tax rates to the
Company's effective tax rate follow:
YEARS ENDED
DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Statutory rate.................................................... 35.0% 35.0% 35.0%
Tax exempt interest and dividends received deduction.............. (3.0) (3.0) (3.8)
Other, net........................................................ (.3) (.2) (1.1)
--- --- ---
Effective tax rate................................................ 31.7% 31.8% 30.1%
--- --- ---
--- --- ---
F-35
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
1998
----------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
---------- ---------- ---------- ----------
Net interest income.............................................. $ 174,577 $ 177,684 $ 149,876 $ 160,515
Less: provision for losses....................................... 5,513 6,387 1,905 14,814
---------- ---------- ---------- ----------
Net interest income after provision for losses................... 169,064 171,297 147,971 145,701
Other income..................................................... 130,402 138,643 99,542 108,380
Operating expenses............................................... 90,862 93,732 86,540 89,735
Income taxes..................................................... 66,923 69,303 50,487 51,260
Minority interest in net earnings of subsidiary.................. 2,673 2,674 2,674 2,673
---------- ---------- ---------- ----------
Net income....................................................... $ 139,008 $ 144,231 $ 107,812 $ 110,413
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Basic earnings per common share.................................. $ .81 $ .86 $ .65 $ .67
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted earnings per common share................................ $ .80 $ .84 $ .64 $ .66
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
1997
----------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
---------- ---------- ---------- ----------
Net interest income.............................................. $ 205,170 $ 208,060 $ 183,599 $ 184,327
Less: provision for losses....................................... 6,144 599 13,257 3,478
---------- ---------- ---------- ----------
Net interest income after provision for losses................... 199,026 207,461 170,342 180,849
Other income..................................................... 75,940 78,055 218,691 123,151
Operating expenses............................................... 101,559 115,283 172,945 103,980
Income taxes..................................................... 54,570 51,069 70,821 64,699
Minority interest in net earnings of subsidiary.................. 2,674 2,673 2,674 2,673
---------- ---------- ---------- ----------
Net income....................................................... $ 116,163 $ 116,491 $ 142,593 $ 132,648
---------- ---------- ---------- ----------
Basic earnings per common share.................................. $ .62 $ .63 $ .79 $ .76
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted earnings per common share................................ $ .62 $ .63 $ .78 $ .75
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
F-36
APPENDIX A
THE FEDERAL FAMILY EDUCATION LOAN PROGRAM
GENERAL
The Federal Family Education Loan Program ("FFELP") (formerly the Guaranteed
Student Loan Program ("GSLP")) under Title IV of the Higher Education Act (the
"Act") provides for loans to be made to students or parents of dependent
students enrolled in eligible institutions to finance a portion of the costs of
attending school. If a borrower defaults on a student loan, becomes totally or
permanently disabled, dies, files for bankruptcy or attends a school that closes
prior to the student earning a degree, or if the applicable education
institution falsely certifies the borrower's eligibility for a federally insured
student loan (collectively "insurance triggers"), the holder of the loan (which
must be an eligible lender) may file a claim with the applicable state or
private nonprofit guarantee agency (each a "Guarantee Agency"). Provided that
the loan has been properly originated and serviced, the Guarantee Agency pays
the holder all or a portion of the unpaid principal balance on the loan as well
as accrued interest ("Guarantee Payments"). Origination and servicing
requirements, as well as procedures to cure deficiencies, are established by the
U.S. Department of Education (the "Department") and the various Guarantee
Agencies.
Under the FFELP, payment of principal and interest with respect to the
student loans is guaranteed against default, death, bankruptcy or disability of
the applicable borrower by the applicable Guarantee Agency. The Guarantee
Agencies are entitled, subject to certain conditions, to be reimbursed for all
or a portion of Guarantee Payments they make by the Department pursuant to a
program of federal reinsurance under the Act. Guarantee Agencies enter into
reinsurance agreements with the Department pursuant to which the Department
agrees to reimburse the Guarantee Agency for all or a portion of the amount
expended by the Guarantee Agency in discharge of its guarantee obligation with
respect to default claims provided the loans have been properly originated and
serviced. Except for claims resulting from death, disability or bankruptcy of a
borrower or where the school the borrower attended closed or the borrower's
eligibility was falsely certified, in which cases the Department pays the full
amount of the claim, the amount of reinsurance depends on the default experience
of the Guarantee Agency. See "--Federal Insurance and Reinsurance of Guarantee
Agencies."
Guarantee Agencies pay the claims to holders of defaulted loans from their
"Federal Reserve Fund." The Federal Reserve Fund is funded by insurance premiums
Guarantee Agencies charge on student loans (currently up to 1 percent of loan
principal), reinsurance received from the Department and a portion of funds
received in connection with their debt collection activities (generally five
percent of its collections on defaulted student loans), and investment income
from reserve funds. Claims that a Guarantee Agency is financially unable to pay
will be paid by the Department or transferred to a financially sound Guarantee
Agency, if the Department makes the necessary determination that the Guarantee
Agency is financially unable to pay.
Several types of guaranteed student loans are currently authorized under the
Act: (i) loans to students who pass certain financial need tests ("Subsidized
Stafford Loans"); (ii) loans to students who do not pass the Stafford need tests
or who need additional loans to supplement their Subsidized Stafford Loans
("Unsubsidized Stafford Loans"); (iii) loans to parents of students ("PLUS
Loans") who are dependents and whose need exceed the financing available from
Subsidized Stafford Loans and/or Unsubsidized Stafford Loans; and (iv) loans to
consolidate the borrower's obligations under various federally authorized
student loan programs into a single loan ("Consolidation Loans"). Prior to July
1, 1994 the Act permitted a different type of loan to graduate and professional
students and independent undergraduate students and, under certain
circumstances, dependent undergraduate students who needed additional loans to
supplement their Subsidized Stafford Loans ("Supplemental Loans to Students" or
"SLS Loans").
A-1
The FFELP is subject to statutory and regulatory revision from time to time.
The most recent significant revisions are contained in the Higher Education
Amendments of 1992 ("the 1992 Amendments"), the Omnibus Budget Reconciliation
Act of 1993 ("the 1993 Act"), the "Higher Education Technical Amendments of
1993" (the "Technical Amendments") and the Higher Education Amendments of 1998
(the "Reauthorization Legislation"). The 1993 Act contains significant changes
to the FFELP and created a direct loan program funded directly by the U.S.
Department of Treasury (each loan under such program, a "Federal Direct Student
Loan").
The description and summaries of the Act, the FFELP, the Guarantee
Agreements and the other statutes and regulations referred to in this report do
not purport to be comprehensive, and are qualified in their entirety by
reference to each such statute or regulation. The Act is codified at 20 U.S.C.
SectionSection1071 et seq., and the principal regulations promulgated thereunder
can be found at 34 C.F.R. Part 682. There can be no assurance that future
amendments or modifications will not materially change any of the terms or
provisions of the programs described in this report of the statutes and
regulations implementing these programs.
LEGISLATIVE AND ADMINISTRATIVE MATTERS
The 1993 Act, effective August 10, 1993, implemented a number of changes to
the federal guaranteed student loan programs, including imposing on lenders or
holders of guaranteed student loans certain fees, providing for 2 percent lender
risk sharing, reducing interest rates and Special Allowance Payments for certain
loans, effectively reducing the interest payable to holders of Consolidation
Loans and affecting the Department's financial assistance to Guarantee Agencies,
including by reducing the percentage of claims the Department will reimburse
Guarantee Agencies and reducing more substantially the premiums and default
collections that Guarantee Agencies are entitled to receive and/or retain.
The Act was amended by enactment of the Reauthorization Legislation, the
general provisions of which became effective October 1, 1998 and which extend
the principal provisions of the FFELP to July 1, 2003. The Reauthorization
Legislation lowered both the borrower interest rate on Stafford loans to a
formula based on the 91-day Treasury bill rate plus 2.3 percent (1.7 percent
during in-school and grace periods) and the lender's rate after special
allowance payments to the 91-day Treasury bill rate plus 2.8 percent (2.2
percent during in-school and grace periods) for loans originated on or after
October 1, 1998 and before July 1, 2003. The borrower interest rate on PLUS
loans originated during this period will be equal to the 91-day Treasury bill
rate plus 3.1 percent. Special allowance payments are also based on the 91-day
Treasury bill rate plus 3.1 percent. These rate reductions were first introduced
on an interim basis in temporary student loan legislation enacted into law on
June 9, 1998 and effective for loans originated from July 1, 1998 through
September 30, 1998.
The Reauthorization Legislation also maintained interest rates for borrowers
of Federal Direct Consolidation Loans whose applications for such loans were
received prior to February 1, 1999 at 7.46 percent, which rates are adjusted
annually based on a formula equal to the 91-day Treasury bill rate plus 2.3
percent. The borrower interest rates on Federal Direct Consolidation Loans for
borrowers whose applications are received on or after February 1, 1999 and
before July 1, 2003 will be a fixed rate equal to the lesser of the weighted
average of the interest rates of the loans consolidated, adjusted up to the
nearest one eighth of one percent, and 8.25%. This is the same rate that the
Reauthorization Legislation sets on FFELP Consolidation Loans for borrowers
whose applications are received on or after October 1, 1998 and before July 31,
2003. The Reauthorization Legislation sets the special allowance payment rate
for FFELP Consolidation Loans at the 91-day Treasury bill rate plus 3.1 percent.
The annual fee paid by lenders on FFELP Consolidation Loans was reduced under
the Reauthorization Legislation from 1.05 percent to .62 percent of the
principal plus accrued unpaid interest on any such Consolidation Loans,
applications for which are received on or after October 1, 1998 and before
February 1, 1999.
A-2
ELIGIBLE LENDERS, STUDENTS AND INSTITUTIONS
Lenders eligible to make and/or hold loans under the FFELP generally include
banks, savings and loan associations, credit unions, insurance companies and,
under certain conditions, schools and guarantee agencies. Sallie Mae is an
eligible lender for making Consolidation Loans, as a lender of last resort and
for holding FFELP loans.
A FFELP loan may be made only to qualified borrowers. Generally a qualified
borrower is an individual or parent of an individual who (a) has been accepted
for enrollment or is enrolled and is maintaining satisfactory progress at an
eligible institution, (b) is carrying or will carry at least one-half of the
normal full-time academic workload for the course of study the student is
pursuing, as determined by such institution and (c) is not in default on any
federal financial aid. Each qualified borrower executes an unsecured promissory
note, although more than one loan may be made under the note.
Eligible institutions are post-secondary schools that meet the requirements
set forth in the Act. They include institutions of higher education and
post-secondary vocational institutions. With specified exceptions, institutions
are excluded from consideration as eligible institutions if the institution (i)
has a default rate in excess of the maximums permitted under the Act; (ii)
offers more than 50 percent of its courses by correspondence; (iii) enrolls 50
percent or more of its students in correspondence courses; (iv) has a student
enrollment in which more than 25 percent of the students are incarcerated; or
(v) has a student enrollment in which more than 50 percent of the students are
admitted without a high school diploma or its equivalent on the basis of their
ability to benefit from the education provided (as defined by statute and
regulation). Further, schools are specifically excluded from participation if
(i) the institution has filed for bankruptcy or (ii) the institution, the owner
or its chief executive officer, has been convicted or pleaded NOLO CONTENDERE or
guilty to a crime involving the acquisition, use or expenditure of federal
student aid funds, or has been judicially determined to have committed fraud
involving funds under the student aid program. To participate in the program,
the eligibility of a school must be approved by the Department under standards
established by regulation.
FINANCIAL NEED ANALYSIS
Student loans may generally be made in amounts, subject to certain limits
and conditions, to cover the student's estimated costs of attendance, including
tuition and fees, books, supplies, room and board, transportation and
miscellaneous personal expenses (as determined by the institution) less other
financial aid. Each borrower must undergo a need analysis, which requires the
borrower to submit family financial information that is forwarded to the federal
central processor. The central processor evaluates the parents' and student's
financial condition under federal guidelines and calculates the amount that the
student and/or the family is expected to contribute towards the student's cost
of education (the "family contribution"). After receiving information on the
family contribution, the institution then subtracts the family contribution from
its cost of attendance to determine the student's eligibility for grants,
Subsidized Stafford Loans and work assistance. The difference between (a) the
sum of the (i) amount of grants, (ii) the amount earned through work assistance
and (iii) the amount of Subsidized Stafford Loans for which the borrower is
eligible and (b) the student's estimated cost of attendance (the "Unmet Need")
may be borrowed through Unsubsidized Stafford Loans. Parents may finance the
family contribution amount through their own resources or through PLUS Loans.
SPECIAL ALLOWANCE PAYMENTS
The Act provides for quarterly special allowance payments ("Special
Allowance Payments") to be made by the Department to holders of student loans to
the extent necessary to ensure that such holder receives at least a specified
market interest rate of return on such loans. The rates for Special Allowance
Payments are based on formulas that differ according to the type of loan and the
date the loan was originally made or insured. A Special Allowance Payment is
made for each of the three-month periods
A-3
ending March 31, June 30, September 30, and December 31. The Special Allowance
Payments equal the average unpaid principal balance (including interest
permitted to be capitalized) of all eligible loans held by such holder during
such period multiplied by the special allowance percentage. The special
allowance percentage is computed by (i) determining the average of the bond
equivalent rates of 91-day Treasury bills auctioned for such three-month period,
(ii) subtracting the applicable borrower interest rate on such loans from such
average, (iii) adding the applicable Special Allowance Margin (defined below) to
the resultant percentage, and (iv) dividing the resultant percentage by four.
DATE OF DISBURSEMENT SPECIAL ALLOWANCE MARGIN
- ------------------------------------ ---------------------------------------------------------------------------
Prior to 10/17/86................... 3.50%
10/17/86-9/30/92.................... 3.25%
10/01/92-6/30/95.................... 3.10%
7/1/95-6/30/98...................... 2.50% (Subsidized and Unsubsidized Stafford Loans, in school, grace or
deferment) 3.10% (Subsidized and Unsubsidized Stafford Loans, in repayment
and all other loans)
7/1/98-7/1/03....................... 2.20% (Subsidized and Unsubsidized Staford Loans, in school and grace)
2.80% (Subsidized and Unsubsidized Stafford Loans, in repayment) 3.10% on
PLUS Loans and Consolidation Loans
Special Allowance Payments are available on variable rate PLUS Loans and SLS
Loans as described below under "PLUS and SLS Loan Programs" only to cover any
amount by which the variable rate, which is reset annually, would exceed the
applicable maximum rate.
ORIGINATION FEES
The eligible lender charges borrowers an origination fee, which in turn is
passed on to the federal government, on Subsidized and Unsubsidized Stafford
Loans and PLUS Loans equal to 3 percent of the principal balance of each loan.
The amount of the origination fee may be deducted from each disbursement
pursuant to a loan on a pro rata basis. No origination fee is paid on
Consolidation Loans.
Lenders must refund all origination fees attributable to a disbursement that
was returned to the lender by the school or repaid or not delivered within 120
days of the disbursement. Such origination fees must be refunded by crediting
the borrower's loan balance with the applicable lender.
STAFFORD LOANS
The Act provides for (i) federal insurance or reinsurance of Subsidized
Stafford Loans made by eligible lenders to qualified students, (ii) federal
interest subsidy payments on certain eligible Subsidized Stafford Loans to be
paid by the Department to holders of the loans in lieu of the borrower making
interest payments ("Interest Subsidy Payments"), and (iii) Special Allowance
Payments representing an additional subsidy paid by the Department to the
holders of eligible Subsidized Stafford Loans (collectively referred to herein
as "Federal Assistance").
Subsidized Stafford Loans are loans under the FFELP that may be made, based
on need, only to post-secondary students accepted or enrolled in good standing
at an eligible institution who are carrying at least one-half the normal
full-time course load at that institution. The Act limits the amount a student
can borrow in any academic year and the amount he or she can have outstanding in
the aggregate. The following chart sets forth the historic loan limits.
A-4
MAXIMUM LOAN AMOUNTS
FEDERAL STAFFORD LOAN PROGRAM
ALL
STUDENTS(1) INDEPENDENT
-------------- STUDENTS(3)
BASE AMOUNT ------------------------
SUBSIDIZED AND ADDITIONAL
SUBSIDIZED UNSUBSIDIZED UNSUBSIDIZED
SUBSIDIZED ON OR AFTER ON OR AFTER ONLY ON OR TOTAL
BORROWER'S ACADEMIC LEVEL PRE-1/1/87 1/1/87 7/7/93(2) AFTER 7/1/94 AMOUNT
- ---------------------------------------------- ----------- ----------- -------------- ------------ ----------
Undergraduate (per year)
1st year...................................... $ 2,500 $ 2,625 $ 2,625 $ 4,000 $ 6,625
2nd year...................................... $ 2,500 $ 2,625 $ 3,500 $ 4,000 $ 7,500
3rd year & above.............................. $ 2,500 $ 4,000 $ 5,500 $ 5,000 $ 10,500
Graduate (per year)........................... $ 5,000 $ 7,500 $ 8,500 $ 10,000 $ 18,500
Aggregate Limit
Undergraduate............................... $ 12,500 $ 17,250 $ 23,000 $ 23,000 $ 46,000
Graduate (including undergraduate).......... $ 25,000 $ 54,750 $ 65,500 $ 73,000 $ 138,500
- ------------------------
(1) The loan limits are inclusive of both Federal Stafford Loans and Federal
Direct Student Loans.
(2) These amounts represent the combined maximum loan amount per year for
Subsidized and Unsubsidized Stafford Loans. Accordingly, the maximum amount
that a student may borrow under an Unsubsidized Loan is the difference
between the combined maximum loan amount and the amount the student received
in the form of a Subsidized Loan.
(3) Independent undergraduate students, graduate students or professional
students may borrow these additional amounts. In addition, dependent
undergraduate students may also receive these additional loan amounts if the
parents of such students are unable to provide the family contribution
amount and it is unlikely that the student's parents will qualify for a
Federal PLUS Loan.
(4) Some graduate health profession students who formerly could have borrowed
under the HEAL program may be entitled to increase unsubsidized loan limits
not to exceed HEAL statutory limits for each course of study per academic
year.
The interest rate paid by borrowers on a Subsidized Stafford Loan is
dependent on the date of the loan except for loans made prior to October 1,
1992, whose interest rate depends on any outstanding borrowings of that borrower
as of such date. The rate for variable rate Subsidized Stafford Loans applicable
for any 12-month period beginning on July 1 and ending on June 30, is determined
on the preceding June 1 and is equal to the lesser of (a) the applicable Maximum
Rate or, (b) the sum of (i) the bond equivalent rate of 91-day Treasury bills
auctioned at the final auction held prior to such June 1, and (ii) the
applicable Interest Rate Margin.
A-5
SUBSIDIZED STAFFORD LOANS
DATE OF DISBURSEMENT BORROWER RATE MAXIMUM RATE INTEREST RATE MARGIN
- --------------------------- ------------------------ ------------------------ -----------------------------------
09/13/83-06/30/88.......... 8% 8.00%
07/01/88-09/30/92.......... 8% for 48 months; 8.00% for 48 months, 3.25%
thereafter, 91-Day then 10%
Treasury +
Interest Rate Margin
10/01/92-06/30/94.......... 91-Day Treasury + 9.00% 3.10%
Interest Rate Margin
07/01/94-06/30/95.......... 91-Day Treasury + 8.25% 3.10%
Interest Rate Margin
07/01/95-06/30/98.......... 91-Day Treasury + 8.25% 2.50% (in school, grace,
Interest Rate Margin or deferment)
3.10% (in repayment)
07/01/98-07/01/03.......... 91-Day Treasury + 8.25% 1.70% (in school or grace)
Interest Rate Margin 2.30% (in repayment)
The Technical Amendments provide that, for fixed rate loans made on or after
July 23, 1992 and for certain loans made to new borrowers on or after July 1,
1988, the lender must convert the loan to a variable rate loan capped at the
interest rate existing prior to the conversion. This conversion must have been
completed by January 1, 1995.
HOLDERS OF SUBSIDIZED STAFFORD LOANS ARE ELIGIBLE TO RECEIVE SPECIAL
ALLOWANCE PAYMENTS. The Department is responsible for paying interest on
Subsidized Stafford Loans while the borrower is a qualified student, during a
grace period or during certain deferment periods. The Department makes quarterly
Interest Subsidy Payments to the owner of Subsidized Stafford Loans in the
amount of interest accruing on the unpaid balance thereof prior to the
commencement of repayment or during any deferment periods. The Act provides that
the owner of an eligible Subsidized Stafford Loan shall be deemed to have a
contractual right against the United States to receive Interest Subsidy Payments
(and Special Allowance Payments) in accordance with its provisions. Receipt of
Interest Subsidy Payments and Special Allowance Payments is conditioned on
compliance with the requirements of the Act and continued eligibility of such
loan for federal reinsurance.
Interest Subsidy Payments and Special Allowance Payments are generally
received within 45 days to 60 days after the end of any given calendar quarter
(provided that the applicable claim form is properly filed with the Department),
although there can be no assurance that such payments will in fact be received
from the Department within that period.
Repayment of principal on a Subsidized or Unsubsidized Stafford Loan
typically does not commence while a student remains a qualified student, but
generally begins upon expiration of the applicable grace period, as described
below. Any borrower may voluntarily prepay without premium or penalty any loan
and in connection therewith may waive any grace period or deferment period. In
general, each loan must be scheduled for repayment over a period of not more
than 10 years after the commencement of repayment. The Act currently requires
minimum annual payments of $600 including principal and interest, unless the
borrower and the lender agree to lesser payments. Lenders are required to offer
borrowers a choice among standard, graduated and income-sensitive repayment
schedules. These repayment options must be offered to all new borrowers who
entered repayment on or after July 1, 1995. If a borrower fails to elect a
particular repayment schedule or fails to submit the documentation necessary for
the option the borrower chooses, the standard repayment schedule is used.
Repayment of principal on a Subsidized Stafford Loan must generally commence
following a period of six months after the borrower ceases to pursue at least a
half-time course of study (a "Grace Period").
A-6
However, during certain other periods (each a "Deferment Period") and subject to
certain conditions, no principal repayments need be made, including periods when
the student has returned to an eligible educational institution on a half time
basis or is pursuing studies pursuant to an approved graduate fellowship
program, or when the student is a member of the Armed Forces or a volunteer
under the Peace Corps Act or the Domestic Volunteer Service Act of 1973, or when
the borrower is temporarily or totally disabled, or periods during which the
borrower may defer principal payments because of temporary financial hardship.
For new borrowers to whom loans are first disbursed on or after July 1, 1993,
payment of principal may be deferred while the borrower is at least a half-time
student, is in an approved graduate fellowship program, is enrolled in a
rehabilitation program, when the borrower is seeking but unable to find
full-time employment, or when for any reason the lender determines that payment
of principal will cause the borrower economic hardship; in the case of
unemployment or economic hardship the deferment is subject to a maximum
deferment period of three years. The Act also requires forbearance of loans in
certain circumstances and permits forbearance of loans in certain other
circumstances (each such period, a "Forbearance Period").
The Unsubsidized Stafford Loan program created under the 1992 Amendments to
replace the SLS Program is designed for students who do not qualify for
Subsidized Stafford Loans because their Unmet Need exceeds what they can borrow
under the Subsidized Stafford Loan Program or because they are graduate and
professional. The basic requirements for Unsubsidized Stafford Loans are
essentially the same as those for the Subsidized Stafford Loans, including with
respect to provisions governing the interest rate, the annual loan limits and
the Special Allowance Payments. The federal government does not make Interest
Subsidy Payments on Unsubsidized Stafford Loans. The borrower must either pay
interest on a periodic basis or capitalize the interest that accrues until
repayment begins. Subject to the same loan limits established for Subsidized
Stafford Loans, the student may borrow up to the amount of such student's cost
of attendance less other financial aid.
PLUS AND SLS LOAN PROGRAMS
The Act also provides for the PLUS Program. The Act authorizes PLUS Loans to
be made to parents of eligible dependent students. The 1992 Act eliminated the
SLS Program after July 1, 1994.
The PLUS program permits parents of dependent students to borrow an amount
equal to each student's cost of attendance less other financial aid. Under the
former SLS program, independent graduate or professional school students and
certain dependent undergraduate students were permitted to borrow subject to the
same loan limitations.
The first payment of principal and interest is due within 60 days of full
disbursement of the loan except for borrowers eligible for deferment who may
defer principal and interest payments while eligible for deferment; deferred
interest is then capitalized periodically or at the end of the deferment period
under specific arrangements with the borrower. The maximum repayment term is 10
years. PLUS and SLS loans carry no in-school interest subsidy.
The interest rate determination for a PLUS or SLS loan is dependent on when
the loan was originally made or disbursed. Some PLUS or SLS loans carry a
variable rate. The rate varies annually for each 12-month period beginning on
July 1 and ending on June 30. The variable rate is determined on the preceding
June 1 and is equal to the lesser of (a) the applicable Maximum Rate or (b) the
sum of (i) the bond equivalent rate of 52-week Treasury bills or 91-day Treasury
bills, as applicable, auctioned at the final auction held prior to such June 1,
and (ii) the applicable Interest Rate Margin as set forth below.
A-7
PLUS/SLS LOANS
INTEREST RATE
DATE OF DISBURSEMENT BORROWER RATE MAXIMUM RATE MARGIN
- -------------------------------------------------- ------------------------ -------------- -------------------
Prior to 10/01/81................................. 9% 9%
10/01/81-10/31/82................................. 14% 14%
11/01/82-06/30/87................................. 12% 12%
07/01/87-09/30/92................................. 52-Week Treasury + 12% 3.25%
Interest Rate Margin
10/01/92-06/30/94................................. 52-Week Treasury + PLUS 10% 3.10%
Interest Rate Margin SLS 11%
06/30/94-06/30/98
(SLS repealed 07/01/94)......................... 52-Week Treasury + 9% 3.10%
Interest Rate Margin
07/01/98-07/01/03................................. 91-Day Treasury & 9% 3.10%
Interest Rate Margin
A holder of a PLUS or SLS loan is eligible to receive Special Allowance
Payments during any such 12-month period only if, were it not for the Maximum
Rate, the borrower rate under the applicable formula would have been higher than
the Maximum Rate.
THE CONSOLIDATION LOAN PROGRAM
The Act authorizes a program under which certain borrowers may consolidate
their various student loans into Consolidation Loans that will be insured and
reinsured to the same extent as other loans made under the FFELP
Consolidation Loans are made in an amount sufficient to pay outstanding
principal and accrued unpaid interest and late charges on all FFELP loans, as
well as loans made pursuant to various other federal student loan programs,
which were selected by the borrower for consolidation. The unpaid principal
balance of a Consolidation Loan made prior to July 1, 1994 bears interest at a
rate not less than 9 percent. The interest rate on a Consolidation Loan made on
or after July 1, 1994 and prior to June 30, 1998 is equal to the weighted
average of the interest rates on the loans selected for consolidation, rounded
upward to the nearest whole percent. Except as noted below, the holder of a
Consolidation Loan made on or after October 1, 1993 must pay the Secretary a
monthly rebate fee calculated on an annual basis equal to 1.05 percent of the
principal plus accrued unpaid interest on any such loan. For borrowers of
Federal Direct Consolidation Loans whose applications are received on or after
July 1, 1998 and prior to February 1, 1999 the interest rate is equal to the
91-Day Treasury bill rate plus 2.3% (1.7% during in-school and grace periods).
The Borrower interest rates on Federal Direct Consolidation Loans for borrowers
whose applications are received on or after February 1, 1999 and before July 1,
2003 will be a fixed rate equal to the lesser of the weighted average of the
interest rates of the loans consolidated, adjusted up to the nearest one eighth
of one percent, and 8.25%. This is the same rate which the Reauthorization
Legislation sets on FFELP Consolidation Loans for borrowers whose applications
are received on or after October 1, 1998 and before July 31, 2003. The
Reauthorization Legislation sets the special allowance payment rate for FFELP
Consolidation Loans at the 91-day Treasury bill rate plus 3.1 percent. The
annual fee paid by lenders on FFELP Consolidation Loans is reduced under the
Reauthorization Legislation from 1.05 percent to .62 percent of the principal
plus accrued unpaid interest on any such consolidation loans, applications for
which are received on or after October 1, 1998 and before February 1, 1999.
The repayment term under a Consolidation Loan varies depending upon the
aggregate amount of the loans being consolidated. In no case may the repayment
term exceed 30 years. A Consolidation Loan is
A-8
evidenced by an unsecured promissory note and entitles the borrower to prepay
the loan, in whole or in part, without penalty.
GUARANTEE AGENCIES
The Act authorizes Guarantee Agencies to support education financing and
credit needs of students at post-secondary schools. Under various programs
throughout the United States, Guarantee Agencies insure student loans. The
Guarantee Agencies are reinsured by the federal government for 75 percent to 100
percent of claims paid, depending on their claims experience, as described in
the table below.
Guarantee Agencies may collect a one-time insurance fee of up to 1 percent
of the principal amount of each loan, other than Consolidation Loans, that the
agency guarantees.
The Guarantee Agencies generally guarantee loans for students attending
institutions in their particular state or for residents of their particular
state attending schools in another state although most are permitted to
guarantee loans throughout the United States. Certain Guarantee Agencies have
been designated as the Guarantee Agency for more than one state. Some Guarantee
Agencies contract with other entities to administer their guarantee agency
programs.
FEDERAL INSURANCE AND REINSURANCE OF GUARANTEE AGENCIES
A student loan is considered to be in default for purposes of the Act when
the borrower fails to make an installment payment when due, or to comply with
other terms of the loan, and if the failure persists for 270 days in the case of
a loan repayable in monthly installments.
If the loan is guaranteed by a Guarantee Agency, the eligible lender is
reimbursed by the Guarantee Agency for 100 percent (98 percent for loans
disbursed on or after October 1, 1993) of the unpaid principal balance of the
loan plus accrued interest on any loan defaulted so long as the eligible lender
has properly originated and serviced such loan. Under certain circumstances a
loan deemed ineligible for reimbursement may be restored to eligibility.
Under the Act, the Department enters into a reinsurance agreement with each
Guarantee Agency, which provides for federal reinsurance of amounts paid to
eligible lenders by the Guarantee Agency. Pursuant to such agreements, the
Department agrees to reimburse a Guarantee Agency for 100 percent of the amounts
expended in connection with a claim resulting from the death, bankruptcy, or
total and permanent disability of a borrower, the death of a student whose
parent is the borrower of a PLUS Loan, or claims by borrowers who received loans
on or after January 1, 1986 and who are unable to complete the programs in which
they are enrolled due to school closure, or borrowers whose borrowing
eligibility was falsely certified by the eligible institution; such claims are
not included in calculating a Guaranty Agency's claims experience for federal
reinsurance purposes, as set forth below. The Department is also required to
repay the unpaid balance of any loan if collection is stayed under Chapter 13 of
the Bankruptcy Code, and is authorized to acquire the loans of borrowers who are
at high risk of default and who request an alternative repayment option from the
Department.
With respect to FFELP loans in default, the Department is required to pay
the applicable Guarantee Agency a certain percentage ("Reinsurance Rate") of the
amount such agency paid pursuant to default claims filed by the lender on a
reinsured loan. The amount of such Reinsurance Rate is subject to specified
reductions when the total reinsurance claims paid by the Department to a
Guarantee Agency during a fiscal year equals or exceeds 5 percent of the
aggregate original principal amount of FFELP loans guaranteed by such agency
that are in repayment on the last day of the prior fiscal year. Accordingly, the
A-9
amount of the reinsurance payment received by the Guarantee Agency may vary. The
Reinsurance Rates are set forth in the following table.
GUARANTEE AGENCY'S CLAIMS EXPERIENCE APPLICABLE REINSURANCE RATE
- ------------------------------------ ---------------------------------------------------------------------------
0% up to 5%..................... 95% (100% for loans disbursed before Oct. 1, 1993; 98% for loans disbursed on
or after October 1, 1993 and before October 1, 1998)
5% up to 9%..................... 85% (90% for loans disbursed before Oct. 1, 1993; 88% for loans disbursed on or
after) October 1, 1993 and before October 1, 1998)
9% and over..................... 75% (80% for loans disbursed before Oct. 1, 1993; 78% for loans disbursed on or
after) October 1, 1993 and before October 1, 1998)
The claims experience is not cumulative. Rather, the claims experience for
any given Guarantee Agency is determined solely on the basis of claims for any
one federal fiscal year compared with the original principal amount of loans in
repayment at the beginning of that year.
The 1992 Amendments addressed industry concerns regarding the Department's
commitment to providing support in the event of Guarantee Agency failures.
Pursuant to the 1992 Amendments, Guarantee Agencies are required to maintain
reserve fund levels defined as 0.25 percent of the total attributable amount of
all outstanding loans guaranteed by the agency for the fiscal year of the agency
that begins in 1998. If (i) the Guarantee Agency fails to achieve the minimum
reserve level in any two consecutive years, (ii) the Guarantee Agency's federal
reimbursements are reduced to 85 percent or (iii) the Department determines the
Guarantee Agency's administrative or financial condition jeopardizes its
continued ability to perform its responsibilities, the Department must require
the Guarantee Agency to submit and implement a management plan to address the
deficiencies. The Department may terminate the Guarantee Agency's agreements
with the Department if the Guarantee Agency fails to submit the required plan,
or fails to improve its administrative or financial condition substantially, or
if the Department determines the Guarantee Agency is in danger of financial
gcollapse. In such event, the Department is authorized to undertake specified
actions to assure the continued payment of claims, including making advances to
guarantee agencies to cover immediate cash needs, transferring of guarantees to
another Guarantee Agency, or transfer of guarantees to the Department itself.
The Act provides that, subject to compliance with the Act, the full faith
and credit of the United States is pledged to the payment of federal reinsurance
claims. It further provides that Guarantee Agencies are deemed to have a
contractual right against the United States to receive reinsurance in accordance
with its provisions. In addition, the 1992 Amendments provide that if the
Department determines that a Guarantee Agency is unable to meet its insurance
obligations, holders of loans may submit insurance claims directly to the
Department until such time as the obligations are transferred to a new Guarantee
Agency capable of meeting such obligations or until a successor Guarantee Agency
assumes such obligations. There can be no assurance that the Department would
under any given circumstances assume such obligation to assure satisfaction of a
guarantee obligation by exercising its right to terminate a reimbursement
agreement with a Guarantee Agency or by making a determination that such
Guarantee Agency is unable to meet its guarantee obligations.
Within each fiscal year, the applicable Reinsurance Rate steps down
incrementally with respect to claims made only after the claims experience
thresholds are reached.
In addition to the Federal Reserve Fund, which is the property of the United
States, each Guarantee Agency has an Agency Operating Fund, which it is
permitted to spend on activities related to the FFELP, including oversight of
schools and lenders, pre-claim collection assistance, maintenance of records,
dissemination public information and issuance of new guarantees. This fund is
created from fees paid by the Department.
A-10
SCHEDULE XX
The Board of Directors and Stockholders
SLM Holding Corporation
We have audited the accompanying consolidated statements of income, changes
in stockholder's equity and cash flows of SLM Holding Corporation for the year
ended December 31, 1996. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatements. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated results of operations and cash flows
of SLM Holding Corporation for the year ended December 31, 1996, in conformity
with generally accepted accounting principles.
ERNST & YOUNG LLP
Washington, D.C.
January 13, 1997
S-1