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U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2004.

OR

For the transition period from                     to                     

Commission file number: 000-29995

EDUCATION LENDING GROUP, INC.

(Exact name of registrant as specified in its charter)

12760 High Bluff Drive,

Suite 210, San Diego, California 92130

(Address of principal executive offices)

(858) 617-6080

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act). YES  x NO  ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date: Shares of Common Stock, $0.001 par value, outstanding at March 31, 2004: 16,296,337, including treasury shares.

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

EDUCATION LENDING GROUP, INC.

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements

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EDUCATION LENDING GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three Months Ended March 31, 2004 and 2003

(Unaudited)

See accompanying notes to consolidated financial statements

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EDUCATION LENDING GROUP, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY/(DEFICIT)

For the Three Months Ended March 31, 2004

(Unaudited)

See accompanying notes to consolidated financial statements

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EDUCATION LENDING GROUP, INC

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended March 31, 2004 and 2003

(Unaudited)

See accompanying notes to consolidated financial statements

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Education Lending Group, Inc.

Notes to Consolidated Financial Statements

March 31, 2004

(Unaudited)

Note 1—Summary of Organization

Organization—Education Lending Group, Inc., (“Education Lending Group,” “we,” “our Company,” “our” and “us”) was incorporated in Delaware on March 26, 1999. Our Company was formed to identify and acquire enterprises in the student loan business. Without consummating any acquisitions, in September 2001, through Education Lending Services, Inc. and Education Funding Resources, LLC, we began operations related to marketing, originating, and purchasing student loans. Through these subsidiaries, we originate or purchase Federal Family Education Loan Program (FFELP) student loans that are eligible for guarantee from the Department of Education (DOE), federally sponsored consolidation loans and other eligible student loans. We have in place two warehouse loan facilities with financial institutions which we use to facilitate originating and purchasing student loans. On a periodic basis, we complete student loan securitizations to pay down the warehouse facility and finance our loans on a permanent basis.

Education Lending Services, Inc., a wholly-owned subsidiary of our Company, was incorporated in Delaware on October 3, 2000. Currently, Education Lending Services, Inc.’s business is focused on the origination of consolidation loans and Parent Loans to Undergraduate Students (PLUS).

Education Funding Resources, LLC was formed in Delaware on July 19, 2001. Education Lending Services, Inc. is the sole equity member of Education Funding Resources, LLC. Education Funding Resources, LLC is a special purpose bankruptcy remote entity that was formed in order to facilitate the student loan origination and funding process and the secondary market acquisitions of student loans.

Student Loan Xpress, Inc., a wholly-owned subsidiary of our Company, was incorporated in Delaware on November 1, 2000 and began operations in November, 2001. Student Loan Xpress, Inc.’s business is primarily focused on development of the traditional school preferred lender-list channel for loan originations. Currently we sell the majority of the loans we generate through this channel.

Education Funding Capital I, LLC was formed in Delaware on April 22, 2002. Education Lending Services, Inc. is the sole equity member of Education Funding Capital I, LLC. Additionally, we have formed Education Funding Capital Trust I, Education Funding Capital Trust II, Education Funding Capital Trust III and Education Funding Capital Trust IV, all of which are Delaware statutory trusts and wholly-owned subsidiaries of Education Funding Capital I. These entities participate in the permanent financing securitizations of our student loan assets.

Education Loan Servicing Corporation was incorporated in Delaware on October 15, 2003 and is expected to begin servicing a portion of our loan portfolio during 2004.

Note 2—Summary of Significant Accounting Policies

Principles of Consolidation—The financial results included in this report are stated in conformity with accounting principles generally accepted in the United States of America and all normal recurring adjustments that we consider necessary for a fair presentation of the results for such periods.

These consolidated financial statements include the accounts of Education Lending Group, Inc., Student Loan Xpress, Inc. (SLX), Education Loan Servicing Corporation (ELSC) and Education Lending Services, Inc. (ELS). SLX, ELSC and ELS are our wholly-owned subsidiaries. ELS consists of Education Funding Resources, LLC (EFR) and Education Funding Capital I, LLC (EFC I). (ELS is the sole member of EFR and EFC I). Additionally, we have formed Education Funding Capital Trust I, Education Funding Capital Trust II, Education Funding Capital Trust III and Education Funding Capital Trust IV, all of which are Delaware statutory trusts and wholly-owned subsidiaries of EFC I. All significant intercompany accounts and transactions have been eliminated in consolidation.

Student Loans—Student loans, consisting of student loans which are 98% guaranteed by the government and alternative supplemental loans (guaranteed by other third parties) are carried at their purchase price, including unamortized premiums and unamortized origination costs. Loan set-up fees and certain direct loan origination costs are deferred. Net deferred loan origination costs related to securitized loans are amortized into interest expense over the contractual life of the student loan using the effective interest method. Net deferred loan origination costs related to loans which have not been securitized are amortized into interest expense over the contractual life of the student loan using the straight-line method. The overall effect of this treatment is approximation of the effective interest method. Deferred fees and costs associated with loans that have been repaid or sold are recorded in the income statement in the period of repayment.

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Student Loans Held for Resale—The majority of the student loans originated through the traditional school preferred lender-list channel are subsequently sold to one of two entities. According to the terms of our agreements with the entities who purchase these loans from us, loans sold to one of the entities are sold immediately upon initial disbursement. Deferred costs related to the origination of these loans are netted against gain on sale when the loans are sold rather than capitalized and amortized as discussed above. Loans sold to the other entity are sold subsequent to the final disbursement. Interest on these loans is earned for the period during which they are held on our balance sheet. Once the loan is sold, the gain on the sale is recorded as discussed below. Costs related to the origination of these loans are capitalized and recognized once the loan is sold. When the loan is sold the costs are written off (netted against gain on sale). Loans held for resale are reflected on our balance sheet at the lower of cost or market.

Student Loan Income and Net Interest Income—We recognize student loan income as earned, including amortization of premiums. We amortize the premiums and deferred origination fees over the estimated life of the student loan. With the guarantee on the student loans applicable to both principal and interest, we recognize interest on student loans as earned regardless of delinquency status. If a student loan should lose its guaranteed status, interest would be recognized as received. To date, there are no student loans in our portfolio which have lost their guaranteed status. Net interest income is derived largely from our portfolio of student loans that remain on our balance sheet and is the spread between interest earned on student loans and our cost of generating that interest income. These costs include interest expense on the warehouse facility and permanent financings, amortization of deferred financing costs, fees paid to third-party servicers to service the loans, mark-to-market adjustments related to interest rate swaps that have not been designated as cash flow hedges, fees paid to the DOE, and amortization of premiums paid to acquire student loans. All servicing of our student loans is currently outsourced to third-party servicers to whom we pay a fee.

Gain on Sale of Student Loans—We currently sell the majority of the Stafford and PLUS loans we originate. Additionally, from time to time, we may elect to sell consolidation loans. We book the sale in the period the loan is sold and record the transaction on the income statement as a gain on the sale of student loans. Sales of student loans are accounted for under Statement of Financial Accounting Standard (SFAS) 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” (SFAS 140). Student loans are sold with the servicing rights released and without recourse. Gains or losses on sales of student loans are recognized based on the difference between the selling prices and the carrying values of the related student loans sold. Unamortized deferred origination fees and expenses are netted against gain on sale when the loans are sold. According to the terms of our agreements with the entities who purchase these non-consolidation loans from us, loans sold to one of the entities are sold immediately upon initial disbursement. Loans sold to the other entity are sold subsequent to the final disbursement.

Allowance for Student Loan Losses—We have established an allowance for potential losses on our existing portfolio of student loans, both securitized and unsecuritized. These student loan assets are presented net of the respective allowances on our balance sheet. In evaluating the adequacy of the allowance for losses, we consider several factors, including trends in student loan claims rejected for payments by guarantors, default rates on alternative supplemental student loans and the amount of FFELP loans held subject to two percent risk-sharing. The allowance is based on periodic evaluations of our loan portfolio, changes to federal student loan programs, current economic conditions and other relevant factors. We utilize these factors to estimate a projected default rate for our student loan portfolio. This estimate, along with the applicable risk-sharing percentage, is used to calculate the allowance for student loan losses. The allowance is maintained at a level that management believes is adequate to provide for probable credit losses. Currently, approximately 98% of our student loan portfolio is guaranteed. The allowance for student loan losses is calculated by multiplying the principal balance of the student loans we carry on our balance sheet by 2% (the uninsured portion of the federally sponsored student loans on our balance sheet) and then multiplying that amount by the projected default rate. This evaluation is inherently subjective as it requires estimates that may be susceptible to significant changes.

Marketing Partner Fees—We have established relationships with various third-party marketing partners to market student loans on our behalf. These fees represent a significant cost to us. SFAS 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases,” (SFAS 91) establishes the accounting for nonrefundable fees and costs associated with lending, committing to lend, or purchasing a loan or group of loans. SFAS 91 specifies that costs incurred to identify and attract potential borrowers should be expensed as incurred. As such, fees we pay to our marketing partners are expensed during the period incurred. These fees are included in sales and marketing operating expenses in the income statement.

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Additionally, some of these marketing partners have been awarded performance-based stock options, which vest in relation to certain performance criteria being met by the partner. These options are accounted for under SFAS 123, “Accounting for Stock-Based Compensation,” (SFAS 123), Emerging Issues Task Force (EITF) Issue 96-18, “Accounting for Equity Instruments that Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services” and FASB Interpretation Number (FIN) 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Options or Award Plans” (FIN 28). Under the guidelines established by these pronouncements, in each quarter until performance under the marketing partner agreement is completed, we must record an expense related to the options that are vested as of the end of the quarter. This expense includes a charge equal to the fair market value of the options which vested during the quarter, and a mark-to-market adjustment for the options which vested in previous quarters. This non-cash charge is directly related to our stock price and the performance of our marketing partners, and will fluctuate from quarter to quarter based on the performance of our stock and the number of options which vest during the quarter. This expense is a component of marketing partner fees which are a component of the sales and marketing expense line item on our income statement.

Restricted Cash and Investments—We periodically take draws against our warehouse loan facility to fund student loans and any premiums associated with them. The restricted cash and investments shown on the balance sheet reflects draws taken against the warehouse line which have not yet been used to fund student loans. These amounts are restricted and may be used only to fund student loans and any premiums associated with them as outlined in the indentures. Additionally, we are required to maintain certain cash levels in our securitizations. Restricted cash and investments shown on the balance sheet also include these cash balances and are restricted to use as outlined in the indentures.

Cash, Cash Equivalents and Credit Risk—We consider all unrestricted highly liquid investments purchased with maturities of three months or less to be cash equivalents. We maintain a large balance in an investment fund that is rated triple A by three rating agencies. These funds are invested in domestic corporate money market securities including commercial paper, repurchase agreements, variable rate instruments and bank instruments. We consider the credit risk associated with our cash and cash investments to be minimal.

Interest and Other Receivables—Interest and other receivables consists of interest receivable on student loans, borrower payments received by third-party servicers not yet sent to us, DOE fees reimbursable on loans sold, and premiums due to us on loans we have sold.

Software and Web-Site Development Costs—We capitalize the costs of software developed for internal use in compliance with Statement of Position, (SOP), 98-1 “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” and EITF Issue 00-2 “Accounting for Web-Site Development Costs.” Capitalization of software developed for internal use and web-site development costs begins at the application development phase of the project. Amortization of software developed for internal use and web-site development costs begins when the software is placed in productive use, and is computed on a straight-line basis over the estimated useful life of the software, which typically ranges from one to three years.

Property and Equipment, net—Property and equipment is stated at cost. Depreciation is recorded using the straight-line method over the estimated useful lives of the assets, which range from three to seven years.

Deferred Financing Costs—Direct costs associated with obtaining financing are capitalized and amortized into interest expense over the term of the respective Education Loan Backed Notes or warehouse loan facility. The majority of the costs are related to our Education Loan Backed Notes, and are amortized, using the effective interest method, over the term of the securitization, typically 40 years. The costs related to the warehouse loan facility are amortized, using the straight-line method, over three years. The overall effect of this treatment is approximation of the effective interest method.

Derivatives and Hedging Activities—SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” (SFAS 133) requires companies to recognize all derivative contracts as either assets or liabilities on the balance sheet and to measure them at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge. SFAS 133, as amended by SFAS 137, “Accounting for Derivative Instruments and Hedging Activities, Deferral of the Effective Date of SFAS 133,” SFAS 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities” and SFAS 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” is effective for all fiscal quarters for fiscal years beginning after June 15, 2000. During the fourth quarter of 2002, we entered into an interest rate swap that was not specifically designated as a hedge. As required by SFAS 133, the fair market value of the interest rate swap contract (mark-to-market) was recognized during the period as an additional liability and treated as additional expense/(income) on our income statement. During the second and fourth quarters of 2003 we entered into additional interest rate swap agreements, both of which were designated as and are effective as cash flow hedges. These swaps are also

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recorded in the accrued expenses and other liabilities section of our balance sheet. As these agreements qualify as cash flow hedges and are currently effective as such, changes in the agreements’ fair values (mark-to-market) are recorded in the other comprehensive loss section of the balance sheet rather than as an expense on the income statement. Accrued interest receivable or payable related to the interest rate swap agreements is recorded in interest expense.

Employee Stock Options—Employee stock options are accounted for under Accounting Principals Board (APB) Opinion 25, “Accounting for Stock Issued to Employees” (APB 25), using the intrinsic value method. Generally, as options granted to employees are fixed in nature, and the awards are made at fair market value on the date of grant, no expense is required to be recognized. However, in January 2003 certain employees were awarded performance-based options, which would vest over three years (with the first tranche vesting December 31, 2003, assuming the performance conditions were met). These criteria were met on December 31, 2003. Since performance-based options require variable plan accounting under the terms of APB 25, during 2003 these options were marked-to-market quarterly, until the performance criteria had or had not been met. Accordingly, we recorded this expense as a component of operating expenses on our income statement. As of December 31, 2003, we determined which performance criteria had been met, and correspondingly, which options would remain outstanding and continue vesting. The final mark-to-market adjustment was made as of December 31, 2003. As required by APB 25, and in accordance with the accelerated vesting schedule described in FIN 28 we will continue to expense these options throughout 2004 and 2005, until they are fully vested, at which time all related expense will have been recognized.

Education Loan Backed Notes—Our Education Loan Backed Notes, consisting of Series 2003 (October) Notes, Series 2003 (April) Notes and Series 2002 Notes, or securitized borrowings, are accounted for under SFAS 140. Under SFAS 140, securitizations that do not qualify for sales treatment are accounted for as secured borrowings. As we retain a call on redeeming any series of the notes under our securitized borrowings, the requirements of paragraph nine of SFAS 140 have not been met. Therefore these transactions are accounted for as secured borrowings in accordance with the provisions of paragraph 15 of SFAS 140.

Government Payables—We are required to pay the DOE a one-time 50 basis point origination fee on consolidation, Stafford and PLUS loans and an annual 105 basis point consolidation loan rebate fee on all consolidation loans originated and held after October 1, 1993. Each fee is payable to the DOE. Fees due the DOE but not yet paid are shown as government payables.

Income Taxes—We account for income taxes in accordance with SFAS 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. We file a consolidated U.S. federal income tax return that includes our eligible subsidiaries.

Income/(Loss) Per Common Share—Basic income/(loss) per share is computed by dividing the income/(loss) available to common stockholders by the weighted average number of common shares outstanding for the period. In periods during which we record a net profit, diluted earnings per share reflect the potential dilutive effect of additional common shares that are issuable on exercise of outstanding stock options and warrants, as determined by application of the treasury stock method. During the periods we reported a net loss, diluted loss per share in the periods presented is equal to basic loss per share since any potential additional dilutive common shares are considered antidilutive and are therefore not included in the computation.

The following table shows a reconciliation of our basic earnings per share to our diluted earnings per share for the quarter ended March 31, 2004. It excludes 6,100 shares that were not included in the calculation as they would have been antidilutive. (There was no difference between our basic and diluted loss per share in the quarter ended March 31, 2003.)

Estimates—The process of preparing financial statements in conformity with accounting principles generally accepted in the United States of America requires the use of estimates and assumptions regarding certain types of assets, liabilities, revenues, and expenses. Such estimates primarily relate to unsettled transactions and events as of the date of the financial statements. Accordingly, upon settlement, actual results may differ from estimated amounts.

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Reclassifications—Certain accounts in the prior year consolidated financial statements have been reclassified for comparative purposes to conform to presentation in the current-year consolidated financial statements.

Disclosure of pro forma earnings in accordance with SFAS 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of SFAS 123”—In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of SFAS 123” (SFAS 148). SFAS 148 addresses transition provisions for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123. As we continue to account for our incentive-based compensation using the intrinsic value method under APB 25, SFAS 148 does not have an impact on our consolidated financial statements. Had compensation costs for our stock options been recognized based upon the estimated fair value on the grant date under the fair value methodology prescribed by SFAS 123 as amended by SFAS 148, our net earnings and earnings per share for the quarters ended March 31, 2004 and 2003 would have been as follows:

Proposed Accounting Pronouncements

SFAS 123, “Accounting for Stock-Based Compensation”, and APB Opinion No. 25, “Accounting for Stock Issued to Employees”

The FASB is currently considering amending SFAS 123 and APB Opinion No. 25. The proposed standard will require us to record compensation expense for all share-based compensation plans. If adopted, this proposed standard would have a negative impact on our earnings in future periods.

Note 3—Student Loans

We originate student loans on our own behalf and we purchase student loans from originating lenders. Our portfolio consists principally of loans originated under FFELP, a federally sponsored program. We also purchase alternative supplemental education loans. There are three principal categories of FFELP loans: consolidation loans, Stafford loans and PLUS loans. The nature of the student loans held at March 31, 2004 is as follows:

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The nature of the student loans held at December 31, 2003 was as follows:

The FFELP is subject to comprehensive reauthorization every five years and to frequent statutory and regulatory changes. The Higher Education Act is scheduled to expire on September 30, 2004, and reauthorization is currently under consideration by the United States Congress. Changes in the Higher Education Act made in the two most recent reauthorizations have included reductions in student loan yields paid to lenders, increased fees paid by lenders and a decreased level of guarantee.

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. The interest rates are either fixed to term or reset annually on July first of each year depending on when the loan was originated. We earn interest at the greater of the borrower’s rate or a floating rate. If the floating rate exceeds the borrower rate, the DOE makes a payment directly to us based upon the Special Allowance Payment (SAP) formula. SAP is generally paid whenever the average of all of the applicable floating rates (91-day Treasury bill, commercial paper, 52-week Treasury bill, or the constant maturity Treasury rate) in a calendar quarter, plus a spread of between 1.74 and 3.50 percentage points depending on the loan status and origination date, exceeds the rate of interest which the borrower is obligated to pay. If the floating rate determined by the SAP formula is less than the rate the borrower is obligated to pay, we simply earn 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 we earn on the loan.

We purchase alternative supplemental loans. These loans are made to students whose loan eligibility under the FFELP program does not meet their total borrowing needs. Unlike FFELP loans, alternative supplemental loans are credit-based. Depending on the loan program, the credit requirements may be met by a co-borrower. Interest rates are reset quarterly and may be tied to prime or to commercial paper (CP) rates. Alternative supplemental loans may be guaranteed by a third-party guarantor. At March 31, 2004, all our alternative supplemental loans were 100% guaranteed by third-party guarantors.

Our portfolio of FFELP student loans generally earns interest at the higher of a floating rate based on the SAP formula set by the DOE and the borrower rate, which is fixed over a period of time. We generally finance our student loan portfolio with floating rate debt over all interest rate levels. In low interest rate environments, when student loans are earning at the fixed borrower rate and the interest on our floating rate debt is continuing to decline, we earn additional spread income and refer to it as floor income. Depending on the type of student loan and when it is originated, the borrower rate is either fixed to term (as is the case of consolidation loans) or is reset to a market rate each July 1st (as is the case for Stafford and PLUS loans). As a result, for loans where the borrower rate is fixed to term, we may earn floor income for an extended period of time, and for those loans where the borrower interest rate is reset annually July first, we may earn floor income until the next reset date.

We are required to pay the DOE a one-time 50 basis point origination fee on Stafford, PLUS, and consolidation loans and an annual 105 basis point consolidation loan rebate fee on all consolidation loans originated and held after October 1, 1993. Each fee is payable to the DOE. The unamortized portion of the origination fees are included in our balance sheet in student loans, net of loan loss reserve, student loans, net of loan loss reserve (securitized) and student loans held for resale at the lower of cost or market. Also, all loans acquired after October 1, 1993 are subject to risk-sharing on claim payments under which the loan is guaranteed for 98% of the outstanding balance plus accrued interest.

The activity relating to the student loan balances held during the period from December 31, 2003 through March 31, 2004 is as follows:

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Included in the above table is a line labeled “Refunds, cancellations and adjustments.” This line item relates to adjustments and receipts on student loans that are not part of payments directly from borrowers or claim payments from guarantee agencies. The primary components of this line item are cash refunds from schools and lenders related to disbursements on loan originations we have previously made, plus payments related to cancellations of existing loans as consolidation loans are processed on behalf of borrowers. (For example, a borrower has an existing consolidation loan and adds another loan to it. The existing loan is included above as a cancellation.)

Note 4—Student Loans—Loan Loss Reserve

The provision for loan losses represents the periodic expense of maintaining an allowance sufficient to absorb losses, net of recoveries, inherent in our portfolio of student loans. We evaluate the adequacy of the provision for losses on our guaranteed student loan portfolio separately from our alternative supplemental loan portfolio. For our guaranteed student loan portfolio, we primarily consider trends in student loan claims rejected for payment by guarantors due to servicing defects as well as overall default rates on those FFELP student loans subject to the two percent risk-sharing, i.e., those loans that are insured as to 98% of principal and accrued interest. Loans are placed on non-accrual status and charged off at the point that a loan claim is rejected for payment by guarantors.

At March 31, 2004 all alternative supplemental loans were 100% guaranteed by third-party guarantors.

The following table summarizes changes in the loan loss reserve for the quarters ended March 31, 2004 and March 31, 2003:

The additions to the loan loss reserve are expensed on the income statement during the period incurred. The balance at the end of the period is netted against student loans outstanding and included in “Student Loans, net of loan loss reserve” and “Student Loans, net of loan loss reserve (securitized)” on the balance sheet.

Note 5—Investments

We are required to maintain certain cash levels in our securitizations. Restricted cash and investments shown on the balance sheet reflect these cash balances and are restricted to use as outlined in the indentures. Substantially all these funds are invested in guaranteed investment contracts, which are all AAA-rated.

Note 6—Warehouse Loan Facilities and Securitizations

We have a $500 million warehouse loan facility (our Conduit Facility) and a $19 million warehouse loan facility that we use to fund the origination and purchase of student loans. Our $500 million loan facility was established in the fourth quarter of 2002. From time to time the lender has approved temporary increases in the Conduit Facility. As of March 31, 2004, the Conduit Facility had been approved for advances of up to $1.25 billion. We use this facility to fund the origination and purchase of student loans. Our Conduit Facility capacity allows us to fund and pool student loans until we aggregate sufficient volume to access the securitization markets for more cost-efficient financing. At March 31, 2004, the balance outstanding on the Conduit Facility was approximately $1.0 billion.

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This Conduit Facility is governed by an indenture and other program documents which were entered into as of October 18, 2002, with a financial institution. The term of the financing is three years. However, the financing is backed by a 364-day liquidity facility which must be renewed on an annual basis. Failure to renew the liquidity facility will result in early termination of the financing. The financing is secured by the assets of the indenture which primarily consist of cash, student loans, and their applicable accrued interest. Interest is calculated and paid on a monthly basis. The interest rate is based upon the CP rate (1.07% at March 31, 2004) of the financial institution providing the liquidity facility. In addition to interest charges, we also pay trustee fees as well as a commitment fee on the unused portion of the facility. The Conduit Facility includes a number of covenants and compliance features that we must meet to continue to make additional draws on the facility as well as to maintain the existing loan balances.

In October of 2003, we completed a $1 billion LIBOR/auction rate student loan securitization. As the assets are merely a pledge of collateral, the secured party does not have the right to sell or repledge the collateral and we have not defaulted under the terms of the securitization, this securitization has been accounted for as a securitized borrowing. Therefore, the securitization is included as student loans (securitized) and Education Loan Backed Notes related to securitized student loans structured as collateralized borrowings on the balance sheet. The notes were issued pursuant to an indenture of trust and consist of senior (Class A) and subordinate (Class B) notes, the proceeds of which were used to pay down the warehouse loan and pre-fund a portfolio of student loans. The student loans are serviced by third-party servicers. Interest rates for certain notes are tied to three-month LIBOR plus an incremental amount ranging from 0.04% to 0.27%. Other notes bear interest at a rate determined by Dutch Auction. All notes mature no later than December 15, 2042. The notes are subject to mandatory redemption, in whole or in part, on any interest payment date with monies on deposit in the principal fund. Additionally, the notes are subject to optional redemption by us on any regularly scheduled interest payment date. At March 31, 2004 the notes’ principal amounts and interest rates were as follows:

$1,000,000,000 Education Loan Backed Notes Issued in October, 2003

We also completed a $1 billion, LIBOR/auction rate student loan securitization in April 2003. This securitization has also been accounted for as a securitized borrowing as the assets are merely a pledge of collateral, the secured party does not have the right to sell or repledge the collateral and we have not defaulted under the terms of the securitization. Therefore, the securitization is included as student loans (securitized) and Education Loan Backed Notes related to securitized student loans structured as collateralized borrowings on the balance sheet. The notes were issued pursuant to an indenture of trust and consist of senior (Class A) and subordinate (Class B) notes, the proceeds of which were used to pay down the warehouse loan and pre-fund a portfolio of student loans. The student loans are serviced by third-party servicers. Interest rates for certain notes are tied to three-month LIBOR plus an incremental amount ranging from 0.05% to 0.30%. Other notes bear interest at a rate determined by Dutch Auction. All notes mature no later than March 17, 2042. The notes are subject to mandatory redemption, in whole or in part, on any interest payment date with monies on deposit in the principal fund. Additionally, the notes are subject to optional redemption by us on any regularly scheduled interest payment date. At March 31, 2004 the notes’ principal amounts and interest rates were as follows:

$1,000,000,000 Education Loan Backed Notes Issued in April, 2003

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In May and August of 2002, we completed $525 million and $500 million, respectively, auction rate student loan securitizations that have been accounted for as collateralized borrowings as the assets are merely a pledge of collateral and the secured party does not have the right to sell or repledge the collateral and we have not defaulted under the terms of the securitization. Therefore, the securitization is included as student loans (securitized) and Education Loan Backed Notes related to securitized student loans structured as collateralized borrowings on the balance sheet. The notes were issued pursuant to an indenture of trust and consist of senior (Class A) and subordinate (Class B) notes, the proceeds of which were used to pay down the warehouse loan and pre-fund a portfolio of student loans. The student loans are sub-serviced by a third-party servicer. The notes bear interest at a rate determined by a Dutch Auction and mature no later than June 1, 2042. At March 31, 2004, the notes bore interest as follows:

$525,000,000 Auction Rate Education Loan Backed Notes Issued in May, 2002

$500,000,000 Auction Rate Education Loan Backed Notes Issued in August, 2002

If certain parity percentages are not met, the notes are subject to mandatory redemption. As long as the parity percentage is less than 100.5%, the notes are subject to mandatory redemption, in whole or in part, on any interest payment date with monies on deposit in the principal fund. Additionally, the notes are subject to optional redemption by us on any regularly scheduled interest payment date.

On January 16, 2004 we filed a shelf registration statement with the SEC. This registration statement will allow us to issue additional Education Loan Backed Notes in the amount of $2 billion over the next two years.

We are in compliance with the debt covenants on both the warehouse loan facilities and the securitizations.

Note 7—Interest-Rate Swaps

To lock in portions of floor income associated with some of our loan assets, from time to time we enter into interest-rate swap agreements on portions of our portfolio. Management expects our hedge program to be effective in offsetting changes in cash flows for the risk being hedged.

We use interest-rate swaps to convert floating-rate debt to fixed rates in order to lock-in a desired spread between our interest-earning assets and interest-bearing liabilities. These swaps usually possess a term between one and one and one-half years, with a

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fixed pay rate and a receive rate indexed to the rates paid on our borrowings. The specific terms and notional amounts of the swaps are determined based on costs to initiate swaps and the length of the agreements which may be entered into.

In order to take advantage of the low interest rate environment, since December of 2002, we have entered into three interest-rate swaps which are described below. Additionally, the swaps entered into in April of 2003 and in October of 2003 were completed as requirements of the corresponding securitizations which are discussed in Note 6.

In October of 2003 we entered into an interest-rate swap related to $485 million of our Education Loan Backed Notes (the notional amount). Under the terms of the agreement, on each quarterly distribution date, commencing December 15, 2003 through the termination date of the agreement, the Counterparty must pay us an amount equal to the product of:

In exchange for the above payments, on each quarterly distribution date, we must pay the Counterparty an amount equal to the product of:

In accordance with the terms of the agreement, any payment amounts will be netted, so that only the net difference in the above amounts will actually be paid quarterly. The agreement is in effect until November 2, 2004. Since the underlying debt is tied to LIBOR, we are effectively fixing the variable component of the cost related to the $485 million notional amount at 1.53% for the period.

This swap was designated as a cash flow hedge under SFAS 133 and as such under the requirements outlined in SFAS 133, we are required to mark-to-market the value of the swap at the end of the quarter. During the quarter ended March 31, 2004 we recorded a charge of $0.3 million to accumulated other comprehensive loss on the balance sheet, representing the effective portion of the hedge. There is no net tax impact related to this charge, as we have established a valuation allowance that fully offsets any deferred tax assets we have recorded. The hedge will expire during 2004. Correspondingly, this amount will reverse out of other comprehensive loss and flow through the interest expense section of the income statement during the year. The fair market value of the interest-rate swap at March 31, 2004 was a liability of $1.0 million. Further, during the quarter ended March 31, 2004, we recorded additional interest expense of $0.4 million related to the interest-rate swap, but not related to the mark-to-market adjustment, on our income statement.

In April of 2003 we entered into an interest-rate swap related to $350 million of our Education Loan Backed Notes (the notional amount). Under the terms of the agreement, on each quarterly distribution date, commencing June 16, 2003 through the termination date of the agreement, the Counterparty must pay us an amount equal to the product of:

In exchange for the above payments, on each quarterly distribution date, we must pay the Counterparty an amount equal to the product of:

In accordance with the terms of the agreement, any payment amounts will be netted, so that only the net difference in the above amounts will actually be paid quarterly. The agreement is in effect until September 15, 2004. Since the underlying debt is tied to LIBOR, we are effectively paying 1.56% over LIBOR for the debt related to the $350 million of the portfolio, for the effective period of the swap.

This swap was designated as a cash flow hedge under SFAS 133 and as such under the requirements outlined in SFAS 133, we are required to mark-to-market the value of the swap at the end of the period. During the quarter ended March 31, 2004, there was no charge to accumulated other comprehensive loss on the balance sheet related to this swap. The hedge will expire during 2004. The fair market value of the interest-rate swap at March 31, 2004 was a liability of $0.7 million. Further, during the quarter ended March 31, 2004, we recorded additional interest expense of $0.3 million, related to the interest-rate swap, but not related to the mark-to-market adjustment, on our income statement.

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In December of 2002 we entered into an interest-rate swap related to $700 million of our Education Loan Backed Notes. This swap was not designated as a hedge under SFAS 133. Under the requirements outlined in SFAS 133, we are required to mark-to-market the value of the swap at the end of the quarter. However, since this swap was not designated as a cash flow hedge, the mark-to-market adjustments were recorded to expense/(income) on the income statement. This swap expired December 31, 2003. Correspondingly, the fair market value of this interest-rate swap at December 31, 2003 was zero. We recorded a charge of $0.9 million during the quarter ended March 31, 2003 (the difference between the fair market value of the swap at December 31, 2002 and at March 31, 2003) as a mark-to-market adjustment. As the hedge expired in 2003, there was no corresponding charge during the quarter ended March 31, 2004. We also recorded additional interest expense related to this interest-rate swap (but not related to the mark-to-market adjustment) of $0 and $0.4 million during the quarters ended March 31, 2004 and 2003, respectively.

Note 8—Sale of Common Stock

During the three months ended March 31, 2004 we received proceeds of $0.8 million for the issuance of 378,632 shares of common stock from the exercise of warrants and employee stock options.

Note 9—Commitments and Contingencies

In March 2004, we signed an operating lease for approximately 23,985 rentable square feet of office space in Cleveland, Ohio, to be used as the central location for our new loan servicing company, Education Loan Servicing Corporation. The lease term is for a period of ten years and is renewable for two five-year periods subsequent to the expiration of the initial lease term. At the commencement of the lease, the premises will be approximately 16,192 rentable square feet. Within the first 16 months of the commencement, the premises will increase in size to be approximately 20,102 rentable square feet. Within 25 months of the commencement, the premises will increase in size to be approximately 23,985 rentable square feet. Expected lease payments under this lease are as follows:

The FFELP is subject to comprehensive reauthorization every five years and to frequent statutory and regulatory changes. The Higher Education Act is scheduled to expire on September 30, 2004, and reauthorization is currently under consideration by the United States Congress. Should Congress fail to reauthorize the Higher Education Act, our business would be significantly adversely impacted. Our business could also be significantly adversely impacted by a range of other changes in the Higher Education Act, or by other legislation that might be enacted.

Note 10—Fair Value of Financial Instruments

The following table summarizes the fair value of our financial assets and liabilities, including our derivative instruments, as of March 31, 2004 and December 31, 2003.