Exhibit 13
Management's Discussion and Analysis
of Financial Condition and Results of Operations
Years ended December 31, 1995-1997
(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.
On January 2, 1998, SLM Holding effected a 7-for-2 stock split through a
stock dividend of an additional five shares for every two owned. All share and
per share amounts have been restated to reflect the stock split.
The GSE was established in 1973 as a for-profit, stockholder-owned,
government-sponsored enterprise to support the education credit needs of
students by, among other things, promoting liquidity in the student loan
marketplace through secondary market purchases. On July 31, 1997, at a Special
Meeting of Shareholders convened pursuant to the Privatization Act, the
shareholders approved the Reorganization. The Reorganization was consummated on
August 7, 1997 and 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. Under the terms of the Reorganization, all GSE
employees were transferred to non-GSE subsidiaries on August 7, 1997 and on
December 31, 1997 the GSE transferred certain assets, including stock in certain
subsidiaries, to SLM Holding or one of its non-GSE subsidiaries. The
shareholders also elected 15 nominees of the Committee to Restore Value at
Sallie Mae ("CRV") as the initial Board of Directors of SLM Holding. The new
Board of Directors installed a new management team to implement the business
plan that the CRV had presented to the shareholders.
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, and the Health Education Assistance Loan Program ("HEAL"). 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 purchases privately
insured loans, principally those insured by a wholly owned subsidiary.
Both the FFELP and HEAL programs are highly regulated. There are three
types of FFELP loans: Stafford loans, PLUS loans, and consolidation loans.
Generally, these loans have repayment periods of between five and ten years,
with the exception of consolidation loans, and obligate the borrower to pay
interest at an annually reset variable rate that has a cap or, on older loans, a
stated fixed rate. In each case, pursuant to a government established formula,
the yield to holders of FFELP loans is subsidized on the borrowers' behalf by
the federal government to provide a market rate of return. The federal subsidy
is referred to as the Special Allowance Payment ("SAP"), which is paid to
holders of FFELP loans whenever the average of all of the 91-day Treasury bill
auctions in a calendar quarter, plus a spread of between 2.50 and 3.50
percentage points depending on the loan's origination date and whether the loan
is in repayment status, exceeds the rate of interest which the borrower is
obligated to pay. In low interest rate environments, the rate which the borrower
is obligated to pay may exceed the rate determined by the special allowance
formula. In those instances, no SAP is paid and the interest rate paid on the
loan by the borrower becomes, in effect, a floor on an otherwise variable rate
asset. When this happens, the difference between the interest rate paid by the
borrower and the rate determined by the SAP formula is referred to as "student
loan floor revenue" or "floor revenue".
1
The Omnibus Budget Reconciliation Act of 1993 changed the FFELP in a number
of ways that lowered the profitability of FFELP loans for all participants and
established the Federal Direct Student Loan Program ("FDSLP") under which the
federal government lends directly to students. FFELP changes include
risk-sharing on defaulted loans, reductions in the special allowance rate, a 105
basis point annual rebate fee on consolidation loans, a 50 basis point
origination fee on Stafford and PLUS loans and a 30 basis point annual offset
fee (the "Offset Fee") unique to the GSE on student loans purchased and held on
or after August 10, 1993.
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. When used herein, the words "anticipate,"
"believe," "estimate" and "expect" and similar expressions, as they relate to
the Company's management, 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, changes in
the demand for educational financing or in financing preferences of educational
institutions, students and their families and changes in the general interest
rate environment and in the securitization markets for student loans.
Selected Financial Data
Condensed Statements of Income
Increase (Decrease)
--------------------------------------
Years ended December 31, 1997 vs. 1996 1996 vs. 1995
1997 1996 1995 $ % $ %
Net interest income.............................$ 758 $ 866 $ 901 $ (108) (13)% $(35) (4)%
Gains on sales of student loans................. 280 49 - 231 472 49 100
Servicing and securitization revenue............ 151 58 1 93 162 57 100
Other income.................................... 70 40 49 30 75 (9) (18)
Operating expenses.............................. 494 405 439 89 22 (34) (8)
Federal income taxes............................ 243 183 141 60 32 42 30
Minority interest in net earnings of
subsidiary................................... 11 11 11 - - - -
------ ------ ------ ------- --- ---- ---
Income before premiums on debt extinguished..... 511 414 360 97 24 54 15
Premiums on debt extinguished, net of tax....... (3) (5) (5) 2 32 - 2
------ ------ ------ ------- --- ---- ---
NET INCOME......................................$ 508 $ 409 $ 355 $ 99 24% $ 54 15%
====== ====== ====== ======= === ==== ===
BASIC EARNINGS PER COMMON SHARE.................$ 2.80 $ 2.10 $ 1.51 $ .70 33% $.59 39%
====== ====== ====== ======= === ==== ===
DILUTED EARNINGS PER COMMON SHARE...............$ 2.78 $ 2.09 $ 1.51 $ .69 33% $.58 38%
====== ====== ====== ======= === ==== ===
Dividends per common share......................$ .52 $ .47 $ .43 $ .05 11% $.04 9%
====== ====== ====== ======= === ==== ===
CORE EARNINGS...................................$ 487 $ 381 $ 350 $ 106 28% $ 31 9%
====== ====== ====== ======= === ==== ===
CORE EARNINGS
Core earnings are defined as the Company's net income less the after-tax effect
of floor revenues. Management believes that this measure, which is not
recognized under generally accepted accounting principles ("GAAP"), assists in
understanding the Company's earnings before the effects of student loan floor
revenues which, to the extent they are not hedged by floor revenue contracts,
are largely outside of the Company's control. Management believes that core
earnings as defined, while not necessarily comparable to other companies' use of
similar terminology, provide for meaningful period-to-period comparisons as a
basis for analyzing trends in the Company's core student loan operations.
2
Condensed Balance Sheets
Increase (Decrease)
------------------------------------------
December 31, 1997 vs. 1996 1996 vs. 1995
1997 1996 $ % $ %
ASSETS
Student loans..................................... $29,521 $33,754 $(4,233) (13)% $ (582) (2)%
Warehousing advances.............................. 1,869 2,790 (921) (33) (1,075) (28)
Academic facilities financings.................... 1,375 1,473 (98) (7) 160 12
Cash and investments.............................. 5,130 7,706 (2,576) (33) (1,161) (13)
Other assets...................................... 2,014 1,907 107 6 286 18
------- ------- ------- --- ------- ---
Total assets...................................... $39,909 $47,630 $(7,721) (16)% $(2,372) (5)%
======= ======= ======= === ======= ===
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings............................. $23,176 $22,518 $ 658 3% $ 5,071 29%
Long-term notes................................... 14,541 22,606 (8,065) (36) (7,477) (25)
Other liabilities................................. 1,303 1,458 (155) (11) 67 5
------- ------- ------- --- ------- ---
Total liabilities................................. 39,020 46,582 (7,562) (16) (2,339) (5)
------- ------- ------- --- ------- ---
Minority interest in subsidiary................... 214 214 - - - -
Stockholders' equity before treasury stock........ 1,099 1,371 (272) (20) (2,291) (63)
Common stock held in treasury at cost............. 424 537 (113) (21) (2,258) (81)
------- ------- ------- --- ------- ---
Total stockholders' equity........................ 675 834 (159) (19) (33) (4)
------- ------- ------- --- ------- ---
Total liabilities and stockholders' equity........ $39,909 $47,630 $(7,721) (16)% $(2,372) (5)%
======= ======= ======= === ======= ===
Results of Operations
Earnings Summary
For the year ended December 31, 1997, the Company's net income was $508 million
($2.78 diluted earnings per common share), compared to $409 million ($2.09
diluted earnings per common share) for the year ended December 31, 1996. The
increase in 1997 net income of $99 million (24 percent) reflects the Company's
strategy of funding its managed portfolio of student loans through its
securitization program. In 1997, the Company securitized $9.4 billion of student
loans and recorded securitization gains of $182 million, after-tax, an increase
of $150 million over the gains recorded in 1996. The increase is mainly due to
the securitization of $3.4 billion more loans in 1997 and to higher average
borrower indebtedness and the longer average life of the portfolios securitized
in 1997 versus 1996. The 1997 gain also includes $36 million, after-tax, related
to the reversal of reserves for Offset Fees on securitizations completed prior
to 1997, which were held in reserve until the third quarter of 1997 when the
Company resolved litigation over whether the Offset Fee applied to securitized
student loans (discussed below). The growth in securitization activity in 1997
increased the average balance of securitized student loans, which increased
servicing and securitization revenue by approximately $61 million, after-tax.
The increased income from the Company's securitization program was offset by the
reduction in net interest income of $71 million, after-tax, which occurred as
the on-balance sheet student loan portfolio was reduced through securitizations
and as a result of declining student loan spreads. Operating expenses increased
by $62 million, after-tax, due mainly to one-time or non-recurring charges
associated with the Reorganization, privatization and proxy expenses (discussed
below) and to the increase in the volume of student loans serviced. Operating
expenses (exclusive of the one-time or non-recurring charges) as a percent of
managed student loans decreased from 109 basis points in 1996 to 98 basis points
in 1997. Each of these components of net income is discussed in further detail
in subsequent sections of this analysis.
3
In the third quarter of 1997, in response to litigation initiated by the
Company, the United States Department of Education determined that the Offset
Fee that the GSE is required to pay on certain student loans does not apply to
securitized student loans. As a result, in the third quarter of 1997 the Company
reversed a pre-tax $97 million reserve ($40 million of which was accrued in the
first half of 1997) for Offset Fees accrued previously on securitized student
loans. 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. Also, during 1997,
net income was reduced by pre-tax charges of $107 million ($86 million included
in operating expenses) for expenses and asset writedowns in connection with the
Reorganization, the proxy contest, the transfer of student loans from a third
party servicer in financial difficulty and the change in business strategies
implemented by the new management. (See -- "Operating Expenses.")
During 1997, the Company spent $680 million to repurchase 18 million common
shares (or 10 percent of its outstanding shares), which further enhanced
earnings per share growth.
Net Interest Income
Net interest income is derived largely from the Company's on-balance sheet
portfolio of student loans. 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. Additional information regarding
the return on the Company's student loan portfolio is set forth below under
"Student Loans".
Taxable Equivalent Net Interest Income
The amounts in the following table are adjusted for the impact of certain
tax-exempt and tax-advantaged investments based on the marginal corporate tax
rate of 35 percent.
Increase (Decrease)
-------------------------------------
Years ended December 31, 1997 vs. 1996 1996 vs. 1995
1997 1996 1995 $ % $ %
Interest income
Student loans............................ $2,462 $2,607 $2,708 $(145) (6)% $ (101) (4)%
Warehousing advances..................... 151 194 408 (43) (22) (214) (53)
Academic facilities financings........... 98 100 108 (2) (2) (8) (7)
Investments.............................. 573 548 697 25 4 (149) (21)
Taxable equivalent adjustment............ 35 36 52 (1) (1) (16) (30)
------ ------ ------ ----- --- ------- ---
Total taxable equivalent interest income.... 3,319 3,485 3,973 (166) (5) (488) (12)
Interest expense............................ 2,526 2,583 3,020 (57) (2) (437) (14)
------ ------ ------ ----- --- ------- ---
Taxable equivalent net interest income...... $ 793 $ 902 $ 953 $(109) (12)% $ (51) (5)%
====== ====== ====== ===== === ======= ===
4
Average Balance Sheets
The following table reflects the rates earned on earning assets and paid on
liabilities for the years ended December 31, 1997, 1996 and 1995.
Years ended December 31,
----------------------------------------------------------------------
1997 1996 1995
Balance Rate Balance Rate Balance Rate
AVERAGE ASSETS
Student loans................................... $31,949 7.70% $33,273 7.83% $32,758 8.27%
Warehousing advances............................ 2,518 6.00 3,206 6.04 6,342 6.43
Academic facilities financings.................. 1,436 8.57 1,500 8.43 1,527 8.92
Investments..................................... 9,592 6.08 9,444 5.91 11,154 6.46
------- ---- ------- ---- ------- ----
Total interest earning assets...................... 45,495 7.30% 47,423 7.35% 51,781 7.67%
==== ==== ====
Non-interest earning assets........................ 1,983 1,858 1,673
------- ------- -------
Total assets....................................... $47,478 $49,281 $53,454
======= ======= =======
AVERAGE LIABILITIES AND STOCKHOLDERS' EQUITY
Six month floating rate notes................... $ 2,908 5.48% $ 2,485 5.42% $ 3,609 5.86%
Other short-term borrowings..................... 23,640 5.51 18,493 5.43 11,802 5.88
Long-term notes................................. 18,677 5.70 26,024 5.55 35,373 5.98
------- ---- ------- ---- ------- ----
Total interest bearing liabilities................. 45,225 5.59% 47,002 5.50% 50,784 5.95%
==== ==== ====
Non-interest bearing liabilities................... 1,473 1,464 1,451
Stockholders' equity............................... 780 815 1,219
------- ------- -------
Total liabilities and stockholders' equity......... $47,478 $49,281 $53,454
======= ======= =======
Net interest margin................................ 1.74% 1.90% 1.84%
==== ==== ====
================================================================================
Rate/Volume Analysis
The Rate/Volume Analysis below shows the relative contribution of changes in
interest rates and asset volumes.
Taxable Increase (decrease)
equivalent attributable to change in
increase
(decrease) Rate Volume
1997 vs. 1996
Taxable equivalent
interest income......... $(166) $ (26) $(140)
Interest expense........... (57) 55 (112)
----- ----- -----
Taxable equivalent net
interest income......... $(109) $ (81) $ (28)
===== ===== =====
1996 vs. 1995
Taxable equivalent
interest income......... $(488) $(235) $(253)
Interest expense........... (437) (223) (214)
----- ----- -----
Taxable equivalent net
interest income......... $ (51) $ (12) $ (39)
===== ===== =====
Taxable equivalent net interest income and net interest margin for the year
ended December 31, 1997 decreased from 1996 by $109 million and .16 percent,
respectively. The $81 million decrease in taxable equivalent net interest income
attributable to the change in rates in 1997 versus 1996 was principally due to a
$21 million increase in consolidation loan rebate fees (See -- "Student Loan
Spread Analysis"), lower student loan yields in the form of reduced SAP rates
which reduced interest income by $12 million and the growth in the balance of
student loan participations which, due to the fact that they earn at a
contractual rate that is net of servicing costs, negatively impacted student
loan spreads by $16 million. Other factors contributing to the decrease were the
writeoff of $13 million of deferred hedge losses in the 1997 third quarter and a
decrease of $12 million in floor revenues, net of payments under the floor
revenue contracts discussed below. 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 $28 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
partially offset by the increase in the average balance of student loan
participations.
5
Taxable equivalent net interest income in 1996 decreased from 1995 by $51
million. The $12 million decrease in taxable equivalent net interest income
attributable to the change in rates in 1996 versus 1995 was principally due to
higher reserves for risk-sharing, consolidation loan rebate fees and yield
reductions totalling $40 million, an increase in student loan loss reserves
(exclusive of risk-sharing) of $14 million and increased leverage of $21
million, partially offset by the increase of $29 million in floor revenues, net
of payments to floor contract counterparties. Other items offsetting the
decreases in taxable equivalent net interest income discussed above include $22
million of revenues from the amortization of the up-front payments received from
student loan floor contracts, the $9 million reversal of a previously
established reserve due to the successful outcome of litigation related to SAP
payments on certain loans, and a higher percentage of student loans relative to
average earning assets. The $39 million decrease attributable to volume is
primarily due to the decrease in the balance of warehousing advances and
investments as the Company reduced these assets and utilized the capital
supporting them to purchase shares of its common stock. Since the Company's
borrowings are largely variable rate in nature, the decrease in interest expense
in 1996 was reflective of the level of interest rates in general. In addition,
the absolute level of borrowings decreased as the balance sheet was reduced in
size through the securitization of student loans as well as the reductions in
the investment and warehousing advance portfolios.
The increase in net interest margin in 1996 from 1995 was due principally
to the increase in student loans as a percentage of average earning assets.
Student Loans
STUDENT LOAN SPREAD ANALYSIS
The following table analyzes the earning spreads on student loans for 1997, 1996
and 1995. The line captioned "Adjusted Student Loan Yields" reflects contractual
yields adjusted for the amortization of premiums paid to purchase loan
portfolios and the estimated costs of borrower benefits. The Company's servicing
subsidiary, as the servicer of student loans that the Company securitizes, will
continue to earn fee revenues over the life of the securitized student loan
portfolios. The off-balance sheet information presented in the Student Loan
Spread Analysis that follows analyzes the on-going revenues associated with the
securitized portfolios of student loans.
Years ended December 31,
1997 1996 1995
ON-BALANCE SHEET
Adjusted student loan yields 7.85% 7.92% 8.40%
Amortization of floor swap
payments............... .12 .07 -
Floor income.............. .10 .13 .04
Consolidation loan
rebate fees............ (.20) (.12) (.10)
Reserves for risk-
sharing costs.......... (.05) (.05) -
Offset fees............... (.12) (.12) (.07)
------- ------- -------
Student loan income....... 7.70 7.83 8.27
Cost of funds............. (5.53) (5.49) (5.95)
------- ------- -------
Student loan spread....... 2.17% 2.34% 2.32%
======= ======= =======
Core student loan spread.. 2.07% 2.21% 2.28%
======= ======= =======
OFF-BALANCE SHEET
Servicing and securitization
revenue................ 1.58% 1.43% .80%
======= ======= =======
AVERAGE BALANCES
Student loans, including
participations......... $31,949 $33,273 $32,758
Securitized loans......... 9,542 4,020 177
------- ------- -------
Managed student loans..... $41,491 $37,293 $32,935
======= ======= =======
The core student loan spread declined from 2.21 percent in 1996 to 2.07
percent in 1997, a decline of .14 percent. The combined impact of consolidation
loan rebate fees, reserves for risk-sharing losses and Offset Fees reduced core
student loan spreads by .37 percent in 1997 versus .29 percent in 1996. This
reduction was principally due to the growth in the portfolio of loans subject to
the consolidation loan rebate fee. Other factors contributing to the decrease in
the core student loan spread were the relative increase in student loan
participations which contractually yield a lower rate than the underlying
student loans (discussed below) 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 contracts and by lower
additions to loss reserves for student loans.
6
In November 1997, the Company suspended its loan consolidation program (See
- -- "Legislative Developments - Loan Consolidation Program") and, unless the
Company is able to reinstate its program, consolidation loan rebate fees will
decline over time as the portfolio of consolidation loans are repaid. However,
on-balance sheet student loan spreads will continue to be negatively impacted as
the balance of newly acquired loans, which are subject to the reduced SAP rates,
risk-sharing and Offset Fees, replaces the runoff of older student loans not
subject to these fees and yield reductions. The Company endeavors to pass
through the impact of these costs through the pricing of loan portfolios it
purchases in the secondary market.
The decrease in the core student loan spread in 1996 relative to 1995 was
due principally to higher consolidation loan rebate fees, reserves for
risk-sharing losses and Offset Fees, the effect of student loan participations
which contractually yield a lower rate than the underlying student loans, and
increased student loan loss reserves, offset by the revenues from the
amortization of upfront payments received from student loan floor contracts and
a one-time gain from the reversal of a previously established loss reserve due
to the successful outcome of litigation related to SAP payments on certain
loans.
In the third quarter of 1996, the GSE restructured its business
relationship with the Chase Manhattan Bank ("Chase") whereby the GSE and Chase
formed a joint venture (the "Joint Venture") that markets education loans made
by Chase. Chase sells the loans to a trust which holds them on behalf of the
Joint Venture. These loan purchases are financed through sales of student loan
participations to the GSE and Chase. The loan participations earn interest at a
contractual rate which is based on the yield of the underlying student loans
less amounts to cover servicing and other operating expenses. Such expenses
reduced the Company's student loan spread by .08 percent in 1997 and .03 percent
in 1996. At December 31, 1997 and 1996, the Joint Venture owned $3.9 billion and
$2.9 billion, respectively, of federally insured education loans with
substantially all of the loans serviced by the Company's servicing subsidiary.
The Company accounts for its investment in the Joint Venture using the equity
method.
STUDENT LOAN FLOOR REVENUES
The yield to holders of FFELP loans is subsidized on the borrower's behalf by
the federal government to provide a market rate of return through the payment of
SAP. The SAP is paid to holders of FFELP loans whenever the average of all of
the 91-day Treasury bill auctions in a calendar quarter plus a spread of 2.50
percent, 3.10 percent, 3.25 percent or 3.50 percent, depending on the loan's
status and origination date, exceeds the rate of interest that the borrower
pays. The interest rate paid by the borrower is either at a fixed rate or a rate
that resets annually. Thus, the yield to holders of student loans varies with
the 91-day Treasury bill rate except in low interest rate environments, when the
interest rate which the borrower is obligated to pay exceeds the variable rate
determined by the SAP formula. When this happens the borrower's interest rate,
which is the minimum interest rate earned on FFELP loans, becomes, in effect, a
floor rate. The floor enables the Company to earn wider spreads on these student
loans since the Company's variable cost of funds, which is indexed to the 91-day
Treasury bill rate, reflects lower market rates. The floor generally becomes a
factor when the Treasury bill rate is less than 5.90 percent. For loans which
have fixed borrower interest rates, the floor remains a factor until Treasury
bill rates rise to a level at which the yield determined by the SAP formula
exceeds the borrower's interest rate ("fixed rate floors"). For loans with
annually reset borrower rates, the floor is a factor until either Treasury bill
rates rise or the borrower's interest rate is reset which occurs on July 1 of
each year ("variable rate floors"). Under the FFELP program, the majority of
loans disbursed after July 1992 have variable borrower interest rates that reset
annually.
MANAGED STUDENT LOANS ELIGIBLE TO EARN FLOOR REVENUES
The following table reflects those loans in the Company's managed student loan
portfolio with potential to earn floor revenue at December 31, 1997 and 1996
(dollars in billions).
December 31, 1997 December 31, 1996
Fixed Variable Total Fixed Variable Total
Student loans with floor revenue potential............ $14.2 $ 20.5 $ 34.7 $16.1 $15.1 $ 31.2
Less notional amount of floor revenue contracts....... (7.2) (10.6) (17.8) (8.6) (4.9) (13.5)
----- ------ ------- ------ ----- ------
Net student loans with floor revenue potential........ $ 7.0 $ 9.9 $ 16.9 $ 7.5 $10.2 $ 17.7
===== ====== ====== ===== ===== ======
Net student loans earning floor revenues at year end.. $ 4.6 $ -- $ 4.6 $ 2.8 $ 6.6 $ 9.4
===== ====== ====== ===== ===== ======
7
Based on the average bond equivalent 91-day Treasury bill rates of 5.21
percent, 5.16 percent and 5.68 percent for the years ended December 31, 1997,
1996 and 1995, respectively, the Company earned floor revenues of $32 million
(net of $19 million in payments under the floor revenue contracts), $43 million
(net of $12 million in payments under the floor revenue contracts), and $14
million, respectively.
FLOOR REVENUE CONTRACTS
During 1996 and 1997, the Company entered into contracts with third parties with
notional amounts of $13 billion and $11 billion, respectively, under which it
agreed to pay the future floor revenues received in exchange for upfront
payments ("floor revenue contracts"). These upfront payments are being amortized
to student loan income over the average life of the contracts, which is
approximately six months for the 1997 contracts and two years for the 1996
contracts. At December 31, 1997, $11 billion of the notional amount of the 1997
contracts was outstanding and $7 billion of the notional amount of the 1996
contracts was outstanding.
For the years ended December 31, 1997 and 1996, the amortization of the
upfront payments received for the sale of fixed rate floor revenue contracts
contributed $34 million and $22 million, respectively, pre-tax to core earnings.
The amortization of these payments is not dependent on future interest rate
levels, and therefore is included in the Company's definition of core earnings.
In addition, for the years ended December 31, 1997 and 1996, the Company earned
$7 million and $1 million, respectively, on variable rate floor revenue
contracts. These contracts typically expire on the interest reset date of the
underlying student loans and the related amortization of up-front payments is
excluded from core earnings.
PROVISION FOR STUDENT LOAN LOSSES
The provision for student loan losses is the periodic expense of maintaining an
allowance sufficient to absorb losses, net of recoveries, inherent in the
existing on-balance sheet loan portfolio. In evaluating the adequacy of the
allowance for loan losses, the Company takes into consideration several factors
including trends in claims rejected for payment by guarantors, default rates on
non-federally insured student loans, principally those insured by a wholly owned
subsidiary of the Company and the amount of FFELP loans subject to 2 percent
risk-sharing. In 1997, the Company added $17 million to this reserve to provide
for losses on non-federally insured student loans versus $14 million in 1996.
The Company also added a net of $5 million for potential losses on its federally
insured student loan portfolio based on the additions for potential losses due
to risk-sharing partially offset by decreases due to improved experience in
recovering unpaid guarantees on defaulted student loans versus $15 million in
1996. The provision for loan losses, net of recoveries, did not change
materially in 1995. Once a student loan is charged off as a result of an unpaid
claim, it is the Company's policy to continue to pursue the recovery of
principal and interest.
Management believes that the allowance for loan losses is adequate to cover
anticipated losses in the on-balance sheet student loan portfolio. However, this
evaluation is inherently subjective as it requires material estimates that may
be susceptible to significant changes.
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
debt (by index after giving effect to the impact of interest rate swaps) for the
years ended December 31, 1997, 1996 and 1995.
Years ended December 31,
----------------------------------------------------------------------------
1997 1996 1995
Average Average Average Average Average Average
Index Balance Rate Balance Rate Balance Rate
Treasury bill, principally 91-day.............. $32,240 5.52% $35,375 5.48% $34,039 5.93%
LIBOR.......................................... 6,219 5.51 7,797 5.38 14,290 5.87
Discount notes................................. 5,267 5.48 2,694 5.35 1,209 5.85
Fixed.......................................... 663 7.02 720 6.81 811 6.68
Zero coupon.................................... 134 11.12 123 11.12 123 11.06
Other.......................................... 702 5.20 293 4.87 312 6.11
------- ----- ------- ----- ------- -----
Total.......................................... $45,225 5.59% $47,002 5.50% $50,784 5.95%
======= ===== ======= ===== ======= =====
8
In the above table, for the years ended December 31, 1997, 1996 and 1995,
spreads for Treasury bill indexed borrowings averaged .24 percent, .25 percent
and .26 percent, respectively, over the weighted average Treasury bill rates for
those years and spreads for London Interbank Offered Rate ("LIBOR") indexed
borrowings averaged .24 percent, .26 percent and .31 percent, respectively,
under the weighted average LIBOR rates.
Other Income
In addition to the $97 million reserve reversal related to the applicability of
the Offset Fee to securitized student loans, the increase in other income of
$354 million over 1996 was mainly due to higher levels of securitization during
1997, and an increase of $93 million in servicing and securitization revenue as
the Company's average balance of securitized student loans increased by $5.5
billion over 1996.
Securitization Program
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 sold to a special purpose finance
subsidiary and by the subsidiary to trusts that issued asset-backed securities
to fund the student loans to term. 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 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 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.
GAINS ON SALES OF STUDENT LOANS
In 1997, the Company recorded securitization gains of $280 million pre-tax, an
increase of $231 million over the gains recorded in 1996. The increase is mainly
due to the securitization of $3.4 billion more student loans in 1997 than in
1996. In the third quarter of 1997, the Company resolved litigation over whether
the Offset Fee applied to securitized student loans. As a result, in the third
quarter of 1997 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 on securitized student loans. If the
Company had recorded gains at the time of each securitization transaction
without reserving for the Offset Fee, then the 1997 gains would have been
pre-tax $226 million versus $95 million in 1996, or, as a percentage of the
securitized portfolios, 2.39 percent in 1997 versus 1.58 percent in 1996. The
increase in gains as a percentage of the securitized portfolio was due mainly to
higher average borrower indebtedness and the longer average life of the
portfolios of loans securitized in 1997 versus 1996. Gains on securitizations
were immaterial in 1995. Gains on future securitizations will continue to vary
depending on the size and the loan characteristics of the loan portfolios
securitized and the funding costs prevailing in the securitization debt markets.
SERVICING AND SECURITIZATION INCOME
Interest earned on the Interest Residual is included in servicing and
securitization revenue and totaled $53 million and $23 million, for the years
ended December 31, 1997 and 1996, respectively. Securitization and servicing
revenue also includes fee income earned for servicing the securitized
portfolios. These fees, less the amortization of the servicing asset, totaled
$98 million and $35 million, for the years ended December 31, 1997 and 1996,
respectively. The increase in servicing and securitization income is mainly due
to the increase in the average balance of the Interest Residual from $144
million in 1996 to $329 million in 1997, and to the increase in the average
balance of securitized student loans from $4.0 billion in 1996 to $9.5 billion
in 1997. Servicing and securitization income in 1997 also includes $3 million
related to the Offset Fee reserve reversal in the third quarter of 1997.
Operating Expenses
Operating expenses include costs to service the Company's managed student loan
portfolio and operational costs incurred in the process of acquiring student
loan portfolios and general and administrative expenses. Total operating
expenses as a percentage of average managed student loans were 119 basis points,
109 basis points and 133 basis points for the years ended December 31, 1997,
1996 and 1995 respectively. Operating expenses in 1997 included one-time
expenses of $86 million ($61 million to corporate operating expenses and $25
million to servicing costs) incurred in 1997 in connection with the Company's
Reorganization, the proxy contest, the transfer of loans from a third party
servicer in financial difficulty 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. Operating expenses are summarized in the tables
on the following page.
9
Years ended December 31,
----------------------------------------------------------------------------------------------
1997 1996 1995
Servicing Servicing Servicing
and and and
Corporate Acquisition Total Corporate Acquisition Total Corporate Acquisition Total
Salaries and employee
benefits................... $ 75 $150 $225 $ 68 $138 $206 $ 75 $137 $212
Occupancy and equipment...... 28 72 100 24 60 84 25 49 74
Professional fees............ 23 20 43 15 8 23 34 11 45
Advertising and printing..... 7 - 7 7 - 7 6 - 6
Office operations............ 8 28 36 8 32 40 9 35 44
Other........................ 34 12 46 9 2 11 12 2 14
---- ----- ----- ---- ----- ----- ---- ----- -----
Total internal operating
expenses................... 175 282 457 131 240 371 161 234 395
Third party servicing costs... - 37 37 - 35 35 - 44 44
---- ----- ----- ---- ----- ----- ---- ----- -----
Total operating expenses...... $175 $319 $494 $131 $275 $406 $161 $278 $439
==== ===== ===== ==== ===== ===== ==== ===== =====
Employees at end of the year.. 563 4,045 4,608 761 4,031 4,792 856 3,885 4,741
==== ===== ===== ==== ===== ===== ==== ===== =====
Years ended December 31, Increase/(Decrease)
-------------------------------- -----------------------------------------
1997 1996 1995 1997 vs. 1996 1996 vs. 1995
$ % $ %
Servicing costs........................ $252 $211 $205 $41 20% $ 6 3%
Acquisition costs...................... 67 64 73 3 4 (9) (13)
---- ---- ---- --- -- --- ---
Total servicing and acquisition costs.. $319 $275 $278 $44 16% $(3) (1)%
==== ==== ==== === == === ===
================================================================================
In 1997, corporate operating expenses increased by $44 million over the
corresponding year. As mentioned above, the increase can be attributed to the
one-time, non-recurring expenses of $61 million that relate to the
Reorganization of the GSE. Specifically, these expenses were related to
privatization costs ($12 million expense related to the warrants issued to the
D.C. government, $5 million for the use of the Sallie Mae name and $3 million in
fees and related costs for the Company's initial SEC registration), severance
costs as a result of staff reductions ($16 million), costs associated with the
consolidation of staff located in the metropolitan Washington D.C. area ($11
million), the write-down of various non-student loan assets ($5 million) and
costs associated with the proxy solicitations relating to the Reorganization ($9
million). The decrease in corporate operating expenses exclusive of the
one-time, non-recurring expenses was due to lower professional fees and the
beneficial impact in the fourth quarter from the staff reductions, lower
depreciation from the asset writedowns and the consolidation of facilities.
For the year ended December 31, 1997, servicing costs increased by $41
million. Approximately $25 million of this increase was due to the one-time,
non-recurring expenses of $11 million for the write-down of assets, $4 million
for severance costs relating to the third quarter staff reductions and $10
million in connection with the transfer of loans from a third party servicer in
financial difficulty to Sallie Mae Servicing Corporation ("SMSC"), a wholly
owned subsidiary of the Company. The increase also reflects increased costs
associated with the increase in the volume of loans serviced.
The decrease of $30 million in corporate operating expenses in 1996 versus
1995 was due principally to the divestiture of a majority interest in CyberMark,
a wholly owned subsidiary, completed during the second quarter of 1996 which
reduced 1996 operating expenses by $20 million. Reductions in corporate staffing
and professional fees reduced operating expenses by an additional $10 million.
Servicing costs include all operations and systems costs incurred to
service the portfolio of managed student loans, including fees paid to third
party servicers. The 1992 legislated expansion of student eligibility and
increases in loan limits resulted in higher average student loan balances, which
generally command a higher price in the secondary market and contribute to lower
servicing costs as a percentage of the average balance of managed student loans.
When expressed as a percentage of the managed student loan portfolio, servicing
costs averaged 61 basis points, 57 basis points and 62 basis points for the
years ended December 31, 1997, 1996 and 1995 respectively. The increase in 1997
was due principally to the one-time costs discussed above, which increased
servicing costs by 6 basis points for the year ended December 31, 1997.
10
Loan acquisition costs are principally costs incurred under the ExportSS(R)
("ExportSS") loan origination and administration service, the costs of
converting newly acquired portfolios onto the Company's servicing platform or
those of third party servicers and costs of loan consolidation activities. The
ExportSS service provides back-office support to clients by performing loan
origination and servicing prior to the sale of portfolios to the Company. During
1997, $4.7 billion of student loans were originated and transferred to the
Company's ExportSS system, of which $1.5 billion was related to the Joint
Venture's portfolio including $760 million committed for sale to the Company,
compared to $4.2 billion in the prior year. The outstanding portfolio of loans
serviced for ExportSS lenders totaled $4.2 billion at December 31, 1997, up 3
percent from $4.0 billion at December 31, 1996.
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 1997, 30 percent in 1996, and 27
percent in 1995. The increase in the effective tax rate for 1997 was mainly due
to $12 million of warrants issued in connection with the privatization and other
privatization costs, which are not deductible for tax purposes. 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 1997 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. Management believes that the financing and capital requirements of
the Company can be adequately accommodated through the foregoing sources.
During 1997, the Company used the proceeds from student loan
securitizations of $9.6 billion, repayments and claim payments on student loans
of $3.8 billion, and the net proceeds from sales of investments of $2.4 billion
to purchase student loans and participations of $9.0 billion, to reduce total
debt by $7.4 billion and to repurchase $680 million of the Company's common
stock.
Operating activities provided net cash inflows of $55 million
in 1997, a decrease of $147 million from the net cash inflows of $202 million in
1996. This decrease was mainly attributable to the decrease in other liabilities
of $130 million in 1997 versus an increase of $188 million in 1996 caused by
1996 student loan purchases of approximately $200 million for which payment was
made in 1997.
During 1997, the GSE issued $4.7 billion of long-term notes to refund
maturing and repurchased obligations. At December 31, 1997, the GSE had $14.5
billion of outstanding long-term debt issues of which $9.6 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 characteristics of its variable interest
rate earning assets. (See "Interest Rate Risk Management.")
11
On August 8, 1997, SLM Holding secured a $600 million bank line of credit
which is being used to meet working capital needs. 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. There will also be a need
for short-term financing for student loans prior to securitization. Such
financings will likely 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. At December
31, 1997, SLM Holding had $281 million outstanding under this line.
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 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 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 December 31, 1997, the GSE's statutory capital
adequacy ratio, after the effect of the dividends to be paid in the first
quarter of 1998, was 2.00 percent.
The Privatization Act imposes certain restrictions on intercompany
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
Since 1995, the Company has diversified its funding sources independent of its
GSE borrower status by securitizing a portion of its student loan assets.
Securitized student loans are funded off-balance sheet to term through the
public issuance of student loan asset-backed securities ("ABS securities"),
which reduces the Company's on-balance sheet funding needs. During 1997, the GSE
completed four transactions in which it sold a total of $9.4 billion of student
loans to trusts which issued $9.6 billion of securities backed by the loans.
Management believes that securitization represents an efficient source of
funding. The GSE's ABS securities 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 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 a "AAA" credit rating on over 96 percent of
its securities sold (with an "A" credit rating on the remaining subordinated
securities).
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.
12
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, 1997, there were approximately $2 billion of PLUS/SLS student loans
outstanding in the trusts which have interest rates which reset annually based
on the final auction of 52-week Treasury bill before each June 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 securitization.
In the table below the Company's variable rate assets and liabilities are
categorized by 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, 1997 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...................................... $27,216 $ 2,305 $ - $ - $ - $ -
Warehousing advances............................... 1,847 2 - 1 - 19
Academic facilities financings..................... 82 39 19 60 345 830
Cash and investments............................... 3,106 26 48 28 84 1,838
Other assets....................................... 4 5 10 29 192 1,774
------- ------- ------- ------- ------ ------
Total assets.................................... 32,255 2,377 77 118 621 4,461
------- ------- ------- ------- ------ ------
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings.............................. 15,170 2,370 5,636 - - -
Long-term notes.................................... 4,221 499 - 4,339 4,900 582
Other liabilities.................................. - - - - - 1,303
Minority interest in subsidiary.................... - - - - - 214
Stockholders' equity............................... - - - - - 675
------- ------- ------- ------- ------ ------
Total liabilities and stockholders' equity...... 19,391 2,869 5,636 4,339 4,900 2,774
------- ------- ------- ------- ------ ------
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
Interest rate swaps................................ 12,232 1,400 (5,556) (4,289) (4,779) 992
Impact of securitized student loans................ 1,831 (1,831) - - - -
------- ------- ------- ------- ------ ------
Total off-balance sheet financial instruments...... 14,063 (431) (5,556) (4,289) (4,779) 992
------- ------- ------- ------- ------ ------
Period gap......................................... $(1,199) $ (61) $ (3) $ 68 $ 500 $ 695
======= ======= ======= ======= ====== ======
Cumulative gap..................................... $(1,199) $(1,260) $(1,263) $(1,195) $ (695) -
======= ======= ======= ======= ====== ======
Ratio of interest-sensitive assets to interest-
sensitive liabilities............................ 166.3% 82.7% 1.2% 2.1% 8.8% 461.7%
======= ======= ======= ======= ====== ======
Ratio of cumulative gap to total assets............ 3.0% 3.2% 3.2% 3.0% 1.7% -%
======= ======= ======= ======= ====== ======
13
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.
Based on this analysis an increase in rates of this magnitude would reduce net
income by approximately $22 million or $.12 diluted earnings per share. The
decline in net income would primarily be due to the reduction in floor revenues
earned net of payments to floor revenue counterparties.
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 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 $50 million. The decrease in student loan fair market
value would be partially offset by a net increase in the fair market value of
the Company's non-student loan assets, long-term debt and hedging instruments of
$5 million. The decrease in student loan market value is mainly due to the
reduction in value of the floor revenue feature of the underlying student loans.
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
earning assets and liabilities at December 31, 1997 (in years):
EARNING ASSETS
Student loans.......................................... 6.0
Warehousing advances................................... 4.5
Academic facilities financings......................... 7.5
Cash and investments................................... 6.0
---
Total earning assets................................... 6.0
---
BORROWINGS
Short-term borrowings.................................. .5
Long-term borrowings................................... 3.0
---
Total borrowings....................................... 1.5
---
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 6.0 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. This increased the
number of common shares outstanding at December 31, 1997 from 49.5 million to
173.4 million.
During 1997, the Company repurchased 18.0 million shares of its common
stock adjusted for the 7-for-2 stock split leaving 173.4 million shares
outstanding at December 31, 1997. For the past few years the GSE has operated
near the statutory minimum capital ratio of 2.0 percent of risk adjusted assets
required under its charter. Capital in excess of such amounts has been used to
repurchase common shares. As of December 31, 1997, the Company had remaining
authority to repurchase up to an additional 6.3 million shares. In January 1998,
the Board of Directors increased this authority by 20 million shares, bringing
the total remaining authority to 26.3 million shares which covers both purchases
of common shares in the open market or effective purchases through equity
forward contracts. Commencing in the fourth quarter of 1997, the Company
supplemented its open market common stock purchases by entering into equity
forward transactions to purchase 7 million shares on a cash or net share settled
basis. The forwards settle at various times over the next two years at prices
ranging from $38 per share to $42 per share.
14
Other Related Events and Information
Legislative Developments
The Higher Education Act provides that the special allowance for student loans
made on or after July 1, 1998 will be based on the U.S. Treasury security with
comparable maturity plus 1.0 percent for Stafford and Unsubsidized Stafford
loans, and 2.1 percent for PLUS loans. The Secretary of Education has not
adopted regulations specifying the U.S. Treasury security on which these
interest rates will be based or how often the special allowance rate will reset.
Depending on the specifics of the regulations, these changes could adversely
impact the FFELP market and the Company's business, because of the uncertain
availability and costs of funding to support this new type of instrument. On
February 25, 1998, the U.S. Treasury Department released a report on "The
Financial Viability of the Government Guaranteed Student Loan Program." The
report concludes that the new special allowance formula scheduled to take effect
for student loans on July 1, 1998 would reduce lenders' net return to below
acceptable levels and would create inefficiencies. The Treasury report also
suggests that the current T-bill based formula provides lenders with a pre-tax
rate of return that exceeds a "reasonable range of target rates." Management
believes that the report's costs and profitability assumptions underlying the
rate of return analysis are flawed. Concurrent with the release of the report,
the Clinton Administration called for a reinstatement of the 91-day T-bill index
and an 80 basis point reduction in the special allowance for both in-school and
repayment loans. Management believes the administration's proposal, as with the
currently scheduled rate change, would result in uneconomic returns for lenders.
Such a reduction would have a material adverse impact on the Company and its
earnings. Management expects Congress to consider this issue in March of 1998.
It is uncertain whether Congress will enact any changes to the law and whether
such changes would be in line with the Administration's proposal.
Loan Consolidation Program
On November 13, 1997, President Clinton signed into law the Emergency Student
Loan Consolidation Act of 1997, which made significant changes to the FFELP loan
consolidation program. These changes include: (1) providing that FDSLP loans are
eligible to be included in a FFELP consolidation loan; (2) changing the borrower
interest rate on new consolidation loans (previously a fixed rate based on the
weighted average of the loans consolidated, rounded up to the nearest whole
percent) to the annually variable rate applicable to Stafford loans (the bond
equivalent rate at the last auction in May of 91-day Treasury bills, plus 3.10
percent, capped at 8.25 percent); (3) providing that the portion of a
consolidated loan that is comprised of subsidized loans retains its subsidy
benefits during periods of deferment; and (4) establishing prohibitions against
various forms of discrimination in the making of consolidation loans. All of
these provisions, with the exception of item 4, expire on September 30, 1998.
The emergency legislation did not alter the 105 basis points annual fee payable
by the holder of a consolidation loan or the 50 basis points origination fee
charged to lenders when a consolidation loan is issued.
Following enactment of this legislation, the Company announced that,
effective as of November 13, 1997, it had suspended its loan consolidation
program (marketed as the SMART LoanSM program). The new legislation made it
difficult for the Company to participate in the FFELP consolidation loan program
for profitability reasons. The Company does, however, strongly endorse the
principle of the legislation that allows FDSLP and FFELP borrowers to
consolidate their loans under either program and plans to continue to press for
changes that will enable the Company to once again participate in the FFELP
consolidation loan program.
Administration's FY 1999 Budget Proposal
On February 3, 1998, President Clinton submitted his Fiscal Year 1999 budget
proposal to Congress. As in past years, the President has included a number of
provisions designed to reduce the costs of the FFELP program and to provide
savings necessary to offset the costs of reducing borrower paid loan origination
fees, which he proposed to eliminate completely for Subsidized Stafford loans by
July 1, 2003. The President proposed to provide FFELP borrowers extended
repayment options that are available in the FDSLP, and to allow for a multi-year
promissory note for both the FFELP and FDSLP to streamline the application
process for serial borrowers. Of specific interest to lenders are proposals to
reset the interest rate for special allowance payments on new loans on an annual
basis, versus the current weekly reset, require lenders to limit interest
capitalization on Unsubsidized Stafford Loans to the beginning of repayment
(versus current policy which permits capitalization to occur as frequently as
quarterly while the borrower is in school) and to require FFELP lenders that
offer benefits involving the partial or complete payment of borrower origination
fees to offer those benefits to all borrowers they serve. Special allowance
payments made on loans funded via tax-exempt obligations would also be reduced.
In Higher Education Act reauthorization proposals submitted subsequent to
submission of the budget, the Administration proposed to reduce the interest
rate on Stafford loans while the borrower is in school to the 10-year Treasury
Note rate without any spread to that rate. The President called again for a
total restructuring of the guaranty agencies, including recalling more than $1
billion in remaining guarantor reserve funds. The President's plan for guaranty
agencies calls for converting them to a "fee for service" model, reducing
amounts they currently retain on amounts collected from defaulted borrowers from
27 percent to 18.5 percent and replacing payments for pre-claims assistance with
a performance-based formula. All these proposals may be considered by Congress
as it deliberates on this budget and addresses the reauthorization of the Higher
Education Act.
15
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. During 1996,
the Company commenced a Year 2000 compliance project to assess and remediate its
internal software and hardware systems to avoid or mitigate Year 2000 problems
and to evaluate potential Year 2000 problems that may arise from entities with
which the Company interacts. The Company is assessing its internal software and
hardware, and is in the process of replacing or modifying those systems. The
Company does not believe that the costs of its internal program will be material
to any single year.
The Company has surveyed its third party service providers and business
partners and is currently reviewing these surveys to determine the level of
compliance and the potential impact of noncompliance. There can be no assurance
that the computer systems of other companies or counterparties on which the
Company relies will be compliant on a timely basis, or that a failure to resolve
Year 2000 issues by another party, or a remediation or conversion that is
incompatible with the Company's computer systems, will not have a material
adverse effect on the Company.
16
Consolidated Balance Sheets
(Dollars in thousands, except per share amounts)
December 31,
1997 1996
ASSETS
Insured student loans purchased............................................................ $27,592,714 $32,307,930
Student loan participations................................................................ 1,927,896 1,445,596
----------- -----------
Insured student loans...................................................................... 29,520,610 33,753,526
Warehousing advances....................................................................... 1,868,654 2,789,485
Academic facilities financings
Bonds - available-for-sale.............................................................. 860,325 934,481
Loans................................................................................... 514,691 538,850
----------- -----------
Total academic facilities financings....................................................... 1,375,016 1,473,331
Investments
Available-for-sale...................................................................... 4,549,977 6,833,695
Held-to-maturity........................................................................ 525,962 601,887
----------- -----------
Total investments.......................................................................... 5,075,939 7,435,582
Cash and cash equivalents.................................................................. 54,022 270,887
Other assets, principally accrued interest receivable...................................... 2,014,556 1,907,079
----------- -----------
Total assets............................................................................... $39,908,797 $47,629,890
=========== ===========
LIABILITIES
Short-term borrowings...................................................................... $23,175,509 $22,517,627
Long-term notes............................................................................ 14,541,316 22,606,226
Other liabilities.......................................................................... 1,303,517 1,458,207
----------- -----------
Total liabilities.......................................................................... 39,020,342 46,582,060
----------- -----------
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: 183,632,694 and 229,934,499 shares issued, respectively..................... 36,726 45,987
Additional paid-in capital................................................................. 28,838 -
Unrealized gains on investments (net of tax of $203,935 and $188,050, respectively)........ 378,736 349,235
Retained earnings.......................................................................... 654,135 975,889
----------- -----------
Stockholders' equity before treasury stock................................................. 1,098,435 1,371,111
Common stock held in treasury at cost: 10,221,757 and 42,017,416 shares, respectively...... 423,863 537,164
----------- -----------
Total stockholders' equity................................................................. 674,572 833,947
----------- -----------
Total liabilities and stockholders' equity................................................. $39,908,797 $47,629,890
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
17
Consolidated Statements of Income
(Dollars in thousands, except per share amounts)
Years ended December 31,
1997 1996 1995
Interest income:
Insured student loans purchased....................................... $2,344,089 $2,586,035 $2,708,079
Student loan participations........................................... 117,571 20,625 -
---------- ---------- ----------
Insured student loans................................................. 2,461,660 2,606,660 2,708,079
Warehousing advances.................................................. 151,086 193,654 407,866
Academic facilities financings:
Taxable............................................................. 51,410 52,163 54,862
Tax-exempt.......................................................... 46,558 48,262 52,859
---------- ---------- ----------
Total academic facilities financings.................................. 97,968 100,425 107,721
Investments........................................................... 573,120 548,582 697,724
---------- ---------- ----------
Total interest income.................................................... 3,283,834 3,449,321 3,921,390
Interest expense:
Short-term debt....................................................... 1,461,954 1,138,272 905,933
Long-term debt........................................................ 1,064,202 1,444,613 2,114,716
---------- ---------- ----------
Total interest expense................................................... 2,526,156 2,582,885 3,020,649
---------- ---------- ----------
NET INTEREST INCOME...................................................... 757,678 866,436 900,741
Other income:
Gain on sale of student loans......................................... 280,221 48,981 -
Servicing and securitization revenue.................................. 151,221 57,736 1,423
Gains/(losses) on sales of securities................................. 21,086 11,898 24,032
Other................................................................. 48,344 28,301 24,958
---------- ---------- ----------
Total other income....................................................... 500,872 146,916 50,413
---------- ---------- ----------
Operating expenses:
Salaries and benefits................................................. 224,554 206,347 211,787
Other................................................................. 269,213 199,305 226,914
---------- ---------- ----------
Total operating expenses................................................. 493,767 405,652 438,701
---------- ---------- ----------
Income before federal income taxes and premiums on debt
extinguished and minority interest in net earnings of subsidiary...... 764,783 607,700 512,453
---------- ---------- ----------
Income tax expense (benefit):
Current............................................................... 219,145 207,437 141,803
Deferred.............................................................. 23,776 (23,939) (540)
---------- ---------- ----------
Total income taxes....................................................... 242,921 183,498 141,263
Minority interest in net earnings of subsidiary.......................... 10,694 10,694 10,694
---------- ---------- ----------
Income before premiums on debt extinguished.............................. 511,168 413,508 360,496
Premiums on debt extinguished, net of tax................................ (3,273) (4,792) (4,911)
---------- ---------- ----------
NET INCOME............................................................... $ 507,895 $ 408,716 $ 355,585
========= ========= =========
Basic earnings per common share before premiums on debt extinguished..... $ 2.82 $ 2.13 $ 1.53
========= ========= =========
BASIC EARNINGS PER COMMON SHARE.......................................... $ 2.80 $ 2.10 $ 1.51
========= ========= =========
Diluted earnings per common share before premiums on debt extinguished... $ 2.80 $ 2.12 $ 1.53
========= ========= =========
DILUTED EARNINGS PER COMMON SHARE........................................ $ 2.78 $ 2.09 $ 1.51
========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
18
Consolidated Statements of
Changes in Stockholders' Equity
(Dollars in thousands, except per share amounts)
Years ended December 31,
1997 1996 1995
COMMON STOCK:
Balance, beginning of year (as restated, See Note 14)..................... $ 45,987 $ 86,885 $ 86,691
Issuance of common shares............................................... 695 402 194
Retirement of treasury shares........................................... (9,956) (41,300) -
---------- ----------- ----------
Balance, end of year...................................................... 36,726 45,987 86,885
---------- ----------- ----------
ADDITIONAL PAID-IN CAPITAL:
Balance, beginning of year (as restated, See Note 14)..................... - 475,757 462,589
Proceeds in excess of par value from issuance of common stock........... 59,729 22,633 11,534
Issuance of warrants.................................................... 12,393 - -
Tax benefit related to employee stock option and purchase plans......... 22,879 7,393 1,634
Premiums on equity forward purchase contracts........................... (18,082) - -
Retirement of treasury shares........................................... (48,081) (505,783) -
---------- ----------- ----------
Balance, end of year...................................................... 28,838 - 475,757
---------- ----------- ----------
UNREALIZED GAINS ON INVESTMENTS, NET OF TAX:
Balance, beginning of year................................................ 349,235 370,846 299,558
Change in unrealized gains.............................................. 29,501 (21,611) 71,288
---------- ----------- ----------
Balance, end of year...................................................... 378,736 349,235 370,846
---------- ----------- ----------
RETAINED EARNINGS:
Balance, beginning of year (as restated, see Notes 2 and 14).............. 975,889 2,728,383 2,473,048
Net income.............................................................. 507,895 408,716 355,585
Retirement of treasury shares........................................... (736,019) (2,070,216) -
Cash dividends:
Common stock ($.52, $.47, and $.43 per share, respectively)........... (93,630) (90,994) (100,250)
---------- ----------- ----------
Balance, end of year...................................................... 654,135 975,889 2,728,383
---------- ----------- ----------
COMMON STOCK HELD IN TREASURY AT COST:
Balance, beginning of year................................................ 537,164 2,794,549 1,934,377
Repurchase of 17,979,497; 16,063,082 and
56,331,454 common shares, respectively................................ 680,342 359,914 860,172
Retirement of 49,775,156 and 206,500,000 treasury shares, respectively.. (793,643) (2,617,299) -
---------- ----------- ----------
Balance, end of year...................................................... 423,863 537,164 2,794,549
---------- ----------- ----------
TOTAL STOCKHOLDERS' EQUITY................................................... $ 674,572 $ 833,947 $ 867,322
========== =========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
19
Consolidated Statements of Cash Flows
(Dollars in thousands)
Years ended December 31,
1997 1996 1995
OPERATING ACTIVITIES
Net income.................................................... $ 507,895 $ 408,716 $ 355,585
Adjustments to reconcile net income to net cash
provided by operating activities:
Gains on sales of student loans............................. (280,221) (48,981) -
(Increase) in accrued interest receivable................... (76,561) (11,286) (179,505)
Increase (decrease) in accrued interest payable............. (40,231) (109,214) 112,133
(Increase) decrease in other assets......................... 74,591 (225,591) (128,799)
Increase (decrease) in other liabilities.................... (130,344) 188,142 15,804
------------- ------------- -------------
Total adjustments............................................. (452,766) (206,930) (180,367)
------------- ------------- -------------
Net cash provided by operating activities........................ 55,129 201,786 175,218
------------- ------------- -------------
INVESTING ACTIVITIES
Insured student loans purchased............................... (8,311,364) (8,370,836) (9,379,663)
Reduction of insured student loans purchased:
Installment payments........................................ 2,486,559 3,094,937 3,452,985
Claims and resales.......................................... 1,112,226 1,277,400 1,161,163
Proceeds from securitization of student loans............... 9,621,989 6,026,780 1,000,000
Participations purchased...................................... (728,733) (1,498,868) -
Participation repayments...................................... 246,433 53,272 -
Warehousing advances made..................................... (695,061) (1,391,590) (2,250,077)
Warehousing advance repayments................................ 1,615,892 2,467,198 5,416,890
Academic facilities financings made........................... (148,033) (465,596) (122,813)
Academic facilities financings reductions..................... 256,420 302,557 379,283
Investments purchased......................................... (16,639,867) (15,966,490) (43,716,393)
Proceeds from sale or maturity of investments................. 19,027,736 16,113,659 46,627,289
------------- ------------- -------------
Net cash provided by investing activities........................ 7,844,197 1,642,423 2,568,664
------------- ------------- -------------
FINANCING ACTIVITIES
Short-term borrowings issued.................................. 685,921,616 268,027,948 163,805,115
Short-term borrowings repaid.................................. (682,026,471) (262,994,320) (166,764,320)
Long-term notes issued........................................ 4,691,827 8,304,988 12,350,217
Long-term notes repaid........................................ (15,994,000) (15,744,378) (12,196,436)
Common stock issued........................................... 64,809 30,428 13,362
Common stock repurchased...................................... (680,342) (359,914) (860,172)
Dividends paid................................................ (93,630) (90,994) (100,250)
------------- ------------- -------------
Net cash (used in) financing activities.......................... (8,116,191) (2,826,242) (3,752,484)
------------- ------------- -------------
(Decrease) in cash and cash equivalents.......................... (216,865) (982,033) (1,008,602)
Cash and cash equivalents at beginning of year................... 270,887 1,252,920 2,261,522
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR......................... $ 54,022 $ 270,887 $ 1,252,920
============= ============= =============
CASH DISBURSEMENTS MADE FOR:
Interest...................................................... $ 2,198,630 $ 2,460,870 $ 2,772,815
============= ============= =============
Income taxes.................................................. $ 143,500 $ 202,200 $ 122,000
============= ============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
20
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).
Privatization
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. Beginning in fiscal 1997, and
until the GSE is dissolved, the GSE also must reimburse the U.S. Treasury
Department up to $800,000 annually (subject to adjustment based on the Consumer
Price Index) for its reasonable costs and expenses of carrying out its
supervisory duties under the Privatization Act.
As required by the Privatization Act the GSE paid $5 million to the
District of Columbia Financial Responsibility and Management Assistance
Authority (the "D.C. Financial Control Board") for the use of the name "Sallie
Mae," and SLM Holding issued to the D.C. Financial Control Board warrants to
purchase 1,942,553 shares of SLM Holding Common Stock at a price of $20.69 per
share after consideration of the Company's 7-for-2 stock split.
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.
2. Significant Accounting Policies
Loans
Loans, consisting of insured student loans purchased (student loans), student
loan participations, warehousing advances, and academic facilities financings
are carried at their unpaid principal balances 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.
21
Student Loan Loss Reserves
The Company has established reserves for potential losses on its student loan
portfolio that can result from defective servicing, and risk-sharing on claim
payments for federally insured loans and credit losses on privately insured
loans. The reserve 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 reserve is maintained at a
level that management believes is adequate to absorb estimated potential credit
losses. This evaluation is inherently subjective as it requires material
estimates that may be susceptible to significant changes.
Cash and Cash Equivalents
Cash and cash equivalents include term federal funds and bank deposits with
terms to maturity less than three months.
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 and foreign currency exchange agreements and 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 rate risk. 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 of 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 their 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 Revenue Contracts
The Company enters into contracts with third parties, under which it agreed to
pay the future floor revenues received in exchange for upfront payments ("floor
revenue contracts"). These upfront payments are being amortized to student loan
income over the average life of the contracts, which is approximately six months
for the 1997 contracts and two years for the 1996 contracts.
Foreign Currency Derivatives
The Company enters into various foreign currency swaps, forward currency
exchange agreements and options on forward currency exchange agreements to hedge
its foreign currency linked debt agreements. These contracts mature concurrently
with the maturities of the debt and are subject to the same credit standards as
interest rate swaps. Foreign currency derivatives and the related foreign
currency borrowings are translated at the market rates of exchange as of the
balance sheet date. Gains and losses on foreign currency transactions that are
designated hedges are deferred and included in the basis of the designated
instrument.
Income Taxes
Deferred income taxes reflect the net effect of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes.
Earnings per Common Share
In 1997, the Company adopted SFAS No. 128, "Earnings per Share". SFAS No. 128
simplifies the standards for computing EPS previously found in Accounting
Principles Board Opinion ("APB") No. 15, "Earnings per Share," and makes the
standards comparable to recently adopted international EPS guidelines. SFAS No.
128 replaces the presentation of "primary" EPS with the presentation of "basic"
EPS. It also requires dual presentation of basic and diluted 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.
22
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, 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, 1996 and 1995, to be consistent with classifications adopted
for 1997.
Restatement of Previously Issued Financial Statements
Student loan servicing costs are generally incurred in a fixed amount per
borrower and thus increase in proportion to principal balances outstanding as
loans are repaid. Prior to 1995, to achieve a level yield to maturity, interest
income was deferred during the early years of the loans, then recognized during
the later years to offset the aforementioned proportional servicing cost
increases. Changes in the estimates of future loan servicing costs were
reflected in student loan income over the estimated remaining terms of the
loans. In the fourth quarter of 1995, the GSE discontinued its accounting method
of deferring income on student loans which resulted in an increase in 1995 net
income and income before premiums on debt extinguished of $21 million ($.09 per
diluted common share).
After discussions with the Securities and Exchange Commission, management
determined that the GSE's method for recognizing student loan income as earned
should be used for all periods presented. Accordingly, the previously reported
financial statements of the GSE for the year ended December 31, 1995 have been
restated. For 1995, the cumulative effect of the change in accounting method of
$130 million ($.55 per diluted common share) has been eliminated, thereby,
decreasing net income and increasing the beginning balance of retained earnings
by $130 million.
Recently Issued Accounting Pronouncements
During the first quarter of 1998 the Company will adopt SFAS No. 130, "Reporting
Comprehensive Income," which addresses the manner in which certain adjustments
to stockholders' equity (principally unrealized gains and losses on
available-for-sale securities) are displayed in the financial statements, with
no effect on reported earnings, assets or capital. During 1997 the Financial
Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which revises the requirements for
disclosing segment data. The Company is reviewing the new requirements for
presentation of segment data under the standard and is determining those
operating segments, if any, that require separate disclosure. Both Statements
are effective for fiscal years beginning after December 15, 1997. Adoption of
these standards will not impact the Company's consolidated financial position,
results of operations or cash flows, and any effect, while not yet determined by
the Company, will be limited to the presentation of its disclosures.
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 purchases privately insured loans from time to time, principally those
insured by a wholly owned subsidiary.
There are three principal categories of FFELP loans: Stafford loans, PLUS
loans, and consolidation loans. Generally, these loans have repayment periods of
between five and ten years, with the exception of consolidation loans, and
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
the special allowance formula. Special allowance is paid whenever the average of
all of the 91-day Treasury bill auctions in a calendar quarter, plus a spread of
between 2.50 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.
In low interest rate environments, if the rate which the borrower is
obligated to pay exceeds the rate determined by the special allowance formula,
then the borrower's rate becomes a floor on an otherwise variable rate asset.
When this happens, the differences between the interest paid by the borrower and
the rate determined by the special allowance formula is referred to as "floor
revenue." During 1997 and 1996, the Company entered into contracts ("floor
revenue contracts") with third parties under which it agreed to pay the future
floor revenues received on student loans with a principal balance of $11 billion
and $13.5 billion, respectively, in exchange for upfront payments of $14 million
and $128 million, respectively. These upfront payments are being amortized to
student loan income over the average life of the contracts, which is
approximately six months for the 1997 contracts, and two years for the 1996
contracts. For the years ended December 31, 1997 and 1996, the amortization of
the upfront payments on fixed and variable floor revenue contracts increased
student loan income by $41 million and $23 million, respectively. For the years
ended December 31, 1997 and 1996, payments under the contracts totaled $19
million and $12 million, respectively.
23
Offset fees, consolidation loan rebate fees, risk-sharing and yield
reductions continue to have 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. In addition, the Federal Direct Student Loan
Program ("FDSLP") originated approximately 32 percent, 31 percent and 7 percent
of student loan originations for academic years 1996-97, 1995-96 and 1994-95,
respectively. Based on Department of Education estimates, management believes
that FDSLP originations will increase to approximately 35 percent of student
loan originations for the 1997-98 academic year and continue at that level
thereafter.
The estimated average remaining term of student loans in the Company's
portfolio, including student loan participations, was approximately 6 years at
December 31, 1997 and 1996. The following table reflects the distribution of the
Company's student loan portfolio by program.
December 31,
1997 1996
FFELP--Stafford............... $12,005,935 $17,292,273
FFELP--PLUS/SLS............... 2,349,310 3,580,803
FFELP--Consolidation loans.... 9,111,299 7,658,035
HEAL.......................... 2,628,719 2,758,860
Privately insured............. 1,497,451 1,017,959
----------- -----------
Insured student loans
purchased.................. 27,592,714 32,307,930
Student loan participations... 1,927,896 1,445,596
----------- -----------
Total student loans........... $29,520,610 $33,753,526
=========== ===========
As of December 31, 1997 and 1996, 86 percent and 84 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, 1997 and 1996, the
Company owned $12.4 billion and $15.5 billion of 100 percent reinsured FFELP
loans, and $13.0 billion and $14.5 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
$10.9 million, $12.8 million and $15.8 million for the years ended December 31,
1997, 1996 and 1995, respectively.
The following table summarizes the reserves that the Company has recorded
for estimated losses due to risk-sharing, unpaid guarantee claims and defaults
on privately insured loans, which are netted against student loans on the
balance sheet.
Years ended December 31,
1997 1996 1995
BALANCE AT BEGINNING
OF PERIOD.................... $ 84,063 $ 60,337 $ 64,928
Additions
Provisions for loan losses... 21,717 29,749 800
Recoveries................... 7,551 7,235 6,096
Deductions
Reductions for sales on
student loans.............. (10,556) (3,188) -
Losses on loans.............. (15,115) (10,070) (11,487)
-------- -------- --------
BALANCE AT END
OF PERIOD.................... $ 87,660 $ 84,063 $ 60,337
======== ======== ========
In addition to the reserves for loan losses in the above table, the Company
through its wholly owned insurance subsidiary, the Hemar Insurance Corporation
of America ("HICA"), maintains a provision for future losses on private student
loans that it insures.
24
At December 31, 1997 and 1996, HICA's reserve was $79 million and $63 million,
respectively, for which the Company owned 89 percent of the $1.5 billion and 73
percent of the $1.2 billion, respectively, of student loans insured by HICA.
4. Warehousing Advances
Warehousing advances are secured loans made, generally, to finance student loans
and other education-related loans at certain financial and educational
institutions and public sector agencies. Such advances are collateralized by
student loans, obligations of the U.S. government or instrumentalities thereof,
or by other collateral, such as residential first mortgages and mortgage-backed
securities. As of December 31, 1997, approximately 96 percent were
collateralized by student loans, 2 percent by U.S. government securities, and 2
percent by other collateral. As of December 31, 1996, approximately 97 percent
were collateralized by student loans, 1 percent by U.S. government securities
and 2 percent by other collateral. A summary of warehousing advances by industry
concentration follows:
December 31,
1997 1996
Commercial banks................ $ 679,113 $1,547,193
Public sector agencies.......... 1,083,168 1,126,095
Educational institutions........ 106,373 116,197
---------- ----------
$1,868,654 $2,789,485
========== ==========
Warehousing advances have specific maturities and generally bear rates of
interest which vary with the 91-day Treasury bill rate, or the London Interbank
Offered Rate ("LIBOR"), or which are fixed for the term of the advance. A
summary of warehousing advance interest rate characteristics follows:
December 31,
1997 1996
Variable rate:
Treasury bill................ $1,167,912 $1,723,588
LIBOR........................ 678,868 1,046,086
Fixed rate...................... 21,874 19,811
---------- ----------
$1,868,654 $2,789,485
========== ==========
The average remaining term to maturity of warehousing advances was 4.5
years as of December 31, 1997 with maturities as follows: 1998-$395,143;
1999-$1,000; 2000-$859,835; 2001-$0; 2002-$2,200 and after 2002-$610,476.
5. Academic Facilities Financings
Academic facilities financings are comprised of bonds issued by and loans to
educational institutions to finance their physical plant and equipment. The
academic facilities bonds are classified as available-for-sale securities under
SFAS No. 115 and are carried at fair market value.
The following tables summarize the academic facilities bonds at December
31, 1997 and 1996.
December 31, 1997
---------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
BONDS -- AVAILABLE-FOR-SALE
Fixed........................................................ $790,163 $28,863 $ (46) $818,980
Variable..................................................... 41,721 7 (383) 41,345
-------- ------- ------- --------
Total academic facilities bonds................................. $831,884 $28,870 $ (429) $860,325
======== ======= ======= ========
December 31, 1996
---------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
BONDS -- AVAILABLE-FOR-SALE
Fixed........................................................ $831,711 $19,794 $ (978) $850,527
Variable..................................................... 84,401 10 (457) 83,954
-------- ------- ------- --------
Total academic facilities bonds................................. $916,112 $19,804 $(1,435) $934,481
======== ======= ======= ========
25
The following table summarizes academic facilities loans at December 31,
1997 and 1996.
December 31,
1997 1996
LOANS
Fixed........................... $456,788 $474,659
Variable........................ 57,903 64,191
-------- --------
Total academic facilities loans.... $514,691 $538,850
======== ========
The average remaining term to maturity of academic facilities financings
was 7.5 years at December 31, 1997. The stated maturities and maturities if
accelerated to the put or call dates for academic facilities bonds and loans at
December 31, 1997 are shown in the following table:
December 31, 1997
----------------------------------
Bonds Loans
Maturity
Stated to Put or Stated
Year of Maturity Maturity Call Date Maturity
1998................... $ 44,163 $103,071 $ 8,942
1999................... 40,577 53,899 45,272
2000................... 64,088 106,246 15,719
2001................... 123,745 143,981 20,827
2002................... 140,194 124,525 29,551
2003-2007.............. 365,221 310,799 82,168
after 2007............. 82,337 17,804 312,212
-------- -------- --------
$860,325 $860,325 $514,691
======== ======== ========
6. Investments
At December 31, 1997 and 1996, 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 $887 million. The fair
market value of U.S. Treasury securities is adjusted for unrealized gains and
losses on $1.1 billion of interest rate swaps (See Note 10), which are held to
reduce interest rate risk related to these securities ($45.7 million of
unrealized losses at December 31, 1997 and $19.5 million of unrealized gains at
December 31, 1996). A summary of investments at December 31, 1997 and 1996
follows:
26
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
========== ======== ======== ==========
December 31, 1996
---------------------------------------------------------
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.................................... $ 809,164 $508,758 $ (41) $1,317,881
State and political subdivisions of the U.S.
Student loan revenue bonds................................. 201,248 5,563 (431) 206,380
Asset-backed and other securities
Asset-backed securities.................................... 4,645,046 4,746 (167) 4,649,625
Variable corporate bonds................................... 634,925 489 - 635,414
Commercial paper........................................... 24,395 - - 24,395
---------- -------- -------- -----------
Total available-for-sale investment securities............... $6,314,778 $519,556 $ (639) $6,833,695
========== ======== ======== ===========
HELD-TO-MATURITY
Other....................................................... $ 601,887 $ 125 $ (267) $ 601,745
========== ======== ======== ===========
================================================================================
The Company sold available-for-sale securities with a carrying value of
$5.6 billion, $4.6 billion and $6.6 billion for the years ended December 31,
1997, 1996 and 1995, respectively.
27
As of December 31, 1997, stated maturities and maturities if accelerated to
the put or call dates for investments are shown in the following table:
December 31, 1997
------------------------------------------
Held-to-Maturity Available-for-Sale
Stated Stated Maturity to
Year of Maturity Maturity Maturity Put or Call Date
1998................ $ 28,780 $ 328,702 $ 330,456
1999................ 10,293 134,205 141,618
2000................ 96,780 55,846 65,563
2001................ 1,184 66,169 80,061
2002................ 630 239,191 261,819
2003-2007........... 48,133 1,727,797 1,741,536
after 2007.......... 340,162 1,998,067 1,928,924
-------- ---------- ----------
$525,962 $4,549,977 $4,549,977
======== ========== ==========
================================================================================
7. 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, 1997, 1996 and 1995, 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 10) during the periods.
At December 31, 1997 Year ended December 31, 1997
------------------------------- -----------------------------------------------
Weighted Weighted Weighted
Ending Average Average Average Average Effective
Balance Interest Rate Balance Interest Rate Interest 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
===========
At December 31, 1996 Year ended December 31, 1996
------------------------------ ------------------------------------------------
Weighted Weighted Weighted
Ending Average Average Average Average Effective
Balance Interest Rate Balance Interest Rate Interest 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
===========
28
At December 31, 1995 Year ended December 31, 1995
------------------------------ -------------------------------------------------
Weighted Weighted Weighted
Ending Average Average Average Average Effective
Balance Interest Rate Balance Interest Rate Interest Rate
Six month floating rate notes........... $ 2,699,595 5.64% $ 3,608,930 5.78% 5.86%
Other floating rate notes............... 1,942,360 5.82 1,221,480 5.60 5.78
Discount notes.......................... 1,074,257 5.58 1,427,363 5.81 5.86
Fixed rate notes........................ 350,000 6.97 903,670 7.99 5.82
Securities sold - not yet purchased
and repurchase agreements............ 131,112 6.38 311,797 6.10 6.10
Short-term portion of long-term notes... 11,249,676 5.79 7,937,658 5.83 5.90
----------- ---- ----------- ---- ----
Total short-term borrowings............. $17,447,000 5.79% $15,410,898 5.93% 5.88%
=========== ==== =========== ==== ====
Maximum outstanding at any month end.... $18,046,974
===========
================================================================================
At December 31, 1996, the short-term portion of long-term notes included
issues totaling $80 million repayable in U.S. dollars, with principal repayment
obligations tied to foreign currency exchange rates, and issues totaling $771
million which require the payment of interest and principal in foreign
currencies. These notes were repaid in 1997. 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 10).
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 10).
================================================================================
8. Long-Term Notes
The following tables summarize outstanding long-term notes at December 31, 1997
and 1996, the weighted average interest rates and related notional amount of
derivatives at the end of the periods, and the related average balances and
weighted average effective interest rates, which include the effects of related
off-balance sheet financial instruments (see Note 10), during the periods.
At December 31, 1997 Year ended December 31, 1997
------------------------------------------- -------------------------------
Weighted Notional Weighted
Ending Average Amount of Average Average Effective
Balance Interest Rate Derivatives Balance Interest 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%
=========== ==== =========== =========== ====
29
At December 31, 1996 Year ended December 31, 1996
-------------------------------------- --------------------------------------------------
Weighted Notional Weighted
Ending Average Amount of Average Average Effective
Balance Interest Rate Derivatives Balance Interest Rate
Floating rate notes:
U.S. dollar denominated:
Interest bearing, due 1998-2003........ $ 8,844,825 5.27% $ 2,022,044 $12,740,190 5.46%
----------- ---- ----------- ----------- ----
Fixed rate notes:
U.S. dollar denominated:
Interest bearing, due 1998-2018........ 12,928,983 6.35 21,676,042 11,971,640 5.59
Zero coupon, due 1998-2022............. 326,875 8.25 358,071 304,990 7.68
Dual currency, due 1998.................. 248,443 7.63 272,000 245,569 6.65
Foreign currency:
Interest bearing, due 1999-2000........ 257,100 5.34 495,785 577,592 5.31
Zero coupon, due 1997.................. - - - 183,647 5.42
----------- ---- ----------- ----------- ----
Total fixed rate notes...................... 13,761,401 6.40 22,801,898 13,283,438 5.64
----------- ---- ----------- ----------- ----
Total long-term notes....................... $22,606,226 5.96% $24,823,942 $26,023,628 5.55%
=========== ==== =========== =========== ====
================================================================================
At December 31, 1997, the Company had outstanding long-term debt issues
with call features totaling $9.6 billion. As of December 31, 1997, the stated
maturities and maturities if accelerated to the call dates for long-term notes
are shown in the following table:
December 31, 1997
---------------------------
Stated Maturity to
Year of Maturity Maturity Call Date
1998........................ $ - $ 9,456,253
1999........................ 7,793,364 2,761,592
2000........................ 3,666,987 1,683,810
2001........................ 2,252,404 79,200
2002........................ 216,020 44,320
2003-2022................... 612,541 516,141
----------- -----------
$14,541,316 $14,541,316
=========== ===========
For the years ended December 31, 1997, 1996 and 1995, the Company
repurchased certain long-term notes prior to their scheduled maturity to lower
future years' interest expense. The following table summarizes these
transactions (dollars in millions):
Years ended December 31,
1997 1996 1995
Maturity value............... $47 $90 $62
=== === ===
Carrying value............... $ 6 $ 8 $ 8
=== === ===
Premiums..................... $ 5 $ 7 $ 8
=== === ===
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, 1997 and 1996, the Company had outstanding long-term
foreign currency notes which require the payment of principal and interest in
foreign currencies, and at December 31, 1996, the Company had dual currency
notes which require the payment of 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 10).
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 10).
30
9. Student Loan Securitization
For the years ended December 31, 1997 and 1996 and in October 1995, SLM Funding
Corporation, a wholly owned special purpose finance subsidiary of the GSE,
purchased from the GSE and sold $9.4 billion, $6 billion and $1 billion,
respectively, of student loans to trusts which issued floating rate student loan
asset-backed securities in underwritten public offerings. At December 31, 1997
and 1996, securitized student loans outstanding totaled $14.1 billion and $6.3
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 No.
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 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 No. 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
cash-flows 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, 1997 there was no valuation allowance on
the servicing asset. At December 31, 1997 the Interest Residual asset was $451
million and the servicing asset was $55 million.
On July 23, 1997, the U.S. Department of 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. 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. Since the third quarter, all securitization gains
are calculated without consideration of the Offset Fee.
10. 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 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, 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. At December 31, 1996, the Company had outstanding $18.2
billion, $1.1 billion and $17.8 billion of notional principal amount of standard
swaps, reverse swaps and basis/reverse basis swaps, respectively. Of the
Company's $37.1 billion of interest rate swaps outstanding at December 31, 1996,
$36 billion was related to debt and $1.1 billion was related to investments.
31
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, 1997 and 1996 (dollars in billions).
At December 31, 1997
--------------------------------------------------------------------------------
Swaps
Basis/ Foreign
Reverse Currency Total
Borrowings Standard 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
===== ===== === ===== === =====
32
At December 31, 1996
--------------------------------------------------------------------------------
Swaps
Basis/ Foreign
Reverse Currency Total
Borrowings Standard Reverse Basis Agreements Derivatives
SHORT-TERM BORROWINGS
Six month floating rate notes............. $ .3 $ - $ - $ .3 $ - $ .3
Other floating rate notes................. .3 - - .6 - .6
Discount notes............................ - - - - - -
Fixed rate notes.......................... 3.4 3.4 - 2.2 - 5.6
Securities sold - not yet purchased and
repurchase agreements.................. - - - - - -
Short-term portion of long-term notes..... 4.5 1.8 - 3.2 .9 5.9
----- ------ --- ----- ---- -----
Total short-term borrowings............ 8.5 5.2 - 6.3 .9 12.4
----- ------ --- ----- ---- -----
LONG-TERM NOTES
Floating rate notes:
U.S. dollar denominated:
Interest bearing..................... 1.4 .3 - 1.8 - 2.1
Fixed rate notes:
U.S. dollar denominated:
Interest bearing..................... 12.3 12.3 - 9.3 - 21.6
Zero coupon.......................... .2 .2 - .1 - .3
Dual currency.......................... .2 .2 - .1 - .3
Foreign currency:
Interest bearing..................... .3 - - .2 .3 .5
Zero coupon.......................... - - - - - -
----- ----- --- ----- ---- -----
Total long-term notes.............. 14.4 13.0 - 11.5 .3 24.8
----- ----- --- ----- ---- -----
Total notes........................ $22.9 $18.2 $ - $17.8 $1.2 $37.2
===== ===== === ===== ==== =====
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, 1995, 1996 and 1997
(dollars in millions).
Notional Principal
---------------------------------
Interest Foreign Currency Futures Contract
Rate Swaps Agreements Amounts
Balance, December 31, 1994........................................ $ 29,038 $ 1,398 $ 556
Issuances/Opens................................................ 19,549 466 2,370
Maturities/Expirations......................................... (10,634) (380) (535)
Terminations/Closes............................................ (1,773) - (2,211)
------- -------- ---------
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
======== ======== =========
33
Interest Rate Swaps
Net payments related to the debt-related swaps are recorded in interest expense.
For the years ended December 31, 1997, 1996 and 1995, the Company received net
payments on debt-related swaps reducing interest expense by $105 million, $165
million and $94 million, respectively.
As of December 31, 1997, 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, 1997
---------------------------
Stated Maturity to
Year of Maturity Maturity Put Date
1998........................... $13,941 $19,514
1999........................... 11,181 9,029
2000........................... 6,290 4,760
2001........................... 3,020 1,350
2002........................... 187 12
2003-2008...................... 1,188 1,142
------- -------
$35,807 $35,807
======= =======
Foreign Currency Agreements
At December 31, 1997 and 1996, the Company had borrowings with principal
repayable in foreign currencies of $257 million and $1.0 billion, respectively.
These borrowings were hedged by notional principal of $257 million and $1.0
billion of foreign currency swaps. The $1.0 billion in foreign currency
borrowings at December 31, 1996 was also hedged by $80 million of forward
currency exchange agreements and $80 million of currency exchange options. 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, 1997 and
1996, using spot rates at the respective dates (dollars in millions).
December 31,
1997 1996
Carrying value of outstanding
foreign currency debt................. $257 $1,108
Currency translation value of
outstanding foreign currency debt..... $191 $1,002
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, mainly
the portfolio of student loans in the PLUS program. These student loans pay
interest that are indexed to the one-year Treasury bill, reset annually on the
final auction prior to June 1. 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, 1997 and 1996, the Company
had futures contracts that hedged approximately $999 million and $178 million of
debt, respectively. Approximately $4.3 million and $7 million of realized losses
had been deferred at December 31, 1997 and 1996, respectively, related to
futures contracts.
Derivative Financial Instruments Held or
Issued for Trading Purposes
From time to time the Company maintains a small number of active 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, 1997 and 1996. During December 1995, the Company entered into
a derivative contract of $1.5 billion notional amount whose value is determined
by both the market value and the yield of certain AAA rated variable rate
asset-backed securities. The mark-to-market gain on this contract, which is
included in gains/(losses) on sales of securities in the consolidated statements
of income, was $3 million and $4 million for the years ended December 31, 1997
and 1996, respectively and immaterial for the year ended December 31, 1995. This
contract matured on January 15, 1998.
11. 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.
34
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, including interest
rate swaps, interest rate cap and collar agreements, foreign currency swaps,
forward exchange agreements and financial futures contracts, were estimated at
the amount that would be required to terminate such agreements, taking into
account current interest rates and credit spreads.
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, 1997 December 31, 1996
---------------------------------- ----------------------------------
Fair Carrying Fair Carrying
Value Value Difference Value Value Difference
EARNING ASSETS
Student loans.................................. $29,850 $29,521 $329 $34,005 $33,754 $251
Warehousing advances........................... 1,864 1,869 (5) 2,793 2,790 3
Academic facilities financings................. 1,405 1,375 30 1,473 1,473 -
Cash and investments........................... 5,130 5,130 - 7,706 7,706 -
------- ------- ---- ------- ------- -----
Total earning assets........................... 38,249 37,895 354 45,977 45,723 254
------- ------- ---- ------- ------- -----
INTEREST BEARING LIABILITIES
Short-term borrowings.......................... 23,161 23,176 15 22,457 22,518 61
Long-term notes................................ 14,553 14,541 (12) 22,519 22,606 87
------- ------- ---- ------- ------- -----
Total interest bearing liabilities............. 37,714 37,717 3 44,976 45,124 148
------- ------- ---- ------- ------- -----
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
Interest rate swaps............................ 59 - 59 (21) - (21)
Forward exchange agreements and
foreign currency swaps...................... (99) - (99) (161) - (161)
Floor revenue contracts........................ (59) (78) 19 (75) (106) 31
Academic facilities financing commitments...... - - - - - -
Letters of credit.............................. - - - - - -
---- -----
Excess of fair value over carrying value....... $336 $251
==== =====
35
At December 31, 1997 and 1996, substantially all interest rate swaps,
foreign exchange agreements and foreign currency swaps were hedging liabilities.
12. 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.
Commitments outstanding are summarized below:
December 31,
1997 1996
Student loan purchase
commitments................... $17,494,734 $15,845,821
Warehousing advance
commitments................... 3,370,419 2,367,288
Academic facilities financing
commitments................... 19,577 9,930
Letters of credit................ 4,829,089 3,743,892
----------- -----------
$25,713,819 $21,966,931
=========== ===========
================================================================================
The following schedules summarize expirations of commitments outstanding at
December 31, 1997:
December 31, 1997
------------------------------------------------------------------
Student Loan Warehousing Academic Facilities Letters of
Purchases Advances Financings Credit
1998..................................................... $ 2,058,029 $ 101,000 $ 8,797 $ 30,346
1999..................................................... 5,351,451 30,000 10,780 167,428
2000..................................................... 2,263,405 132,887 - 185,754
2001..................................................... - - - 168,247
2002..................................................... 7,821,849 1,700,001 - 503,959
2003-2017................................................ - 1,406,531 - 3,773,355
----------- ---------- ------- ----------
Total................................................. $17,494,734 $3,370,419 $19,577 $4,829,089
=========== ========== ======= ==========
================================================================================
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, 1997, the GSE's statutory capital
adequacy ratio, after the effect of the dividends to be paid in the first
quarter of 1998, was 2.00 percent.
Legislative Developments
The Higher Education Act provides that the special allowance for student loans
made on or after July 1, 1998 will be based on the U.S. Treasury security with
comparable maturity plus 1.0 percent for Stafford and Unsubsidized Stafford
loans, and 2.1 percent for PLUS loans. The Secretary of Education has not
adopted regulations specifying the U.S. Treasury security on which these
interest rates will be based or how often the special allowance rate will reset.
Depending on the specifics of the regulations, these changes could adversely
impact the FFELP market and the Company's business, because of the uncertain
availability and costs of funding to support this new type of instrument. On
February 25, 1998, the U.S. Department Treasury released a report on "The
Financial Viability of the Government Guaranteed Student Loan Program." The
report concludes that the new special allowance formula scheduled to take effect
for student loans on July 1, 1998 would reduce lenders' net return to below
acceptable levels and creates inefficiencies. The Treasury report also suggests
that the current T-bill based formula provides lenders with a pre-tax rate of
return that exceeds a "reasonable range of target rates." Management believes
that the report's costs and profitability assumptions underlying the rate of
return analysis are flawed. Concurrent with the release of the report, the
Clinton Administration called for a reinstatement of the 91-day T-bill index and
an 80 basis point reduction in the special allowance for both in-school and
repayment loans. Management believes the administration's proposal, as with the
currently scheduled rate change, would result in uneconomic returns for lenders.
Such a reduction would have a material adverse impact on the Company and its
earnings. Management expects Congress to consider this issue in March of 1998.
It is uncertain whether Congress will enact any changes to the law and whether
such changes would be in line with the Administration's proposal.
36
Litigation
On June 11, 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 Company
responsible 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 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 of 1934, as amended, and Rule 10b-5
promulgated thereunder. In addition, the complaint includes counts under the
California Corporations Code, as well as a count for common law fraud. On
December 24, 1997, the Company filed a motion for partial summary judgement
dismissing certain of Orange County's claims. The Company believes that the
complaint is without merit and intends to defend the case vigorously. At this
time, Management believes the impact of the lawsuit will not be material to the
Company.
13. 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, 1997, 1996 and 1995, the GSE's preferred
dividend rate was 5.00 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.
14. 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 to common stock from
retained earnings ($26.1 million) and additional paid-in-capital ($.1 million)
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 the Reorganization date, 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 36.2 million common
shares for issuance under various compensation and benefit plans. Under these
authorizations, the Company has 30.9 million shares in reserve and a remaining
authority for issuance of 20.9 million shares.
The Company has engaged in repurchases of its common stock since 1986.
Commencing in the fourth quarter of 1997, the Company supplemented its open
market common stock purchases by entering into equity forward transactions to
purchase 7 million shares on a cash or net share settled basis. The forwards
settle at various times over the next two years at prices ranging from $38 per
share to $42 per share. As of December 31, 1997, the Company held as treasury
stock 10.2 million common shares purchased at an average price of $41.47.
37
Basic earnings per common share are computed based on net income divided by
the weighted average common shares outstanding for the period. Average common
shares outstanding for the years ended December 31, 1997, 1996 and 1995 totaled
181,554,368; 194,465,537 and 235,467,631, respectively. Diluted earnings per
common share are computed based on net income divided by the weighted average
common and common equivalent shares outstanding for the period. Average common
and common equivalent shares outstanding for the years ended December 31, 1997,
1996 and 1995 totaled 182,941,173; 195,339,477 and 236,078,112, respectively.
The major difference between the basic and the dilutive earnings per share
calculations are the dilutive effect of applying the treasury stock method of
accounting to 996,149; 873,940 and 610,481 of in-the-money stock options for the
years ended December 31, 1997, 1996 and 1995, respectively, and 390,656 of
in-the-money warrants for the year ended December 31, 1997.
15. 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 to officers and key employees under the 1993-1998
Stock Option Plan, all of which have 10 year terms and vest in one-third
increments. 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. 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, of which there is a remaining authority of 8.9 million shares.
Options granted by prior Boards of Directors generally have 10 year terms and
vest one year after the date of the grant.
In August 1997, the Company's Board of Directors also authorized the grant
of options for up to 3.5 million shares of common stock under a new Employee
Stock Option Plan. 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.
In January 1998, the Board of Directors approved a Management Incentive
Plan, which will replace the 1993-1998 Stock Option Plan which expires in March
1998. 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 could be issued pursuant to such awards. This plan is subject to
shareholder approval at the Company's 1998 Annual Meeting of Shareholders.
The following table summarizes the employee stock option plans for the
years ended December 31, 1997, 1996 and 1995. The weighted average fair value of
options granted during the year is based on the Extended Binomial Option Pricing
Model, a variation of the Black-Sholes option pricing model.
Years ended December 31,
----------------------------------------------------------------------------------
1997 1996 1995
Average Average Average
Options Price Options Price Options Price
Outstanding at beginning of year.......... 3,261,500 $17.37 3,832,413 $13.94 3,259,393 $15.57
Granted................................... 13,156,252 40.64 1,139,408 20.88 1,812,300 10.61
Exercised................................. (2,864,110) 17.53 (1,698,771) 11.97 (781,130) 12.22
Canceled.................................. (5,188,110) 44.16 (11,550) 20.86 (458,150) 15.29
---------- ------ ---------- ------ --------- ------
Outstanding at end of year................ 8,365,532 $37.30 3,261,500 $17.37 3,832,413 $13.94
========== ------ ========== ------ ========= ------
Exercisable at end of year................ 486,465 $18.79 2,133,642 $15.51 2,243,763 $16.31
========== ------ ========== ------ ========= ------
Weighted-average fair value of
options granted during the year........ $17.96 $ 7.39 $ 2.91
------ ------ ------
38
The following table summarizes the number, average exercise prices (which ranged
from $10 per share to $41 per share) and average remaining contractual life of
the employee stock options outstanding at December 31, 1997.
Average
Average Remaining
Exercise Prices Options Price Contractual Life
Under $16.......... 116,200 $12.07 6.5 yrs.
$16-$32............ 1,059,772 27.29 8.0
Above $32.......... 7,189,560 39.18 10.0
--------- ------ ---------
Total.............. 8,365,532 $37.30 9.5 yrs.
========= ------ ---------
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. The Board approved a Directors' Stock Plan, which, if
approved by shareholders, will replace 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. Options granted under this plan
have ten year terms and vest in 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. This plan is subject to shareholder approval at
the Company's 1998 Annual Meeting of Shareholders.
================================================================================
The following table summarizes the Board of Directors' Stock Options for
the years ended December 31, 1997 and 1996.
Years ended December 31,
-----------------------------------------------------
1997 1996
Average Average
Options Price Options Price
Outstanding at beginning of year.................................. 220,500 $20.86 - $ -
Granted........................................................... 1,638,000 38.96 220,500 20.86
Exercised......................................................... (141,225) 22.34 - -
Canceled.......................................................... (59,500) 24.39 - -
--------- ------ ------- ------
Outstanding at end of year........................................ 1,657,775 $38.49 220,500 $20.86
========= ------ ======= ------
Exercisable at end of year........................................ 614,775 $37.05 220,500 $20.86
========= ------ ======= ------
Weighted-average fair value of
options granted during the year................................ $17.79 $ 7.38
------ ------
================================================================================
At December 31, 1997, the outstanding Board of Directors options had a
weighted-average remaining contractual life of 9.5 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, 1997, 1996 and 1995, 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 the Extended Binomial Options Pricing
Model, a variation of the Black-Sholes option pricing model, with the following
weighted average assumptions for the years ended December 31, 1997, 1996 and
1995, respectively: risk-free interest rate of 6 percent, 6 percent and 8
percent; volatility factor of the expected market price of SLM Holding's common
stock of 31 percent, 29 percent and 29 percent; dividend growth rate of 8
percent; and the time of exercise-expiration date. Vesting for options with
vesting periods tied to the Company's stock price is assumed to occur annually
in one-third increments.
39
Years ended December 31,
1997 1996 1995
Net income................ $507,895 $408,716 $355,585
======== ======== ========
Pro forma net income...... $486,052 $402,420 $352,806
======== ======== ========
Basic earnings per common
share.................. $ 2.80 $ 2.10 $ 1.51
======== ======== ========
Pro forma basic earnings
per common share ...... $ 2.68 $ 2.07 $ 1.50
======== ======== ========
Diluted earnings per
common share........... $ 2.78 $ 2.09 $ 1.51
======== ======== ========
Pro forma diluted earnings
per common share....... $ 2.66 $ 2.06 $ 1.49
======== ======== ========
16. 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. Effective April 1, 1995, the Company modified the Plan
to compute plan benefits on 5-year highest average base salary, a maximum
service accrual period of 30 years, and normal retirement age of 62. Prior to
these modifications, Plan benefits were computed based on 3-year highest average
base salary, a maximum service accrual period of 26.67 years, and a normal
retirement age of 60. 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.
The following table sets forth the Plan's actuarially determined funded
status and amounts recognized in the Company's consolidated financial
statements.
December 31,
1997 1996
Accumulated Benefits:
Actuarial present value of accumulated benefit obligations:
Vested............................. $ 49,247 $ 39,949
Nonvested........................... 5,206 5,099
-------- ---------
Total............................ $ 54,453 $ 45,048
======== =========
Pension Asset (Liability):
Actuarial present value of
projected benefit obligation
for service rendered to date..... $(92,885) $ (75,106)
Plan assets at fair value.......... 101,389 75,587
-------- ---------
Plan assets greater than
projected benefit obligation .... 8,504 481
Unrecognized prior service cost.... (3,600) (4,023)
Unrecognized transition obligation.. 1,072 1,286
Unrecognized gain................ (15,461) (7,149)
-------- ---------
Accrued pension cost........... $ (9,485) $ (9,405)
======== =========
In determining the projected benefit obligation, the weighted-average
assumed discount rate used was 7.0 percent in 1997, 7.5 percent in 1996 and 7.0
percent in 1995, while the assumed average rate of compensation increase was 6.0
percent in 1997, 1996 and 1995. The expected long-term rate of return on Plan
assets used in determining net periodic pension cost was 8.0 percent in 1997,
1996 and 1995.
Net periodic pension cost included the following components:
Years ended December 31,
1997 1996 1995
Service cost -- benefits
earned during the period $ 8,453 $ 8,369 $ 8,867
Interest cost on projected
benefit obligations.... 5,617 5,055 3,659
Actual return on plan assets (19,203) (13,009) (11,736)
Net amortization
and deferral........... 12,431 8,429 8,327
-------- -------- --------
Net periodic pension cost... $ 7,298 $ 8,844 $ 9,117
======== ======== ========
40
The Company also maintains a non-qualified pension plan for certain key
employees as designated by the Board of Directors and a nonqualified pension
plan for its Board of Directors. Total pension expense for these plans in 1997,
1996 and 1995 was $11.8 million, $11.9 million and $11.2 million, respectively.
401(k) Plans
The Company's 401(k) 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) Plan were $5.2 million, $5.0 million
and $4.9 million in 1997, 1996 and 1995, respectively.
17. 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 purposes. Significant components of
the Company's deferred tax liabilities and assets as of December 31, 1997 and
1996 under the liability method are as follows:
December 31,
1997 1996
Deferred tax liabilities:
Leases........................ $352,046 $351,093
Unrealized investment gains... 203,935 188,050
Securitization transactions... 39,735 -
Other......................... 34,500 32,669
-------- --------
630,216 571,812
-------- --------
Deferred tax assets:
ExportSS operating costs...... 46,643 68,874
Student loan reserves......... 51,188 47,004
In-substance defeasance
transactions................ 30,520 30,788
Asset valuation allowances.... 24,490 24,842
Securitization transactions... - 13,076
Other......................... 49,904 31,211
-------- --------
202,745 215,795
-------- --------
Net deferred tax liabilities..... $427,471 $356,017
======== ========
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 1997 and 1996.
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 United States federal income tax rates to
the Company's effective tax rate follow:
Years ended December 31,
1997 1996 1995
Statutory rate.............. 35.0% 35.0% 35.0%
Tax exempt interest and
dividends received
deduction................ (3.0) (3.8) (6.4)
Other, net.................. (.3) (1.1) (1.2)
---- ---- ----
Effective tax rate.......... 31.7% 30.1% 27.4%
==== ==== ====
41
18. Quarterly Financial Information (unaudited)
1997
---------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
Net interest income................................................... $199,026 $207,461 $170,342 $180,849
Other income.......................................................... 75,940 78,055 222,174 124,703
Operating expenses.................................................... 101,559 115,283 172,945 103,980
Federal income taxes.................................................. 54,570 51,069 72,040 65,242
Minority interest in net earnings of subsidiary....................... 2,674 2,673 2,674 2,673
-------- -------- -------- --------
Income before premiums on debt extinguished........................... 116,163 116,491 144,857 133,657
Premiums on debt extinguished, net of tax............................. - - (2,264) (1,009)
-------- -------- -------- --------
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
======== ======== ======== =====-==
1996
---------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
Net interest income................................................... $232,679 $219,561 $208,988 $205,208
Other income.......................................................... 21,754 27,899 35,211 62,052
Operating expenses.................................................... 98,773 100,145 100,075 106,659
Federal income taxes.................................................. 47,968 44,340 42,877 48,313
Minority interest in net earnings of subsidiary....................... 2,673 2,674 2,673 2,674
-------- -------- -------- --------
Income before premiums on debt extinguished........................... 105,019 100,301 98,574 109,614
Premiums on debt extinguished, net of tax............................. (4,792) - - -
-------- -------- -------- --------
Net income............................................................ $100,227 $100,301 $ 98,574 $109,614
======== ======== ======== =====-==
Basic earnings per common share....................................... $ .50 $ .51 $ .51 $ .58
======== ======== ======== =====-==
Diluted earnings per common share..................................... $ .50 $ .51 $ .51 $ .57
======== ======== ======== =====-==
================================================================================
19. College Construction Loan Insurance Association
On November 12, 1997, in connection with a merger agreement between AMBAC
Assurance Corporation ("AMBAC") and College Construction Loan Insurance
Association ("Connie Lee"), the Company agreed to sell its investment in Connie
Lee for $44 million which approximated the carrying value of the Company's
investment in Connie Lee. At the time of the merger, the Company, through its
ownership of preferred and common stock and through agreements with other
shareholders, effectively controlled 42 percent of Connie Lee's outstanding
voting stock. The merger was approved at a special shareholders' meeting with
the total purchase price being approximately $106 million in cash. In connection
with this transaction, on December 18, 1997 AMBAC repaid the $18 million lent to
Connie Lee by the GSE.
42
Report of Independent Public Accountants
To the Board of Directors and Stockholders of SLM Holding Corporation:
We have audited the accompanying consolidated balance sheet of SLM Holding
Corporation and subsidiaries as of December 31, 1997 and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for the year 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 audit. The financial statements of SLM
Holding Corporation as of December 31, 1996 and 1995, were audited by other
auditors whose report dated January 13, 1997, included an explanatory paragraph
with respect to a change in the method of accounting for student loan income,
discussed in Note 2 to the previously issued financial statements, and expressed
an unqualified opinion.
We conducted our audit 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 audit provides 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, 1997 and the consolidated results of their
operations and their cash flows for the year then ended in conformity with
generally accepted accounting principles.
/s/ Arthur Andersen LLP
Washington, DC
January 13, 1998
43
Average Balance Sheets and
Related Income/Expense 1993-1997
Dollars in millions
1997 1996
---------------------------------- ---------------------------------
*Income/ *Income/
Balance Expense Rate Balance Expense Rate
ASSETS
Student loans, net............................ $31,949 $2,461.7 7.70% $33,273 $2,606.7 7.83%
Warehousing advances.......................... 2,518 151.1 6.00 3,206 193.8 6.04
Academic facilities financings................ 1,436 123.0 8.57 1,500 126.4 8.43
Investments................................... 9,592 583.6 6.08 9,444 558.5 5.91
------- -------- ---- ------- -------- ----
Total interest earning assets................. 45,495 3,319.4 7.30% 47,423 3,485.4 7.35%
-------- ==== -------- ====
Non-interest earning assets................... 1,983 1,858
------- -------
Total assets.................................. $47,478 $49,281
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings......................... $26,548 1,462.0 5.51% $20,978 1,138.3 5.43%
Long-term notes............................... 18,677 1,064.2 5.70 26,024 1,444.6 5.55
------- -------- ---- ------- -------- ----
Total interest bearing liabilities............ 45,225 2,526.2 5.59% 47,002 2,582.9 5.50%
-------- ==== -------- ====
Non-interest bearing liabilities.............. 1,473 1,464
Stockholders' equity.......................... 780 815
------- -------
Total liabilities and stockholders' equity.... $47,478 $49,281
======= =======
Tax equivalent net interest income and
margin..................................... $ 793.2 1.74% $ 902.5 1.90%
======== ==== ======== ====
Average 91-day Treasury bill rate............. 5.21% 5.16%
==== ====
* To compare nontaxable asset yields to taxable yields on a similar basis,
income in the above table includes the impact of certain tax-exempt and
tax-advantaged investments based on the marginal corporate tax rate of 35%,
which represents tax equivalent income.
As part of the GSE's privatization, SLM Holding became the parent company of the
GSE on August 7, 1997. As a result, the GSE's preferred stock (totaling $214
million) is now reflected as a minority interest in the consolidated financial
statements. The financial statements for prior periods have been restated to
reflect this change.
44
1995 1994
--------------------------------- ----------------------------------
*Income/ *Income/
Balance Expense Rate Balance Expense Rate
ASSETS
Student loans, net............................ $32,758 $2,708.1 8.27% $28,642 $2,189.0 7.64%
Warehousing advances.......................... 6,342 408.0 6.43 6,981 336.8 4.82
Academic facilities financings................ 1,527 136.2 8.92 1,489 128.3 8.62
Investments................................... 11,154 720.6 6.46 11,283 524.2 4.65
------- -------- ---- ------- ------- ----
Total interest earning assets................. 51,781 3,972.9 7.67% 48,395 3,178.3 6.57%
-------- ==== ------- ====
Non-interest earning assets................... 1,673 1,240
------- -------
Total assets.................................. $53,454 $49,635
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings......................... $15,411 905.9 5.88% $16,577 737.8 4.45%
Long-term notes............................... 35,373 2,114.7 5.98 30,397 1,404.7 4.62
------- -------- ---- ------- -------- ----
Total interest bearing liabilities............ 50,784 3,020.6 5.95% 46,974 2,142.5 4.56%
-------- ==== -------- ====
Non-interest bearing liabilities.............. 1,451 1,191
Stockholders' equity.......................... 1,219 1,470
------- -------
Total liabilities and stockholders' equity.... $53,454 $49,635
======= =======
Tax equivalent net interest income and
margin..................................... $ 952.3 1.84% $1,035.8 2.14%
======== ==== ======== ====
Average 91-day Treasury bill rate............. 5.68% 4.38%
==== ====
1993
-----------------------------------
*Income/
Balance Expense Rate
ASSETS
Student loans, net............................ $25,385 $1,899.2 7.48%
Warehousing advances.......................... 7,669 306.7 4.00
Academic facilities financings................ 1,258 90.5 7.20
Investments................................... 10,359 406.6 3.93
------- ------- ----
Total interest earning assets................. 44,671 2,703.0 6.05%
------- ----
Non-interest earning assets................... 1,183
-------
Total assets.................................. $45,854
=======
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings......................... $13,272 $ 449.0 3.38%
Long-term notes............................... 30,374 1,031.7 3.40
------- -------- ----
Total interest bearing liabilities............ 43,646 1,480.7 3.39%
-------- ====
Non-interest bearing liabilities.............. 1,061
Stockholders' equity.......................... 1,147
-------
Total liabilities and stockholders' equity.... $45,854
=======
Tax equivalent net interest income and
margin..................................... $1,222.3 2.74%
======== ====
Average 91-day Treasury bill rate............. 3.08%
====
45
Selected Financial Data 1993-1997
Dollars in millions, except per share amounts)
The following table sets forth selected financial and other operating
information of SLM Holding. The selected financial data in the table is derived
from the consolidated financial statements of SLM Holding. 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 elsewhere herein.
1997(2) 1996(2) 1995(1)(2) 1994(1)(2) 1993(1)(2)
OPERATING DATA:
Net interest income............................... $ 758 $ 866 $ 901 $ 982 $ 1,169
Net income........................................ 508 409 356 410 432
Basic earnings per common share(3)................ 2.80 2.10 1.51 1.47 1.42
Diluted earnings per common share(3).............. 2.78 2.09 1.51 1.47 1.42
Dividends per common share........................ 0.52 0.47 0.43 0.41 0.36
Return on common shareholders' equity............. 65.14% 50.13% 29.17% 27.85% 37.68%
Net interest margin............................... 1.74 1.90 1.84 2.14 2.74
Return on assets.................................. 1.12 .86 .69 .85 .97
Dividend payout ratio............................. 18.73 22.40 28.64 27.66 25.10
Average equity/average assets..................... 1.64 1.65 2.28 2.96 2.50
BALANCE SHEET DATA:
Student loans purchased........................... $27,593 $32,308 $34,336 $30,571 $26,978
Student loan participations....................... 1,928 1,446 - - -
Warehousing advances.............................. 1,869 2,789 3,865 7,032 7,034
Academic facilities financings.................... 1,375 1,473 1,312 1,548 1,359
Total assets...................................... 39,909 47,630 50,002 53,161 46,682
Long-term notes................................... 14,541 22,606 30,083 34,319 30,925
Total borrowings.................................. 37,717 45,124 47,530 50,335 44,544
Stockholders' equity.............................. 675(4) 834(4) 867(4) 1,388(4) 1,179(4)
Book value per common share(3).................... 3.89 4.44 4.29 5.39 4.01
OTHER DATA:
Securitized student loans outstanding............. $14,104 $ 6,263 $ 954 $ - $ -
Core earnings(5).................................. 487 381 350 345 388
Premiums on debt extinguished..................... 5 7 8 14 211
(1) Previously reported results for the years ended December 31, 1995, 1994, and
1993 have been restated to retroactively reflect the recognition of student
loan income as earned (see Note 2 to the Consolidated Financial Statements).
This restatement resulted in the elimination of the previously reported 1995
cumulative effect of the change in accounting method of $130 million (.55
per common share) and an increase to previously reported net income of $17
million (.06 per common share), and $13 million (.04 per common share), for
the years ended December 31, 1994 and 1993, respectively.
(2) As part of the GSE's privatization, SLM Holding became the parent company of
the GSE on August 7, 1997. As a result, the GSE's preferred stock (totaling
$214 million) is now reflected as a minority interest in the consolidated
financial statements. The financial statements for prior periods have been
restated to reflect this change.
(3) 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. All share and per share amounts, for all periods
presented, reflect payment of that dividend.
(4) At December 31, 1997, 1996, 1995, and 1994, stockholders' equity reflects
the addition to stockholders' equity of $379 million, $349 million, $371
million, and $300 million, respectively, net of tax, of unrealized gains on
certain investments recognized pursuant to FAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities."
(5) Core earnings is defined as the Company's net income less the after-tax
effect of floor revenues and other one time charges. Management believes
that these measures, which are not measures under generally accepted
accounting principles (GAAP), are important because they depict the
Company's earnings before the effects of one time events such as floor
revenues which are largely outside of the Company's control. Management
believes that core earnings as defined while not necessarily comparable to
other companies' use of similar terminology, provide for meaningful period
to period comparisons as a basis for analyzing trends in the Company's
student loan operations.
46