<PAGE> 1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
(AMENDED BY EXCH ACT REL NO. 312905. EFF 4/26/93.)
COMMISSION FILE NUMBER: 001-13251
------------------------
SLM HOLDING CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 52-2013874
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11600 SALLIE MAE DRIVE, RESTON, VIRGINIA 20193
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's telephone number, including area code: (703) 810-3000
------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
<TABLE>
<CAPTION>
CLASS OUTSTANDING AT SEPTEMBER 30, 1998
----- ---------------------------------
<S> <C>
Common Stock, $.20 par value 165,708,640 shares
</TABLE>
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- --------------------------------------------------------------------------------
<PAGE> 2
SLM HOLDING CORPORATION
FORM 10-Q
INDEX
SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements.............................. 3
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 11
PART II OTHER INFORMATION
Item 1. Legal Proceedings................................. 30
Item 2. Changes in Securities............................. 30
Item 3. Defaults Upon Senior Securities................... 30
Item 4. Submission of Matters to a Vote of Security
Holders................................................ 30
Item 5. Other Information................................. 30
Item 6. Exhibits and Reports on Form 8-K.................. 30
SIGNATURES.................................................. 31
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SLM HOLDING CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Insured student loans.................................. $26,750,793 $29,520,610
Warehousing advances................................... 1,488,075 1,868,654
Academic facilities financings
Bonds--available-for-sale......................... 768,389 860,325
Loans............................................. 477,483 514,691
----------- -----------
Total academic facilities financings................... 1,245,872 1,375,016
Investments
Available-for-sale................................ 3,724,137 4,549,977
Held-to-maturity.................................. 646,977 525,962
----------- -----------
Total investments...................................... 4,371,114 5,075,939
Cash and cash equivalents.............................. 81,104 54,022
Other assets, principally accrued interest
receivable............................................ 2,006,007 2,014,556
----------- -----------
Total assets...................................... $35,942,965 $39,908,797
=========== ===========
LIABILITIES
Short-term borrowings.................................. $24,346,632 $23,175,509
Long-term notes........................................ 9,410,101 14,541,316
Other liabilities...................................... 1,305,981 1,303,517
----------- -----------
Total liabilities................................. 35,062,714 39,020,342
----------- -----------
COMMITMENTS AND CONTINGENCIES
MINORITY INTEREST IN SUBSIDIARY............................. 213,883 213,883
STOCKHOLDERS' EQUITY
Common stock, par value $.20 per share, 250,000,000
shares authorized, 184,120,674 and 183,632,694 shares
issued, respectively.................................. 36,824 36,726
Additional paid-in capital............................. 19,698 28,838
Unrealized gains on investments (net of tax of $215,485
and $203,935, respectively)........................... 400,187 378,736
Retained earnings...................................... 974,522 654,135
----------- -----------
Stockholders' equity before treasury stock............. 1,431,231 1,098,435
Common stock held in treasury at cost: 18,412,034 and
10,221,757 shares, respectively....................... 764,863 423,863
----------- -----------
Total stockholders' equity........................ 666,368 674,572
----------- -----------
Total liabilities and stockholders' equity... $35,942,965 $39,908,797
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
SLM HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Interest income:
Insured student loans..................... $492,815 $607,129 $1,596,821 $1,880,703
Warehousing advances...................... 23,010 36,403 81,143 114,606
Academic facilities financings:
Taxable.............................. 11,100 11,810 33,703 36,341
Tax-exempt........................... 10,028 11,786 31,535 35,073
-------- -------- ---------- ----------
Total academic facilities financings...... 21,128 23,596 65,238 71,414
Investments............................... 68,176 144,674 236,368 457,140
-------- -------- ---------- ----------
Total interest income.......................... 605,129 811,802 1,979,570 2,523,863
Interest expense:
Short-term debt........................... 314,392 364,417 981,161 1,103,181
Long-term debt............................ 142,766 277,043 510,077 843,853
-------- -------- ---------- ----------
Total interest expense......................... 457,158 641,460 1,491,238 1,947,034
-------- -------- ---------- ----------
NET INTEREST INCOME............................ 147,971 170,342 488,332 576,829
Other income:
Gain on sale of student loans............. -- 159,959 117,068 224,589
Servicing and securitization revenue...... 74,552 44,449 189,925 101,640
Gains on sales of securities.............. 6,624 2,890 12,423 10,272
Other..................................... 18,366 11,393 49,171 36,185
-------- -------- ---------- ----------
Total other income............................. 99,542 218,691 368,587 372,686
-------- -------- ---------- ----------
Operating expenses:
Salaries and benefits..................... 45,773 71,902 143,899 174,683
Other..................................... 40,767 101,043 127,235 215,104
-------- -------- ---------- ----------
Total operating expenses....................... 86,540 172,945 271,134 389,787
-------- -------- ---------- ----------
Income before income taxes and minority
interest in net earnings of subsidiary....... 160,973 216,088 585,785 559,728
-------- -------- ---------- ----------
Income taxes:
Current................................... 80,007 84,460 220,224 202,581
Deferred.................................. (29,520) (13,639) (33,511) (26,121)
-------- -------- ---------- ----------
Total income taxes............................. 50,487 70,821 186,713 176,460
Minority interest in net earnings of
subsidiary................................... 2,674 2,674 8,021 8,021
-------- -------- ---------- ----------
NET INCOME..................................... $107,812 $142,593 $ 391,051 $ 375,247
======== ======== ========== ==========
BASIC EARNINGS PER COMMON SHARE................ $ .65 $ .79 $ 2.32 $ 2.04
======== ======== ========== ==========
Average common shares outstanding.............. 166,298 180,649 168,751 183,828
======== ======== ========== ==========
DILUTED EARNINGS PER COMMON SHARE.............. $ .64 $ .78 $ 2.29 $ 2.03
======== ======== ========== ==========
Average common and common equivalent shares
outstanding.................................. 168,630 182,393 171,133 185,188
======== ======== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
SLM HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
COMMON STOCK SHARES
--------------------------------------- COMMON ADDITIONAL RETAINED
ISSUED TREASURY OUTSTANDING STOCK PAID-IN CAPITAL EARNINGS
----------- ----------- ----------- ------- --------------- ----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT JUNE 30, 1997............... 231,553,333 (48,382,467) 183,170,866 $46,311 $ 27,986 $1,161,921
Comprehensive income (see Note 2):
Net Income..................... 142,593
Other comprehensive income, net
of tax:
Unrealized gains (losses)
on investments, net of
tax......................
Comprehensive income...............
Cash dividends ($.13 per share).... (22,623)
Issuance of common shares.......... 1,545,940 1,545,940 309 25,610
Issuance of warrants............... 12,393
Repurchase of common shares........ (8,082,610) (8,082,610)
Retirement of treasury shares...... (49,775,156) 49,775,156 (9,955) (47,668) (736,020)
----------- ----------- ----------- ------- -------- ----------
BALANCE AT SEPTEMBER 30, 1997.......... 183,324,117 (6,689,921) 176,634,196 $36,665 $ 18,321 $ 545,871
=========== =========== =========== ======= ======== ==========
BALANCE AT JUNE 30, 1998............... 184,041,735 (16,565,869) 167,475,866 $36,808 $ 22,310 $ 889,917
Comprehensive income (see Note 2):
Net Income..................... 107,812
Other comprehensive income, net
of tax:
Unrealized gains (losses)
on investments, net of
tax......................
Comprehensive income...............
Cash dividends ($.14 per share).... (23,207)
Issuance of common shares.......... 78,939 78,939 16 1,810
Premiums on equity forward purchase
contracts........................ (4,422)
Repurchase of common shares........ (1,846,165) (1,846,165)
----------- ----------- ----------- ------- -------- ----------
BALANCE AT SEPTEMBER 30, 1998.......... 184,120,674 (18,412,034) 165,708,640 $36,824 $ 19,698 $ 974,522
=========== =========== =========== ======= ======== ==========
<CAPTION>
ACCUMULATED
OTHER TOTAL
TREASURY COMPREHENSIVE STOCKHOLDERS'
STOCK INCOME EQUITY
--------- ------------- -------------
<S> <C> <C> <C>
BALANCE AT JUNE 30, 1997............... $(738,260) $344,628 $ 842,586
---------
Comprehensive income (see Note 2):
Net Income..................... 142,593
Other comprehensive income, net
of tax:
Unrealized gains (losses)
on investments, net of
tax...................... 16,912 16,912
---------
Comprehensive income............... 159,505
Cash dividends ($.13 per share).... (22,623)
Issuance of common shares.......... 25,919
Issuance of warrants............... 12,393
Repurchase of common shares........ (329,994) (329,994)
Retirement of treasury shares...... 793,643 --
--------- -------- ---------
BALANCE AT SEPTEMBER 30, 1997.......... $(274,611) $361,540 $ 687,786
========= ======== =========
BALANCE AT JUNE 30, 1998............... $(690,290) $371,635 $ 630,380
---------
Comprehensive income (see Note 2):
Net Income..................... 107,812
Other comprehensive income, net
of tax:
Unrealized gains (losses)
on investments, net of
tax...................... 28,552 28,552
---------
Comprehensive income............... 136,364
Cash dividends ($.14 per share).... (23,207)
Issuance of common shares.......... 1,826
Premiums on equity forward purchase
contracts........................ (4,422)
Repurchase of common shares........ (74,573) (74,573)
--------- -------- ---------
BALANCE AT SEPTEMBER 30, 1998.......... $(764,863) $400,187 $ 666,368
========= ======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
SLM HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
COMMON STOCK SHARES
--------------------------------------- COMMON ADDITIONAL RETAINED
ISSUED TREASURY OUTSTANDING STOCK PAID-IN CAPITAL EARNINGS
----------- ----------- ----------- ------- --------------- ---------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996........... 229,934,499 (42,017,416) 187,917,083 $45,987 $ -- $ 975,889
Comprehensive income (see Note 2):
Net Income..................... 375,247
Other comprehensive income, net
of tax:
Unrealized gains (losses)
on investments, net of
tax......................
Comprehensive income...............
Cash dividends ($.38 per share).... (69,245)
Issuance of common shares.......... 3,164,774 3,164,774 633 53,596
Issuance of warrants............... 12,393
Repurchase of common shares........ (14,447,661) (14,447,661)
Retirement of treasury shares...... (49,775,156) 49,775,156 -- (9,955) (47,668) (736,020)
----------- ----------- ----------- ------- -------- ---------
BALANCE AT SEPTEMBER 30, 1997.......... 183,324,117 (6,689,921) 176,634,196 $36,665 $ 18,321 $ 545,871
=========== =========== =========== ======= ======== =========
BALANCE AT DECEMBER 31, 1997........... 183,632,694 (10,221,757) 173,410,937 $36,726 $ 28,838 $ 654,135
Comprehensive income (see Note 2):
Net Income..................... 391,051
Other comprehensive income, net
of tax:
Unrealized gains (losses)
on investments, net of
tax......................
Comprehensive income...............
Cash dividends ($.42 per share).... (70,664)
Issuance of common shares.......... 487,980 487,980 98 12,376
Premiums on equity forward purchase
contracts........................ (21,516)
Repurchase of common shares........ (8,190,277) (8,190,277)
----------- ----------- ----------- ------- -------- ---------
BALANCE AT SEPTEMBER 30, 1998.......... 184,120,674 (18,412,034) 165,708,640 $36,824 $ 19,698 $ 974,522
=========== =========== =========== ======= ======== =========
<CAPTION>
ACCUMULATED
OTHER TOTAL
TREASURY COMPREHENSIVE STOCKHOLDERS'
STOCK INCOME EQUITY
--------- ------------- -------------
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996........... $(537,164) $349,235 $ 833,947
---------
Comprehensive income (see Note 2):
Net Income..................... 375,247
Other comprehensive income, net
of tax:
Unrealized gains (losses)
on investments, net of
tax...................... 12,305 12,305
---------
Comprehensive income............... 387,552
Cash dividends ($.38 per share).... (69,245)
Issuance of common shares.......... 54,229
Issuance of warrants............... 12,393
Repurchase of common shares........ (531,090) (531,090)
Retirement of treasury shares...... 793,643 --
--------- -------- ---------
BALANCE AT SEPTEMBER 30, 1997.......... $(274,611) $361,540 $ 687,786
========= ======== =========
BALANCE AT DECEMBER 31, 1997........... $(423,863) $378,736 $ 674,572
---------
Comprehensive income (see Note 2):
Net Income..................... 391,051
Other comprehensive income, net
of tax:
Unrealized gains (losses)
on investments, net of
tax...................... 21,451 21,451
---------
Comprehensive income............... 412,502
Cash dividends ($.42 per share).... (70,664)
Issuance of common shares.......... 12,474
Premiums on equity forward purchase
contracts........................ (21,516)
Repurchase of common shares........ (341,000) (341,000)
--------- -------- ---------
BALANCE AT SEPTEMBER 30, 1998.......... $(764,863) $400,187 $ 666,368
========= ======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 7
SLM HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1998 1997
-------------- --------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net income.................................................. $ 391,051 $ 375,247
Adjustments to reconcile net income to net cash provided by
operating activities:
Gains on sales of student loans........................ (117,068) (224,589)
Decrease in accrued interest receivable................ 166,604 12,236
(Decrease) in accrued interest payable................. (165,262) (38,453)
(Increase) decrease in other assets.................... (84,477) 50,531
Increase in other liabilities.......................... 156,176 159,183
------------- -------------
Total adjustments................................. (44,027) (41,092)
------------- -------------
Net cash provided by operating activities................... 347,024 334,155
------------- -------------
INVESTING ACTIVITIES
Insured student loans purchased............................. (5,879,621) (6,533,989)
Reduction of insured student loans purchased:
Installment payments................................... 2,061,421 2,081,741
Claims and resales..................................... 602,042 854,518
Proceeds from securitization of student loans.......... 6,035,218 7,070,408
Warehousing advances made................................... (715,981) (499,208)
Warehousing advance repayments.............................. 1,096,560 846,274
Academic facilities financings made......................... (4,226) (144,103)
Academic facilities financings reductions................... 140,914 205,643
Investments purchased....................................... (8,151,265) (12,708,312)
Proceeds from sale or maturity of investments............... 8,875,794 13,453,113
------------- -------------
Net cash provided by investing activities................... 4,060,856 4,626,085
------------- -------------
FINANCING ACTIVITIES
Short-term borrowings issued................................ 318,600,741 544,138,964
Short-term borrowings repaid................................ (317,077,287) (541,607,863)
Long-term notes issued...................................... 4,227,531 3,397,681
Long-term notes repaid...................................... (9,711,077) (10,521,688)
Equity forward contracts and common stock issued............ (9,042) 54,231
Common stock repurchased.................................... (341,000) (531,090)
Dividends paid.............................................. (70,664) (69,245)
------------- -------------
Net cash (used in) financing activities..................... (4,380,798) (5,139,010)
------------- -------------
Net increase (decrease) in cash and cash equivalents........ 27,082 (178,770)
Cash and cash equivalents at beginning of period............ 54,022 270,887
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 81,104 $ 92,117
============= =============
CASH DISBURSEMENTS MADE FOR:
Interest............................................... $ 1,539,653 $ 1,695,418
============= =============
Income Taxes........................................... $ 263,336 $ 143,000
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE> 8
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AT SEPTEMBER 30, 1998 AND FOR THE THREE AND NINE MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997 IS UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated financial statements of SLM Holding
Corporation (the "Company") have been prepared in accordance with generally
accepted accounting principles for interim financial information. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete consolidated financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates. Operating results for the
three and nine months ended September 30, 1998 are not necessarily indicative of
the results for the year ending December 31, 1998.
2. NEW ACCOUNTING PRONOUNCEMENTS
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income." This statement
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be included in a financial
statement that is displayed with the same prominence as other financial
statements. Under SFAS 130, the Company's unrealized gains or losses on its
available-for-sale securities, which prior to adoption were reported separately
in stockholders' equity, are now included in other comprehensive income. The
adoption of SFAS 130 has no impact on the Company's financial condition or
results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded on the
balance sheet as either an asset or liability measured at its fair value. It
also requires that gains or losses resulting from changes in the values of those
derivatives be recognized currently in earnings unless specific hedge criteria
are met. Gains and losses on derivatives that qualify as hedges can be used to
offset related results on the hedged item in the income statement. The Company
is required to adopt SFAS 133 for fiscal years beginning January 1, 2000 at the
latest. Early adoption of SFAS 133 at the beginning of any fiscal quarter is
permitted, but the effects of SFAS 133 cannot be applied retroactively to
periods prior to adoption. Management has not yet quantified the impact of
adopting SFAS 133 and has not determined the timing and the method of adoption.
Management believes that SFAS 133 could increase volatility in reported earnings
and other comprehensive income.
8
<PAGE> 9
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. STUDENT LOANS
The following table summarizes the reserves that the Company has recorded
for estimated losses due to risk-sharing, unpaid guarantee claims on federally
guaranteed student loans and defaults on privately insured loans.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- ------------------
1998 1997 1998 1997
-------- -------- ------- --------
<S> <C> <C> <C> <C>
BALANCE AT BEGINNING OF PERIOD................. $87,372 $82,463 $87,660 $ 84,063
Additions
Provisions for loan losses................ 1,165 12,767 11,770 18,750
Recoveries................................ 1,140 1,091 3,170 5,561
Deductions
Reductions for sales of student loans..... -- (3,146) (7,474) (7,474)
Losses on loans........................... (3,234) (3,084) (8,683) (10,809)
------- ------- ------- --------
BALANCE AT END OF PERIOD....................... $86,443 $90,091 $86,443 $ 90,091
======= ======= ======= ========
</TABLE>
In addition to the reserves for loan losses in the above table, the
Company, through its wholly owned insurance subsidiary, Hemar Insurance
Corporation of America ("HICA"), maintains a provision for future losses on
private student loans that it insures. At September 30, 1998 and 1997, HICA's
reserves were $91 million and $75 million, respectively. At September 30, 1998
and 1997, HICA insured repayment of principal and interest on $1.8 billion and
$1.4 billion of student loans, of which, the Company owned $1.5 billion and $1.2
billion at September 30, 1998 and 1997, respectively.
4. STUDENT LOAN SECURITIZATION
Due to unfavorable market conditions, the Company did not complete a
securitization transaction in the third quarter of 1998. For the three months
ended September 30, 1997, the Company securitized $2.5 billion of student loans
and recorded a pre-tax gain of $66 million. For the nine months ended September
30, 1998 and 1997, the Company securitized $6.0 billion (in two transactions)
and $7.0 billion (in three transactions), respectively, of student loans and
recorded pre-tax gains of $117 million and $131 million, respectively. The gains
in the three and nine months ended September 30, 1997 are exclusive of the $94
million one-time gain associated with the successful outcome of the offset fee
litigation. At September 30, 1998 and December 31, 1997, securitized student
loans outstanding totaled $18.4 billion and $14.1 billion, respectively.
5. 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 shares already
outstanding for shareholders of record on December 12, 1997. All share and per
share amounts, for all periods presented, have been restated to reflect the
payment of that dividend.
Basic earnings per common share are calculated using the weighted average
number of shares of common stock outstanding during each period. Diluted
earnings per common share reflect the potential dilutive effect of additional
common shares that are issuable upon exercise of outstanding stock options and
warrants,
9
<PAGE> 10
SLM HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
determined by the treasury stock method, and equity forwards, determined by the
reverse treasury stock method, as follows:
<TABLE>
<CAPTION>
AVERAGE EARNINGS
NET INCOME SHARES PER SHARE
----------- ----------- ---------
(THOUSANDS) (THOUSANDS)
<S> <C> <C> <C>
THREE MONTHS ENDED SEPTEMBER 30, 1998
Basic EPS................................................... $107,812 166,298 $ .65
Dilutive effect of stock options, warrants and equity
forwards.................................................. -- 2,332 (.01)
-------- ------- -----
Diluted EPS................................................. $107,812 168,630 $ .64
======== ======= =====
THREE MONTHS ENDED SEPTEMBER 30, 1997
Basic EPS................................................... $142,593 180,649 $ .79
Dilutive effect of stock options and warrants............... -- 1,744 (.01)
-------- ------- -----
Diluted EPS................................................. $142,593 182,393 $ .78
======== ======= =====
</TABLE>
<TABLE>
<CAPTION>
AVERAGE EARNINGS
NET INCOME SHARES PER SHARE
----------- ----------- ---------
(THOUSANDS) (THOUSANDS)
<S> <C> <C> <C>
NINE MONTHS ENDED SEPTEMBER 30, 1998
Basic EPS................................................... $391,051 168,751 $2.32
Dilutive effect of stock options, warrants and equity
forwards.................................................. -- 2,382 (.03)
-------- ------- -----
Diluted EPS................................................. $391,051 171,133 $2.29
======== ======= =====
NINE MONTHS ENDED SEPTEMBER 30, 1997
Basic EPS................................................... $375,247 183,828 $2.04
Dilutive effect of stock options and warrants............... -- 1,360 (.01)
-------- ------- -----
Diluted EPS................................................. $375,247 185,188 $2.03
======== ======= =====
</TABLE>
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 SHARES OWNED. ALL
PRIOR PERIOD SHARE AND PER SHARE AMOUNTS HAVE BEEN RESTATED TO REFLECT THE STOCK
SPLIT.
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, changes in the general interest rate
environment and in the securitization markets for student loans and the success
of the Company and its significant third-party service providers and business
partners in addressing the Year 2000 issue.
Set forth below is Management's Discussion and Analysis of Financial
Condition and Results of Operations of SLM Holding for the three and nine months
ended September 30, 1998 and 1997. This section should be read in conjunction
with Management's Discussion and Analysis of Financial Condition and Results of
Operations for the years ended December 31, 1995-97 presented in the Company's
Annual Report on Form 10-K as filed with the Securities and Exchange Commission.
All dollar amounts are in millions, except per share amounts or as otherwise
noted.
11
<PAGE> 12
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
SELECTED FINANCIAL DATA
CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED INCREASE ENDED INCREASE
SEPTEMBER 30, (DECREASE) SEPTEMBER 30, (DECREASE)
------------- ---------------- ------------- -------------------
1998 1997 $ % 1998 1997 $ %
----- ----- ----- -------- ----- ----- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net interest income........................ $148 $170 $ (22) (13)% $ 488 $ 577 $ (89) (15)%
Gains on sales of student loans............ -- 160 (160) (100) 117 225 (108) (48)
Servicing and securitization revenue....... 75 45 30 68 190 102 88 87
Other income............................... 25 15 10 75 62 46 16 33
Operating expenses......................... 87 173 (86) (50) 271 390 (119) (30)
Income taxes............................... 50 71 (21) (29) 187 177 10 6
Minority interest in net earnings of
subsidiary............................... 3 3 -- -- 8 8 -- --
---- ---- ----- ---- ----- ----- ----- ---
NET INCOME................................. $108 $143 $ (35) (24)% $ 391 $ 375 $ 16 4%
==== ==== ===== ==== ===== ===== ===== ===
BASIC EARNINGS PER COMMON SHARE............ $.65 $.79 $(.14) (18)% $2.32 $2.04 $ .28 14%
==== ==== ===== ==== ===== ===== ===== ===
DILUTED EARNINGS PER COMMON SHARE.......... $.64 $.78 $(.14) (18)% $2.29 $2.03 $ .26 13%
==== ==== ===== ==== ===== ===== ===== ===
Dividends per common share................. $.14 $.13 $ .01 11% $ .42 $ .38 $ .04 11%
==== ==== ===== ==== ===== ===== ===== ===
</TABLE>
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
INCREASE
(DECREASE)
SEPTEMBER 30, DECEMBER 31, -------------------
1998 1997 $ %
------------- ------------ -------- --------
<S> <C> <C> <C> <C>
ASSETS
Student loans...................................... $26,751 $29,521 $(2,770) (9)%
Warehousing advances............................... 1,488 1,869 (381) (20)
Academic facilities financings..................... 1,246 1,375 (129) (9)
Cash and investments............................... 4,452 5,130 (678) (13)
Other assets....................................... 2,006 2,014 (8) --
------- ------- ------- ---
Total assets............................. $35,943 $39,909 $(3,966) (10)%
======= ======= ======= ===
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings.............................. $24,347 $23,176 $ 1,171 5%
Long-term notes.................................... 9,410 14,541 (5,131) (35)
Other liabilities.................................. 1,306 1,303 3 --
------- ------- ------- ---
Total liabilities........................ 35,063 39,020 (3,957) (10)
------- ------- ------- ---
Minority interest in subsidiary.................... 214 214 -- --
Stockholders' equity before treasury stock......... 1,431 1,099 332 30
Common stock held in treasury at cost.............. 765 424 341 80
------- ------- ------- ---
Total stockholders' equity............... 666 675 (9) (1)
------- ------- ------- ---
Total liabilities and stockholders'
equity................................. $35,943 $39,909 $(3,966) (10)%
======= ======= ======= ===
</TABLE>
RESULTS OF OPERATIONS
EARNINGS SUMMARY
For the three months ended September 30, 1998, the Company's net income was
$108 million ($.64 diluted earnings per common share), versus net income of $143
million ($.78 diluted earnings per common share) in the third quarter of 1997.
For the nine months ended September 30, 1998, the Company earned net
12
<PAGE> 13
income of $391 million ($2.29 diluted earnings per common share) compared with
$375 million ($2.03 diluted earnings per common share) for the nine months ended
September 30, 1997.
The decrease in the third quarter earnings versus the year ago quarter can
be attributed to the Company's decision to not enter into a securitization
transaction during the quarter. As a result, no securitization gain was
recognized in the third quarter of 1998 while an after-tax securitization gain
of $43 million (exclusive of the $61 million one-time gain associated with the
successful outcome of the offset fee litigation) was recognized in the third
quarter of 1997. The gain on the $2.5 billion securitization in the third
quarter of 1997 contributed approximately $.24 per share. The Company's decision
to defer selling loans through securitizations was due to the turbulence in the
global financial markets in the third quarter, which caused increased demand for
U.S. Treasury securities. This increase in demand caused Treasury bill rates, to
which the Company's asset backed securities are indexed, to fall relative to
other market indices and financing spreads to widen.
For the nine months ended September 30, 1998, the increase in net income of
$16 million versus the year ago period is due to the increase in the Company's
managed portfolio of student loans and to one-time events recorded in the third
quarter of 1997. Average managed student loans increased from $41.0 billion for
the nine months ended September 30, 1997 to $44.3 billion for the nine months
ended September 30, 1998. Included in the third quarter of 1997 results, when
the Company resolved litigation over whether the offset fee applied to
securitized student loans, was a reversal of an after-tax $63 million reserve
for offset fees. Also in the third quarter of 1997, the Company recorded $59
million, after-tax ($46 million in operating expenses) in charges incurred in
connection with the Company's Reorganization and the change in business
strategies implemented by new management.
The Company securitized $6.0 billion of student loans in the first nine
months of 1998 ($3.0 billion in each of the first and second quarters) and
recorded securitization gains of $76 million, after-tax, a decrease of $9
million from the after-tax gains of $85 million recorded on the $7.0 billion of
student loans securitized in the nine months ended September 30, 1997. The
decrease in gains is mainly due to the securitization of $1.0 billion less loans
in the first nine months of 1998. As more student loans are managed off-balance
sheet through securitizations, the income earned on those loans will continue to
shift on the Company's income statement from net interest income to servicing
and securitization revenue and gain on sales of student loans. The average
balance of securitized student loans increased from $8.3 billion in the first
nine months of 1997 to $16.6 billion in the first nine months of 1998. As a
result servicing and securitization revenue increased by approximately $57
million, after-tax for the nine months ended September 30, 1998 and net interest
income decreased by approximately $58 million, after-tax, versus the same period
a year ago. The decrease in net interest income in the first nine months of 1998
was also due to the reduction of warehousing advances and investments as the
Company continued to reduce these assets to better utilize capital.
Exclusive of the $46 million in one-time charges taken in the third quarter
of 1997, after-tax operating expenses in the third quarter of 1998 were $15
million lower than the third quarter of 1997, and for the first nine months of
1998 after-tax operating expenses were $36 million lower than the first nine
months of 1997. These reductions were a direct result of the Company's
restructuring of operations performed in the second half of 1997 and the
continued management focus on cost control. For the three and nine months ended
September 30, 1998 servicing costs decreased by $3 million and $6 million,
after-tax, respectively, versus the corresponding year-ago periods. Included in
the 1998 year to date servicing expense is a $8 million after-tax charge
relating to the closing of two satellite loan servicing centers and to the
ongoing servicing center reconfiguration program. Included in the 1997 year to
date servicing expense is a $5 million after-tax charge relating to the transfer
of loans from a third party servicer to Sallie Mae Servicing Corporation
("SMSC"), a wholly owned subsidiary of the Company.
During the first nine months of 1998, the Company spent $341 million to
repurchase 8.2 million common shares (or 5 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
13
<PAGE> 14
non-taxable 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.
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED INCREASE ENDED INCREASE
SEPTEMBER 30, (DECREASE) SEPTEMBER 30, (DECREASE)
------------- ------------ --------------- -----------
1998 1997 $ % 1998 1997 $ %
----- ----- ----- ---- ------ ------ ----- ---
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income
Student loans........................ $493 $607 $(114) (19)% $1,597 $1,881 $(284) (15)%
Warehousing advances................. 23 36 (13) (37) 81 115 (34) (29)
Academic facilities financings....... 21 24 (3) (10) 65 71 (6) (9)
Investments.......................... 68 145 (77) (53) 236 457 (221) (48)
Taxable equivalent adjustment........ 8 9 (1) (12) 27 27 -- (3)
---- ---- ----- ---- ------ ------ ----- ---
Total taxable equivalent interest
income................................. 613 821 (208) (25) 2,006 2,551 (545) (21)
Interest expense......................... 457 641 (184) (29) 1,491 1,947 (456) (23)
---- ---- ----- ---- ------ ------ ----- ---
Taxable equivalent net interest income... $156 $180 $ (24) (15)% $ 515 $ 604 $ (89) (15)%
==== ==== ===== ==== ====== ====== ===== ===
</TABLE>
AVERAGE BALANCE SHEETS
The following table reflects the rates earned on earning assets and paid on
liabilities for the three and nine months ended September 30, 1998 and 1997.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------- -------------------------------
1998 1997 1998 1997
---------------- ---------------- -------------- --------------
BALANCE RATE BALANCE RATE BALANCE RATE BALANCE RATE
-------- ----- -------- ----- ------- ---- ------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
AVERAGE ASSETS
Student loans............... $25,921 7.54% $31,467 7.65% $27,673 7.71% $32,681 7.69%
Warehousing advances........ 1,523 5.99 2,400 6.02 1,793 6.05 2,558 5.99
Academic facilities
financings................ 1,292 8.15 1,436 8.27 1,341 8.20 1,440 8.38
Investments................. 4,411 6.37 9,659 6.06 5,135 6.39 10,287 6.05
------- ---- ------- ---- ------- ---- ------- ----
Total interest earning assets.... 33,147 7.34% 44,962 7.24% 35,942 7.46% 46,966 7.26%
==== ==== ==== ====
Non-interest earning assets...... 2,226 2,107 2,076 1,991
------- ------- ------- -------
Total assets........... $35,373 $47,069 $38,018 $48,957
======= ======= ======= =======
AVERAGE LIABILITIES AND
STOCKHOLDERS' EQUITY
Six month floating rate
notes..................... $ 2,715 5.44% $ 2,804 5.43% $ 2,887 5.53% $ 2,902 5.45%
Other short-term
borrowings................ 20,467 5.37 23,418 5.52 21,020 5.48 23,965 5.49
Long-term notes............. 10,105 5.60 18,552 5.92 11,986 5.69 19,807 5.70
------- ---- ------- ---- ------- ---- ------- ----
Total interest bearing
liabilities.................... 33,287 5.45% 44,774 5.68% 35,893 5.55% 46,674 5.58%
==== ==== ==== ====
Non-interest bearing
liabilities.................... 1,462 1,483 1,513 1,466
Stockholders' equity............. 624 812 612 817
------- ------- ------- -------
Total liabilities and
stockholders'
equity............... $35,373 $47,069 $38,018 $48,957
======= ======= ======= =======
Net interest margin.............. 1.87% 1.58% 1.91% 1.72%
==== ==== ==== ====
</TABLE>
14
<PAGE> 15
RATE/VOLUME ANALYSIS
The Rate/Volume Analysis below shows the relative contribution of changes
in interest rates and asset volumes.
<TABLE>
<CAPTION>
INCREASE
(DECREASE)
ATTRIBUTABLE
TAXABLE TO CHANGE IN
EQUIVALENT -------------
(DECREASE) RATE VOLUME
---------- ---- ------
<S> <C> <C> <C>
THREE MONTHS ENDED SEPTEMBER 30, 1998 VS. THREE MONTHS ENDED
SEPTEMBER 30, 1997
Taxable equivalent interest income.......................... $(208) $ (2) (206)
Interest expense............................................ (184) (23) (161)
----- ---- -----
Taxable equivalent net interest income...................... $ (24) $ 21 $ (45)
===== ==== =====
</TABLE>
<TABLE>
<CAPTION>
INCREASE
(DECREASE)
ATTRIBUTABLE
TAXABLE TO CHANGE IN
EQUIVALENT -------------
(DECREASE) RATE VOLUME
---------- ---- ------
<S> <C> <C> <C>
NINE MONTHS ENDED SEPTEMBER 30, 1998 VS. NINE MONTHS ENDED
SEPTEMBER 30, 1997
Taxable equivalent interest income.......................... $(545) $ 31 $(576)
Interest expense............................................ (456) (2) (454)
----- ---- -----
Taxable equivalent net interest income...................... $ (89) $ 33 $(122)
===== ==== =====
</TABLE>
Taxable equivalent net interest income for the three months ended September
30, 1998 decreased by $24 million while the net interest margin increased by .29
percent, versus the three months ended September 30, 1997. The $21 million
increase in taxable equivalent net interest income attributable to the change in
rates for the three months ended September 30, 1998 was principally due to the
increase in the student loan spread discussed below under "Student
Loans -- Student Loan Spread Analysis," the increase in student loans as a
percentage of average earning assets, increased earnings spreads on investments
and to a third quarter 1997 $13 million write-off in deferred hedge losses.
The $45 million decrease in taxable equivalent net interest income for the
three months ended September 30, 1998, attributable to the change in volume,
resulted primarily from the $6.1 billion decrease in the average balance of
on-balance sheet purchased student loans as loans were moved off-balance sheet
through securitizations, and the decrease of $5.2 billion and $877 million in
the average balance of investments and warehousing advances, respectively, as
the Company reduced these assets to better utilize capital. The decrease in the
interest earned on the on-balance sheet portfolio of student loans was partially
offset by the increase in the average balance of student loan participations of
$595 million.
Taxable equivalent net interest income for the nine months ended September
30, 1998 decreased by $89 million while the net interest margin increased by .19
percent, versus the nine months ended September 30, 1997. The $33 million
increase in taxable equivalent net interest income attributable to the change in
rates in the first nine months of 1998 versus 1997 was principally due to the
increase in the student loan spread discussed below under "Student
Loans -- Student Loan Spread Analysis," to a third quarter 1997 $13 million
write-off in deferred hedge losses and to lower yields on fixed rate academic
facilities financings as the runoff of older financings purchased in higher
interest rate environments are being replaced by financings in the current
interest rate environment.
The $122 million decrease in taxable equivalent net interest income for the
nine months ended September 30, 1998 attributable to the change in volume
resulted primarily from the $5.6 billion decrease in the average balance of
on-balance sheet purchased student loans as a result of the Company's ongoing
securitization program, and the decrease of $5.2 billion and $765 million in the
average balance of investments
15
<PAGE> 16
and warehousing advances, respectively, as the Company reduced these assets to
better utilize capital. The decrease in the interest earned on the on-balance
sheet portfolio of student loans was partially offset by the increase in the
average balance of student loan participations of $551 million.
The increase in the net interest margin is due to the factors mentioned
above regarding the increase in taxable equivalent net interest income
attributable to rates plus 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 the
three and nine months ended September 30, 1998 and 1997.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
1998 1997 1998 1997
-------- -------- ------- -------
<S> <C> <C> <C> <C>
ON-BALANCE SHEET
Adjusted student loan yields........................... 7.64% 7.86% 7.80% 7.88%
Amortization of floor swap payments.................... .10 .10 .10 .11
Floor income........................................... .17 .09 .19 .08
Consolidation loan rebate fees......................... (.24) (.22) (.24) (.19)
Reserves for risk-sharing costs........................ (.03) (.06) (.03) (.06)
Offset fees............................................ (.10) (.12) (.11) (.13)
------- ------- ------- -------
Student loan income.................................... 7.54 7.65 7.71 7.69
Cost of funds.......................................... (5.36) (5.52) (5.48) (5.52)
------- ------- ------- -------
Student loan spread.................................... 2.18% 2.13% 2.23% 2.17%
======= ======= ======= =======
OFF-BALANCE SHEET
Servicing and securitization revenue................... 1.58% 1.58% 1.53% 1.64%
======= ======= ======= =======
AVERAGE BALANCES
Student loans, including participations................ $25,921 $31,467 $27,673 $32,681
Securitized loans...................................... 18,750 10,383 16,607 8,312
------- ------- ------- -------
Managed student loans.................................. $44,671 $41,850 $44,280 $40,993
======= ======= ======= =======
</TABLE>
The increase in the student loan spread for the three and nine months ended
September 30, 1998 versus the corresponding periods is due mainly to the net
decrease of $11 million and $17 million, respectively, in 1998 additions to the
provision for student loan losses and other reserves versus the corresponding
periods in 1997. For the three months ended September 30, 1998 versus 1997 the
decrease in the reserves was mainly due to a $15 million third quarter addition
in 1997 to the reserve for the privately insured loan portfolio versus no
addition in 1998, and to lower reserves in the 1997 third quarter for
risk-sharing costs of $3 million as loans subject to these costs were sold
through securitizations. Also in the 1997 third quarter, student loan reserves
were reduced by $7 million due to improved experience in recovering unpaid
claims. The year over year decrease in the reserves was mainly due to a $9
million smaller addition in 1998 to the reserve for the privately insured loan
portfolio versus 1997, and to lower reserves for risk-sharing costs of $8
million as loans subject to these costs were sold through securitizations. The
Company continues to show improvement in recovering unpaid guarantees on
defaulted student loans and as a result the reserve for these loans has been
reduced by $11 million for both nine months ended September 30, 1998 and 1997.
Also increasing the student loan spread for the three and nine months ended
September 30, 1998 versus the corresponding year ago periods was an increase in
on-balance sheet floor income of $5 million and $19 million, respectively, and
reduced offset fees of $3 million and $9 million, respectively, as the balance
of student loans remaining on-balance sheet that were subject to these fees was
reduced through securitizations. For the nine months ended, these increases were
offset by the growth in the portfolio of loans subject to the
16
<PAGE> 17
consolidation loan rebate fees which reduced the student loan spread by $4
million. (See below for discussion of the suspension and reinstatement of
consolidation loan program). These increases were offset by lower student loan
yields in the form of reduced SAP rates and the effect of student loan
participations, which contractually yield a lower rate than the underlying
student loans.
As a result of the passage of the Higher Education Amendments of 1998 (See
"Legislation"), the Company reinstated its loan consolidation program (marketed
as the SMART LOAN(R) consolidation program). The legislation provides market
rates of returns for lenders and also allows the Company to consolidate loans
from the Federal Direct Student Loan Program ("FDSLP"). The Company had
suspended its loan consolidation program in November 1997 as the Emergency
Student Loan Consolidation Act of 1997 made it difficult for the Company to
participate in the FFELP consolidation loan program for profitability reasons.
STUDENT LOAN FLOOR REVENUES
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 September 30, 1998 and
1997 (dollars in billions).
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
------------------------- ------------------------
FIXED VARIABLE TOTAL FIXED VARIABLE TOTAL
----- -------- ------ ----- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Student loans with floor revenue potential..... $13.1 $ 23.3 $ 36.4 $14.7 $19.0 $33.7
Less notional amount of floor revenue
contracts.................................... (5.3) (14.7) (20.0) (7.7) -- (7.7)
----- ------ ------ ----- ----- -----
Net student loans with floor revenue
potential.................................... $ 7.8 $ 8.6 $ 16.4 $ 7.0 $19.0 $26.0
===== ====== ====== ===== ===== =====
Net student loans earning floor revenues....... $ 4.8 $ 5.9 $ 10.7 $ 4.3 $ -- $ 4.3
===== ====== ====== ===== ===== =====
</TABLE>
Based on the average bond equivalent 91-day Treasury bill rates of 5.01
percent and 5.20 percent for the three months ended September 30, 1998 and 1997,
respectively, the Company earned floor revenues of $19 million (net of $10
million in payments under the floor revenue contracts) and $7 million (net of $5
million in payments under the floor revenue contracts), respectively. The
average bond equivalent 91-day Treasury bill rate was 5.11 percent and 5.20
percent for the nine months ended September 30, 1998 and 1997, respectively, and
the Company earned floor revenues of $49 million (net of $20 million in payments
under the floor revenue contracts) and $21 million (net of $15 million in
payments under the floor revenue contracts), respectively.
FLOOR REVENUE CONTRACTS
During 1998, 1997 and 1996, the Company entered into contracts with third
parties with notional amounts of $23 billion, $11 billion and $13 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 eight months for the 1998 contracts, eight
months for the 1997 contracts and two years for the 1996 contracts. At September
30, 1998, $14.7 billion of the notional amount of the 1998 contracts was
outstanding and $5.3 billion of the notional amount of the 1996 contracts was
outstanding; as of July 1, 1998, all of the 1997 contracts had expired.
For the three months ended September 30, 1998 and 1997, the amortization of
the upfront payments received for the sale of fixed rate floor revenue contracts
contributed $7 million and $8 million, respectively, to pre-tax earnings. In
addition, for the three months ended September 30, 1998 and 1997, the Company
earned $4 million and $0, respectively, on variable rate floor revenue
contracts. For the nine months ended September 30, 1998 and 1997, the
amortization of the upfront payments received for the sale of fixed rate floor
revenue contracts contributed $21 million and $26 million, respectively, pre-tax
to earnings and during the same period the Company earned $18 million and $3
million, respectively, on variable rate floor revenue contracts.
17
<PAGE> 18
PROVISION FOR STUDENT LOAN LOSSES
The provision for student loan losses of $86 million at September 30, 1998
is $1 million less than the $87 million provision at December 31, 1997 as
increases in the provision were more than offset by reductions for sales of
loans to securitized trusts and losses on unpaid claims on federally insured
student loans. The additions to the provision for the nine months ended
September 30, 1998 of $12 million were $7 million less than the additions to the
provision in the year-ago period. The reductions in the provision for the nine
months ended September 30, 1998 versus 1997 were mainly due to a $9 million
reduction in the reserve for risk-sharing, a decrease of $9 million in the
amount reserved for non-federally insured student loans, offset by a 1997
reserve reduction of $11 million due to improved experience in recovering unpaid
claims. Once a student loan is charged off as a result of an unpaid claim, the
Company's policy is to continue to pursue the recovery of principal and
interest. Management believes that the provision 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 three and nine months ended September 30, 1998 and 1997.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------- -------------------------------------
1998 1997 1998 1997
----------------- ----------------- ----------------- -----------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
INDEX BALANCE RATE BALANCE RATE BALANCE RATE BALANCE RATE
----- ------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Treasury bill,
principally 91-day..... $26,479 5.34% $31,722 5.51% $27,837 5.46% $33,145 5.51%
LIBOR.................... 3,546 5.52 6,684 5.58 4,480 5.55 6,471 5.48
Discount notes........... 1,554 5.46 4,870 5.53 1,857 5.49 5,623 5.46
Fixed.................... 591 7.00 654 6.99 627 7.10 667 7.03
Zero coupon.............. 140 11.14 137 11.12 139 11.13 134 11.12
Other.................... 977 5.56 707 5.21 953 5.53 634 5.14
------- ----- ------- ----- ------- ----- ------- -----
Total.......... $33,287 5.45% $44,774 5.68% $35,893 5.55% $46,674 5.58%
======= ===== ======= ===== ======= ===== ======= =====
</TABLE>
In the above table, for the three months ended September 30, 1998 and 1997,
spreads for all Treasury bill-indexed borrowings averaged .26 percent and .22
percent, respectively, over the weighted average Treasury bill rates for those
periods and spreads for London Interbank Offered Rate ("LIBOR")-indexed
borrowings averaged .23 percent and .25 percent, respectively, under the
weighted average LIBOR rates.
In the above table, for the nine months ended September 30, 1998 and 1997,
spreads for all Treasury bill-indexed borrowings averaged .26 percent and .24
percent, respectively, over the weighted average Treasury bill rates for those
periods and spreads for LIBOR-indexed borrowings averaged .24 percent and .25
percent, respectively, under the weighted average LIBOR rates.
OTHER INCOME
The decrease in other income of $119 million in the third quarter of 1998
versus 1997 can mainly be attributed to the $94 million one-time gain associated
with the successful outcome of the offset fee litigation in the third quarter of
1997. Also the Company's decision to not enter into a securitization transaction
during the 1998 third quarter resulted in no securitization gain being
recognized while a pre-tax securitization gain of $66 million (exclusive of the
$94 million one-time gain associated with the successful outcome of the offset
fee litigation) was recognized in the third quarter of 1997. These decreases
were offset by an increase of $30 million in servicing and securitization
revenue as the Company's average balance of securitized student loans in the
third quarter of 1998 increased by $8.4 billion over the third quarter of 1997.
For the nine months ended September 30, 1998 securitization gains decreased by
$108 million due mainly to the recognition of the
18
<PAGE> 19
one time gain of $94 million in the third quarter of 1997, while servicing and
securitization revenue increased by $88 million over the corresponding year ago
period as the Company's average balance of securitized student loans for the
nine months ended September 30, 1998 increased by $8.3 billion over the first
nine months of 1997.
SECURITIZATION PROGRAM
For each securitization transaction the Company records a gain on sale and
an asset (the "Interest Residual") equal to the present value of the expected
net cash flows from the trust to the Company over the life of the portfolio
securitized. In the third quarter of 1998, the Company decided not to enter into
a securitization transaction due to the turbulence in the global financial
markets, which caused increased demand for U.S. Treasury Securities. This
increase in demand caused Treasury bill rates to fall relative to other market
indices and financing spreads for Treasury bill-indexed debt to widen. As a
result, no securitization gain was recognized, while a pre-tax securitization
gain of $160 million was recognized in the third quarter of 1997. 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. 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. The
1997 third quarter gain (exclusive of the $94 million one-time gain) as a
percentage of the portfolio securitized was 2.64 percent.
In the first nine months of 1998, the Company completed two securitization
transactions in which a total of $6.0 billion of student loans were securitized.
In the first nine months of 1997, the Company completed three securitization
transactions in which a total of $7.0 billion of student loans were securitized
by the Company. For the nine months ended September 30, 1998 and 1997, the
Company recorded securitization gains of $117 million and $225 million, pre-tax.
In 1997, if the Company had recorded gains at the time of each securitization
transaction without reserving for the Offset Fee, then 1997 gains would have
been pre-tax $170 million or as a percentage of the portfolios securitized, 2.45
percent, versus 1.95 percent for the nine months ended September 30, 1998.
The decrease in the gains in the nine months ended September 30, 1998
versus 1997 was mainly due to the securitization of $1.0 billion less student
loans in 1998. The decrease in the 1998 gains as a percentage of the securitized
portfolios versus 1997 is mainly due to the inclusion of lower yielding
consolidation loans in the portfolios of loans securitized in 1998 and to higher
cost of funds offset by lower relative servicing costs due to the higher average
balance of loans securitized in 1998. Gains on future securitizations will
continue to vary depending on the size and the loan characteristics of the loan
portfolios securitized, the structure of the transaction and the funding costs
prevailing in the securitization debt markets.
SERVICING AND SECURITIZATION REVENUE
Interest earned on the Interest Residual is included in servicing and
securitization revenue and totaled $43 million and $115 million, for the three
and nine months ended September 30, 1998, respectively, versus $27 million and
$67 million in the corresponding periods in 1997, respectively. Servicing and
securitization revenue also includes fee income earned for servicing the
securitized portfolios. These fees, less the amortization of the servicing
asset, totaled $32 million and $75 million, for the three and nine months ended
September 30, 1998, respectively, versus $17 million and $35 million, for the
three and nine months ended September 30, 1997, respectively. The increase in
servicing and securitization income is mainly due to the increase in the average
balance of the Interest Residual from $299 million in the first nine months of
1997 to $585 million in the first nine months of 1998, and to the increase in
the average balance of securitized student loans from $8.3 billion in the first
nine months of 1997 to $16.6 billion in the corresponding period in 1998.
19
<PAGE> 20
PRO-FORMA STATEMENTS OF INCOME
Under generally accepted accounting principles ("GAAP"), the Company's
securitization transactions are treated as sales. At the time of sale, in
accordance with FAS 125, the Company records a gain equal to the present value
of the estimated future net cash flows from the portfolio of loans sold.
Interest earned on the Interest Residual and fees earned for servicing the loan
portfolios are recognized over the life of the securitization transaction as
servicing and securitization revenue. In addition to GAAP basis statements of
income, the Company prepares pro-forma statements of income that present the
Company's student loan portfolios on a managed basis. These pro-forma statements
of income enable management to monitor the periodic earnings of the managed
student loan portfolio. The pro-forma statements of income present
securitization as a financing and assume that the securitized student loans were
not sold. As such, no gain on sale or subsequent servicing and securitization
revenue is recognized. Instead, the earnings of the trusts and related financing
costs are reflected over the life of the underlying pool of loans. Management
believes that the pro-forma statements of income, while not recognized under
GAAP, assist in the understanding of the Company's student loan business.
Following the pro-forma statements of income is a reconciliation of net income
per the Company's consolidated statements of income to the pro-forma statements
of income.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- -----------------
1998 1997 1998 1997
----- ------ ------- -------
<S> <C> <C> <C> <C>
PRO-FORMA STATEMENTS OF INCOME:
Insured student loans...................................... $ 855 $ 814 $ 2,551 $ 2,371
Advances/Facilities/Investments............................ 113 205 386 644
----- ------ ------- -------
Total interest income...................................... 968 1,019 2,937 3,015
Interest expense........................................... (734) (798) (2,232) (2,318)
----- ------ ------- -------
Net interest income........................................ 234 221 705 697
----- ------ ------- -------
OTHER INCOME:
Gain on sales of student loans........................ -- -- -- --
Servicing and securitization revenue.................. -- -- -- --
Gains/(losses) on sales............................... 7 3 12 10
Other................................................. 18 12 49 36
----- ------ ------- -------
Total other income......................................... 25 15 61 46
Total operating expenses................................... 87 173 271 390
----- ------ ------- -------
Income before taxes and minority interest in earnings of
subsidiary............................................... 172 63 495 353
Pro-forma income taxes..................................... 54 17 155 104
Minority interest in earnings of subsidiary................ 3 3 8 8
----- ------ ------- -------
Pro-forma net income....................................... $ 115 $ 43 $ 332 $ 241
===== ====== ======= =======
Pro-forma diluted earnings per common share................ $ .68 $ .23 $ 1.94 $ 1.30
===== ====== ======= =======
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS
ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- ------------------
1998 1997 1998 1997
---- ----- ------- -------
<S> <C> <C> <C> <C>
RECONCILIATION OF NET INCOME TO PRO-FORMA NET INCOME:
Net income............................................... $108 $ 143 $ 391 $ 375
Gain on sales of student loans........................... -- (160) (117) (225)
Servicing and securitization revenue..................... (75) (45) (190) (102)
Net interest income...................................... 86 51 216 120
---- ----- ----- -----
Pro-forma net income before taxes........................ 119 (11) 300 168
Net tax effect........................................... (4) 54 32 73
---- ----- ----- -----
Pro-forma net income..................................... $115 $ 43 $ 332 $ 241
==== ===== ===== =====
</TABLE>
20
<PAGE> 21
OPERATING EXPENSES
Operating expenses include costs to service the Company's managed student
loan portfolio, operational costs incurred in the process of acquiring student
loan portfolios and general and administrative expenses. Total operating
expenses as a percentage of average managed student loans were 77 basis points
and 164 basis points for the three months ended September 30, 1998 and 1997,
respectively, and 82 basis points and 127 basis points for the three and nine
months ended September 30, 1998 and 1997, respectively. The decreases were due
principally to the one-time costs of $64 million ($49 million to corporate
operating expenses and $15 million to servicing costs) incurred in the 1997
third quarter for expenses and asset write-downs in connection with the
reorganization of the Company to a privatized entity and to the change in
business strategies being implemented by the new management. Operating expenses
are summarized in the following tables:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------
1998 1997
-------------------------------- --------------------------------
SERVICING SERVICING
AND AND
CORPORATE ACQUISITION TOTAL CORPORATE ACQUISITION TOTAL
--------- ----------- ------ --------- ----------- ------
<S> <C> <C> <C> <C> <C> <C>
Salaries and employee benefits....... $ 11 $ 35 $ 46 $ 31 $ 41 $ 72
Occupancy and equipment.............. 3 13 16 12 27 39
Professional fees.................... 3 5 8 9 6 15
Office operations.................... 1 7 8 2 8 10
Other................................ 2 2 4 25 4 29
---- ------ ------ ---- ------ ------
Total internal operating expenses.... 20 62 82 79 86 165
Third party servicing costs.......... -- 5 5 -- 8 8
---- ------ ------ ---- ------ ------
Total operating expenses... $ 20 $ 67 $ 87 $ 79 $ 94 $ 173
==== ====== ====== ==== ====== ======
Employees............................ 526 3,401 3,927 562 4,177 4,739
==== ====== ====== ==== ====== ======
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
SEPTEMBER 30, DECREASE
--------------- -----------------------
1998 1997 $ %
---- ---- -------- --------
<S> <C> <C> <C> <C>
Servicing costs.......................................... $55 $74 $(19) (26)%
Acquisition costs........................................ 12 20 (8) (41)
--- --- ---- ----
Total servicing and acquisition costs.......... $67 $94 $(27) (29)%
=== === ==== ====
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------
1998 1997
-------------------------------- --------------------------------
SERVICING SERVICING
AND AND
CORPORATE ACQUISITION TOTAL CORPORATE ACQUISITION TOTAL
--------- ----------- ------ --------- ----------- ------
<S> <C> <C> <C> <C> <C> <C>
Salaries and employee benefits....... $ 35 $ 109 $ 144 $ 62 $ 113 $ 175
Occupancy and equipment.............. 8 48 56 21 57 78
Professional fees.................... 8 13 21 26 14 40
Office operations.................... 4 19 23 6 21 27
Other................................ 8 3 11 32 9 41
---- ------ ------ ---- ------ ------
Total internal operating expenses.... 63 192 255 147 214 361
Third party servicing costs.......... -- 16 16 -- 29 29
---- ------ ------ ---- ------ ------
Total operating expenses... $ 63 $ 208 $ 271 $147 $ 243 $ 390
==== ====== ====== ==== ====== ======
Employees............................ 526 3,401 3,927 562 4,177 4,739
==== ====== ====== ==== ====== ======
</TABLE>
21
<PAGE> 22
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, DECREASE
--------------- -----------------------
1998 1997 $ %
---- ---- -------- --------
<S> <C> <C> <C> <C>
Servicing costs........................................ $172 $195 $(23) (12)%
Acquisition costs...................................... 36 48 (12) (26)
---- ---- ---- ----
Total servicing and acquisition costs........ $208 $243 $(35) (15)%
==== ==== ==== ====
</TABLE>
In the three and nine months ended September 30, 1998, corporate operating
expenses decreased by $59 million and $84 million, respectively, compared to the
corresponding year-ago periods. The decreases can be attributed mainly to the
one-time charges of $49 million incurred in the 1997 third quarter related to
the reorganization of the Company and $11 million of proxy and privatization
charges incurred in the first six months of 1997. The decrease in operating
expenses in 1998 is also due to the effect of the Company's restructuring of
operations in the second half of 1997 and reflects management's continued
commitment to control expenses.
Servicing costs include all operations and systems costs incurred to
service the portfolio of managed student loans, including fees paid to third
party servicers. In the three and nine months ended September 30, 1998,
servicing expenses, exclusive of one-time charges, decreased by $5 million and
$12 million, respectively, from the corresponding year-ago periods. These
decreases were due mainly to operating efficiencies gained as a result of the
reorganization and the on-going servicing center reconfiguration program. During
1998, the Company has incurred one-time charges of $12 million ($3 million in
the third quarter of 1998) relating to the servicing center reconfiguration
program, which included the closing of two satellite servicing centers in the
second quarter and the continued restructuring of all servicing operations.
During the first nine months of 1997, the Company incurred one-time costs of $15
million related to asset write-offs in connection with the reorganization of the
Company and $8 million in connection with the early transfer of loans from a
third party servicer to SMSC. All but $6 million of the 1997 one-time charges
were incurred in the third quarter.
When expressed as a percentage of the managed student loan portfolio,
servicing costs averaged 49 basis points and 70 basis points for the three
months ended September 30, 1998 and 1997, respectively, and 52 basis points and
64 basis points for the nine months ended September 30, 1998 and 1997,
respectively. These decreases were principally due to the one-time charges
mentioned above, without which servicing costs as a percentage of the managed
student loan portfolio would have been 46 basis points and 54 basis points for
the three months ended September 30, 1998 and 1997, respectively, versus 48
basis points and 56 basis points for the nine months ended September 30, 1998
and 1997, respectively. The decreases before consideration of the one time
charges were mainly due to operational efficiencies and the termination of
business initiatives in 1997 that did not fit management's business strategies.
In addition to the decrease in servicing costs, higher average student loan
balances contributed to the lower servicing costs when expressed in this
percentage.
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. The
decrease of $8 million and $12 million in loan acquisition costs for the three
months and nine months ended September 30, 1998 versus the year ago periods is
mainly due to operational efficiencies and the suspension of the loan
consolidation program in the fourth quarter of 1997. As discussed under "Student
Loans -- Student Loan Spread Analysis" in the fourth quarter of 1998 the Company
announced the reinstatement of its consolidation loan program which will
increase acquisition costs in future periods.
STUDENT LOAN PURCHASES
Sallie Mae purchased $2.0 billion of student loans in the third quarter of
1998 compared with $2.3 billion in the year-ago quarter. For the nine months
ended September 30, 1998, the Company purchased $5.9 billion compared with $6.5
billion in the corresponding year-ago period. The decrease in the purchase
volume versus
22
<PAGE> 23
the prior year is attributable to the following factors: reduced purchases of
student loans in the spot market, the suspension of Sallie Mae's consolidation
loan program in the fourth quarter of 1997 due to legislated changes in the
profitability of consolidation loans offset by a modest increase in the amount
of loans purchased from lenders who have forward purchase commitments with
Sallie Mae. Sallie Mae's portfolio of managed student loans totaled $45.2
billion at September 30, 1998 versus $42.5 billion at September 30, 1997.
In the third quarter of 1998, $1.5 billion of student loans were originated
and transferred to the Company's ExportSS system, the same level as the
year-ago. For the nine months ended September 30, 1998, $3.7 billion of student
loans were originated and transferred to Sallie Mae's ExportSS system versus
$3.5 billion in the year-ago period. The outstanding portfolio of loans serviced
for ExportSS lenders and committed for sale to the Company totaled $3.5 billion
at September 30, 1998, compared to $3.8 billion at September 30, 1997. See
"Other Related Events and Information -- Legislative Developments" for
discussion of renegotiations of forward purchase commitments. As discussed under
"Student Loans -- Student Loan Spread Analysis," the Company has announced the
reinstatement of its consolidation loan program.
The Department of Education offers existing FFELP borrowers the opportunity
to refinance FFELP loans into FDLSP loans. During the first nine months of 1998
and 1997, approximately $730 million and $368 million, respectively, of the
Company's managed student loans were accepted for refinancing into the FDSLP.
Since the inception of this program approximately $1.5 billion of FFELP loans
managed by Sallie Mae have been accepted for refinancing into FDSLP loans and
approximately $1.1 billion have been refinanced into FDSLP with the remainder
awaiting disbursements by the federal government.
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 31.4 percent and 32.8 percent for the three
months ended September 30, 1998 and 1997, respectively, and to 31.9 percent and
31.5 percent for the nine months ended September 30, 1998 and 1997,
respectively. 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, that are
subject to taxation at the state and local level. State taxes were immaterial in
the three and nine months ended September 30, 1998 and 1997 as the majority of
the Company's business activities were conducted in the GSE.
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 Company's unsecured financing requirements are driven by three
principal factors: refinancing of existing liabilities as they mature; financing
of student loan portfolio growth and the Company's level of securitization
activity. As discussed under "Securitization Program" the recent turmoil in the
global financial markets has caused financing spreads in the asset-backed market
to widen. Until market conditions improve, management intends to continue to
finance its student loan portfolio through unsecured GSE debt issuances. The
uncertainty in the financial markets has also caused funding spreads on the
Company's unsecured debt to widen. Management believes that the current adverse
spread environment is temporary so to mitigate its effect on the Company's cost
of funds, the Company intends to meet its funding needs through short term
financings. Should these market conditions persist over an extended period of
time, the increased cost of the Company's funding could have a material adverse
effect on the Company's earnings.
23
<PAGE> 24
During the nine months ended September 30, 1998, the Company used the
proceeds from student loan securitizations of $6 billion, repayments and claim
payments on student loans of $2.7 billion, and proceeds from sale or maturity of
investments of $725 million to purchase student loans and participations of $5.9
billion, to reduce total debt by $4.0 billion and to repurchase $341 million of
the Company's common stock.
Operating activities provided $347 million of cash in the nine months ended
September 30, 1998, an increase in cash flow of $13 million from the net cash
inflows of $334 million in the corresponding period in the prior year. This
increase was mainly attributable to the decrease in the gains on sales of
student loans in the first nine months of 1998 offset by the increase in the
Interest Residual asset as a result of the securitizations in 1998.
During the nine months ended September 30, 1998, the GSE issued $4.2
billion of long-term notes to refund maturing and repurchased obligations. At
September 30, 1998, the GSE had $9.4 billion of outstanding long-term debt
issues, of which $5.0 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.").
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. The Privatization Act also 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 September 30, 1998, the GSE's statutory
capital adequacy ratio, after the effect of the dividends to be paid in the
fourth quarter of 1998, was 2.00 percent. The Privatization Act prohibits the
GSE from issuing new debt obligations that mature beyond September 30, 2008 and
requires the GSE to transfer any remaining GSE obligations into a defeasance
trust for the benefit of the holders of such obligations, along with cash or
full-faith and credit obligations of the United States, or an agency thereof, in
amounts sufficient, as determined by the Secretary of the Treasury, to pay the
principal and interest of the deposited obligations.
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'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 September 30, 1998, there were
approximately $2 billion of PLUS student loans outstanding in the trusts which
have interest rates that reset annually based on the final auction of 52-week
Treasury bill before each July 1. The Company manages this basis risk within the
trusts through its on-balance sheet financing activities. The effect of this
basis risk management is included in the following table as the impact of
securitized student loans.
In the following table, 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
24
<PAGE> 25
specific future time intervals. The following gap analysis reflects
rate-sensitive positions at September 30, 1998 and is not necessarily reflective
of positions that existed throughout the period.
<TABLE>
<CAPTION>
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
-------- -------- -------- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Student loans......................... $24,672 $ -- $ 2,079 $ -- $ -- $ --
Warehousing advances.................. 1,452 19 -- -- 1 16
Academic facilities financings........ 49 6 16 73 359 743
Cash and investments.................. 2,441 41 37 26 88 1,819
Other assets.......................... 20 23 47 135 210 1,571
------- ------- ------- ------- ------- ------
Total assets................ 28,634 89 2,179 234 658 4,149
------- ------- ------- ------- ------- ------
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings................. 17,708 3,065 3,574 -- -- --
Long-term notes....................... 1,775 322 500 4,649 1,660 504
Other liabilities..................... -- -- -- -- -- 1,306
Minority interest in subsidiary....... -- -- -- -- -- 214
Stockholders' equity.................. -- -- -- -- -- 666
------- ------- ------- ------- ------- ------
Total liabilities and
stockholders' equity...... 19,483 3,387 4,074 4,649 1,660 2,690
------- ------- ------- ------- ------- ------
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
Interest rate swaps................... (8,042) 3,225 (274) 4,614 1,560 (1,083)
Impact of securitized student loans... (2,273) -- 2,273 -- -- --
------- ------- ------- ------- ------- ------
Total off-balance sheet
financial instruments..... (10,315) 3,225 1,999 4,614 1,560 (1,083)
------- ------- ------- ------- ------- ------
Period gap............................ $(1,164) $ (73) $ 104 $ 199 $ 558 $ 376
======= ======= ======= ======= ======= ======
Cumulative gap........................ $(1,164) $(1,237) $(1,133) $ (934) $ (376) $ --
======= ======= ======= ======= ======= ======
Ratio of interest-sensitive assets to
interest-sensitive liabilities...... 146.9% 1.9% 52.3% 2.1% 27.0% 511.5%
======= ======= ======= ======= ======= ======
Ratio of cumulative gap to total
assets.............................. 3.2% 3.4% 3.2% 2.6% 1.0% --%
======= ======= ======= ======= ======= ======
</TABLE>
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 and based on this analysis there has not been a material
change in market risk from December 31, 1997 as reported in Company's Form 10-K.
25
<PAGE> 26
AVERAGE TERMS TO MATURITY
The following table reflects the average terms to maturity for the
Company's earning assets and liabilities at September 30, 1998 (in years):
<TABLE>
<S> <C>
EARNING ASSETS
Student loans............................................... 7.0
Warehousing advances........................................ 4.0
Academic facilities financings.............................. 7.5
Cash and investments........................................ 6.5
---
Total earning assets.............................. 7.0
---
BORROWINGS
Short-term borrowings....................................... .5
Long-term borrowings........................................ 3.0
---
Total borrowings.................................. 1.0
---
</TABLE>
In the above table, Treasury receipts and variable rate asset-backed
securities, although generally liquid in nature, extend the weighted average
remaining term to maturity of cash and investments to 6.5 years. As student
loans are securitized, the need for long-term on-balance sheet financing will
decrease.
COMMON STOCK
On January 2, 1998, the Company effected a 7-for-2 stock split through a
stock dividend of an additional five shares for every two shares owned.
During the nine months ended September 30, 1998, the Company repurchased
8.2 million shares of its common stock leaving 166 million shares outstanding at
September 30, 1998. 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 September 30, 1998, the Company had remaining authority to
repurchase up to an additional 4.7 million shares which covers both purchases of
common shares in the open market or effective purchases through equity forward
contracts. In the first nine months of 1998, the Company continued to supplement
its open market common stock purchases by entering into equity forward
transactions to purchase 16.5 million shares on a net cash or share settled
basis. These forwards settle at various times over the next three years at an
average price of $42 per share. As of September 30, 1998, the Company had
outstanding equity forward contracts to purchase 20.4 million shares of common
stock at prices ranging from $32 per share to $47 per share.
OTHER RELATED EVENTS AND INFORMATION
LEGISLATIVE DEVELOPMENTS
On October 7, 1998, the President signed into law the Higher Education
Amendments of 1998, legislation that reauthorizes federal higher education
programs for a six-year period (the "Reauthorization Legislation"). The
Reauthorization Legislation lowers both the borrower interest rate on Stafford
loans to a formula based on the 91-day Treasury bill rate plus 2.3 percent (1.7
percent during in-school and grace periods) and the lender's rate after special
allowance payments to the 91-day Treasury bill rate plus 2.8 percent (2.2
percent during in-school and grace periods) for loans originated on or after
October 1, 1998 and before July 1, 2003. The borrower interest rate on PLUS
loans originated during this period will be equal to the 91-day Treasury bill
rate plus 3.1 percent. Special allowance payments are also based on the 91-day
Treasury bill rate plus 3.1 percent. These rate reductions were first introduced
on an interim basis in temporary student loan legislation enacted into law on
June 9, 1998 and effective for loans originated from July 1, 1998 through
September 30, 1998. As a result of these earlier rate reductions, the Company
renegotiated certain contract provisions with some lenders, including,
principally, price and/or settlement timing provisions, under the student loan
forward purchase commitments it has entered into with some of its lenders and is
currently engaged in renegotiating these same contract provisions with other
lenders. However, there can be no
26
<PAGE> 27
assurance that as a result of such renegotiations the Company will realize the
same overall return under any such renegotiated commitment contracts with
respect to student loans originated after July 1, 1998, as it has under the
prior legislation with respect to the loans whose first disbursements occurred
before July 1, 1998.
The Reauthorization Legislation maintains interest rates for borrowers of
Federal Direct Consolidation Loans whose applications for such loans are
received prior to February 1, 1999 at 7.46 percent (6.86 percent during
in-school and grace periods), which rates are adjusted annually based on a
formula equal to the 91-day Treasury bill rate plus 2.3 percent (1.7 percent
during in-school and grace periods). The borrower interest rates on Federal
Direct Consolidation Loans for borrowers whose applications are received on or
after February 1, 1999 and before July 1, 2003 will be a fixed rate equal to the
lesser of the weighted average of the interest rates of the loans consolidated,
adjusted up to the nearest one eighth of one percent, and 8.25%. This is the
same rate which the Reauthorization Legislation sets on FFELP consolidation
loans for borrowers whose applications are received on or after October 1, 1998
and before July 31, 2003. The Reauthorization Legislation sets the special
allowance payment rate for FFELP consolidation loans at the 91-day Treasury bill
rate plus 3.1 percent. The annual fee paid by lenders on FFELP consolidation
loans is reduced under the Reauthorization Legislation from 1.05 percent to .62
percent of the principal plus accrued unpaid interest on any such consolidation
loans, applications for which are received on or after October 1, 1998 and
before February 1, 1999. As a result of the Reauthorization Legislation, the
Company announced that it will once again offer student loan borrowers the SMART
LOAN(R) consolidation program, which it suspended in the fourth quarter of 1997.
The availability of the comparatively lower borrower interest rates (at least
prior to subsequent annual rate adjustments) on Federal Direct Consolidation
Loans made on or before January 31, 1999 may increase the likelihood that a
FFELP student loan managed by the Company will be prepaid from the proceeds of
such loans during such four-month period. The Company believes, however, that
the likelihood of any such prepayment may be mitigated by the cost savings that
borrowers may realize over Federal Direct Consolidation Loans under certain
circumstances by enrolling in the Company's SMART REWARDS(R) program and Direct
Repay(SM) Plan during such four month period. The volume of FFELP student loans
managed by the Company that may be prepaid in this fashion, and the effect, if
any, on the Company's earnings, cannot be determined at this time and will be
affected by, among other things, operational limitations on the ability of the
Department of Education to process a significant increase in Federal Direct
Consolidation Loan volume. Depending upon the significance of this and other
factors, such prepayments could have a material adverse effect on the Company's
earnings.
The Omnibus Appropriations Act of 1998, signed into law by the President on
October 21, 1998, contains several provisions that amend the Federal Deposit
Insurance Act. These provisions provide an exception to the current prohibition
on affiliations between government-sponsored entities and depository
institutions contained in the Federal Deposit Insurance Act. This exception
allows SLM Holding Corporation to become affiliated with a depository
institution upon certain conditions and with the approval of the Secretary of
the Treasury. Among the conditions are that: the dissolution of the GSE cannot
be adversely affected by the affiliation; the dissolution of the GSE must occur
within two years after the affiliation is consummated subject to the ability of
the Secretary to extend such deadline for up to two one-year periods; and the
GSE must be separate and distinct from the affiliated depository institution and
cannot extend credit, provide credit enhancement or purchase any obligation of
the depository institution.
YEAR 2000 ISSUE
The "Year 2000 issue" refers to a wide variety of potential computer
program processing and functionality issues that may arise from the inability of
computer programs to properly process date-sensitive information relating to the
Year 2000, years thereafter and to a lesser degree the Year 1999.
The Company's State of Readiness
During 1996, the Company commenced a Year 2000 compliance project to assess
and remediate its internal software and hardware systems to avoid or mitigate
Year 2000 problems and to evaluate Year 2000 problems that may arise from
entities with which the Company interacts. In 1997, a comprehensive project
structure was implemented and a Year 2000 project team was formed. The Year 2000
project team briefs
27
<PAGE> 28
senior executives of the Company and the Company's board of directors on the
progress of the Year 2000 effort. The Company's Year 2000 compliance project
encompasses the Company's information technology (IT) systems, as well as its
non-IT systems, such as systems embedded in its office equipment and facilities.
The Company has completed the assessment of its internal software and hardware,
and is in the process of replacing or modifying those systems. The Company
expects to have substantially all of the systems and application modifications
in place and tested by the end of 1998, allowing time in 1999 for any system
refinements that may be needed.
The Company's Year 2000 compliance project is divided into five phases:
Awareness, Assessment, Remediation, Testing and Implementation. The Awareness
phase, which is 100 percent complete, involved the dissemination of Year 2000
information throughout the Company and the education of all levels of management
about Year 2000 issues and their potential impact on the Company's operation.
The Assessment phase, which is also 100 percent complete, involved a
comprehensive inventory of and the determination of the requirements for fixes,
upgrades and replacements for all hardware, application software, embedded
systems (e.g., the microcontrollers in the Company's elevators) and desktop
applications. Approximately 47 percent of the Company's core applications are in
either remediation, the Year 2000 project phase where hardware, systems and
applications are fixed, upgraded or replaced to be Year 2000 ready, or testing,
the phase in which Year 2000 remediation is validated. The remaining
approximately 53 percent of the Company's core applications have been determined
to be Year 2000 ready in accordance with the procedures established by the
Company to make such determination.
The following describes the Company's state of readiness with respect to
the IT systems that support the Company's core business--loan delivery and
acquisition and loan servicing:
- CLASS(SM), the Company's Consolidated Loan Administration and Servicing
System, is the system that services the Company's managed student loans
and the student loan portfolios of our PortSS(R) and TransportSS(SM)
clients. In July 1998, remediation of CLASS was completed and it was
installed into production. A second, full round of comprehensive
functional testing is currently underway. Integration testing of all
internal application interfaces with CLASS is also currently in process.
Testing of external interfaces is scheduled to be completed in 1999.
- SALLIENET, the Company's translation and communication system used to
electronically exchange data with our customers, completed remediation in
September 1998 and was installed into production in October 1998.
SallieNet is currently undergoing integration testing with CLASS.
- PORTSS(R)III, the Company's PC-based system used by lenders to originate
loans, was developed in 1997 to be Year 2000 ready. Minor remediation was
completed on PortSS III in mid-October 1998 and PortSS III is currently
undergoing integration testing with CLASS.
- LINESS(SM), the Company's PC-based product used by colleges and
universities to process financial aid loan application information, was
developed in 1993 to be Year 2000 ready. The LineSS disbursement
component used to transmit disbursement roster information from Sallie
Mae's CLASS system to the college or university, was developed in 1995 to
be Year 2000 ready. LineSS utilizes the industry approved CommonLine(SM)
formats for all communications. Minor remediation on LineSS was completed
in mid-October 1998. LineSS is currently undergoing integration testing
with CLASS.
- IMDOC(R), the Company's document imaging system, has completed
remediation and functional testing and is currently undergoing
integration testing with CLASS.
In addition, certain significant financial and administrative systems,
including the Company's payroll and human resources, debt accounting, investment
management and financial accounting and control systems have all completed
remediation and are currently undergoing integration testing with other internal
systems.
The Company's non-IT systems principally support the Company's facilities
and telecommunications. As of October 1998, all of the Company's headquarters
core facilities systems, including elevators, internal security and fire alarms,
were determined to be Year 2000 ready in accordance with the procedures
established by the Company to make such a determination. In addition, the Year
2000 compliance procedures for over
28
<PAGE> 29
50% of the core facilities systems that support the Company's loan servicing
centers have been completed. The Company is currently testing internally, as
well as working with certain significant providers such as Lucent Technologies
Inc., to test its telecommunications systems. In addition, the Company intends
to work closely with all of its utility providers to make a reasonable
assessment of the Company's potential exposure to any failure on their part to
resolve their Year 2000 issues. Although the Company's Reston, Virginia
headquarters building is equipped with five emergency powered generators
designed to back up building power without refueling for a period of two weeks,
there can be no assurance that such back-up systems will adequately insulate the
Company from any business interruptions caused by any widespread power outages
or power outages in any service area where its loan servicing centers are
located.
The Company has surveyed its third party service providers and business
partners and is currently reviewing these surveys and testing all third-party
developed software to determine the level of compliance and the potential impact
of noncompliance. In addition, the Company plans to work with select third party
service providers and business partners to ascertain their Year 2000 compliance
status and to coordinate testing efforts throughout 1999. There can be no
assurance that the computer systems of other companies or counterparties on
which the Company relies will be Year 2000 ready on a timely basis, or that a
failure to resolve Year 2000 issues by another party, or remediation or
conversion that is incompatible with the Company's computer systems, will not
have a material adverse effect on the Company.
The Risks of the Company's Year 2000 Issues
Generally, the failure by the Company or any of its significant third-party
service providers or business partners to resolve a material Year 2000 issue
could result in the interruption in, or a failure of, certain normal business
activities or operations such as servicing loans or processing payments. Such
failures could materially and adversely affect the Company's results of
operations. For example, the Company submits claims for payment, including
special allowance payments and interest subsidy payments, directly to the U.S.
Department of Education (the "DOE"). To the extent that the DOE is unable to
timely process the payments because of its failure to remediate its Year 2000
problem, the Company's liquidity could be adversely affected, possibly to a
material extent. In addition, the Company submits claims to various state or
private nonprofit guarantee agencies for payment of all or a portion of the
unpaid principal balance on loans plus accrued interest if a borrower defaults
on a student loan and in certain other circumstances such as the death,
permanent or total disability of or the filing for bankruptcy by the borrower.
The Company has surveyed each of the guarantee agencies and is in the process of
performing follow-up telephone inquiries to determine the level of their Year
2000 compliance and the potential impact of noncompliance. To the extent that
any of the larger guarantee agencies are unable to timely process the payments
because of its failure to remediate its Year 2000 problem, the Company's
liquidity could be adversely affected, possibly to a material extent.
The Costs to Address the Company's Year 2000 Issues
Costs to modify computer systems have been, and will continue to be,
expensed as incurred and are not expected to have a material impact on the
Company's future financial results or condition. The Company spent approximately
$2 million in 1997 and expects to spend between $8 million and $10 million in
1998 on this project (of which approximately $6 million was spent in the first
nine months of 1998). However, there can be no guarantee that these estimates
will be achieved, and actual results could differ materially from these
estimates. Specific factors that might cause such material differences include,
but are not limited to, the availability and cost of personnel trained in this
area, the ability to locate and correct all relevant computer codes and similar
uncertainties.
The Company's Contingency Plans
The Company has developed high level contingency plans for its core
applications and will refine these plans in 1999. In addition, the Company
intends to commit the required resources in 1999 to its Year 2000 compliance
project if all of its core applications are not Year 2000 ready as of the end of
1998. There can be no assurance that the Company's remediation efforts and
contingency plans will be sufficient to avoid unforeseen business disruptions or
other problems resulting from the Year 2000 issue.
29
<PAGE> 30
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
A hearing has been scheduled in November 1998 for court approval of Orange
County's settlement agreement with Merrill, Lynch, Pierce Fenner & Smith, which
calls for, among other things, dismissal with prejudice of all claims against
the Student Loan Marketing Association and certain other government sponsored
enterprises.
ITEM 2. CHANGES IN SECURITIES.
Nothing to report.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Nothing to report.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Nothing to report.
ITEM 5. OTHER INFORMATION.
Effective September 1, 1998, Joseph D. Corvaia joined the Company's
executive management team as Senior Vice President, Private Credit. Before
joining the Company, Mr. Corvaia was the Vice President of Systems and Servicing
of Equity One, Inc. Prior to joining Equity One in December 1995, Mr. Corvaia
spent nine years in the credit reporting industry and 16 years in the banking
industry.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed with the Securities and Exchange
Commission during the Quarter ended September 30, 1998.
30
<PAGE> 31
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF
BY THE UNDERSIGNED HEREUNTO DULY AUTHORIZED.
SLM HOLDING CORPORATION
(Registrant)
/s/ MARK G. OVEREND
--------------------------------------
Mark G. Overend
Senior Vice President &
Chief Financial Officer
(Principal Financial and Accounting
Officer and Duly Authorized Officer)
Date: October 28, 1998
31
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