Edgar Filing: NELNET INC

NNI-9.30.12-10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)



ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

COMMISSION FILE NUMBER 001-31924

NELNET, INC.

(Exact name of registrant as specified in its charter)



NEBRASKA (State or other jurisdiction of incorporation or organization)	84-0748903 (I.R.S. Employer Identification No.)
121 SOUTH 13TH STREET, SUITE 201 LINCOLN, NEBRASKA (Address of principal executive offices)	68508 (Zip Code)

(402) 458-2370

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [ ] Accelerated filer [X]

Non-accelerated filer [ ] Smaller reporting company [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes[ ] No[X]

As of October 31, 2012, there were 35,835,327 and 11,495,377 shares of Class A Common Stock and Class B Common Stock, par value $0.01 per share, outstanding, respectively (excluding 11,317,364 shares of Class A Common Stock held by wholly owned subsidiaries).

NELNET, INC.

FORM 10-Q

INDEX

September 30, 2012



PART I. FINANCIAL INFORMATION
	Item 1.	Financial Statements	2
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	62
	Item 4.	Controls and Procedures	67

PART II. OTHER INFORMATION
	Item 1.	Legal Proceedings	68
	Item 1A.	Risk Factors	69
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	69
	Item 6.	Exhibits	70

Signatures			71

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS



NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
	As of			As of
	September 30, 2012			December 31, 2011
	(unaudited)
Assets:
Student loans receivable (net of allowance for loan losses of $48,209 and $48,482, respectively)	$	22,559,341		24,297,876
Cash and cash equivalents:
Cash and cash equivalents - not held at a related party	5,776			7,299
Cash and cash equivalents - held at a related party	87,898			35,271
Total cash and cash equivalents	93,674			42,570
Investments	92,860			50,780
Restricted cash and investments	905,561			614,322
Restricted cash - due to customers	98,327			109,809
Accrued interest receivable	267,856			308,401
Accounts receivable (net of allowance for doubtful accounts of $1,796 and $1,284, respectively)	71,399			63,654
Goodwill	117,118			117,118
Intangible assets, net	14,360			28,374
Property and equipment, net	32,752			34,819
Other assets	87,871			92,275
Fair value of derivative instruments	67,725			92,219
Total assets	$	24,408,844		25,852,217
Liabilities:
Bonds and notes payable	$	22,884,096		24,434,540
Accrued interest payable	16,636			19,634
Other liabilities	153,282			178,189
Due to customers	98,327			109,809
Fair value of derivative instruments	80,265			43,840
Total liabilities	23,232,606			24,786,012
Equity:
Nelnet, Inc. shareholders' equity:
Preferred stock, $0.01 par value. Authorized 50,000,000 shares; no shares issued or outstanding	—			—
Common stock:
Class A, $0.01 par value. Authorized 600,000,000 shares; issued and outstanding 35,839,076 shares and 35,643,102 shares, respectively	358			356
Class B, convertible, $0.01 par value. Authorized 60,000,000 shares; issued and outstanding 11,495,377 shares	115			115
Additional paid-in capital	52,843			49,245
Retained earnings	1,124,806			1,017,629
Accumulated other comprehensive loss	(1,933		)	—
Employee notes receivable	(368		)	(1,140	)
Total Nelnet, Inc. shareholders' equity	1,175,821			1,066,205
Noncontrolling interest	417			—
Total equity	1,176,238			1,066,205
Commitments and contingencies
Total liabilities and equity	$	24,408,844		25,852,217

See accompanying notes to consolidated financial statements.



NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except share data)
(unaudited)
	Three months					Nine months
	ended September 30,					ended September 30,
	2012			2011		2012		2011
Interest income:
Loan interest	$	150,528		156,955		454,574		433,247
Investment interest	1,140			672		3,290		2,254
Total interest income	151,668			157,627		457,864		435,501
Interest expense:
Interest on bonds and notes payable	66,402			60,866		203,175		164,227
Net interest income	85,266			96,761		254,689		271,274
Less provision for loan losses	5,000			5,250		18,000		14,250
Net interest income after provision for loan losses	80,266			91,511		236,689		257,024
Other income (expense):
Loan and guaranty servicing revenue	53,285			42,549		155,164		124,697
Tuition payment processing and campus commerce revenue	17,928			16,774		56,675		50,904
Enrollment services revenue	30,661			35,505		92,035		101,688
Other income	12,699			3,931		32,453		17,249
Gain on sale of loans and debt repurchases	195			—		1,130		8,307
Derivative market value and foreign currency adjustments and derivative settlements, net	(31,275		)	(13,631	)	(68,073	)	(37,002	)
Total other income	83,493			85,128		269,384		265,843
Operating expenses:
Salaries and benefits	46,395			44,132		144,193		130,925
Cost to provide enrollment services	20,151			23,825		62,203		68,804
Depreciation and amortization	8,402			7,917		24,764		21,462
Other	29,989			28,904		93,160		83,776
Total operating expenses	104,937			104,778		324,320		304,967
Income before income taxes	58,822			71,861		181,753		217,900
Income tax expense	(21,870		)	(24,410	)	(59,978	)	(78,444	)
Net income	36,952			47,451		121,775		139,456
Net income attributable to noncontrolling interest	124			—		412		—
Net income attributable to Nelnet, Inc.	$	36,828		47,451		121,363		139,456
Earnings per common share:
Net income attributable to Nelnet, Inc. shareholders - basic	$	0.78		0.98		2.56		2.88
Net income attributable to Nelnet, Inc. shareholders - diluted	$	0.77		0.98		2.55		2.87
Weighted average common shares outstanding:
Basic	47,086,098			48,059,747		47,042,035		48,177,539
Diluted	47,321,797			48,253,888		47,267,036		48,367,923

See accompanying notes to consolidated financial statements.



NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
(unaudited)
	Three months				Nine months
	ended September 30,				ended September 30,
	2012			2011	2012		2011
Net income	$	36,952		47,451	121,775		139,456
Other comprehensive income (loss):
Available-for-sale securities:
Unrealized holding gains arising during period, net	133			—	1,745		—
Less reclassification adjustment for gains recognized in net income, net	(2,618		)	—	(4,848	)	—
Income tax effect	961			—	1,170		—
Total other comprehensive income (loss)	(1,524		)	—	(1,933	)	—
Comprehensive income	35,428			47,451	119,842		139,456
Comprehensive income attributable to noncontrolling interest	124			—	412		—
Comprehensive income attributable to Nelnet, Inc.	$	35,304		47,451	119,430		139,456

See accompanying notes to consolidated financial statements.



NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollars in thousands, except share data)
(unaudited)
	Nelnet, Inc. Shareholders
	Preferred stock shares	Common stock shares			Preferred stock		Class A common stock		Class B common stock	Additional paid-in capital		Retained earnings		Accumulated other comprehensive loss		Employee notes receivable		Noncontrolling interest	Total equity
	Preferred stock shares	Class A		Class B	Preferred stock		Class A common stock		Class B common stock	Additional paid-in capital		Retained earnings		Accumulated other comprehensive loss		Employee notes receivable		Noncontrolling interest	Total equity
Balance as of June 30, 2011	—	37,044,372		11,495,377	$	—	370		115	74,646		914,823		—		(1,170	)	—	988,784
Net income	—	—		—	—		—		—	—		47,451		—		—		—	47,451
Cash dividend on Class A and Class B common stock - $0.10 per share	—	—		—	—		—		—	—		(4,811	)	—		—		—	(4,811	)
Issuance of common stock, net of forfeitures	—	17,157		—	—		1		—	314		—		—		—		—	315
Compensation expense for stock based awards	—	—		—	—		—		—	310		—		—		—		—	310
Repurchase of common stock	—	(1,097,441	)	—	—		(11	)	—	(20,585	)	—		—		—		—	(20,596	)
Payments received on employee stock notes receivable	—	—		—	—		—		—	—		—		—		30		—	30
Balance as of September 30, 2011	—	35,964,088		11,495,377	$	—	360		115	54,685		957,463		—		(1,140	)	—	1,011,483
Balance as of June 30, 2012	—	35,847,801		11,495,377	$	—	358		115	52,194		1,092,715		(409	)	(368	)	293	1,144,898
Net income	—	—		—	—		—		—	—		36,828		—		—		124	36,952
Other comprehensive loss	—	—		—	—		—		—	—		—		(1,524	)	—		—	(1,524	)
Cash dividend on Class A and Class B common stock - $0.10 per share	—	—		—	—		—		—	—		(4,737	)	—		—		—	(4,737	)
Issuance of common stock, net of forfeitures	—	(180	)	—	—		—		—	271		—		—		—		—	271
Compensation expense for stock based awards	—	—		—	—		—		—	584		—		—		—		—	584
Repurchase of common stock	—	(8,545	)	—	—		—		—	(206	)	—		—		—		—	(206	)
Balance as of September 30, 2012	—	35,839,076		11,495,377	$	—	358		115	52,843		1,124,806		(1,933	)	(368	)	417	1,176,238
Balance as of December 31, 2010	—	36,846,353		11,495,377	$	—	368		115	76,263		831,057		—		(1,170	)	—	906,633
Net income	—	—		—	—		—		—	—		139,456		—		—		—	139,456
Cash dividend on Class A and Class B common stock - $0.27 per share	—	—		—	—		—		—	—		(13,050	)	—		—		—	(13,050	)
Contingency payment related to business combination	—	—		—	—		—		—	(5,893	)	—		—		—		—	(5,893	)
Issuance of common stock, net of forfeitures	—	239,620		—	—		3		—	4,427		—		—		—		—	4,430
Compensation expense for stock based awards	—	—		—	—		—		—	1,007		—		—		—		—	1,007
Repurchase of common stock	—	(1,121,885	)	—	—		(11	)	—	(21,119	)	—		—		—		—	(21,130	)
Payments received on employee stock notes receivable	—	—		—	—		—		—	—		—		—		30		—	30
Balance as of September 30, 2011	—	35,964,088		11,495,377	$	—	360		115	54,685		957,463		—		(1,140	)	—	1,011,483
Balance as of December 31, 2011	—	35,643,102		11,495,377	$	—	356		115	49,245		1,017,629		—		(1,140	)	—	1,066,205
Issuance of noncontrolling interest	—	—		—	—		—		—	—		—		—		—		5	5
Net income	—	—		—	—		—		—	—		121,363		—		—		412	121,775
Other comprehensive loss	—	—		—	—		—		—	—		—		(1,933	)	—		—	(1,933	)
Cash dividend on Class A and Class B common stock - $0.30 per share	—	—		—	—		—		—	—		(14,186	)	—		—		—	(14,186	)
Issuance of common stock, net of forfeitures	—	255,538		—	—		3		—	3,545		—		—		—		—	3,548
Compensation expense for stock based awards	—	—		—	—		—		—	1,573		—		—		—		—	1,573
Repurchase of common stock	—	(59,564	)	—	—		(1	)	—	(1,520	)	—		—		—		—	(1,521	)
Payments received on employee stock notes receivable	—	—		—	—		—		—	—		—		—		772		—	772
Balance as of September 30, 2012	—	35,839,076		11,495,377	$	—	358		115	52,843		1,124,806		(1,933	)	(368	)	417	1,176,238

See accompanying notes to consolidated financial statements.



NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)
	Nine months ended September 30,
	2012			2011
Net income attributable to Nelnet, Inc.	$	121,363		139,456
Net income attributable to noncontrolling interest	412			—
Net income	121,775			139,456
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization, including loan and debt premiums/discounts and deferred origination costs	53,677			54,462
Provision for loan losses	18,000			14,250
Derivative market value adjustment	67,349			18,683
Foreign currency transaction adjustment	(6,186		)	10,902
(Payments) proceeds to terminate and/or amend derivative instruments, net	(6,430		)	2,301
Gain on sale of loans	(80		)	(1,345	)
Gain from debt repurchases	(1,050		)	(6,962	)
Gain from sale of available-for-sale securities, net	(4,848		)	—
Change in investments - trading securities, net	(2,024		)	(6,598	)
Deferred income tax benefit	(29,141		)	(15,916	)
Non-cash compensation expense	2,166			1,574
Other non-cash items	621			(124	)
Decrease in accrued interest receivable	40,545			6,550
Increase in accounts receivable	(7,745		)	(6,280	)
Decrease in other assets	2,330			1,065
Decrease in accrued interest payable	(2,998		)	(3,207	)
Increase in other liabilities	14,636			3,135
Net cash provided by operating activities	260,597			211,946
Cash flows from investing activities:
Purchases of student loans	(875,556		)	(820,812	)
Purchases of student loans from a related party	(299		)	(59	)
Net proceeds from student loan repayments, claims, capitalized interest, participations, and other	2,500,005			1,778,729
Proceeds from sale of student loans	92,149			95,178
Purchases of available-for-sale securities	(155,057		)	—
Proceeds from sales of available-for-sale securities	112,854			—
Purchases of property and equipment, net	(7,370		)	(9,776	)
(Increase) decrease in restricted cash and investments, net	(291,239		)	101,009
Business and asset acquisition contingency payments	—			(14,029	)
Net cash provided by investing activities	1,375,487			1,130,240
Cash flows from financing activities:
Payments on bonds and notes payable	(2,795,019		)	(2,386,461	)
Proceeds from issuance of bonds and notes payable	1,232,250			995,644
Payments on bonds payable due to a related party	—			(107,050	)
Payments of debt issuance costs	(7,630		)	(2,282	)
Dividends paid	(14,186		)	(13,050	)
Repurchases of common stock	(1,521		)	(21,130	)
Proceeds from issuance of common stock	349			406
Payments received on employee stock notes receivable	772			30
Issuance of noncontrolling interest	5			—
Net cash used in financing activities	(1,584,980		)	(1,533,893	)
Net increase (decrease) in cash and cash equivalents	51,104			(191,707	)
Cash and cash equivalents, beginning of period	42,570			283,801
Cash and cash equivalents, end of period	$	93,674		92,094
Supplemental disclosures of cash flow information:
Interest paid	$	179,007		153,167
Income taxes paid, net of refunds	$	86,798		97,640
Noncash activity:
Investing activity - Student loans acquired	$	—		1,716,681
Operating activity - Other assets acquired and other liabilities assumed, net	$	—		50,336
Financing activity - Borrowings assumed in acquisition of student loans and other assets	$	—		1,741,017

See accompanying notes to consolidated financial statements.

NELNET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Information as of September 30, 2012 and for the three and nine months ended

September 30, 2012 and 2011 is unaudited)

(Dollars in thousands, except per share amounts, unless otherwise noted)

1. Basis of Financial Reporting

The accompanying unaudited consolidated financial statements of Nelnet, Inc. and subsidiaries (the “Company”) as of September 30, 2012 and for the three and nine month periods ended September 30, 2012 and 2011 have been prepared on the same basis as the audited consolidated financial statements for the year ended December 31, 2011 and, in the opinion of the Company’s management, the unaudited consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of results of operations for the interim periods presented. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Operating results for the three and nine months ended September 30, 2012 are not necessarily indicative of the results for the year ending December 31, 2012. The unaudited consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

Noncontrolling Interest

Noncontrolling interest reflects the proportionate share of membership interest (equity) and net income attributable to the holders of minority membership interests in Whitetail Rock Capital Management, LLC ("WRCM"), a subsidiary of the Company that issued minority membership interests on January 1, 2012.

2. Student Loans Receivable and Allowance for Loan Losses

Student loans receivable consisted of the following:



	As of			As of
	September 30, 2012			December 31, 2011
Federally insured loans
Stafford and other	$	6,652,639		7,480,182
Consolidation	15,962,969			16,852,527
Total	22,615,608			24,332,709
Non-federally insured loans	29,272			26,916
	22,644,880			24,359,625
Loan discount, net of unamortized loan premiums and deferred origination costs	(37,330		)	(13,267	)
Allowance for loan losses – federally insured loans	(35,614		)	(37,205	)
Allowance for loan losses – non-federally insured loans	(12,595		)	(11,277	)
	$	22,559,341		24,297,876
Allowance for federally insured loans as a percentage of such loans	0.16		%	0.15	%
Allowance for non-federally insured loans as a percentage of such loans	43.03		%	41.90	%

Activity in the Allowance for Loan Losses

The provision for loan losses represents the periodic expense of maintaining an allowance sufficient to absorb losses, net of recoveries, inherent in the portfolio of student loans. Activity in the allowance for loan losses is shown below.



	Three months ended September 30,					Nine months ended September 30,
	2012			2011		2012		2011
Balance at beginning of period	$	49,657		42,300		48,482		43,626
Provision for loan losses:
Federally insured loans	5,000			5,000		18,000		13,500
Non-federally insured loans	—			250		—		750
Total provision for loan losses	5,000			5,250		18,000		14,250
Charge-offs:
Federally insured loans	(5,449		)	(3,978	)	(16,943	)	(13,418	)
Non-federally insured loans	(1,058		)	(1,175	)	(2,355	)	(3,395	)
Total charge-offs	(6,507		)	(5,153	)	(19,298	)	(16,813	)
Recoveries - non-federally insured loans	399			350		1,104		1,003
Purchase (sale) of loans, net:
Federally insured loans	(928		)	2,200		(2,647	)	2,200
Non-federally insured loans	—			—		—		—
Total purchase (sale) of loans, net	(928		)	2,200		(2,647	)	2,200
Transfer from repurchase obligation related to loans purchased, net	588			826		2,568		1,507
Balance at end of period	$	48,209		45,773		48,209		45,773
Allocation of the allowance for loan losses:
Federally insured loans	$	35,614		35,190		35,614		35,190
Non-federally insured loans	12,595			10,583		12,595		10,583
Total allowance for loan losses	$	48,209		45,773		48,209		45,773

Repurchase Obligations

As of September 30, 2012, the Company had participated a cumulative amount of $107.7 million of non-federally insured loans to third parties. Loans participated under these agreements have been accounted for by the Company as loan sales. Accordingly, the participation interests sold are not included in the Company’s consolidated balance sheets. Per the terms of the servicing agreements, the Company’s servicing operations are obligated to repurchase loans subject to the participation interests in the event such loans become 60 or 90 days delinquent.

In addition, on January 13, 2011, the Company sold a portfolio of non-federally insured loans for proceeds of $91.3 million (100% of par value). The Company retained credit risk related to this portfolio and will pay cash to purchase back any loans which become 60 days delinquent.

The Company’s estimate related to its obligation to repurchase these loans is included in “other liabilities” in the Company’s consolidated balance sheets. The activity related to this accrual is detailed below.



	Three months ended September 30,					Nine months ended September 30,
	2012			2011		2012		2011
Beginning balance	$	17,243		20,689		19,223		12,600
Transfer to the allowance for loan losses related to loans purchased, net	(588		)	(826	)	(2,568	)	(1,507	)
Repurchase obligation associated with loans sold on January 13, 2011	—			—		—		6,270
Current period expense	—			—		—		2,500
Ending balance	$	16,655		19,863		16,655		19,863

Student Loan Status and Delinquencies

Delinquencies have the potential to adversely impact the Company’s earnings through increased servicing and collection costs and account charge-offs. The table below shows the Company’s student loan delinquencies.



	As of September 30, 2012				As of December 31, 2011				As of September 30, 2011
Federally Insured Loans:
Loans in-school/grace/deferment (a)	$	3,254,654			$	3,664,899			$	4,358,786
Loans in forbearance (b)	2,997,330				3,330,452				3,390,367
Loans in repayment status:
Loans current	14,091,408		86.1	%	14,600,372		84.2	%	14,555,949		86.1	%
Loans delinquent 31-60 days (c)	637,994		3.9		844,204		4.9		675,053		4.0
Loans delinquent 61-90 days (c)	343,428		2.1		407,094		2.3		366,831		2.2
Loans delinquent 91-270 days (c)	1,000,250		6.1		1,163,437		6.7		1,060,385		6.3
Loans delinquent 271 days or greater (c)(d)	290,544		1.8		322,251		1.9		248,281		1.4
Total loans in repayment	16,363,624		100.0	%	17,337,358		100.0	%	16,906,499		100.0	%
Total federally insured loans	$	22,615,608			$	24,332,709			$	24,655,652

Non-Federally Insured Loans:
Loans in-school/grace/deferment (a)	$	2,315			$	2,058			$	2,944
Loans in forbearance (b)	382				371				473
Loans in repayment status:
Loans current	18,951		71.3	%	16,776		68.5	%	19,209		74.9	%
Loans delinquent 31-60 days (c)	808		3.0		706		2.9		893		3.5
Loans delinquent 61-90 days (c)	1,959		7.4		1,987		8.1		1,344		5.2
Loans delinquent 91 days or greater (c)	4,857		18.3		5,018		20.5		4,198		16.4
Total loans in repayment	26,575		100.0	%	24,487		100.0	%	25,644		100.0	%
Total non-federally insured loans	$	29,272			$	26,916			$	29,061


(a)	Loans for borrowers who still may be attending school or engaging in other permitted educational activities and are not yet required to make payments on the loans, e.g., residency periods for medical students or a grace period for bar exam preparation for law students.


(b)	Loans for borrowers who have temporarily ceased making full payments due to hardship or other factors, according to a schedule approved by the servicer consistent with the established loan program servicing procedures and policies.


(c)	The period of delinquency is based on the number of days scheduled payments are contractually past due and relate to repayment loans, that is, receivables not charged off, and not in school, grace, deferment, or forbearance.


(d)	A portion of loans included in loans delinquent 271 days or greater includes federally insured loans in claim status, which are loans that have gone into default and have been submitted to the guaranty agency.

3. Bonds and Notes Payable

The following tables summarize the Company’s outstanding debt obligations by type of instrument:



	As of September 30, 2012
	Carrying amount			Interest rate range	Final maturity
Variable-rate bonds and notes (a):
Bonds and notes based on indices	$	19,393,718		0.40% - 6.90%	11/25/15 - 7/27/48
Bonds and notes based on auction or remarketing	969,925			0.18% - 2.10%	5/1/28 - 5/25/42
Total variable-rate bonds and notes	20,363,643
FFELP warehouse facilities	499,352			0.23% - 0.38%	1/31/15 - 6/30/15
Department of Education Conduit	1,988,035			0.79%	5/8/14
Secured line of credit	50,000			1.71%	4/11/14
Unsecured line of credit	—			—	2/17/16
Unsecured debt - Junior Subordinated Hybrid Securities	100,697			3.73%	9/15/61
Other borrowings	28,316			3.66% - 5.72%	11/14/12 - 3/1/22
	23,030,043
Discount on bonds and notes payable	(145,947		)
Total	$	22,884,096



	As of December 31, 2011
	Carrying amount			Interest rate range	Final maturity
Variable-rate bonds and notes (a):
Bonds and notes based on indices	$	20,252,403		0.42% - 6.90%	11/25/15 - 7/27/48
Bonds and notes based on auction or remarketing	970,575			0.11% - 2.19%	5/1/28 - 5/25/42
Total variable-rate bonds and notes	21,222,978
FFELP warehouse facilities	824,410			0.26% - 0.70%	7/1/14
Department of Education Conduit	2,339,575			0.74%	5/8/14
Unsecured line of credit	64,390			0.69%	5/8/12
Unsecured debt - Junior Subordinated Hybrid Securities	100,697			3.95%	9/15/61
Other borrowings	43,119			3.78% - 5.72%	11/14/12 - 3/1/22
	24,595,169
Discount on bonds and notes payable	(160,629		)
Total	$	24,434,540


(a)	Issued in asset-backed securitizations.

Secured Financing Transactions

The Company has historically relied upon secured financing vehicles as its most significant source of funding for student loans. The net cash flow the Company receives from the securitized student loans generally represents the excess amounts, if any, generated by the underlying student loans over the amounts required to be paid to the bondholders, after deducting servicing fees and any other expenses relating to the securitizations. The Company’s rights to cash flow from securitized student loans are subordinate to bondholder interests and may fail to generate any cash flow beyond what is due to bondholders. The Company’s secured student loan financing vehicles during the periods presented above include loan warehouse facilities, asset-backed securitizations, and the government’s Conduit Program.

The majority of the bonds and notes payable are primarily secured by the student loans receivable, related accrued interest, and by the amounts on deposit in the accounts established under the respective bond resolutions or financing agreements. Certain variable rate bonds and notes are secured by a letter of credit and reimbursement agreement issued by a third-party liquidity provider.

FFELP warehouse facilities

The Company funds a portion of its Federal Family Education Loan Program (the “FFEL Program” or “FFELP”) loan acquisitions using its FFELP warehouse facilities. Student loan warehousing allows the Company to buy and manage student loans prior to transferring them into more permanent financing arrangements.

As of September 30, 2012, the Company has three FFELP warehouse facilities as summarized below.



	NHELP-II (a)		NHELP-I (b)	NFSLW-I (c)	Total
Maximum financing amount	$	250,000	500,000	500,000	1,250,000
Amount outstanding	42,620		117,051	339,681	499,352
Amount available	$	207,380	382,949	160,319	750,648
Expiration of liquidity provisions	January 31, 2013		October 2, 2013	June 28, 2013
Final maturity date	January 31, 2015		April 2, 2015	June 30, 2015
Maximum advance rates	90.5 - 93.5%		80 - 100%	90 - 98%
Minimum advance rates	90.5 - 93.5%		80 - 95%	84.5 - 90%
Advanced as equity support	$	4,147	6,038	24,413	34,598


(a)	The Company entered into this facility on February 1, 2012.


(b)	The terms of this facility were amended on April 2, 2012. The table above reflects all amended terms.


(c)	The terms of this facility were amended on June 29, 2012. The table above reflects these amended terms. On October 11, 2012, this facility was amended to increase the maximum financing amount to $800 million. The increased maximum financing amount is a temporary increase and must be reduced to $600 million by December 7, 2012.

Each FFELP warehouse facility is supported by 364-day liquidity provisions, which are subject to the respective expiration date shown in the table above. In the event the Company is unable to renew the liquidity provisions by such date, the facility would become a term facility at a stepped-up cost, with no additional student loans being eligible for financing, and the Company would be required to refinance the existing loans in the facility by the facility's final maturity date. The warehouse facilities provide for formula-based advance rates, depending on FFELP loan type, up to a maximum of the principal and interest of loans financed as shown in the table above. The advance rates for collateral may increase or decrease based on market conditions, but they are subject to minimums as disclosed above.

The FFELP warehouse facilities contain financial covenants relating to levels of the Company’s consolidated net worth, ratio of recourse indebtedness to adjusted EBITDA, and unencumbered cash. Any noncompliance with these covenants could result in a requirement for the immediate repayment of any outstanding borrowings under the facilities.

Asset-backed securitizations

On May 4, 2012, June 11, 2012, and July 27, 2012, the Company completed asset-backed securitizations of $343.9 million, $333.0 million, and $424.3 million, respectively. Notes issued in the June and July securitizations were issued at a discount of $3.6 million and $1.3 million, respectively. These discounts are being accreted using the effective interest method over the expected term of the notes issued in the securitizations. The notes issued in these asset-backed securities transactions carry interest rates based on a spread to one-month LIBOR. As part of the Company's issuance of these asset-backed securities, the Company purchased the Class B subordinated notes in the aggregate amount of $27.6 million (par value). These notes are not included in the Company's consolidated balance sheet. If the Company sells these notes to third parties, the Company would obtain cash proceeds equal to the market value of the notes on the date of such sale. Upon sale, these notes would be shown as “bonds and notes payable” in the Company's consolidated balance sheet. The Company believes the market value of such notes is currently less than par value. Any excess of the par value over the market value on the date of sale would be recognized by the Company as interest expense over the life of the bonds.

Secured line of credit

On April 12, 2012, the Company entered into a $50.0 million line of credit, which is collateralized by asset-backed security investments. The line of credit has a maturity date of April 11, 2014 and has covenants and cross default provisions similar to those under the Company's unsecured line of credit discussed below. As of September 30, 2012, $50.0 million was outstanding on this line of credit.

Unsecured Line of Credit

As of December 31, 2011, the Company had a $750.0 million unsecured line of credit with a maturity date of May 8, 2012. As of December 31, 2011, there was $64.4 million outstanding on this line. On February 17, 2012, the Company entered into a new $250.0 million unsecured line of credit. In conjunction with entering into this new agreement, the outstanding balance on the $750.0 million unsecured line of credit of $64.4 million was paid off in full and the agreement was terminated. As of September 30, 2012, the $250.0 million unsecured line of credit had no amounts outstanding and $250.0 million was available for future use. The $250.0 million line of credit has a maturity date of February 17, 2016.

The new line of credit agreement contains certain financial covenants that, if not met, lead to an event of default under the agreement. The covenants include maintaining:


•	A minimum consolidated net worth


•	A minimum adjusted EBITDA to corporate debt interest (over the last four rolling quarters)


•	A limitation on subsidiary indebtedness


•	A limitation on the percentage of non-federally insured loans in the Company’s portfolio

As of September 30, 2012, the Company was in compliance with all of these requirements. Many of these covenants are duplicated in the Company’s other lending facilities, including its FFELP warehouse facilities.

The Company’s new operating line of credit does not have any covenants related to unsecured debt ratings. However, changes in the Company’s ratings (as well as the amounts the Company borrows) have modest implications on the pricing level at which the Company obtains funding.

A default on the Company’s FFELP warehouse facilities would result in an event of default on the Company’s unsecured line of credit that would result in the outstanding balance on the line of credit becoming immediately due and payable.

4. Derivative Financial Instruments

The Company is exposed to certain risks relating to its ongoing business operations. The primary risks managed by using derivative instruments are interest rate risk and foreign currency exchange risk.

Interest Rate Risk

The Company is exposed to interest rate risk in the form of basis risk and repricing risk because the interest rate characteristics of the Company’s assets do not match the interest rate characteristics of the funding for those assets. The Company has adopted a policy of periodically reviewing the mismatch related to the interest rate characteristics of its assets and liabilities together with the Company’s outlook as to current and future market conditions. Based on those factors, the Company uses derivative instruments as part of its overall risk management strategy. Derivative instruments used as part of the Company’s interest rate risk management strategy currently include basis swaps and interest rate swaps.

Basis Swaps

Prior to April 1, 2012, the interest earned on the majority of the Company's FFELP student loan assets was indexed to the three-month commercial paper index. As allowed by recent legislation, effective April 1, 2012, the Company elected to change the index on which the Special Allowance Payments ("SAP") are calculated for the majority of the Company's FFELP loans from the commercial paper rate to the one-month LIBOR rate. Meanwhile, the Company funds the majority of its assets with three-month LIBOR indexed floating rate securities. The different interest rate characteristics of the Company's loan assets and liabilities funding these assets results in basis risk.

The Company also faces repricing risk due to the timing of the interest rate resets on its liabilities, which may occur as infrequently as once a quarter, in contrast to the timing of the interest rate resets on its assets, which generally occur daily. In a declining interest rate environment, this may cause the Company’s student loan spread to compress, while in a rising rate environment, it may cause the spread to increase.

As of September 30, 2012, the Company had $21.7 billion and $0.9 billion of FFELP loans indexed to the one-month LIBOR rate and the three-month treasury bill rate, respectively, both of which reset daily, and $17.8 billion of debt indexed to three-month LIBOR, which resets quarterly, and $1.7 billion of debt indexed to one-month LIBOR, which resets monthly.

The Company has used derivative instruments to hedge its basis risk and repricing risk. The Company has entered into basis swaps in which the Company receives three-month LIBOR set discretely in advance and pays one-month LIBOR plus or minus a spread as defined in the agreements (the 1:3 Basis Swaps).

The following table summarizes the Company’s 1:3 Basis Swaps outstanding as of both September 30, 2012 and December 31, 2011:



Maturity		Notional amount
2021		$	250,000
2023		1,250,000
2024		250,000
2026		800,000
2028		100,000
2036		700,000
2039	(a)	150,000
2040	(b)	200,000
		$	3,700,000	(c)

(a)This derivative has a forward effective start date in 2015.

(b)This derivative has a forward effective start date in 2020.


(c)	The weighted average rate paid by the Company on the 1:3 Basis Swaps is one-month LIBOR plus 1.2 basis points.

Interest rate swaps – floor income hedges

FFELP loans originated prior to April 1, 2006 generally earn interest at the higher of a floating rate based on the SAP formula set by the Department of Education (the "Department") and the borrower rate, which is fixed over a period of time. The SAP formula is based on an applicable indice plus a fixed spread that is dependent upon when the loan was originated, the loan’s repayment status, and funding sources for the loan. The Company generally finances its student loan portfolio with variable rate debt. In low and/or declining interest rate environments, when the fixed borrower rate is higher than the rate produced by the SAP formula, the Company’s student loans earn at a fixed rate while the interest on the variable rate debt typically continues to decline. In these interest rate environments, the Company may earn additional spread income that it refers to as floor income.

Depending on the type of loan and when it was originated, the borrower rate is either fixed to term or is reset to an annual rate each July 1. As a result, for loans where the borrower rate is fixed to term, the Company may earn floor income for an extended period of time, which the Company refers to as fixed rate floor income, and for those loans where the borrower rate is reset annually on July 1, the Company may earn floor income to the next reset date, which the Company refers to as variable rate floor income. In accordance with legislation enacted in 2006, lenders are required to rebate fixed rate floor income and variable rate floor income to the Department for all FFELP loans first originated on or after April 1, 2006.

Absent the use of derivative instruments, a rise in interest rates may reduce the amount of floor income received and this may have an impact on earnings due to interest margin compression caused by increasing financing costs, until such time as the federally insured loans earn interest at a variable rate in accordance with their SAP formulas. In higher interest rate environments, where the interest rate rises above the borrower rate and fixed rate loans effectively become variable rate loans, the impact of the rate fluctuations is reduced.

As of September 30, 2012 and December 31, 2011, the Company had $8.9 billion and $10.9 billion, respectively, of student loan assets that were earning fixed rate floor income of which the weighted average estimated variable conversion rate for these loans, which is the estimated short-term interest rate at which loans would convert to a variable rate, was 2.05% and 1.79%, respectively.

The following tables summarize the outstanding derivative instruments used by the Company to economically hedge these loans.



As of September 30, 2012
	Maturity		Notional amount		Weighted average fixed rate paid by the Company (a)
	Maturity		Notional amount		Weighted average fixed rate paid by the Company (a)
	2013		$	3,150,000	0.71	%
	2014		1,750,000		0.71
	2015	(b)	1,100,000		0.89
	2016		750,000		0.85
	2017		750,000		0.99
			$	7,500,000	0.78	%



As of December 31, 2011
	Maturity	Notional amount		Weighted average fixed rate paid by the Company (a)
	Maturity	Notional amount		Weighted average fixed rate paid by the Company (a)
	2013	$	2,150,000	0.85	%
	2014	750,000		0.85
	2015	100,000		2.26
	2020	50,000		3.23
		$	3,050,000	0.93	%


(a)	For all interest rate derivatives, the Company receives discrete three-month LIBOR.


(b)	$500 million of these derivatives have a forward effective start date in 2013.

Interest rate swaps – unsecured debt hedges

As of September 30, 2012 and December 31, 2011, the Company had $100.7 million of unsecured Junior Subordinated Hybrid Securities debt outstanding. The interest rate on the Hybrid Securities through September 29, 2036 is equal to three-month LIBOR plus 3.375%, payable quarterly. As of September 30, 2012 and December 31, 2011, the Company had the following derivatives outstanding that are used to effectively convert the variable interest rate on the Hybrid Securities to a fixed rate.



Maturity	Notional amount		Weighted average fixed rate paid by the Company (a)
2036	$	75,000	4.28	%


(a)	For all interest rate derivatives, the Company receives discrete three-month LIBOR.

Foreign Currency Exchange Risk

During 2006, the Company completed separate debt offerings of student loan asset-backed securities that included €420.5 million and €352.7 million Euro Notes with interest rates based on a spread to the EURIBOR index. As a result of these transactions, the Company is exposed to market risk related to fluctuations in foreign currency exchange rates between the U.S. dollar and Euro. The principal and accrued interest on these notes are re-measured at each reporting period and recorded in the Company’s consolidated balance sheet in U.S. dollars based on the foreign currency exchange rate on that date. Changes in the principal and accrued interest amounts as a result of foreign currency exchange rate fluctuations are included in the Company’s consolidated statements of income.

The Company entered into cross-currency interest rate swaps in connection with the issuance of the Euro Notes. Under the terms of these derivative instrument agreements, the Company receives from a counterparty a spread to the EURIBOR indice based on notional amounts of €420.5 million and €352.7 million and pays a spread to the LIBOR indice based on notional amounts of $500.0 million and $450.0 million, respectively. In addition, under the terms of these agreements, all principal payments on the Euro Notes will effectively be paid at the exchange rate in effect between the U.S. dollar and Euro as of the issuance of the notes.

The following table shows the income statement impact as a result of the re-measurement of the Euro Notes and the change in the fair value of the related derivative instruments. These items are included in the Company's consolidated statements of income.



	Three months ended September 30,					Nine months ended September 30,
	2012			2011		2012		2011
Re-measurement of Euro Notes	$	(20,799	)	73,453		6,186		(10,902	)
Change in fair value of cross currency interest rate swaps	24,586			(53,142	)	(24,934	)	28,125
Total impact to consolidated statements of income - income (expense) (a)	$	3,787		20,311		(18,748	)	17,223


(a)	The financial statement impact of the above items is included in "Derivative market value and foreign currency adjustments and derivative settlements, net" in the Company's consolidated statements of income.

The re-measurement of the Euro-denominated bonds generally correlates with the change in fair value of the cross-currency interest rate swaps. However, the Company will experience unrealized gains or losses related to the cross-currency interest rate swaps if the two underlying indices (and related forward curve) do not move in parallel. Management currently intends to hold the cross-currency interest rate swaps through the maturity of the Euro-denominated bonds.

Accounting for Derivative Financial Instruments

The Company records derivative instruments in the consolidated balance sheets as either an asset or liability measured at its fair value. Management has structured the majority of the Company’s derivative transactions with the intent that each is economically effective; however, the Company’s derivative instruments do not qualify for hedge accounting. As a result, the change in fair value of the Company’s derivatives at each reporting date are included in the Company’s consolidated statements of income. Changes or shifts in the forward yield curve and fluctuations in currency rates can significantly impact the valuation of the Company’s derivatives. Accordingly, changes or shifts to the forward yield curve and fluctuations in currency rates will impact the financial position and results of operations of the Company.

Any proceeds received or payments made by the Company to terminate a derivative in advance of its expiration date, or to amend the terms of an existing derivative, are included in the Company's consolidated statements of income and are accounted for as a change in fair value of such derivative.

The following table summarizes the fair value of the Company’s derivatives:



	Fair value of asset derivatives			Fair value of liability derivatives
	As of		As of	As of	As of
	September 30, 2012		December 31, 2011	September 30, 2012	December 31, 2011
1:3 basis swaps	$	9,859	10,988	1,517	641
Interest rate swaps - floor income hedges	—		592	52,379	18,384
Interest rate swaps - hybrid debt hedges	—		—	26,369	24,814
Cross-currency interest rate swaps	55,697		80,631	—	—
Other	2,169		8	—	1
Total	$	67,725	92,219	80,265	43,840

The following table summarizes the effect of derivative instruments in the consolidated statements of income.



	Three months ended September 30,					Nine months ended September 30,
	2012			2011		2012		2011
Settlements:
1:3 basis swaps	$	1,100		321		3,651		902
T-Bill/LIBOR basis swaps	—			(69	)	—		(263	)
Interest rate swaps - floor income hedges	(5,595		)	(3,482	)	(12,237	)	(16,045	)
Interest rate swaps - hybrid debt hedges	(733		)	(250	)	(1,479	)	(744	)
Cross-currency interest rate swaps	227			3,745		3,390		8,625
Other	(50		)	(8	)	(235	)	108
Total settlements - income (expense)	(5,051		)	257		(6,910	)	(7,417	)
Change in fair value:
1:3 basis swaps	(4,578		)	1,702		(2,005	)	(3,736	)
T-Bill/LIBOR basis swaps	—			87		—		208
Interest rate swaps - floor income hedges	(29,903		)	(15,423	)	(41,681	)	(20,137	)
Interest rate swaps - hybrid debt hedges	1,695			(20,747	)	(890	)	(23,196	)
Cross-currency interest rate swaps	24,586			(53,142	)	(24,934	)	28,125
Other	2,775			182		2,161		53
Total change in fair value - income (expense)	(5,425		)	(87,341	)	(67,349	)	(18,683	)
Re-measurement of Euro Notes (foreign currency transaction adjustment) - income (expense)	(20,799		)	73,453		6,186		(10,902	)
Derivative market value and foreign currency adjustments and derivative settlements, net - income (expense)	$	(31,275	)	(13,631	)	(68,073	)	(37,002	)

Derivative Instruments - Credit and Market Risk

By using derivative instruments, the Company is exposed to credit and market risk.

The Company manages credit and market risks associated with interest rates by establishing and monitoring limits as to the types and degree of risk that may be undertaken and by entering into transactions with high-quality counterparties that are reviewed periodically by the Company's risk committee. As of September 30, 2012, all of the Company's derivative counterparties had investment grade credit ratings. The Company also has a policy of requiring that all derivative contracts be governed by an International Swaps and Derivatives Association, Inc. Master Agreement.

Credit Risk

When the fair value of a derivative contract is positive (an asset in the Company's consolidated balance sheet), this generally indicates that the counterparty would owe the Company if the derivative was settled. If the counterparty fails to perform, credit risk with such counterparty is equal to the extent of the fair value gain in the derivative less any collateral held by the Company. If the Company was unable to collect from a counterparty, it would have a loss equal to the amount the derivative is recorded in the consolidated balance sheet. As of September 30, 2012, the trustee for certain of the Company's asset-backed securities transactions held $19.1 million of collateral from the counterparty on the cross-currency interest rate swaps.

The Company considers counterparties' credit risk when determining the fair value of derivative positions on its exposure net of collateral. However, the Company does not use the collateral to offset fair value amounts recognized for derivative instruments in the financial statements.

Market Risk

When the fair value of a derivative instrument is negative (a liability in the Company's consolidated balance sheet), the Company would owe the counterparty if the derivative was settled and, therefore, has no immediate credit risk. If the negative fair value of derivatives with a counterparty exceeds a specified threshold, the Company may have to make a collateral deposit with the counterparty. The threshold at which the Company may be required to post collateral is dependent upon the Company's unsecured credit rating. At the Company's current unsecured credit rating (Standard & Poor's: BBB- (stable outlook) and Moody's: Ba1

(stable outlook)), the Company has substantially collateralized its corporate derivative liability position with its counterparties. As such, any downgrades from the current rating would not result in additional collateral requirements of a material nature. In addition, no counterparty has the right to terminate its contracts in the event of downgrades from the current rating. However, some long-dated derivative contracts have mutual optional termination provisions that can be exercised in 2016, 2017, and 2021. As of September 30, 2012, the fair value of derivatives with early termination provisions was a positive $0.5 million (an asset in the Company's consolidated balance sheet). As of September 30, 2012, the Company had $70.3 million posted as collateral to derivative counterparties, which is included in “restricted cash and investments” in the Company's consolidated balance sheet.

Interest rate movements have an impact on the amount of collateral the Company is required to deposit with its derivative instrument counterparties. With the Company's current derivative portfolio, the Company does not currently anticipate any movement in interest rates having a material impact on its capital or liquidity profile, nor expects that any movement in interest rates would have a material impact on its ability to meet potential collateral deposits with its counterparties. Due to the existing low interest rate environment, the Company's exposure to downward movements in interest rates on its interest rate swaps is limited. In addition, the historical high correlation between one-month and three-month LIBOR and the limited notional amount of 1:3 Basis Swaps derivatives outstanding limit the Company's exposure to interest rate movements on these derivatives.

The Company's cross-currency interest rate swaps are derivatives entered into as a result of certain asset-backed security financings. These derivatives are entered into at the securitization trust level with the counterparty. Trust related derivatives do not contain credit contingent features related to the Company or the trust's credit ratings.

5. Investments

The Company's available-for-sale investment portfolio consists of student loan asset-backed securities and equity and debt securities. These securities are carried at fair value, with the temporary changes in fair value, net of taxes, carried as a separate component of stockholders’ equity. The amortized cost of debt securities in this category (including the student loan asset-backed securities) is adjusted for amortization of premiums and accretion of discounts, which are amortized using the effective interest rate method. Other-than-temporary impairment is evaluated by considering several factors, including the length of time and extent to which the fair value has been less than the amortized cost basis, the financial condition and near-term prospects of the security (considering factors such as adverse conditions specific to the security and ratings agency actions), and the intent and ability to retain the investment to allow for an anticipated recovery in fair value. The entire fair value loss on a security that is other-than-temporary impairment is recorded in earnings if the Company intends to sell the security or if it is more likely than not that the Company will be required to sell the security before the expected recovery of the loss. However, if the impairment is other-than-temporary, and either of those two conditions does not exist, the portion of the impairment related to credit losses is recorded in earnings and the impairment related to other factors is recorded in other comprehensive income.

Securities classified as trading are accounted for at fair value with unrealized gains and losses included in "other income" in the consolidated statements of income.

Securities that the Company has the intent and ability to hold to maturity are classified as held-to-maturity and are accounted for at amortized cost unless the security is determined to have an other-than-temporary impairment. In that case, it is accounted for in the same manner as described above for available-for-sale investments.

A summary of the Company's investments and restricted investments follows:

As of September 30, 2012

Amortized cost