UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

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

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 þ No o

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 o No o

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 o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o

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

As of July 31, 2009, there were 38,325,862 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 a wholly owned subsidiary).

 

 

NELNET, INC.
FORM 10-Q
INDEX
June 30, 2009

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements			2
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			29
Item 3. Quantitative and Qualitative Disclosures about Market Risk			73
Item 4. Controls and Procedures			78
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			78
Item 1A. Risk Factors			80
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			80
Item 4. Submission of Matters to a Vote of Security Holders			82
Item 6. Exhibits			83
Signatures			84
Exhibit 10.2
Exhibit 10.3
Exhibit 10.4
Exhibit 31.1
Exhibit 31.2
Exhibit 32

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
		June 30, 2009				December 31, 2008
		(unaudited)
Assets:
Student loans receivable (net of allowance for loan losses of $50,000 and $50,922, respectively)		$	23,889,571				25,413,008
Student loans receivable — held for sale			1,749,290				—
Cash and cash equivalents:
Cash and cash equivalents — not held at a related party			14,171				13,129
Cash and cash equivalents — held at a related party			352,656				176,718
Total cash and cash equivalents			366,827				189,847
Restricted cash and investments			1,082,480				997,272
Restricted cash — due to customers			41,127				160,985
Accrued interest receivable			385,158				471,878
Accounts receivable (net of allowance for doubtful accounts of $1,273 and $1,005, respectively)			52,106				42,088
Goodwill			175,178				175,178
Intangible assets, net			65,115				77,054
Property and equipment, net			31,541				38,747
Other assets			103,429				113,666
Fair value of derivative instruments			168,720				175,174
Total assets		$	28,110,542				27,854,897
Liabilities:
Bonds and notes payable		$	27,169,573				26,787,959
Accrued interest payable			34,911				81,576
Other liabilities			176,390				179,336
Due to customers			41,127				160,985
Fair value of derivative instruments			7,354				1,815
Total liabilities			27,429,355				27,211,671
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 38,325,492 shares as of June 30, 2009 and 37,794,067 shares as of December 31, 2008			383				378
Class B, convertible, $0.01 par value. Authorized 60,000,000 shares; issued and outstanding 11,495,377 shares as of June 30, 2009 and December 31, 2008			115				115
Additional paid-in capital			107,959				103,762
Retained earnings			574,179				540,521
Employee notes receivable			(1,449	)			(1,550	)
Total shareholders’ equity			681,187				643,226
Commitments and contingencies
Total liabilities and shareholders’ equity		$	28,110,542				27,854,897

See accompanying notes to consolidated financial statements.

NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share data)
(unaudited)

		Three months								Six months
		ended June 30,								ended June 30,
		2009				2008				2009				2008
Interest income:
Loan interest		$	160,413				296,686				331,332				626,672
Investment interest			2,776				9,116				6,867				20,796
Total interest income			163,189				305,802				338,199				647,468
Interest expense:
Interest on bonds and notes payable			106,082				232,464				252,584				557,605
Net interest income			57,107				73,338				85,615				89,863
Less provision for loan losses			8,000				6,000				15,500				11,000
Net interest income after provision for loan losses			49,107				67,338				70,115				78,863
Other income (expense):
Loan and guaranty servicing revenue			28,803				23,821				55,274				48,482
Tuition payment processing and campus commerce revenue			11,848				10,270				27,386				24,117
Enrollment services revenue			28,747				26,068				57,518				53,290
Software services revenue			6,119				5,979				11,824				14,183
Other income			11,527				6,125				28,389				12,379
Gain (loss) on sale of loans			(196	)			48				(402	)			(47,426	)
Derivative market value, foreign currency, and put option adjustments and derivative settlements, net			(24,478	)			20,192				(5,000	)			3,594
Total other income			62,370				92,503				174,989				108,619
Operating expenses:
Salaries and benefits			40,180				43,549				78,406				97,392
Other operating expenses:
Cost to provide enrollment services			18,092				14,755				35,885				30,158
Depreciation and amortization			9,527				10,603				19,610				21,437
Professional and other services			7,721				8,029				13,798				15,224
Occupancy and communications			5,588				4,914				10,942				10,755
Trustee and other debt related fees			2,444				2,464				5,100				4,854
Postage and distribution			2,274				2,534				5,142				6,115
Advertising and marketing			1,986				2,046				3,696				3,994
Impairment expense			—				—				—				18,834
Other			9,544				9,028				17,348				17,996
Total other operating expenses			57,176				54,373				111,521				129,367
Total operating expenses			97,356				97,922				189,927				226,759
Income (loss) before income taxes			14,121				61,919				55,177				(39,277	)
Income tax (expense) benefit			(5,918	)			(19,195	)			(21,519	)			12,176
Income (loss) from continuing operations			8,203				42,724				33,658				(27,101	)
Income from discontinued operations, net of tax			—				981				—				981
Net income (loss)		$	8,203				43,705				33,658				(26,120	)
Earnings (loss) per share, basic and diluted:
Income (loss) from continuing operations		$	0.16				0.86				0.68				(0.55	)
Income from discontinued operations			—				0.02				—				0.02
Net income (loss)		$	0.16				0.88				0.68				(0.53	)

See accompanying notes to consolidated financial statements.

NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands, except share data)
(unaudited)

		Preferred																Class A				Class B				Additional								Employee				Total
		stock				Common stock shares								Preferred				common				common				paid-in				Retained				notes				shareholders’
		shares				Class A				Class B				stock				stock				stock				capital				earnings				receivable				equity
Balance as of March 31, 2008			—				37,912,773				11,495,377			$	—				379				115				97,875				442,034				(2,296	)			538,107
Comprehensive income:
Net income			—				—				—				—				—				—				—				43,705				—				43,705
Total comprehensive income																																							43,705
Issuance of common stock, net of forfeitures			—				53,467				—				—				1				—				310				—				—				311
Compensation expense for stock based awards			—				—				—				—				—				—				1,848				—				—				1,848
Repurchase of common stock			—				(13,994	)			—				—				—				—				(179	)			—				—				(179	)
Reduction of employee stock notes receivable			—				—				—				—				—				—				—				—				250				250
Balance as of June 30, 2008			—				37,952,246				11,495,377			$	—				380				115				99,854				485,739				(2,046	)			584,042
Balance as of March 31, 2009			—				38,276,870				11,495,377			$	—				383				115				106,678				565,976				(1,550	)			671,602
Comprehensive income:
Net income			—				—				—				—				—				—				—				8,203				—				8,203
Total comprehensive income																																							8,203
Issuance of common stock, net of forfeitures			—				51,951				—				—				—				—				953				—				—				953
Compensation expense for stock based awards			—				—				—				—				—				—				353				—				—				353
Repurchase of common stock			—				(3,329	)			—				—				—				—				(25	)			—				—				(25	)
Reduction of employee stock notes receivable			—				—				—				—				—				—				—				—				101				101
Balance as of June 30, 2009			—				38,325,492				11,495,377			$	—				383				115				107,959				574,179				(1,449	)			681,187
Balance as of December 31, 2007			—				37,980,617				11,495,377			$	—				380				115				96,185				515,317				(3,118	)			608,879
Comprehensive income:
Net loss			—				—				—				—				—				—				—				(26,120	)			—				(26,120	)
Total comprehensive income (loss)																																							(26,120	)
Cash dividend on Class A and Class B common stock — $0.07 per share			—				—				—				—				—				—				—				(3,458	)			—				(3,458	)
Issuance of common stock, net of forfeitures			—				33,687				—				—				—				—				1,073				—				—				1,073
Compensation expense for stock based awards			—				—				—				—				—				—				3,263				—				—				3,263
Repurchase of common stock			—				(62,058	)			—				—				—				—				(667	)			—				—				(667	)
Reduction of employee stock notes receivable			—				—				—				—				—				—				—				—				1,072				1,072
Balance as of June 30, 2008			—				37,952,246				11,495,377			$	—				380				115				99,854				485,739				(2,046	)			584,042
Balance as of December 31, 2008			—				37,794,067				11,495,377			$	—				378				115				103,762				540,521				(1,550	)			643,226
Comprehensive income:
Net income			—				—				—				—				—				—				—				33,658				—				33,658
Total comprehensive income																																							33,658
Issuance of common stock, net of forfeitures			—				538,534				—				—				5				—				3,298				—				—				3,303
Compensation expense for stock based awards			—				—				—				—				—				—				961				—				—				961
Repurchase of common stock			—				(7,109	)			—				—				—				—				(62	)			—				—				(62	)
Reduction of employee stock notes receivable			—				—				—				—				—				—				—				—				101				101
Balance as of June 30, 2009			—				38,325,492				11,495,377			$	—				383				115				107,959				574,179				(1,449	)			681,187

See accompanying notes to consolidated financial statements.

NELNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)

		Six months ended June 30,
		2009				2008
Net income (loss)		$	33,658				(26,120	)
Income from discontinued operations			—				981
Income (loss) from continuing operations			33,658				(27,101	)
Adjustments to reconcile income (loss) from continuing operations to net cash provided by operating activities:
Depreciation and amortization, including loan premiums and deferred origination costs			57,890				74,312
Provision for loan losses			15,500				11,000
Impairment expense			—				18,834
Derivative market value adjustment			22,270				(47,462	)
Foreign currency transaction adjustment			16,623				88,530
Change in value of put options issued in business combinations			—				538
Proceeds to terminate and/or amend derivative instruments			1,432				7,547
Payments to terminate and/or amend derivative instruments			(11,710	)			—
Gain from purchase of debt			(13,937	)			—
Loss on sale of loans			402				47,426
Non-cash compensation expense			1,371				4,372
Deferred income tax benefit			(26,864	)			(24,237	)
Other non-cash items			8,692				344
Decrease in accrued interest receivable			86,720				91,778
(Increase) decrease in accounts receivable			(10,018	)			3,098
Decrease in other assets			10,036				9,419
Decrease in accrued interest payable			(46,665	)			(42,950	)
Increase (decrease) in other liabilities			10,616				(28,351	)
Net cash flows from operating activities — continuing operations			156,016				187,097
Net cash flows from operating activities — discontinued operations			—				—
Net cash provided by operating activities			156,016				187,097
Cash flows from investing activities:
Originations, purchases, and consolidations of student loans, including loan premiums and deferred origination costs			(1,467,312	)			(1,480,305	)
Purchases of student loans, including loan premiums, from a related party			(20,392	)			(212,888	)
Net proceeds from student loan repayments, claims, capitalized interest, participations, and other			1,177,455				1,061,510
Proceeds from sale of student loans			341				1,267,826
Proceeds from sale of student loans to a related party			40,033				—
Purchases of property and equipment, net			(444	)			(3,721	)
Increase in restricted cash and investments, net			(85,208	)			(80,066	)
Purchases of equity method investments			—				(2,988	)
Business acquisition — contingent consideration			—				(18,000	)
Net cash flows from investing activities — continuing operations			(355,527	)			531,368
Net cash flows from investing activities — discontinued operations			—				—
Net cash (used in) provided by investing activities			(355,527	)			531,368
Cash flows from financing activities:
Payments on bonds and notes payable			(2,184,109	)			(5,444,408	)
Proceeds from issuance of bonds and notes payable			2,584,680				4,761,143
(Payments) proceeds from issuance of notes payable due to a related party, net			(21,520	)			9,269
Payments of debt issuance costs			(2,830	)			(14,634	)
Dividends paid			—				(3,458	)
Proceeds from issuance of common stock			231				423
Repurchases of common stock			(62	)			(667	)
Payments received on employee stock notes receivable			101				575
Net cash flows from financing activities — continuing operations			376,491				(691,757	)
Net cash flows from financing activities — discontinued operations			—				—
Net cash provided by (used in) financing activities			376,491				(691,757	)
Net increase in cash and cash equivalents			176,980				26,708
Cash and cash equivalents, beginning of period			189,847				111,746
Cash and cash equivalents, end of period		$	366,827				138,454
Supplemental disclosures of cash flow information:
Interest paid		$	294,041				589,578
Income taxes paid, net of refunds		$	30,299				14,126

See accompanying notes to consolidated financial statements.

NELNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information as of June 30, 2009 and for the three and six months ended
June 30, 2009 and 2008 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 June 30, 2009 and for the three and six months ended June 30, 2009 and 2008 have been prepared on the same basis as the audited consolidated financial statements for the year ended December 31, 2008 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 six months ended June 30, 2009 are not necessarily indicative of the results for the year ending December 31, 2009. 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, 2008. Certain amounts from 2008 have been reclassified to conform to the current period presentation. Management has evaluated subsequent events, and the impact on the reported results and disclosures, through August 10, 2009, which is the date these financial statements were filed with the Securities and Exchange Commission.

2. Restructuring Charge

During the second quarter of 2009, the Company adopted a plan to further streamline its operations by continuing to reduce its geographic footprint and consolidate servicing operations and related support services.

Management has developed a restructuring plan that will result in lower costs and provide enhanced synergies through cross training, career development, and simplified communications. The Company will simplify its operating structure to leverage its larger facilities and technology by closing certain offices and downsizing its presence in certain geographic locations. Approximately 300 associates will be impacted by this restructuring plan. However, the majority of these functions will be relocated to the Company’s Lincoln headquarters and Denver offices. Implementation of the plan began immediately and is expected to be substantially complete during the second quarter of 2010.

The Company estimates that the charge to earnings associated with this restructuring plan will be fully recognized by December 31, 2010 and will total approximately $9.2 million, consisting of approximately $5.7 million in severance costs and approximately $3.5 million in contract terminations, of which approximately $5.4 million are expected to be recognized in 2009. During the three month period ended June 30, 2009, the Company recorded charges of $2.8 million. Selected information relating to the restructuring charge follows:

		Employee
		termination				Lease
		benefits				terminations				Total
Restructuring costs recognized during the three month period ended June 30, 2009		$	1,482	(a)			1,291	(b)			2,773
Cash payments			672				—				672
Restructuring accrual as of June 30, 2009		$	810				1,291				2,101

Selected information relating to the restructuring charge by operating segment and Corporate Activity and Overhead follows:

		Restructuring
		costs
		recognized
		during the three								Restructuring
		month period ended				Cash				accrual as of
Operating segment		June 30, 2009				payments				June 30, 2009
Student Loan and Guaranty Servicing		$	1,998				186				1,812
Tuition Payment Processing and Campus Commerce			—				—				—
Enrollment Services			—				—				—
Software and Technical Services			422				273				149
Asset Generation and Management			—				—				—
Corporate Activity and Overhead			353				213				140
		$	2,773				672				2,101

						Restructuring
						costs recognized				Remaining
		Estimated				during the three				restructuring costs
		total restructuring				month period ended				expected to be
Operating segment		costs				June 30, 2009				recognized
Student Loan and Guaranty Servicing		$	6,752				1,998				4,754
Tuition Payment Processing and Campus Commerce			—				—				—
Enrollment Services			—				—				—
Software and Technical Services			1,066				422				644
Asset Generation and Management			—				—				—
Corporate Activity and Overhead			1,418				353				1,065
		$	9,236				2,773				6,463

In 2007 and 2008, the Company recorded restructuring charges related to certain legislative events and disruptions in the capital markets. As a result of the restructurings, the Company incurred expenses related to severance, contract terminations, and impairment of long-lived assets. These restructuring plans were completed by management in December 2007 and January 2008. However, an accrual related to certain lease terminations remains. Information relating to such accrual follows:

Restructuring accrual as of December 31, 2008		$	3,480
Cash payments			(228	)
Restructuring accrual as of March 31, 2009			3,252
Cash payments			(228	)
Adjustment from initial estimate of charges (a)			515
Restructuring accrual as of June 30, 2009		$	3,539

3. Student Loans Receivable and Allowance for Loan Losses

Student loans consist of federally insured student loans, non-federally insured student loans, and student loan participations. If the Company has the ability and intent to hold loans for the foreseeable future, such loans are held for investment and, carried at amortized cost. Amortized cost includes the unamortized premiums and capitalized origination costs and fees, all of which are amortized to interest income. Loans which are held-for-investment also have an allowance for loan loss as needed. Any loans the Company has the ability and intent to sell are classified as held for sale and are carried at the lower of cost or fair value. Loans which are held-for-sale do not have the associated premium and origination costs and fees amortized into interest income and there is also no related allowance for loan losses.

As of June 30, 2009, the Company had $1.7 billion of Federal Family Education Loan Program (“FFELP”) loans classified as held for sale. These loans are funded using the Department of Education’s Loan Participation Program (the “Participation Program”) and are expected to be sold to the Department of Education (the “Department”) under the Department’s Loan Purchase Commitment Program (the “Purchase Program”) during 2009. Under the Purchase Program, the Department will purchase loans at a price equal to the sum of (i) par value, (ii) accrued interest, (iii) the one percent origination fee paid to the Department, and (iv) a fixed amount of $75 per loan. Upon selling the $1.7 billion in loans held for sale, the Company expects to recognize a gain of approximately $31 million to $34 million. The Company plans to continue to use the Participation and Purchase Programs to fund loans originated through the 2009-2010 academic year (see note 4 for additional information related to the Department’s Participation and Purchase Programs).

Student loans receivable consisted of the following:

		As of				As of
		June 30, 2009				December 31, 2008
Federally insured loans — held-for-investment		$	23,367,777				24,787,941
Federally insured loans — held-for-sale			1,731,040				—
Non-federally insured loans			200,722				273,108
			25,299,539				25,061,049
Unamortized loan premiums and deferred origination costs — held-for-investment			371,072				402,881
Unamortized loan premiums and deferred origination costs — held-for-sale			18,250				—
Allowance for loan losses – federally insured loans (held-for-investment)			(28,093	)			(25,577	)
Allowance for loan losses – non-federally insured loans			(21,907	)			(25,345	)
		$	25,638,861				25,413,008
Allowance for federally insured loans — held-for-investment as a percentage of such loans			0.12	%			0.10	%
Allowance for non-federally insured loans as a percentage of such loans			10.91	%			9.28	%
Total allowance as a percentage of the ending balance of total loans (excluding loans held-for-sale)			0.21	%			0.20	%

The Company has provided for an allowance for loan losses related to its student loan portfolio. Activity in the allowance for loan losses is shown below:

		Three months ended June 30,								Six months ended June 30,
		2009				2008				2009				2008
Beginning balance		$	48,497				46,137				50,922				45,592
Provision for loan losses			8,000				6,000				15,500				11,000
Loans charged off, net of recoveries			(5,197	)			(4,228	)			(9,102	)			(7,933	)
Sale of loans			(1,300	)			—				(7,320	)			(750	)
Ending balance		$	50,000				47,909				50,000				47,909

Loan Sales

During 2008 and the six months ended June 30, 2009, the Company sold federally insured student loans to third parties in order to reduce the amount of student loans remaining under the Company’s multi-year committed financing facility for FFELP loans, which contains certain equity support provisions and has an expiration date in May 2010 (see note 4 for additional information related to the FFELP warehouse facility).

On March 31, 2008, the Company sold $857.8 million (par value) of federally insured student loans resulting in the recognition of a loss of $30.4 million. In addition, on April 8, 2008, the Company sold $428.6 million (par value) of federally insured student loans. The portfolio of student loans sold on April 8, 2008 was presented as “held for sale” on the March 31, 2008 consolidated balance sheet and was valued at the lower of cost or fair value. The Company recognized a loss of $17.1 million during the three month period ended March 31, 2008 as a result of marking these loans to fair value.

During the three and six months ended June 30, 2009, the Company sold $20.0 million (par value) and $40.0 million (par value), respectively, of federally insured student loans to Union Bank & Trust Company (“Union Bank”), an entity under common control with the Company, resulting in the recognition of losses of $0.2 million and $0.4 million, respectively.

In addition, during the three and six months ended June 30, 2009, the Company participated $14.5 million and $65.0 million, respectively, of non-federally insured loans to third parties. Loans participated under these agreements qualify as sales pursuant to the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS No. 140”). Accordingly, the participation interests sold are not included on the Company’s consolidated balance sheet. The loss on the sale of these loans was not material. Per the terms of the servicing agreements, the Company’s servicing operations are obligated to repurchase loans subject to the participation interests when such loans become 60 or 90 days delinquent. The activity in the accrual account related to this repurchase obligation, which is included in “other liabilities” in the accompanying consolidated balance sheet, is detailed below.

		Three months ended June 30,								Six months ended June 30,
		2009				2008				2009				2008
Beginning balance		$	5,500				—				—				—
Transfer from allowance for loan losses			1,300				—				6,800				—
Reserve for repurchase of delinquent loans (a)			800				—				800				—
Ending balance		$	7,600				—				7,600				—

4. Bonds and Notes Payable

The following tables summarize outstanding bonds and notes payable by type of instrument:

		As of June 30, 2009
		Carrying				Interest rate
		amount				range		Final maturity
Variable-rate bonds and notes (a):
Bonds and notes based on indices		$	20,063,227			0.61% – 6.90%		09/25/13 – 06/25/41
Bonds and notes based on auction or remarketing			2,606,740			0.46% – 2.96%		11/01/09 – 07/01/43
Total variable-rate bonds and notes			22,669,967
Commercial paper — FFELP facility (b)			420,936			0.32% – 1.13%		05/09/10
Fixed-rate bonds and notes (a)			188,797			5.40% – 6.50%		11/01/09 – 05/01/29
Unsecured fixed rate debt			402,864			5.125% and 7.40%		06/01/10 and 09/15/61
Unsecured line of credit			691,500			0.79% – 0.85%		05/08/12
Department of Education Participation			1,741,481			1.24%		09/30/09
Department of Education Conduit			1,023,600			0.52%		05/08/14
Other borrowings			30,428			0.32% – 5.10%		01/01/10 – 11/01/15
		$	27,169,573

As of December 31, 2008

Carrying

Interest rate

amount

range

Final maturity

Variable-rate bonds and notes (a):

Bonds and notes based on indices

$

20,509,073

0.75% – 5.02%

09/25/13 – 06/25/41

Bonds and notes based on auction or remarketing

2,713,285

0.00% – 6.00%

11/01/09 – 07/01/43

Total variable-rate bonds and notes

23,222,358

Commercial paper — FFELP facility (b)

1,445,327

1.32% – 2.94%

05/09/10

Commercial paper — private loan facility (b)

95,020

2.49%

03/14/09

Fixed-rate bonds and notes (a)

202,096

5.30% – 6.68%

11/01/09 – 05/01/29

Unsecured fixed rate debt

475,000

5.125% and 7.40%

06/01/10 and 09/15/61

Unsecured line of credit

691,500

0.98% – 2.41%

05/08/12

Department of Education Participation

622,170

3.37%

09/30/09

Other borrowings

34,488

1.25% – 5.47%

05/22/09 – 11/01/15

$

26,787,959

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 financing vehicles are loan warehouse facilities, asset-backed securitizations, and the government’s Participation and Conduit Programs (as described below).

Most 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. The student loan interest margin notes, included in fixed rate bonds and notes in the above tables, are secured by the rights to residual cash flows from certain variable rate bonds and notes and fixed rate notes. Certain variable rate bonds and notes and fixed rate bonds are secured by financial guaranty insurance policies or a letter of credit and reimbursement agreement issued by Municipal Bond Investors Assurance Corporation, Ambac Assurance Corporation, and State Street.

On July 31, 2008, the Company did not renew its liquidity provisions on its FFELP loan warehouse facility. Accordingly, the facility became a term facility and no new loan originations could be funded with this facility. In August 2008, the Company began to fund FFELP student loan originations for the 2008-2009 academic year pursuant to the Department’s Participation Program and an existing participation agreement with Union Bank. In May 2009, the Company began to fund FFELP loans pursuant to the Department’s program under which it finances eligible FFELP Stafford and PLUS loans in a conduit vehicle established to provide funding for student lenders (the “Conduit Program”).

Loan warehouse facilities

Student loan warehousing has historically allowed the Company to buy and manage student loans prior to transferring them into more permanent financing arrangements. To support its funding needs on a short-term basis, the Company historically relied upon a multi-year committed facility for FFELP loans.

FFELP Warehouse Facility

The Company’s multi-year committed facility for FFELP loans terminates in May 2010 and was supported by 364-day liquidity which was up for renewal on May 9, 2008. The Company obtained an extension on this renewal until July 31, 2008. On July 31, 2008, the Company did not renew the liquidity provisions of this facility. Accordingly, as of July 31, 2008, the facility became a term facility with a final maturity date of May 9, 2010. Pursuant to the terms of the agreement, since liquidity was not renewed, the Company’s cost of financing under this facility increased 10 basis points. The agreement also includes provisions which allow the banks to charge a rate equal to LIBOR plus 128.5 basis points if they choose to finance their portion of the facility with sources of funds other than their commercial paper conduit.

The terms and conditions of the Company’s warehouse facility for FFELP loans provides for formula based advance rates based on market conditions. While the Company does not believe that the loan valuation formula is reflective of the actual fair value of its loans, it is subject to compliance with such mark-to-formula provisions of the warehouse facility agreement. As of December 31, 2008, the Company had $1.6 billion of student loans in the facility, $1.4 billion borrowed under the facility, and $280.6 million posted as equity funding support for this facility.

On March 26, 2009, the Company completed a privately placed asset-backed securitization of $294.6 million. Subsequent to March 31, 2009, the Company used the proceeds from the sale of these notes and additional funds of approximately $10 million to purchase approximately $305 million of principal and interest on student loans, which were previously financed under the Company’s FFELP warehouse facility.

In June 2009, the Company accessed the Department’s Conduit Program (as further discussed below) to fund approximately $790 million of principal and interest on student loans, which were previously financed under the Company’s FFELP warehouse facility. The Company is permitted to fund 97% of the principal and interest expected to be capitalized. Accordingly, the Company borrowed approximately $763 million under the Conduit Program for purposes of refinancing loans in the FFELP warehouse facility. Excess amounts needed to fund the remaining 3% of the student loan balances were contributed by the Company.

Removing student loans from the FFELP warehouse facility as a result of the privately placed asset-backed securitization and Conduit Program allowed the Company to withdraw cash posted as equity funding support for the FFELP facility. As of June 30, 2009, the Company had $403.7 million of student loans in the facility, $420.9 million borrowed under the facility, and $62.8 million posted as equity funding support.

On August 3, 2009, the Company entered into a new FFELP warehouse facility (the “2009 FFELP Warehouse Facility”). The 2009 FFELP Warehouse Facility has a maximum financing amount of $500.0 million, with a revolving financing structure supported by 364-day liquidity provisions, which expire on August 2, 2010. The final maturity date of the facility is August 3, 2012. In the event the Company is unable to renew the liquidity provisions by August 2, 2010, 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 August 3, 2012. The Company plans to utilize the new facility to refinance the remaining student loans in the Company’s prior FFELP warehouse facility that expires in May 2010. Refinancing these loans will allow the Company to withdraw all remaining equity funding support from the prior FFELP warehouse facility.

The 2009 FFELP Warehouse Facility provides for formula based advance rates depending on FFELP loan type. The advance rates for collateral may increase or decrease based on market conditions. The all-in pricing for the facility during the first year (including up-front fees and other costs to structure the facility) is expected to be just below the conduit’s commercial paper rate plus 1%. The facility contains financial covenants relating to levels of the Company’s consolidated net worth, ratio of adjusted EBITDA to corporate debt interest, and unencumbered cash. Any violation of these covenants could result in a requirement for the immediate repayment of any outstanding borrowings under the facility. Unlike the Company’s prior FFELP warehouse facility, the new facility does not require the Company to refinance or remove a percentage of the pledged student loan collateral on an annual basis.

Private Loan Warehouse Facility

On February 25, 2009, the Company paid $91.5 million on the outstanding debt of its private loan warehouse facility with operating cash and terminated the facility. Beginning in January 2008, the Company suspended private student loan originations.

Asset-backed securitizations

As part of the Company’s issuance of asset-backed securities in March 2008 and May 2008, due to credit market conditions when these notes were issued, the Company purchased the Class B subordinated notes of $36 million (par value) and $41 million (par value), respectively. These notes are not included on the Company’s consolidated balance sheet. If the credit market conditions improve, the Company anticipates selling these notes to third parties. Upon a sale 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” on the Company’s consolidated balance sheet. Unless there is a significant market improvement, the Company believes the market value of such notes will be less than par value. The difference between the par value and market value would be recognized by the Company as interest expense over the life of the bonds.

Department of Education’s Loan Participation and Purchase Commitment Programs

In August 2008, the Department implemented the Purchase Program and the Participation Program pursuant to the Ensuring Continued Access to Student Loans Act of 2008 (“ECASLA”). Under the Department’s Purchase Program, the Department will purchase loans at a price equal to the sum of (i) par value, (ii) accrued interest, (iii) the one percent origination fee paid to the Department, and (iv) a fixed amount of $75 per loan. Under the Participation Program, the Department provides interim short term liquidity to FFELP lenders by purchasing participation interests in pools of FFELP loans. FFELP lenders are charged a rate of commercial paper plus 50 basis points on the principal amount of participation interests outstanding. Loans funded under the Participation Program for the 2008-2009 academic year must be either refinanced by the lender or sold to the Department pursuant to the Purchase Program prior to September 30, 2009. To be eligible for purchase or participation under the Department’s programs, loans were originally limited to FFELP Stafford or PLUS loans made for the academic year 2008-2009, first disbursed between May 1, 2008 and July 1, 2009, with eligible borrower benefits.

On October 7, 2008, legislation was enacted to extend the Department’s authority to address FFELP student loans made for the 2009-2010 academic year and allowing for the extension of the Participation Program and Purchase Program from September 30, 2009 to September 30, 2010. The Department indicated that loans for the 2008-2009 academic year which are funded under the Department’s Participation Program will need to be refinanced or sold to the Department prior to September 30, 2009. On November 8, 2008, the Department announced the replication of the terms of the Participation and Purchase Programs, in accordance with the October 7, 2008 legislation, which will include FFELP student loans made for the 2009-2010 academic year.

As of June 30, 2009, the Company had $1.7 billion of FFELP loans funded using the Participation Program, which are classified as held for sale on the Company’s consolidated balance sheet. These loans are expected to be sold to the Department under its Purchase Program in 2009. The Company plans to continue to use the Participation and Purchase Programs to fund loans through the 2009-2010 academic year.

Department of Education’s Conduit Program

In January 2009, the Department published summary terms under which it will finance eligible FFELP Stafford and PLUS loans in a conduit vehicle established to provide funding for student lenders. Loans eligible for the Conduit Program must be first disbursed on or after October 1, 2003, but not later than June 30, 2009, and fully disbursed before September 30, 2009, and meet certain other requirements. The Conduit Program was launched on May 11, 2009. Funding for the Conduit Program is provided by the capital markets at a cost based on market rates, with the Company being advanced 97 percent of the student loan face amount. The Conduit Program has a term of five years and expires on May 8, 2014. The Student Loan Short-Term Notes (“Student Loan Notes”) issued by the Conduit Program are supported by a combination of (i) notes backed by FFELP loans, (ii) the Liquidity Agreement with the Federal Financing Bank, and (iii) the Put Agreement provided by the Department. If the conduit does not have sufficient funds to pay all Student Loan Notes, then those Student Loan Notes will be repaid with funds from the Federal Financing Bank. The Federal Financing Bank will hold the notes for a short period of time and, if at the end of that time, the Student Loan Notes still cannot be paid off, the underlying FFELP loans that serve as collateral to the Conduit Program will be sold to the Department through the Put Agreement at a price of 97% of the face amount of the loans. As of June 30, 2009, the Company had $1.1 billion of student loans funded through the Conduit Program and $1.0 billion borrowed under the facility.

Union Bank Participation Agreement

The Company maintains an agreement with Union Bank, as trustee for various grantor trusts, under which Union Bank has agreed to purchase from the Company participation interests in student loans (the “FFELP Participation Agreement”). The Company has the option to purchase the participation interests from the grantor trusts at the end of a 364-day term upon termination of the participation certificate. As of June 30, 2009 and December 31, 2008, $786.3 million and $548.4 million, respectively, of loans were subject to outstanding participation interests held by Union Bank, as trustee, under this agreement. The agreement automatically renews annually and is terminable by either party upon five business days notice. This agreement provides beneficiaries of Union Bank’s grantor trusts with access to investments in interests in student loans, while providing liquidity to the Company on a short-term basis. The Company can participate loans to Union Bank to the extent of availability under the grantor trusts, up to $750 million or an amount in excess of $750 million if mutually agreed to by both parties. Loans participated under this agreement qualify as a sale pursuant to the provisions of SFAS No. 140. Accordingly, the participation interests sold are not included on the Company’s consolidated balance sheet.

Unsecured Line of Credit

The Company has a $750.0 million unsecured line of credit that terminates in May 2012. As of June 30, 2009, there was $691.5 million outstanding on this line. The weighted average interest rate on this line of credit was 0.80% as of June 30, 2009. Upon termination in 2012, there can be no assurance that the Company will be able to maintain this line of credit, find alternative funding, or increase the amount outstanding under the line, if necessary. The lending commitment under the Company’s unsecured line of credit is provided by a total of thirteen banks, with no individual bank representing more than 11% of the total lending commitment. The bank lending group includes Lehman Brothers Bank (“Lehman”), a subsidiary of Lehman Brothers Holdings Inc., which represents approximately 7% of the lending commitment under the line of credit. On September 15, 2008, Lehman Brothers Holdings Inc. filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code. Since the bankruptcy filing, the Company has experienced funding delays from Lehman for its portion of the lending commitment under the line of credit and the Company does not expect that Lehman will fund future borrowing requests. As of June 30, 2009, excluding Lehman’s lending commitment, the Company has $51.2 million available for future use under its unsecured line of credit.

The 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-guaranteed loans in the Company’s portfolio

As of June 30, 2009, 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 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 2009 FFELP Warehouse Facility 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.

Debt Purchases

During the first and second quarters of 2009, the Company purchased $34.9 million and $35.5 million, respectively, of its 5.125% Senior Notes due 2010 (the “2010 Notes”) for a purchase price of $26.8 million and $31.1 million, respectively. These transactions resulted in gains of $8.1 million and $4.4 million, respectively. On July 28, 2009, the Company purchased $102.6 million of the 2010 Notes at par. Subsequent to this transaction, the Company has $102.0 million of 2010 Notes outstanding.

During the second quarter of 2009, the Company purchased $1.75 million of its Junior Subordinated Hybrid Securities for a purchase price of $0.35 million, which resulted in a gain of $1.4 million.

Subsequent to June 30, 2009, the Company repurchased $21.6 million of certain asset-backed securities for a purchase price of $19.3 million, which resulted in the Company recording a gain of $2.3 million in the third quarter of 2009.

Any gains recorded by the Company from the purchase of debt are included in “other income” on the Company’s consolidated statement of operations.

5. 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’s primary market risk exposure arises from fluctuations in its borrowing and lending rates, the spread between which could impact the Company due to shifts in market interest rates. Because the Company generates a significant portion of its earnings from its student loan spread, the interest rate sensitivity of the balance sheet is a key profitability driver. 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.

The Company issues asset-backed securities, the vast majority being variable rate, to fund its student loan assets. The variable rate debt is generally indexed to 3-month LIBOR, set by auction, or through a remarketing process. The income generated by the Company’s student loan assets is generally driven by short term indices (treasury bills, commercial paper, and certain fixed rates) that are different from those which affect the Company’s liabilities (generally LIBOR), which creates basis risk. Moreover, the Company also faces repricing risk due to the timing of the interest rate resets on its liabilities, which may occur as infrequently as every quarter, and the timing of the interest rate resets on its assets, which generally occurs 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.

In using different index types and different index reset frequencies to fund assets, the Company is exposed to interest rate risk in the form of basis risk and repricing risk, which, as noted above, is the risk that the different indices may reset at different frequencies, or will not move in the same direction or with the same magnitude. While these indices are short term with rate movements that are highly correlated over a longer period of time, they have recently become less correlated. Due to capital market dislocations or other factors not within the Company’s control, there can be no assurance the indices will regain their high level of correlation in the future.

The Company has used derivative instruments to hedge the repricing risk due to the timing of the interest rate resets on its assets and liabilities. The Company has entered into basis swaps in which the Company (i) receives three-month LIBOR set discretely in advance and pays a daily weighted average three-month LIBOR less a spread as defined in the agreements (the “Average/Discrete Basis Swaps”); and (ii) receives three-month LIBOR and pays one-month LIBOR plus or minus a spread as defined in the agreements (the “1/3 Basis Swaps”).

However, the Company does not generally hedge the basis risk due to the different interest rate indices associated with its assets and liabilities, since the derivatives needed to hedge this risk are generally illiquid or non-existent and the relationship between the indices for most of the Company’s assets and liabilities has been highly correlated over a long period of time.

As of June 30, 2009, the Company had approximately $24.0 billion of FFELP loans indexed to three-month financial commercial paper rate and $20.1 billion of debt indexed to LIBOR. Due to the unintended consequences of government intervention in the commercial paper markets and limited issuances of qualifying financial commercial paper, the relationship between the three-month financial CP and LIBOR rates has been distorted and volatile. To address this issue, the Department announced that for purposes of calculating the FFELP loan index from October 27, 2008 to December 31, 2008, the Federal Reserve’s Commercial Paper Funding Facility rate was used for those days in which no three-month financial commercial paper rate was available. This action partially mitigated the volatility between CP and LIBOR during the fourth quarter of 2008. However, the Department did not implement a similar methodology for the first and second quarters of 2009, which negatively impacted the Company’s interest income earned on its student loan portfolio.

The following table summarizes the Company’s basis swaps outstanding as of June 30, 2009 and December 31, 2008 used by the Company to hedge the repricing risk due to the timing of the interest rate resets on its assets and liabilities.

		As of June 30, 2009
		Notional amount
		Average/Discrete
Maturity		Basis Swaps				1/3 Basis Swaps (c)
2009 (a)		$	7,000,000				—
2011 (b)			6,000,000				—
2018			—				1,300,000
2019			—				500,000
2021			—				250,000
2023			—				1,250,000
2024			—				250,000
2028			—				100,000
		$	13,000,000				3,650,000