10-Q 1 nelnet1.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the transition period from ------------------------------------------------- Commission file number 333-08929 ---------------------------------------------------- NELNET STUDENT LOAN CORPORATION-1 --------------------------------- (Exact name of registrant as specified in its charter) NEVADA 86-0817755 ------------------------------ ------------------ State or other jurisdiction of (I.R.S. Employer incorporation or organization Identification No.) 121 South 13th Street, Suite 301, Lincoln, Nebraska 68508 ---------------------------------------------------------- (Address of principal executive offices) (Zip Code) (402) 475-7272 -------------- (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 [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class of Stock Amount Outstanding -------------- ------------------ Common Stock, No par value 1,000 Shares of Common Stock as of November 14, 2002 1 NELNET STUDENT LOAN CORPORATION-1 INDEX Page No. -------- PART I. - FINANCIAL INFORMATION Item 1. Financial Statements Balance Sheets as of September 30, 2002 and December 31, 2001........................................3 Statements of Income for the three months and nine months ended September 30, 2002 and 2001........................4 Statement of Stockholder's Equity for the nine months ended September 30, 2002.................................5 Statements of Cash Flows for the nine months ended September 30, 2002 and 2001..............................6 Notes to Financial Statements..............................7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 8 Item 3. Quantitative and Qualitative Disclosures About Market Risk ...11 Item 4. Controls and Procedures ......................................12 PART II. - OTHER INFORMATION Item 1. Legal Proceedings.............................................12 Item 2. Changes in Securities.........................................12 Item 3. Defaults upon Senior Securities...............................12 Item 4. Submission of Matters to a Vote of Security Holders...........12 Item 5. Other Information.............................................12 Item 6. Exhibits and Reports on Form 8-K..............................13 2

See accompanying notes to financial statements. 3

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See accompanying notes to financial statements. 6 NELNET STUDENT LOAN CORPORATION-1 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2002 -------------------------------------------------------------------------------- (1) BASIS OF PRESENTATION NELNET Student Loan Corporation-1 (the "Company"), formerly Union Financial Services - 1, Inc., was incorporated under the laws of the state of Nevada on February 28, 1996. The Company is a wholly owned subsidiary of NELnet, Inc. and a wholly owned indirect subsidiary of Nelnet Loan Services, Inc. (formerly UNIPAC Service Corporation), a privately held Nebraska Corporation. The accompanying financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") and, in the opinion of management, include all adjustments necessary for a fair presentation of the financial statements for each period shown. All such adjustments made are of a normal recurring nature, except when noted as extraordinary or nonrecurring. The balance sheet at December 31, 2001 is derived from the audited balance sheet as of that date. All other financial statements are unaudited. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to SEC rules and regulations. Management believes that the disclosures made are adequate and that the information is fairly presented. The results for the interim periods are not necessarily indicative of the results for the full year. These financial statements should be read in conjunction with the financial statements and notes thereto in the Company's Annual Report on Form 10-K. (2) STUDENT LOAN INTEREST MARGIN SECURITIES TRANSACTION Effective April 3, 2001, NELnet Group Trust-I (the "Trust") issued student loan interest margin securities. In connection with that transaction, the Company transferred to the Trust its rights to receive future excess residual cash flows and the administrative fees that are permitted to be withdrawn from the Company's trust estate created under the Company's Trust Indenture. Those revenues, along with revenues from similar transfers made by an affiliate of the Company, will be used by the Trust to make payments of principal and interest due on the Trust's securities. NELnet, Inc., which is the parent and sole owner of the Company along with its affiliates, is the sole beneficial owner of the Trust. The proceeds from the issuance of the Trust's securities which were attributed to the transfer to the Trust made by the Company were paid to NELnet, Inc. The future excess residual cash flows of the Company's trust estate represent funds which would normally be available for the payment of dividends by the Company to NELnet, Inc. After the obligations of the Trust are satisfied in full, NELnet, Inc. and its affiliates will receive any remaining excess cash flows as the sole beneficial owner of the Trust and will be reflected as dividends from the Company. NELnet, Inc. has agreed to provide the administrative services necessary for administration of the Company's trust estate. The Trust securities are not obligations of the Company or NELnet, Inc. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. GENERAL The Company was formed solely for the purpose of acquiring and holding student loans originated under the Federal Family Education Loan Program created by the Higher Education Act of 1965, as amended. The Company finances its purchases of student loans through the issuance of student loan asset-backed notes (the "Notes") and is an "asset-backed issuer" as that term is defined in Rule 15d-14(g) under the Securities Exchange Act of 1934. The Notes are limited obligations of the Company secured solely by the student loans and other assets in the trust estate created by the Indenture of Trust governing the issuance of the Notes. SIGNIFICANT ACCOUNTING POLICIES The notes to the audited financial statements contain a summary of the Company's significant accounting policies. Certain of these policies are considered to be important to the portrayal of the Company's financial condition, since they may require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. The Company's significant accounting policy is determining the level of the allowance for loan losses. Additional information about this policy can be found in Note 1 to the audited financial statements as of and for the year ended December 31, 2001. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses represents management's estimate of probable losses on Eligible Loans in the Trust Estate and pledged to repay the Notes. This evaluation process is subject to numerous estimates and judgments. In making such estimates and judgments, management considers such things as the value and character of loans outstanding, past loan loss experience and general economic conditions. The allowance for loan losses is determined via a process that begins with estimates of probable losses on Eligible Loans held in the Trust Estates, based upon a statistical analysis. Historical delinquencies and credit loss experience is applied to the current aging of the portfolio, together with analyses that reflect current trends and conditions. RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2001 REVENUES. Revenues for the three months ended September 30, 2002 consisted primarily of interest earned on student loans. Revenues from interest on student loans decreased by $5,620,627 from $23,201,109 for the three months ended September 30, 2001 to $17,580,482 for the three months ended September 30, 2002. The decrease in revenues is attributable to a declining interest rate environment during the current fiscal year along with a reduced investment in student loans. The Company's average net investment in student loans during the three months ended September 30, 2002 and 2001 was approximately $1,255,000,000 and $1,328,000,000, respectively, (excluding funds held by the Trustee) and the average effective annual interest rate of interest income on student loans during the three months ended September 30, 2002 and 2001 was 5.60% and 6.99%, respectively. The decrease in the effective annual interest rate of interest income on student loans is a direct result of the declining interest rate environment and the "floor rate" on the student loan assets being reset annually on July 1. Investment interest decreased by $283,208 from $493,934 for the three months ended September 30, 2001 to $210,726 for the three months ended September 30, 2002. The decrease in investment interest was a result of a decreased average restricted cash balance, which was used to acquire student loans along with lower interest rates on investments in the current fiscal year and a declining Reserve Fund balance. 8 EXPENSES. The Company's expenses consisted primarily of interest on the Company's outstanding Notes. Interest on the Company's outstanding Notes decreased by $5,662,619 from $15,407,020 for the three months ended September 30, 2001 to $9,744,401 for the three months ended September 30, 2002. This decrease in expenses is attributable to a decrease in interest rates during the current fiscal year and a lower outstanding Notes balance. For the three months ended September 30, 2002 and 2001, the Company's average Notes outstanding was approximately $1,340,000,000 and $1,429,000,000, respectively, and the average annual cost of borrowings was 2.91% and 4.31%, respectively. The decrease in the average annual cost of borrowings is a direct result of a declining interest rate environment. The Company also incurred loan servicing fees to a related party in the amount of $3,027,512 for the three months ended September 30, 2002, as compared to $3,173,166 for the three months ended September 30, 2001, a decrease of $145,654. Amortization of loan premiums increased by $1,448,221 from $1,789,417 for the three months ended September 30, 2001 to $3,237,638 for the three months ended September 30, 2002. This increase is attributable to an increase in the rate of amortization due to more prepayments and consolidations. INCOME TAX EXPENSE. The Company has recognized income tax expense of $71,223 for the three months ended September 30, 2002, compared to $572,310 for the three months ended September 30, 2001. The decrease in income tax expense was a result of a lower net income before income tax expense for the three months ended September 30, 2002. The effective tax rate utilized by the Company to recognize a provision for income tax expense was 36%. The effective tax rate may be adjusted in the future for changes to the corporate tax regulations. NET INCOME. The Company had net income of $126,619 for the three months ended September 30, 2002 and $1,017,440 for the three months ended September 30, 2001. The decrease in net income is a direct result of an increase in the amount recognized for amortization of loan premiums. Amortization of loan premiums out weighed any increase in net income that would have been attributable to a higher net interest margin on student loans due to the declining interest rates on the Notes during the period while the "floor rate" on the student loan assets is determined annually on July 1. Consequently, in a declining interest rate environment, the net interest margin on student loans increases and in a rising interest rate environment it decreases. The net interest margin on student loans increased by $41,992 from $7,794,089 (interest margin percentage of 2.35%) for the three months ended September 30, 2001 to $7,836,081 (interest margin percentage of 2.50%) for the three months ended September 30, 2002. NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2001 REVENUES. Revenues for the nine months ended September 30, 2002 consisted primarily of interest earned on student loans. Revenues from interest on student loans decreased by $17,391,920 from $77,841,660 for the nine months ended September 30, 2001 to $60,449,740 for the nine months ended September 30, 2002. The decrease in revenues is attributable to a declining interest rate environment during the current fiscal year along with a reduced investment in student loans. The Company's average net investment in student loans during the nine months ended September 30, 2002 and 2001 was approximately $1,274,000,000 and $1,349,000,000, respectively, (excluding funds held by the Trustee) and the average effective annual interest rate of interest income on student loans during the nine months ended September 30, 2002 and 2001 was 6.33% and 7.70%, respectively. The decrease in the effective annual interest rate of interest income on student loans is a direct result of the declining interest rate environment and the "floor rate" on the student loan assets being reset annually 9 on July 1. Investment interest decreased by $1,211,083 from $1,957,266 for the nine months ended September 30, 2001 to $746,183 for the nine months ended September 30, 2002. The decrease in investment interest was a result of a decreased average restricted cash balance, which was used to acquire student loans along with lower interest rates on investments in the current fiscal year and a declining Reserve Fund balance. EXPENSES. The Company's expenses consisted primarily of interest on the Company's outstanding Notes. Interest on the Company's outstanding Notes decreased by $23,980,027 from $54,278,884 for the nine months ended September 30, 2001 to $30,298,857 for the nine months ended September 30, 2002. This decrease in expenses is attributable to a decrease in interest rates during the current fiscal year and a lower outstanding Notes balance. For the nine months ended September 30, 2002 and 2001, the Company's average Notes outstanding was approximately $1,362,000,000 and $1,452,000,000, respectively, and the average annual cost of borrowings was 2.97% and 4.98%, respectively. The decrease in the average annual cost of borrowings is a direct result of a declining interest rate environment. The Company also incurred loan servicing fees to a related party in the amount of $9,289,711 for the nine months ended September 30, 2002, as compared to $9,416,407 for the nine months ended September 30, 2001, a decrease of $126,696. Amortization of loan premiums increased by $2,491,412 from $4,709,385 for the nine months ended September 30, 2001 to $7,200,797 for the nine months ended September 30, 2002. This increase is attributable to an increase in the rate of amortization due to more prepayments and consolidations. Provision for loan losses increased by $5,000, from $350,000 for the nine months ended September 30, 2001 to $355,000 for the nine months ended September 30, 2002. An increased provision expense was recognized in order to reflect the appropriate allowance amounts in relation to the estimated defaults. INCOME TAX EXPENSE. The Company has recognized income tax expense of $3,456,360 for the nine months ended September 30, 2002, compared to $2,255,656 for the nine months ended September 30, 2001. The increase in income tax expense was a result of a higher net income before income tax expense for the nine months ended September 30, 2002. The effective tax rate utilized by the Company to recognize a provision for income tax expense was 36%. The effective tax rate may be adjusted in the future for changes to the corporate tax regulations. NET INCOME. The Company had net income of $6,144,639 for the nine months ended September 30, 2002 and $4,010,055 for the nine months ended September 30, 2001. The increase in net income is attributable to a higher net interest margin on student loans due to the declining interest rates on the Notes during the period while the "floor rate" on the student loan assets is determined annually on July 1. Consequently, in a declining interest rate environment, the net interest margin on student loans increases and in a rising interest rate environment it decreases. The net interest margin on student loans increased by $6,588,107 from $23,562,776 (interest margin percentage of 2.33%) for the nine months ended September 30, 2001 to $30,150,883 (interest margin percentage of 3.16%) for the nine months ended September 30, 2002. For the nine months ended September 30, 2002, there were no unusual or infrequent events or transactions that materially affected the amount of reported income. LIQUIDITY AND CAPITAL RESOURCES Student loans held by the Company are pledged as collateral for the Notes under an Indenture of Trust, the terms of which provide for the retirement of all Notes from the proceeds of the student loans. Cash flows from payments on the student loans, together with proceeds of reinvestment of the income earned on student loans, are intended to provide cash sufficient to make all required payments of principal and interest on each outstanding series of the Notes. If current revenues are insufficient to pay principal and interest due on the 10 Notes, money in the Reserve Fund created under the Indenture is available for payment of amounts due. The Company has restricted cash held by the trustee of approximately $69,344,000 as of September 30, 2002. The restricted cash includes cash held by the trustee in an Acquisition and Revenue Fund of approximately $48,314,000 and cash held by the trustee in a Reserve Fund of approximately $21,030,000. All restricted cash is held by the trustee and can be used only for designated purposes. The Reserve Fund is fully funded under the terms of the Indenture. The Company had a net decrease in cash and cash equivalents of $80,943 for the nine months ended September 30, 2002. This net change consists of (1) net cash provided by operating activities of approximately $11,332,000 due primarily to an increase in net income and amortization of loan premiums, offset by a decrease in due to affiliates, (2) net cash provided by investing activities of approximately $56,058,000 due to the proceeds from student loan principal payments, net of student loan purchases and (3) net cash used in financing activities of $67,470,000 due to payments on the Notes, net of capital contributions by the parent. The Company purchased student loans, including unamortized premiums, from affiliates of approximately $23,700,000 for the nine months ended September 30, 2002 and $233,800,000 for the nine months ended September 30, 2001. No student loans were sold to affiliates for the nine months ended September 30, 2002 compared to approximately $229,000,000 of loans sold, including unamortized premiums, for the nine months ended September 30, 2001. These sales were made at amortized cost. It is anticipated that regular payments under the terms of the student loans, as well as early prepayment, will reduce the number of student loans held in the trust estate created under the Indenture. The Company is authorized under the Indenture to use principal receipts from student loans to purchase additional student loans until April 1, 2005. Thereafter, principal receipts from student loans will be used to redeem the Notes. The shelf registration of $1,500,000,000 is at full capacity and no additional notes will be issued. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's assets consist almost entirely of student loans. Variable rate student loans are subject to market risk in that the cash flows generated by the variable rate student loans can be affected by changes in interest rates. The variable rate student loans generally bear interest at a rate equal to the average bond equivalent rates of weekly auctions of 91-day Treasury bills (the "91 day Treasury Bill Rate") plus a margin specified for each variable rate student loan. Thus, if interest rates generally increase, the Company would expect to earn greater interest on its variable rate student loans, and if interest rates generally decrease, the Company would expect the interest that it earns to be reduced. The Company does not hold any of its assets for trading purposes. The Company attempts to manage its interest rate risk by funding its portfolio of variable rate student loans with variable rate debt instruments. The majority of the Notes bear interest at a variable rate that is reset periodically by means of auction procedures, or by reference to the London Interbank Offered Rate ("LIBOR") or a specified Treasury rate plus an applicable margin. By funding its variable rate student loans with variable rate Notes, the Company attempts to maintain a positive "spread" between the interest earned on its variable rate student loans and its interest payment obligations under the variable rate Notes. Thus, in an environment of generally declining interest rates, the Company should earn less interest on its variable rate student loans, but the interest expense on the variable rate Notes should also be lower. 11 The interest rates on each series of Auction Rate Notes is based generally on the outcome of each auction of such series of Notes. The interest rates on each series of LIBOR Rate Notes and Treasury Rate Notes is based generally on the LIBOR Rate or Treasury Rate then in effect for the applicable interest rate period. The variable rate student loans, however, generally bear interest at the 91-day Treasury Bill Rate plus margins specified for such variable rate student loans. As a result of the differences between the indices used to determine the interest rates on variable rate student loans and the interest rates on the variable rate Notes, there could be periods of time when the rates on variable rate student loans are inadequate to generate sufficient cash flow to cover the interest on the variable rate Notes and the expenses required to be paid under the Indenture. In a period of rapidly rising interest rates, LIBOR or auction rates may rise more quickly than the 91-day Treasury Bill Rate. If there is a decline in the rates on variable rate student loans, the funds deposited into the trust estate created under the Indenture may be reduced and, even if there is a similar reduction in the variable interest rates applicable to any series of Notes, there may not necessarily be a similar reduction in the other amounts required to be paid out of such funds (such as administrative expenses). There have been no material changes in the reported market risks faced by the Company since the end of its most recent fiscal year. ITEM 4. CONTROLS AND PROCEDURES Not applicable PART II. OTHER INFORMATION -------------------------- ITEM 1. LEGAL PROCEEDINGS. None ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. None ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None ITEM 5. OTHER INFORMATION. None 12 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K The following is a complete list of exhibits filed as part of this Form 10-Q. Exhibit numbers correspond to the numbers in the Exhibit Table of Item 601 of Regulation S-K. Exhibit No. Description ----------- ----------- 3.1 Articles of Incorporation of the Company (Incorporated by reference herein to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996). 3.2 Certificate of Amendment to the Articles of Incorporation of Union Financial Services-1, Inc. (Incorporated by reference to the Company's Quarterly Report on Form 10-Q dated September 30, 1999). 3.3 Bylaws of the Company (Incorporated by reference herein to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996). 4.1 Second Amended and Restated Indenture by and between the Company and Norwest Bank Minnesota, N.A. (Incorporated by reference herein to the Company's current report on Form 8-K, filed January 7, 1997). 4.2 Series 1996C Supplemental Indenture by and between the Company and Norwest Bank Minnesota, N.A. (Incorporated by reference herein to the Company's current report on Form 8-K, filed January 7, 1997). 4.2.1 1998 Supplemental Indenture by and between the Company and Zions First National Bank (Incorporated by reference herein to the Company's current report on Form 8-K, filed January 6, 1999). 4.2.2 Series 1999 Supplemental Indenture of Trust by and between the Company and Zions First National Bank (Incorporated by reference herein to the Company's current report on Form 8-K, filed July 8, 1999). 10.1 Servicing Agreement, dated as of July 1, 1999, by and between the Company and National Education Loan Network Inc. (Incorporated by reference herein to the Company's Registration Statement on Form S-3 (File No. 333-75693)). 10.2 Trust Agreement dated as of April 1, 2001, among NELNET Student Loan Corporation-1, MELMAC LLC, NELnet, Inc., The Chase Manhattan Bank and Wilmington Trust Company (Incorporated by reference herein to the Company's Quarterly Report on Form 10-Q dated June 30, 2001). 99.1 Certification Pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002of the Chief Executive Officer of the Company is filed herewith. 99.2 Certification Pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002of the Chief Financial Officer of the Company is filed herewith. 13 REPORTS ON FORM 8-K The Company did not file any reports on Form 8-K during the three months covered by this report. 14 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NELNET STUDENT LOAN CORPORATION-1 By: /s/ Stephen F. Butterfield ------------------------------------- Stephen F. Butterfield, President (Chief Executive Officer) By: /s/ Jeffrey Noordhoek ------------------------------------- Jeffrey Noordhoek, Treasurer (Principal Financial Officer) Date: November 14, 2002 15

NELNET STUDENT LOAN CORP 1 10-Q