10-Q 1 d15195.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 June 30, 2004 or |_| 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 333-104736 NELNET EDUCATION LOAN FUNDING, INC. (Exact name of registrant as specified in its charter) NEBRASKA 47-0809600 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 121 SOUTH 13TH STREET, SUITE 201 68508 LINCOLN, NEBRASKA (Zip Code) (Address of principal executive offices) (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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] As of July 31, 2004, there are 111 shares of common stock, $100 par value, outstanding. The registrant meets the condition set forth in General Instructions H(1)(a) and (b) of Form 10-Q and is therefore filing this form with the reduced disclosure format. NELNET EDUCATION LOAN FUNDING, INC. FORM 10-Q INDEX June 30, 2004 Part I. FINANCIAL INFORMATION Item 1. Financial Statements ......................................................................... 2 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ........ 7 Item 3. Quantitative and Qualitative Disclosures About Market Risk ................................... 13 Item 4. Controls and Procedures ...................................................................... 14 Part II. OTHER INFORMATION Item 1. Legal Proceedings ............................................................................ 14 Item 2. Changes in Securities and Use of Proceeds .................................................... 14 Item 3. Defaults Upon Senior Securities .............................................................. 14 Item 4. Submission of Matters to a Vote of Security Holders .......................................... 14 Item 5. Other Information ............................................................................ 14 Item 6. Exhibits and Reports on Form 8-K ............................................................. 15 Signatures .................................................................................................... 18

PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS NELNET EDUCATION LOAN FUNDING, INC. (A Wholly Owned Subsidiary of National Education Loan Network, Inc.) Balance Sheets

See accompanying notes to financial statements. 2 NELNET EDUCATION LOAN FUNDING, INC. (A Wholly Owned Subsidiary of National Education Loan Network, Inc.) Statements of Income (unaudited)

See accompanying notes to financial statements. 3 NELNET EDUCATION LOAN FUNDING, INC. (A Wholly Owned Subsidiary of National Education Loan Network, Inc.) Statements of Cash Flows (unaudited)

See accompanying notes to financial statements. 4 NELNET EDUCATION LOAN FUNDING, INC. (A Wholly Owned Subsidiary of National Education Loan Network, Inc.) Notes to Financial Statements (Information at June 30, 2004 and for the three and six months ended June 30, 2004 and 2003 is unaudited) 1. Basis of Presentation Nelnet Education Loan Funding, Inc. (the "Company") is a wholly-owned subsidiary of National Education Loan Network, Inc. ("NELN" or the "Parent") and a wholly-owned indirect subsidiary of Nelnet, Inc ("Nelnet"). The Parent is a holding company organized for the purpose of establishing and owning the stock of corporations like the Company engaged in the securitization of financial assets. The Parent also provides managerial and administrative support to the Company. The Company contracts the majority of its loan servicing with Nelnet. In addition, the Company files a consolidated tax return with Nelnet, the legal parent of NELN. The financial statements reflect income taxes computed as if the Company filed a separate tax return. Current income tax liabilities are recorded by the Company to its Parent as if the Company were a separate tax-paying entity. The accompanying unaudited financial statements of the Company as of June 30, 2004 and for the three and six months ended June 30, 2004 and 2003 have been prepared on the same basis as the audited financial statements for the year ended December 31, 2003 and, in the opinion of the Company's management, the unaudited financial statements reflect all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of results of operations which might be expected for the entire year. 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 financial statements and accompanying notes. Actual results could differ from those estimates. Operating results for the three and six months ended June 30, 2004 are not necessarily indicative of the results for the year ending December 31, 2004. The unaudited financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2003. Certain amounts from 2003 have been reclassified to conform to the current period presentation. 2. Deferred Income A portion of the Company's Federal Family Education Loan Program ("FFELP" or "FFEL Program") loan portfolio is comprised of loans that are currently or were previously financed with tax-exempt obligations issued prior to October 1, 1993. Based upon provisions of the Higher Education Act of 1965, as amended, and related interpretations by the U.S. Department of Education (the "Department"), the Company is entitled to receive special allowance payments on these loans providing the Company with a 9.5% minimum rate of return. In May 2003, the Company sought confirmation from the Department regarding whether it was allowed to recognize the income based on the 9.5% minimum rate of return. While pending satisfactory resolution of this issue with the Department, the Company deferred recognition of the interest income that was generated by these loans in excess of income based upon the standard special allowance rate. In June 2004, after consideration of certain clarifying information received in connection with the guidance it had sought, including written and verbal communications with the Department, the Company concluded that the earnings process had been completed related to the special allowance payments on these loans and recognized $123.9 million of interest income. At December 31, 2003 and March 31, 2004, the amount of deferred excess interest income on these loans was approximately $43 million and approximately $79 million, respectively, and was included in other liabilities on the Company's balance sheet. In future periods, the Company will recognize the income from the special allowance payments on these loans as it is earned. 3. Allowance for Loan Losses The allowance for loan losses is estimated and established through a provision charged to expense. Losses are charged against the allowance when management believes the collectibility of the loan principal is unlikely. Recovery of amounts previously charged off is credited to the allowance for loan losses. The allowance for the Company's federally insured loan portfolio is based on periodic evaluations of the Company's loan portfolio considering past experience, trends in student loan claims rejected for payment by guarantors, changes to federal student loan programs, current economic conditions, and other relevant factors. The federal government guarantees 98% of principal and interest of federally insured student loans, which limits the Company's loss exposure to 2% of the outstanding balance of the Company's federally insured portfolio. 5 Effective June 1, 2004, Nelnet was designated as an Exceptional Performer by the Department in recognition of its exceptional level of performance in servicing FFEL Program loans. As a result of this designation, Nelnet's servicing customers receive 100% reimbursement on all eligible FFEL Program default claims submitted for reimbursement beginning June 1, 2004 and are not subject to the 2% risk sharing loss for eligible claims submitted after that date. Only FFEL Program loans that are serviced by Nelnet, as well as loans owned by the Company and serviced by other service providers designated as Exceptional Performers by the Department, are subject to the 100% reimbursement. At June 30, 2004, the majority of the Company's loans were serviced by a service provider designated as an Exceptional Performer. The majority of these loans (95%) are serviced by Nelnet. The Company is entitled to receive this benefit as long as its service providers continue to meet the required servicing standards published by the Department. Compliance with such standards is assessed on a quarterly basis. In June 2004, the Company's allowance for loan loss balance was reduced by $3.7 million and the provision for loan losses was similarly reduced to account for the estimated effects of the Exceptional Performer designations achieved by the Company's service providers. 4. Bonds and Notes Payable and Accounting for Derivatives On January 15, 2004 and April 29, 2004, the Company consummated debt offerings of student loan asset-backed notes of $1.0 billion each, with final maturity dates ranging from 2009 through 2039. The majority of notes issued in these transactions have variable interest rates based on a spread to LIBOR or reset under auction procedures. In conjunction with these offerings, the Company entered into certain interest rate cap financial instruments. The Company executed a 5.25% interest rate cap, effective January 30, 2004, with a notional amount of $800.0 million that terminates in February 2006. In addition, the Company executed two interest rate caps, effective April 29, 2004, with notional amounts of $450.0 million and $651.0 million that terminate in May 2006 and August 2019, respectively. The interest rate caps on these derivatives are 5.0% and 7.10%, respectively. The Company accounts for these interest rate caps under the provisions of Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133"). SFAS No. 133 establishes accounting and reporting standards for derivative instruments and hedging activities, as defined, including certain derivative instruments embedded in other contracts, and requires that an entity recognize all derivatives as either an asset or liability on the balance sheet and measure them at fair value. The fair value of the Company's interest rate caps are determined from market quotes from independent security brokers. At June 30, 2004, the fair market value of the Company's outstanding interest rate caps was $6.2 million, which is included in other assets on the accompanying balance sheet. The Company incorporates the use of derivative instruments to minimize the economic effect of interest rate volatility. The Company's goal is to manage interest rate sensitivity by modifying the repricing characteristics of certain liabilities so that movements in interest rates do not, on a material basis, adversely affect interest expense. The Company views this strategy as a prudent management of interest rate sensitivity. Management believes its derivative transactions are economically effective; however, they do not qualify for hedge accounting under SFAS No. 133. Changes in the fair value of derivative instruments that do not qualify for hedge accounting are reported in current period earnings. For the three and six months ended June 30, 2004, the Company recorded losses of $1.4 million and $2.2 million, respectively, related to the change in fair value of its outstanding interest rate caps. By using derivative instruments, the Company is exposed to credit and market risk. If the counterparty fails to perform, credit risk is equal to the extent of the fair value gain in a derivative. When the fair value of a derivative contract is positive, this generally indicates that the counterparty would owe the Company if the derivative was terminated. When the fair value of a derivative contract is negative, the Company would owe the counterparty if the derivative was terminated and, therefore, it has no credit risk. The Company minimizes the credit (or repayment) risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company's risk committee. The Company also maintains a policy of requiring that an International Swaps and Derivative Association Master Agreement govern all derivative contracts. Market risk is the adverse effect that a change in interest rates, or implied volatility rates, has on the value of a financial instrument. The Company manages market risk associated with interest rates by establishing and monitoring limits as to the types and degree of risk that may be undertaken. 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis provides information that the Company's management believes is relevant to an assessment and understanding of the results of operations and financial condition of the Company. The discussion should be read in conjunction with the Company's financial statements for the year ended December 31, 2003 included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. This report contains forward-looking statements and information that are based on management's current expectations as of the date of this document. When used in this report, the words "anticipate," "believe," "estimate," "intend," "expect," and similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to risks, uncertainties, assumptions, and other factors that may cause the actual results to be materially different from those reflected in such forward-looking statements. These factors include, among others, changes in the terms of student loans and the educational credit marketplace arising from the implementation of applicable laws and regulations and from changes in these laws and regulations, which may reduce the volume, average term, and costs of yields on student loans under the Federal Family Education Loan Program ("FFEL Program" or "FFELP") or result in loans being originated or refinanced under non-FFELP programs or may affect the terms upon which banks and others agree to sell FFELP loans to the Company. The Company could also be affected by changes in the demand for educational financing or in financing preferences of lenders, educational institutions, students and their families; changes in the general interest rate environment, and in the securitization markets for education loans, which may increase the costs or limit the availability of financings necessary to initiate, purchase, or carry education loans; losses from loan defaults; and changes in prepayment rates and credit spreads. The reader should not place undue reliance on forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. The Company is not obligated to publicly release any revisions to forward-looking statements to reflect events after the date of this Quarterly Report on Form 10-Q or unforeseen events. The Company The Company is a bankruptcy remote, special purpose corporation formed under the laws of the State of Nebraska. The Company was organized in 1998 to acquire the student loan assets and liabilities of Nebraska Higher Education Loan Program, Inc., a non-profit corporation that had previously operated as a qualified scholarship funding corporation under Section 150(d) of the Internal Revenue Code. In connection with that transaction, the Company assumed the obligations of Nebraska Higher Education Loan Program, Inc. to pay the principal and interest due on its outstanding student loan revenue bonds. When those obligations were assumed, the Company also received from Nebraska Higher Education Loan Program, Inc. an assignment of all of the student loans and other assets that had been pledged to secure their repayment, and certain other related assets. Since completing that transaction, the Company has issued additional series of student loan asset-backed notes and used the proceeds of those notes to finance additional portfolios of student loans. The Company is a wholly owned subsidiary of National Education Loan Network, Inc., which is a wholly owned subsidiary of Nelnet, Inc., a reporting company under the Securities Exchange Act of 1934. Prior to April 21, 2003, the Company was named NEBHELP, INC. General Description of the Business of the Company The Company is a special purpose corporation formed to engage in the business of originating, acquiring, financing, holding, and managing guaranteed education loans made to students and to parents of students under the Higher Education Act of 1965, as amended (the "Higher Education Act"). As a special purpose corporation, the Company may not engage in any activity other than: o originating, acquiring, financing, holding, and managing student loans and the other related assets, and the proceeds there from; o issuing bonds and notes; and o engaging in other activities related to the activities listed above. As of June 30, 2004, the Company held a student loan portfolio of $4.9 billion, consisting entirely of loans originated under the FFEL Program. As of June 30, 2004, the Company had issued and outstanding $5.1 billion of debt 7 obligations, the proceeds of which were used to finance its student loan portfolio. The Company's student loans, and certain other assets, are pledged to secure payment of its debt obligation under various indentures of trust. The Company originates new student loans for its portfolio, participates in student loans, and purchases student loans from other holders, including affiliated companies. When the Company originates student loans or when it acquires student loans from other holders, the Company engages one or more "eligible lenders," as defined in the Higher Education Act, to act as trustees to hold title to all such originated and acquired student loans. These eligible lender trustees hold the legal title to the student loans, and the Company holds 100% of the beneficial interests in those loans. Significant Drivers and Trends The Company's earnings and earnings growth are directly affected by the size of its portfolio of student loans, the interest rate characteristics of its portfolio, the costs associated with financing and managing its portfolio, and the costs associated with the origination and acquisition of the student loans in the portfolio. In addition to the impact of growth of the Company's student loan portfolio, the Company's results of operations and financial condition may be materially affected by, among other things, changes in: o applicable laws and regulations that may affect the volume, terms, effective yields, or refinancing options of education loans; o demand for education financing and competition within the student loan industry; o the interest rate environment, funding spreads on the Company's financing programs, and access to capital markets; and o prepayment rates on student loans, including prepayments relating to loan consolidations. Results of Operations The Company's results of operations consist of the following components: Net Interest Income The Company generates the majority of its earnings from the spread between the yield the Company receives on its portfolio of student loans and the cost of funding these loans. This spread income is reported on the Company's income statement as net interest income. While the spread between the yield the Company receives on its student loan portfolio and the cost of funding those loans may vary due to fluctuations in interest rates, special allowance payments from the federal government ensure that the Company receives a minimum yield on its student loans, so long as certain requirements are met. The amortization and write-offs of premiums or discounts, including capitalized costs of origination, the consolidation loan rebate fee, and yield adjustments from borrower benefit programs, are netted against loan interest income on the Company's income statement. The amortization and write-offs of bond issuance costs are included in interest expense on the Company's income statement. The Company's portfolio of FFELP loans generally earns interest at the higher of a variable rate based on the special allowance payment, or SAP, formula set by the U.S. 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 index plus a fixed spread that is dependent upon when the loan was originated, the loan's repayment status, and funding sources for the loan. Depending on the type of student loan and when the loan was originated, the borrower rate is either fixed to term or is reset to a market rate each July 1. The more drastic the reduction in rates subsequent to the July 1 annual borrower interest rate reset date, the greater the Company's opportunity to earn variable-rate floor income. In declining interest rate environments, the Company can earn significant amounts of such income. Conversely, as the decline in rates abates, or in environments where interest rates are rising, the Company's opportunity to earn variable-rate floor income can be reduced, in some cases substantially. Since the borrower rates are reset annually, the Company views earnings on variable-rate floor income as temporary and not necessarily sustainable. The Company's ability to earn variable-rate floor income in the future periods is dependent upon the interest rate environment following the annual reset of borrower rates, and the Company cannot assure the nature of such environment in the future. Based upon provisions of the Higher Education Act, loans previously financed with tax-exempt obligations issued prior to October 1, 1993 are entitled to receive special allowance payments equal to a 9.5% minimum rate of return. 8 Because the Company generates the majority of its earnings from the spread between the yield the Company receives on its portfolio of student loans and the cost of financing these loans, the interest rate sensitivity of the Company's balance sheet is very important to its operations. The current and future interest rate environment can and will affect the Company's interest earnings, net interest income, and net income. On those student loans with fixed to term borrower rates, primarily consolidation loans, the Company earns interest at the greater of the borrower rate or a variable rate based on the SAP formula. Since the Company finances the majority of its student loan portfolio with variable-rate debt, the Company may earn excess spread on these loans for an extended period of time. On most consolidation loans, the Company must pay a 1.05% per year rebate fee to the Department. Those consolidation loans, which have variable interest rates based on the SAP formula, earn a yield less than that of a Stafford loan. Those consolidation loans, which have fixed interest rates less than the sum of 1.05% and the variable rate based on the SAP formula, also earn a yield less than that of a Stafford loan. As a result, as consolidation loans matching these criteria become a larger portion of the Company's loan portfolio, there will be a lower yield on the Company's loan portfolio in the short term. However, due to the extended terms of consolidation loans, the Company expects to earn the yield on these loans for a longer duration, making them beneficial to the Company in the long term. A portion of the Company's FFELP loan portfolio is comprised of loans that are currently or were previously financed with tax-exempt obligations issued prior to October 1, 1993. Based upon provisions of the Higher Education Act and related interpretations by the Department, the Company is entitled to receive special allowance payments on these loans providing the Company with a 9.5% minimum rate of return. In May 2003, the Company sought confirmation from the Department regarding whether it was allowed to recognize the income based on the 9.5% minimum rate of return. While pending satisfactory resolution of this issue with the Department, the Company deferred recognition of the excess interest income that was generated by these loans. In June 2004, after consideration of certain clarifying information received in connection with the guidance it had sought, including written and verbal communications with the Department, the Company concluded that the earnings process had been completed related to the special allowance payments on these loans and recognized $123.9 million of interest income. At December 31, 2003 and March 31, 2004, the amount of deferred excess interest income on these loans was approximately $43 million and approximately $79 million, respectively. In future periods, the Company will recognize the income from the special allowance payments on these loans as it is earned. Investment interest income includes income from restricted cash and investments and income from unrestricted interest-earning deposits and funds pledged to secure repayment of the bonds and notes payable. Provision for Loan Losses The allowance for loan losses is estimated and established through a provision charged to expense. Losses are charged against the allowance when management believes the collectibility of the loan principal is unlikely. Recovery of amounts previously charged off is credited to the allowance for loan losses. The Company maintains an allowance for loan losses associated with its student loan portfolio at a level that is based on the performance characteristics of the underlying loans. The allowance for the federally insured loan portfolio is based on periodic evaluations of the Company's loan portfolios considering past experience, trends in student loan claims rejected for payment by guarantors, changes to federal student loan programs, current economic conditions, and other relevant factors. The federal government guarantees 98% of principal and interest of federally insured student loans, which limits the Company's loss exposure to 2% of the outstanding balance of the Company's federally insured portfolio. Effective June 1, 2004, Nelnet was designated as an Exceptional Performer by the Department in recognition of its exceptional level of performance in servicing FFEL Program loans. As a result of this designation, Nelnet's servicing customers receive 100 percent reimbursement on all eligible FFEL Program default claims submitted for reimbursement beginning June 1, 2004 and are not subject to the 2% risk sharing loss for eligible claims submitted after that date. Only FFEL Program loans that are serviced by Nelnet, as well as loans owned by the Company and serviced by other service providers designated as Exceptional Performers by the Department, are subject to the 100% reimbursement. At June 30, 2004, the majority of the Company's loans were serviced by a service provider designated as an Exceptional Performer. The majority of these loans (95%) are serviced by Nelnet. The Company is entitled to receive this benefit as long as its service providers continue to meet the required servicing standards published by the Department. Compliance with such standards is assessed on a quarterly basis. In June 2004, the Company's allowance for loan loss balance was reduced by $3.7 million and the provision for loan losses was similarly reduced to account for 9 the estimated effects of the Exceptional Performer designations achieved by the Company's service providers. The Company anticipates lower provision expense for loan losses compared to historical periods as a result of its service providers' Exceptional Performer designations. The evaluation of the provision for loan losses is inherently subjective, as it requires material estimates that may be subject to significant changes. The provision for loan losses reflects the activity for the applicable period and provides an allowance at a level that management believes is adequate to cover probable losses inherent in the loan portfolio. Other Income (Expense) Other income (expense) primarily includes the derivative market value adjustment related to the Company's interest rate caps. Operating Expenses Operating expenses include costs incurred to manage and administer the Company's student loan portfolio and its financing transactions, costs incurred to generate and acquire student loans, and administrative expenses. The Company does not believe inflation has a significant effect on its operations. Results of Operations Three months ended June 30, 2004 compared to the three months ended June 30, 2003

Net interest income. Total loan interest, including variable-rate floor income and amortization of loan premiums and deferred origination costs, increased as a result of an increase in the size of the student loan portfolio and recognition of the special allowance yield adjustment, offset by changes in the interest rate environment and in the pricing characteristics of the Company's student loan assets. Recognition of the special allowance yield adjustment of $123.9 10 million, offset by lower interest rates during the three months ended June 30, 2004, caused an increase in the student loan net yield to 14.36% from 4.18% in the comparable period in 2003. The special allowance yield adjustment increased the student loan net yield 11.19% during the three months ended June 30, 2004. Variable-rate floor income decreased in 2004 compared to 2003 due to the timing and relative change in interest rates during the periods. Essentially, prevailing interest rates declined drastically subsequent to the July 1, 2002 annual borrower interest rate reset date compared to their less substantial decline following the reset of rates on July 1, 2003. Consequently, the Company realized no variable-rate floor income during the three months ended June 30, 2004 as compared to $0.8 million during the comparable period in 2003. The weighted average interest rate on the student loan portfolio increased during the three months ended June 30, 2004 due to recognition of the special allowance yield adjustment, offset by lower interest rates and the increase in the number of lower yielding consolidation loans. The higher weighted average loan interest rate resulted in an increase in loan interest income of approximately $35.7 million. Consolidation loan activity increased the amortization and write-offs of amortization of premiums and deferred origination costs and increased the consolidation rebate fee, reducing loan interest income approximately $9.3 million. The increase in loan interest income was also a result of an increase in the Company's portfolio of student loans. The average student loan portfolio increased by $3.1 billion, or 228.3%, at June 30, 2004 as compared to June 30, 2003, which, coupled with the recognition of the special allowance yield adjustment, increased loan interest income by approximately $119.2 million. Interest expense on bonds and notes payable increased due to an increase in average total debt of approximately $3.3 billion, specifically an increase in average variable-rate debt, which increased interest expense by approximately $10.8 million during the three months ended June 30, 2004 as compared to the comparable period in 2003. The increase in average debt also resulted in an increase in amortization of bond issuance costs of approximately $162,000. The reduction in interest rates, specifically LIBOR and auction rates, decreased the Company's average cost of funds to 1.54% during the three months ended June 30, 2004 from 2.18% during the comparable period in 2003, which decreased interest expense on existing variable-rate debt approximately $435,000. The Company reduced average fixed-rate debt by $11.1 million during the three months ended June 30, 2004 as compared to the comparable period in 2003, which decreased the Company's interest expense by approximately $175,000. Net interest income, excluding the effects of variable-rate floor income and recognition of the special allowance yield adjustment, increased approximately $11.7 million to approximately $17.9 million during the three months ended June 30, 2004 from approximately $6.2 million during the comparable period in 2003. Provision for loan losses. The provision for loan losses for student loans decreased $3.4 million from an expense of $0.1 million for the three months ended June 30, 2003 to a recovery of $3.3 million during the three months ended June 30, 2004 as a result of the Exceptional Performer designations previously discussed. Other income (expense). The company began utilizing interest rate caps in January 2004. The Company recorded a loss of $1.4 million related to the change in fair value of its outstanding interest rate caps for the three months ended June 30, 2004. Operating expenses. Total operating expenses increased during the three months ended June 30, 2004 as compared to the comparable period in 2003 as a result of the growth in the Company's assets and liabilities. Trustee and other debt related fees increased as result of the increase in average total debt outstanding. Loan servicing fees to related parties and administrative fees to parent increased as a result of the increase in average student loans outstanding. Income tax expense. Income tax expense increased due to the increase in income before income taxes. The Company's effective tax rate was 36.9% during the three months ended June 30, 2004 and 36.0% during the three months ended June 30, 2003. 11 Six months ended June 30, 2004 compared to the six months ended June 30, 2003

Net interest income. Total loan interest, including variable-rate floor income and amortization of loan premiums and deferred origination costs, increased as a result of recognition of an increase in the size of the student loan portfolio and the special allowance yield adjustment, offset by changes in the interest rate environment and in the pricing characteristics of the Company's student loan assets. Recognition of the special allowance yield adjustment of $123.9 million, offset by lower interest rates during the six months ended June 30, 2004, caused an increase in the student loan net yield to 9.45% from 4.84% in the comparable period in 2003. The special allowance yield adjustment recognized in June 2004 increased the student loan net yield 6.18% during the six months ended June 30, 2004. Variable-rate floor income decreased in 2004 compared to 2003 due to the timing and relative change in interest rates during the periods. Essentially, prevailing interest rates declined drastically subsequent to the July 1, 2002 annual borrower interest rate reset date compared to their less substantial decline following the reset of rates on July 1, 2003. Consequently, the Company realized approximately $62,000 in variable-rate floor income during the six months ended June 30, 2004 as compared to $1.4 million during the comparable period in 2003. The weighted average interest rate on the student loan portfolio increased during the six months ended June 30, 2004 due to recognition of the special allowance yield adjustment, offset by lower interest rates and the increase in the number of lower yielding consolidation loans. The higher weighted average loan interest rate resulted in an increase in loan interest income of approximately $28.3 million. Consolidation loan activity increased the amortization and write-offs of premiums and deferred origination costs and increased the consolidation rebate fee, reducing loan interest income approximately $17.9 million. The increase in loan interest income was also a result of an increase in the Company's portfolio of student loans. The average student loan portfolio increased by $2.9 billion, or 261.2%, at June 30, 2004 as compared to June 30, 2003, which, coupled with the recognition of the special allowance yield adjustment, increased loan interest income by approximately $153.6 million. Interest expense on bonds and notes payable increased due to an increase in average total debt of approximately $3.1 billion, specifically an increase in average variable-rate debt, which increased interest expense by approximately $20.2 million during the six months ended June 30, 2004 as compared to the same period in 2003. The increase in average debt also resulted in an increase in amortization of bond issuance costs of approximately $375,000. The reduction in 12 interest rates, specifically LIBOR and auction rates, decreased the Company's average cost of funds to 1.54% during the six months ended June 30, 2004 from 2.26% during the comparable period in 2003, which decreased interest expense on existing variable rate debt approximately $980,000. The Company reduced average fixed-rate debt by $11.1 million during the six months ended June 30, 2004 as compared to the comparable period in 2003, which decreased the Company's interest expense by approximately $350,000. Net interest income, excluding the effects of variable-rate floor income and the recognition of the special allowance yield adjustment, increased approximately $21.2 million to approximately $34.3 million during the six months ended June 30, 2004 from approximately $13.1 million during the comparable period in 2003. Provision for loan losses. The provision for loan losses for student loans decreased $2.3 million from an expense of $0.1 million during the six months ended June 30, 2003 to a recovery of $2.2 million for the six months ended June 30, 2004 as a result of the Exceptional Performer designations previously discussed. Other income (expense). The company began utilizing interest rate caps in January 2004. The Company recorded a loss of $2.2 million related to the change in fair value of its outstanding interest rate caps for the six months ended June 30, 2004. Operating expenses. Total operating expenses increased during the six months ended June 30, 2004 as compared to the comparable period in 2003 as a result of the growth in the Company's assets and liabilities. Trustee and other debt related fees increased as result of the increase in average total debt outstanding. Loan servicing fees to related parties and administrative fees to parent increased as a result of the increase in average student loans outstanding. Income tax expense. Income tax expense increased due to the increase in income before income taxes. The Company's effective tax rate was 36.8% during the six months ended June 30, 2004 and 36.0% during the six months ended June 30, 2003. Student Loan Spread Analysis Maintenance of the spread on assets is a key factor in maintaining and growing the Company's income. The following table analyzes the student loan spread on the Company's portfolio of student loans during the three and six months ended June, 2004 and 2003, and represents the spread on assets earned in conjunction with the liabilities used to fund the assets.

(a) On June 30, 2004, the Company recognized $123.9 million of excess interest income that had previously been deferred. At December 31, 2003 and March 31, 2004, the amount of deferred excess interest income on these loans was $42.9 million and $78.8 million, respectively. In future periods, the Company will recognize the income from the special allowance payments on these loans as it is earned. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable under General Instruction H-2. 13 ITEM 4. CONTROLS AND PROCEDURES Under supervision and with the participation of certain members of the Company's management, including the principal executive officer and principal financial officer, the Company completed an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) to the Securities Exchange Act of 1934, as amended). Based on this evaluation, the Company's principal executive officer and principal financial officer believe that the disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report on Form 10-Q with respect to timely communication to them and other members of management responsible for preparing periodic reports and material information required to be disclosed in this Quarterly Report on Form 10-Q as it relates to the Company. There was no change in the Company's internal control over financial reporting during the Company's last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. The effectiveness of the Company's or any system of disclosure controls and procedures is subject to certain limitations, including the exercise of judgment in designing, implementing, and evaluating the controls and procedures, the assumptions used in identifying the likelihood of future events, and the inability to eliminate misconduct completely. As a result, there can be no assurance that the Company's disclosure controls and procedures will prevent all errors or fraud or ensure that all material information will be made known to appropriate management in a timely fashion. By their nature, the Company's or any system of disclosure controls and procedures can provide only reasonable assurance regarding management's control objectives. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is subject to various claims, lawsuits, and proceedings that arise in the normal course of business. These matters principally consist of claims by borrowers disputing the manner in which their loans have been processed. On the basis of present information, anticipated insurance coverage, and advice received from counsel, it is the opinion of the Company's management that the disposition or ultimate determination of these claims, lawsuits, and proceedings will not have a material adverse effect on the Company's business, financial position, or results of operations. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable under General Instruction H-2. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable under General Instruction H-2. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable under General Instruction H-2. ITEM 5. OTHER INFORMATION Nothing to report. 14 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits

15 10.7 Letter Agreement by and between Nelnet Education Loan Funding, Inc. and Societe Generale, dated as of June 25, 2003, relating to the increase of the Warehouse Note Purchase and Security Agreement dated as of May 1, 2003 is incorporated by reference to Exhibit 10.92 to the registration statement of Nelnet, Inc. (File No. 333-108070). 10.8 Amendment to Application and Agreement for Standby Letter of Credit, Loan Purchase Agreements and Standby Student Loan Purchase Agreements, dated effective October 21, 2003, by and among National Education Loan Network, Inc., Nelnet, Inc., Nelnet Education Loan Funding, Inc., Union Bank and Trust Company and Bank of America, N.A. is incorporated by reference to Exhibit 10.94 to the registration statement of Nelnet, Inc. (File No. 333-108070). 10.9 Letter Agreement between Nelnet Education Loan Funding, Inc. and Deutsche Bank AG, dated as of February 20, 2004 is incorporated herein by reference to Exhibit 10.56 of the Annual Report on Form 10-K of Nelnet, Inc. for the year ended December 31, 2003. 10.10 Letter Agreement between Nelnet Education Loan Funding, Inc. and Bank of America, N.A., dated as of February 20, 2004 is incorporated herein by reference to Exhibit 10.57 of the Annual Report on Form 10-K of Nelnet, Inc. for the year ended December 31, 2003. 10.11 Letter Agreement between Nelnet Education Loan Funding, Inc. and Societe Generale, dated as of February 20, 2004 is incorporated herein by reference to Exhibit 10.58 of the Annual Report on Form 10-K of Nelnet, Inc. for the year ended December 31, 2003. 10.12 February 2004 Amendment to Application and Agreement for Standby Letter of Credit, Loan Purchase Agreements and Standby Student Loan Purchase Agreements, dated as of February 20, 2004, among National Education Loan Network, Inc., Nelnet, Inc., Nelnet Education Loan Funding, Inc., Union Bank and Trust Company and Bank of America, N.A. Incorporated by reference to Exhibit 10.62 to the Annual Report on Form 10-K of Nelnet, Inc. for the year ended 2003. 10.13 Amendment to Application and Agreement for Standby Letter of Credit, Loan Purchase Agreements and Standby Student Loan Purchase Agreements, dated effective November 20, 2003, by and among National Education Loan Network, Inc., Nelnet, Inc., Nelnet Education Loan Funding, Inc., Union Bank and Trust Company and Bank of America, N.A. Incorporated by reference to Exhibit 10.63 to the Annual Report on Form 10-K of Nelnet, Inc. for the year ended 2003. 10.14 Amendment to Application and Agreement for Standby Letter of Credit, Loan Purchase Agreements and Standby Student Loan Purchase Agreements, dated effective December 19, 2003, by and among National Education Loan Network, Inc., Nelnet, Inc., Nelnet Education Loan Funding, Inc., Union Bank and Trust Company and Bank of America, N.A. Incorporated by reference to Exhibit 10.64 to the Annual Report on Form 10-K of Nelnet, Inc. for the year ended 2003. 10.15 April 2004 Amendment to Application and Agreement for Standby Letter of Credit, Loan Purchase Agreements and Standby Purchase Agreements, dated effective April 15, 2004, among Bank of America, N.A., Nelnet Education Loan Funding, Inc., National Education Loan Network, Inc., Nelnet, Inc., and Union Bank and Trust Company is incorporated by reference to Exhibit 10.67 of the Quarterly Report on Form 10-Q of Nelnet, Inc. for the three months ended March 31, 2004. 10.16 Agreement to Extend Termination Date for the Warehouse Note Purchase and Security Agreement, dated as of May 1, 2004, among Nelnet Education Loan Funding, Inc., Bank of America, N.A., Deutsche Bank AG, New York Branch, and Societe Generale is incorporated by reference to Exhibit 10.71 of the Quarterly Report on Form 10-Q of Nelnet, Inc. for the three months ended March 31, 2004. 31.1* Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Principal Executive Officer. 31.2* Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Principal Financial Officer. 32** Certification Pursuant to 18 U.S.C. Section 1350, as Adopted, Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

-------------- * Filed herewith ** Furnished herewith 16 (b) Reports on Form 8-K. The Company filed a current report on Form 8-K on May 4, 2004, for the purpose of filing copies of certain documents executed and delivered in connection with issuance by the Company of $817,700,000 of Student Loan Asset-Backed Rate Notes. The Company filed a current report on Form 8-K on July 2, 2004 announcing that effective June 30, 2004, it will begin to recognize income related to student loan portfolios funded from the proceeds of tax-exempt bonds, including amounts previously deferred through that date. 17 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 EDUCATION LOAN FUNDING, INC. Date: August 16, 2004 By: /s/ Terry J. Heimes --------------------------------- Name: Terry J. Heimes Title: President (Principal Executive Officer) By: /s/ James D. Kruger --------------------------------- Name: James D. Kruger Title: Secretary and Treasurer (Principal Financial Officer) 18

NELNET EDUCATION LOAN FUNDING INC 10-Q