10-Q 1 n10q211-01.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, 2001 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 333-93865 ---------------------------------------------------- NELNET STUDENT LOAN CORPORATION-2 --------------------------------- (Exact name of registrant as specified in its charter) NEVADA 84-1518863 ------------------------------ ------------------ State or other jurisdiction (I.R.S. Employer of 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, 2001 1 NELNET STUDENT LOAN CORPORATION-2 INDEX Page No. PART I. - FINANCIAL INFORMATION Item 1.Financial Statements Balance Sheets as of September 30, 2001 and December 31, 2000.....3 Statements of Operations for the three months and nine months ended September 30, 2001 and for the three months and period ended September 30, 2000......................4 Statement of Stockholder's Equity (Deficit) for the nine months ended September 30, 2001............................5 Statements of Cash Flows for the nine months ended September 30, 2001 and for the period ended September 30, 2000..............................................6 Note 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 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

6 NELNET STUDENT LOAN CORPORATION-2 NOTE TO FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2001 -------------------------------------------------------------------------------- (1) BASIS OF PRESENTATION NELNET Student Loan Corporation-2 (the "Company") was incorporated under the laws of the state of Nevada on October 8, 1999. The Company is a wholly owned subsidiary of NELnet, Inc. and a wholly owned indirect subsidiary of UNIPAC Service Corporation, a Nebraska Corporation ("UNIPAC"). UNIPAC is a privately held 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 the periods shown. All such adjustments made are of a normal recurring nature, except when noted as extraordinary or nonrecurring. The Company commenced its business operations on June 1, 2000; consequently no nine month comparison exists for the previous year. Information concerning income and cash flows during the period of June 1, 2000 though September 30, 2000 has been included, but its usefulness for comparative purposes is limited as it only covers four months of business activity. The balance sheet at December 31, 2000 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 period 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. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. GENERAL The Company was incorporated under the laws of the state of Nevada on October 8, 1999. The Company is a wholly owned subsidiary of NELnet, Inc. and a wholly owned indirect subsidiary of UNIPAC. UNIPAC is a privately held corporation. 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"). The initial issuance of the Series 2000 Notes occurred on June 1, 2000 in the amount of $1,000,000,000. Series 2001A Notes were issued on April 2, 2001 in the amount of $480,000,000. Series 2001B Notes were issued on September 4, 2001 in the amount of $550,000,000. Approximately $511,000,000 of the Note proceeds were utilized on September 4, 2001 for the purchase of student loans. Substantially all of the remaining proceeds of the 2001B Notes were utilized on October 1, 2001 for the purchase of additional student loans. 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. RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2000 REVENUES. Revenues for the three months ended September 30, 2001 consisted primarily of interest earned on student loans. Revenues from interest on student loans increased by $4,828,471 from $20,462,126 for the three months ended September 30, 2000 to $25,290,597 for the three months ended September 30, 2001. The increase in revenues is directly attributable to the acquisition of additional student loans by the Company in the second and third quarters of 2001. The Company's average net investment in student loans during the three months ended September 30, 2001 and 2000 was approximately $1,530,000,000 and $923,200,000, 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, 2001 and 2000 was 6.61% and 8.91%, 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 $139,872 from $599,840 for the three months ended September 30, 2000 to $459,968 for the three months ended September 30, 2001. The decrease in investment interest was a result of the restricted cash being utilized to acquire student loans along with lower interest rates on investments in the current fiscal year. EXPENSES. The Company's expenses consisted primarily of interest on the Company's outstanding Notes. Interest on the Company's outstanding Notes increased by $1,152,981 from $16,863,970 for the three months ended September 30, 2000 to $18,016,951 for the three months ended September 30, 2001. This increase in expenses is directly attributable to the issuance of additional Notes in the second and third quarters of 2001. For the three months ended September 30, 2001, the Company's average debt outstanding was approximately $1,663,000,000 compared to debt outstanding of $1,000,000,000 for the three months ended September 30, 2000. The average annual cost of borrowings for the three months ended September 30, 2001 and 2000 was 4.33% and 6.75%, 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 $3,499,641 for the three months ended September 30, 2001, as compared to $2,261,562 for the three months 8 ended September 30, 2000, an increase of $1,238,079. The increase in loan servicing fees to a related party is directly related to the servicing of additional student loans. The average annual rate of servicing realized on the average principal amount of student loans for the three months ended September 30, 2001 and 200 was .91% and 1.00%, respectively. Trustee and broker fees increased by $146,199 from $752,198 for the three months ended September 30, 2000 to $898,397 for the three months ended September 30, 2001. This increase is a result of increased financing activity. Amortization of loan premiums and debt issuance costs increased by $562,583 from $611,513 for the three months ended September 30, 2000 to $1,174,096 for the three months ended September 30, 2001. The increase is attributable to the issuance of additional Notes in the second and third quarters of 2001 along with an increase in the rate of amortization due to an increase in principal payments on the loans as a greater percentage of the loan portfolio that is in repayment status. Provision for loan losses increased by $450,000 from $150,000 for the three months ended September 30, 2000 to $600,000 for the three months ended September 30, 2001. Additional amounts were recognized as provision for loan losses in order to reflect the appropriate allowance amounts in comparison to the estimated defaults. INCOME TAX EXPENSE. The Company has recognized income tax expense of $337,721 for the three months ended September 30, 2001 compared to an income tax benefit in the amount of $99,134 for the three months ended September 30, 2000. The income tax expense was a result of net income being realized for the three months ended September 30, 2001 compared with the net loss realized for the three months ended September 30, 2000. The effective tax rate utilized by the Company to recognize a provision for income taxes was 36%. The effective tax rate will be adjusted in the future for changes to the corporate tax regulations. NET INCOME. The Company had net income of $600,393 for the three months ended September 30, 2001 and a net loss of $176,237 for the three months ended September 30, 2000. The 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 increases and in a rising interest rate environment it decreases. The net interest margin increased by $3,675,490 from $3,598,156 for the three months ended September 30, 2000 to $7,273,646 for the three months ended September 30, 2001. NINE MONTHS ENDED SEPTEMBER 30, 2001 REVENUES. Revenues for the nine months ended September 30, 2001 consisted primarily of interest earned on student loans. The Company's average net investment in student loans during the nine months ended September 30, 2001 was approximately $1,271,000,000. The average effective annual interest rate of interest income on student loans during the nine months ended September 30, 2001 was 7.35%. EXPENSES. The Company's expenses consisted primarily of interest due on the Company's outstanding Notes. For the nine months ended September 30, 2001, the Company's average debt outstanding was $1,381,000,000, and the average annual cost of borrowings was 4.97%. Loan servicing expense to a related party for the nine months ended September 30, 2001 was approximately $9,127,000. The average annual rate of servicing realized on the average principal amount of student loans was .96%. INCOME TAX EXPENSE. The Company has recognized income tax expense of $1,186,069 for the nine months ended September 30, 2001. The effective tax rate utilized by the Company to recognize a provision for income taxes was 36%. The effective tax rate will be adjusted in the future for changes to the corporate tax regulations. 9 NET INCOME. The Company had net income of $2,108,567 for the nine months ended September 30, 2001. The net income is attributable to higher net interest margins during 2001 due to the declining interest rate environment. For the nine months ended September 30, 2001, there were no unusual or infrequent events or transactions that materially affected the amount of reported income. PERIOD ENDED SEPTEMBER 30, 2000 REVENUES. Revenues since inception consisted primarily of interest earned on student loans. The amount of interest reported for the period ended September 30, 2000 was derived from student loans in an aggregate principal amount of approximately $923,200,000. The average effective annual interest rate of interest income on student loans during the period ended September 30, 2000 was 8.83%. EXPENSES. Since inception, the Company's expenses consisted primarily of interest due on the Company's outstanding Notes. For the period ended September 30, 2000, the Company's debt outstanding was $1,000,000,000, and the average annual cost of borrowings was 6.73%. Loan servicing expense to a related party for the period ended September 30, 2001 was approximately $2,923,000. The average annual rate of servicing realized on the average principal amount of student loans was 1.00%. INCOME TAX BENEFIT. As a result of a net loss, the Company has recognized an income tax benefit of $288,167 for the period ended September 30, 2000. The effective tax rate utilized by the Company to recognize a provision for an income tax benefit was 36%. This benefit has been more than offset in fiscal year 2001 due to net income recognized. NET LOSS. Since inception, a net loss existed in the amount of $512,297. This net loss for the period June 1, 2000 through September 30, 2000 is attributable in part to a significant amount of amortization of loan premiums. Additionally, there was approximately $200,000,000 which was pre-funded on June 1, 2000 where the cost of borrowing on the proceeds of the Notes exceeded the earnings during the one month period of time that these funds were not invested in student loans. 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 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 $95,180,000 as of September 30, 2001. The restricted cash includes cash held by the trustee in an Acquisition and Revenue fund of approximately $84,080,000 and cash held by the trustee in a Reserve Fund of approximately $11,100,000. 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. 10 The Company had a net decrease in cash equivalents of approximately $911,000 for the nine months ended September 30, 2001 compared to an increase in cash equivalents of approximately $469,000 for the nine months ended September 30, 2000. This change is a result of the net cash used in investing activities for the purchase of student loans. 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 June 1, 2003. Thereafter, principal receipts from student loans will be used to redeem the Notes. 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 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 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 Company's variable rate Notes bear interest at a rate that is reset periodically by means of auction procedures. 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. 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 variable rate student loans, however, generally bear interest at the 91-day Treasury Bill Rate plus margins specified for such student loans. As a result of the differences between the indices used to determine the variable interest rates on student loans and the interest rates on the variable rate Notes, there could be periods of time when the variable rates on 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, auction rates may rise more quickly than the 91-day Treasury Bill Rate. If there is a decline in the variable rates on 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). Effective with the issuance of Notes on April 2, 2001, $480,000,000 of the Company's Notes bear interest at a fixed rate. The proceeds from the fixed rate Notes were used to finance a portfolio of fixed rate student loans. As a result of the fixed rate nature, no changes will occur in the "spread" between the interest earned on its fixed rate student loans and its interest payment obligations under the fixed rate Notes. Therefore, the approximate $480,670,000 fixed rate student loans are not subject to market risk in that the cash flows generated by the fixed rate student loans will not be affected by any change in interest rates. 11 There have been no material changes in the reported market risks faced by the Company since the end of its most recent fiscal year. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. None ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. On September 4, 2001, the Company issued $550,000,000 of its Student Loan Asset-Backed Auction Rate Notes. The Notes were issued pursuant to a Registration Statement on Form S-3 for $2,500,000,000 of Notes which was declared effective by the Securities and Exchange Commission on February 16, 2000. UBS Paine Webber Inc. acted as the managing underwriter for the offering. Approximately $900,000 of the proceeds of the offering were used to pay expenses incurred in connection with the offering. In addition, a financial advisory fee of $275,000 was paid to UFS Securities, L.L.C., an affiliate of the Company, and UBS Paine Webber Inc. received a structuring fee in the amount of $275,000. Proceeds from the offering in the amount of $4,125,000 were deposited to the Reserve Fund under the Indenture of Trust governing the issuance of the Notes. Approximately $511,000,000 of proceeds in the 2001B Acquisition Fund were utilized on September 4, 2001 for the purchase of student loans. On October 1, 2001, substantially all of the remaining proceeds in the 2001B Acquisition Fund were utilized for the purchase of additional student loans. 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 Quarterly Report on Form 10-Q dated June 30, 2000). 3.2 By-Laws of the Company (Incorporated by reference herein to the Company's Quarterly Report on Form 10-Q dated June 30, 2000). 4.1 Indenture of Trust between the Company and Zions First National Bank dated June 1, 2000 (Incorporated by reference herein to the Company's current report on Form 8-K filed June 16, 2000). 4.2 Series 2000 Supplemental Indenture of Trust between the Company and Zions First National Bank dated June 1, 2000 (Incorporated by reference to the Company's current report on Form 8-K filed June 16, 2000). 4.3 Series 2001A Supplemental Indenture of Trust by and between NELNET Student Loan Corporation-2 and Zions First National Bank, dated as of April 1, 2000 (Incorporated by reference herein to the Company's current report on Form 8-K filed April 16, 2001). 4.4 Series 2001B Supplemental Indenture of Trust between NELNET Student Loan Corporation-2 and Zions First National Bank, dated as of September 1, 2001 (Incorporated by reference herein to the Company's current report on Form 8-K filed September 7, 2001). 10.1 Servicing Agreement dated June 1, 2000 between the Company and NELnet, Inc. (Incorporated by reference herein to the Company's Quarterly Report on Form 10-Q dated June 30, 2000). REPORTS ON FORM 8-K The Company filed a current report on Form 8-K on September 7, 2001 to report the issuance of $550,000,000 of the Company's Student Loan Asset-Backed Notes and to file certain exhibits related thereto. 13 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-2 By: /s/ Terry J. Heimes -------------------------------------- Terry J. Heimes, Vice President (Principal Executive Officer) By: /s/ Jim Kruger -------------------------------------- Jim Kruger, Vice President (Principal Financial and Accounting Officer) Date: November 14, 2001 14

NELNET STUDENT LOAN CORP- 2 10-Q