| SLM CORP Item 1A Risk Factors LENDING BUSINESS SEGMENT—FFELP STUDENT LOANS A larger than expected increase in third party consolidation activity may reduce our FFELP student loan spread, materially impair our Retained Interest and otherwise materially adversely affect our results of operations |
| If third party consolidation activity increases beyond management’s expectations, our FFELP student loan spread may be adversely affected, our Retained Interest may be materially impaired and our results of operations may be adversely affected |
| Our FFELP student loan spread may be adversely affected because third party consolidators generally target our highest yielding Consolidation Loans |
| Our Retained Interest may be materially impaired if consolidation activity reaches levels not anticipated by management |
| We may also incur impairment charges if we increase our expected future Constant Prepayment Rate (“CPR”) assumptions used to value the Residual Interest as a result of such unanticipated levels of consolidation |
| The potentially material adverse affect on our operating results relates principally to our hedging activities in connection with Floor Income |
| We enter into certain Floor Income Contracts under which we receive an upfront fee in exchange for our payment of the Floor Income earned on a notional amount of underlying Consolidation Loans over the life of the Floor Income Contract |
| If third party consolidation activity that involves refinancing an existing FFELP Consolidation Loan with a new FFELP Consolidation Loan increases substantially, then the Floor Income that we are obligated to pay under such Floor Income Contracts may exceed the Floor Income actually generated from the underlying Consolidation Loans, possibly to a material extent |
| In such a scenario, we would either close out the related Floor Income Contracts or purchase an offsetting hedge |
| In either case, the adverse impact on both our GAAP and “core earnings” could be material |
| ”) Incorrect estimates and assumptions by management in connection with the preparation of our consolidated financial statements could adversely affect the reported amounts of assets and liabilities and the reported amounts of income and expenses |
| The preparation of our consolidated financial statements requires management to make certain critical accounting estimates and assumptions that could affect the reported amounts of assets and liabilities and the reported amounts of income and expense during the reporting periods |
| (See “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—CRITICAL ACCOUNTING POLICIES AND ESTIMATES”) For example, for both our federally insured and Private Education Loans the unamortized portion of the premiums and the discounts is included in the carrying value of the student loan on the consolidated balance sheet |
| We recognize income on our student loan portfolio based on the expected yield of the student loan after giving effect to the amortization of purchase premiums and accretion of student loan income discounts, as well as the impact of Borrower Benefits |
| In arriving at the expected yield, we must make a number of estimates that when changed must be reflected as a cumulative student loan catch-up from the inception of the student loan |
| The most sensitive estimate for premium and discount amortization is the estimate of the CPR, which measures the rate at which loans in the portfolio pay before their stated maturity |
| The CPR is used in calculating the average life of the portfolio |
| A number of factors can affect the CPR estimate such as the rate of Consolidation Loan activity and default rates |
| If we make an incorrect CPR estimate, the previously recognized income on our student loan portfolio based on the expected yield of the student loan will need to be adjusted in the current period |
| In addition, the impact of our Borrower Benefits programs, which provide incentives to borrowers to make timely payments on their loans by allowing for reductions in future interest rates as well as rebates on outstanding balances, is dependent on the number of borrowers who will eventually qualify for these benefits |
| The incentives are offered to attract new borrowers and to improve our borrowers’ payment behavior |
| For example, we offer borrowers an incentive program that reduces their interest rate by a 22 ______________________________________________________________________ specified percentage per year or reduces their loan balance after they have made a specified initial number of scheduled payments on time and for so long as they continue to make subsequent scheduled payments on time |
| We regularly estimate the qualification rates for Borrower Benefits programs and book a level yield adjustment based upon that estimate |
| If our estimate of the qualification rates is lower than the actual rates, both the yield on our student loan portfolio and our net interest income will be lower than estimated and a cumulative adjustment will be made to reduce income, possibly to a material extent |
| Such an underestimation may also adversely affect the value of our Retained Interest because one of the assumptions made in assessing its value is the amount of Borrower Benefits expected to be earned by borrowers |
| Finally, we continue to look at new ways to attract new borrowers and to improve our borrowers’ payment behavior |
| These efforts as well as the actions of competing lenders may lead to the addition or modification of Borrower Benefits programs |
| LENDING BUSINESS SEGMENT—PRIVATE EDUCATION LOANS Changes in the composition of our Managed student loan portfolio will increase the risk profile of our asset base and our capital requirements |
| As of December 31, 2005, 13 percent of our Managed student loans are Private Education Loans |
| Private Education Loans are unsecured and are not guaranteed or reinsured under the FFELP or any other federal student loan program and are not insured by any private insurance program |
| Accordingly, we bear the full risk of loss on most of these loans if the borrower and co-borrower, if applicable, defaults |
| Events beyond our control such as a prolonged economic downturn could make it difficult for Private Education Loan borrowers to meet their payment obligations for a variety of reasons, including job loss and underemployment, which could lead to higher levels of delinquencies and defaults |
| Private Education Loans now account for 25 percent of our net interest income and 13 percent of our Managed student loan portfolio |
| We expect that Private Education Loans will become an increasingly higher percentage of both our margin and our Managed student loan portfolio, which will increase the risk profile of our asset base and raise our capital requirements because Private Education Loans have significantly higher capital requirements than FFELP loans |
| This may affect the availability of capital for other purposes |
| In addition, the comparatively larger spreads on Private Education Loans, which historically have compensated for the narrowing FFELP spreads, may narrow as competition increases |
| Past charge-off rates on our Private Education Loans may not be indicative of future charge-off rates because, among other things, we use forbearance policies and our failure to adequately predict and reserve for charge-offs may adversely impact our results of operations |
| We have established forbearance policies for our Private Education Loans under which we provide to the borrower temporary relief from payment of principal or interest in exchange for a processing fee paid by the borrower, which is waived under certain circumstances |
| During the forbearance period, generally granted in three month increments, interest that the borrower otherwise would have paid is typically capitalized at the end of the forbearance term |
| At December 31, 2005, approximately 10 percent of our Managed Private Education Loans in repayment and forbearance were in forbearance |
| Forbearance is used most heavily when the borrower’s loan enters repayment; however, borrowers may apply for forbearance multiple times and a significant number of Private Education Loan borrowers have taken advantage of this option |
| Accordingly, a borrower who may have been delinquent in his payments or may not have made any recent payments on his account will be accounted for as a borrower in a current repayment status when the borrower exits the forbearance period |
| In addition, past charge-off rates on our Private Education Loans may not be indicative of future charge-off rates because of, among other things, our use of forbearance and the effect of future changes to the forbearance policies |
| If our forbearance policies prove over time to be less effective on cash collections than we expect, they could have a material adverse effect on the amount of future charge-offs and the ultimate default rate used to calculate loan loss reserves which could have a material adverse effect on our results of operations |
| (See “MANAGEMENT’S 23 ______________________________________________________________________ DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—LENDING BUSINESS SEGMENT—Total Loan Net Charge-offs |
| ”) In addition, our future charge-off rates could be materially impacted by downturns in the economy |
| DEBT MANAGEMENT OPERATIONS BUSINESS SEGMENT Our growth in our DMO business segment is dependent in part on successfully identifying, consummating and integrating strategic acquisitions |
| Since 2000, we have acquired five companies that are now successfully integrated within our Debt Management Operations group |
| Each of these acquisitions has contributed to DMO’s substantial growth |
| Future growth in the DMO group is dependent in part on successfully identifying, consummating and integrating strategic acquisitions |
| In addition, certain of these acquisitions have expanded our operations into businesses and asset classes that pose substantially more business and litigation risks than our core FFELP student loan business |
| For example, on September 16, 2004, we acquired a 64 percent (now 76 percent) interest in AFS Holdings, LLC, commonly known as Arrow Financial Services, a company that, among other services, purchases non-performing receivables |
| In addition, on August 30, 2005, we purchased GRP, a company that purchases distressed mortgage receivables |
| While both companies purchase such assets at a discount and have sophisticated analytical and operational tools to price and collect on portfolio purchases, there can be no assurance that the price paid for defaulted portfolios will yield adequate returns, or that other factors beyond their control will not have a material adverse affect on their results of operations |
| Portfolio performance below original projections could result in impairments to the purchased portfolio assets |
| In addition, these businesses are subject to litigation risk under the Fair Debt Collection Practices Act, Fair Credit Reporting Act and various other federal, state and local laws in the normal course |
| Finally, we may explore additional business opportunities that may pose further risks |
| Our DMO group may not be able to purchase defaulted consumer receivables at prices that management believes to be appropriate, and a decrease in our ability to purchase portfolios of receivables could adversely affect our net income |
| If our DMO group is not able to purchase defaulted consumer receivables at planned levels and at prices that management believes to be appropriate, we could experience short-term and long-term decreases in income |
| The availability of receivables portfolios at prices which generate an appropriate return on our investment depends on a number of factors both within and outside of our control, including the following: · the continuation of current growth trends in the levels of consumer obligations; · sales of receivables portfolios by debt owners; · competitive factors affecting potential purchasers and credit originators of receivables; and · the ability to continue to service portfolios to yield an adequate return |
| Because of the length of time involved in collecting defaulted consumer receivables on acquired portfolios and the volatility in the timing of our collections, we may not be able to identify trends and make changes in our purchasing strategies in a timely manner |
| LIQUIDITY AND CAPITAL RESOURCES If our stock price falls significantly we may be required to settle our equity forward positions in a manner that could have a materially dilutive effect on our common stock |
| We regularly repurchase our common stock through both open market purchases and equity forward contracts |
| At December 31, 2005, we had outstanding equity forward contracts to purchase 42dtta7 million shares of our common stock at an average price of dlra54dtta74 per share |
| The equity forward contracts permit 24 ______________________________________________________________________ the counterparty to terminate a portion of the equity forward contract if the common stock price falls below an “initial trigger price” and the counterparty can continue to terminate portions of the contract as the stock price reaches lower predetermined levels, until the stock price reaches the “final trigger price” whereby the entire contract can be terminated |
| The final trigger price is generally 50 percent of the strike price |
| If the counterparty terminates the contract, we can settle by paying cash or delivering common stock |
| If we issue common stock to settle the contracts in such circumstances, it could have a materially dilutive effect on our common stock |
| Because we fund most of our daily reset commercial paper-indexed FFELP student loans with daily reset LIBOR funding, we are exposed to interest rate risk in the form of basis risk and repricing risk |
| Depending on economic and other factors, we may fund our assets with debt that has a different index and/or reset frequency than the asset, but generally only where we believe there is a high degree of correlation between the interest rate movement of the two indices |
| We also use different index types and index reset frequencies to fund various other assets |
| In using different index types and different index reset frequencies to fund our assets, we are exposed to interest rate risk in the form of basis risk and repricing risk, which is the risk that the different indices may reset at different frequencies will not move in the same direction or with the same magnitude |
| While these indices are short-term with rate movements that are highly correlated over a long period of time, there can be no assurance that this high correlation will not be disrupted by capital market dislocations or other factors not within our control |
| In such circumstances, our earnings could be adversely affected, possibly to a material extent |
| We may face limited availability of financing, variation in our funding costs and uncertainty in our securitization financing |
| In general, the amount, type and cost of our funding, including securitization and unsecured financing from the capital markets and borrowings from financial institutions, have a direct impact on our operating expenses and financial results and can limit our ability to grow our assets |
| A number of factors could make such securitization and unsecured financing more difficult, more expensive or unavailable on any terms both domestically and internationally (where funding transactions may be on terms more or less favorable than in the United States), including, but not limited to, financial results and losses, changes within our organization, specific events that have an adverse impact on our reputation, changes in the activities of our business partners, disruptions in the capital markets, specific events that have an adverse impact on the financial services industry, counter-party availability, changes affecting our assets, our corporate and regulatory structure, interest rate fluctuations, ratings agencies’ actions, general economic conditions and the legal, regulatory, accounting and tax environments governing our funding transactions |
| In addition, our ability to raise funds is strongly affected by the general state of the US and world economies, and may become increasingly difficult due to economic and other factors |
| Finally, we compete for funding with other industry participants, some of which are publicly traded |
| Competition from these institutions may increase our cost of funds |
| We are dependent on the securitization markets for the long-term financing of student loans, which we expect to provide more than 70 percent of our funding needs |
| If this market were to experience difficulties, if our asset quality were to deteriorate or if our debt ratings were to be downgraded, we may be unable to securitize our student loans or to do so on favorable terms, including pricing |
| If we were unable to continue to securitize our student loans at current levels or on favorable terms, we would use alternative funding sources to fund increases in student loans and meet our other liquidity needs |
| If we were unable to find cost-effective and stable funding alternatives, our funding capabilities and liquidity would be negatively impacted and our cost of funds could increase, adversely affecting our results of operations, and our ability to grow would be limited |
| 25 ______________________________________________________________________ In addition, the occurrence of certain events such as consolidations and reconsolidations may cause the securitization transactions to amortize earlier than scheduled, which could accelerate the need for additional funding to the extent that we effected the refinancing |
| GENERAL Our business is subject to a number of risks, uncertainties and conditions, some of which are not within our control, including general economic conditions, increased competition, adverse changes in the laws and regulations that govern our businesses and failure to successfully identify, consummate and integrate strategic acquisitions |
| Our business is subject to a number of risks, uncertainties and conditions, some of which we cannot control |
| For example, if the US economy were to sustain a prolonged economic downturn a number of our businesses—including our fastest growing businesses, Private Education Loan business and Debt Management Operations—could be adversely affected |
| We bear the full risk of loss on our portfolio of Private Education Loans |
| A prolonged economic downturn could make it difficult for borrowers to meet their payment obligations for a variety of reasons, including job loss and underemployment |
| In addition, a prolonged economic downturn could extend the amortization period on DMO’s purchased receivables |
| We face strong competition in all of our businesses, particularly in our FFELP business |
| For example, some FFELP lenders use the federal government’s Direct Lending program as a vehicle to circumvent the statutory prohibition on refinancing an existing FFELP Consolidation Loan in cases where the borrower is not eligible to consolidate his loans |
| The Reauthorization Legislation eliminates this practice effective July 1, 2006 |
| However, we expect that lenders who employ this practice will substantially increase their marketing efforts in anticipation of the prohibition of the practice |
| As a result, we may experience additional prepayments on our Consolidation Loans through June 30, 2006 |
| There can also be no assurance that our competitors will not engage in other practices that result in higher than expected prepayments on our Consolidation Loan portfolio |
| ”) Such prepayments would adversely impact our earnings |
| We are also currently competing with substantial lending partners, including our largest lending partner, JPMorgan Chase, which accounts for a substantial portion of our FFELP originations and purchases |
| Finally, we expect to see more competition in our Private Education Loan business |
| The strong margins that we currently maintain in this growing business and that offset some of the margin erosion that we have experienced in our FFELP business may begin to weaken as more competitors offer competing products |
| If these competitive trends intensify, we could face further margin pressure |
| Because we earn our revenues from federally insured loans under a federally sponsored loan program, we are subject to political and regulatory risk |
| As part of the HEA, the student loan program is periodically amended and must be “reauthorized” every six years |
| Past legislative changes included reduced loan yields paid to lenders (1993 and 1998), increased fees paid by lenders (1993), decreased level of the government guaranty (1993) and reduced fees to guarantors and collectors, among others |
| On February 8, 2006, the President signed the Reauthorization Legislation |
| The Reauthorization Legislation contains a number of provisions that over time will reduce our earnings on FFELP student loans, including a requirement that lenders rebate Floor Income on new loans and a reduction in lender reinsurance |
| In addition, there can be no assurances that future reauthorizations and other political developments will not result in changes that have a materially adverse impact on the Company |
| ”) Our principal business is comprised of acquiring, originating, holding and servicing education loans made and guaranteed under the FFELP program |
| Most significant aspects of our principal business are governed by the HEA We must also meet various requirements of the guaranty agencies, which are private not-for-profit organizations or state agencies that have entered into federal reinsurance contracts 26 ______________________________________________________________________ with ED, to maintain the federal guarantee on our FFELP loans |
| These requirements establish origination and servicing requirements, procedural guidelines and school and borrower eligibility criteria |
| The federal guarantee of FFELP loans is conditioned on loans being originated, disbursed or serviced in accordance with ED regulations |
| If we fail to comply with any of the above requirements, we could incur penalties or lose the federal guarantee on some or all of our FFELP loans |
| In addition, our marketing practices are subject to the HEA’s prohibited inducement regulation and our failure to comply with such regulation could subject us to a limitation, suspension or termination of our eligible lender status |
| Even if we comply with the above requirements, a failure to comply by third parties with whom we conduct business could result in us incurring penalties or losing the federal guarantee on some or all of our FFELP loans |
| If we experience a high rate of servicing deficiencies, we could incur costs associated with remedial servicing, and, if we are unsuccessful in curing such deficiencies, the eventual losses on the loans that are not cured could be material |
| Failure to comply with these laws and regulations could result in our liability to borrowers and potential class action suits, all of which could adversely affect our future growth rates |
| An additional consequence of servicing deficiencies would be the loss of our Exceptional Performer Designation |
| Finally, our continued growth in our DMO operations is dependent in part on strategic acquisitions |
| If we are unable to successfully identify, consummate and integrate such acquisitions, the growth rate for our DMO business, which is currently our fastest growing business segment, may be adversely affected, possibly to a material extent |
| Because of the risks, uncertainties and conditions described above, there can be no assurance that we can maintain our future growth rates at rates consistent with our historic growth rates |
| Our GAAP earnings are highly susceptible to changes in interest rates because most of our derivatives do not qualify for hedge accounting treatment under SFAS Nodtta 133 |
| Changes in interest rates can cause volatility in our earnings as a result of changes in the market value of our derivatives that do not qualify for hedge accounting treatment under SFAS Nodtta 133, “Accounting for Derivative Instruments and Hedging Activities |
| ” Under SFAS Nodtta 133, changes in derivative market values are recognized immediately in earnings |
| If a derivative instrument does not qualify for hedge accounting treatment under SFAS Nodtta 133, there is no corresponding change in the fair value of the hedged item |
| As a result, gain or loss recognized on a derivative will not be offset by a corresponding gain or loss on the underlying hedged item |
| Because most of our derivatives do not qualify for hedge accounting treatment, when interest rates change significantly, our GAAP earnings may fluctuate significantly |