10-K 1 nelnet2.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------------- FORM 10-K For Annual and Transition Reports Pursuant to Sections 13 or 15(d) of the Securities Exchange Act of 1934 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2002 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 333-93865 ------------------------------ NELNET STUDENT LOAN CORPORATION-2 (Exact name of registrant as specified in its charter) Nevada 84-1518863 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 121 South 13th Street, Suite 201 Lincoln, Nebraska 68508 (Address of principal executive offices) (Zip Code) (402) 458-2370 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant on December 31, 2002: None The number of shares outstanding of registrant's common stock as of March 31, 2003 was 1,000. ----------------------------------- DOCUMENTS INCORPORATED BY REFERENCE None 1 TABLE OF CONTENTS Page PART I ITEM 1. BUSINESS.................................................3 ITEM 2. PROPERTIES...............................................9 ITEM 3. LEGAL PROCEEDINGS........................................9 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.....................................9 ITEM 6. SELECTED FINANCIAL DATA.................................10 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.....................11 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.............................................14 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.............15 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.....................15 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......16 ITEM 11. EXECUTIVE COMPENSATION..................................17 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..............................................18 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..........18 ITEM 14. CONTROLS AND PROCEDURES.................................19 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.............................................19 SIGNATURES....................................................................22 2 Forward Looking Statements Statements regarding the Company's expectations as to its ability to purchase Eligible Loans, to structure and issue competitive securities and to compete generally, and certain of the information presented in this report, constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results will not differ materially from its expectations. PART I ITEM 1. BUSINESS The Company NELNET Student Loan Corporation-2 (the "Company") was incorporated under the laws of the State of Nevada on October 8, 1999. Effective March 2, 2000, the Company became a wholly owned subsidiary of Nelnet, Inc. ("Nelnet") and a wholly owned indirect subsidiary of Nelnet Loan Services, Inc., a privately held Nebraska Corporation. Business of Company GENERAL. The Company is a special purpose corporation formed to engage in the business of purchasing, financing, holding and selling guaranteed educational loans made to students and to parents of students ("Eligible Loans") under the Higher Education Act of 1965, as amended (the "Higher Education Act"). Eligible Loans are purchased by the Company from eligible lenders under the Higher Education Act pursuant to the terms and subject to the conditions stated in student loan purchase agreements. The proceeds of the Eligible Loans are used by the borrowers to pay the costs associated with attendance at post-secondary educational institutions. The Company finances its purchases of Eligible Loans through the issuance of its Taxable Student Loan Asset-Backed Notes (the "Notes"). The Notes have been issued in several series. Repayment of the Notes is secured by the pledge of a revolving pool of Eligible Loans and certain other property held for the benefit of the owners of the Notes (the "Trust Estate"). The Trust Estate is held by a trustee (the "Trustee") pursuant to the terms of the Indenture of Trust governing the issuance of the Notes (the "Indenture"). REGISTRATION AND RECENT ISSUANCE OF NOTES. A registration statement on Form S-3, Registration No. 333-93865 (the "Registration Statement"), was filed with the Securities and Exchange Commission (the "SEC") by the Company under the Securities Act of 1933, as amended (the "Securities Act"), for $2,500,000,000 of Notes, and was declared effective by order of the SEC in February, 2000. The Notes may be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933. In March of 2002, the Company filed with the SEC a registration statement on Form S-3 pursuant to Rule 462(b) under the Securities Act of 1933 for $94,000,000 of Notes. The Company issued Taxable Student Loan Asset-Backed Auction Rate Notes, Series 2002A (the "Series 2002A Notes") on March 27, 2002 in the aggregate principal amount of $564,000,000, pursuant to the Registration Statement. The Series 2002A Notes consisted of (i) Senior Class 2002A-1 Auction Rate Notes (the "Class 2002A-1 Notes"), (ii) Senior Class 2002A-2 Auction Rate Notes (the "Class 2002A-2 Notes"), (iii) Senior Class 2002A-3 Auction Rate Notes (the "Class 2002A-3 Notes"), (iv) Senior Class 2002A-4 Auction Rate Notes (the "Class 2002A-4 Notes"), (v) Senior Class 2002A-5 Auction Rate Notes (the "Class 2002A-5 Notes"), (vi) Senior Class 2002A-6 Auction Rate Notes (the "Class 2002A-6 Notes"), and (vii) Senior Class 2002A-7 Auction Rate Notes (the "Class 2002A-7 Notes"). Issuance of the Series 2002A Notes completed the Company's offering under the Registration Statement. Further information regarding the issuance of Notes by the Company since its inception is provided in Table A. THE FEDERAL FAMILY EDUCATION LOAN PROGRAM. The Higher Education Act provides for a program of direct federal insurance of student loans ("FISLP") and reinsurance of student loans guaranteed or insured by a state agency or private non-profit corporation (collectively, "Federal Family Education Loans," with such program referred to herein as the "Federal Family Education Loan Program"). Several types of loans are currently authorized as Federal Family Education Loans pursuant to the Federal Family Education Loan Program. These include: (a) loans to students with respect to which the federal government makes interest payments available to reduce student interest cost during periods of enrollment ("Subsidized Federal Stafford Loans"); (b) loans to students with respect to which the federal government does not make such interest payments ("Unsubsidized Federal Stafford Loans" and, collectively with 3 Subsidized Federal Stafford Loans, "Federal Stafford Loans"); (c) supplemental loans to parents of dependent students ("Federal PLUS Loans"); and (d) loans to fund payment and consolidation of certain of the borrower's obligations ("Federal Consolidation Loans"). Prior to July 1, 1994, the Federal Family Education Loan Program also included a separate type of loan to graduate and professional students and independent undergraduate students and, under certain circumstances, dependent undergraduate students, to supplement their Stafford Loans ("Federal Supplemental Loans for Students" or "Federal SLS Loans"). GUARANTEE AGENCIES. Each Eligible Loan is guaranteed as to the payment of principal and interest by a state or private non-profit guarantor (each, a "Guarantee Agency"). Eligible Loans originated prior to October 1, 1993 are fully guaranteed as to the principal amount of such loans and accrued interest by the applicable Guarantee Agency. Eligible Loans originated on or after October 1, 1993 are guaranteed as to 98% of the principal amount of such loans and accrued interest by the applicable Guarantee Agency. Each of the Guarantee Agencies has a reinsurance contract with the Department of Education (the "Department"). The Department reimburses the Guarantee Agencies for claims paid by the Guarantee Agencies. The amount of such reinsurance payment is calculated annually and is subject to reduction based upon the annual claims rate of the Guarantee Agency to the Department. Regardless of the level of reinsurance that the applicable Guarantee Agency receives from the Department, the Trustee will continue to be entitled to reimbursement for the applicable guaranteed portion of an Eligible Loan (either 98% or 100%, as applicable) from such Guarantee Agency. The obligations of each of the Guarantee Agencies to the holders of Eligible Loans reinsured by the Department (the "Federal Loans"), such as the Trustee, are payable from the general funds available to such Guarantee Agency, including cash on deposit therewith, reimbursements received from the Department and reserve funds maintained by such Guarantee Agency as required by the Higher Education Act. The Higher Education Act provides that, subject to the provisions thereof including the proper origination and servicing of Eligible Loans, the full faith and credit of the United States is pledged to the reinsurance payments by the Department to the Guarantee Agencies. In addition, the Higher Education Act provides that if the Secretary of Education has determined that a Guarantee Agency is unable to meet its obligations to holders of Federal Loans, such as the Trustee, then the holders of Federal Loans may submit guarantee claims directly to the Department and the Department is required to pay to the holders the full insurance obligation of such Guarantee Agency until such time as the obligations are transferred by the Department to a new Guarantee Agency capable of meeting such obligations or until a qualified successor Guarantee Agency assumes such obligations. Certain delays in receiving reimbursement could occur if a Guarantee Agency fails to meet its obligations. In addition, failure to properly originate or service an Eligible Loan can cause an Eligible Loan to lose its guarantee. SERVICING OF ELIGIBLE LOANS. Nelnet acts as servicer (the "Servicer") of the Company's Eligible Loans in accordance with a Servicing Agreement, dated as of June 1, 2000 (the "Servicing Agreement"). Nelnet Loan Services, Inc. acts as subservicer (the "Subservicer") and custodian (the "Custodian") of the Eligible Loans in accordance with the Subservicing Agreement (the "Subservicing Agreement") between Nelnet and Nelnet Loan Services, Inc., respectively. The Company may appoint other entities to act as a servicer or subservicer if approved by the rating agencies which rate the Notes. Nelnet Loan Services, Inc. began its education loan servicing operations on January 1, 1978, and provides education loan servicing, time sharing, administration and other services to lenders, secondary market purchasers and Guarantee Agencies throughout the United States. 4 Information on the Notes and Eligible Loans In accordance with the Indenture, the Company is required to provide information periodically to the Trustee regarding the Notes and Eligible Loans, which information is then forwarded to registered holders of the Notes. Provided below is selected information as of December 31, 2002 that was previously provided to holders of the Notes, as well as additional components not previously reported. Although the information set forth below has not been independently verified by third parties, the Company believes it to be accurate to the best of its knowledge. The principal balance of Eligible Loans as of December 31, 2002 was $1,222,296,890. Set forth in Table A below is the aggregate outstanding principal amount of Notes of each Class as of December 31, 2002.
Table A Original Principal Amount of Notes Issued by the Company And the Outstanding Aggregate Principal Amount Per Class (December 31, 2002) Principal Original Outstanding as of Series Class Date Issued Maturity Dates Principal Amount December 31, 2002 2000 A-1 June 1, 2000 December 1, 2032 $50,000,000 $ --------(i) 2000 A-2 June 1, 2000 December 1, 2032 50,000,000 --------(i) 2000 A-3 June 1, 2000 December 1, 2032 50,000,000 --------(i) 2000 A-4 June 1, 2000 December 1, 2032 50,000,000 --------(i) 2000 A-5 June 1, 2000 December 1, 2032 50,000,000 --------(i) 2000 A-6 June 1, 2000 December 1, 2032 50,000,000 --------(i) 2000 A-7 June 1, 2000 December 1, 2032 50,000,000 --------(i) 2000 A-8 June 1, 2000 December 1, 2032 75,000,000 --------(i) 2000 A-9 June 1, 2000 December 1, 2032 75,000,000 --------(i) 2000 A-10 June 1, 2000 December 1, 2032 75,000,000 --------(i) 2000 A-11 June 1, 2000 December 1, 2032 75,000,000 --------(i) 2000 A-12 June 1, 2000 December 1, 2032 100,000,000 --------(i) 2000 A-13 June 1, 2000 December 1, 2032 100,000,000 --------(i) 2000 A-14 June 1, 2000 December 1, 2032 100,000,000 --------(i) 2000 B-1 June 1, 2000 December 1, 2032 50,000,000 50,000,000 2001 A-1 April 2, 2001 July 1, 2012 480,000,000 480,000,000 2001 A-2 September 4, 2001 June 1, 2035 50,000,000 50,000,000 2001 A-3 September 4, 2001 June 1, 2035 50,000,000 --------(i) 2001 A-4 September 4, 2001 June 1, 2035 75,000,000 --------(i) 2001 A-5 September 4, 2001 June 1, 2035 100,000,000 100,000,000 2001 A-6 September 4, 2001 June 1, 2035 100,000,000 --------(i) 2001 A-7 September 4, 2001 June 1, 2035 100,000,000 100,000,000 2001 B-1 September 4, 2001 June 1, 2035 37,500,000 37,500,000 2001 B-2 September 4, 2001 June 1, 2035 37,500,000 37,500,000 2002 A-1 March 27, 2002 June 1, 2035 70,500,000 70,500,000 2002 A-2 March 27, 2002 June 1, 2035 70,500,000 70,500,000 2002 A-3 March 27, 2002 June 1, 2035 70,500,000 70,500,000 2002 A-4 March 27, 2002 June 1, 2035 70,500,000 70,500,000 2002 A-5 March 27, 2002 June 1, 2035 100,000,000 100,000,000 2002 A-6 March 27, 2002 June 1, 2035 100,000,000 100,000,000 2002 A-7 March 27, 2002 June 1, 2035 82,000,000 82,000,000 ------------- -------------- $2,594,000,000 $1,419,000,000
(i) Notes in the amount of $1,175,000,000 were redeemed by the Company during the months of October and November of 2002. Funds utilized for this redemption were derived from the proceeds of a sale of a portfolio of loans by the Company to Nelnet Student Loan Funding, LLC on October 8, 2002. 5 Set forth in Table B below is the interest rate for each outstanding Class of Notes as of December 31, 2002. The interest rate is calculated based on the applicable Auction Rate. The term "Auction Rate" refers to the rate of interest per annum that results from implementation of the auction procedures as described in the Indenture. Table B Applicable Interest Rate Per Class (as of December 31, 2002) Class Calculation method ----- ------------------ AUCTION RATE 2000B-1 1.60% 2001A-2 1.50% 2001A-5 1.52% 2001A-7 1.50% 2001B-1 1.65% 2001B-2 1.60% 2002A-1 1.65% 2002A-2 1.39% 2002A-3 1.50% 2002A-4 1.52% 2002A-5 1.50% 2002A-6 1.50% 2002A-7 1.50% FIXED RATE 2001A-1 5.76% 6 Set forth in the tables below are the characteristics of Eligible Loans held in the Trust Estate on December 31, 2002. Although the information set forth below has not been independently verified by third parties, the Company believes it to be accurate to the best of its knowledge. Table C Composition of the Eligible Loans & Distribution by Loan Type (as of December 31, 2002) Outstanding Percent of Loans Principal By Outstanding Loan Types Balance Balance ---------- ------------ --------------- Consolidation $ 738,148,955 60.39 % PLUS 9,149,382 .75 SLS 1,366,715 .11 Stafford-Subsidized 236,653,470 19.36 Stafford-Unsubsidized 236,978,368 19.39 ----------- ----- Total $1,222,296,890 100.00 % ============== ====== Number of Borrowers 77,356 Average Outstanding Principal Balance Per Borrower $ 15,801 Number of Loans 155,402 Average Outstanding Principal Balance Per Loan $ 7,865 Approximate Weighted Average Remaining Term (Months) 175 7 Table D Distribution of the Eligible Loans by Interest Rate (as of December 31, 2002) Outstanding Percent of Loans Principal By Outstanding Interest Rate Range Balance Balance ------------------- ----------- ----------------- Less than 7.50% $ 621,319,218 50.83 % 7.50% to 7.99% 64,764,760 5.30 8.00% to 8.49% 301,903,491 24.70 8.50% to 8.99% - .00 9.00% to 9.49% 225,574,872 18.46 9.50% or greater 8,734,549 .71 -------------- ------ Total $1,222,296,890 100.00 % ============== ====== Table E Distribution of the Eligible Loans by School Types (as of December 31, 2002) Outstanding Percent of Loans Principal By Outstanding School Type Balance Balance ----------- ------------- ---------------- 2-Year $28,519,113 2.33 % 4-Year 413,162,296 33.80 Proprietary 40,073,265 3.28 Unknown 2,393,261 .20 Consolidation 738,148,955 60.39 ----------- ----- Total $1,222,296,890 100.00 % ============== ====== COMPETITION The Company experiences competition from banks and savings associations and other private companies, non-profit companies, trusts and financial firms issuing debt securities the proceeds of which are used to purchase pools of student loans. Many of these entities have greater financial, technical, management and other resources than does the Company. The Company believes that key factors in its ability to compete will be its ability to purchase Eligible Loans and its ability to structure notes or other securities in a manner which will be competitive with securities offered by competitors. EMPLOYEES The Company does not employ any employees. The Company and Nelnet have entered into an Administrative Services Agreement which is more fully described in ITEM 13 hereof. The Company does not plan to hire any employees in the next fiscal year. 8 ITEM 2. PROPERTIES The Company has no materially important physical properties. ITEM 3. LEGAL PROCEEDINGS None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2002. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company is a wholly owned subsidiary of Nelnet. There is no public trading market for the Company's common stock and the Company does not have any compensation plans that provide for issuance of its equity securities. As of March 31, 2003, Nelnet was the only record holder of the Company's outstanding shares of common stock. The Company paid dividends on December 30, 2002 in the amount of $6,400,000 and on December 31, 2001 in the amount of $5,500,000. 9 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth the Company's selected financial data as of December 31, 2002, 2001, and 2000, and for the years ended December 31, 2002 and 2001and for the period from June 1, 2000 (date of inception) through December 31, 2000. This information has been derived from the financial statements of the Company which have been audited by KPMG LLP. The information below should be read in conjunction with the Financial Statements and notes thereto appearing elsewhere in this document.
NELNET STUDENT LOAN CORPORATION-2 SELECTED FINANCIAL DATA Year Ended Year Ended Period Ended Statement of Operations Data: December 31, December 31, December 31, 2002 2001 2000 (1) ---- ---- -------- Revenues: Loan interest........................ $ 113,531,516 $ 100,455,019 $ 46,225,110 Investment interest.................. 2,635,858 1,743,425 2,174,126 Other................................ 598,458 198,289 80,481 ----------- ----------- ---------- Total revenues............... 116,765,832 102,396,733 48,479,717 ----------- ----------- ---------- Expenses: Interest on notes payable............ 63,180,085 68,190,154 39,401,390 Loan servicing fees to related party. 17,150,999 13,586,370 5,414,538 Trustee and broker fees.............. 4,715,340 3,311,175 1,621,060 Amortization and write down of debt issuance costs....................... 5,707,491 344,311 78,537 Amortization of loan premiums and lender fees.......................... 10,454,316 4,434,839 1,652,178 Provision for loan losses............ 1,100,000 1,600,000 1.010,000 Other general and administrative .... 3,570,669 2,767,940 1,147,800 ----------- ----------- ---------- Total expenses............... 105,878,900 94,234,789 50,325,503 ----------- ----------- ---------- Income (loss) before income tax expense (benefit)........ 10,886,932 8,161,944 (1,845,786) Income tax expense (benefit) ............ 3,919,295 2,938,300 (664,483) ----------- ----------- ---------- Net income (loss) ........... $ 6,967,637 $ 5,223,644 $ (1,181,303) =========== =========== =========== Ratio of earnings to fixed charges....... 1.16% 1.12% .95% (2) Balance Sheet Data: Cash and cash equivalents ............... $ - $ 8,093 $ 1,008,671 Restricted cash - held by trustee ....... 153,201,633 46,135,799 24,532,423 Student loans receivable, net............ 1,241,067,610 1,933,941,068 942,498,737 Total assets............................. 1,435,119,250 2,044,484,139 1,003,025,980 Notes payable ........................... 1,419,000,000 2,030,000,000 1,000,000,000 Total liabilities........................ 1,425,169,906 2,040,340,798 1,004,206,283 Stockholder's equity (deficit)........... 9,949,344 4,143,341 (1,180,303) (1) The Company was incorporated on October 8, 1999. The Company commenced its business operations on June 1, 2000. (2) Earnings were inadequate to cover fixed charges by $1,845,786 for the period ended December 31, 2000.
10 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the information set forth under the caption entitled "ITEM 6.--SELECTED FINANCIAL DATA" and the financial statements and notes thereto included elsewhere herein. Moreover, any forward looking statements should be read in conjunction with information set forth in "ITEM 1 -- Forward Looking Statements." GENERAL The Company was formed on October 8, 1999 solely for the purpose of acquiring, from time to time, Eligible Loans and issuing notes, such as the Notes, secured by such Eligible Loans. Since its inception, the Company has issued four (4) series of Notes consisting of thirty-one (31) classes. The Notes shown in the financial statements of the Company represent limited obligations of the Company secured solely by the Eligible Loans and other assets in the Trust Estate. The assets of the Company consist primarily of Eligible Loans. The total principal balance of Eligible Loans held by the Company was $1,222,300,000 on December 31, 2002. The initial issuance of Notes occurred on June 1, 2000 in the amount of $1,000,000,000. There were two additional issuances in 2001, on April 2, 2001 in the amount of $480,000,000 and on September 4, 2001 in the amount of $550,000,000. There was one additional issuance in 2002, on March 27, 2002, in the amount of $564,000,000. SIGNIFICANT ACCOUNTING POLICIES The notes to the financial statements contain a summary of the Company's significant accounting policies. Certain of these policies are considered to be important to the portrayal of the Company's financial condition, since they may require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. The Company's critical accounting policy is determining the level of the allowance for loan losses. Additional information about this policy can be found in Note 1 to the financial statements. CRITICAL ACCOUNTING POLICY - ALLOWANCE FOR LOAN LOSSES The allowance for loan losses represents management's estimate of probable losses on Eligible Loans held in the Trust Estate and pledged to repay the Notes. This evaluation process is subject to numerous estimates and judgments. In making such estimates and judgments, management considers such things as the value and character of loans outstanding, past loan loss experience and general economic conditions. The allowance for loan losses is determined via a process that begins with estimates of probable losses on Eligible Loans held in the Trust Estate, based upon a statistical analysis. Historical delinquencies and credit loss experience is applied to the current aging of the portfolio, together with analyses that reflect current trends and conditions. The allowance for loan losses reflects assumptions and estimates the Company believes are reasonable in light of historical loan losses and known trends with respect to Eligible Loans held in the Trust Estate. However, these estimates and assumptions are inherently uncertain and there can be no guarantee that management's estimates and assumptions will prove correct in future periods. Management continually measures expected losses against actual losses and assumptions are revised accordingly. Moreover, changes in the estimates and assumptions management uses to estimate the allowance for loan losses could have a direct impact on the amount of the allowance and the Company's financial condition in future periods. RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001 REVENUES. Revenues for the year ended December 31, 2002 consisted primarily of interest earned on student loans, which totaled $113,531,516, compared to $100,455,019 for the year ended December 31, 2001, an increase of 13.02%. The increase in revenues is directly attributable to the issuance of additional debt by the Company to acquire student loans in the first quarter of 2002. The Company's average net investment in student loans during the year ended December 31, 2002 was $2,040,687,694 (excluding funds held by the Trustee), compared to $1,422,838,180 for the year ended December 31, 2001, and the average effective annual interest rate of interest income on Eligible Loans was 5.56% for the year ended December 31, 2002, compared to 7.06% for the year 11 ended December 31, 2001, 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 during 2002 and the "floor rate" on the student loan assets being reset annually on July 1. The Company also received investment interest and other income for the year ended December 31, 2002 in the amounts of $2,635,858 and $598,458, respectively, compared to $1,743,425 and $198,289, respectively, for the year ended December 31, 2001. The increase in investment interest was a result of restricted cash being held by the Trust to redeem bonds during the fourth quarter of 2002. EXPENSES. Expenses for the year ended December 31, 2002 consisted primarily of interest on the Company's outstanding Notes which totaled $63,180,085, compared to $68,190,154 for the year ended December 31, 2001, a decrease of 7.35%. The amount of interest expense reported depends upon the amount of Notes outstanding during the years and the interest rates on such Notes. The Company's average debt outstanding was approximately $2,258,000,000 for the year ended December 31, 2002, compared to average debt outstanding of $1,543,000,000 for the year ended December 31, 2001 and the average annual cost of borrowings was approximately 2.80% for the year ended December 31, 2002, compared to approximately 4.42% for the year ended December 31, 2001. The decrease in expense and the average annual cost of borrowings is a direct result of a declining interest rate environment during 2002. The Company also incurred loan servicing fees to a related party in the amount of $17,150,999 for the year ended December 31, 2002, compared to $13,586,370 for the year ended December 31, 2001. See "ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" for a description of the Servicing Agreement and Administrative Services Agreement pursuant to which such fees are owed. Loan servicing fees to a related party were higher in 2002 because the Company held, on average, more student loans in 2002. Trustee and broker fees, amortization of debt issuance costs and amortization of loan premiums and lender fees for the year ended December 31, 2002 amounted to $4,715,340, $5,707,491, and $10,454,316, respectively, compared to $3,311,175, $344,311, and $4,434,839, respectively, for the year ended December 31, 2001. The increases are attributable to the issuance of additional Notes and the acquisition of student loans in the first quarter of 2002. The increase in amortization of debt issuance costs is attributable to the write-off of debt issuance costs related to the approximate $1.2 billion of redeemed notes in 2002. Amortization of loans premiums and lender fees also increased due to an increase in the rate of amortization based on an increase in principal payments on the loans as a greater percentage of the loan portfolio is in repayment status. Provision for loan losses for the year ended December 31, 2002 amounted to $1,100,000, compared to $1,600,000 for the year ended December 31, 2001. The decrease in the provision for loan losses occurred in order to reflect the appropriate allowance amounts in comparison to the estimated defaults. General and administrative expenses for the year ended December 31, 2002 amounted to $3,570,669, compared to $2,767,940 for the year ended December 31, 2001. This increase is due to an increase in administrative fees incurred to the parent as the average outstanding student loan balances increased in 2002. INCOME TAX EXPENSE. The Company has recognized income tax expense of $3,919,295 for the year ended December 31, 2002 compared to $2,938,300 for the year ended December 31, 2001. The increase in income tax expense was a result of higher net income being realized for the year ended December 31, 2002, compared to the year ended December 31, 2001. The effective tax rate utilized by the Company to recognize a provision for income taxes in 2002 and 2001 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 $6,967,637 for the year ended December 31, 2002 compared to $5,223,644 for the year ended December 31, 2001. The increase in net income is attributable to a higher net interest margin on student loans due to the declining interest rates on the Notes during the period while the "floor rate" on 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 $18,086,566 from $32,264,865 for the year ended December 31, 2001 to $50,351,431 for the year ended December 31, 2002. On October 8, 2002, the Company sold a portfolio of student loans to Nelnet Student Loan Funding LLC, which is a 100% owned subsidiary of Nelnet. Proceeds from the loan sale were used to redeem approximately $1.2 billion of the Company's notes. Additional amortization of debt issuance costs of $5,219,919 included in the statement of operations for the year ended December 31, 2002 is a result of a write-off of debt issuance costs related to the redeemed notes. There were no other unusual or infrequent events or transactions that materially affected the amount of reported income. YEAR ENDED DECEMBER 31, 2001 COMPARED TO PERIOD ENDED DECEMBER 31, 2000 REVENUES. Revenues for the year ended December 31, 2001 consisted primarily of interest earned on student loans, which totaled $100,455,019, compared to $46,225,110 for the period ended December 31, 2000, an increase of 117.32%. 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 along with the financial results on a full year of business activity in 2001 compared to seven months of business activity in 2000. The amount of interest reported for each period was derived from Eligible Loans in an aggregate 12 principal amount, net of allowance for loan losses and unamortized premiums, of $1,933,941,068 at December 31, 2001, compared to $942,498,737 at December 31, 2000. The Company's average net investment in student loans during the year ended December 31, 2001 was $1,422,838,180 (excluding funds held by the Trustee), compared to $891,888,250 for the period ended December 31, 2000, and the average effective annual interest rate of interest income on Eligible Loans was 7.06% for the year ended December 31, 2001, compared to 8.88% for the period ended December 31, 2000, 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 during 2001 and the "floor rate" on the student loan assets being reset annually on July 1. The Company also received investment interest and other income for the year ended December 31, 2001 in the amounts of $1,743,425 and $198,289, respectively, compared to $2,174,126 and $80,481, respectively, for the period ended December 31, 2000. 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. Expenses for the year ended December 31, 2001 consisted primarily of interest on the Company's outstanding Notes which totaled $68,190,154, compared to $39,401,390 for the period ended December 31, 2000, an increase of 73.07% . The amount of interest expense reported depends upon the amount of Notes outstanding during the years and the interest rates on such Notes. This increase in expenses is directly attributable to the issuance of additional Notes in the second and third quarters of 2001 along with the financial information on a full year of business activity compared to seven months of business activity in 2000. The Company's average debt outstanding was approximately $1,543,000,000 for the year ended December 31, 2001, compared to debt outstanding of $1,000,000,000 for the period ended December 31, 2000 and the average annual cost of borrowings was approximately 4.42% for the year ended December 31, 2001, compared to approximately 6.75% for the period ended December 31, 2000. The decrease in the average annual cost of borrowings is a direct result of a declining interest rate environment during 2001. The Company also incurred loan servicing fees to a related party in the amount of $13,586,370 for the year ended December 31, 2001, compared to $5,414,538 for the period ended December 31, 2000. See "ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" for a description of the Servicing Agreement and Administrative Services Agreement pursuant to which such fees are owed. Loan servicing fees to a related party were higher in 2001 because the Company held, on average, more student loans in 2001 and incurred a full year of servicing costs. Trustee and broker fees, amortization of debt issuance costs and amortization of loan premiums and lender fees for the year ended December 31, 2001 amounted to $3,311,175, $344,311 and $4,434,839 respectively, compared to $1,621,060, $78,537 and $1,652,178 respectively, for the period ended December 31, 2000. The increases are attributable to the issuance of additional Notes in the second and third quarters of 2001 and a comparison of a full year of expenses in 2001 to seven months of expenses in 2000. Amortization of loans premiums and lender fees also increased due to an increase in the rate of amortization based on 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 for the year ended December 31, 2001 amounted to $1,600,000, compared to $1,010,000 for the period ended December 31, 2000. Additional amounts were recognized as provision for loan losses in order to reflect the appropriate allowance amounts in comparison to the estimated defaults. Other general and administrative expenses for the year ended December 31, 2001 amounted to $2,767,940, compared to $1,147,800 for the period ended December 31, 2000. This increase is due to an increase in administrative fees incurred to the parent as the average outstanding student loan balances increased in 2001 along with a full year of expenses reported in 2001 compared to seven months in 2000. INCOME TAX EXPENSE. The Company has recognized income tax expense of $2,938,300 for the year ended December 31, 2001 compared to an income tax benefit of $664,483 for the period ended December 31, 2000. The income tax expense was a result of net income being realized for the year ended December 31, 2001 compared with the net loss realized for the period ended December 31, 2000. The effective tax rate utilized by the Company to recognize a provision for income taxes in 2001 and 2000 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 $5,223,644 for the year ended December 31, 2001 compared to a net loss of $1,181,303 for the period ended December 31, 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 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 $25,441,145 from $6,823,720 for the period ended December 31, 2000 to $32,264,865 for the year ended December 31, 2001. The net loss for the period ended December 31, 2000 resulted from the pre-funding of a portion of the Series 2000 Notes, establishing the allowance for loan loss and amortization expense related to student loan premiums being higher than expected. For the year ended December 31, 2001, there were no unusual or infrequent events or transactions or any significant economic dangers that materially affected the amount of reported income. 13 LIQUIDITY AND CAPITAL RESOURCES Eligible Loans held by the Company are pledged as collateral for the Notes, the terms of which provide for the retirement of all Notes from the proceeds of the Eligible Loans. Cash flows from payments on the Eligible Loans, together with proceeds of reinvestment income earned on the Eligible Loans, are intended to provide cash sufficient to make all required payments of principal and interest on each outstanding series of Notes. The Indenture under which the Notes were issued also creates a Reserve Fund from which money can be drawn to make payments or interest and principal on the Notes. The Reserve Fund is fully funded under the terms of the Indenture and the Company anticipates that cash flows generated from its Eligible Loans will be sufficient to meet the obligation on its outstanding Notes. It is anticipated that regular payments under the terms of the Eligible Loans, as well as early prepayment, will reduce the number of Eligible Loans held in the Trust Estate. The Company is authorized under the Indenture to use principal receipts from Eligible Loans to purchase additional Eligible Loans until July 1, 2004. Scheduled payments on the Company's notes payable will be made, only to the extent funds are available. Assuming funds are available, scheduled payments are due as follows: 2003 $48,000,000 2004 89,760,000 2005 84,000,000 2006 84,000,000 2007 79,200,000 2008 and thereafter 1,034,040,000 ------------- $1,419,000,000 Management's expectations are that future cash flows provided by operating activities will be sufficient to meet the Company's obligations. For further discussion of the above obligations, refer to Note 4 of the financial statements. IMPACT OF INFLATION For the year ended December 31, 2002, cost increases to the Company were not materially impacted by inflation. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's assets consist almost entirely of student loans. Those 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 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 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 student loans with variable rate debt instruments. The Notes bear interest at a rate that is reset periodically by means of auction procedures. By funding its student loans with variable rate Notes, the Company attempts to maintain a positive "spread" between the interest earned on its student loans and its interest payment obligations under the Notes. Thus, in an environment of generally declining interest rates, the Company should earn less interest on its student loans, but the interest expense on the Notes should also be lower. The interest rate on each series of Auction Rate Notes is based generally on the outcome of each auction of such series of Notes. The 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 interest rates on student loans and the interest rates on the Notes, there could be periods of time when the rates on student loans are inadequate to generate sufficient cash flow to cover the interest on the 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 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). 14 As shown by the chart below, the Company has conducted a sensitivity analysis to determine what effect different changes in the interest rates on student loans and the Notes would have on its cash flows and its resulting ability to pay the principal and interest due on the Notes. Historically, the majority of the Company's Notes have borne interest at a rate that approximates 1 Month LIBOR. Generally, student loans bear interest at a rate based on the 91-day Treasury Bill Rate. Thus, the Company's analysis of the effect of different interest rates on its cash flows was prepared assuming spreads of 10, 30, 40, 60, 80 and 100 basis points between 91-day Treasury Bills and 1 Month LIBOR (the "NELNET-2 Ted Spread"). The NELNET-2 Ted Spreads were then applied at different rates of interest to determine their effect on the "spread" between the interest the Company earns on its student loans and its interest payment obligations under the notes (the "NELNET-2 Net Spread"). -------------------------------------------------------------------------------- T-Bill* NELNET-2 Net Spread ---------- --------- ----------- ----------- ---------- ----------- 5.00% .10% -.03% -.10% -.23% -.37% -.50% ---------- --------- ----------- ----------- ---------- ----------- 4.00% .24% .11% .04% -.09% -.22% -.36% ---------- --------- ----------- ----------- ---------- ----------- 3.00% .44% .31% .24% .11% -.02% -.16% ---------- --------- ----------- ----------- ---------- ----------- 2.00% .64% .51% .44% .31% .18% .04% ---------- --------- ----------- ----------- ---------- ----------- 1.50% .78% .65% .59% .45% .32% .19% ---------- --------- ----------- ----------- ---------- ----------- 1.00% .91% .78% .71% .58% .44% .31% ---------- --------- ----------- ----------- ---------- ----------- ------------ ---------- --------- ----------- ----------- ---------- ----------- NELNET-2 Ted Spread** 10 30 40 60 80 100 -------------------------------------------------------------------------------- * 91 Day T-Bill (Yield) ** 1 Month LIBOR vs. 91 Day T-Bill (Yield) Generally, increases in the NELNET-2 Ted Spread and decreases in interest rates have the effect of reducing the NELNET-2 Net Spread, and correspondingly, the Company's cash flows. For example, as of March 21, 2003 the 1 Month LIBOR rate was 1.305% and the 91-day Treasury Bill Rate was 1.16%. Thus, the NELNET-2 Ted Spread was approximately fifteen basis points (1.305- 1.16) and the NELNET-2 Net Spread was approximately 91 basis points. If, at the same interest rate (approximately 1.00%), the NELNET-2 Ted Spread is increased to 100, the Company's cash flows are significantly reduced, as evidenced by a NELNET-2 Net Spread of 31 basis points. The Company, however, believes that a NELNET-2 Ted Spread of 100 is unlikely to occur. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary financial data required by this ITEM 8 are set forth in ITEM 15 of this Form 10-K. All information which has been omitted is either inapplicable or not required. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There were no adverse opinions or disclaimers of opinion, nor were there any modifications as to uncertainty, audit scope, or accounting principles rendered by the independent accountants. There were no disagreements with the current accounting firm on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure. There are no changes in or disagreements on accounting and financial statement disclosure. 15 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The Company is governed by a Board of Directors, which is required by the Company's Articles of Incorporation to include at least three directors. Directors are required to be elected at each annual meeting of the shareholders. The present directors and executive officers and their addresses and principal occupations or affiliations are as follows:
Principal Officers and Other Occupation Directors Term Name of Director Offices Held Age Address or Affiliation From To* ---------------- ------------ --- ------- -------------- ------ ----- Michael S. Chairman 39 6801 S. 27th Street Chief October Present Dunlap P.O. Box 82529 Executive 1999 Lincoln, Nebraska Officer of 68501 Union Bank and Trust Company; President, Farmers & Merchants Investment, Inc.; Chairman, Nelnet, Inc. Stephen F. President 50 6991 East Camelback Vice October Present Butterfield Road, Suite B290 Chairman, 1999 Scottsdale, Arizona Nelnet, Inc.; 85251 President of Union Financial Services, Inc. Terry J. Heimes Vice 38 121 S. 13th Street Executive December Present President, Suite 201 Vice President 2002 Treasurer Lincoln, NE 68508 and Chief and Secretary Financial Officer, - Nelnet, Inc. Jeffery R. Vice 37 3015 S. Parker Road Executive November Present Noordhoek President Suite 400 Director, 2001 Aurora, CO 80014 Capital Markets - Nelnet, Inc. Ross Wilcox Director 60 4732 Calvert Street Chairman of October Present Lincoln, Nebraska the Board of 1999 68506 Union Bank and Trust Company Dr. Paul R. Hoff Director 68 Hernia Hill, Rural Retired October Present Route 1 Physician 1999 Seward, Nebraska 68434 (*) Each director holds office until the next annual meeting of shareholders following his or her election until such director's successors shall have been elected and qualified. The Company's next annual meeting is scheduled for March 2004.
EXECUTIVE MANAGEMENT The Board of Directors and executive officers described below are responsible for overall management of the Company. The Company's officers and directors are shareholders, officers and directors of business entities that have engaged in the business of purchasing, holding and selling student loans. MICHAEL S. DUNLAP, CHAIRMAN OF THE BOARD. As co-founder and chairman of the board of both Nelnet and Union Financial Services, Inc. ("UFS"), Michael S. Dunlap is responsible for the overall strategy and direction of the companies. Mr. Dunlap is also the chief executive officer of Union Bank and Trust Company, and president of Farmers & Merchants Investment, Inc. (the parent of Union Bank and Trust Company). Mr. Dunlap has been an employee of Union Bank and Trust Company for approximately 20 years and is a member of the Nebraska State Bar Association. Mr. Dunlap received his B.S. degree in finance and accounting and his law degree from the University of Nebraska. 16 STEPHEN F. BUTTERFIELD, PRESIDENT AND DIRECTOR. Stephen F. Butterfield serves as the vice chairman of Nelnet, assisting in the executive direction of the company and managing its capital market relationships. As co-founder and president of UFS, Mr. Butterfield directs the overall management and direction of the company, including asset purchasing, marketing of corporate services, and coordination of the company's capital market activities. Mr. Butterfield has been a member of the student loan industry since January 1989, first as president of a for-profit student loan secondary marketing facility located in Scottsdale, Arizona, and second as president of the Student Loan Acquisition Authority of Arizona, a non-profit secondary marketing facility in Scottsdale, Arizona. Prior to his work in the student loan industry, Mr. Butterfield spent 15 years as an investment banker for Boettcher and Company specializing in municipal finance. Mr. Butterfield received his B.S. degree in business administration from Arizona State University. TERRY J. HEIMES, VICE PRESIDENT, TREASURER AND SECRETARY. Terry J. Heimes serves as chief financial officer and executive vice president of Nelnet and its operating companies and is responsible for the coordination of all financial and accounting functions for the corporation. Active in the strategic planning and direction of the company, Mr. Heimes oversees the preparation and issuance of financial statements, corporate accounting/tax matters, preparation of asset-backed securitization, and warehousing activities. With over 13 years experience in education finance, Mr. Heimes is versed in taxable and tax-exempt issuances of debt, warehousing lines of credit, asset-backed commercial paper, conduit financing, private placements, and conversion of non-profit tax-exempt issuers to taxable issuers. Mr. Heimes joined Nelnet in 1998 with the conversion and acquisition of the Nebraska Higher Education Loan Program, Inc. (NEBHELP). Prior to joining NEBHELP, Mr. Heimes worked for the public accounting firm of KPMG Peat Marwick through 1992 as a manager in the audit department. Mr. Heimes graduated Magna cum Laude from the University of Nebraska-Kearney with a bachelor of science in business administration with an emphasis in accounting. JEFFERY R. NOORDHOEK, VICE PRESIDENT AND DIRECTOR. As executive director of the Capital Markets area of Nelnet, Jeffrey R. Noordhoek is responsible for leading the company in its securitization and capital markets funding efforts. Mr. Noordhoek's primary function is to raise low cost capital and to design creative methods to finance the company's student loan portfolios through warehouse lines of credit, long-term securitizations, and private debt arrangements. Mr. Noordhoek has been in the capital markets area of Nelnet since 1996. Prior to joining Nelnet, Mr. Noordhoek served as a senior associate for State Street Capital Corporation where he assisted in the establishment of Clipper Receivables Commercial Paper Conduit and the Clipper Blue Tax-Exempt financing vehicles. While at State Street, Mr. Noordhoek worked at its offices in Luxembourg, Toronto, and Boston where he successfully executed securitizations in numerous asset classes. Mr. Noordhoek received his B.S. in business administration from the University of Nebraska and his M.B.A. from Boston University. ROSS WILCOX, DIRECTOR. Ross Wilcox has been with Union Bank and Trust Company since 1966 and serves as chairman of its Board of Directors. Mr. Wilcox is the chairman of the Lincoln Chamber of Commerce. A graduate of Nebraska Wesleyan University, Mr. Wilcox now serves as a trustee for the University. Mr. Wilcox also serves as trustee for Lighthouse (a youth intervention program), the Lincoln Public Schools Foundation, and Bryan LGH Medical Center. Mr. Wilcox is also on the Board of Directors for the Lincoln Country Club, the Lincoln Chamber of Commerce, and the Nebraska chapter of the Nature Conservancy. DR. R. PAUL HOFF, DIRECTOR. Dr. R. Paul Hoff has worked as a family practice physician in Seward, Nebraska for 35 years. In addition, Dr. Hoff has served as a past member of Admissions Board of University of Nebraska Medical School and the Deans Advisory Board. Dr. Hoff currently acts as a board member for Stratus Mutual Fund and Security Home Bank, and as a past board member for: Hawkeye Bank Corp., NEBHELP and Nelnet Loan Services. The Company's executive officers are elected annually by the Board of Directors and serve at the discretion of the Board. The Company's directors hold office until the next annual meeting of stockholders and until their successors have been duly elected and qualified. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934 is not applicable to the Company, because the Company has no class of equity securities registered pursuant to Section 12 thereof. ITEM 11. EXECUTIVE COMPENSATION The Company's executive officers are not compensated by the Company for services rendered by them, although some of the Company's officers are compensated by Nelnet, which receives remuneration from the Company pursuant to an Administrative Services Agreement by and between Nelnet and the Company. A detailed description of the Administrative Services Agreement is set forth in ITEM 13 of this Form 10-K. 17 AGGREGATED OPTION EXERCISES AND YEAR-END OPTION VALUES IN 2002 The Company has not issued any options. LONG-TERM INCENTIVE PLAN AWARDS IN 2002 The Company has no long-term incentive plan. DEFINED BENEFIT OR ACTUARIAL PLAN DISCLOSURE IN 2002 The Company has no such benefit plans. EMPLOYMENT AGREEMENTS The Company has not entered into any employment agreements. DIRECTOR COMPENSATION Directors of the Company are not compensated as directors, but may receive reimbursement of out-of-pocket expenses in connection with attendance at Board meetings. OFFICER COMPENSATION The Company has not adopted a compensation plan for officers. BOARD MEETINGS During fiscal year 2002, the Board held three regular meetings. COMMITTEES OF THE BOARD The Board of Directors has not established an Audit Committee or a Compensation Committee. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT As of March 31, 2003, there were 1,000 shares of the Company's common stock, no par value, outstanding, all of which were held by Nelnet. No director or executive officer owns any shares of the Company and there are no other beneficial owners. CHANGES IN CONTROL. The Company knows of no arrangement, including the pledge by any person of securities of the Company, which may at a subsequent date result in change of control of the Company. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Administrative Services Agreement. The Company and Nelnet, the Company's parent corporation, entered into an Administrative Services Agreement (the "Agreement") dated as of June 1, 2000. Under the Agreement, Nelnet agreed: (i) to furnish or cause to be furnished to the Company or the Trustee copies of reports received with respect to the Loans, and prepare such additional reports with respect to the Loans as the Company or the Trustee may reasonably request from time to time; (ii) to respond to inquiries and requests made by borrowers, educational institutions, Guarantee Agencies, the Trustee, and other parties with respect to the Loans and respond to requests by the Company's independent auditors for information concerning the Company's financial affairs; (iii) to maintain financial records concerning the Loans and, if furnished adequate information with respect to financial affairs not related to the Loans, prepare and maintain a general ledger and financial statements for the Company; (iv) provide instructions to the Trustee with respect to the administration of the Loans; (v) to prepare for and furnish to the Company such statistical reports and cash flow projections as may be required under the Indenture or requested by the Company; and (vi) to provide such other services with respect to administration of its program as the Company may reasonably request. The Agreement expires upon the stated maturity of the Notes. In return for the services provided by Nelnet, the Company pays to Nelnet on the first day of each 18 calendar month an amount equal to 0.015% of the average outstanding balance of the Loans during the preceding month. The obligation of the Company to pay fees under the Agreement is a limited obligation to be satisfied solely from distributions made by the Trustee to the Company under the terms of the Indenture. Although the Company is obligated to pay to Nelnet the full amount of all accrued fees, such payments are made exclusively from amounts deposited in the Operating Fund for payment of the Company's Maintenance and Operating Expenses (as defined in the Indenture). If the Company does not have funds on hand to cover the full amount of the fees due under the Agreement, then payment of the unpaid balance is deferred until there are sufficient funds available from such sources to satisfy part, or all, of the outstanding debt. The fee payable to Nelnet under the Agreement may be revised on each January 1 during the term of the Agreement. To alter the fee, Nelnet must provide written notice of the proposed new fee to the Company ninety (90) days prior to the next January 1. If Nelnet and the Company cannot reach an agreement within sixty (60) days of the receipt of the notice, either party may terminate the Agreement upon thirty (30) day's written notice to the other party. SERVICING AGREEMENT. The Company and Nelnet entered into a Servicing Agreement (the "Servicing Agreement") dated as of June 1, 2000. Under the Servicing Agreement, Nelnet services the Eligible Loans. Nelnet entered into subservicing agreements with Nelnet Loan Services, Inc. (the "Subservicing Agreement") dated as of June 1, 2000. Under the Subservicing Agreement, Nelnet Loan Services, Inc., as Subservicer, assumes substantially all of the duties of the Servicer under the Servicing Agreement for the term of the Servicing Agreement. The Company believes that the terms and conditions of the Servicing Agreement (and the subservicing arrangement) are comparable to those offered by or available to unrelated parties. The servicing fee to Nelnet is calculated using an annual asset-based charge that ranges from 0.60 to 1.25 percent of the student loan principal balance, depending on the type of loan, calculated monthly. STUDENT LOAN PURCHASE AGREEMENTS. The Company has entered into Student Loan Purchase Agreements with various financial institutions including, but not limited to, Union Bank and Trust Company, NEBHELP, Inc., MELMAC, LLC, NHELP-I, Inc., NHELP-III, Inc., NELNET Student Loan Corporation-1, EFS Finance Co., EMT Corporation, Nelnet Student Loan Warehouse Corporation-1, and Nelnet Student Loan Funding, LLC pursuant to which the Company has purchased or sold Eligible Loans. NEBHELP, Inc., MELMAC, LLC, NHELP-I, Inc., NHELP-III, Inc., NELNET Student Loan Corporation-1, EFS Finance Co., EMT Corporation, Nelnet Student Loan Warehouse Corporation-1, and Nelnet Student Loan Funding, LLC are subsidiary corporations of or are controlled by Nelnet. Certain of the shareholders of Nelnet Loan Services, Inc. also hold an interest in the bank holding company that owns and controls Union Bank and Trust Company, and certain of the officers and directors of the Company are also officers and directors of Union Bank and Trust Company. Although the above mentioned entities are related to the Company as described above, the Company believes that the terms and conditions of the Student Loan Purchase Agreements are comparable to those offered by or available to unrelated parties. ITEM 14. CONTROLS AND PROCEDURES The principal executive officer and the principal financial officer of the Company have reviewed and evaluated the Company's disclosure controls and procedures and found that they are effective to gather, analyze, and report all information that is required to be disclosed in this report. There were no significant changes to the Company's disclosure procedures and controls since the date of that review. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K FINANCIAL STATEMENTS The financial statements and financial statement information and schedules required by this Item are included in this report commencing on page F-1. The Independent Auditors' Report appears on page F-1 of this report. All other schedules have been omitted because they are inapplicable, not required, or the information is included elsewhere in the financial statements or notes thereto. EXHIBITS All exhibits listed hereunder, unless otherwise indicated, have previously been filed as exhibits to the Company's Registration Statement declared effective in February, 2000. Such exhibits have been filed with the Commission pursuant to the requirements of the Acts administered by the Commission. Such exhibits are incorporated herein by reference under Rule 12b-23 of the Securities Exchange Act of 1934. 19 The following is a complete list of exhibits filed as part of the Company's Registration Statement and this Form 10-K. 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 for the period ended June 30, 2000.) 3.3 Bylaws of the Company (Incorporated by reference herein to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2000.) 4.1 Indenture of Trust by and between the Company and Zions First National Bank, dated as of 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 by and between the Company and Zions First National Bank, dated as of June 1, 2000 (Incorporated by reference herein 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 the Company and Zions First National Bank, dated as of April 1, 2001 (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 by and between the Company 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.) 4.5 Series 2002A Supplemental Indenture of Trust between the Company and Zions First National Bank, dated as of March 1, 2002 (Incorporated by reference herein to the Company's current report on Form 8-K filed April 5, 2002.) 10.1 Servicing Agreement, dated as of June 1, 2000, by and between the Company and Nelnet, Inc. (Incorporated by reference herein to the Company's Quarterly report on Form 10-Q for the period ended June 30, 2000.) 99.1 Certification Pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 of the Chief Executive Officer of the Company. * 99.2 Certification Pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 of the Chief Financial Officer of the Company. * * Filed herewith Reports on Form 8-K The Company filed a report on Form 8-K on April 5, 2002 to report in response to Item 5 the issuance of $564,000,000 of Student Loan Asset-Backed Auction Rate Notes Series 2002A. The Company filed a report on Form 8-K on October 8, 2002 to report in response to Item 2 the sale of a portfolio of student loans having an outstanding principal balance of approximately $1,152,000,000. 20 INDEX TO FINANCIAL STATEMENTS Financial Statements of NELNET STUDENT LOAN CORPORATION-2 Independent Auditors' Report.................................................F-1 Balance Sheets as of December 31, 2002 and 2001..............................F-2 Statements of Operations for the years ended December 31, 2002 and 2001 and for the period from June 1, 2000 (date of inception) through December 31, 2000............................................................F-3 Statements of Stockholder's Equity (deficit) for the years ended December 31, 2002 and 2001 and for the period from June 1, 2000 (date of inception) through December 31, 2000................................F-4 Statements of Cash Flows for the years ended December 31, 2002 and 2001 and for the period from June 1, 2000 (date of inception) through December 31, 2000....................................................F-5 Notes to Financial Statements................................................F-6 All other schedules are omitted as they are not applicable or the required information is shown in the financial statements or notes thereto. 21 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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/ Michael S. Dunlap ------------------------------- Michael S. Dunlap, Chairman of the Board (Principal Executive Officer) Date: March 31, 2003 By: /s/ Terry J. Heimes -------------------------------- Terry J. Heimes, Vice President (Principal Financial and Accounting Officer) Date: March 31, 2003 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date By: /s/ Michael S. Dunlap Chairman of the Board March 31, 2003 ---------------------------- (Principal Executive Michael S. Dunlap Officer) By: /s/ Stephen F. Butterfield President and Director March 31, 2003 ----------------------------- Stephen F. Butterfield By: /s/ Jeffery R. Noordhoek Vice President and March 31, 2003 ----------------------------- Director Jeffery R. Noordhoek By: /s/ Ross Wilcox Director March 28, 2003 ----------------------------- Ross Wilcox By: /s/ Dr. Paul Hoff Director March 28, 2003 ----------------------------- Dr. Paul Hoff 22 CERTIFICATIONS I, Michael S. Dunlap, certify that: 1. I have reviewed this annual report on Form 10-K, of NELNET Student Loan Corporation-2 (the "Company"); 2. Based on my knowledge, the information in the report, does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this annual report; 4. The Company's other certifying officers and I are responsible for establishing and maintaining the disclosure controls and procedures (as defined in Exchange Act Rule 15d-14) for the Company and we have: (a) Designed such disclosure controls and procedures to ensure that material information relating to the Company is made known to us by others within those entities, particularly during the period in which the report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of the report (the "Evaluation Date"); and (c) Presented in the report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date 5. The Company's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the board of directors (or persons performing the equivalent function): (a) All significant deficiencies in the design or operation of internal controls which could adversely affect the Company's ability to record, process, summarize, and report financial data and have identified for the Company's auditors any material weaknesses in internal controls; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal controls; and 6. The Company's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 31, 2003 /s/ Michael S. Dunlap ------------------------- Michael S. Dunlap Chairman 23 I, Terry J. Heimes, certify that: 1. I have reviewed this annual report on Form 10-K, of NELNET Student Loan Corporation-2 (the "Company"); 2. Based on my knowledge, the information in the report, does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this annual report; 4. The Company's other certifying officers and I are responsible for establishing and maintaining the disclosure controls and procedures (as defined in Exchange Act Rule 15d-14) for the Company and we have: (a) Designed such disclosure controls and procedures to ensure that material information relating to the Company is made known to us by others within those entities, particularly during the period in which the report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of the report (the "Evaluation Date"); and (c) Presented in the report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date 5. The Company's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the board of directors (or persons performing the equivalent function): (a) All significant deficiencies in the design or operation of internal controls which could adversely affect the Company's ability to record, process, summarize, and report financial data and have identified for the Company's auditors any material weaknesses in internal controls; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal controls; and 6. The Company's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 31, 2003 /s/ Terry J. Heimes ------------------------------------------ Terry J. Heimes Principal Financial and Accounting Officer SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT. The registrant has not sent to security holders any annual report for its last fiscal year or any proxy material with respect to a meeting of shareholders. 24 NELNET STUDENT LOAN CORPORATION-2 (A Wholly Owned Subsidiary of Nelnet, Inc.) Financial Statements December 31, 2002 and 2001 (With Independent Auditors' Report Thereon) Independent Auditors' Report The Board of Directors NELNET Student Loan Corporation-2: We have audited the accompanying balance sheets of NELNET Student Loan Corporation-2, (a wholly owned subsidiary of Nelnet, Inc.), as of December 31, 2002 and 2001, and the related statements of operations, stockholder's equity (deficit), and cash flows for the years ended December 31, 2002 and 2001 and for the period from June 1, 2000 (date of inception) through December 31, 2000. These financial statements are the responsibility of NELNET Student Loan Corporation-2's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of NELNET Student Loan Corporation-2 at December 31, 2002 and 2001 and the results of its operations and its cash flows for the years ended December 31, 2002 and 2001 and for the period from June 1, 2000 (date of inception) through December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. /s/ KPMG LLP --------------- March 21, 2003 Lincoln, Nebraska F-1
NELNET STUDENT LOAN CORPORATION-2 (A Wholly Owned Subsidiary of Nelnet, Inc.) Balance Sheets December 31, 2002 and 2001 Assets 2002 2001 --------------- ---------------- Cash and cash equivalents $ -- 8,093 Student loans receivable, net of allowance of $1,285,201 in 2002 and $1,891,253 in 2001 1,241,067,610 1,933,941,068 Accrued interest receivable 31,655,348 50,256,051 Restricted cash - held by trustee 153,201,633 46,135,799 Debt issuance costs, net of accumulated amortization of $910,420 in 2002 and $422,848 in 2001 6,072,333 9,355,177 Income taxes receivable from parent 2,467,186 -- Due from parent -- 4,100,000 Deferred tax assets 655,140 687,951 --------------- ---------------- Total assets $1,435,119,250 2,044,484,139 =============== ================ Liabilities and Stockholder's Equity Liabilities: Notes payable $1,419,000,000 2,030,000,000 Accrued interest payable 2,999,062 4,087,348 Other liabilities 3,170,844 3,833,683 Income taxes payable to parent -- 2,419,767 --------------- ---------------- Total liabilities 1,425,169,906 2,040,340,798 --------------- ---------------- Stockholder's equity: Common stock, no par value, authorized 1,000 shares; issued and outstanding 1,000 shares 1,000 1,000 Additional paid-in capital 9,380,707 4,142,341 Retained earnings 567,637 -- --------------- ---------------- Total stockholder's equity 9,949,344 4,143,341 Commitments and contingencies --------------- ---------------- Total liabilities and stockholder's equity $1,435,119,250 2,044,484,139 =============== ================ See accompanying notes to financial statements.
F-2
NELNET STUDENT LOAN CORPORATION-2 (A Wholly Owned Subsidiary of Nelnet, Inc.) Statements of Operations Years ended December 31, 2002 and 2001 and for the period from June 1, 2000 (date of inception) through December 31, 2000 2002 2001 2000 -------------- -------------- -------------- Revenues: Loan interest $ 113,531,516 100,455,019 46,225,110 Investment interest 2,635,858 1,743,425 2,174,126 Other 598,458 198,289 80,481 -------------- -------------- -------------- Total revenues 116,765,832 102,396,733 48,479,717 -------------- -------------- -------------- Expenses: Interest on notes payable 63,180,085 68,190,154 39,401,390 Loan servicing fees to related party 17,150,999 13,586,370 5,414,538 Trustee and broker fees 4,715,340 3,311,175 1,621,060 Amortization and write down of debt issuance costs 5,707,491 344,311 78,537 Amortization of loan premiums and lender fees 10,454,316 4,434,839 1,652,178 Provision for loan losses 1,100,000 1,600,000 1,010,000 Other general and administrative 3,570,669 2,767,940 1,147,800 -------------- -------------- -------------- Total expenses 105,878,900 94,234,789 50,325,503 -------------- -------------- -------------- Income (loss) before income tax expense (benefit) 10,886,932 8,161,944 (1,845,786) Income tax expense (benefit) 3,919,295 2,938,300 (664,483) -------------- -------------- -------------- Net income (loss) $ 6,967,637 5,223,644 (1,181,303) ============== ============== ============== See accompanying notes to financial statements.
F-3
NELNET STUDENT LOAN CORPORATION-2 (A Wholly Owned Subsidiary of Nelnet, Inc.) Statements of Stockholder's Equity (Deficit) Years ended December 31, 2002 and 2001 and for the period from June 1, 2000 (date of inception) through December 31, 2000 Total Additional Retained stockholder's Common paid-in earnings equity stock capital (deficit) (deficit) --------- ------------ ------------ -------------- Balance at June 1, 2000 (date of inception) $ -- -- -- -- Issuance of common stock 1,000 -- -- 1,000 Net loss -- -- (1,181,303) (1,181,303) --------- ------------ ------------ -------------- Balance at December 31, 2000 1,000 -- (1,181,303) (1,180,303) Net income -- -- 5,223,644 5,223,644 Capital contributions from parent -- 5,600,000 -- 5,600,000 Dividends paid - $5,500 a share -- (1,457,659) (4,042,341) (5,500,000) --------- ------------ ------------ -------------- Balance at December 31, 2001 1,000 4,142,341 -- 4,143,341 Net income -- -- 6,967,637 6,967,637 Capital contributions from parent -- 13,077,830 -- 13,077,830 Return of capital to parent -- (7,839,464) -- (7,839,464) Dividends paid - $6,400 a share -- -- (6,400,000) (6,400,000) --------- ------------ ------------ -------------- Balance at December 31, 2002 $ 1,000 9,380,707 567,637 9,949,344 ========= ============ ============ ============== See accompanying notes to financial statements.
F-4
NELNET STUDENT LOAN CORPORATION-2 (A Wholly Owned Subsidiary of Nelnet, Inc.) Statements of Cash Flows Years ended December 31, 2002 and 2001 and for the period from June 1, 2000 (date of inception) through December 31, 2000 2002 2001 2000 -------------- ------------- ------------- Net income (loss) $ 6,967,637 5,223,644 (1,181,303) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Amortization and write down of loan premiums, lender fees, and debt issuance costs 16,161,807 4,779,150 1,730,715 Deferred income tax expense (benefit) 32,811 (847,754) (287,775) Provision for loan losses 1,100,000 1,600,000 1,010,000 Decrease (increase) in accrued interest receivable 18,600,703 (20,231,474) (30,024,577) Increase (decrease) in accrued interest payable (1,088,286) 966,733 3,120,615 Increase (decrease) in other liabilities (662,839) 2,748,015 1,085,668 Change in income taxes recoverable/payable from/to parent (4,886,953) 3,244,053 (376,708) Decrease (increase) in due from parent 4,100,000 (4,100,000) -- ------------ ------------ ------------- Net cash provided by (used in) operating activities 40,324,880 (6,617,633) (24,923,365) ------------ ------------ ------------- Cash flows from investing activities: Purchases of student loans, including premiums (834,697,043) (1,188,809,680) (1,007,842,817) Proceeds from sales of student loans 1,429,690,080 54,923,189 11,698 Net proceeds from student loan principal payments and loan consolidations 86,326,105 136,409,321 62,670,204 Increase in restricted cash - held by trustee (107,065,834) (21,603,376) (24,532,423) -------------- -------------- -------------- Net cash provided by (used in) investing activities 574,253,308 (1,019,080,546) (969,693,338) -------------- -------------- -------------- Cash flows from financing activities: Payment on notes payable (1,175,000,000) -- -- Proceeds from issuance of notes payable 564,000,000 1,030,000,000 1,000,000,000 Payment for debt issuance costs (2,424,647) (5,402,399) (4,375,626) Issuance of common stock -- -- 1,000 Capital contributions from parent 13,077,830 5,600,000 -- Return of capital to parent (7,839,464) -- -- Dividends paid (6,400,000) (5,500,000) -- -------------- -------------- -------------- Net cash provided by (used in) financing activities (614,586,281) 1,024,697,601 995,625,374 -------------- -------------- -------------- Net increase (decrease) in cash and cash equivalents (8,093) (1,000,578) 1,008,671 Cash and cash equivalents, beginning of the year 8,093 1,008,671 -- -------------- -------------- -------------- Cash and cash equivalents, end of year $ -- 8,093 1,008,671 ============== ============== ============== Supplemental disclosures of cash flow information: Interest paid $ 64,268,371 67,223,421 36,280,775 ============== ============== ============== Income taxes paid to parent $ 9,221,016 542,001 -- ============== ============== ============== See accompanying notes to financial statements.
F-5 Nelnet Student Loan Corporation-2 (A Wholly Owned Subsidiary of Nelnet, Inc.) Notes to Financial Statements December 31, 2002 and 2001 (1) Summary of Significant Accounting Policies and Practices (a) Description of Business NELNET Student Loan Corporation-2 (the Company), a wholly owned subsidiary of Nelnet, Inc. (the Parent or Nelnet) is a C corporation which invests in eligible student loans issued under Title IV of the Higher Education Act of 1965, as amended (the Act). The 2000 financial statements reflect the operations of the Company for the period June 1, 2000 (date of inception) through December 31, 2000. Student loans beneficially owned by the Company include those originated under the Stafford Loan Program (SLP), the Parent Loan Program for Undergraduate Students (PLUS) program, the Supplemental Loans for Students (SLS) program and loans which consolidate certain borrower obligations (Consolidation). Title to the loans is held by an eligible lender trustee under the Act for the benefit of the Company. The financed eligible loan borrowers are geographically located throughout the United States and the majority are in school or in repayment status. The notes payable outstanding are payable primarily from interest and principal payments on the student loans receivable. 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. (b) Cash Equivalents For purposes of the statement of cash flows, the Company considers all investments with original maturities of three months or less to be cash equivalents. (c) Student Loans Receivable and Allowance for Loan Losses Investments in student loans, including premiums, are recorded at cost, net of premium amortization and the allowance for loan losses. Premiums are amortized over the estimated principal life of the related loans. The allowance for loan losses is estimated and established through a provision charged to expense. Losses are charged against the allowance when management believes that the collectibility of the loan principal is unlikely. Recovery of amounts previously charged off are credited to the allowance for loan losses. The charge to operations is estimated and based on management's evaluation of the loan portfolio, including such factors as the volume and character of loans outstanding, past loan loss experience, and general economic conditions. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize probable losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions. F-6 (Continued) (d) Interest on Student Loans Interest on student loans is accrued when earned and is either paid by the Department of Education or the borrower depending on the status of the loan at the time of accrual. In addition, the Department of Education makes quarterly interest subsidy payments on certain qualified Title IV loans until the student is required under the provisions of the Act to begin repayment. Repayment on guaranteed student loans normally begins within six months after completion of their course of study, leaving school or ceasing to carry at least one-half the normal full-time academic load as determined by the educational institution. Repayment of PLUS loans normally begins within 60 days from the date of loan disbursement and repayment of SLS loans begins within one month after completion of course study, leaving school, or ceasing to carry at least the normal full-time academic load as determined by the educational institution. (e) Debt Issuance Costs Debt issuance costs are amortized over the estimated life of the related debt, ranging from 12 to 34 years. (f) Income Taxes The Company files a consolidated Federal tax return with Nelnet Loan Services, Inc. (NLS), the legal parent of Nelnet. The financial statements reflect income tax expense (benefit) computed as if the Company filed a separate tax return. Income tax expense (benefit) is allocated by (to) the Company to (from) its Parent as if the Company were a separate tax paying entity. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (g) Use of Estimates The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make a number of estimates and assumptions that effect the reported amounts of assets and liabilities, reported amounts of revenues and expenses, and other disclosures. Actual results could differ from those estimates. (h) Comprehensive Income The Company has no sources of other comprehensive income. Therefore, the Company's comprehensive income consists solely of its net income (loss). F-7 (Continued) (i) Reclassification Certain amounts have been reclassified to conform to the 2002 financial statement presentation. (2) Restricted Cash - Held by Trustee The Company's restricted cash, consisting primarily of U.S. Treasury money market funds, is held by the trustee in various accounts subject to use restrictions, imposed by the indenture of trust. These trustee funds include: the recycling account fund which is used to maintain excess funds for future operating needs, if necessary, and purchases of eligible student loans; the reserve fund which is used to cure any deficiencies in the debt service requirement; and the revenue fund which is used for the receipt of interest payments on eligible student loans and investment securities and to pay fees and expenses incurred under the indenture. (3) Student Loans Receivable and Concentration of Credit Risk Guaranteed loans may be made under the insured student loan program by certain lenders as defined by the Act. These loans, including related accrued interest, are guaranteed at their maximum level permitted under the Act by an authorized guarantee agency which has a contract of reinsurance with the Department of Education. The terms of the loans, which vary on an individual basis, generally provide for repayment in monthly installments of principal and interest over a period of up to 20 years. Interest rates on loans may be fixed or variable, and will vary based on the average of the 91-day U. S. Treasury bill rate, and currently range from 3.5% to 12.0% (the weighted average rate was 6.4% at December 31, 2002) dependent upon type, terms of loan agreements, and date of origination. For Title IV loans, the Company has entered into a trust agreement in which an unrelated financial institution will serve as the eligible lender trustee. As an eligible lender trustee, the financial institution acts as the eligible lender in acquiring certain eligible student loans as an accommodation to the Company who holds a beneficial interest in the student loan assets as the beneficiary of such trust. Substantially all student loan principal and related accrued interest are guaranteed as defined by the Act. These guarantees are made subject to the performance of certain loan servicing procedures stipulated by applicable regulations. If these procedures are not met, affected student loans may not be covered by the guarantees should the borrower default. The Company retains and enforces recourse provisions against servicers and lenders under certain circumstances. Such loans are subject to "cure" procedures and reinstatement of the guarantee under certain circumstances. Also, in accordance with Student Loan Reform Act of 1993, loans disbursed prior to October 1, 1993 are fully insured and loans disbursed subsequent to October 1, 1993 (approximately 95% and 96% of the student loans at December 31, 2002 and 2001, respectively) are insured up to 98%. F-8 (Continued) The Company has provided for an allowance for loan losses related to those student loans only guaranteed up to 98% for principal and interest. The provision is based upon historical default rates for such loans. Activity in the allowance for loan losses for the years ended December 31, 2002, 2001, and for the period from June 1, 2000 (date of inception) through December 31, 2000 is shown below:
2002 2001 2000 ----------- ---------- ---------- Beginning balance $ 1,891,253 826,279 -- Provision for loan losses 1,100,000 1,600,000 1,010,000 Transfer of allowance for sale of student loans receivable to affiliates (1,150,000) -- -- Loans charged off, net of recoveries (556,052) (535,026) (183,721) ----------- ---------- ---------- Ending balance $ 1,285,201 1,891,253 826,279 =========== ========== ==========
(4) Notes Payable The Company periodically issues taxable student loan asset-backed notes to finance the acquisition of student loans. All notes are primarily secured by the student loans receivable, related accrued interest, and other property and funds held in trust. The majority of the notes are variable rate notes with interest rates reset periodically based upon auction rates and national indices. F-9 (Continued) The table below summarizes the outstanding notes payable at December 31, 2002 and 2001 by issue:
2002 2001 --------------------------- ------------------------- Carrying Interest Carrying Interest Maturity amount rate amount rate ------------- ------------- ------------- ------------- ---------- 2000 Senior Auction Rate Notes, Class A-1 12/1/2032 $ -- -- % $ 50,000,000 2.12% 2000 Senior Auction Rate Notes, Class A-2 12/1/2032 -- -- 50,000,000 2.20 2000 Senior Auction Rate Notes, Class A-3 12/1/2032 -- -- 50,000,000 2.15 2000 Senior Auction Rate Notes, Class A-4 12/1/2032 -- -- 50,000,000 2.15 2000 Senior Auction Rate Notes, Class A-5 12/1/2032 -- -- 50,000,000 2.30 2000 Senior Auction Rate Notes, Class A-6 12/1/2032 -- -- 50,000,000 2.40 2000 Senior Auction Rate Notes, Class A-7 12/1/2032 -- -- 50,000,000 2.12 2000 Senior Auction Rate Notes, Class A-8 12/1/2032 -- -- 75,000,000 2.24 2000 Senior Auction Rate Notes, Class A-9 12/1/2032 -- -- 75,000,000 2.15 2000 Senior Auction Rate Notes, Class A-10 12/1/2032 -- -- 75,000,000 2.10 2000 Senior Auction Rate Notes, Class A-11 12/1/2032 -- -- 75,000,000 2.28 2000 Senior Auction Rate Notes, Class A-12 12/1/2032 -- -- 100,000,000 2.15 2000 Senior Auction Rate Notes, Class A-13 12/1/2032 -- -- 100,000,000 2.35 2000 Senior Auction Rate Notes, Class A-14 12/1/2032 -- -- 100,000,000 2.20 2000 Subordinate Auction Rate Notes, Class B-1 12/1/2032 50,000,000 1.60 50,000,000 2.17 2001 Senior Fixed Rate Notes, Class A-1 7/1/2012 480,000,000 5.76 480,000,000 5.76 2001 Senior Auction Rate Notes, Class A-2 6/1/2035 50,000,000 1.50 50,000,000 2.11 2001 Senior Auction Rate Notes, Class A-3 6/1/2035 -- -- 50,000,000 2.30 2001 Senior Auction Rate Notes, Class A-4 6/1/2035 -- -- 75,000,000 2.11 2001 Senior Auction Rate Notes, Class A-5 6/1/2035 100,000,000 1.52 100,000,000 2.20 2001 Senior Auction Rate Notes, Class A-6 6/1/2035 -- -- 100,000,000 2.15 2001 Senior Auction Rate Notes, Class A-7 6/1/2035 100,000,000 1.50 100,000,000 2.20 2001 Subordinate Auction Rate Notes, Class B-1 6/1/2035 37,500,000 1.65 37,500,000 2.12 2001 Subordinate Auction Rate Notes, Class B-1 6/1/2035 37,500,000 1.60 37,500,000 2.20 2002 Senior Auction Rate Notes, Class A-1 6/1/2035 70,500,000 1.65 -- -- 2002 Senior Auction Rate Notes, Class A-2 6/1/2035 70,500,000 1.39 -- -- 2002 Senior Auction Rate Notes, Class A-3 6/1/2035 70,500,000 1.50 -- -- 2002 Senior Auction Rate Notes, Class A-4 6/1/2035 70,500,000 1.52 -- -- 2002 Senior Auction Rate Notes, Class A-5 6/1/2035 100,000,000 1.50 -- -- 2002 Senior Auction Rate Notes, Class A-6 6/1/2035 100,000,000 1.50 -- -- 2002 Senior Auction Rate Notes, Class A-7 6/1/2035 82,000,000 1.50 -- -- ------------- ------------- $ 1,419,000,000 $ 2,030,000,000 ============= =============
On October 8, 2002, the Company sold a portfolio of student loans to Nelnet Student Loan Funding, LLC. Proceeds from the loan sale were used to redeem approximately $1.2 billion of the Company's notes. As a result of this transaction, the Company wrote down debt issuance costs of $5,219,919, that were related to the redeemed notes, through a charge to operations. F-10 (Continued) Generally, the notes can be redeemed on any interest payment date at par plus accrued interest at the option of the Company, without a prepayment penalty. The Company's prospectus supplement for the 2001 Senior Fixed Rate Notes, Class A-1 provides that beginning July 1, 2003, scheduled payments will be made, only to the extent funds are available. Assuming funds are available, scheduled payments are due as follows: 2003 $ 48,000,000 2004 89,760,000 2005 84,000,000 2006 84,000,000 2007 79,200,000 2008 and thereafter 1,034,040,000 -------------- $ 1,419,000,000 ============== The indenture of trust contains, among other requirements, covenants related to the restriction of funds to be maintained in a reserve fund. Management believes the Company is in compliance with all covenants of the note agreements at December 31, 2002 and 2001. (5) Income Taxes Components of the income tax expense (benefit) for the years ended December 31, 2002 and 2001 and for the period from June 1, 2000 (date of inception) through December 31, 2000 are shown below. 2002 2001 2000 ----------- ----------- ---------- Current: Federal $ 3,562,539 3,474,268 (346,123) State 323,945 311,786 (30,585) ----------- ----------- ---------- 3,886,484 3,786,054 (376,708) ----------- ----------- ---------- Deferred: Federal 30,148 (780,826) (262,987) State 2,663 (66,928) (24,788) ----------- ----------- ---------- 32,811 (847,754) (287,775) ----------- ----------- ---------- $ 3,919,295 2,938,300 (664,483) =========== =========== ========== F-11 (Continued) The actual income tax expense (benefit) differs from the "expected" income tax expense (benefit), computed by applying the federal statutory corporate tax rates to income (loss) before income tax expense (benefit) for the years ended December 31, 2002 and 2001 and for the period from June 1, 2000 (date of inception) through December 31, 2000, as shown below. 2002 2001 2000 ---------- ---------- --------- Computed "expected" income tax expense (benefit) $ 3,701,557 2,775,061 (627,567) Increase in income tax expense (benefit) resulting from: State taxes, net of Federal income tax expense (benefit) 215,561 161,606 (36,916) Other 2,177 1,633 -- ---------- ---------- --------- $ 3,919,295 2,938,300 (664,483) ========== ========== ========= The Company's net deferred tax assets at December 31, 2002 and 2001 resulted primarily from the future tax benefit of the allowance for loan losses, not currently deductible for tax purposes. Management believes that it is more likely than not that the Company will generate sufficient future taxable income to fully recover deferred tax assets recognized and, therefore, no valuation allowance is required. (6) Fair Value of Financial Instruments Fair value estimates, methods, and assumptions are set forth below: Cash and Cash Equivalents, Restricted Cash - Held by Trustee, and Accrued Interest Receivable/Payable The carrying amount approximates fair value due to the variable rate of interest and/or the short maturities of these instruments. Student Loans Receivable The fair value of student loans receivable is estimated at amounts recently paid by Nelnet to acquire loans in the market. The fair value of the student loans receivable at December 31, 2002 and 2001 is approximately $1.26 billion and $1.98 billion, respectively. Notes Payable The fair value of notes payable is based on market prices for securities that possess similar credit risk and interest rate risk at or near December 31, 2002 and 2001. The estimated fair value of notes payable at December 31, 2002 and 2001 is approximately $1.43 billion and $2.04 billion, respectively. F-12 (Continued) Limitations Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. (7) Guarantee Agencies As of December 31, 2002 and 2001, Nebraska Student Loan Program, Inc., the Florida Department of Education Office of Student Financial Assistance, California Student Aid Commission, and the United Student Aid Funds, Inc. were the primary guarantors, guaranteeing approximately 85% and 66%, respectively, of the total student loans beneficially owned by the Company. Management periodically reviews the financial condition of its guarantors and does not believe the level of concentration creates an unusual or unanticipated credit risk. In addition, management believes that based on the Higher Education Amendments of 1998, as amended, the security for and payment of any of the Company's obligations would not be materially adversely affected as a result of legislative action or other failure to perform on its obligations on the part of any guarantee agency. The Company, however, offers no assurances to that effect. (8) Related Parties Certain shareholders and directors of Nelnet are also officers and directors of Union Bank & Trust Company (UB&T). A majority of the loans currently held were purchased from UB&T and other wholly owned subsidiaries of Nelnet. Under the terms of an agreement, the Company contracts all loan servicing through Nelnet who contracts NLS as a sub-servicer. Fees paid to Nelnet are calculated using an annual asset-based charge ranging from 0.60% to 1.25% of the student loan principal balance, calculated monthly. The fees amounted to approximately $17.2 million, $13.6 million, and $5.4 million in 2002, 2001, and 2000, respectively. At December 31, 2002 and 2001, approximately $1.7 million and $2.9 million, respectively, was payable to Nelnet and NLS for loan servicing and is included in other liabilities on the accompanying balance sheets. During 2002 and 2001, the Company purchased student loans in the approximate amounts, from the following wholly owned subsidiaries of Nelnet. Premiums paid on these loans, not included in the amounts below, totaled approximately $19 million and $14 million in 2002 and 2001, respectively. 2002 2001 ------------- ------------- NELNET Student Loan Corporation-1 $ -- 224,800,000 NHELP-I, Inc. 132,100,000 191,600,000 NHELP-III, Inc. 193,300,000 42,400,000 NEBHELP, Inc. 286,800,000 390,600,000 MELMAC, LLC -- 4,900,000 EFS Finance Co. 53,800,000 -- EMT Corp. 7,900,000 -- F-13 (Continued) During 2002 and 2001, the Company sold student loans, including unamortized premiums, to the following wholly owned subsidiaries of Nelnet. No gains or losses were recognized, as sales between wholly owned subsidiaries of Nelnet are recorded at amortized cost, which approximates fair value. 2002 2001 ------------- ----------- Nelnet Student Loan Funding, LLC $ 1,333,700,000 -- Nelnet Student Loan Warehouse Corporation-1 77,300,000 -- NEBHELP, Inc. 18,600,000 54,900,000 During 2002 and 2001, the Company purchased student loans of approximately $59 million and $270 million, respectively, from UB&T. Premiums paid on these loans totaled approximately $1.2 million and $3.4 million, respectively. During 2002, the Company paid a related party through common ownership approximately $280,000 for services related to the Company's debt issuance. This payment has been recorded as debt issuance costs in the accompanying balance sheet at December 31, 2002. The Company incurred fees to Nelnet for managerial and administrative support for the operations of the Company based on a service agreement that requires 0.015% of the average outstanding loan balance to be paid monthly. In addition, Nelnet has provided additional services to the Company on an as-needed transactional basis. These fees, included in other general and administrative expenses on the accompanying statements of operations, amounted to approximately $3.6 million, $2.6 million, and $800,000 in 2002, 2001, and 2000, respectively. F-14 (Continued)